10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

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

For the quarterly period ended June 30, 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: 105,802,533 outstanding as of July 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

     43   

CRITICAL ACCOUNTING POLICIES

     43   

OVERVIEW

     43   

ANALYSIS OF THE RESULTS OF OPERATIONS

     45   

RESULTS BY BUSINESS SEGMENTS

     54   

ANALYSIS OF FINANCIAL CONDITION

     56   

ASSET/LIABILITY AND MARKET RISK MANAGEMENT

     70   

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     72   

ITEM 4. CONTROLS AND PROCEDURES

     72   

PART II - OTHER INFORMATION

     72   

ITEM 1. LEGAL PROCEEDINGS

     72   

ITEM 1A. RISK FACTORS

     74   

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

     74   

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

     74   

ITEM 4. MINE SAFETY DISCLOSURES

     74   

ITEM 5. OTHER INFORMATION

     74   

ITEM 6. EXHIBITS

     74   

SIGNATURES

     75   

 

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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, vendor management 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; the Company’s relationships with and reliance upon vendors with respect to the operation of certain of the Company key systems and applications; 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 (UNAUDITED)

CVB FINANCIAL CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except share data)

(Unaudited)

 

     June 30,     December 31,  
     2014     2013  
ASSETS     

Cash and due from banks

   $ 134,874      $ 88,776   

Interest-earning balances due from Federal Reserve

     269,309        5,917   
  

 

 

   

 

 

 

Total cash and cash equivalents

     404,183        94,693   
  

 

 

   

 

 

 

Interest-earning balances due from depository institutions

     79,311        70,000   

Investment securities available-for-sale, at fair value (with amortized cost of $2,976,012 at June 30, 2014, and $2,679,727 at December 31, 2013)

     3,017,490        2,663,642   

Investment securities held-to-maturity

     1,650        1,777   

Investment in stock of Federal Home Loan Bank (FHLB)

     26,852        32,331   

Non-covered loans held-for-sale

     —          3,667   

Loans and lease finance receivables, excluding covered loans

     3,482,231        3,385,916   

Allowance for loan losses

     (60,974     (75,235
  

 

 

   

 

 

 

Net loans and lease finance receivables

     3,421,257        3,310,681   
  

 

 

   

 

 

 

Covered loans and lease finance receivables, net

     138,696        160,315   

Premises and equipment, net

     36,014        32,831   

Bank owned life insurance

     124,329        123,168   

Accrued interest receivable

     22,444        22,051   

Intangibles

     3,048        2,261   

Goodwill

     74,762        55,097   

FDIC loss sharing asset

     996        4,764   

Non-covered other real estate owned

     6,539        6,475   

Covered other real estate owned

     655        504   

Income taxes

     40,787        59,786   

Other assets

     24,980        20,924   
  

 

 

   

 

 

 

TOTAL ASSETS

   $ 7,423,993      $ 6,664,967   
  

 

 

   

 

 

 
LIABILITIES AND STOCKHOLDERS’ EQUITY     

Liabilities:

    

Deposits:

    

Noninterest-bearing

   $ 2,962,146      $ 2,562,980   

Interest-bearing

     2,667,200        2,327,651   
  

 

 

   

 

 

 

Total deposits

     5,629,346        4,890,631   

Customer repurchase agreements

     611,459        643,251   

FHLB advances

     199,342        199,206   

Other borrowings

     —          69,000   

Accrued interest payable

     1,168        1,111   

Deferred compensation

     10,088        9,449   

Junior subordinated debentures

     25,774        25,774   

Payable for securities purchased

     56,430        3,533   

Other liabilities

     49,627        51,125   
  

 

 

   

 

 

 

TOTAL LIABILITIES

     6,583,234        5,893,080   
  

 

 

   

 

 

 

COMMITMENTS AND CONTINGENCIES

    

Stockholders’ Equity:

    

Common stock, authorized, 225,000,000 shares without par; issued and outstanding 105,799,073 at June 30, 2014 and 105,370,170 at December 31, 2013

     493,596        491,068   

Retained earnings

     323,106        290,149   

Accumulated other comprehensive income, net of tax

     24,057        (9,330
  

 

 

   

 

 

 

Total stockholders’ equity

     840,759        771,887   
  

 

 

   

 

 

 

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

   $ 7,423,993      $ 6,664,967   
  

 

 

   

 

 

 

See accompanying notes to the unaudited 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     For the Six Months Ended  
     June 30,     June 30,  
     2014     2013     2014     2013  

Interest income:

        

Loans and leases, including fees

   $ 42,091      $ 41,519      $ 85,040      $ 83,173   

Accretion on acquired covered loans

     1,467        3,456        3,174        7,849   
  

 

 

   

 

 

   

 

 

   

 

 

 

Loans, including fees

     43,558        44,975        88,214        91,022   

Investment securities:

        

Taxable

     11,686        5,431        21,965        12,178   

Tax-advantaged

     5,186        5,511        10,464        11,052   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total investment income

     16,872        10,942        32,429        23,230   

Dividends from FHLB stock

     526        467        1,130        810   

Federal funds sold

     127        86        251        100   

Interest-earning deposits with other institutions

     133        123        254        244   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income

     61,216        56,593        122,278        115,406   
  

 

 

   

 

 

   

 

 

   

 

 

 

Interest expense:

        

Deposits

     1,222        1,158        2,408        2,399   

Borrowings

     2,729        2,716        5,559        5,416   

Junior subordinated debentures

     106        124        210        407   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest expense

     4,057        3,998        8,177        8,222   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income before provision for loan losses

     57,159        52,595        114,101        107,184   

Provision for loan losses

     (7,600     (6,200     (15,100     (6,200
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income after provision for loan losses

     64,759        58,795        129,201        113,384   
  

 

 

   

 

 

   

 

 

   

 

 

 

Noninterest income:

        

Service charges on deposit accounts

     3,905        4,145        7,733        7,971   

Trust and investment services

     2,133        2,072        4,058        4,077   

Bankcard services

     923        938        1,701        1,777   

BOLI income

     601        627        1,239        1,370   

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

     (1,467     (3,444     (3,174     (7,467

Gain on OREO, net

     130        2,568        135        3,132   

Other

     825        789        1,526        1,486   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total noninterest income

     7,050        7,695        18,548        14,440   
  

 

 

   

 

 

   

 

 

   

 

 

 

Noninterest expense:

        

Salaries and employee benefits

     18,614        17,088        38,031        34,388   

Occupancy and equipment

     3,676        3,565        7,401        7,247   

Professional services

     1,646        1,387        3,010        2,983   

Software licenses and maintenance

     1,010        1,188        2,075        2,353   

Promotion

     1,341        1,140        2,607        2,398   

Amortization of intangible assets

     193        437        315        875   

OREO expense

     113        33        138        363   

Other

     4,731        3,410        8,904        8,439   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total noninterest expense

     31,324        28,248        62,481        59,046   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings before income taxes

     40,485        38,242        85,268        68,778   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income taxes

     15,001        13,776        31,123        22,697   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net earnings

   $ 25,484      $ 24,466      $ 54,145      $ 46,081   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income (loss):

        

Unrealized gain (loss) on securities arising during the period

   $ 32,782      $ (53,854   $ 57,563      $ (65,550

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

     —          —          —          (2,094
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income (loss), before tax

     32,782        (53,854     57,563        (67,644

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

     (13,769     22,618        (24,176     28,410   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income (loss), net of tax

     19,013        (31,236     33,387        (39,234
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

   $ 44,497      $ (6,770   $ 87,532      $ 6,847   
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic earnings per common share

   $ 0.24      $ 0.23      $ 0.51      $ 0.44   

Diluted earnings per common share

   $ 0.24      $ 0.23      $ 0.51      $ 0.44   

Cash dividends declared per common share

   $ 0.10      $ 0.10      $ 0.20      $ 0.185   

See accompanying notes to the unaudited condensed consolidated financial statements.

 

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Table of Contents

CVB FINANCIAL CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

Six Months Ended June 30, 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

     (6     (61         (61

Exercise of stock options

     84        780            780   

Tax benefit from exercise of stock options

       59            59   

Shares issued pursuant to stock-based compensation plan

     10        893            893   

Cash dividends declared on Common ($0.185 per share)

         (19,414       (19,414

Net earnings

         46,081          46,081   

Other comprehensive income

           (39,234     (39,234
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance June 30, 2013

     104,978      $ 486,380      $ 261,677      $ 4,017      $ 752,074   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance January 1, 2014

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

Repurchase of common stock

     (346     (4,908         (4,908

Exercise of stock options

     469        5,109            5,109   

Tax benefit from exercise of stock options

       796            796   

Shares issued pursuant to stock-based compensation plan

     306        1,531            1,531   

Cash dividends declared on Common ($0.20 per share)

         (21,188       (21,188

Net earnings

         54,145          54,145   

Other comprehensive income

           33,387        33,387   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance June 30, 2014

     105,799      $ 493,596      $ 323,106      $ 24,057      $ 840,759   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to the unaudited 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 Six Months Ended  
     June 30,  
     2014     2013  

CASH FLOWS FROM OPERATING ACTIVITIES

    

Interest and dividends received

   $ 125,583      $ 120,161   

Service charges and other fees received

     15,036        18,130   

Interest paid

     (7,984     (8,402

Net cash paid to vendors and employees

     (63,504     (38,837

Income taxes paid

     (35,500     (38,200

(Payments to) proceeds from FDIC loss share agreement

     (1,372     312   
  

 

 

   

 

 

 

Net cash provided by operating activities

     32,259        53,164   
  

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES

    

Proceeds from redemption of FHLB stock

     8,899        11,435   

Proceeds from maturity of interest-earning balances from depository institutions

     1,494        —     

Proceeds from sale of investment securities

     14,271        99,155   

Proceeds from repayment of investment securities

     143,151        249,749   

Proceeds from maturity of investment securities

     47,199        25,867   

Purchases of investment securities

     (413,458     (368,829

Net decrease in loan and lease finance receivables

     184,031        111,102   

Proceeds from sales of premises and equipment

     663        5   

Purchase of premises and equipment

     (964     (1,541

Proceeds from sales of other real estate owned

     2,254        12,872   

Cash acquired on purchase of American Security Bank, net of cash paid

     50,038        —     
  

 

 

   

 

 

 

Net cash provided by investing activities

     37,578        139,815   
  

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES

    

Net increase in transaction deposits

     392,737        69,142   

Net decrease in time deposits

     (32,172     (10,807

Repayment of junior subordinated debentures

     —          (41,238

Net decrease in other borrowings

     (69,000     (26,000

Net (decrease) increase in customer repurchase agreements

     (31,792     18,397   

Cash dividends on common stock

     (21,117     (19,414

Repurchase of common stock

     (4,908     (61

Proceeds from exercise of stock options

     5,109        780   

Tax benefit related to exercise of stock options

     796        59   
  

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     239,653        (9,142
  

 

 

   

 

 

 

NET INCREASE IN CASH AND CASH EQUIVALENTS

     309,490        183,837   

CASH AND CASH EQUIVALENTS, beginning of period

     94,693        98,431   
  

 

 

   

 

 

 

CASH AND CASH EQUIVALENTS, end of period

   $ 404,183      $ 282,268   
  

 

 

   

 

 

 

See accompanying notes to the unaudited 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 Six Months Ended  
     June 30,  
     2014     2013  

RECONCILIATION OF NET EARNINGS TO NET CASH PROVIDED BY OPERATING ACTIVITIES

    

Net earnings

   $ 54,145      $ 46,081   

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

     71        6   

Gain on sale of other real estate owned

     (117     (3,053

Amortization of capitalized prepayment penalty on borrowings

     136        136   

Increase in bank owned life insurance

     (1,161     (1,322

Net amortization of premiums and discounts on investment securities

     10,044        13,938   

Accretion of SJB discount

     (3,174     (7,849

Provision for loan losses

     (15,100     (6,200

Valuation adjustment on other real estate owned

     —          87   

Change in FDIC loss share asset

     3,174        7,467   

(Payments to) proceeds from FDIC loss share agreement

     (1,372     312   

Stock-based compensation

     1,531        893   

Depreciation and amortization, net

     858        1,603   

Change in accrued interest receivable

     331        193   

Change in accrued interest payable

     12        (317

Change in other assets and liabilities

     (11,789     3,283   
  

 

 

   

 

 

 

Total adjustments

     (21,886     7,083   
  

 

 

   

 

 

 

Net cash provided by operating activities

   $ 32,259      $ 53,164   
  

 

 

   

 

 

 

SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING ACTIVITIES

    

Securities purchased and not settled

   $ 56,430      $ 67,483   

Transfer of loans to other real estate owned

   $ 478      $ 1,492   

See accompanying notes to the unaudited condensed consolidated financial statements.

 

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CVB FINANCIAL CORP. AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(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” or “CBB”) 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 43 Business Financial Centers, six Commercial Banking Centers, and three trust office locations. The Company is headquartered in the city of Ontario, California.

On May 15, 2014, we announced the completion of our acquisition of American Security Bank (“ASB”), a Newport Beach, CA headquartered regional bank with approximately $433 million in total assets and five branch locations throughout Orange County, San Bernardino County, and Los Angeles County. Our condensed consolidated financial statements for the second quarter include 45 days of ASB operations, post-merger. See Note 4 — Business Combinations, included herein.

 

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 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. The results of operations for the three and six months ended June 30, 2014 are not necessarily indicative of the results for the full year. Certain information and note disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted. These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated 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. 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’ condensed consolidated 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.

 

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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.

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

 

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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.

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

 

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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.

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.

 

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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.

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

 

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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.

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 June 30, 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 8 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 June 30, 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

 

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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.

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 June 30, 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 new guidance is not expected to have a material impact on the Company’s consolidated financial statements.

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606)”. This update to the ASC is the culmination of efforts by the FASB and the International Accounting Standards Board (IASB) to develop a common revenue standard for U.S. GAAP and International Financial Reporting Standards (IFRS). ASU 2014-09 supersedes Topic 605 – Revenue Recognition and most industry-specific guidance. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance in ASU 2014-09 describes a 5-step process entities can apply to achieve the core principle of revenue recognition and requires disclosures sufficient to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers and the significant judgments used in determining that information. The amendments in ASU 2014-9 are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period and early application is not allowed. The adoption of this new guidance is not expected to have a material impact on the Company’s consolidated financial statements.

In June 2014, the FASB issued ASU No. 2014-12, “Compensation – Stock Compensation (Topic 718) –Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Services Period”. The amendments in ASU 2014-12 provide guidance for determining compensation cost under specific circumstances when an employee is eligible to vest in an award regardless of whether the employee is rendering service on the date the performance target is achieved. ASU 2014-12 becomes effective for annual and interim periods beginning after December 15, 2015 with early adoption permitted. The Company is currently evaluating the effects of ASU 2014-12 on its consolidated financial statements and disclosures, if any.

 

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4. BUSINESS COMBINATIONS

American Security Bank Acquisition

On May 15, 2014, the Bank acquired all of the assets and assumed all of the liabilities of ASB for $57.0 million in cash. As a result, ASB was merged with CBB, the principal subsidiary of CVB. The Company believes this transaction serves to further expand its footprint in Southern California. At close, ASB had five branches located in the Southern California communities of: Newport Beach, Laguna Niguel, Corona, Lancaster, and Apple Valley. ASB also had two electronic branch locations in the High Desert area of California and a loan production office in Ontario, California. CBB received regulatory approval to consolidate three locations into existing locations of CBB. The consolidations will take place in the third quarter of 2014.

Goodwill of $19.7 million from the acquisition represents the excess of the purchase price over the fair value of the net tangible and intangible assets acquired.

The total fair value of assets acquired was $436.2 million, which included $117.8 million in cash and cash due from banks, $44.5 million in investment securities available for sale, $1.9 million in FHLB stock, $242.7 million in loans receivable, $4.8 million in fixed assets, $1.1 million in core deposit intangible assets acquired, $1.9 million in other real estate owned (“OREO”), and $1.8 million in other assets. The total fair value of liabilities assumed was $379.2 million, which included $378.2 million in deposits and $1.0 million in other liabilities. The assets and liabilities, both tangible and intangible, were recorded at their estimated fair values as of May 15, 2014. The assets acquired and liabilities assumed have been accounted for under the acquisition method accounting.

We have included the financial results of the business combination in the condensed consolidated statement of income beginning on the acquisition date.

For the three and six months ended June 30, 2014, the Company incurred non-recurring merger related expenses associated with the ASB acquisition of $638,000 and $1.1 million, respectively.

 

5. 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.

 

     June 30, 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

   $ 346,315       $ 2       $ (13,146   $ 333,171         11.04

Residential mortgage-backed securities

     1,725,530         28,829         (6,278     1,748,081         57.93

CMO’s / REMIC’s - residential

     335,121         8,546         (405     343,262         11.38

Municipal bonds

     564,046         25,234         (1,404     587,876         19.48

Other securities

     5,000         100         —          5,100         0.17
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 2,976,012       $ 62,711       $ (21,233   $ 3,017,490         100.00
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

 

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     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
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Approximately 80% of the available-for-sale portfolio at June 30, 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 June 30, 2014 and December 31, 2013. The Bank has $452,000 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 for the six months ended June 30, 2013. There were no realized gains or losses for the three and six months ended June 30, 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 June 30, 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.

 

     June 30, 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

   $ 12,279       $ 14       $ 310,140       $ 13,132       $ 322,419       $ 13,146   

Residential mortgage-backed securities

     1         —           318,837         6,278         318,838         6,278   

CMO / REMICs - residential

     10,190         11         44,425         394         54,615         405   

Municipal bonds

     15,399         134         37,358         1,270         52,757         1,404   

Other securities

     —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 37,869       $ 159       $ 710,760       $ 21,074       $ 748,629       $ 21,233   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents
     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 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 June 30, 2014, the unrealized loss on this security was zero and the current fair value on the security was 78.02% of the current par value. This Alt-A bond, with a book value of $1.6 million as of June 30, 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 June 30, 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 and six months ended June 30, 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 June 30, 2014, approximately $137.6 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 4.2 years. Of the total MBS/CMO, 99.98% have the implied guarantee of U.S. government-sponsored agencies and enterprises. The remaining 0.02% 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 8.8 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 June 30, 2014.

 

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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 OTTI for any given security.

At June 30, 2014 and December 31, 2013, investment securities having a carrying value of approximately $2.92 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 June 30, 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.

 

     June 30, 2014  
     Amortized
Cost
     Fair
Value
     Weighted-
Average
Yield
 
     (Dollars in thousands)  

Available-for-sale:

        

Due in one year or less

   $ 120,916       $ 124,164         3.54

Due after one year through five years

     1,950,883         2,001,556         2.52

Due after five years through ten years

     862,082         849,399         2.17

Due after ten years

     42,131         42,371         3.51
  

 

 

    

 

 

    

Total

   $ 2,976,012       $ 3,017,490         2.48
  

 

 

    

 

 

    

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 June 30, 2014.

 

6. 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 June 30, 2014, the remaining discount associated with the SJB loans approximated $9.5 million. Based on the Company’s regular forecast of expected cash flows from these loans, approximately $6.9 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 1.3 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 $996,000 at June 30, 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.

 

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Table of Contents

The following table provides a summary of the components of covered loan and lease finance receivables:

 

     June 30, 2014     December 31, 2013  
     (Dollars in thousands)  

Commercial and industrial

   $ 17,194      $ 20,461   

Real estate:

    

Commercial real estate

     126,768        141,141   

Construction

     —          644   

SFR mortgage

     295        313   

Dairy & livestock and agribusiness

     411        6,000   

Municipal lease finance receivables

     —          —     

Consumer and other loans

     3,504        4,545   
  

 

 

   

 

 

 

Gross covered loans

     148,172        173,104   

Less: Purchase accounting discount

     (9,476     (12,789
  

 

 

   

 

 

 

Gross covered loans, net of discount

     138,696        160,315   

Less: Allowance for covered loan losses

     —          —     
  

 

 

   

 

 

 

Net covered loans

   $ 138,696      $ 160,315   
  

 

 

   

 

 

 

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 accepted or modified 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:

 

     June 30, 2014      December 31, 2013  
     (Dollars in thousands)  

Pass

   $ 31,596       $ 38,961   

Watch list

     69,797         74,369   

Special mention

     11,647         15,492   

Substandard

     35,093         44,241   

Doubtful & loss

     39         41   
  

 

 

    

 

 

 

Total covered gross loans

   $ 148,172       $ 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 June 30, 2014 and December 31, 2013, the Company had zero allowance for loan losses recorded for covered loans.

 

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Table of Contents
7. 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:

 

     June 30, 2014     December 31, 2013  
     (Dollars in thousands)  

Commercial and industrial

   $ 514,409      $ 512,792   

Real estate:

    

Commercial real estate

     2,400,864        2,207,515   

Construction

     59,477        47,109   

SFR mortgage

     186,924        189,233   

Dairy & livestock and agribusiness

     180,051        294,292   

Municipal lease finance receivables

     78,934        89,106   

Consumer and other loans

     70,997        55,103   
  

 

 

   

 

 

 

Gross non-covered loans

     3,491,656        3,395,150   

Less: Deferred loan fees, net

     (9,425     (9,234
  

 

 

   

 

 

 

Gross loans, net of deferred loan fees

     3,482,231        3,385,916   

Less: Allowance for non-covered loan losses

     (60,974     (75,235
  

 

 

   

 

 

 

Net non-covered loans

   $ 3,421,257      $ 3,310,681   
  

 

 

   

 

 

 

As of June 30, 2014, 68.76% of the total non-covered loan portfolio consisted of commercial real estate loans and 1.70% 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 June 30, 2014, the Company held approximately $1.72 billion of non-covered fixed rate loans.

At June 30, 2014 and December 31, 2013, loans totaling $2.39 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 six months ended June 30, 2014 and 2013:

 

     For the Six Months Ended June 30,  
     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 June 30, 2014 and December 31, 2013:

 

     June 30, 2014  
     Pass      Watch List      Special
Mention
     Substandard (1)      Doubtful &
Loss (2)
     Total  
     (Dollars in thousands)  

Commercial and industrial (1)

   $ 323,199       $ 120,299       $ 53,724       $ 16,825       $ 362       $ 514,409   

Real estate:

                 

Commercial real estate

                 

Owner occupied

     507,806         152,058         73,561         28,592         —           762,017   

Non-owner occupied (1)

     1,291,673         242,581         57,461         47,132         —           1,638,847   

Construction

                 

Speculative

     15,299         747         1,503         17,418         —           34,967   

Non-speculative

     12,890         2,476         8         9,136         —           24,510   

SFR mortgage

     152,538         19,745         2,468         12,173         —           186,924   

Dairy & livestock and agribusiness

     24,529         106,227         26,300         17,862         5,133         180,051   

Municipal lease finance receivables

     39,587         18,621         20,726         —           —           78,934   

Consumer and other loans (1)

     58,118         7,635         3,089         2,155         —           70,997   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total non-covered gross loans

   $ 2,425,639       $ 670,389       $ 238,840       $ 151,293       $ 5,495       $ 3,491,656   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Includes $7.2 million of substandard loans acquired from ASB: $1.7 million in commercial and industrial loans, $4.8 million in commercial real estate, and $729,000 in consumer loans.
(2) There were no loans classified as loss as of June 30, 2014.

 

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Table of Contents
     December 31, 2013  
     Pass      Watch List      Special
Mention
     Substandard      Doubtful &
Loss (1)
     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   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) There were no loans classified as loss as of December 31, 2013.

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 Directors 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 June 30, 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 for the three and six months ended June 30, 2014 and 2013:

 

     For the Three Months Ended June 30, 2014  
     Ending
Balance
March 31,
          2014           
     Charge-offs     Recoveries      Provision for
Loan Losses
    Ending
Balance
June 30,
2014
 
     (Dollars in thousands)  

Commercial and industrial

   $ 8,836       $ (60   $ 106       $ (480   $ 8,402   

Real estate:

            

Commercial real estate

     39,400         (352     70         (3,200     35,918   

Construction

     458         —          19         128        605   

SFR mortgage

     2,282         —          —           (68     2,214   

Dairy & livestock and agribusiness

     9,267         —          98         (3,937     5,428   

Municipal lease finance receivables

     1,519         —          —           (55     1,464   

Consumer and other loans

     950         (6     14         (28     930   

Covered loans

     —           (40     —           40        —     

Unallocated

     6,013         —          —           —          6,013   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total allowance for loan losses

   $ 68,725       $ (458   $ 307       $ (7,600   $ 60,974   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

 

23


Table of Contents
     For the Three Months Ended June 30, 2013  
     Ending
Balance
March 31,
          2013           
     Charge-offs     Recoveries     Provision for
Loan Losses
    Ending
Balance
June 30,
2013
 
     (Dollars in thousands)  

Commercial and industrial

   $ 12,313       $ (747   $ 109      $ 911      $ 12,586   

Real estate:

           

Commercial real estate

     46,725         —          29        (2,362     44,392   

Construction

     2,124         —          (58     (894     1,172   

SFR mortgage

     3,606         —          99        10        3,715   

Dairy & livestock and agribusiness

     16,571         —          14        (2,360     14,225   

Municipal lease finance receivables

     2,632         —          —          (263     2,369   

Consumer and other loans

     1,133         (22     15        (74     1,052   

Unallocated

     7,114         —          —          (1,168     5,946   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total allowance for loan losses

   $ 92,218       $ (769   $ 208      $ (6,200   $ 85,457   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

 

     For the Six Months Ended June 30, 2014  
     Ending
Balance
December 31,
          2013           
     Charge-offs     Recoveries      Provision for
Loan Losses
    Ending
Balance
June 30,
2014
 
     (Dollars in thousands)  

Commercial and industrial

   $ 10,834       $ (514   $ 561       $ (2,479   $ 8,402   

Real estate:

            

Commercial real estate

     39,402         (352     138         (3,270     35,918   

Construction

     1,305         —          797         (1,497     605   

SFR mortgage

     2,718         —          —           (504     2,214   

Dairy & livestock and agribusiness

     11,728         —          242         (6,542     5,428   

Municipal lease finance receivables

     2,335         —          —           (871     1,464   

Consumer and other loans

     960         (19     26         (37     930   

Covered loans

     —           (40     —           40        —     

Unallocated

     5,953         —          —           60        6,013   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total allowance for loan losses

   $ 75,235       $ (925   $ 1,764       $ (15,100   $ 60,974   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

 

     For the Six Months Ended June 30, 2013  
     Ending
Balance
December 31,
          2012           
     Charge-offs     Recoveries      Provision for
Loan Losses
    Ending
Balance
June 30,
2013
 
     (Dollars in thousands)  

Commercial and industrial

   $ 11,652       $ (1,104   $ 208       $ 1,830      $ 12,586   

Real estate:

            

Commercial real estate

     47,457         —          66         (3,131     44,392   

Construction

     2,291         —          68         (1,187     1,172   

SFR mortgage

     3,448         (142     133         276        3,715   

Dairy & livestock and agribusiness

     18,696         —          28         (4,499     14,225   

Municipal lease finance receivables

     1,588         —          —           781        2,369   

Consumer and other loans

     1,170         (69     28         (77     1,052   

Unallocated

     6,139         —          —           (193     5,946   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total allowance for loan losses

   $ 92,441       $ (1,315   $ 531       $ (6,200   $ 85,457   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

 

24


Table of Contents

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 June 30, 2014 and 2013:

 

     June 30, 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

   $ 8,042       $ 506,367       $ 707       $ 7,698   

Real estate:

           

Commercial real estate

     36,873         2,363,991         —           35,918   

Construction

     26,554         32,923         —           605   

SFR mortgage

     10,554         176,370         44         2,167   

Dairy & livestock and agribusiness

     23,355         156,696         1,366         4,062   

Municipal lease finance receivables

     —           78,934         —           1,464   

Consumer and other loans

     470         70,527         96         834   

Unallocated

     —           —           —           6,013   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 105,848       $ 3,385,808       $ 2,213       $ 58,761   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     June 30, 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

   $ 6,171       $ 518,973       $ 1,905       $ 10,681   

Real estate:

           

Commercial real estate

     39,623         1,969,123         1         44,391   

Construction

     27,365         19,000         —           1,172   

SFR mortgage

     13,440         166,683         351         3,364   

Dairy & livestock and agribusiness

     28,161         230,966         2,593         11,632   

Municipal lease finance receivables

     —           105,246         —           2,369   

Consumer and other loans

     157         53,063         6         1,046   

Unallocated

     —           —           —           5,946   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 114,917       $ 3,063,054       $ 4,856       $ 80,601   
  

 

 

    

 

 

    

 

 

    

 

 

 

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.

 

25


Table of Contents

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 June 30, 2014 and December 31, 2013:

 

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

Commercial and industrial

   $ 1,205       $ —         $ 1,205       $ 6,969       $ 506,235       $ 514,409   

Real estate:

                 

Commercial real estate

                 

Owner occupied

     474         —           474         4,150         757,394         762,018   

Non-owner occupied

     258         —           258         10,716         1,627,872         1,638,846   

Construction

                 

Speculative

     —           —           —           9,767         25,200         34,967   

Non-speculative

     —           —           —           —           24,510         24,510   

SFR mortgage

     161         —           161         6,765         179,998         186,924   

Dairy & livestock and agribusiness

     —           —           —           5,133         174,918         180,051   

Municipal lease finance receivables

     —           —           —           —           78,934         78,934   

Consumer and other loans

     160         8         168         470         70,359         70,997   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total non-covered gross loans

   $ 2,258       $ 8       $ 2,266       $ 43,970       $ 3,445,420       $ 3,491,656   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) As of June 30, 2014, $27.6 million of nonaccrual loans were current according to original or restructured terms, $240,000 were 30-59 days past due, zero were 60-89 days past due, and $16.1 million were 90+ days past due. Includes $5.5 million of nonaccrual loans acquired from ASB: $3.7 million in commercial real estate loans, $1.7 million in commercial and industrial loans, and $76,000 in consumer loans.

 

     December 31, 2013  
     30-59
Days Past
Due
     60-89
Days Past
Due
     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.

 

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Table of Contents

Non-Covered Impaired Loans

At June 30, 2014, the Company had non-covered impaired loans of $105.8 million. Of this amount, there were $9.8 million in nonaccrual commercial construction loans, $6.7 million of nonaccrual SFR mortgage loans, $14.9 million of nonaccrual commercial real estate loans, $7.0 million of nonaccrual commercial and industrial loans, $5.1 million of nonaccrual dairy & livestock and agribusiness loans and $470,000 of consumer and other loans. These non-covered impaired loans included $89.3 million of loans whose terms were modified in a troubled debt restructuring, of which $27.4 million were classified as nonaccrual. The remaining balance of $61.9 million consisted of 42 loans performing according to the restructured terms. The impaired loans had a specific allowance of $2.2 million at June 30, 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.

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 Six Months Ended
June 30, 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

   $ 6,450       $ 7,953       $ —         $ 6,508       $ 30   

Real estate:

              

Commercial real estate

              

Owner occupied

     11,822         12,910         —           11,967         247   

Non-owner occupied

     25,051         31,676         —           25,390         430   

Construction

              

Speculative

     17,418         18,407         —           17,484         154   

Non-speculative

     9,136         9,136         —           9,158         308   

SFR mortgage

     10,078         11,719         —           10,156         52   

Dairy & livestock and agribusiness

     20,015         20,714         —           22,529         456   

Municipal lease finance receivables

     —           —           —           —           —     

Consumer and other loans

     366         718         —           368         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     100,336         113,233         —           103,560         1,677   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

With a related allowance recorded:

              

Commercial and industrial

     1,592         1,924         707         1,598         —     

Real estate:

              

Commercial real estate

              

Owner occupied

     —           —           —           —           —     

Non-owner occupied

     —           —           —           —           —     

Construction

              

Speculative

     —           —           —           —           —     

Non-speculative

     —           —           —           —           —     

SFR mortgage

     476         486         44         478         —     

Dairy & livestock and agribusiness

     3,340         3,340         1,366         3,408         25   

Municipal lease finance receivables

     —           —           —           —           —     

Consumer and other loans

     104         165         96         105         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     5,512         5,915         2,213         5,589         25   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total non-covered impaired loans

   $ 105,848       $ 119,148       $ 2,213       $ 109,149       $ 1,702   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

27


Table of Contents
     As of and For the Six Months Ended
June 30, 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

   $ 3,158       $ 4,079       $ —         $ 3,280       $ 35   

Real estate:

              

Commercial real estate

              

Owner occupied

     12,316         13,445         —           12,742         235   

Non-owner occupied

     27,298         38,081         —           27,787         406   

Construction

              

Speculative

     18,146         18,607         —           18,230         154   

Non-speculative

     9,219         9,219         —           9,219         284   

SFR mortgage

     10,571         13,303         —           10,690         33   

Dairy & livestock and agribusiness

     23,085         24,138         —           24,868         248   

Municipal lease finance receivables

     —           —           —           —           —     

Consumer and other loans

     139         196         —           141         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     103,932         121,068         —           106,957         1,395   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

With a related allowance recorded:

              

Commercial and industrial

     3,013         3,131         1,905         3,108         —     

Real estate:

              

Commercial real estate

              

Owner occupied

     9         10         1         13         —     

Non-owner occupied

     —           —           —           —           —     

Construction

              

Speculative

     —           —           —           —           —     

Non-speculative

     —           —           —           —           —     

SFR mortgage

     2,869         3,010         351         2,877         —     

Dairy & livestock and agribusiness

     5,076         5,578         2,593         5,879         22   

Municipal lease finance receivables

     —           —           —           —           —     

Consumer and other loans

     18         20         6         20         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     10,985         11,749         4,856         11,897         22   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total non-covered impaired loans

   $ 114,917       $ 132,817       $ 4,856       $ 118,854       $ 1,417   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents
     As of December 31, 2013  
            Unpaid         
     Recorded      Principal      Related  
     Investment      Balance      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 June 30, 2014 and December 31, 2013 has already been written down to the 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 June 30, 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 $9.8 million as of June 30, 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 and six months ended June 30, 2014 and 2013. At June 30, 2014 and December 31, 2013, the balance of the reserve was $9.1 million and was included in other liabilities.

 

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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 June 30, 2014, there were $89.3 million of loans classified as TDR, of which $27.4 million were nonperforming and $61.9 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 June 30, 2014, performing TDRs were comprised of 13 commercial real estate loans of $22.0 million, two construction loans of $16.8 million, 10 dairy & livestock loans of $18.2 million, 11 SFR mortgage loans of $3.8 million, and six commercial and industrial loans of $1.1 million. There were no loans removed from TDR classification during the three and six months ended June 30, 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 $1.7 million and $2.7 million of specific allowance to TDRs as of June 30, 2014 and December 31, 2013, respectively.

The following tables provide a summary of the activity related to TDRs for the three and six months ended June 30, 2014 and 2013:

 

     For the Three Months Ended
June 30,
    For the Six Months Ended
June 30,
 
     2014     2013     2014     2013  
     (Dollars in thousands)     (Dollars in thousands)  

Performing TDRs:

        

Beginning balance

   $ 66,394      $ 57,591      $ 66,955      $ 50,392   

New modifications

     —          11,119        41        21,364   

Payoffs and payments, net

     (4,516     (7,144     (5,118     (11,339

TDRs returned to accrual status

     —          —          —          1,149   

TDRs placed on nonaccrual status

     —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 61,878      $ 61,566      $ 61,878      $ 61,566   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

     For the Three Months Ended     For the Six Months Ended  
     June 30,     June 30,  
     2014     2013     2014     2013  
     (Dollars in thousands)     (Dollars in thousands)  

Nonperforming TDRs:

        

Beginning balance

   $ 23,968      $ 29,566      $ 25,119      $ 31,309   

New modifications (1)

     4,187        28        4,187        128   

Payoffs and payments, net

     (758     (3,097     (1,909     (3,791

TDRs returned to accrual status

     —          —          —          (1,149

TDRs placed on nonaccrual status

     —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 27,397      $ 26,497      $ 27,397      $ 26,497   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) New modifications for the three and six months ended June 30, 2014 represent TDRs acquired from ASB.

 

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Table of Contents

The following tables summarize loans modified as troubled debt restructurings during the three and six months ended June 30, 2014 and 2013:

Modifications (1)

 

     For the Three Months Ended June 30, 2014  
     Number
of Loans
     Pre-Modification
Outstanding
Recorded
Investment
     Post-Modification
Outstanding
Recorded
Investment
     Outstanding
Recorded
Investment at
June 30, 2014
     Financial Effect
Resulting From
Modifications (2)
 
     (Dollars in thousands)  

Commercial and industrial:

              

Interest rate reduction

     —         $ —         $ —         $ —         $ —     

Change in amortization period or maturity (3)

     1         47         47         45         —     

Real estate:

              

Commercial real estate:

              

Owner occupied

              

Interest rate reduction (3)

     2         389         389         376         —     

Change in amortization period or maturity

     —           —           —           —           —     

Other

     —           —           —           —           —     

Non-owner occupied

              

Interest rate reduction (3)

     4         3,751         3,751         3,710         —     

Change in amortization period or maturity

     —           —           —           —           —     

Other

     —           —           —           —           —     

Dairy & livestock and agribusiness:

              

Interest rate reduction

     —           —           —           —           —     

Change in amortization period or maturity

     —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total non-covered loans

     7         4,187         4,187         4,131         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     For the Three Months Ended June 30, 2013  
     Number
of Loans
     Pre-Modification
Outstanding
Recorded
Investment
     Post-Modification
Outstanding
Recorded
Investment
     Outstanding
Recorded
Investment at
June 30, 2013
     Financial Effect
Resulting From
Modifications (2)
 
     (Dollars in thousands)  

Commercial and industrial:

              

Interest rate reduction

     —         $ —         $ —         $ —         $ —     

Change in amortization period or maturity

     1         28         28         28         28   

Real estate:

              

Commercial real estate:

              

Owner occupied

              

Interest rate reduction

     —           —           —           —           —     

Change in amortization period or maturity

     —           —           —           —           —     

Dairy & livestock and agribusiness:

              

Interest rate reduction

     —           —           —           —           —     

Change in amortization period or maturity

     3         11,119         11,119         10,932         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total non-covered loans

     4       $ 11,147       $ 11,147       $ 10,960       $ 28   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(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.
(3) New modifications for the three and six months ended June 30, 2014 represent TDRs acquired from ASB.

 

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Table of Contents
     For the Six Months Ended June 30, 2014  
     Number
of Loans
     Pre-Modification
Outstanding
Recorded
Investment
     Post-Modification
Outstanding
Recorded
Investment
     Outstanding
Recorded
Investment at
June 30, 2014
     Financial Effect
Resulting From
Modifications (2)
 
     (Dollars in thousands)  

Commercial and industrial:

              

Interest rate reduction

     —         $ —         $ —         $ —         $ —     

Change in amortization period or maturity (3)

     2         88         88         84         —     

Real estate:

     —           —           —           —           —     

Commercial real estate:

     —           —           —           —           —     

Owner occupied

     —           —           —           —           —     

Interest rate reduction (3)

     2         389         389         376         —     

Change in amortization period or maturity

     —           —           —           —           —     

Other

     —           —           —           —           —     

Non-owner occupied

     —           —           —           —           —     

Interest rate reduction (3)

     4         3,751         3,751         3,710         —     

Change in amortization period or maturity

     —           —           —           —           —     

Other

     —           —           —           —           —     

Dairy & livestock and agribusiness:

     —           —           —           —           —     

Interest rate reduction

     —           —           —           —           —     

Change in amortization period or maturity

     —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total non-covered loans

     8         4,228         4,228         4,170         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     For the Six Months Ended June 30, 2013  
     Number
of Loans
     Pre-Modification
Outstanding
Recorded
Investment
     Post-Modification
Outstanding
Recorded
Investment
     Outstanding
Recorded
Investment at
June 30, 2013
     Financial Effect
Resulting From
Modifications (2)
 
     (Dollars in thousands)  

Commercial and industrial:

              

Interest rate reduction

     —         $ —         $ —         $ —         $ —     

Change in amortization period or maturity

     3         231         231         207         122   

Real estate:

              

Commercial real estate:

              

Owner occupied

              

Interest rate reduction

     —           —           —           —           —     

Change in amortization period or maturity

     1         168         168         158         —     

Dairy & livestock and agribusiness:

              

Interest rate reduction

     —           —           —           —           —     

Change in amortization period or maturity

     6         15,207         15,207         15,136         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total non-covered loans

     10       $ 15,606       $ 15,606       $ 15,501       $ 122   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(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.
(3) New modifications for the three and six months ended June 30, 2014 represent TDRs acquired from ASB.

As of June 30, 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 and six months ended June 30, 2014.

 

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Table of Contents
8. 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 and six months ended June 30, 2014, shares deemed to be antidilutive, and thus excluded from the computation of earnings per common share, were 222,000 and 186,000 shares, respectively. For both the three and six months ended June 30, 2013, shares deemed to be antidilutive, and thus excluded from the computation of earnings per common share, were 1.0 million shares.

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 Three Months Ended
June 30,
     For the Six Months Ended
June 30,
 
     2014      2013      2014      2013  
     (In thousands, except per share amounts)  

Earnings per common share:

           

Net earnings

   $ 25,484       $ 24,466       $ 54,145       $ 46,081   

Less: Net earnings allocated to restricted stock

     145         75         274         144   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net earnings allocated to common shareholders

   $ 25,339       $ 24,391       $ 53,871       $ 45,937   
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average shares outstanding

     105,251         104,641         105,222         104,603   

Earnings per common share

   $ 0.24       $ 0.23       $ 0.51       $ 0.44   
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted earnings per common share:

           

Net income allocated to common shareholders

   $ 25,339       $ 24,391       $ 53,871       $ 45,937   
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average shares outstanding

     105,251         104,641         105,222         104,603   

Incremental shares from assumed exercise of outstanding options

     504         273         552         257   
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted weighted average shares outstanding

     105,755         104,914         105,774         104,860   

Diluted earnings per common share

   $ 0.24       $ 0.23       $ 0.51       $ 0.44   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

9. 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 June 30, 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 six months ended June 30, 2014 and 2013.

 

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Table of Contents

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.

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, which 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. 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.

 

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Table of Contents

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.

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 June 30, 2014 and December 31, 2013:

 

    Carrying Value at
June 30, 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

  $ 333,171      $ —        $ 333,171      $ —     

Residential mortgage-backed securities

    1,748,081        —          1,748,081        —     

CMO’s / REMIC’s - residential

    343,262        —          343,262        —     

Municipal bonds

    587,876        —          587,876        —     

Other securities

    5,100        —          5,100        —     
 

 

 

   

 

 

   

 

 

   

 

 

 

Total investment securities - AFS

    3,017,490        —          3,017,490        —     

Interest rate swaps

    11,306        —          11,306        —     
 

 

 

   

 

 

   

 

 

   

 

 

 

Total assets

  $ 3,028,796      $ —        $ 3,028,796      $ —     
 

 

 

   

 

 

   

 

 

   

 

 

 

Description of liability

       

Interest rate swaps

  $ 11,306      $ —        $ 11,306      $ —     
 

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities

  $ 11,306      $ —        $ 11,306      $ —     
 

 

 

   

 

 

   

 

 

   

 

 

 

 

    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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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 June 30, 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
June 30, 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 Six
Months Ended

     June 30, 2014     
 
     (Dollars in thousands)  

Description of assets

              

Impaired loans-non-covered:

              

Commercial and industrial

   $ 3,000       $ —         $ —         $ 3,000       $ 913   

Real estate:

              

Commercial real estate

     1,518         —           —           1,518         117   

Dairy & livestock and agribusiness

     2,100         —           —           2,100         171   

Consumer and other loans

     104         —           —           104         95   

Other real estate owned:

              

Covered

     —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total assets

   $ 6,722       $ —         $ —         $ 6,722       $ 1,296   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     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 June 30, 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.

 

     June 30, 2014  
            Estimated Fair Value  
     Carrying
Amount
     Level 1      Level 2      Level 3      Total  
     (Dollars in thousands)  

Assets

              

Total cash and cash equivalents

   $ 404,183       $ 404,183       $ —         $ —         $ 404,183   

Interest-earning balances due from depository institutions

     79,311         —           79,311         —           79,311   

FHLB stock

     26,852         —           26,852         —           26,852   

Investment securities available-for-sale

     3,017,490         —           3,017,490         —           3,017,490   

Investment securities held-to-maturity

     1,650         —           —           2,225         2,225   

Non-covered loans held-for-sale

     —           —           —           —           —     

Total loans, net of allowance for loan losses

     3,559,953         —           —           3,613,742         3,613,742   

Accrued interest receivable

     22,444         —           22,444         —           22,444   

Swaps

     11,306         —           11,306         —           11,306   

Liabilities

              

Deposits:

              

Noninterest-bearing

   $ 2,962,146       $ 2,962,146       $ —         $ —         $ 2,962,146   

Interest-bearing

     2,667,200         —           2,668,317         —           2,668,317   

Borrowings

     810,801         —           827,783         —           827,783   

Junior subordinated debentures

     25,774         —           25,701         —           25,701   

Accrued interest payable

     1,168         —           1,168         —           1,168   

Swaps

     11,306         —           11,306         —           11,306   

 

     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 June 30, 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
10. 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 43 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. 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 June 30, 2014  
     Centers      Treasury      Other     Eliminations     Total  
     (Dollars in thousands)  

Interest income, including loan fees

   $ 35,398       $ 17,675       $ 8,143      $ —        $ 61,216   

Credit for funds provided (1)

     7,660         —           11,414        (19,074     —     
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total interest income

     43,058         17,675         19,557        (19,074     61,216   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Interest expense

     1,561         2,390         106        —          4,057   

Charge for funds used (1)

     1,237         13,436         4,401        (19,074     —     
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total interest expense

     2,798         15,826         4,507        (19,074     4,057   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Net interest income

     40,260         1,849         15,050        —          57,159   

Provision for loan losses

     —           —           (7,600     —          (7,600
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Net interest income after provision for loan losses

     40,260         1,849         22,650        —          64,759   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Noninterest income

     5,162         —           1,888        —          7,050   

Noninterest expense

     11,522         182         19,620        —          31,324   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Segment pre-tax profit

   $ 33,900       $ 1,667       $ 4,918      $ —        $ 40,485   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Segment assets as of June 30, 2014

   $ 5,928,852       $ 3,511,341       $ 782,387      $ (2,798,587   $ 7,423,993   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

 

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

 

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Table of Contents
     For the Three Months Ended June 30, 2013  
     Centers      Treasury     Other     Eliminations     Total  
     (Dollars in thousands)  

Interest income, including loan fees

   $ 35,201       $ 11,641      $ 9,751      $ —        $ 56,593   

Credit for funds provided (1)

     6,509         —          10,185        (16,694     —     
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income

     41,710         11,641        19,936        (16,694     56,593   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Interest expense

     1,445         2,418        135        —          3,998   

Charge for funds used (1)

     1,033         10,864        4,797        (16,694     —     
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total interest expense

     2,478         13,282        4,932        (16,694     3,998   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

     39,232         (1,641     15,004        —          52,595   

Provision for loan losses

     —           —          (6,200     —          (6,200
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income after provision for loan losses

     39,232         (1,641     21,204        —          58,795   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Noninterest income

     5,477         —          2,218        —          7,695   

Noninterest expense

     11,319         177        16,752        —          28,248   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Segment pre-tax profit (loss)

   $ 33,390       $ (1,818   $ 6,670      $ —        $ 38,242   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Segment assets as of June 30, 2013

   $ 5,146,329       $ 2,826,947      $ 746,429      $ (2,294,149   $ 6,425,556   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

 

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

 

     For the Six Months Ended June 30, 2014  
     Centers      Treasury      Other     Eliminations     Total  
     (Dollars in thousands)  

Interest income, including loan fees

   $ 68,489       $ 34,107       $ 19,682      $ —        $ 122,278   

Credit for funds provided (1)

     14,734         —           22,877        (37,611     —     
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total interest income

     83,223         34,107         42,559        (37,611     122,278   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Interest expense

     3,198         4,763         216        —          8,177   

Charge for funds used (1)

     2,327         26,233         9,051        (37,611     —     
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total interest expense

     5,525         30,996         9,267        (37,611     8,177   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Net interest income

     77,698         3,111         33,292        —          114,101   

Provision for loan losses

     —           —           (15,100     —          (15,100
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Net interest income after provision for loan losses

     77,698         3,111         48,392        —          129,201   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Noninterest income

     9,944         —           8,604        —          18,548   

Noninterest expense

     23,350         378         38,753        —          62,481   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Segment pre-tax profit

   $ 64,292       $ 2,733       $ 18,243      $ —        $ 85,268   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Segment assets as of June 30, 2014

   $ 5,928,852       $ 3,511,341       $ 782,387      $ (2,798,587   $ 7,423,993   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

 

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

 

     For the Six Months Ended June 30, 2013  
     Centers      Treasury     Other     Eliminations     Total  
     (Dollars in thousands)  

Interest income, including loan fees

   $ 70,636       $ 24,429      $ 20,341      $ —        $ 115,406   

Credit for funds provided (1)

     12,821         —          20,385        (33,206     —     
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income

     83,457         24,429        40,726        (33,206     115,406   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Interest expense

     2,944         4,835        443        —          8,222   

Charge for funds used (1)

     2,106         21,378        9,722        (33,206     —     
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total interest expense

     5,050         26,213        10,165        (33,206     8,222   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

     78,407         (1,784     30,561        —          107,184   

Provision for loan losses

     —           —          (6,200     —          (6,200
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income after provision for loan losses

     78,407         (1,784     36,761        —          113,384   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Noninterest income

     10,583         2,094        1,763        —          14,440   

Noninterest expense

     22,896         361        35,789        —          59,046   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Segment pre-tax profit

   $ 66,094       $ (51   $ 2,735      $ —        $ 68,778   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Segment assets as of June 30, 2013

   $ 5,146,329       $ 2,826,947      $ 746,429      $ (2,294,149   $ 6,425,556   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

 

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

 

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Table of Contents
11. 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 June 30, 2014, the Bank has entered into 79 interest-rate swap agreements with customers and 79 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.

Balance Sheet Classification of Derivative Financial Instruments

As of June 30, 2014 and December 31, 2013, the total notional amount of the Company’s swaps was $207.0 million, and $221.5 million, respectively. The location of the asset and liability, and their respective fair values are summarized in the table below:

 

     June 30, 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    $ 11,306       Other liabilities    $ 11,306   
     

 

 

       

 

 

 

Total derivatives

      $ 11,306          $ 11,306   
     

 

 

       

 

 

 

 

     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 and six months ended June 30, 2014 and 2013.

 

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Table of Contents
12. OTHER COMPREHENSIVE INCOME (LOSS)

The tables below provide a summary of the components of other comprehensive income (“OCI”) for the three and six months ended June 30, 2014 and 2013:

 

       For the Three Months Ended June 30, 2014    
     Before-Tax     Tax Effect     After-Tax  
     (Dollars in thousands)  

Investment securities available-for-sale:

      

Net change in fair value recorded in accumulated OCI

   $  32,782      $  13,769      $  19,013   
  

 

 

   

 

 

   

 

 

 

Net change

   $ 32,782      $ 13,769      $ 19,013   
  

 

 

   

 

 

   

 

 

 
         For the Three Months Ended June 30, 2013      
     Before-Tax     Tax Effect     After-Tax  
     (Dollars in thousands)  

Investment securities available-for-sale:

      

Net change in fair value recorded in accumulated OCI

   $ (53,854   $ (22,618   $ (31,236
  

 

 

   

 

 

   

 

 

 

Net change

   $ (53,854   $ (22,618   $ (31,236
  

 

 

   

 

 

   

 

 

 
           For the Six Months Ended June 30, 2014        
     Before-Tax     Tax Effect     After-Tax  
     (Dollars in thousands)  

Investment securities available-for-sale:

      

Net change in fair value recorded in accumulated OCI

   $  57,563      $  24,176      $  33,387   
  

 

 

   

 

 

   

 

 

 

Net change

   $ 57,563      $ 24,176      $ 33,387   
  

 

 

   

 

 

   

 

 

 
           For the Six Months Ended June 30, 2013        
     Before-Tax     Tax Effect     After-Tax  
     (Dollars in thousands)  

Investment securities available-for-sale:

      

Net change in fair value recorded in accumulated OCI

   $ (65,550   $ (27,531   $ (38,019

Net realized gains reclassified into earnings (1)

     (2,094     (879     (1,215
  

 

 

   

 

 

   

 

 

 

Net change

   $ (67,644   $ (28,410   $ (39,234
  

 

 

   

 

 

   

 

 

 

 

(1) Net realized gains are included in noninterest income in the unaudited condensed consolidated statements of earnings and comprehensive income for the six months ended June 30, 2013.

The following table provides a summary of the change in accumulated other comprehensive income for the six months ended June 30, 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

     33,387   

Net realized losses reclassified into earnings

     —     
  

 

 

 

Balance, June 30, 2014

   $ 24,057   
  

 

 

 

 

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

Balance, January 1, 2013

   $ 43,251   

Net change in fair value recorded in accumulated OCI

     (38,019

Net realized gains reclassified into earnings

     (1,215
  

 

 

 

Balance, June 30, 2013

   $ 4,017   
  

 

 

 

 

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

June 30, 2014

               

Financial assets:

               

Derivatives not designated as hedging instruments

   $ 11,306       $ —        $ —         $ 11,306       $ —        $ 11,306   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 11,306       $ —        $ —         $ 11,306       $ —        $ 11,306   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Financial liabilities:

               

Derivatives not designated as hedging instruments

   $ 11,761       $ 455      $ 11,306       $ 455       $ (16,707   $ (4,946

Repurchase agreements

     611,459         —          611,459         —           (681,639     (70,180
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 623,220       $ 455      $ 622,765       $ 455       $ (698,346   $ (75,126
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

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
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

 

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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 second quarter of 2014, we reported net income of $25.5 million, compared with $24.5 million for the second quarter of 2013. This represents a year-over-year increase of $1.0 million, or 4.16%. Diluted earnings per share were $0.24 per share for the second quarter of 2014, compared to $0.23 for the same period of 2013. The allowance for loan losses was reduced by $7.6 million for the quarter.

On May 15, 2014, we announced the completion of our acquisition of American Security Bank (“ASB”), a Newport Beach, CA headquartered regional bank with approximately $433 million in total assets and five branch locations throughout Orange County, San Bernardino County, and Los Angeles County. Our financial statements for the second quarter include 45 days of ASB operations, post-merger.

At June 30, 2014, total assets of $7.42 billion increased $759.0 million, or 11.39%, from total assets of $6.66 billion at December 31, 2013. The increase in total assets at June 30, 2014 included $240 million in acquired loans and $30 million in acquired investment securities. Earning assets of $7.02 billion at June 30, 2014 increased $692.0 million, or 10.94%, when compared with $6.32 billion at December 31, 2013. The increase in earning assets during the first six months of 2014 was primarily due to $353.7 million increase in investment securities, a $71.0 million increase in total loans, and a $263.4 million increase in interest-earning deposits with the Federal Reserve Bank.

 

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Investment securities totaled $3.02 billion at June 30, 2014, up from $2.67 billion at December 31, 2013. As of June 30, 2014, we had a pre-tax unrealized net gain of $41.5 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 second quarter of 2014, we purchased $276.4 million of MBS with an average yield of 2.14%. Our new purchases of MBS have an average duration of approximately four years. We also purchased $19.7 million in municipal securities with an average tax-equivalent (TE) yield of 3.85%.

Total loans and leases, net of deferred fees and discount was $3.62 billion at June 30, 2014, compared to $3.42 billion at March 31, 2014 and $3.55 billion at December 31, 2013. Quarter-over-quarter, non-covered loans increased by $224.7 million, and covered loans decreased by $6.6 million. The increase in total loans included $240 million of loans acquired from ASB. The $224.7 million quarter-over-quarter increase in non-covered loans was principally due to increases of $206.8 million in commercial real estate loans, $23.7 million in commercial and industrial loans, and $16.6 million in construction loans. The overall increase in non-covered loans was partially offset by a $32.9 million decrease in dairy and livestock and agribusiness loans. Our dairy & livestock portfolio decreased by $37.0 million for the second quarter of 2014. The combination of higher milk prices and lower feed costs produced strong profitability for our dairy customers. This profitability led to significant paydowns on many of our customer’s herd and feed lines with the Bank. Although the market for new loans remains competitive, our loan pipeline continued to build momentum throughout the quarter.

Noninterest-bearing deposits were $2.96 billion at June 30, 2014, an increase of $399.2 million, or 15.57%, compared to $2.56 billion at December 31, 2013. At June 30, 2014, noninterest-bearing deposits were 52.62% of total deposits, compared to 52.41% at December 31, 2013 and 52.13% at June 30, 2013. Our average cost of total deposits for the quarter ended June 30, 2014 was 9 basis points, compared to 10 basis points for the same period of 2013.

At June 30, 2014, we had $25.8 million of junior subordinated debentures, unchanged from December 31, 2013 and June 30, 2013.

The allowance for loan losses was $61.0 million, or 1.75% of total non-covered loans at June 30, 2014, compared to $75.2 million, or 2.22%, at December 31, 2013. The $7.6 million recapture of loan loss provision during the second quarter of 2014 was primarily the result of improved credit quality. This follows a reduction of $7.5 million for the first quarter of 2014, $6.8 million 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 fiscal quarters.

Our capital ratios remain well-above regulatory standards. As of June 30, 2014, our Tier 1 leverage capital ratio totaled 10.99%, our Tier 1 risk-based capital ratio totaled 17.36%, and our total risk-based capital ratio totaled 18.61%.

 

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ANALYSIS OF THE RESULTS OF OPERATIONS

Financial Performance

 

     For the Three Months Ended
June 30,
    Variance     For the Six Months Ended
June 30,
    YTD Variance  
     2014     2013     $     %     2014     2013     $     %  
     (Dollars in thousands, except per share amounts)  

Net interest income

   $ 57,159      $ 52,595      $ 4,564        8.68   $ 114,101      $ 107,184      $ 6,917        6.45

Recapture of provision for loan losses

     7,600        6,200        1,400        22.58     15,100        6,200        8,900        143.55

Noninterest income

     7,050        7,695        (645     -8.38     18,548        14,440        4,108        28.45

Noninterest expense

     (31,324     (28,248     (3,076     -10.89     (62,481     (59,046     (3,435     -5.82

Income taxes

     (15,001     (13,776     (1,225     -8.89     (31,123     (22,697     (8,426     -37.12
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net earnings

   $ 25,484      $ 24,466      $ 1,018        4.16   $ 54,145      $ 46,081      $ 8,064        17.50
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Earnings per common share:

                

Basic

   $ 0.24      $ 0.23      $ 0.01        4.35   $ 0.51      $ 0.44      $ 0.07        15.91

Diluted

   $ 0.24      $ 0.23      $ 0.01        4.35   $ 0.51      $ 0.44      $ 0.07        15.91

Return on average assets

     1.45     1.56     -0.11       1.58     1.47     0.11  

Return on average shareholders’ equity

     12.48     12.58     -0.10       13.58     11.95     1.63  

Efficiency ratio

     48.78     46.85     1.93       47.10     48.55     -1.45  

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
June 30,
    For the Six Months Ended
June 30,
 
     2014     2013     2014     2013  
     (Dollars in thousands)  

Interest income

        

Interest income-accretion

   $ 1,467      $ 3,456      $ 3,174      $ 7,849   

Noninterest income

        

Decrease in FDIC loss share asset

     (1,467     (3,444     (3,174     (7,467

Net gain on sale of OREO

     19        —          19        376   

Noninterest expense

        

Legal and professional

     57        (91     65        (222

OREO write-down

     —          (14     —          (14

OREO expenses

     (41     (4     (46     (62

Other expenses (appraisals, and etc.)

     (39     173        (82     (102
  

 

 

   

 

 

   

 

 

   

 

 

 

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

   $ (4   $ 76      $ (44   $ 358   
  

 

 

   

 

 

   

 

 

   

 

 

 

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 $1.5 million for the second quarter 2014, recognized as part of interest income from covered loans, decreased $2.0 million, compared to $3.5 million for the second quarter of 2013. This decrease was reduced by the changes in the FDIC loss sharing asset, a net decrease of $1.5 million for the second quarter of 2014, compared to a net decrease of $3.4 million for the second quarter of 2013.

At June 30, 2014, the remaining discount associated with the SJB loans approximated $9.5 million. Based on the regular forecast of expected cash flows of these loans, approximately $6.9 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 1.3 years, respectively. The FDIC loss sharing asset totaled $996,000 at June 30, 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 $19,000 and $376,000 for the six months ended June 30, 2014 and 2013, respectively.

 

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Noninterest expense, including OREO expenses, legal and professional expenses and other covered asset related expenses, totaled $63,000 and $400,000 for the six months ended June 30, 2014 and 2013, respectively. Gross covered loans decreased $43.2 million to $148.2 million at June 30, 2014 from $191.4 million at June 30, 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 (TE) 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. 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.

The tables below present 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:

 

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Table of Contents
     For the Three Months Ended June 30,  
     2014     2013  
     Average
Balance
    Interest      Yield/
Rate
    Average
Balance
    Interest      Yield/
Rate
 
     (Dollars in thousands)  

INTEREST-EARNING ASSETS

              

Investment securities (1)

              

Taxable

   $ 2,272,756      $ 11,686         2.05   $ 1,704,935      $ 5,431         1.28

Tax-advantaged

     571,740        5,186         4.97     617,695        5,511         4.89

Investment in FHLB stock

     26,264        526         8.03     48,321        467         3.88

Federal funds sold and interest-earning deposits with other institutions

     288,103        260         0.36     206,912        209         0.40

Loans held-for-sale

     —          —           0.00     —          —           0.00

Loans (2)

     3,517,984        42,091         4.80     3,348,307        41,519         4.97

Yield adjustment to interest income from discount accretion on covered loans

     (10,801     1,467           (20,013     3,456      
  

 

 

   

 

 

      

 

 

   

 

 

    

Total interest-earning assets

     6,666,046        61,216         3.80     5,906,157        56,593         3.98

Total noninterest-earning assets

     369,328             375,281        
  

 

 

        

 

 

      

Total assets

   $ 7,035,374           $ 6,281,438        
  

 

 

        

 

 

      

INTEREST-BEARING LIABILITIES

              

Savings deposits (3)

   $ 1,867,228        877         0.19   $ 1,600,525        834         0.21

Time deposits

     691,188        345         0.20     702,121        324         0.19
  

 

 

   

 

 

      

 

 

   

 

 

    

Total interest-bearing deposits

     2,558,416        1,222         0.19     2,302,646        1,158         0.20

FHLB advances and other borrowings

     852,257        2,835         1.33     739,015        2,840         1.54
  

 

 

   

 

 

      

 

 

   

 

 

    

Interest-bearing liabilities

     3,410,673        4,057         0.48     3,041,661        3,998         0.53
  

 

 

   

 

 

      

 

 

   

 

 

    

Noninterest-bearing deposits

     2,735,042             2,399,930        

Other liabilities

     70,373             59,706        

Stockholders’ equity

     819,286             780,141        
  

 

 

        

 

 

      

Total liabilities and stockholders’ equity

   $ 7,035,374           $ 6,281,438        
  

 

 

        

 

 

      

Net interest income

     $ 57,159           $ 52,595      
    

 

 

        

 

 

    

Net interest income excluding discount on covered loans

     $ 55,692           $ 49,139      
    

 

 

        

 

 

    

Net interest spread - tax equivalent

          3.32          3.45

Net interest spread - tax equivalent excluding discount

          3.23          3.21

Net interest margin

          3.44          3.57

Net interest margin - tax equivalent

          3.55          3.71

Net interest margin - tax equivalent excluding discount

          3.46          3.46

Net interest margin excluding loan fees

          3.39          3.52

Net interest margin excluding loan fees - tax equivalent

          3.50          3.65

 

(1) Non tax-equivalent (TE) rate was 2.37% and 1.89% for the three months ended June 30, 2014 and 2013, respectively.
(2) Includes loan fees of: $769 and $786 for the three months ended June 30, 2014 and 2013, respectively.
   Prepayment penalty fees of $791 and $1,139 are included in interest income for the three months ended June 30, 2014 and 2013, respectively.
(3) Includes interest-bearing demand and money market accounts.

 

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Table of Contents
     For the Six Months Ended June 30,  
     2014     2013  
     Average
Balance
    Interest      Yield/
Rate
    Average
Balance
    Interest      Yield/
Rate
 
     (Dollars in thousands)  

INTEREST-EARNING ASSETS

              

Investment securities (1)

              

Taxable

   $ 2,171,572      $ 21,965         2.03   $ 1,748,440      $ 12,178         1.40

Tax-advantaged

     571,476        10,464         5.01     621,750        11,052         4.87

Investment in FHLB stock

     28,981        1,130         7.86     52,306        810         3.12

Federal funds sold and interest-earning deposits with other institutions

     278,732        505         0.36     149,875        344         0.46

Loans held-for-sale

     182        —           0.00     37        1         5.45

Loans (2)

     3,500,791        85,040         4.90     3,374,919        83,172         4.97

Yield adjustment to interest income from discount accretion on covered loans

     (11,744     3,174           (22,033     7,849      
  

 

 

   

 

 

      

 

 

   

 

 

    

Total interest-earning assets

     6,539,990        122,278         3.89     5,925,294        115,406         4.07

Total noninterest-earning assets

     364,747             383,577        
  

 

 

        

 

 

      

Total assets

   $ 6,904,737           $ 6,308,871        
  

 

 

        

 

 

      

INTEREST-BEARING LIABILITIES

              

Savings deposits (3)

   $ 1,786,445        1,756         0.20   $ 1,617,065        1,716         0.21

Time deposits

     681,535        652         0.19     707,004        683         0.19
  

 

 

   

 

 

      

 

 

   

 

 

    

Total interest-bearing deposits

     2,467,980        2,408         0.20     2,324,069        2,399         0.21

FHLB advances and other borrowings

     903,751        5,769         1.29     772,628        5,823         1.52
  

 

 

   

 

 

      

 

 

   

 

 

    

Interest-bearing liabilities

     3,371,731        8,177         0.49     3,096,697        8,222         0.54
  

 

 

   

 

 

      

 

 

   

 

 

    

Noninterest-bearing deposits

     2,657,203             2,361,498        

Other liabilities

     71,693             73,349        

Stockholders’ equity

     804,110             777,327        
  

 

 

        

 

 

      

Total liabilities and stockholders’ equity

   $ 6,904,737           $ 6,308,871        
  

 

 

        

 

 

      

Net interest income

     $ 114,101           $ 107,184      
    

 

 

        

 

 

    

Net interest income excluding discount on covered loans

     $ 110,927           $ 99,335      
    

 

 

        

 

 

    

Net interest spread - tax equivalent

          3.40          3.53

Net interest spread - tax equivalent excluding discount

          3.29          3.25

Net interest margin

          3.52          3.65

Net interest margin - tax equivalent

          3.63          3.78

Net interest margin - tax equivalent excluding discount

          3.53          3.50

Net interest margin excluding loan fees

          3.46          3.59

Net interest margin excluding loan fees - tax equivalent

          3.58          3.73

 

(1) Non tax-equivalent (TE) rate was 2.37% and 1.97% for the six months ended June 30, 2014 and 2013, respectively.
(2) Includes loan fees of: $1,560 and $1,527 for the six months ended June 30, 2014 and 2013, respectively.
   Prepayment penalty fees of $1,376 and $2,093 are included in interest income for the six months ended June 30, 2014 and 2013, respectively.
(3) Includes interest-bearing demand and money market accounts.

 

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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 June 30, 2014 and 2013 include a yield adjustment of $1.5 million and $3.5 million, respectively. Net interest income for the six months ended June 30, 2014 and 2013 include a yield adjustment of $3.2 million and $7.8 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 June 30,  
     2014     2013  
     Average
Balance
     Interest     Yield     Average
Balance
     Interest     Yield  
     (Dollars in thousands)  

Total interest-earning assets (TE)

   $ 6,666,046       $ 63,122        3.80   $ 5,906,157       $ 58,618        3.98

Discount on acquired covered loans

     10,801         (1,467       20,013         (3,456  
  

 

 

    

 

 

     

 

 

    

 

 

   

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

   $ 6,676,847       $ 61,655        3.70   $ 5,926,170       $ 55,162        3.73
  

 

 

    

 

 

     

 

 

    

 

 

   

Net interest income and net interest margin (TE)

      $ 59,065        3.55      $ 54,620        3.71

Yield adjustment to interest income from discount accretion on acquired covered loans

        (1,467          (3,456  
     

 

 

        

 

 

   

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

      $ 57,598        3.46      $ 51,164        3.46
     

 

 

        

 

 

   

 

     For the Six Months Ended June 30,  
     2014     2013  
     Average
Balance
     Interest     Yield     Average
Balance
     Interest     Yield  
     (Dollars in thousands)  

Total interest-earning assets (TE)

   $ 6,539,990       $ 126,114        3.89   $ 5,925,294       $ 119,463        4.07

Discount on acquired covered loans

     11,744         (3,174       22,033         (7,849  
  

 

 

    

 

 

     

 

 

    

 

 

   

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

   $ 6,551,734       $ 122,940        3.78   $ 5,947,327       $ 111,614        3.78
  

 

 

    

 

 

     

 

 

    

 

 

   

Net interest income and net interest margin (TE)

      $ 117,937        3.63      $ 111,241        3.78

Yield adjustment to interest income from discount accretion on acquired covered loans

        (3,174          (7,849  
     

 

 

        

 

 

   

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

      $ 114,763        3.53      $ 103,392        3.50
     

 

 

        

 

 

   

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.

 

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Table of Contents
     Comparision of Three Months Ended June 30,
2014 Compared to 2013
Increase (Decrease) Due to
 
     Volume     Rate     Rate/
Volume
    Total  
    

(Dollars in thousands)

 

Interest income:

        

Taxable investment securities

   $ 1,833      $ 3,318      $ 1,104      $ 6,255   

Tax-advantaged securities

     (408     90        (7     (325

Investment in FHLB stock

     (215     504        (230     59   

Fed funds sold & interest-earning deposits with other institutions

     78        (19     (8     51   

Loans HFS

     —          —          —          —     

Loans

     2,010        (1,369     (69     572   

Yield adjustment from discount accretion

     (1,591     (738     340        (1,989
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income

     1,707        1,786        1,130        4,623   

Interest expense:

        

Savings deposits

     154        (95     (16     43   

Time deposits

     (9     30        —          21   

FHLB advances and other borrowings

     872        (760     (117     (5
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest expense

     1,017        (825     (133     59   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

   $ 690      $ 2,611      $ 1,263      $ 4,564   
  

 

 

   

 

 

   

 

 

   

 

 

 
     Comparision of Six Months Ended June 30,
2014 Compared to 2013
Increase (Decrease) Due to
 
     Volume     Rate     Rate/
Volume
    Total  
     (Dollars in thousands)  

Interest income:

        

Taxable investment securities

   $ 2,951      $ 5,504      $ 1,332      $ 9,787   

Tax-advantaged securities

     (872     309        (25     (588

Investment in FHLB stock

     (360     1,227        (547     320   

Fed funds sold and interest-earning deposits with other institutions

     297        (73     (63     161   

Loans HFS

     4        (1     (4     (1

Loans

     3,160        (1,246     (46     1,868   

Yield adjustment from discount accretion

     (3,666     (1,894     885        (4,675
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income

     1,514        3,826        1,532        6,872   

Interest expense:

        

Savings deposits

     98        (52     (6     40   

Time deposits

     (53     23        (1     (31

FHLB advances and other borrowings

     979        (883     (150     (54
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest expense

     1,024        (912     (157     (45
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

   $ 490      $ 4,738      $ 1,689      $ 6,917   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income, before the provision for loan losses of $57.2 million for the second quarter of 2014 increased $4.6 million, or 8.68%, compared to the second quarter of 2013. Interest income and fees on loans for the second quarter of 2014 totaled $43.6 million, which included $1.5 million of discount accretion from accelerated principal reductions, payoffs and improved credit loss experienced on covered loans acquired from SJB. This represented a $1.1 million, or 2.46%, decrease when compared to interest income and fees on loans of $44.7 million for the first quarter of 2014, which included $1.7 million of discount accretion on covered loans, and a decrease of $1.4 million, or 3.15%, from the second quarter of 2013, which included $3.5 million of discount accretion on covered loans.

Excluding the impact of the yield adjustment on covered loans, our tax equivalent (TE) net interest margin was 3.46% for the second quarter of 2014, compared to 3.60% for the first quarter of 2014 and 3.46% for the second quarter of 2013. Total average earning asset yields (excluding the discount on covered loans) were 3.70% for the second quarter of 2014, compared to 3.87% for the first quarter of 2014 and 3.73% for the second quarter of 2013. Total cost of funds of 0.26% for the second quarter of 2014, decreased 2 basis points from 0.28% for the first quarter of 2014 and decreased 3 basis points from 0.29% for the second quarter of 2013. During the first quarter of 2014, we had one non-performing commercial real estate loan that was paid in full, resulting in a $2.3 million increase in interest income. This positively impacted our net interest margin by approximately 15 basis points for the first quarter of 2014.

 

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The average balance of total loans increased $169.7 million to $3.52 billion for the second quarter of 2014, compared to $3.35 billion for the second quarter of 2013. The increase included $128.9 million of average loans acquired from ASB on May 15, 2014. The average yield on loans (excluding the discount on covered loans) was 4.80% for the second quarter of 2014, compared to 4.97% for the second quarter of 2013. Lower rates on mortgages continued to result in refinancings during the second quarter of 2014 as we continued to see competitive pressure on rates in all classes of loans. We earned $791,000 in loan prepayment penalty fees for the second quarter of 2014, compared with $585,000 for the first quarter of 2014 and $1.1 million for the second quarter of 2013.

Total average earning assets of $6.67 billion increased $759.9 million, or 12.87%, from $5.91 billion for the second quarter of 2013. This increase was principally due to a $521.9 million increase in average investment securities to $2.84 billion for the second quarter of 2014, compared to $2.32 billion for the second quarter of 2013. Total average loans, net of deferred fees and discount on covered loans, increased $178.9 million primarily due to a $210.4 million increase in average non-covered loans to $3.37 billion for the second quarter of 2014, compared to $3.16 billion for the second quarter of 2013. The increase in non-covered loans included $128.9 million of average loans acquired from ASB on May 15, 2014. Average overnight funds sold to the Federal Reserve and interest-earning deposits with other institutions also increased $81.2 million. These increases were partially offset by a $22.1 million decrease in average investment in FHLB stock.

In general, we stop accruing interest on a loan after its principal or interest becomes 90 days or more past due. When a loan is placed on nonaccrual, all interest previously accrued but not collected is charged against earnings. There was no interest income that was accrued and not reversed on nonaccrual loans at June 30, 2014 and 2013. As of June 30, 2014 and 2013, we had $44.0 million and $53.4 million of non-covered nonaccrual loans, respectively.

Fees collected on loans are an integral part of the loan pricing decision. Net loan fees and the direct costs associated with the origination of loans are deferred and deducted from total loans on our balance sheet. Net deferred loan fees are recognized in interest income over the term of the loan using the effective-yield method. We recognized loan fee income of $769,000 and $1.6 million for the three and six months ended June 30, 2014, respectively, compared to $786,000 and $1.5 million for the three and six months ended June, 2013, respectively.

Interest income on investments of $16.9 million for the second quarter of 2014, increased $5.9 million, or 54.19%, from $10.9 million for the second quarter of 2013. Total TE yield on investments was 2.64% for the second quarter of 2014, compared to 2.24% for the same period in 2013. During the second quarter of 2014 we purchased $276.4 million in MBS with an average yield of 2.14% and an average duration of approximately four years. We also purchased $19.7 million in municipal securities with an average TE yield of 3.85% and an average duration of approximately seven years during the second quarter of 2014.

Interest expense of $4.1 million for the second quarter of 2014 increased $59,000, or 1.48%, compared to $4.0 million for the second quarter of 2013. Average interest-bearing deposits increased $255.8 million to $2.56 billion for the second quarter of 2014, compared to $2.30 billion for the second quarter of 2013. The average rate paid on interest-bearing liabilities decreased 5 basis points to 0.48% for the second quarter of 2014, from the second quarter of 2013, as a result of the continued low interest rate environment experienced for the second quarter of 2014, as well as the mix of interest-bearing liabilities.

Provision for Loan Losses

We maintain an allowance for loan losses that is increased by a provision for non-covered loan losses charged against operating results. The provision for loan losses is determined by management as the amount to be added to the allowance for loan losses after net charge-offs have been deducted to bring the allowance to an appropriate level which, in management’s best estimate, is necessary to absorb probable credit losses within the existing loan portfolio.

The allowance for loan losses was reduced to $61.0 million at June 30, 2014, primarily as a result of improved credit quality, compared to $75.2 million at December 31, 2013. We recorded a $7.6 million loan loss provision recapture for the three months ended June 30, 2014, compared to a $6.2 million loan loss provision recapture for the same period of 2013. We believe the allowance is appropriate at June 30, 2014. We periodically assess the quality of our portfolio to determine whether additional provisions for loan losses are necessary. The ratio of the allowance for loan losses to total non-covered net loans as of June 30, 2014 and December 31, 2013 was 1.75% and 2.22%, respectively. Refer to the discussion of “Allowance for Loan Losses” in Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations, contained herein, for discussion concerning observed changes in the credit quality of various components of our loan portfolio as well as changes and refinements to our methodology.

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, as the nature of this process requires considerable judgment. Net recoveries totaled $839,000 for the six months ended June 30, 2014, compared to net charge-offs of $784,000 for the same period of 2013. See “Allowance for Loan Losses” under Analysis of Financial Condition herein.

SJB loans acquired in the FDIC-assisted transaction were initially recorded at their fair value and are covered by a loss sharing agreement with the FDIC, which expires in October 2014. Due to the timing of the acquisition and the October 16, 2009 fair value estimate, there was no provision for loan losses on the covered SJB loans in 2009. During the six months ended June 30, 2014 and 2013, there was $39,000 in net charge-offs and zero in net charge-offs or recoveries, respectively, for loans in excess of the amount originally expected in the fair value of the loans at acquisition.

 

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Noninterest Income

Noninterest income includes income derived from special services offered, such as CitizensTrust, BankCard services, international banking, and other business services. Also included in noninterest income are service charges and fees, primarily from deposit accounts; gains (net of losses) from the disposition of investment securities, loans, other real estate owned, and fixed assets; and other revenues not included as interest on earning assets.

The following table sets forth the various components of noninterest income for the periods indicated.

 

     For the Three Months
Ended June 30,
    Variance     For the Six Months
Ended June 30,
    Variance  
     2014     2013     $     %     2014     2013     $     %  
     (Dollars in thousands)  

Noninterest income:

                

Service charges on deposit accounts

   $ 3,905      $ 4,145      $ (240     -5.79   $ 7,733      $ 7,971      $ (238     -2.99

Trust and investment services

     2,133        2,072        61        2.94     4,058        4,077        (19     -0.47

Bankcard services

     923        938        (15     -1.60     1,701        1,777        (76     -4.28

BOLI income

     601        627        (26     -4.15     1,239        1,370        (131     -9.56

Gain on sale of investment securities, net

     —          —          —          —          —          2,094        (2,094     -100.00

Decrease in FDIC loss sharing asset, net

     (1,467     (3,444     1,977        57.40     (3,174     (7,467     4,293        57.49

Gain on OREO, net

     130        2,568        (2,438     -94.94     135        3,132        (2,997     -95.69

Gain on sale of loans held-for-sale

     —          —          —          —          5,330        —          5,330        100.00

Other

     825        789        36        4.56     1,526        1,486        40        2.69
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total noninterest income

   $ 7,050      $ 7,695      $ (645     -8.38   $ 18,548      $ 14,440      $ 4,108        28.45
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Second Quarter of 2014 Compared to Second Quarter of 2013

Noninterest income of $7.1 million for the second quarter of 2014 decreased $645,000, or 8.38%, over noninterest income of $7.7 million for the second quarter of 2013. Noninterest income for the second quarter of 2014 decreased primarily due to a $2.5 million net pre-tax gain on the sale of one OREO property in the second quarter of 2013, partially offset by a $1.5 million net decrease in the FDIC loss sharing asset during the second quarter of 2014, compared to a $3.4 million net decrease in the FDIC loss sharing asset for the second quarter of 2013.

CitizensTrust consists of Wealth Management and Investment Services income. The Wealth Management group provides a variety of services, which include asset management, financial planning, estate planning, retirement planning, private and corporate trustee services, and probate services. Investment Services provides self-directed brokerage, 401(k) plans, mutual funds, insurance and other non-insured investment products. At June 30, 2014, CitizensTrust had approximately $2.46 billion in assets under management and administration, including $1.86 billion in assets under management. CitizensTrust generated fees of $2.2 million for the second quarter of 2014, compared to $2.1 million for the second quarter of 2013.

The Bank invests in Bank-Owned Life Insurance (BOLI). BOLI involves the purchasing of life insurance by the Bank on a selected group of employees. The Bank is the owner and beneficiary of these policies. BOLI is recorded as an asset at its cash surrender value. Increases in the cash value of these policies, as well as insurance proceeds received, are recorded in noninterest income and are not subject to income tax, as long as they are held for the life of the covered parties. BOLI income of $601,000 for the second quarter of 2014 decreased $26,000, or 4.15% from the second quarter of 2013.

Six Months of 2014 Compared to Six Months of 2013

The $4.1 million increase in noninterest income for the first six months of 2014 was primarily due to a $5.3 million pre-tax gain on the sale of one loan held-for-sale and a $3.2 million net decrease in the FDIC loss sharing asset during the six months ended June 2014, compared to a $7.5 million net decrease in the FDIC loss sharing asset for the same period of 2013. Noninterest income for the six months ended June 30, 2013 included a net pre-tax gain of $2.1 million on the sale of investments securities and $2.5 million net pre-tax gain on the sale of one OREO property.

 

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Table of Contents

Noninterest Expense

The following table summarizes the various components of noninterest expense for the periods indicated.

 

     For the Three Months
Ended June 30,
    Variance     For the Six Months
Ended June 30,
    Variance  
     2014     2013     $     %     2014     2013     $     %  
     (Dollars in thousands)  

Noninterest expense:

                

Salaries and employee benefits

   $ 18,614      $ 17,088      $ 1,526        8.93   $ 38,031      $ 34,388      $ 3,643        10.59

Occupancy

     2,704        2,638        66        2.50     5,521        5,260        261        4.96

Equipment

     972        927        45        4.85     1,880        1,987        (107     -5.39

Professional services

     1,646        1,387        259        18.67     3,010        2,983        27        0.91

Software licenses and maintenance

     1,010        1,163        (153     -13.16     2,075        2,315        (240     -10.37

Stationery and supplies

     337        366        (29     -7.92     769        843        (74     -8.78

Telecommunications expense

     362        312        50        16.03     677        634        43        6.78

Promotion

     1,341        1,140        201        17.63     2,607        2,398        209        8.72

Amortization of intangible assets

     193        437        (244     -55.84     315        875        (560     -64.00

OREO expense

     113        33        80        242.42     138        363        (225     -61.98

Regulatory assessments

     997        865        132        15.26     1,958        1,755        203        11.57

Loan expense

     321        150        171        114.00     558        813        (255     -31.37

Acquisition related expenses

     638        —          638        100.00     1,065        —          1,065        100.00

Other

     2,076        1,742        334        19.17     3,877        4,432        (555     -12.52
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total noninterest expense

   $ 31,324      $ 28,248      $ 3,076        10.89   $ 62,481      $ 59,046      $ 3,435        5.82
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Noninterest expense to average assets

     1.79     1.80         1.82     1.89    

Efficiency ratio (1)

     48.78     46.85         47.10     48.55    

 

(1) Noninterest expense divided by net interest income before provision for loan losses plus noninterest income.

Second Quarter of 2014 Compared to Second Quarter of 2013

Our ability to control noninterest expenses in relation to asset growth can be measured in terms of total noninterest expense as a percentage of average assets. Noninterest expense measured as a percentage of average assets was 1.79% for the second quarter of 2014, compared to 1.80% for the second quarter of 2013.

Our ability to control noninterest expenses in relation to the level of total revenue (net interest income before provision for loan losses plus noninterest income) is measured by the efficiency ratio and indicates the percentage of net revenue that is used to cover expenses. For the second quarter of 2014, the efficiency ratio was 48.78%, compared to 46.85% for the second quarter of 2013.

Noninterest expense for the second quarter of 2014 increased $3.1 million, or 10.89%. The overall increase was primarily due to a $1.5 million increase in salaries and employee benefits, principally due to increased new hire expenses, other employee benefits, and expenses related to new associates acquired through ASB. The second quarter of 2014 included $638,000 for non-recurring merger related expenses in connection with our acquisition of ASB.

Six Months of 2014 Compared to Six Months of 2013

The $3.4 million increase in noninterest expense for the six months ended June 30, 3014 was primarily attributable to increases of $3.6 million in salaries and employee benefits expense and $1.1 million for non-recurring acquisition related expenses. The increases were partially offset by decreases of $560,000 in intangible amortization expense, $255,000 in loan expense, $240,000 in software licenses and maintenance, and $555,000 in other expenses. Other expense for the six months ended June 30, 2013 included a $1.0 million accrual for potential interest and penalties associated with previous years’ federal and state income tax returns.

Income Taxes

The Company’s effective tax rate for the three and six months ended June 30, 2014 was 37.05% and 36.50%, respectively. This compares to 36.02% for the second quarter of 2013. Our estimated annual effective tax rate varies depending upon tax-advantaged income as well as available tax credits. We benefited from approximately $1.1 million of enterprise zone tax credits reflected during the first half of 2013, many of which have been eliminated in 2014.

The effective tax rates are below the nominal combined Federal and State tax rate as a result of tax-advantaged income from certain investments and municipal loans and leases as a percentage of total income as well as available tax credits for each period. The majority of tax-advantaged income is derived from municipal securities.

 

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RESULTS BY BUSINESS SEGMENTS

We have two reportable business segments: which are (i) Business Financial and Commercial Banking Centers (“Centers”) and (ii) Treasury. The results of these two segments are included in the reconciliation between business segment totals and our consolidated total. Our business segments do not include the results of administration units that do not meet the definition of an operating segment. There are no provisions for loan losses or taxes in the segments as these are accounted for at the corporate level.

Key measures we use to evaluate the segments’ performance are included in the following table for the three and six months ended June 30, 2014 and 2013. These tables also provide additional significant segment measures useful to understanding the performance of this segment.

Business Financial and Commercial Banking Centers

 

     For the Three Months Ended
June 30,
    For the Six Months Ended
June 30,
 
     2014     2013     2014     2013  
     (Dollars in thousands)  

Key Measures:

        

Statement of Operations

        

Interest income (1)

   $ 43,058      $ 41,710      $ 83,223      $ 83,457   

Interest expense (1)

     2,798        2,478        5,525        5,050   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

     40,260        39,232      $ 77,698      $ 78,407   
  

 

 

   

 

 

   

 

 

   

 

 

 

Noninterest income

     5,162        5,477        9,944        10,583   

Noninterest expense

     11,522        11,319        23,350        22,896   
  

 

 

   

 

 

   

 

 

   

 

 

 

Segment pre-tax profit

   $ 33,900      $ 33,390      $ 64,292      $ 66,094   
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance Sheet

        

Average loans

   $ 2,857,862      $ 2,595,592      $ 2,806,544      $ 2,597,860   

Average interest-bearing deposits and customer repurchases

   $ 2,939,290      $ 2,565,202      $ 2,907,191      $ 2,600,266   

Yield on loans (2)

     4.97     5.44     4.92     5.48

Rate paid on interest-bearing deposits and customer repurchases

     0.21     0.23     0.22     0.23

 

(1) Interest income and interest expense include credit for funds provided and charges for funds used, respectively. These are eliminated in the condensed consolidated presentation.
(2) Yield on loans excludes SJB discount accretion, and is accounted for at the corporate level.

For the second quarter of 2014, the Centers’ segment pre-tax profit increased by $510,000, or 1.53%, primarily due to an increase in net interest income of $1.0 million, or 2.62%, compared to the second quarter of 2013. The $1.0 million increase in interest income for the second quarter of 2014 was principally due to a $262.3 million increase in average loans, (approximately $129 million acquired from ASB), partially offset by a 47 basis point drop in the loan yield to 4.97% for the second quarter of 2014, compared to 5.44% for the second quarter of 2013. This increase in interest income was offset by a $315,000 decrease in noninterest income and a $203,000 increase in noninterest expense for the three months ended June 30, 2014, compared to the same period of 2013.

 

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Treasury

 

     For the Three Months Ended
June 30,
    For the Six Months Ended
June 30,
 
     2014     2013     2014     2013  
     (Dollars in thousands)     (Dollars in thousands)  

Key Measures:

        

Statement of Operations

        

Interest income (1)

   $ 17,675      $ 11,641      $ 34,107      $ 24,429   

Interest expense (1)

     15,826        13,282        30,996        26,213   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

     1,849        (1,641   $ 3,111      $ (1,784
  

 

 

   

 

 

   

 

 

   

 

 

 

Noninterest income

     —          —          —          2,094   

Noninterest expense

     182        177        378        361   
  

 

 

   

 

 

   

 

 

   

 

 

 

Segment pre-tax profit (loss)

   $ 1,667      $ (1,818   $ 2,733      $ (51
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance Sheet

        

Average investments

   $ 2,844,496      $ 2,322,630      $ 2,743,048      $ 2,370,190   

Average interest-bearing deposits

   $ 238,352      $ 240,001      $ 239,172      $ 240,002   

Average borrowings

   $ 199,417      $ 201,617        201,880      $ 213,556   

Yield on investments-TE

     2.64     2.24     2.66     2.31

Non-tax equivalent yield

     2.37     1.89     2.37     1.97

Average cost of borrowings

     4.73     4.68     4.68     4.43

 

(1) Interest income and interest expense include credit for funds provided and charges for funds used, respectively. These are eliminated in the condensed consolidated presentation.

For the second quarter of 2014, the Company’s Treasury department reported a pre-tax profit of $1.7 million, compared to a pre-tax loss of $1.8 million for the second quarter of 2013. This increase was primarily due to a $6.0 million increase in interest income due to a $521.9 million increase in average investments and a 40 basis point increase in yield on investments (TE). The increase in interest income was partially offset by a $2.5 million increase in interest expense.

Other

 

     For the Three Months Ended
June 30,
    For the Six Months Ended
June 30,
 
     2014     2013     2014     2013  
     (Dollars in thousands)     (Dollars in thousands)  

Key Measures:

        

Statement of Operations

        

Interest income (1)

   $ 19,557      $ 19,936      $ 42,559      $ 40,726   

Interest expense (1)

     4,507        4,932        9,267        10,165   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

     15,050        15,004      $ 33,292      $ 30,561   
  

 

 

   

 

 

   

 

 

   

 

 

 

Recapture of provision for loan losses

     (7,600     (6,200     (15,100     (6,200

Noninterest income

     1,888        2,218        8,604        1,763   

Noninterest expense

     19,620        16,752        38,753        35,789   
  

 

 

   

 

 

   

 

 

   

 

 

 

Segment pre-tax profit

   $ 4,918      $ 6,670      $ 18,243      $ 2,735   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Interest income and interest expense include credit for funds provided and charges for funds used, respectively. These are eliminated in the condensed consolidated presentation.

The Company’s administration and other operating departments reported pre-tax profit of $4.9 million for the second quarter of 2014, a decrease of $1.8 million, or 26.27%, from $6.7 million for the second quarter of 2013. The decrease in pre-tax profit was principally due to an increase in salaries and employee benefits of $1.5 million, non-recurring merger related expenses associated with the ASB acquisitions of $638,000. The second quarter of 2014 included a $7.6 million loan loss provision recapture, compared to a $6.2 million provision recapture for the second quarter of 2013.

 

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ANALYSIS OF FINANCIAL CONDITION

The Company reported total assets of $7.42 billion at June 30, 2014. This represented an increase of $759.0 million, or 11.39%, from total assets of $6.66 billion at December 31, 2013. Earning assets of $7.02 billion at June 30, 2014 increased $692.0 million, or 10.94% when compared with $6.32 billion at December 31, 2013. The increase in earning assets during the first half of 2014 was primarily due to a $353.7 million increase in investment securities, a $71.0 million increase in total loans, and a $263.4 million increase in interest-earning deposits with the Federal Reserve. Total liabilities were $6.58 billion at June 30, 2014, an increase of $690.2 million, or 11.71%, from total liabilities of $5.89 billion at December 31, 2013. Total equity increased $68.9 million, or 8.92%, to $840.8 million at June 30, 2014, compared to total equity of $771.9 million at December 31, 2013.

On May 15, 2014, we completed the acquisition of American Security Bank, a Newport Beach, CA headquartered regional bank with approximately $433 million in total assets and five branch locations throughout Orange County, San Bernardino County, and Los Angeles County. The increase in total assets at June 30, 2014 included approximately $240 million in acquired loans, $30 million in acquired investment securities and $374 million in acquired total deposits.

Investment Securities

The Company maintains a portfolio of investment securities to provide interest income and to serve as a source of liquidity for its ongoing operations. At June 30, 2014, we reported total investment securities of $3.02 billion. This represented an increase of $353.7 million, or 13.27%, from total investment securities of $2.67 billion at December 31, 2013. As of June 30, 2014, the Company had a pre-tax net unrealized holding gain on total investment securities of $41.5 million, compared to a pre-tax net unrealized loss of $16.1 million at December 31, 2013. The changes in the net unrealized holding gain resulted primarily from fluctuations in market interest rates and the increased portfolio balance. For the six months ended June 30, 2014 and 2013, total repayments/maturities and proceeds from sales of investment securities totaled $204.6 million and $374.8 million, respectively. The Company purchased additional investment securities totaling $413.5 million and $368.8 million for the six months ended June 30, 2014 and 2013, respectively. The proceeds from sales of investment securities, which included the 13 investment securities that were sold for a net gain on sale of $2.1 million in the first quarter of 2013, were used to purchase additional investment securities. No investment securities were sold during the first six months of 2014.

The table below sets forth investment securities available-for-sale at June 30, 2014 and December 31, 2013.

 

     June 30, 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

   $ 346,315       $ 2       $ (13,146   $ 333,171         11.04

Residential mortgage-backed securities

     1,725,530         28,829         (6,278     1,748,081         57.93

CMO’s / REMIC’s - residential

     335,121         8,546         (405     343,262         11.38

Municipal bonds

     564,046         25,234         (1,404     587,876         19.48

Other securities

     5,000         100         —          5,100         0.17
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 2,976,012       $ 62,711       $ (21,233   $ 3,017,490         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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The weighted-average yield (TE) on the investment portfolio at June 30, 2014 was 2.48% with a weighted-average life of 4.1 years. This compares to a weighted-average yield of 2.35% at December 31, 2013 with a weighted-average life of 4.0 years and a yield of 2.20% at June 30, 2013 with a weighted-average life of 4.4 years.

Approximately 80% of the securities in the total investment portfolio, at June 30, 2014, are issued by the U.S government or U.S. government-sponsored agencies and enterprises, which have the implied guarantee payment of principal and interest. As of June 30, 2014, approximately $137.6 million in U.S. government agency bonds are callable.

The remaining CMO/REMICs are backed by agency-pooled collateral or whole loan collateral. 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 June 30, 2014 and December 31, 2013.

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 June 30, 2014 and December 31, 2013. The unrealized losses on these securities were primarily attributed to changes in interest rates. The issuers of these securities have not, to our knowledge, established any cause for default on these securities. These securities have fluctuated in value since their purchase dates as market rates have fluctuated. However, we have the ability and the intention to hold these securities until their fair values recover to cost or maturity. As such, management does not deem these securities to be other-than-temporarily-impaired except for one investment security classified as held-to-maturity. A summary of our analysis of these securities and the unrealized losses is described more fully in Note 4 — Investment Securities in the notes to the unaudited condensed consolidated financial statements. Economic trends may adversely affect the value of the portfolio of investment securities that we hold.

 

     June 30, 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

   $ 12,279       $ 14       $ 310,140       $ 13,132       $ 322,419       $ 13,146   

Residential mortgage-backed securities

     1         —           318,837         6,278         318,838         6,278   

CMO / REMICs - residential

     10,190         11         44,425         394         54,615         405   

Municipal bonds

     15,399         134         37,358         1,270         52,757         1,404   

Other securities

     —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 37,869       $ 159       $ 710,760       $ 21,074       $ 748,629       $ 21,233   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     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   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

During the six months ended June 30, 2014 and 2013, there were no other-than-temporary impairment recognized on the held-to-maturity investment security.

 

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Loans

Total loans and leases, net of deferred fees and discount was $3.62 billion at June 30, 2014, compared to $3.42 billion at March 31, 2014 and $3.55 billion at December 31, 2013. Quarter-over-quarter, non-covered loans increased by $224.7 million, and covered loans decreased by $6.6 million. The increase in total loans included $240 million of loans acquired from ASB. The $224.7 million quarter-over-quarter increase in non-covered loans was principally due to increases of $206.8 million in commercial real estate loans, $23.7 million in commercial and industrial loans, and $16.6 million in construction loans. The overall increase in non-covered loans was partially offset by a $32.9 million decrease in dairy & livestock and agribusiness loans. Our dairy & livestock portfolio decreased by $37.0 million for the second quarter of 2014. The combination of higher milk prices and lower feed costs produced strong profitability for our dairy customers. This profitability led to significant paydowns on many of our customer’s herd and feed lines with the Bank. The overall decrease in loans was partially offset by an increase of $8.2 million in SFR mortgage-direct loans (excluding pools), for the quarter.

Total loans, net of deferred loan fees, comprise 51.61% of our total earning assets of June 30, 2014. The following table presents our total loan portfolio, excluding held-for-sale loans, by category for the periods indicated below:

 

     June 30, 2014  
     Non-Covered
Loans
    Covered Loans     Total  
     (Dollars in thousands)  

Commercial and industrial

   $ 514,409      $ 17,194      $ 531,603   

Real estate:

      

Commercial real estate

     2,400,864        126,768        2,527,632   

Construction

     59,477        —          59,477   

SFR mortgage

     186,924        295        187,219   

Dairy & livestock and agribusiness

     180,051        411        180,462   

Municipal lease finance receivables

     78,934        —          78,934   

Consumer and other loans

     70,997        3,504        74,501   
  

 

 

   

 

 

   

 

 

 

Gross loans

     3,491,656        148,172        3,639,828   

Less:

      

Purchase accounting discount on covered loans

     —          (9,476     (9,476

Deferred loan fees, net

     (9,425     —          (9,425
  

 

 

   

 

 

   

 

 

 

Gross loans, net of deferred loan fees and discount

     3,482,231        138,696        3,620,927   

Less: Allowance for loan losses

     (60,974     —          (60,974
  

 

 

   

 

 

   

 

 

 

Net loans

   $ 3,421,257      $ 138,696      $ 3,559,953   
  

 

 

   

 

 

   

 

 

 

Allowance for loan losses as a percentage of loans, net of deferred loan fees

     1.75    

 

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Table of Contents
     December 31, 2013  
     Non-Covered
Loans
    Covered Loans     Total  
     (Dollars in thousands)  

Commercial and industrial

   $ 512,792      $ 20,461      $ 533,253   

Real estate:

      

Commercial real estate

     2,207,515        141,141        2,348,656   

Construction

     47,109        644        47,753   

SFR mortgage

     189,233        313        189,546   

Dairy & livestock and agribusiness

     294,292        6,000        300,292   

Municipal lease finance receivables

     89,106        —          89,106   

Consumer and other loans

     55,103        4,545        59,648   
  

 

 

   

 

 

   

 

 

 

Gross loans

     3,395,150        173,104        3,568,254   

Less:

      

Purchase accounting discount

     —          (12,789     (12,789

Deferred loan fees, net

     (9,234     —          (9,234
  

 

 

   

 

 

   

 

 

 

Gross loans, net of deferred loan fees and discount

     3,385,916        160,315        3,546,231   

Less: Allowance for loan losses

     (75,235     —          (75,235
  

 

 

   

 

 

   

 

 

 

Net loans

   $ 3,310,681      $ 160,315      $ 3,470,996   
  

 

 

   

 

 

   

 

 

 

Allowance for loan losses as a percentage of loans, net of deferred loan fees

     2.22    

Commercial and industrial loans are loans to commercial entities to finance capital purchases or improvements, or to provide cash flow for operations. Real estate loans are loans secured by conforming trust deeds on real property, including property under construction, land development, commercial property and single-family and multi-family residences. Consumer loans include auto and equipment leases, installment loans to consumers as well as home equity loans and other loans secured by junior liens on real property. Municipal lease finance receivables are leases to municipalities. Dairy & livestock and agribusiness loans are loans to finance the operating needs of wholesale dairy farm operations, cattle feeders, livestock raisers and farmers.

Our loan portfolio is from a variety of areas throughout our marketplace. The following is the breakdown of our total non-covered held-for-investment loans and commercial real estate loans by region as of June 30, 2014.

Non-Covered Loans by Market Area

 

     June 30, 2014  
     Total
Non-Covered Loans
    Non-Covered
Commercial Real Estate Loans
 
     (Dollars in thousands)  

Los Angeles County

   $ 1,399,668         40.1   $ 993,194         41.4

Inland Empire

     629,532         18.0     538,359         22.4

Central Valley

     629,006         18.0     425,580         17.7

Orange County

     563,721         16.2     280,823         11.7

Other areas (1)

     269,729         7.7     162,908         6.8
  

 

 

    

 

 

   

 

 

    

 

 

 
   $ 3,491,656         100.0   $ 2,400,864         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) Other areas include loans that are out-of-state or in other areas of California.

 

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Table of Contents

Covered Loans by Market Area

 

     June 30, 2014  
     Total
Covered Loans
    Covered
Commercial Real Estate Loans
 
     (Dollars in thousands)  

Los Angeles County

   $ 9,611         6.5   $ 7,833         6.2

Inland Empire

     —           —          —           —     

Central Valley

     130,449         88.0     114,497         90.3

Other areas (1)

     8,112         5.5     4,438         3.5
  

 

 

    

 

 

   

 

 

    

 

 

 
   $ 148,172         100.0   $ 126,768         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) Other areas include loans that are out-of-state or in other areas of California.

Our real estate loans are comprised of industrial, office, retail, single-family residences, multi-family residences, and farmland. We strive to have an original loan-to-value ratio less than 75%. The table below breaks down our non-covered real estate portfolio, with the exception of construction loans which are addressed in a separate table.

Non-Covered SFR Mortgage and Commercial Real Estate Loans

 

     June 30, 2014  
     Loan Balance      Percent     Percent
Owner-
Occupied (1)
    Average
Loan Balance
 
     (Dollars in thousands)  

SFR mortgage:

         

SFR mortgage - Direct

   $ 114,662         4.4     100.0   $ 494   

SFR mortgage - Mortgage pools

     72,262         2.8     100.0     228   
  

 

 

    

 

 

     

Total SFR mortgage

     186,924         7.2    
  

 

 

    

 

 

     

Commercial real estate:

         

Multi-family

     217,991         8.4     1.6     1,444   

Industrial

     673,352         26.0     33.8     973   

Office

     414,753         16.0     30.0     1,069   

Retail

     436,650         16.9     8.6     1,456   

Medical

     168,947         6.5     36.6     1,817   

Secured by farmland

     140,928         5.5     100.0     1,957   

Other

     348,243         13.5     47.6     1,309   
  

 

 

    

 

 

     

Total commercial real estate

     2,400,864         92.8    
  

 

 

    

 

 

     

Total SFR mortgage and commercial real estate loans

   $ 2,587,788         100.0     36.7     1,221   
  

 

 

    

 

 

     

 

(1) Represents percentage of reported owner-occupied at origination in each real estate loan category.

The SFR mortgage—Direct loans in the table above include SFR mortgage loans which are currently generated through an internal program in our Centers. This program is focused on owner-occupied SFR’s with defined loan-to-value, debt-to-income and other credit criteria, such as FICO credit scores, that we believe are appropriate for loans which are primarily intended for retention in our Bank’s loan portfolio. The program was changed to enable our Bank to underwrite and process SFR mortgage loans generated through our Centers, as opposed to our past practice of contracting with an outside party for certain underwriting and related loan origination services. This program involving Bank-generated referrals, credit guidelines and underwriting was initiated during the quarter ended December 31, 2012, and we originated loan volume in the aggregate principal amount of $9.3 million under this program during the second quarter of 2014.

In addition, we previously purchased pools of owner-occupied single-family loans from real estate lenders, SFR mortgage—Mortgage Pools, totaling $72.3 million at June 30, 2014. These loans were purchased with average FICO scores predominantly ranging from 700 to over 800 and overall original loan-to-value ratios of 60% to 80%. These pools were purchased to diversify our loan portfolio. We have not purchased any mortgage pools since August 2007.

 

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Table of Contents

The table below provides a breakdown of our covered commercial real estate and SFR mortgage portfolios:

Covered SFR Mortgage and Commercial Real Estate Loans

 

     June 30, 2014  
     Loan Balance      Percent     Percent
Owner-
Occupied (1)
    Average
Loan Balance
 
     (Dollars in thousands)  

SFR mortgage

         

SFR mortgage - Direct

   $ 295         0.2     100.0   $ 98   

SFR mortgage - Mortgage pools

     —           —          —          —     
  

 

 

    

 

 

     

Total SFR mortgage

     295         0.2    

Commercial real estate:

         

Multi-family

     2,696         2.1     —          1,348   

Industrial

     27,247         21.5     49.8     605   

Office

     14,241         11.2     41.3     570   

Retail

     15,523         12.2     31.5     706   

Medical

     13,608         10.7     83.4     1,134   

Secured by farmland

     5,815         4.6     100.0     342   

Other (2)

     47,638         37.5     58.6     851   
  

 

 

    

 

 

     

Total commercial real estate

     126,768         99.8    
  

 

 

    

 

 

     

Total SFR mortgage and commercial real estate loans

   $ 127,063         100.0     54.9     765   
  

 

 

    

 

 

     

 

(1) Represents percentage of reported owner-occupied at origination in each real estate loan category.
(2) Includes loans associated with hospitality, churches, gas stations, and hospitals, which represents approximately 72% of other loans.

Non-Covered Construction Loans

As of June 30, 2014, the Company had $59.5 million in non-covered construction loans. This represents 1.70% of total non-covered gross loans held-for-investment. Although our construction loans are located throughout our market footprint, the majority of non-covered construction loans consist of commercial land development and construction projects in Los Angeles, Orange County, and the Inland empire region of Southern California. At June 30, 2014, non-covered construction loans consist of $13.4 million in SFR and multi-family construction loans and $46.1 million in commercial construction loans. As of June 30, 2014, there was one nonperforming loan totaling $9.8 million, or 16.42% of total construction loans.

Nonperforming Assets (Non-Covered)

The following table provides information on non-covered nonperforming assets as of June 30, 2014 and December 31, 2013.

 

     June 30, 2014     December 31, 2013  
     (Dollars in thousands)  

Nonaccrual loans

   $ 16,573      $ 14,835   

Troubled debt restructured loans (nonperforming)

     27,397        25,119   

Other real estate owned (“OREO”)

     6,539        6,475   
  

 

 

   

 

 

 

Total nonperforming assets

   $ 50,509      $ 46,429   
  

 

 

   

 

 

 

Troubled debt restructured performing loans

   $ 61,878      $ 66,955   
  

 

 

   

 

 

 

Percentage of nonperforming assets to total loans outstanding, net of deferred fees, and OREO

     1.45     1.37
  

 

 

   

 

 

 

Percentage of nonperforming assets to total assets

     0.68     0.70
  

 

 

   

 

 

 

At June 30, 2014, loans classified as impaired totaled $105.8 million or 3.03% of total non-covered loans, compared to $106.9 million or 3.15% of total non-covered loans at December 31, 2013. This balance included nonperforming loans of $44.0 million. At June 30, 2014, impaired loans which were restructured in a troubled debt restructuring (“TDR”) represented $89.3 million, of which $27.4 million were nonperforming and $61.9 million were performing.

 

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Of the total impaired loans as of June 30, 2014, $46.3 million were considered collateral dependent and measured using the fair value of the collateral based on current appraisals (obtained within 1 year). Impaired loans measured for impairment using the present value of expected future cash flows discounted at the loans effective rate were $59.5 million.

Troubled Debt Restructurings

Total TDRs were $89.3 million at June 30, 2014, compared to $92.1 million at December 31, 2013. Of the $27.4 million of nonperforming TDRs at June 30, 2014, $2.5 million were not paying in accordance with the modified terms and $24.9 million have either not demonstrated repayment performance for a sustained period, and/or we have not received all necessary documents to determine the borrower’s ability to meet all future principal and interest payments under the modified terms. At June 30, 2014, $61.9 million of performing TDRs were accruing restructured loans. Performing TDRs were granted in response to borrower financial difficulty and generally provide for a modification of loan repayment terms. The performing restructured loans represent the only impaired loans accruing interest at each respective reporting date. A performing restructured loan is reasonably assured of repayment and is performing in accordance with the modified terms. We have not restructured loans into multiple loans in what is typically referred to as an “A/B” note structure, where normally the “A” note meets current underwriting standards and the “B” note is typically immediately charged off upon restructuring.

The following table provides a summary of TDRs as of June 30, 2014 and December 31, 2013:

 

     June 30, 2014      December 31, 2013  
     Balance      Number of Loans      Balance      Number of Loans  
     (Dollars in thousands)  

Performing TDRs:

           

Commercial and industrial

   $ 1,073         6       $ 1,171         7   

Real Estate:

           

Commercial real estate

     22,007         13         21,030         15   

Construction

     16,787         2         16,853         2   

SFR mortgage

     3,789         11         3,828         11   

Dairy & livestock and agribusiness

     18,222         10         24,073         11   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total performing TDRs

   $ 61,878         42       $ 66,955         46   
  

 

 

    

 

 

    

 

 

    

 

 

 

Nonperforming TDRs:

           

Commercial and industrial

   $ 1,460         7       $ 1,509         5   

Real Estate:

           

Commercial real estate

     10,430         10         7,281         6   

Construction

     9,767         1         9,966         1   

SFR mortgage

     682         1         705         1   

Dairy & livestock and agribusiness

     5,058         3         5,658         4   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total nonperforming TDRs

   $ 27,397         22       $ 25,119         17   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total TDRs

   $ 89,275         64       $ 92,074         63   
  

 

 

    

 

 

    

 

 

    

 

 

 

At June 30, 2014 and December 31, 2013, $1.7 million and $2.7 million of the allowance for loan losses was specifically allocated to TDRs, respectively. Impairment amounts identified are typically charged off against the allowance at the time a probable loss is determined. There were no charge-offs for TDRs recorded during the three months ended June 30, 2014 and 2013.

 

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The table below provides trends in our non-covered nonperforming assets and delinquencies for the periods presented.

Nonperforming Assets and Delinquency Trends (Non-Covered)

 

     June 30,
2014 (1)
    March 31,
2014
    December 31,
2013
    September 30,
2013
    June 30,
2013
 
     (Dollars in thousands)  

Nonperforming loans:

          

Commercial and industrial

   $ 6,969      $ 4,821      $ 3,861      $ 3,734      $ 5,012   

Real estate:

          

Commercial real estate

     14,866        11,852        12,410        17,829        18,610   

Construction

     9,767        9,867        9,966        10,368        10,494   

SFR mortgage

     6,765        7,868        7,577        10,421        11,423   

Dairy & livestock and agribusiness

     5,133        5,397        5,739        6,973        7,655   

Consumer and other loans

     470        397        401        159        157   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 43,970      $ 40,202      $ 39,954      $ 49,484      $ 53,351   

% of Total gross loans

     1.26     1.23     1.18     1.51     1.68

Past due 30-89 days:

          

Commercial and industrial

   $ 1,205      $ —        $ 993      $ 417      $ 373   

Real estate:

          

Commercial real estate

     732        520        523        1,015        1,251   

Construction

     —          —          —          —          —     

SFR mortgage

     161        432        1,708        —          —     

Dairy & livestock and agribusiness

     —          —          —          —          —     

Consumer and other loans

     168        8        75        255        8   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 2,266      $ 960      $ 3,299      $ 1,687      $ 1,632   

% of Total gross loans

     0.07     0.03     0.10     0.05     0.05

OREO:

          

Commercial and industrial

   $ 1,638      $ —        $ —        $ —        $ —     

Real estate:

          

Commercial real estate

     —          —          —          —          —     

Construction

     4,901        6,475        6,475        6,524        6,524   

SFR mortgage

     —          —          —          —          —     

Consumer and other loans

     —          —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 6,539      $ 6,475      $ 6,475      $ 6,524      $ 6,524   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming, past due, and OREO

   $ 52,775      $ 47,637      $ 49,728      $ 57,695      $ 61,507   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

% of Total gross loans

     1.52     1.46     1.47     1.76     1.94

 

(1) Includes $8.0 million of nonperforming assets acquired from ASB: $5.5 million of nonaccrual loans, $412,000 of past due loans and $2.0 million of OREOs.

At June 30, 2014, six customer relationships comprised $22.1 million, or 50.23%, of our nonperforming loans. Four of these customer relationships are commercial real estate developers (owner/non-owner occupied); and the primary collateral securing these loans are commercial real estate properties. The other two customer relationships are in the dairy & livestock industry and the collateral is primarily the dairy farm property and the dairy livestock. At June 30, 2014, there was $1.5 million of the allowance for loan losses was specifically allocated to these loans. There were no charge-offs recorded for these six customer relationships during the six months ended June 30, 2014.

We had $6.5 million in OREO at June 30, 2014, December 31, 2013, and June 30, 2013. As of June 30, 2014, we had six OREO properties compared with two OREO properties at December 31, 2013. During the first half of 2014, we acquired three OREO properties and added two additional properties. We sold one property with a carrying value of $1.9 million, realizing a net gain on sale of $98,000.

Changes in economic and business conditions have had an impact on our market area and on our loan portfolio. We continually monitor these conditions in determining our estimates of needed reserves. However, we cannot predict the extent to which the deterioration in general economic conditions, real estate values, increases in general rates of interest, and changes in the financial conditions or business of a borrower may adversely affect a borrower’s ability to pay. See “Risk Management — Credit Risk Management” contained in our Annual Report on Form 10-K for the year ended December 31, 2013.

 

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Nonperforming Assets (Covered)

Loans acquired through the SJB acquisition are accounted for under ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality (“ASC 310-30”). Covered loans accounted for under ASC 310-30 are generally considered accruing and performing loans as the loans accrete interest income over the estimated life of the loan when cash flows are reasonably estimable. Accordingly, acquired impaired loans that are contractually past due are still considered to be accruing and performing loans. If the timing and amount of future cash flows is not reasonably estimable, the loans may be classified as nonperforming loans and interest income is not recognized until the timing and amount of future cash flows can be reasonably estimated. As of June 30, 2014, there were no covered loans considered as nonperforming as described above.

We had two properties in OREO totaling $655,000 at June 30, 2014, compared to two properties totaling $504,000 at March 31, 2014 and December 31, 2013. For the six months ended June 30, 2014, there was one addition to OREO totaling $340,000. During the first half of 2014, we sold one property with a carrying value of $189,000.

Allowance for Loan Losses

The allowance for loan losses is established as management’s estimate of probable losses inherent in the loan and lease receivables portfolio. The allowance is increased (decreased) 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 added 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 credit 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 credit losses.

We maintain an allowance for inherent loan losses that is increased by a provision for loan losses charged against operating results. The allowance for loan losses is also increased by recoveries on loans previously charged off and is reduced by actual loan losses charged to the allowance. The allowance for loan losses was $61.0 million as of June 30, 2014. This represents a decrease of $14.3 million, or 18.96%, compared to the allowance for loan losses of $75.2 million as of December 31, 2013. We recorded a $7.6 million loan loss provision recapture for the three months ended June 30, 2014, compared to $6.2 million recapture of provision for loan losses for the same period of 2013.

 

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The table below presents a comparison of net loan losses, the provision for loan losses, and the resulting allowance for loan losses for the six months ended June 30, 2014 and 2013.

Summary of Loan Loss Experience (Non-Covered Loans)

 

     As of and For the
Six Months Ended
June 30,
 
     2014     2013  
     (Dollars in thousands)  

Allowance for loan losses at beginning of period

   $ 75,235      $ 92,441   

Charge-offs:

    

Commercial and industrial

     514        1,104   

Commercial real estate

     352        —     

Construction

     —          —     

SFR mortgage

     —          142   

Dairy & livestock and agribusiness

     —          —     

Consumer and other loans

     19        69   

Covered Loans

     40        —     
  

 

 

   

 

 

 

Total charge-offs

     925        1,315   
  

 

 

   

 

 

 

Recoveries:

    

Commercial and industrial

     561        208   

Commercial real estate

     138        66   

Construction

     797        68   

SFR mortgage

     —          133   

Dairy & livestock and agribusiness

     242        28   

Consumer and other loans

     26        28   

Covered Loans

     —          —     
  

 

 

   

 

 

 

Total recoveries

     1,764        531   
  

 

 

   

 

 

 

Net (recoveries) charge-offs

     (839     784   

Other reallocation

     —          —     

Recapture of provision for loan losses

     (15,100     (6,200
  

 

 

   

 

 

 

Allowance for loan losses at end of period

   $ 60,974      $ 85,457   
  

 

 

   

 

 

 

Summary of reserve for unfunded loan commitments:

    

Reserve for unfunded loan commitments at beginning of period

   $ 9,088      $ 8,588   

Provision for unfunded loan commitments

     —          —     
  

 

 

   

 

 

 

Reserve for unfunded loan commitments at end of period

   $ 9,088      $ 8,588   
  

 

 

   

 

 

 

Reserve for unfunded loan commitments to total unfunded loan commitments

     1.14     1.46

Amount of total loans at end of period (1)

   $ 3,482,231      $ 3,169,815   

Average total loans outstanding (1)

   $ 3,341,283      $ 3,176,095   

Net (recoveries) charge-offs to average total loans

     -0.03     0.02

Net (recoveries) charge-offs to total loans at end of period

     -0.02     0.02

Allowance for loan losses to average total loans

     1.82     2.69

Allowance for loan losses to total loans at end of period

     1.75     2.70

Net (recoveries) charge-offs to allowance for loan losses

     -1.38     0.92

Net recoveries (charge-offs) to provision for loan losses

     5.56     -12.65

 

(1) Net of deferred loan origination fees.

Specific allowance: For impaired loans, we incorporate specific allowances based on loans individually evaluated utilizing one of three valuation methods, as prescribed under ASC 310-10. If the measure of the impaired loan is less than the recorded investment in the loan, the deficiency will be charged off against the ALLL or, alternatively, a specific allocation will be established and included in the overall ALLL balance. The specific allocation represents $2.2 million (3.63%), $3.2 million (4.22%) and $4.9 million (5.68%) of the total allowance as of June 30, 2014, December 31, 2013 and June 30, 2013, respectively.

General allowance: The loan portfolio collectively evaluated for impairment under ASC 450-20 is divided into classes of loan receivables between “classified” loans (including substandard and special mention loans) and “unclassified” loans, and then further disaggregated into loan segments by loan type with similar risk characteristics. The non-classified loans are divided into 37 segments,

 

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including 25 specific segments within the commercial real estate and construction loan portfolios split between owner and non-owner properties and based on property type (i.e. industrial, office, retail, etc.). The allowance is provided for each segment based upon that segment’s average historical loss experience over a rolling twenty-quarter period, adjusted for current conditions based on our analysis of specific environmental or qualitative loss factors, as prescribed in the 2006 Interagency Policy Statement on ALLL, affecting the collectability of our loan portfolio that may cause actual loss rates to differ from historical loss experience.

In addition, recognizing the inherent imprecision in the estimation of these loss factors, we also incorporate an unallocated reserve that reflects management’s best estimate of probable losses not otherwise captured by our qualitative loss factors or otherwise accounted for in our ALLL methodology. Management believes that appropriate drawdowns from usage of the unallocated reserve may include, but are not limited to, (i) consideration of conditions or factors that may not be easily allocated to a specific loan segment, (ii) addressing elevated risks from unique or unusual conditions of volatility and uncertainty affecting the collectability of our loan portfolio, (iii) supporting allocations resulting from refinements to our factors, and (iv) prudent releases of general reserves, if warranted and appropriate when current conditions show demonstrable improvement in credit quality for a sustained period.

Moreover, as conditions change, we may modify or refine our methodology to better reflect risk characteristics that currently impact underlying credit components and the collectability of the loan portfolio. Examples of such modifications or refinements impacting our ALLL in recent quarters include (i) addition of a qualitative factor on “changes in the value of underlying collateral for collateral-dependent loans”, based on continuing weakness in the values of commercial real estate in our primary lending markets, (ii) increasing the number of segments within the classified and criticized pools primarily to disaggregate our real estate portfolio between owner-occupied and non-owner occupied commercial real estate loans, as well as between residential and non-residential construction loans, and (iii) creating a specific allocated pool for our dairy and livestock loan segment to address perceived weaknesses in this segment due to phenomena such as highly volatile milk and feed prices, reduced levels of cow milk production, shorter cyclical periods between industry highs and lows, unstable values for herd liquidations, lack of adequate farm land to raise forage crops in certain geographical locations, and depleted resources available to certain dairy operators due to periodic industry stress factors.

During the second quarter of June 30, 2014, the Bank adjusted its qualitative factor for changes in the volume and severity of past due loans, the volume of nonaccrual loans, and the volume and severity of adversely classified or graded loans. The Bank reduced this factor to reflect our judgment regarding the effect on our loan portfolio of certain improved credit conditions including, but not limited to, (i) the continued improvement in the portfolio’s credit quality and underlying credit metrics, (ii) the continued reduction in classified loans, and (iii) the continued low level of delinquent and past due loans. As a result of the factors described above, including, among other things, the general improvement in loan risk ratings and the quarter-over-quarter decline in classified loans of $62.2 million, the reserve was reduced by approximately $7.7 million. The reduction combined with net loan losses of $151,000 during the second quarter, resulted in a loan loss provision recapture of $7.6 million for the quarter ended June 30, 2014.

During the first quarter of March 31, 2014, the Bank adjusted several qualitative factors including (i) changes in international, national, regional and local economic and business conditions and developments that affect the collectability of the portfolio, including the condition of various market segments, (ii) changes in the nature and volume of the portfolio and in the terms of loans, (iii) changes in the experience, ability, and depth of lending management and other relevant staff, and (iv) the effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the institution’s existing portfolio. The changes to the qualitative factors noted above reflect our judgment regarding the effect on our loan portfolio of certain conditions including, but not limited to, (i) conditions in the local and national economy as well as the risk to our local economy from climate/weather issues including regional drought conditions, (ii) potential impact on municipal borrowers due to the drought and overhanging risk of unfunded pension liabilities, (iii) increasing pressure to change the nature and terms offered on Bank loans in response to loan terms being offered by our competitors, especially in construction, commercial, commercial real estate and residential real estate loans, (iv) increased competition for loans and (v) the challenges in pursuing collection efforts through the legal system. As a result of the factors described above, the quarterly decline in outstanding loan totals from December 31, 2013, and a quarterly decline in classified loans of $26.6 million, the ALLL was reduced by approximately $6.5 million for the first quarter of 2014. The reduction combined with net recoveries of $990,000 during the first quarter of 2014, resulted in a loan loss provision recapture of $7.5 million for the quarter ended June 30, 2014.

While we believe that the allowance at June 30, 2014 was appropriate to absorb losses from any known or inherent risks in the portfolio, no assurance can be given that economic conditions, interest rate fluctuations, conditions of our borrowers, or natural disasters, which adversely affect our service areas or other circumstances or conditions, including those defined above, will not be reflected in increased provisions for loan losses in the future.

 

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Deposits

The primary source of funds to support earning assets (loans and investments) is the generation of deposits.

Total deposits were $5.63 billion at June 30, 2014. This represented an increase of $738.7 million, or 15.10%, over total deposits of $4.89 billion at December 31, 2013. The composition of deposits is as follows:

 

     June 30, 2014     December 31, 2013  
     Balance      Percent     Balance      Percent  
     (Dollars in thousands)  

Noninterest-bearing deposits:

          

Demand deposits

   $ 2,962,146         52.6   $ 2,562,980         52.4

Interest-bearing deposits:

          

Savings deposits

     1,968,037         35.0     1,646,111         33.7

Time deposits

     699,163         12.4     681,540         13.9
  

 

 

    

 

 

   

 

 

    

 

 

 

Total deposits

   $ 5,629,346         100.0   $ 4,890,631         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

The amount of noninterest-bearing demand deposits in relation to total deposits is an integral element in achieving a low cost of funds. Demand deposits totaled $2.96 billion at June 30, 2014, representing an increase of $399.2 million, or 15.57%, from demand deposits of $2.56 billion at December 31, 2013. Noninterest-bearing demand deposits represented 52.62% of total deposits as of June 30, 2014, compared to 52.41% of total deposits as of December 31, 2013.

Savings deposits, which include savings, interest-bearing demand, and money market accounts, totaled $1.97 billion at June 30, 2014 representing an increase of $321.9 million, or 19.56%, from savings deposits of $1.65 billion at December 31, 2013.

Time deposits totaled $699.2 million at June 30, 2014. This represented an increase of $17.6 million, or 2.59%, from total time deposits of $681.5 billion at December 31, 2013.

Borrowings

In order to enhance the Bank’s spread between its cost of funds and interest-earning assets, we first seek noninterest-bearing deposits (the lowest cost of funds to the Company). Next, we pursue growth in interest-bearing deposits, and finally, we supplement the growth in deposits with borrowed funds (borrowings and customer repurchase agreements). Average borrowed funds, as a percent of average total funding (total deposits plus borrowed funds) was 13.50% for the second quarter of 2014, compared to 13.16% for the second quarter of 2013.

At June 30, 2014 and December 31, 2013, we had zero and $69.0 million, respectively, in short-term borrowings.

At June 30, 2014, borrowed funds totaled $810.8 million. This represented a decrease of $100.7 million, or 11.04%, from total borrowed funds of $911.5 million at December 31, 2013.

In November 2006, we began a repurchase agreement product with our customers. This product, known as Citizens Sweep Manager, sells our investment securities overnight to our customers under an agreement to repurchase them the next day at a price which reflects the market value of the use of funds by the Bank for the period concerned. These repurchase agreements are signed with customers who want to invest their excess deposits, above a pre-determined balance in a demand deposit account, in order to earn interest. As of June 30, 2014 and December 31, 2013, total customer repurchases were $611.5 million and $643.3 million, respectively, with weighted average interest rates of 0.24% and 0.29%, respectively.

We entered into borrowing agreements with the FHLB. We had outstanding balances of $199.3 million under these agreements at June 30, 2014 and $199.2 million at December 31, 2013. The interest rate was 4.52% at June 30, 2014 and December 31, 2013. The FHLB holds certain investment securities and loans as collateral available for these borrowings.

At June 30, 2014, $2.39 billion of loans and $2.92 billion of investment securities, at carrying value, were pledged to secure public deposits, short and long-term borrowings, and for other purposes as required or permitted by law.

 

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Aggregate Contractual Obligations

The following table summarizes our contractual commitments as of June 30, 2014:

 

            Maturity by Period  
     Total      Less Than
One
Year
     One Year
Through
Three Years
     Four Years
Through
Five Years
     Over
Five
Years
 
     (Dollars in thousands)  

Deposits (1)

   $ 5,629,346       $ 5,603,719       $ 19,237       $ 2,638       $ 3,752   

Customer repurchase agreements (1)

     611,459         611,459         —           —           —     

FHLB advances (1)

     199,342         —           199,342         —           —     

Junior subordinated debentures (1)

     25,774         —           —           —           25,774   

Deferred compensation

     10,088         834         1,274         559         7,421   

Operating leases

     22,298         5,773         9,506         5,562         1,457   

Advertising agreements

     3,650         1,050         1,600         1,000         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 6,501,957       $ 6,222,835       $ 230,959       $ 9,759       $ 38,404   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Amounts exclude accrued interest.

Deposits represent noninterest bearing, money market, savings, NOW, certificates of deposits, brokered and all other deposits held by the Bank.

Customer repurchase agreements represent excess amounts swept from customer demand deposit accounts, which mature the following business day and are collateralized by investment securities. These amounts are due to customers.

FHLB advances represent the amount that is due to the FHLB. We have one advance with a fixed maturity date of November 28, 2016.

Junior subordinated debentures represent the amounts that are due from the Company to CVB Statutory Trust III. The debentures have the same maturity as the Trust Preferred Securities. CVB Statutory Trust III matures in 2036, and became callable in whole or in part in March 2011.

Deferred compensation represents the amounts that are due to former employees’ based on salary continuation agreements as a result of acquisitions and amounts due to current employees under our deferred compensation plans.

Operating leases represent the total minimum lease payments due under non-cancelable operating leases.

Advertising agreements represent the amounts that are due on various agreements that provide advertising benefits to the Company.

 

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Off-Balance Sheet Arrangements

The following table summarizes the off-balance sheet arrangements at June 30, 2014:

 

            Maturity by Period  
     Total      Less Than
One
Year
     One Year
to Three
Years
     Four Years
to Five
Years
     After
Five
Years
 
     (Dollars in thousands)  

Commitment to extend credit:

              

Commercial and industrial

   $ 354,958       $ 277,618       $ 57,627       $ 17,358       $ 2,355   

Real estate:

              

Commercial real estate

     58,236         10,674         20,719         21,294         5,549   

Construction

     51,591         19,454         32,137         —           —     

Dairy & livestock and agribusiness (1)

     233,277         158,365         74,912         —           —     

Consumer and other loans

     67,692         7,773         3,760         9,173         46,986   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Commitment to extend credit

     765,754         473,884         189,155         47,825         54,890   

Obligations under letters of credit

     34,289         28,735         5,304         200         50   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 800,043       $ 502,619       $ 194,459       $ 48,025       $ 54,940   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Total commitments to extend credit to agribusiness were $12.1 million at June 30, 2014.

As of June 30, 2014, we had commitments to extend credit of approximately $765.8 million, and obligations under letters of credit of $34.3 million. Commitments to extend credit are agreements to lend to customers, provided there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Commitments are generally variable rate, and many of these commitments are expected to expire without being drawn upon. As such, the total commitment amounts do not necessarily represent future cash requirements. We use the same credit underwriting policies in granting or accepting such commitments or contingent obligations as we do for on-balance sheet instruments, which consist of evaluating customers’ creditworthiness individually. The Company had a reserve for unfunded loan commitments of $9.1 million as of June 30, 2014 and December 31, 2013 included in other liabilities.

Standby letters of credit are conditional commitments issued by the Bank to guarantee the financial performance of a customer to a third party. Those guarantees are primarily issued to support private borrowing or purchase arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. When deemed necessary, we hold appropriate collateral supporting those commitments. We do not anticipate any material losses as a result of these transactions.

Capital Resources

Historically, our primary source of capital has been the retention of operating earnings. In order to ensure adequate levels of capital, we conduct an ongoing assessment of projected sources, needs and uses of capital in conjunction with projected increases in assets and the level of risk. As part of this ongoing assessment, the Board of Directors reviews the various components of capital.

The Company’s equity capital was $840.8 million at June 30, 2014. This represented an increase of $68.9 million, or 8.92%, from equity capital of $771.9 million at December 31, 2013. The increase during the first six months of 2014 resulted from $54.1 million in net earnings, $33.4 million in other comprehensive income, net of tax, resulting from the net change in fair value of our investment securities portfolio, and $7.5 million for shares issued pursuant to our stock-based compensation plan, offset by $21.2 million for cash dividends declared on common stock and $4.9 million for stock repurchases.

The Company’s 2013 Annual Report on Form 10-K (Management’s Discussion and Analysis and Note 18 of the consolidated financial statements) describes the regulatory capital requirements of the Company and the Bank.

The Bank and the Company are required to meet risk-based capital standards set by their respective regulatory authorities. The risk-based capital standards require the achievement of a minimum ratio of total capital to risk-weighted assets of 8.0% (of which at least 4.0% must be Tier 1 capital). In addition, the regulatory authorities require the highest rated institutions to maintain a minimum leverage ratio of 4.0%. To be considered “well-capitalized” for bank regulatory purposes, the Bank and the Company are required to have a Tier 1 risk-based capital ratio equal to or greater than 6%, a total risk-based capital ratio equal to or greater than 10% and a Tier 1 leverage ratio equal to or greater than 5%. At June 30, 2014, the Bank and the Company exceeded the minimum risk-based capital ratios and leverage ratios required to be considered “well-capitalized” for regulatory purposes.

 

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During the first six months of 2014, the Board of Directors of the Company declared a quarterly common stock cash dividend of $0.20 per share. Dividends are payable at the discretion of the Board of Directors and there can be no assurance that the Board of Directors will continue to pay dividends at the same rate, or at all, in the future. CVB’s ability to pay cash dividends to its shareholders is subject to restrictions under federal and California law, including restrictions imposed by the Federal Reserve, and covenants set forth in various agreements we are a party to including covenants set forth in our junior subordinated debentures.

In July 2008, our Board of Directors authorized the repurchase of up to 10,000,000 shares of our common stock. During the first six months of 2014, we repurchased 344,493 shares of our common stock outstanding. As of June 30, 2014, we had 7,420,678 shares of our common stock remaining that are eligible for repurchase.

The table below presents the Company’s and the Bank’s risk-based and leverage capital ratios as of June 30, 2014 and December 31, 2013.

 

           June 30, 2014     December 31, 2013  

Capital Ratios

   Adequately
Capitalized
Ratios
    Well
Capitalized
Ratios
    CVB Financial
Corp.
Consolidated
    Citizens
Business
Bank
    CVB Financial
Corp.
Consolidated
    Citizens
Business
Bank
 

Tier 1 leverage capital ratio

     4.00     5.00     10.99     10.88     11.30     11.20

Tier 1 risk-based capital ratio

     4.00     6.00     17.36     17.20     17.83     17.67

Total risk-based capital ratio

     8.00     10.00     18.61     18.46     19.09     18.93

As a result of recently adopted federal regulatory changes to capital requirements (Basel III), which will become effective for us commencing in 2015, our board of directors, in consultation with management, will continue to assess the adequacy and components of our capital to ensure that we meet all required regulatory standards.

ASSET/LIABILITY AND MARKET RISK MANAGEMENT

Liquidity and Cash Flow

In general, liquidity risk is managed daily by controlling the level of fed funds and the use of funds provided by the cash flow from the investment portfolio, loan demand and deposit fluctuations. To meet unexpected demands, lines of credit are maintained with correspondent banks, the Federal Home Loan Bank and the Federal Reserve. The sale of bonds maturing in the near future can also serve as a contingent source of funds. Increases in deposit rates are considered a last resort as a means of raising funds to increase liquidity.

Since the primary sources and uses of funds for the Company are loans and deposits, the relationship between gross loans and total deposits provides a useful measure of the Bank’s liquidity. Typically, the closer the ratio of loans to deposits is to 100%, the more reliant we are on loan portfolio interest and principal payments to provide for short-term liquidity needs. Since repayment of loans tends to be less predictable than the maturity of investments and other liquid resources, the higher the loans to deposit ratio the less liquid are the Company’s assets. For the first six months of 2014, the loan to deposit ratio averaged 68.08% compared to an average ratio of 71.56% for the same period in 2013. The ratio of loans to deposits and customer repurchases averaged 60.14% for the first six months of 2014 and 64.38% for the same period in 2013.

CVB Financial Corp. (“CVB”) is a company separate and apart from the Bank that must provide for its own liquidity and must service its own obligations. Substantially all of CVB’s revenues are obtained from dividends declared and paid by the Bank to CVB. There are statutory and regulatory provisions that could limit the ability of the Bank to pay dividends to CVB. In addition, our regulators could limit the ability of the Bank or the CVB to pay dividends or make other distributions.

Under applicable California law, the Bank cannot make any distribution (including a cash dividend) to its shareholder in an amount which exceeds the lesser of: (i) the retained earnings of the Bank or (ii) the net income of the Bank for its last three fiscal years, less the amount of any distributions made by the Bank to its shareholder during such period. Notwithstanding the foregoing, with the prior approval of the California Department of Business Oversight Commissioner, the Bank may make a distribution (including a cash dividend) to CVB in an amount not exceeding the greater of: (i) the retained earnings of the Bank; (ii) the net income of the Bank for its last fiscal year; or (iii) the net income of the Bank for its current fiscal year.

Based on the Bank’s last three fiscal years, at June 30, 2014, approximately $52.6 million of the Bank’s equity was unrestricted and available to be paid as dividends to CVB. Management of the Company believes that such restrictions will not have any current impact on the ability of CVB to meet its ongoing cash obligations. As of June 30, 2014, neither the Bank nor CVB had any material commitments for capital expenditures.

 

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For the Bank, sources of funds normally include principal payments on loans and investments, growth in deposits, FHLB advances, and other borrowed funds. Uses of funds include withdrawal of deposits, interest paid on deposits, increased loan balances, purchases, and noninterest expenses.

Net cash provided by operating activities totaled $32.3 million for the first six months of 2014, compared to $53.2 million for the same period last year. The decrease in cash provided by operating activities was primarily attributed to an increase in vendor and employee payments and a decrease in service charges and other fees received, partially offset by a decrease in income taxes paid and an increase in interest and dividends received.

Net cash provided by investing activities totaled $37.6 million for the first six months of 2014, compared to $139.8 million for the first six months of 2013. The decrease in cash provided by investing activities was primarily the result of an increase in purchases of investment securities, a decrease in proceeds from repayment and sale of investment securities and the acquisition of ASB, net of cash paid, partially offset by a decrease in loan and lease finance receivables.

Net cash provided by financing activities totaled $239.7 million for the first six months of 2014, compared to net cash used in financing activities of $9.1 million for the same period last year. The cash provided by financing activities during the first six months of 2014 was primarily due to deposits, partially offset by $69.0 million for repayment of other borrowings and a decrease in customer repurchase agreements. The cash used in financing activities during the first six months of 2013 was primarily due to a decrease in deposits and the redemption of $41.2 million of junior subordinated debentures and repayment of $26.0 million of other borrowings.

At June 30, 2014, cash and cash equivalents totaled $404.2 million. This represented an increase of $121.9 million, or 43.19%, from $282.3 million at June 30, 2013 and an increase of $309.5 million, or 326.84%, from $94.7 million at December 31, 2013. Total deposits of $5.62 billion at June 30, 2014 increased $738.7 million, or 15.10%, over total deposits of $4.89 billion at December 31, 2013.

Interest Rate Sensitivity Management

During periods of changing interest rates, the ability to re-price interest-earning assets and interest-bearing liabilities can influence net interest income, the net interest margin, and consequently, our earnings. Interest rate risk is managed by attempting to control the spread between rates earned on interest-earning assets and the rates paid on interest-bearing liabilities within the constraints imposed by market competition in our service area. Short-term re-pricing risk is minimized by controlling the level of floating rate loans and maintaining a downward sloping ladder of bond payments and maturities. Basis risk is managed by the timing and magnitude of changes to interest-bearing deposit rates. Yield curve risk is reduced by keeping the duration of the loan and bond portfolios relatively short. Options risk in the bond portfolio is monitored monthly and actions are recommended when appropriate.

We monitor the interest rate “sensitivity” risk to earnings from potential changes in interest rates using various methods, including a maturity/re-pricing gap analysis. This analysis measures, at specific time intervals, the differences between earning assets and interest-bearing liabilities for which re-pricing opportunities will occur. A positive difference, or gap, indicates that earning assets will re-price faster than interest-bearing liabilities. This will generally produce a greater net interest margin during periods of rising interest rates, and a lower net interest margin during periods of declining interest rates. Conversely, a negative gap will generally produce a lower net interest margin during periods of rising interest rates and a greater net interest margin during periods of decreasing interest rates. In managing risks associated with rising interest rates, we utilize interest rate derivative contracts on certain loans and borrowed funds.

The interest rates paid on deposit accounts do not always move in unison with the rates charged on loans. In addition, the magnitude of changes in the rates charged on loans is not always proportionate to the magnitude of changes in the rate paid on deposits. Consequently, changes in interest rates do not necessarily result in an increase or decrease in the net interest margin solely as a result of the differences between re-pricing opportunities of earning assets or interest-bearing liabilities. In general, whether we report a positive gap in the short-term period or negative gap in the long-term period does not necessarily indicate that, if interest rates decreased, net interest income would increase, or if interest rates increased, net interest income would decrease.

Approximately $2.09 billion, or 69%, of the total investment portfolio at June 30, 2014 consisted of securities backed by mortgages. The final maturity of these securities can be affected by the speed at which the underlying mortgages repay. Mortgages tend to repay faster as interest rates fall, and slower as interest rates rise. As a result, we may be subject to a “prepayment risk” resulting from greater funds available for reinvestment at a time when available yields are lower. Conversely, we may be subject to “extension risk” resulting, as lesser amounts would be available for reinvestment at a time when available yields are higher. Prepayment risk includes the risk associated with the payment of an investment’s principal faster than originally intended. Extension risk is the risk associated with the payment of an investment’s principal over a longer time period than originally anticipated. In addition, there can be greater risk of price volatility for mortgage-backed securities as a result of anticipated prepayment or extension risk.

 

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We utilize the results of a simulation model to quantify the estimated exposure of net interest income to sustained interest rate changes. The sensitivity of our net interest income is measured over a rolling two-year horizon.

The simulation model estimates the impact of changing interest rates on interest income from all interest-earning assets and interest expense paid on all interest-bearing liabilities reflected on our balance sheet. This sensitivity analysis is compared to policy limits, which specify a maximum tolerance level for net interest income exposure over a one-year horizon assuming no balance sheet growth, given a 200 basis point upward and a 100 basis point downward shift in interest rates. A parallel and pro rata shift in rates over a 12-month period is assumed.

The following depicts the Company’s net interest income sensitivity analysis as of June 30, 2014:

 

Simulated Rate Changes

 

Estimated Net Interest
Income Sensitivity (1)

+ 200 basis points

  (2.03%)

- 100 basis points

  (0.77%)

 

(1) Cumulative changes from the base case for a 12-month period.

Based on our current models, we believe that the interest rate risk profile of the balance sheet is slightly liability-sensitive over a two year horizon. The estimated sensitivity does not necessarily represent a forecast and the results may not be indicative of actual changes to our net interest income. These estimates are based upon a number of assumptions including: the nature and timing of interest rate levels including yield curve shape, prepayments on loans and securities, pricing strategies on loans and deposits, and replacement of asset and liability cash flows. While the assumptions used are based on current economic and local market conditions, there is no assurance as to the predictive nature of these conditions including how customer preferences or competitor influences might change.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

For quantitative and qualitative disclosures about market risks in our portfolio, see “Asset/Liability Management and Interest Rate Sensitivity Management” included in Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” presented elsewhere in this report. This analysis should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2013. Our analysis of market risk and market-sensitive financial information contain forward looking statements and is subject to the disclosure at the beginning of Part I regarding such forward-looking information.

 

ITEM 4. CONTROLS AND PROCEDURES

As of the end of the period covered by this report, we carried out an evaluation of the effectiveness of the Company’s disclosure controls and procedures under the supervision and with the participation of the Chief Executive Officer, the Chief Financial Officer and other senior management of the Company. Based on the foregoing, the Company’s Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this report.

During our most recent fiscal quarter, there have been no changes in our internal control over financial reporting that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

PART II - OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

Certain lawsuits and claims arising in the ordinary course of business have been filed or are pending against us or our affiliates. Where appropriate, we establish reserves in accordance with FASB guidance over contingencies (ASC 450). The outcome of litigation and other legal and regulatory matters is inherently uncertain, however, and it is possible that one or more of the legal or regulatory matters currently pending or threatened could have a material adverse effect on our liquidity, consolidated financial position, and/or results of operations. As of June 30, 2014, the Company does not have any litigation reserves.

The Company is involved in the following significant legal actions and complaints.

On July 26, 2010, we received a subpoena from the Los Angeles office of the SEC regarding the Company’s allowance for loan loss methodology, loan underwriting guidelines, methodology for grading loans, and the process for making provisions for loan losses. In addition, the subpoena requested information regarding certain presentations Company officers have given or conferences

 

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Company officers have attended with analysts, brokers, investors or prospective investors. We have fully cooperated with the SEC in its investigation, and we will continue to do so if and to the extent any further information is requested. We cannot predict the timing or outcome of the SEC investigation or if it is still continuing.

In the wake of the Company’s disclosure of the SEC investigation, on August 23, 2010, a purported shareholder class action complaint was filed against the Company, in an action captioned Lloyd v. CVB Financial Corp., et al., Case No. CV 10-06256- MMM, in the United States District Court for the Central District of California. Along with the Company, Christopher D. Myers (our President and Chief Executive Officer) and Edward J. Biebrich, Jr. (our former Chief Financial Officer) were also named as defendants. On September 14, 2010, a second purported shareholder class action complaint was filed against the Company, in an action originally captioned Englund v. CVB Financial Corp., et al., Case No. CV 10-06815-RGK, in the United States District Court for the Central District of California. The Englund complaint named the same defendants as the Lloyd complaint and made allegations substantially similar to those included in the Lloyd complaint. On January 21, 2011, the Court consolidated the two actions for all purposes under the Lloyd action, now captioned as Case No. CV 10-06256-MMM (PJWx). That same day, the Court also appointed the Jacksonville Police and Fire Pension Fund (the “Jacksonville Fund”) as lead plaintiff in the consolidated action and approved the Jacksonville Fund’s selection of lead counsel for the plaintiffs in the consolidated action. On March 7, 2011, the Jacksonville Fund filed a consolidated complaint naming the same defendants and alleging violations by all defendants of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder and violations by the individual defendants of Section 20(a) of the Exchange Act. Specifically, the complaint alleges that defendants misrepresented and failed to disclose conditions adversely affecting the Company throughout the purported class period, which is alleged to be between October 21, 2009 and August 9, 2010. The consolidated complaint sought compensatory damages and other relief in favor of the purported class.

Following the filing by each side of various motions and briefs, and a hearing on August 29, 2011, the District Court issued a ruling on January 12, 2012, granting defendants’ motion to dismiss the consolidated complaint, but the ruling provided the plaintiffs with leave to file an amended complaint within 45 days of the date of the order. On February 27, 2012, the plaintiffs filed a first amended complaint against the same defendants, and, following filings by both sides and another hearing on June 4, 2012, the District Court issued a ruling on August 21, 2012, granting defendants’ motion to dismiss the first amended complaint, but providing the plaintiffs with leave to file another amended complaint within 30 days of the ruling. On September 20, 2012, the plaintiffs filed a second amended complaint against the same defendants, the Company filed its third motion to dismiss on October 25, 2012, and following another hearing on February 25, 2013, the District Court issued an order dismissing the plaintiffs’ complaint for the third time on May 9, 2013.

Although the District Court’s most recent order of dismissal provided the plaintiffs with leave to file a third amended and restated complaint within 30 days of the issuance of the order, on June 3, 2013, counsel for the plaintiffs instead filed a Notice of Intent Not to File an Amended Complaint, along with a request that the District Court convert its order to a dismissal with prejudice, so that plaintiffs could proceed straight to appeal at the U.S. Court of Appeals for the Ninth Circuit. On September 30, 2013, the District Court entered its order dismissing the plaintiffs’ second amended complaint with prejudice, and the plaintiffs filed their notice of appeal on October 24, 2013.

The plaintiffs’ opening brief was filed on June 7, 2014, and the Company’s reply brief was filed on July 7, 2014. The plaintiff’s rebuttal brief is due on or about August 6, 2014, and the Court of Appeals will schedule oral argument thereafter at a time to be determined, which is not expected to be take place until at least the middle of 2015.

The Company intends to continue to vigorously contest the plaintiff’s allegations in this case.

On February 28, 2011, a purported and related shareholder derivative complaint was filed in an action captioned Sanderson v. Borba, et al., Case No. CIVRS1102119, in California State Superior Court in San Bernardino County. The complaint names as defendants the members of our board of directors and also refers to unnamed defendants allegedly responsible for the conduct alleged. The Company is included as a nominal defendant. The complaint alleges breaches of fiduciary duties, abuse of control, gross mismanagement and corporate waste. Specifically, the complaint alleges, among other things, that defendants engaged in accounting manipulations in order to falsely portray the Company’s financial results in connection with its commercial real estate portfolio. Plaintiff seeks compensatory and exemplary damages to be paid by the defendants and awarded to the Company, as well as other relief.

On June 20, 2011, defendants filed a demurrer requesting dismissal of the derivative complaint. Following the filing by each side of additional motions, the parties have subsequently filed repeated notices to postpone the Court’s hearing on the defendants’ demurrer, pending resolution of the federal securities shareholder class action complaint. On July 30, 2013, the Court signed a Minute Order agreeing to the parties’ stipulation to further extend the postponement of the derivative action hearing, at least to the date of any ruling by the Ninth Circuit Court of Appeals in connection with the pending appeal in the federal class action securities case, subject to brief status conferences every six months or so, with the next status update scheduled for March 25, 2015.

 

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Because the outcome of these proceedings is uncertain, we cannot predict any range of loss or even if any loss is probable related to the actions described above.

 

ITEM 1A. RISK FACTORS

There have been no material changes to the risk factors as previously disclosed in Item 1A. to Part I of our Annual Report on Form 10-K for the year ended December 31, 2013. The materiality of any risks and uncertainties identified in our Forward Looking Statements contained in this report together with those previously disclosed in the Form 10-K and any subsequent Form 10-Q or those that are presently unforeseen could result in significant adverse effects on our financial condition, results of operations and cash flows. See Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Quarterly Report on Form 10-Q.

 

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

On July 16, 2008, our Board of Directors approved a program to repurchase up to 10,000,000 shares of our common stock (such number will not be adjusted for stock splits, stock dividends, and the like) in the open market or in privately negotiated transactions, at times and at prices considered appropriate by us, depending upon prevailing market conditions and other corporate and legal considerations. There is no expiration date for our current stock repurchase program. During the second quarter of 2014, we repurchased 344,493 shares of our common stock outstanding. As of June 30, 2014, we had 7,420,678 shares of our common stock remaining that are eligible for repurchase.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not Applicable

 

ITEM 4. MINE SAFETY DISCLOSURES

Not Applicable

 

ITEM 5. OTHER INFORMATION

None

 

ITEM 6. EXHIBITS

 

Exhibit No.

  

Description of Exhibits

  31.1    Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  31.2    Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  32.1    Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
  32.2    Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS    XBRL Instance Document
101.SCH    XBRL Taxonomy Extension Schema Document
101.CAL    XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF    XBRL Taxonomy Extension Definition Linkbase Document
101.LAB    XBRL Taxonomy Extension Label Linkbase Document
101.PRE    XBRL Taxonomy Extension Presentation Linkbase Document

 

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SIGNATURES

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

 

CVB FINANCIAL CORP.
(Registrant)

Date: August 11, 2014

 

/s/ Richard C. Thomas                        
Duly Authorized Officer and
Chief Financial Officer

 

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