10-Q 1 banc-6302015x10q.htm 10-Q BANC-6.30.2015-10Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 

FORM 10-Q 
 
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2015
or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission file number 001-35522
 
 
BANC OF CALIFORNIA, INC.
(Exact name of registrant as specified in its charter)
 
 
Maryland
(State or other jurisdiction of
incorporation or organization)
04-3639825
(IRS Employer Identification No.)
18500 Von Karman Ave, Suite 1100, Irvine, California
(Address of principal executive offices)
92612
(Zip Code)
(855) 361-2262
(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  ý    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 (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” “and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
¨
  
Accelerated filer
 
ý
 
 
 
 
Non-accelerated filer
 
¨ (Do not check if a smaller reporting company)
  
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 ý
Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date.
As of July 31, 2015, the registrant had outstanding 37,466,750 shares of voting common stock.



BANC OF CALIFORNIA, INC.
FORM 10-Q QUARTERLY REPORT
June 30, 2015
Table of Contents
 

2


Forward-looking Statements

When used in this report and in public stockholder communications, in other documents of Banc of California, Inc. (the Company, we, us and our) filed with or furnished to the Securities and Exchange Commission (the SEC), or in oral statements made with the approval of an authorized executive officer, the words or phrases “believe,” “will,” “should,” “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimate,” “project,” “plans,” “guidance” or similar expressions are intended to identify “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. You are cautioned not to place undue reliance on any forward-looking statements, which speak only as of the date made. These statements may relate to our future financial performance, strategic plans or objectives, revenue, expense or earnings projections, or other financial items. By their nature, these statements are subject to numerous uncertainties that could cause actual results to differ materially from those anticipated in the statements.

Factors that could cause actual results to differ materially from the results anticipated or projected include, but are not limited to, the following:

i.
the ability of the Company to successfully integrate the branches its wholly owned bank subsidiary, Banc of California, N.A. (the Bank), acquired from Banco Popular North America (BPNA or Banco Popular);
ii.
risks that the Company’s merger and acquisition activities, including but not limited to the recent acquisition of the BPNA branches and the acquisitions of The Private Bank of California (PBOC), The Palisades Group, LLC and CS Financial, Inc., as well as the merger of the Company’s subsidiary banks, may disrupt current plans and operations and lead to difficulties in customer and employee retention, risks that the amount of the costs, fees, expenses and charges related to these transactions could be significantly higher than anticipated and risks that the expected revenues, cost savings, synergies and other benefits of these transactions might not be realized to the extent anticipated, within the anticipated timetables, or at all;
iii.
risks that funds obtained from capital raising activities will not be utilized efficiently or effectively;
iv.
a worsening of current economic conditions, as well as turmoil in the financial markets;
v.
the credit risks of lending activities, which may be affected by deterioration in real estate markets and the financial condition of borrowers, may lead to increased loan and lease delinquencies, losses and nonperforming assets in our loan and lease portfolio, and may result in our allowance for loan and lease losses not being adequate to cover actual losses and require us to materially increase our loan and lease loss reserves;
vi.
the quality and composition of our securities portfolio;
vii.
changes in general economic conditions, either nationally or in our market areas, or financial markets;
viii.
continuation of the historically low short-term interest rate environment, changes in the levels of general interest rates, and the relative differences between short- and long-term interest rates, deposit interest rates, our net interest margin and funding sources;
ix.
fluctuations in the demand for loans and leases, the number of unsold homes and other properties and fluctuations in commercial and residential real estate values in our market area;
x.
results of examinations of us by regulatory authorities and the possibility that any such regulatory authority may, among other things, require us to increase our allowance for loan and lease losses, write-down asset values, increase our capital levels, or affect our ability to borrow funds or maintain or increase deposits, which could adversely affect our liquidity and earnings;
xi.
legislative or regulatory changes that adversely affect our business, including changes in regulatory capital or other rules;
xii.
our ability to control operating costs and expenses;
xiii.
staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our work force and potential associated charges;
xiv.
errors in our estimates in determining fair value of certain of our assets, which may result in significant declines in valuation;
xv.
the network and computer systems on which we depend could fail or experience a security breach;
xvi.
our ability to attract and retain key members of our senior management team;
xvii.
costs and effects of litigation, including settlements and judgments;

3


xviii.
increased competitive pressures among financial services companies;
xix.
changes in consumer spending, borrowing and saving habits;
xx.
adverse changes in the securities markets;
xxi.
earthquake, fire or other natural disasters affecting the condition of real estate collateral;
xxii.
the availability of resources to address changes in laws, rules or regulations or to respond to regulatory actions;
xxiii.
inability of key third-party providers to perform their obligations to us;
xxiv.
changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board or their application to our business, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods;
xxv.
war or terrorist activities; and
xxvi.
other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services and the other risks described in this report and from time to time in other documents that we file with or furnish to the SEC, including, without limitation, the risks described under “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2014.

The Company undertakes no obligation to update any such statement to reflect circumstances or events that occur after the date on which the forward-looking statement is made, except as required by law.



4


PART I – FINANCIAL INFORMATION

ITEM 1 – FINANCIAL STATEMENTS
BANC OF CALIFORNIA, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Amounts in thousands, except share and per share data)
(Unaudited) 
 
June 30,
2015
 
December 31,
2014
ASSETS
 
 
 
Cash and due from banks
$
12,444

 
$
14,364

Interest-bearing deposits
446,546

 
216,835

Total cash and cash equivalents
458,990

 
231,199

Time deposits in financial institutions
1,900

 
1,900

Securities available for sale, at fair value
487,293

 
345,695

Securities held to maturity, at amortized cost (fair value of $53,303 at June 30, 2015)
53,414

 

Loans held for sale, carried at fair value
409,799

 
278,749

Loans held for sale, carried at lower of cost or fair value
336,852

 
908,341

Loans and leases receivable, net of allowance of $34,787 at June 30, 2015 and $29,480 at December 31, 2014
4,438,308

 
3,919,642

Federal Home Loan Bank and other bank stock, at cost
34,187

 
42,241

Servicing rights, net ($34,198 and $13,135 measured at fair value at June 30, 2015 and December 31, 2014, respectively)
34,942

 
13,619

Servicing rights held for sale, carried at fair value

 
5,947

Accrued interest receivable
14,875

 
15,113

Other real estate owned, net
50

 
423

Premises, equipment, and capital leases, net
35,229

 
78,685

Bank-owned life insurance
19,201

 
19,095

Goodwill
31,591

 
31,591

Affordable housing fund investment
4,417

 
4,737

Deferred income tax
12,081

 
16,373

Income tax receivable
3,091

 

Other intangible assets, net
21,905

 
25,252

Other assets
39,757

 
32,695

Total Assets
$
6,437,882

 
$
5,971,297

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Noninterest-bearing deposits
$
867,930

 
$
662,295

Interest-bearing deposits
4,184,260

 
4,009,536

Deposits held for sale
52,820

 

Total deposits
5,105,010

 
4,671,831

Advances from Federal Home Loan Bank
350,000

 
633,000

Long term debt, net
264,077

 
93,569

Reserve for loss on repurchased loans
9,411

 
8,303

Income taxes payable

 
56

Accrued expenses and other liabilities
75,502

 
61,223

Total liabilities
5,804,000

 
5,467,982

Commitments and contingent liabilities

 

Preferred stock, $0.01 par value per share, 50,000,000 shares authorized:
 
 
 
Series A, non-cumulative perpetual preferred stock, $1,000 per share liquidation preference, 32,000 shares authorized, 32,000 shares issued and outstanding at June 30, 2015 and December 31, 2014
31,934

 
31,934

Series B, non-cumulative perpetual preferred stock, $1,000 per share liquidation preference, 10,000 shares authorized, 10,000 shares issued and outstanding at June 30, 2015 and December 31, 2014
10,000

 
10,000

Series C, 8.00% non-cumulative perpetual preferred stock, $1,000 per share liquidation preference, 40,250 shares authorized, 40,250 shares issued and outstanding at June 30, 2015 and December 31, 2014
37,943

 
37,943

Series D, 7.375% non-cumulative perpetual preferred stock, $1,000 per share liquidation preference, 115,000 shares authorized, 115,000 shares issued and outstanding at June 30, 2015
110,873

 

Common stock, $0.01 par value per share, 446,863,844 shares authorized; 37,246,499 shares issued and 35,647,476 shares outstanding at June 30, 2015; 35,829,763 shares issued and 34,190,740 shares outstanding at December 31, 2014
372

 
358

Class B non-voting non-convertible common stock, $0.01 par value per share, 3,136,156 shares authorized; 0 shares issued and outstanding at June 30, 2015 and 609,195 shares issued and outstanding at December 31, 2014

 
6

Additional paid-in capital
425,784

 
422,910

Retained earnings
45,494

 
29,589

Treasury stock, at cost (1,599,023 shares at June 30, 2015 and 1,639,023 shares at December 31, 2014)
(29,070
)
 
(29,798
)
Accumulated other comprehensive income, net
552

 
373

Total stockholders’ equity
633,882

 
503,315

Total liabilities and stockholders’ equity
$
6,437,882

 
$
5,971,297

See Accompanying Notes to Consolidated Financial Statements (Unaudited)

5


BANC OF CALIFORNIA, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share data)
(Unaudited)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
Interest and dividend income
 
 
 
 
 
 
 
Loans, including fees
$
60,699

 
$
42,077

 
$
118,854

 
$
83,607

Securities
2,119

 
993

 
4,046

 
1,917

Dividends and other interest-earning assets
2,026

 
564

 
2,724

 
886

Total interest and dividend income
64,844

 
43,634

 
125,624

 
86,410

Interest expense
 
 
 
 
 
 
 
Deposits
6,165

 
6,071

 
12,526

 
11,806

Federal Home Loan Bank advances
290

 
99

 
643

 
199

Long term debt and other interest-bearing liabilities
4,285

 
1,889

 
6,354

 
3,645

Total interest expense
10,740

 
8,059

 
19,523

 
15,650

Net interest income
54,104

 
35,575

 
106,101

 
70,760

Provision for loan and lease losses
5,474

 
2,108

 
5,474

 
4,037

Net interest income after provision for loan and lease losses
48,630

 
33,467

 
100,627

 
66,723

Noninterest income
 
 
 
 
 
 
 
Customer service fees
1,072

 
356

 
1,982

 
609

Loan servicing income
2,007

 
774

 
1,565

 
2,027

Income from bank owned life insurance
47

 
56

 
106

 
103

Net gain (loss) on sale of securities available for sale

 
15

 
(2
)
 
522

Net gain on sale of loans
7,838

 
3,038

 
12,310

 
5,641

Net revenue on mortgage banking activities
39,403

 
26,133

 
77,336

 
43,457

Advisory service fees
4,435

 
1,808

 
5,632

 
2,918

Loan brokerage income
661

 
2,416

 
1,802

 
4,327

Gain on sale of building
9,919

 

 
9,919

 

Other income
1,311

 
776

 
2,023

 
1,046

Total noninterest income
66,693

 
35,372

 
112,673

 
60,650

Noninterest expense
 
 
 
 
 
 
 
Salaries and employee benefits
56,120

 
39,130

 
105,891

 
73,811

Occupancy and equipment
10,325

 
7,425

 
20,096

 
15,962

Professional fees
6,689

 
3,528

 
10,124

 
7,393

Data processing
2,075

 
1,270

 
3,910

 
2,061

Advertising
1,252

 
710

 
2,164

 
1,785

Regulatory assessments
1,376

 
1,046

 
2,730

 
1,987

Loan servicing and foreclosure expense
276

 
175

 
595

 
350

Valuation allowance for other real estate owned

 

 
22

 

Net gain on sales of other real estate owned
(6
)
 

 
(23
)
 

Provision for loan repurchases
999

 
330

 
1,844

 
901

Amortization of intangible assets
1,545

 
944

 
3,089

 
1,883

Impairment on intangible assets
258

 

 
258

 

All other expense
7,011

 
5,746

 
13,099

 
11,765

Total noninterest expense
87,920

 
60,304

 
163,799

 
117,898

Income before income taxes
27,403

 
8,535

 
49,501

 
9,475

Income tax expense
11,479

 
436

 
21,003

 
627

Net income
15,924

 
8,099

 
28,498

 
8,848

Preferred stock dividends
2,843

 
910

 
3,753

 
1,820

Net income available to common stockholders
$
13,081

 
$
7,189

 
$
24,745

 
$
7,028

Basic earnings per common share
$
0.33

 
$
0.27

 
$
0.62

 
$
0.30

Diluted earnings per common share
$
0.32

 
$
0.27

 
$
0.62

 
$
0.30

Basic earnings per class B common share
$
0.33

 
$
0.27

 
$
0.62

 
$
0.30

Diluted earnings per class B common share
$
0.33

 
$
0.25

 
$
0.62

 
$
0.24

See Accompanying Notes to Consolidated Financial Statements (Unaudited)

6


BANC OF CALIFORNIA, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Amounts in thousands)
(Unaudited)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
Net income
$
15,924

 
$
8,099

 
$
28,498

 
$
8,848

Other comprehensive income, net of tax:
 
 
 
 
 
 
 
Unrealized gain on available for sale securities:
 
 
 
 
 
 
 
Unrealized (loss) gain arising during the period
(1,982
)
 
1,099

 
(54
)
 
2,122

Reclassification adjustment for loss (gain) included in net income

 
(15
)
 
1

 
(522
)
Total change in unrealized gain on available for sale securities
(1,982
)
 
1,084

 
(53
)
 
1,600

Unrealized gain (loss) on cash flow hedge:
 
 
 
 
 
 
 
Unrealized gain (loss) arising during the period
336

 
(292
)
 
232

 
(509
)
Total change in unrealized gain (loss) on cash flow hedge
336

 
(292
)
 
232

 
(509
)
Total change in other comprehensive income
(1,646
)
 
792

 
179

 
1,091

Comprehensive income
$
14,278

 
$
8,891

 
$
28,677

 
$
9,939

See Accompanying Notes to Consolidated Financial Statements (Unaudited)


7


BANC OF CALIFORNIA, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(Amounts in thousands)
(Unaudited)
 
Preferred Stock
 
Common Stock
 
Additional
Paid-
in Capital
 
Retained
Earnings
 
Treasury
Stock
 
Accumulated
Other
Comprehensive
Income (Loss)
 
 
 
Series A
 
Series B
 
Series C
 
Series D
 
Voting
 
Class B Non-Voting
 
 
 
 
 
Total
Balance at December 31, 2013
$
31,934

 
$
10,000

 
$
37,943

 

 
$
210

 
$
6

 
$
256,306

 
$
16,820

 
$
(27,911
)
 
$
(600
)
 
$
324,708

Comprehensive income:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income

 

 

 

 

 

 

 
8,848

 

 

 
8,848

Other comprehensive income, net

 

 

 

 

 

 

 

 

 
1,091

 
1,091

Issuance of common stock

 

 

 

 
77

 

 
55,397

 

 

 

 
55,474

Issuance of tangible equity units

 

 

 

 

 

 
51,720

 

 

 

 
51,720

Repurchase of 10,888 shares of common stock

 

 

 

 

 

 

 

 
(134
)
 

 
(134
)
Reclassification adjustment for awards issued from treasury stock

 

 

 

 

 

 
1,926

 

 
(1,926
)
 

 

Exercise of stock options

 

 

 

 

 

 
757

 

 

 

 
757

Issuance of stock awards from treasury stock

 

 

 

 

 

 
(319
)
 

 
319

 

 

Shares purchased under the Dividend Reinvestment Plan

 

 

 

 

 

 
410

 
28

 

 

 
438

Stock option compensation expense

 

 

 

 

 

 
156

 

 

 

 
156

Restricted stock compensation expense

 

 

 

 

 

 
2,663

 

 

 

 
2,663

Stock appreciation right expense

 

 

 

 

 

 
514

 

 

 

 
514

Dividends declared ($0.24 per common share)

 

 

 

 

 

 

 
(5,288
)
 

 

 
(5,288
)
Preferred stock dividends

 

 

 

 

 

 

 
(1,820
)
 

 

 
(1,820
)
Balance at June 30, 2014
$
31,934

 
$
10,000

 
$
37,943

 

 
$
287

 
$
6

 
$
369,530

 
$
18,588

 
$
(29,652
)
 
$
491

 
$
439,127

Balance at December 31, 2014
$
31,934

 
$
10,000

 
$
37,943

 

 
$
358

 
$
6

 
$
422,910

 
$
29,589

 
$
(29,798
)
 
$
373

 
$
503,315

Comprehensive income:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income

 

 

 

 

 

 

 
28,498

 

 

 
28,498

Other comprehensive income, net

 

 

 

 

 

 

 

 

 
179

 
179

Issuance of common stock

 

 

 

 
15

 
(6
)
 
(9
)
 

 

 

 

Issuance of preferred stock

 

 

 
110,873

 

 

 

 

 

 

 
110,873

Exercise of stock options

 

 

 

 

 

 
(263
)
 

 
728

 

 
465

Stock option compensation expense

 

 

 

 

 

 
247

 

 

 

 
247

Restricted stock compensation expense

 

 

 

 

 

 
4,038

 

 

 

 
4,038

Stock appreciation right expense

 

 

 

 

 

 
72

 

 

 

 
72

Restricted stock surrendered due to employee tax liability

 

 

 

 
(1
)
 

 
(1,441
)
 

 

 

 
(1,442
)
Tax effect of dividends paid on unvested equity awards

 

 

 

 

 

 
135

 

 

 


 
135

Shares purchased under the Dividend Reinvestment Plan

 

 

 

 

 

 
95

 
(95
)
 

 

 

Stock appreciation right dividend equivalents

 

 

 

 

 

 

 
(346
)
 

 

 
(346
)
Dividends declared ($0.24 per common share)

 

 

 

 

 

 

 
(8,399
)
 

 

 
(8,399
)
Preferred stock dividends

 

 

 

 

 

 

 
(3,753
)
 

 

 
(3,753
)
Balance at June 30, 2015
$
31,934

 
$
10,000

 
$
37,943

 
110,873

 
$
372

 
$

 
$
425,784

 
$
45,494

 
$
(29,070
)
 
$
552

 
$
633,882

See Accompanying Notes to Consolidated Financial Statements (Unaudited)

8


BANC OF CALIFORNIA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
(Unaudited)

 
Six Months Ended June 30,
 
2015
 
2014
Cash flows from operating activities:
 
 
 
Net income
$
28,498

 
$
8,848

Adjustments to reconcile net income to net cash used in operating activities
 
 
 
Provision for loan and lease losses
5,474

 
4,037

Provision for loan repurchases
1,844

 
901

Net revenue on mortgage banking activities
(77,336
)
 
(43,457
)
Net gain on sale of loans
(12,310
)
 
(5,641
)
Net amortization (accretion) of securities
618

 
345

Depreciation on premises and equipment
4,374

 
3,250

Amortization of intangibles
3,089

 
1,883

Amortization of debt issuance cost
546

 
239

Stock option compensation expense
247

 
156

Stock award compensation expense
4,038

 
2,663

Stock appreciation right expense
72

 
514

Bank owned life insurance income
(106
)
 
(103
)
Impairment on intangible assets
258

 

Net loss (gain) on sale of securities available for sale
2

 
(522
)
Gain on sale of building
(9,919
)
 

Gain on sale of other real estate owned
(23
)
 

Deferred income tax expense
4,293

 

Loss on sale or disposal of property and equipment

 
297

Increase in valuation allowances on other real estate owned
22

 

Repurchase of mortgage loans
(6,908
)
 

Originations of loans held for sale from mortgage banking
(2,276,490
)
 
(1,226,599
)
Originations of other loans held for sale
(381,767
)
 
(751,061
)
Proceeds from sales of and principal collected on loans held for sale from mortgage banking
2,195,821

 
1,215,423

Proceeds from sales of and principal collected on other loans held for sale
452,535

 
339,144

Change in deferred loan (costs) fees
(808
)
 
617

Amortization of premiums and discounts on purchased loans
(13,967
)
 
(19,311
)
Change in accrued interest receivable
238

 
(304
)
Change in other assets
1,619

 
9,282

Change in accrued interest payable and other liabilities
10,868

 
(984
)
Net cash used in operating activities
(65,178
)
 
(460,383
)
Cash flows from investing activities:
 
 
 
Proceeds from sales of securities available for sale
174

 
52,245

Proceeds from maturities and calls of securities available for sale
687

 
1,105

Proceeds from principal repayments of securities available for sale
54,096

 
16,843

Purchases of securities available for sale
(197,258
)
 
(131,407
)
Purchases of securities held to maturity
(53,419
)
 

Net cash used in acquisitions

 
(1,000
)
Loan originations and principal collections, net
(173,082
)
 
(116,192
)
Purchase of loans
(131,532
)
 
(11,956
)
Redemption of Federal Home Loan Bank stock
16,913

 

Purchase of Federal Home Loan Bank and other bank stocks
(8,859
)
 
(11,792
)
Proceeds from sale of loans held for investment
313,746

 
73,398

Net change in time deposits in financial institutions

 
(299
)
Proceeds from sale of other real estate owned
908

 
48

Proceeds from sale of mortgage servicing rights
3,089

 

Proceeds from sale of premises and equipment
52,250

 

Additions to premises and equipment
(3,815
)
 
(5,355
)
Payments of capital lease obligations
(469
)
 
(504
)
Net cash (used in) provided by investing activities
(126,571
)
 
(134,866
)
Cash flows from financing activities:
 
 
 
Net increase in deposits
433,179

 
428,711

Net increase (decrease) in short-term Federal Home Loan Bank advances
(318,000
)
 
210,000

Repayment of long-term Federal Home Loan Bank advances
(115,000
)
 
(10,000
)
Proceeds from long-term Federal Home Loan Bank advances
150,000

 

Net proceeds from issuance of common stock

 
54,474

Net proceeds from issuance of preferred stock
110,873

 

Net proceeds from issuance of tangible equity units

 
65,642

Net proceeds from issuance of long term debt
172,304

 

Payment of amortizing debt
(2,314
)
 

Purchase of treasury stock

 
(134
)
Proceeds from exercise of stock options
465

 
757

Dividend equivalents paid on stock appreciation rights
(343
)
 

Dividends paid on preferred stock
(3,385
)
 
(1,832
)
Dividends paid on common stock
(8,239
)
 
(4,436
)
Net cash provided by financing activities
419,540

 
743,182

Net change in cash and cash equivalents
227,791

 
147,933

Cash and cash equivalents at beginning of period
231,199

 
110,118

Cash and cash equivalents at end of period
$
458,990

 
$
258,051

Supplemental cash flow information
 
 
 
Interest paid on deposits and borrowed funds
$
21,686

 
$
15,563

Income taxes paid
19,502

 

Income taxes refunds received
158

 

Supplemental disclosure of noncash activities
 
 
 
Transfer from loans to other real estate owned, net
534

 
653

Transfer of loans receivable to loans held for sale, net of transfer of $0 and $963 from allowance for loan and lease losses for the six months ended June 30, 2015 and 2014, respectively
43,667

 
62,057

Transfer of loans held for sale to loans receivable
476,901

 
94,837

Transfer of deposits to deposits held for sale

 

Equipment acquired under capital leases
34

 
989

See Accompanying Notes to Consolidated Financial Statements (Unaudited)


9


BANC OF CALIFORNIA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
June 30, 2015

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation: The accompanying unaudited consolidated financial statements include the accounts of Banc of California, Inc. (collectively, with its consolidated subsidiaries, the Company, we, us and our) and its wholly owned subsidiaries, Banc of California, National Association (the Bank), The Palisades Group, LLC (the Palisades Group), and PTB Property Holdings, LLC (PTB), as of June 30, 2015 and December 31, 2014 and for the three and six months ended June 30, 2015 and 2014. Significant intercompany accounts and transactions have been eliminated in consolidation. Unless the context requires otherwise, all references to the Company include its wholly owned subsidiaries.

Nature of Operations: Banc of California, Inc. is a financial holding company under the Bank Holding Company Act of 1956, as amended, headquartered in Orange County, California and incorporated under the laws of Maryland. Banc of California, Inc.'s assets primarily consist of the outstanding stock of the Bank, as well as the outstanding membership interests of the Palisades Group and PTB.

Banc of California, Inc. is subject to regulation by the Board of Governors of the Federal Reserve System (the Federal Reserve Board or FRB) and the Bank operates under a national bank charter issued by the Office of the Comptroller of the Currency (the OCC), its primary regulator. The Bank is a member of the Federal Home Loan Bank (FHLB) system, and maintains insurance on deposit accounts with the Federal Deposit Insurance Corporation (FDIC). The Bank offers a variety of financial services to meet the banking and financial needs of the communities we serve, with operations conducted through 37 banking offices, serving San Diego, Los Angeles, Santa Barbara and Orange counties, California and 63 loan production offices in California, Arizona, Oregon, Virginia, Indiana, Maryland, Colorado, Idaho, North Carolina and Nevada as of June 30, 2015. The Palisades Group provides financial advisory and asset management services and PTB manages and disposes of other real estate owned properties.

The accounting and reporting policies of the Company are based upon U.S. generally accepted accounting principles (GAAP) and conform to predominant practices within the banking industry. The Company has not made any significant changes in its critical accounting policies or in its estimates and assumptions from those disclosed in its 2014 Annual Report on Form 10-K, the adoption of new accounting pronouncements and other authoritative guidance that became effective for the Company on or after January 1, 2015. Refer to Accounting Pronouncements below for discussion of accounting pronouncements adopted in 2015.

Basis of Presentation: The accompanying unaudited interim consolidated financial statements have been prepared pursuant to the rules and regulations for reporting on Form 10-Q. Accordingly, certain disclosures required by GAAP are not included herein. These interim statements should be read in conjunction with the consolidated financial statements and notes included in the Annual Report on Form 10-K for the year ended December 31, 2014 filed by the Company with the Securities and Exchange Commission. The December 31, 2014 balance sheet presented herein has been derived from the audited financial statements included in the Annual Report on Form 10-K for the year ended December 31, 2014 filed with the Securities and Exchange Commission, but does not include all of the disclosures required by GAAP.

In the opinion of management of the Company, the accompanying unaudited interim consolidated financial statements reflect all of the adjustments (consisting of normal recurring adjustments) necessary for a fair presentation of the consolidated financial position and consolidated results of operations for the periods presented. Certain reclassifications have been made in the prior period financial statements to conform to the current period presentation.

The results of operations for the three and six months ended June 30, 2015 are not necessarily indicative of the results to be expected for the full year.

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 based on available information. These estimates and assumptions affect the amounts reported in the financial statements and disclosures provided, and actual results could differ. The allowance for loan and lease losses, reserve for loss on repurchased loans, servicing rights, realization of deferred tax assets, the valuation of goodwill and other intangible assets, mortgage banking derivatives, purchased credit impaired loan discount accretion, fair value of assets and liabilities acquired in business combinations, and the fair value measurement of financial instruments are particularly subject to change and any such change could have a material effect on the consolidated financial statements.

10



Income Taxes: Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance is established when necessary to reduce deferred tax assets when it is more-likely-than-not that a portion or all of the net deferred tax assets will not be realized. As of June 30, 2015, the Company had a deferred tax asset of $12.1 million, with no valuation allowance and as of December 31, 2014, the Company had a deferred tax asset of $16.4 million, with no valuation allowance (See further discussion in Note 11, Income Taxes).

The effective tax rate for both the 2015 and 2014 periods reflects the adoption of Accounting Standards Update (ASU) 2014-01, which relates to amortization of investments in low income housing tax credits. See the Accounting Pronouncements portion of Note 1 - Summary of Significant Accounting Policies for detail. The retrospective application of this guidance resulted in increased income tax expense in both periods due to the reclassification of noninterest expense associated with these investments.

Allowance for Loan and Lease Losses: During the year ended December 31, 2014, the Company enhanced the methodologies, processes and controls over the allowance for loan and lease losses (ALLL), due to the Company's organic and acquisitive growth and changing profile.

The following is a synopsis of the enhancements for each component of ALLL:

Expand the look-back period to 28 rolling quarters to capture the full economic cycle.
Utilize net historical losses versus gross historical losses.
Expand the peer group used to determine industry average loss history to include three industry groups: i) all U.S. financial and bank holding companies, ii) all California based financial and bank holding companies, and iii) the peer group average from the Uniform Bank Performance Report.
Apply the segment specific loss emergence period to each segment's loss.
Determine qualitative reserves at each loan segment level based on a baseline risk weighting adjusted for current risks, trends and business conditions.
Disaggregate certain qualitative factors to be determined on the portfolio segment level.

Accounting Pronouncements: During the six months ended June 30, 2015, the following pronouncements applicable to the Company were issued or became effective:

In January 2014, the FASB issued guidance within ASU 2014-01, “Accounting for Investments in Qualified Affordable Housing Projects," which amends ASC 323-720 to permit entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. The Company invests in qualified affordable housing projects (affordable housing fund investments) and previously accounted for them under the equity method of accounting. The Company recognized its share of partnership losses in noninterest expense with the tax benefit recognized in the income tax provision. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received, and recognizes the net investment performance in the income statement as a component of income tax expense (benefit). The amendments are effective for fiscal years, and interim periods within those years, beginning after December 31, 2014 and should be applied retrospectively to all periods presented.

The Company elected the proportional amortization method retrospectively for all periods presented. This accounting change in the amortization methodology resulted in changes to account for amortization recognized in prior periods, which impacted the balance of tax credit investments and related tax accounts. The investment amortization expense is presented as a component of the income tax expense (benefit). The cumulative effect of the retrospective application of this accounting principle was $274 thousand at December 31, 2014. Net income decreased by $22 thousand and $30 thousand due to the change in accounting principle for the three and six months ended June 30, 2014, respectively.


11


The following tables present the effect of the retrospective application of this change in accounting principle on the Company’s Consolidated Statements of Financial Condition, Consolidated Statements of Operations and Consolidated Statements of Cash Flows for the respective periods:
BANC OF CALIFORNIA, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Unaudited)
 
December 31, 2014
 
As Previously Reported
 
Effect of Change in Accounting Principle
 
As Adjusted
 
(In thousands)
Assets
 
 
 
 
 
Cash and cash equivalents
$
231,199

 
$

 
$
231,199

Time deposits in financial institutions
1,900

 

 
1,900

Securities available for sale
345,695

 

 
345,695

Loans held for sale
1,187,090

 

 
1,187,090

Loans and leases receivable
3,919,642

 

 
3,919,642

Deferred income tax
16,445

 
(72
)
 
16,373

Other assets
269,600

 
(202
)
 
269,398

Total assets
$
5,971,571

 
$
(274
)
 
$
5,971,297

Liabilities and stockholders' equity
 
 
 
 
 
Liabilities
$
5,467,982

 
$

 
$
5,467,982

Stockholders' equity
503,589

 
(274
)
 
503,315

Total liabilities and stockholders' equity
$
5,971,571

 
$
(274
)
 
$
5,971,297


BANC OF CALIFORNIA, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
 
Three Months Ended June 30, 2014
 
As Previously Reported
 
Effect of Change in Accounting Principle
 
As Adjusted
 
(In thousands, except per share data)
Interest and dividend income
$
43,634

 
$

 
$
43,634

Interest expense
8,059

 

 
8,059

Net interest income
35,575

 

 
35,575

Provision for loan and lease losses
2,108

 

 
2,108

Noninterest income
35,372

 

 
35,372

Noninterest expense
60,465

 
(161
)
 
60,304

Income before income taxes
8,374

 
161

 
8,535

Income tax expense
253

 
183

 
436

Net income
8,121

 
(22
)
 
8,099

Preferred stock dividends
910

 

 
910

Net income available for common stockholders
$
7,211

 
$
(22
)
 
$
7,189

Basic earnings per total common share
$
0.27

 
$

 
$
0.27

Diluted earnings per total common share
$
0.27

 
$

 
$
0.27



12


BANC OF CALIFORNIA, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
 
Six Months Ended June 30, 2014
 
As Previously Reported
 
Effect of Change in Accounting Principle
 
As Adjusted
 
(In thousands, except per share data)
Interest and dividend income
$
86,410

 
$

 
$
86,410

Interest expense
15,650

 

 
15,650

Net interest income
70,760

 

 
70,760

Provision for loan and lease losses
4,037

 

 
4,037

Noninterest income
60,650

 

 
60,650

Noninterest expense
118,233

 
(335
)
 
117,898

Income before income taxes
9,140

 
335

 
9,475

Income tax expense
262

 
365

 
627

Net income
8,878

 
(30
)
 
8,848

Preferred stock dividends
1,820

 

 
1,820

Net income available for common stockholders
$
7,058

 
$
(30
)
 
$
7,028

Basic earnings per total common share
$
0.30

 
$

 
$
0.30

Diluted earnings per total common share
$
0.30

 
$

 
$
0.30


BANC OF CALIFORNIA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
Six Months Ended June 30, 2014
 
As Previously Reported
 
Effect of Change in Accounting Principle
 
As Adjusted
 
(In thousands)
Cash flow from operating activities
 
 
 
 

Net income
$
8,878

 
$
(30
)
 
$
8,848

Total adjustment in net income
(469,261
)
 
30

 
(469,231
)
Net cash used in operating activities
(460,383
)
 

 
(460,383
)
Cash flow from investing activities
 
 
 
 
 
Net cash used in investing activities
(134,866
)
 

 
(134,866
)
Cash flow from financing activities
 
 
 
 
 
Net cash provided by financing activities
743,182

 

 
743,182

Net increase in cash and cash equivalents
147,933

 

 
147,933

Cash and cash equivalents at beginning of period
110,118

 
 
 
110,118

Cash and cash equivalents at end of period
$
258,051

 
$

 
$
258,051


In January 2014, the FASB issued ASU No. 2014-04, “Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure.” ASU 2014-04 clarifies that an in substance repossession or foreclosure has occurred, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure. Interim and annual disclosure is required of both the amount of foreclosed residential real estate property held by the creditor and the recorded investment in consumer mortgage loans collateralized by

13


residential real estate property that are in the process of foreclosure. ASU 2014-04 is effective using either the modified retrospective transition method or a prospective transition method for fiscal years and interim periods within those years, beginning after December 15, 2014, and early adoption is permitted. Adoption of the new guidance did not have a significant impact on the Company’s consolidated financial statements.

In May 2014, the FASB issued ASU No. 2014-09, “Revenue From Contracts With Customers,” which outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The ASU is based on the principle that an entity should recognize revenue to depict the transfer of 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 ASU also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to fulfill a contract. Entities have the option of using either a full retrospective or a modified retrospective approach for the adoption of the new standard. The ASU becomes effective for Company at the beginning of its 2017 fiscal year; early adoption is not permitted. The Company is in the process of evaluating the impact that adoption of this guidance may have on its consolidated financial statements.

In June 2014, the FASB issued ASU No. 2014-11, “Transfers and Servicing: Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures.” The ASU changes the accounting for repurchase-to-maturity transactions to secured borrowing accounting. In addition, for repurchase financing arrangements, the amendments require separate accounting for a transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counterparty, which will result in secured borrowing accounting for the repurchase agreement. The ASU also requires disclosures for certain transactions comprising (1) a transfer of a financial asset accounted for as a sale and (2) an agreement with the same transferee entered into in contemplation of the initial transfer that results in the transferor retaining substantially all of the exposure to the economic return on the transferred financial asset throughout the term of the transaction. There are additional disclosure requirements for repurchase agreements, securities lending transactions, and repurchase-to-maturity transactions that are accounted for as secured borrowings. Adoption of the new guidance did not have a significant 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 Service Period.” The ASU requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. A reporting entity should apply existing guidance in Topic 718 as it relates to awards with performance conditions that affect vesting to account for such awards. As such, the performance target should not be reflected in estimating the grant-date fair value of the award. The Company is in the process of evaluating the impact that adoption of this guidance may have on its consolidated financial statements.

In August 2014, the FASB issued ASU 2014-14, “Receivables-Troubled Debt Restructurings by Creditors (Subtopic 310-40), Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure.” Under ASU 2014-14, a mortgage loan should be derecognized and a separate receivable based on the principal and interest expected to be recovered from the governmental guarantor should be recognized upon foreclosure when all of the following conditions exist: a government guarantee exists that is not separable from the loan prior to the foreclosure; as of the date of the foreclosure the creditor has the intent to convey the real estate to the governmental agency that issued the guarantee, to make a claim on the guarantee and the creditor has the ability to recover amounts due from the governmental entity as a result of the claim; and, as of the time of the foreclosure, the claim amount that is based on the fair value of the real estate is fixed. ASU 2014-14 is effective using either the modified retrospective transition method or a prospective transition method for fiscal years and interim periods within those years, beginning after December 15, 2014. Adoption of the new guidance did not have a significant impact on the Company’s consolidated financial statements.

In February 2015, the FASB issued ASU 2015-02, "Consolidation (Topic 810): Amendments to the Consolidation Analysis," which significantly changes the consolidation analysis required under U.S. GAAP. The new consolidation guidance maintains two models: one for assessing most corporate entities based on the notion that majority voting rights indicate control (the voting model) and another for assessing entities that may be controlled through other means, such as management contracts or subordinated financial support (the variable interest model). Under the new guidance, limited partnerships will be VIEs, unless the limited partners have either substantive kick-out or participating rights. There is no longer a presumption that a general partner should consolidate a limited partnership. The ASU also changes the effect that fees paid to a decision maker or service provider have on the consolidation analysis. For entities other than limited partnerships, the ASU clarifies how to determine whether the equity holders (as a group) have power over the entity. The ASU is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2015. Early adoption is allowed for all entities, but the guidance must be applied as of the beginning of the annual period containing the adoption date. Entities have the option of using either a

14


full or modified retrospective approach for adoption. The Company is assessing the impact of the new guidance on its consolidated financial statements.
In April 2015, the FASB issued ASU 2015-03, "Interest-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs," which requires the debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The ASU is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2015. Early adoption is permitted. The amendments in this ASU are to be applied on a retrospective basis. Adoption of the new guidance is not expected to have a significant impact on the Company’s consolidated financial statements.


15


NOTE 2 – BUSINESS COMBINATIONS AND TRANSACTIONS

The Company completed the following acquisitions between January 1, 2014 and June 30, 2015 and used the acquisition method of accounting. Accordingly, the operating results of the acquired entities have been included in the consolidated financial statements from their respective dates of acquisition.

The following table presents a summary of acquired assets and assumed liabilities along with a summary of the acquisition consideration as of the dates of acquisition:
 
Acquisition and Date Acquired
 
Banco Popular Branches
 
Renovation
Ready
 
November 8, 2014
 
January 31,
2014
 
(In thousands)
Assets acquired:
 
 
 
Cash and due from banks
$
5,532

 
$

Loans and leases receivable
1,072,449

 

Premises, equipment, and capital leases
9,002

 

Goodwill

 
2,239

Other intangible assets
15,777

 
761

Other assets
2,301

 

Total assets acquired
$
1,105,061

 
$
3,000

Liabilities assumed:
 
 
 
Deposits
$
1,076,614

 
$

Other liabilities
506

 
1,000

Total liabilities assumed
1,077,120

 
1,000

Total consideration paid
$
27,941

 
$
2,000

Summary of consideration
 
 
 
Cash paid
$
27,941

 
$
1,000

Common stock issued

 
1,000

Earn-out liabilities

 
1,000


Banco Popular’s California Branch Network Acquisition

Effective November 8, 2014, the Bank acquired 20 full-service branches from Banco Popular North America (BPNA) in the Southern California banking market (the BPNA Branch Acquisition). The purchase price, net of deposit premiums received of $3.9 million, was $24.0 million. The transaction added $1.07 billion in loans and $1.08 billion in deposits to the Bank.

The following table summarizes the total consideration transferred as part of the BPNA Branch Acquisition as well as the fair value adjustments to the net assets acquired as of the acquisition date:
 
November 8, 2014
 
(In thousands)
Total Consideration
 
 
$
27,941

Net assets pre-acquisition
 
 
24,027

Fair value adjustments
 
 
 
Loans receivable
$
(12,165
)
 
 
Core deposit intangibles
15,777

 
 
Certificates of deposit purchase premium
(916
)
 
 
Premises and equipment
1,218

 
 
Total fair value adjustments
 
 
3,914

Fair value of net assets acquired
 
 
27,941

Net fair value in excess of consideration
 
 
$



16


The fair value of loans acquired from BPNA was estimated by utilizing a methodology wherein similar loans were aggregated into pools. Cash flows for each pool were determined by estimating future credit losses and the rate of prepayments. Projected monthly cash flows were then discounted to present value based on a market rate for similar loans. There was no carryover of BPNA's allowance for loan losses associated with the acquired loans as the loans were initially recorded at fair value.

Core deposit intangible asset of $15.8 million recognized as part of the BPNA Branch Acquisition was valued using a net cost savings method and was calculated as the present value of the estimated net cost savings attributable to the core deposit base over the expected remaining life of the deposits. The cost savings derived from the core deposit balance was calculated as the difference between the prevailing alternative cost of funds and the estimated actual cost of the core deposits. The core deposit intangible is being amortized over its estimated useful life of 10 years using the sum of years-digits amortization methodology.

The fair value of savings and transaction deposit accounts acquired from BPNA was assumed to approximate the carrying value as these accounts have no stated maturity and are payable on demand. Certificates of deposit were valued by projecting the expected cash flows based on the remaining contractual terms of the certificates of deposit. These cash flows were discounted based on market rates for certificates of deposit with corresponding remaining maturities.

Direct costs related to the BPNA Branch Acquisition were expensed as incurred and amounted to $4.3 million for the year ended December 31, 2014. These included technology costs related to system conversion and professional fees.

Certain valuations related to acquired loans receivable, premises and equipment, and other intangible assets and assumed deposits are still under review by management and considered preliminary and could differ significantly when management's review is finalized.

RenovationReady® Acquisition

Effective January 31, 2014, the Company acquired certain assets, including service contracts and intellectual property, of RenovationReady, a provider of specialized loan services to financial institutions and mortgage bankers that originate agency eligible residential renovation and construction loan products.

The RenovationReady acquisition was accounted for under GAAP guidance for business combinations. The purchased identifiable intangible assets and assumed liabilities were recorded at their estimated fair values as of January 31, 2014. The Company recorded $2.2 million of goodwill and $761 thousand of other intangible assets. The other intangible assets are related to a customer relationship intangible.

Pro Forma Information

While the BPNA Branch Acquisition is considered a purchase of a business for accounting purposes, pro forma income statement information is not presented because the BPNA Branch Acquisition does not represent the acquisition of a business which has continuity both before and after the acquisition. Pro formation income statement information for RenovationReady is not presented because it is immaterial.

Building Sales

During the three months ended June 30, 2015, the Company sold a certain improved real property office complex located at 1588 South Coast Drive, Costa Mesa, California (the Property) at a sale price of approximately $52.3 million with a gain on sale of $9.9 million. The Property had a book value of $42.3 million at the sale date. Additionally, the Company incurred selling costs of $2.3 million for this transaction, which were reported in Professional Fees and All Other Expenses in the Consolidated Statements of Operations.

Branch Sales

On July 3, 2015, the Bank entered into a definitive agreement with Americas United Bank, a California banking corporation (AUB), pursuant to which the Bank has agreed to sell two branches and certain related assets and deposit liabilities to AUB as well as certain loans. See Note 21 for additional information.


17


NOTE 3 – FAIR VALUES OF FINANCIAL INSTRUMENTS

Fair Value Hierarchy

ASC 820-10 establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The topic describes three levels of inputs that may be used to measure fair value:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2: Significant observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

Categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

Assets and Liabilities Measured on a Recurring Basis

Securities Available for Sale: The fair values of securities available for sale are generally determined by quoted market prices in active market, if available (Level 1). If quoted market prices are not available, the Company employs an independent pricing service that utilizes matrix pricing to calculate fair value. Such fair value measurements consider observable data such as dealer quotes, market spreads, cash flows, yield curves, live trading levels, trade execution data, market consensus prepayment speeds, credit information, and respective terms and conditions for debt instruments. The Company employs procedures to monitor the pricing service's assumptions and establishes processes to challenge the pricing service's valuations that appear unusual or unexpected. Level 2 securities include SBA loan pool securities, U.S. GSE and agency securities, private label residential MBS, and agency MBS. When a market is illiquid or there is a lack of transparency around the inputs to valuation, the securities are classified as Level 3 and reliance is placed upon internally developed models, and management judgment and evaluation for valuation. The Company had no securities available for sale classified as Level 3 at June 30, 2015 and December 31, 2014.

Loans Held for Sale, carried at fair value: The fair value of loans held for sale is based on commitments outstanding from investors as well as what secondary markets are currently offering for portfolios with similar characteristics. Therefore, loans held for sale subjected to recurring fair value adjustments are classified as Level 2. The fair value includes the servicing value of the loans as well as any accrued interest.

Derivative Assets and Liabilities: The Company’s derivative assets and liabilities are carried at fair value as required by GAAP and are accounted for as freestanding derivatives. The Company has entered into pay-fixed, receive-variable interest rate swap contracts with institutional counterparties to hedge against variability in cash flow attributable to interest rate risk caused by changes in the LIBOR benchmark interest rate on the Company’s ongoing LIBOR-based variable rate deposits. The Company is accounting for the swaps as cash flow hedges under ASC 815. The other derivative assets are interest rate lock commitments (IRLCs) with prospective residential mortgage borrowers. These commitments are carried at fair value based on the fair value of the underlying mortgage loans which are based on observable market data. The Company adjusts the outstanding IRLCs with prospective borrowers based on an expectation that it will be exercised and the loan will be funded. Changes in fair value are recorded in earnings as a component of net revenue on mortgage banking activities. These commitments are classified as Level 2 in the fair value disclosures, as the valuations are based on market observable inputs. Additional derivative assets and liabilities, typically mortgage-backed to-be-announced (TBA) securities, are used to hedge fair value changes, driven by changes in interest rates, in the Company’s mortgage assets. The Company hedges the period from the interest rate lock (assuming a fall-out factor for loans that ultimately do not close) to the date of the loan sale. The estimated fair value is based on current market prices for similar instruments. Given the meaningful level of secondary market activity for derivative contracts, active pricing is available for similar assets and accordingly, the Company classifies its derivative assets and liabilities as Level 2.

Mortgage Servicing Rights: The Company retains servicing on some of its mortgage loans sold and elected the fair value option for valuation of these mortgage servicing rights (MSRs). The value is based on a third party provider that calculates the present value of the expected net servicing income from the portfolio based on key factors that include interest rates, prepayment assumptions, discount rate and estimated cash flows. Because of the significance of unobservable inputs, these servicing rights

18


are classified as Level 3. At June 30, 2015 and December 31, 2014, $0 and $5.9 million of the mortgage servicing rights were valued based on a market bid that settled subsequent to each period end, which is included as Level 3, respectively.

The following table presents the Company’s financial assets and liabilities measured at fair value on a recurring basis as of the dates indicated: 
 
 
 
Fair Value Measurement Level
 
Carrying
Value
 
Quoted Prices
in Active Markets
for Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
(In thousands)
June 30, 2015
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
Available for sale securities:
 
 
 
 
 
 
 
SBA loan pools securities
$
1,618

 
$

 
$
1,618

 
$

U.S. government-sponsored entities and agency securities
2,000

 

 
2,000

 

Private label residential mortgage-backed securities
2,146

 

 
2,146

 

Agency mortgage-backed securities
481,529

 

 
481,529

 

Loans held for sale
409,799

 

 
409,799

 

Derivative assets (1)
11,800

 

 
11,800

 

Mortgage servicing rights (2)
34,198

 

 

 
34,198

Liabilities
 
 
 
 
 
 
 
Derivative liabilities (3)
557

 

 
557

 

December 31, 2014
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
Available for sale securities:
 
 
 
 
 
 
 
SBA loan pools securities
$
1,715

 
$

 
$
1,715

 
$

U.S. government-sponsored entities and agency securities
1,982

 

 
1,982

 

Private label residential mortgage-backed securities
3,168

 

 
3,168

 

Agency mortgage-backed securities
338,830

 

 
338,830

 

Loans held for sale
278,749

 

 
278,749

 

Derivative assets (1)
6,379

 

 
6,379

 

Mortgage servicing rights (2)
19,082

 

 

 
19,082

Liabilities
 
 
 
 
 
 
 
Derivative liabilities (3)
3,235

 

 
3,235

 

 

(1)
Included in Other Assets on the Consolidated Statements of Financial Condition
(2)
Included in Servicing Rights, Net and Servicing Rights Held For Sale on the Consolidated Statements of Financial Condition
(3)
Included in Accrued Expenses and Other Liabilities on the Consolidated Statements of Financial Condition

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The following table presents a reconciliation of assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the periods indicated:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands)
Mortgage servicing rights
 
 
 
 
 
 
 
Balance at beginning of period
$
21,165

 
$
8,407

 
$
19,082

 
$
13,535

Transfers out of Level 3 (1)

 

 

 
(9,185
)
Total gains or losses (realized/unrealized):
 
 
 
 
 
 
 
Included in earnings—realized

 

 

 

Included in earnings—fair value adjustment
1,538

 
(565
)
 
1,010

 
(250
)
Included in other comprehensive income

 

 

 

Amortization of premium (discount)

 

 

 

Additions
13,699

 
5,996

 
23,891

 
10,322

Sales and settlements
(2,204
)
 
(4,022
)
 
(9,785
)
 
(4,606
)
Balance at end of period
$
34,198

 
$
9,816

 
$
34,198

 
$
9,816

 

(1)
The Company’s policy is to recognize transfers in and transfers out as of the actual date of the event or change in circumstances that causes the transfer.

The following table presents quantitative information about Level 3 fair value measurements on a recurring basis as of the dates indicated:
 
Fair Value
(In thousands)
 
Valuation Technique(s)
 
Unobservable Input(s)
 
Range (Weighted Average)
June 30, 2015
 
 
 
 
 
 
 
Mortgage servicing rights
$
34,198

 
Discounted cash flow
 
Discount rate
 
9.00% to 18.00% (9.87%)
 
 
 
 
 
Prepayment rate
 
6.09% to 33.55% (10.44%)
December 31, 2014
 
 
 
 
 
 
 
Mortgage servicing rights
$
13,135

 
Discounted cash flow
 
Discount rate
 
9.00% to 19.50% (10.09%)
 
 
 
 
 
Prepayment rate
 
4.59% to 31.02% (13.22%)
June 30, 2014
 
 
 
 
 
 
 
Mortgage servicing rights
$
9,816

 
Discounted cash flow
 
Discount rate
 
10.00% to 16.42% (10.92%)
 
 
 
 
 
Prepayment rate
 
4.34% to 36.13% (14.20%)

The significant unobservable inputs used in the fair value measurement of the Company’s servicing rights include the discount rate and prepayment rate. There may be inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results.

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Assets and Liabilities Measured on a Non-Recurring Basis

Securities held to maturity: Investment securities that the Company has the ability and the intent to hold to maturity are classified as held to maturity. Investment securities classified as held to maturity are carried at cost. The fair values of securities held to maturity are generally determined by quoted market prices in active market, if available (Level 1). If quoted market prices are not available, the Company employs an independent pricing service that utilizes matrix pricing to calculate fair value. Such fair value measurements consider observable data such as dealer quotes, market spreads, cash flows, yield curves, live trading levels, trade execution data, market consensus prepayment speeds, credit information, and respective terms and conditions for debt instruments (Level 2). The Company employs procedures to monitor the pricing service's assumptions and establishes processes to challenge the pricing service's valuations that appear unusual or unexpected. When a market is illiquid or there is a lack of transparency around the inputs to valuation, the securities are classified as Level 3 and reliance is placed upon internally developed models, and management judgment and evaluation for valuation. Only securities held to maturities with other-than-temporary impairment (OTTI) are considered to be carried at fair value. The Company did not have any OTTI on securities held to maturity at June 30, 2015.

Impaired Loans and Leases: The fair value of impaired loans and leases with specific allocations of the allowance for loan and lease losses based on collateral values is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value.

Loans Held for Sale, carried at lower of cost or fair value: The Company records non-conforming jumbo mortgage loans held for sale at the lower of cost or fair value, on an aggregate basis. The Company obtains fair values from a third party independent valuation service provider. Loans held for sale accounted for at the lower of cost or fair value are considered to be recognized at fair value when they are recorded at below cost, on an aggregate basis, and are classified as Level 2.

SBA Servicing Assets: SBA servicing assets represent the value associated with servicing SBA loans that have been sold. The fair value for SBA servicing assets is determined through discounted cash flow analysis and utilizes discount rates and prepayment speed assumptions as inputs. All of these assumptions require a significant degree of management estimation and judgment. The fair market valuation is performed on a quarterly basis for SBA servicing assets. SBA servicing assets are accounted for at the lower of cost or market and considered to be recognized at fair value when they are recorded at below cost and are classified as Level 3.

Other Real Estate Owned Assets: Other real estate owned assets (OREO) are recorded at the fair value less estimated costs to sell at the time of foreclosure. The fair value of other real estate owned assets is generally based on recent real estate appraisals adjusted for estimated selling costs. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments may be significant and result in a Level 3 classification of the inputs for determining fair value. Only OREO with a valuation allowance are considered to be carried at fair value. The Company recorded valuation allowance expense for OREO of $0 and $0 for the three months ended June 30, 2015 and 2014, respectively, and $22 thousand and $0 for the six months ended June 30, 2015 and 2014, respectively.

Alternative Investments (Affordable Housing Fund Investment & SBIC): The Company generally accounts for its percentage ownership of alternative investment funds at cost, subject to impairment testing. These are non-public investments that cannot be redeemed since the Company’s investment is distributed as the underlying investments are liquidated, which generally takes 10 years. There are currently no plans to sell any of these investments prior to their liquidation. The alternative investments carried at cost are considered to be measured at fair value on a non-recurring basis when there is impairment. The Company had unfunded commitments of $487 thousand and $7.1 million for Affordable House Fund Investment and SBIC at June 30, 2015, respectively.


21


The following table presents the Company’s financial assets and liabilities measured at fair value on a non-recurring basis as of the dates indicated:
 
 
 
Fair Value Measurement Level
 
Carrying
Value
 
Quoted Prices
in Active Markets
for Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
(In thousands)
June 30, 2015
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
Impaired loans:
 
 
 
 
 
 
 
Single family residential mortgage
$
5,271