10-K 1 d288036d10k.htm FORM 10-K Form 10-K
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20015

FORM 10-K

(Mark One)

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

For the fiscal year ended December 31, 2016

 

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

For the transition period from             to            

CU BANCORP

(Exact name of registrant as specified in its charter)

Commission File Number 001-35683

 

California   90-0779788
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)

818 W. 7th Street, Suite 220

Los Angeles, California

  90017
(Address of principal executive offices)   (Zip Code)

(213) 430-7000

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(g) of the Act:

None

Securities registered pursuant to Section 12(b) of the Act:

Common Stock, no par value, The NASDAQ Stock Market, LLC

Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes      No  

Indicate by check mark whether the registrant is not required to file reports pursuant Section 13 or 15(d) of the Exchange act.    Yes      No  

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      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 (§ 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      No  

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    Yes  ☐    No  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer      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  

As of June 30, 2016, the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of the voting and non-voting common equity held by non-affiliates was approximately $367 million based upon the closing price of shares of the registrant’s Common Stock, no par value, as reported by The NASDAQ Stock Market, LLC.

The number of shares outstanding of the registrant’s common stock (no par value) at the close of business on March 6, 2017 was 17,807,122.

DOCUMENTS INCORPORATED BY REFERENCE

The information required to be disclosed pursuant to Part III of this report either shall be (i) deemed to be incorporated by reference from selected portions of CU Bancorp’s definitive proxy statement for the 2017 Annual Meeting of Shareholders, if such proxy statement is filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the Company’s most recently completed fiscal year, or (ii) included in an amendment to this report filed with the SEC on Form 10-K/A not later than the end of such 120 day period.


Table of Contents

TABLE OF CONTENTS

 

PART I

  

ITEM 1

     Business    5

ITEM 1A

     Risk Factors    26

ITEM 1B

     Unresolved Staff Comments   

ITEM 2

     Properties    46

ITEM 3

     Legal Proceedings    46

ITEM 4

     Mine Safety Disclosures    46

PART II

  

ITEM 5

     Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities    47

ITEM 6

     Selected Financial Data    50

ITEM 7

     Management’s Discussion and Analysis of Financial Condition and Results of Operations    52

ITEM 7A

     Quantitative and Qualitative Disclosures About Market Risk    89

ITEM 8

     Financial Statements and Supplementary Data    95

ITEM 9

     Changes in and Disagreements With Accountants on Accounting and Financial Disclosure    95

ITEM 9A

     Controls and Procedures    95

ITEM 9B

     Other Information    96

PART III

  

ITEM 10

     Directors, Executive Officers and Corporate Governance    96

ITEM 11

     Executive Compensation    96

ITEM 12

     Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters    96

ITEM 13

     Certain Relationships and Related Transactions, and Director Independence    96

ITEM 14

     Principal Accountant Fees and Services    96

PART IV

  

ITEM 15

     Exhibits and Financial Statement Schedules    97

ITEM 16

     Form 10-K Summary    97

Signatures

   169

 

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Forward Looking Statements

In addition to the historical information, this Annual Report on Form 10-K includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, (the “1933 Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “1934 Act”). Those sections of the 1933 Act and 1934 Act provide a “safe harbor” for forward-looking statements to encourage companies to provide prospective information about their financial performance so long as they provide meaningful, cautionary statements identifying important factors that could cause actual results to differ significantly from projected results.

The Company’s forward-looking statements include descriptions of plans or objectives of management for future operations, products or services, and forecasts of its revenues, earnings or other measures of economic performance. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include the words “believe,” “expect,” “intend,” “estimate,” “anticipates,” “project,” “assume,” “plan,” “predict,” or words of similar meaning, or future or conditional verbs such as “will,” “would,” “should,” “could” or “may.”

We make forward-looking statements as set forth above and regarding projected sources of funds, availability of acquisition and growth opportunities, dividends, adequacy of our allowance for loan losses and provision for loan losses, our loan portfolio and subsequent charge-offs. Forward-looking statements involve substantial risks and uncertainties, many of which are difficult to predict and are generally beyond our control. There are many factors that could cause actual results to differ materially from those contemplated by these forward-looking statements. Risks and uncertainties that could cause our financial performance to differ materially from our goals, plans, expectations and projections expressed in forward-looking statements include those set forth in our filings with the SEC, Item 1A of this Annual Report on Form 10-K, and the following:

 

   

Current and future economic and market conditions in the United States generally or in the communities we serve, including the effects of declines in property values, high unemployment rates and overall slowdowns in economic growth should these events occur.

 

   

The effects of trade, monetary and fiscal policies and laws.

 

   

Possible losses of businesses and population in the Los Angeles, Orange, Ventura, San Bernardino or Riverside Counties.

 

   

Loss of customer checking and money-market account deposits as customers pursue other higher-yield investments, particularly in a rising rate environment.

 

   

Possible changes in consumer and business spending and saving habits and the related effect on our ability to increase assets and to attract deposits.

 

   

Competitive market pricing factors.

 

   

Risks associated with concentrations including but not limited to concentrations in real estate related loans and concentrations in deposits.

 

   

Loss of significant customers.

 

   

Continued low interest rate environment or interest rate volatility.

 

   

Possible changes in the creditworthiness of customers and the possible impairment of the collectability of loans.

 

   

Changes in the speed of loan prepayments, loan origination and sale volumes, loan loss provisions, charge-offs or actual loan losses.

 

   

Compression of our net interest margin.

 

   

Stability of funding sources and continued availability of borrowings to the extent necessary.

 

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Changes in legal or regulatory requirements.

 

   

The inability of our risk management controls to prevent or detect all errors or fraudulent acts.

 

   

Inability of our framework to manage risks associated with our business, including but not limited to, operational risk, regulatory risk, cyber risk and credit risk, to mitigate all risk or loss to us.

 

   

Our ability to keep pace with technological changes, including our ability to identify and address cyber-security risks such as data security breaches, “denial of service” attacks, “hacking” and identity theft.

 

   

The effects of man-made and natural disasters, including, but not limited to, earthquakes, floods, droughts, brush fires, tornadoes and hurricanes.

 

   

The effect of labor and port strikes or slowdowns on customer businesses.

 

   

Risks of loss of funding of Small Business Administration or SBA loan programs, or changes in those programs.

 

   

Lack of take-out financing or problems with sales or lease-up with respect to our construction loans.

 

   

Our ability to recruit and retain key management and staff.

 

   

Risks associated with merger and acquisition integration.

 

   

Significant decline in the market value of the Company that could result in an impairment of goodwill.

 

   

Regulatory limits on the Bank’s ability to pay dividends to the Company.

 

   

New accounting pronouncements.

 

   

The impact of the federal and state laws and regulations on the Company’s business operations and competitiveness.

 

   

Our ability to comply with applicable capital and liquidity requirements (including the finalized Basel III capital standards), including our ability to generate capital internally or raise capital on favorable terms.

 

   

Increased regulation of the securities markets, including the securities of the Company, whether pursuant to the Sarbanes-Oxley Act of 2002, or otherwise.

 

   

The satisfaction of the Federal Deposit Insurance Corporation (“FDIC”) and the California Department of Business Oversight (“DBO”) with our compliance with the Consent Order (as defined herein).

 

   

The effects of any damage to our reputation resulting from developments related to any of the items identified above.

For a more detailed discussion of some of the risk factors, see the section entitled “Risk Factors” below.

Forward-looking statements speak only as of the date they are made. The Company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made or to reflect the occurrence of unanticipated events and specifically disclaims any obligation to revise or update such forward looking statements for any reason, except as may be required by applicable law. You should consider any forward looking statements in light of this explanation, and we caution you about relying on forward-looking statements.

 

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PART I

ITEM 1 — BUSINESS

General

CU Bancorp, headquartered in Downtown Los Angeles, California, is a bank holding company registered under the Bank Holding Company Act of 1956, as amended, and is also a bank holding company within the meaning of Section 1280 of the California Financial Code. Our principal business is to serve as the holding company for our bank subsidiary, California United Bank, which we refer to as “CUB” or the “Bank”. When we say “we,” “our” or the “Company,” we mean the Company on a consolidated basis with the Bank. When we refer to CU Bancorp or the “holding company,” we are referring to the parent company on a stand-alone basis. The shares of CU Bancorp are listed on the NASDAQ Capital Market under the trading symbol “CUNB”.

CU Bancorp was incorporated as a California corporation on November 16, 2011, and became the holding company for California United Bank on July 31, 2012 by acquiring all the voting stock of California United Bank. The creation of the bank holding company for the Bank was approved by the shareholders of the Bank on July 23, 2012.

California United Bank was incorporated on September 30, 2004, under the laws of the State of California and commenced operations on May 23, 2005. The Bank is authorized to engage in the general commercial banking business and its deposits are insured by the FDIC up to the applicable limits of the law. CUB is a California state-chartered banking corporation and is not a member of the Federal Reserve System.

At year-end 2016, the Company had consolidated total assets of $3.0 billion, total loan balances of $2.0 billion, and total deposits of $2.6 billion. Additional information regarding our business, as well as regarding our acquisitions, is included in the information set forth in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) and Note 2, Business Combinations, of the Notes to Consolidated Financial Statements, and is incorporated herein by reference.

The internet address of the Company’s website is www.cubancorp.com. The Company makes available free of charge through the Company’s website, the Company’s annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to these reports. The Company makes these reports available on its website on the same day they appear on the Securities and Exchange Commission (“SEC”) website.

Banking Business

CU Bancorp’s principal business is to serve as the holding company for the Bank and for any other banking or banking related subsidiaries which the Company may establish in the future. We have not engaged in any other material activities to date.

The Bank is a full-service commercial bank offering a broad range of banking products and services designed for small and medium-sized businesses, non-profit organizations, business owners and entrepreneurs, and the professional community, including attorneys, certified public accountants, financial advisors and healthcare providers and investors. Our deposit products include demand, money market, and certificates of deposit. Our loan products include commercial, real estate construction, commercial real estate, SBA and personal loans. We also provide cash management services, online banking, commercial credit cards and other primarily business-oriented products.

The principal executive offices of the Bank and the Company are located at 818 W. 7th Street, Suite 220, Los Angeles, CA, 90017. In addition to the Los Angeles headquarters office of the Bank, the Bank has eight additional full-service branches in the Ventura/Los Angeles/ Orange County/San Bernardino metropolitan area; those branches are located in Encino, West Los Angeles, Valencia, Thousand Oaks, Gardena, Anaheim, Irvine/Newport Beach and Ontario.

 

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Recent Developments

On September 23, 2016, the “Bank entered into a Stipulation to the Issuance of a Consent Order with its bank regulatory agencies, the Federal Deposit Insurance Corporation (“FDIC”) and the California Department of Business Oversight (“CDBO”), consenting to the issuance of a consent order (the “Consent Order”) relating to weaknesses in the Bank’s Bank Secrecy Act and Anti-Money Laundering (collectively “BSA”) compliance program. In consenting to the issuance of the Consent Order, the Bank did not admit or deny any charges of unsafe or unsound banking practices related to the BSA compliance program.

Under the terms of the Consent Order the Bank and/or its Board of Directors is required to take certain actions which include, but are not limited to:

 

   

Increasing Board supervision of the BSA compliance program;

 

   

Notification to the regulatory agencies prior to appointment of a new BSA Officer or the executive to whom the BSA Officer reports;

 

   

Formulation of a written action plan describing the actions to be taken to correct BSA/AML related deficiencies, a revised, written BSA/AML compliance program and review and enhancement of the Bank’s BSA risk assessment;

 

   

Performance of a review of BSA staffing needs;

 

   

Enhancement of internal controls to ensure full compliance with the BSA;

 

   

Establishment of an independent testing program for compliance with the BSA rules and regulations; and

 

   

Obtaining regulatory agency consent for expansionary activities such as new branches, offices, delivery channels, products and services.

The Consent Order resulted in additional BSA compliance expenses for the Bank and the Company (See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Non-Interest Expense”). It may also have the effect of limiting or delaying the Bank’s and the Company’s ability to obtain regulatory approval for certain expansionary activities, should the Company wish to undertake these activities. The Consent Order does not otherwise impact the Bank’s business activities outside of BSA and does not require the Bank to pay any civil money penalty or require additional capital.

The Consent Order will remain in effect and be enforceable until it is modified, terminated, suspended or set aside by the FDIC and the CBDO. Management and the Board have expressed their full intention to comply with all parts of the Consent Order at the earliest possible date.

In July 2016, Robert Sjogren joined the Bank and Company as an Executive Vice President and its Chief Risk Officer, a newly created executive management position. As Chief Risk Officer, Mr. Sjogren is responsible for overseeing the Company’s risk management function and regulatory compliance, including relationships with key regulators. Mr. Sjogren was previously the Chief Operating Officer of Pacific Mercantile Bancorp and was its General Counsel prior to that.

Strategy

Our strategic objective is to be the premier community-based commercial bank in Southern California, with emphasis on the Greater Los Angeles/Orange/Ventura/San Bernardino and Riverside metropolitan and suburban business areas. The Bank’s value proposition is to provide a premier business banking experience through relationship banking, depth of expertise, resources and products. Our objective is to serve most segments of the business community and industries within our market area. We compete actively for deposits, and emphasize solicitation of core deposits, particularly noninterest-bearing deposits. In managing the top line of our business, we focus on making quality loans and gathering low-cost deposits to maximize our net interest margin and to support growth of a strong and stable loan portfolio.

 

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We maintain a strong community bank philosophy of focusing on and understanding the individualized banking needs of the businesses, professionals, entrepreneurs and other of our core constituents. We believe this focus allows us to be more responsive to our customers’ needs and provide a high level of personal service, which differentiates us from larger competitors. We combine this with experienced, in-market relationship banking officers who provide the full suite of available products to customers. These individuals and the Company’s marketing outreach are supplemented by the various Advisory Director Boards which are established in strategic regions of our market and which provide us with knowledge of the business environment in individual communities and access to local business leaders. We have also established a Director Emeritus Board to retain the expertise and marked acumen of former members of our Board of Directors and the Boards of Premier Commercial Bank and 1st Enterprise. We are also active in charities and non-profit organizations in our market, with a philosophy which emphasizes outstanding corporate citizenship.

We generate our revenue primarily from the interest received on the various loan products and investment securities and fees from providing deposit services and making loans. In sales of the guaranteed portion of SBA loans, we typically receive gains on sale which is also non-interest income. The Bank relies on a foundation of locally generated and relationship-based deposits to fund loans. Our Bank has a relatively low cost of funds compared to its peers due to a high percentage of noninterest-bearing and low cost deposits to total deposits. Other than as discussed herein with regard to ICS™ deposits, we do not currently utilize brokered deposits. Our operations, similar to other financial institutions with operations predominately focused in Southern California, are significantly influenced by economic conditions in Southern California, including the strength of the commercial real estate market, the fiscal and regulatory policies of the federal and state governments and the regulatory authorities that govern financial institutions. See “Supervision and Regulation” below.

We expect to continue to grow our business by building on our business strategy and increasing market share in our key Southern California markets. We believe the demographics and growth characteristics within the communities we serve provide us with significant long-term opportunities for internal or organic growth as well as significant franchise enhancement opportunities to leverage our core competencies when appropriate and achievable.

Products Offered

The Bank offers a full array of competitively priced commercial and personal loan and deposit products, as well as other services delivered directly or through strategic alliances with other service providers. The products offered are aimed at both business and individual customers in our target market.

Loan Products

We offer a diversified mix of business loans encompassing the following loan products: (i) commercial real estate loans; (ii) commercial and industrial loans; (iii) construction loans; and (iv) SBA loans. We also offer home equity lines of credit “HELOCS” to accommodate the needs of business owners and individual clients, as well as personal loans (both secured and unsecured) for that customer segment, and business credit cards to assist businesses with their short term working capital needs. We encourage relationship banking, and often obtain a substantial portion of each borrower’s banking business, including deposit accounts. Other than as set forth below, the Bank does not currently engage in consumer mortgage lending.

Commercial and Multi-Family Real Estate Loans. We originate and underwrite commercial property and multi-family loans principally within our service area. Typically, these loans are held in our loan portfolio and collateralized by the underlying property. The property financed must be supported by current independent third party appraisals at the date of origination (which are reviewed by other independent third parties) and other relevant information.

 

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Commercial and Industrial Loans. These loans comprise a significant portion of our loan portfolio and are made to businesses located in the Southern California region and surrounding communities. These loans are directly underwritten by us. These loans are made to finance operations, to provide working capital, or for specific purposes such as to finance the purchase of assets, equipment or inventory. Our commercial and industrial loans may be secured (other than by real estate) or unsecured. They may take the form of single payment, installment, equipment financing loans (secured by the underlying equipment) or lines of credit. These are generally based on the financial strength and integrity of the borrower and guarantor(s) and generally (with some exceptions) are collateralized by short term assets such as accounts receivable, inventory, equipment, real estate or a borrower’s other business assets. Commercial term loans are typically made to finance the acquisition of fixed assets, refinance short-term debt originally used to purchase fixed assets, or, in rare cases, to finance the purchase of businesses.

Construction, Miniperm Loans, Land Development and Other Land Loans. We originate and underwrite interim land and construction loans as well as miniperm loans, collateralized by first or junior deeds of trust on specific commercial properties which are principally in our primary market areas. Land loans are primarily for entitlements and infrastructure. We originate construction, renovation and conversion loans to businesses on commercial, residential and income producing properties. Our construction loans are generally limited to experienced developers who are known to our management. We impose a limit on the loan to value ratio on all real estate lending. The project financed must be supported by current independent third party appraisals (which are reviewed by other independent third parties), environmental reviews where appropriate and other relevant information. We review each loan request and renewal individually.

SBA Loans. SBA loans are made through programs designed by the federal government to assist the small business community in obtaining financing from financial institutions that are given government guarantees as an incentive to make the loans. The Bank has been designated as an SBA Preferred Lender. Our SBA loans fall into three categories, loans originated under the SBA’s 7a Program (“7a Loans”), loans originated under the SBA’s 504 Program (“504 Loans”) and SBA “Express” Loans. SBA 7a Loans are commercial business loans generally made for the purpose of purchasing real estate to be occupied by the business owner, providing working capital, and/or purchasing equipment or inventory. SBA 504 Loans are collateralized by commercial real estate and are generally made to business owners for the purpose of purchasing or improving real estate for their use and for equipment used in their business.

SBA lending is subject to federal legislation that can affect the availability and funding of the program. From time to time, this dependence on legislative funding causes limitations and uncertainties with regard to the continued funding of such programs, which could potentially have an adverse financial impact on our business.

Home Equity Lines of Credit “HELOCS”. We offer home equity lines of credit “HELOCS”, which are revolving lines of credit collateralized by senior or junior deeds of trust on residential real properties, the applicants for which are generally our individual clientele and the principals and executives of our business customers.

Personal Loans. We offer personal loans. Generally, these are unsecured, but they may be secured by collateral, including deposit accounts or marketable securities. The Bank does not currently originate first trust deed home mortgage loans or home improvement loans.

Business Credit Cards. We originate and underwrite business credit cards to assist businesses with meeting short term working capital needs. Our program allows business clients to provide credit cards to their employees to be used exclusively for business use purposes. The Bank does not currently underwrite consumer credit cards but does participate in an Associate Cardholder Program to provide credit cards to consumers.

 

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Deposit Products

As a full-service commercial bank, we focus deposit generation on relationship accounts, encompassing non-interest bearing demand, interest bearing demand, and money market. In order to facilitate generation of non-interest bearing demand deposits, we require, depending on the circumstances and the type of relationship, our borrowers to maintain deposit balances with us as a typical condition of granting loans. We also offer certificates of deposit and savings accounts. We service our attorney clients by offering Interest on Lawyers’ Trust Accounts, “IOLTA” in accordance with the requirements of the California State Bar. We market deposits by offering the convenience of third party “couriers” or, in appropriate cases armored vehicles, which contract with our customers, as well as a “remote deposit capture” product that allows deposits to be made via computer at the customer’s business location. We also offer customers “e-statements” that allows customers to receive statements electronically, which is more convenient and secure than receiving paper statements, in addition to reducing paper and being environmentally-friendly.

For customers requiring full FDIC insurance on certificates of deposit in excess of $250,000, we offer the ICS™ program, which is a product offered by Promontory Interfinancial Network, LLC and allows the Bank to accept non-interest bearing deposits in excess of the FDIC maximum from a depositor and place the deposits through the ICS™ network into other member banks in increments of less than the FDIC insured maximum in order to provide the depositor full FDIC insurance coverage. The Company does not have any CDARS® reciprocal deposits on its consolidated balance sheet because all of these deposits matured in 2016.These “reciprocal” ICS™ deposits are classified as “brokered” deposits in regulatory reports and are currently the only brokered deposits utilized by the Bank; the Bank considers these deposits to be “core” in nature.

Investment Products

We compete with other larger and multi-state institutions for deposits. We have traditionally offered sophisticated business customers requiring either higher yields or more security investment sweeps into multiple types of money market funds provided by Dreyfus Corporation, a wholly owned subsidiary of Bank of New York Mellon Corporation. All of the funds invest in short-term securities and seek high current income, the preservation of capital and the maintenance of liquidity and each fund favors stability over growth. As a condition to access these products, we require the customer to maintain a certain level of demand deposits. Furthermore, we have also entered into “repurchase agreements” with sophisticated business customers, many of whom act as fiduciaries and require additional security above FDIC deposit insurance. These are essentially borrowings by the Bank, secured by U.S. Government and Agency securities from its investment portfolio. These are disclosed on the Bank’s financial statements as “Securities Sold under Agreements to Repurchase.” We also offer a “repo sweep” product whereby the deposits of qualifying customers are “swept” into repurchase agreements on a daily basis.

Through a third party arrangement with a registered representative of National Planning Corporation, member FINRA/SIPC we offer customers, upon request, the ability to purchase mutual funds, securities, annuities and limited types of insurance. The Bank considers this an ancillary product to its commercial banking activities.

Electronic Banking

While personalized, service-oriented banking is the cornerstone of our business plan, we use technology and the Internet as a secondary means for servicing customers, to compete with larger banks and to provide a convenient platform for customers to review and transact business. We offer sophisticated electronic or “internet banking” opportunities that permit commercial customers to conduct much of their banking business remotely from their business premises. However, our customers will always have the opportunity to personally discuss specific banking needs with knowledgeable bank officers and staff who are directly accessible in the branches and offices as well as by telephone and email.

 

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The Bank offers multiple electronic banking options to its customers. It does not allow the origination of deposit accounts through online banking, nor does it accept loan applications through its online services. All of the Bank’s electronic banking services allow customers to review transactions and statements, review images of paid items, transfer funds between accounts at the Bank, place stop orders, pay bills and export to various business and personal software applications. CUB Online Commercial Banking also allows customers to initiate domestic wire transfers and ACH transactions, with the added security and functionality of assigning discrete access and levels of security to different employees of the client and division of functions to allow separation of duties, such as input and release.

Additionally, we offer Payee Positive Pay, an antifraud service that allows businesses to review all issued checks daily and provides them with the ability to pay or reject any item. ACH Positive Pay is also offered to allow customers to review non-matching ACH transactions efficiently on a daily basis.

We also offer our internet banking customers an additional third party product designed to assist in mitigating fraud risk to both the customer and the Bank in internet banking and other internet activities conducted by the customer, at no cost to the customer.

The Bank has its own “home page” address on the World Wide Web as an additional means of expanding our market and providing banking services through the Internet. Members of the public can also communicate with us through the website. Our website address is: www.californiaunitedbank.com or www.cunb.com.

Other Services

In addition to providing a full complement of lending and deposit products and related services, we provide our customers with many additional services, either directly or through other providers, including, but not limited to, commercial and stand-by letters of credit, domestic and international wire transfers, on site Automated Teller Machines (“ATM’s”) and Visa® Debit Cards and ATM cards. We also provide bank-by-mail services, courier services, armored transport, lock box, cash vault, cash management services, telephone banking, night depositories, commercial credit cards and international services (some of these through arrangements with third parties). Our customers may utilize ATM’s other than California United Bank’s ATM’s; we reimburse our customers for charges for utilization of other banks’ ATM’s up to a maximum of $20 per month.

Competition

The banking business in California, and in our market area, is highly competitive with respect to both loans and deposits and is dominated by a relatively small number of major financial institutions with many offices operating over a wide geographic area, including institutions based outside of California. The increasingly competitive environment faced by banks is a result primarily of changes in laws and regulations, changes in technology and product delivery systems, and the accelerating pace of consolidation among financial services providers. We also compete for loans and deposits with other commercial banks, as well as with finance companies, credit unions, securities and brokerage companies, money market funds and other non-financial institutions. Larger financial institutions offer certain services (such as trust services or wealth management) that we do not offer directly (but some of which we offer indirectly through correspondent institutions or other relationships). These institutions also have the ability to finance extensive advertising campaigns, and have the ability to allocate investment assets to regions of highest yield and demand. By virtue of their greater total capitalization, such institutions also have substantially higher lending limits1 than we have. Customers may also move deposits into the equity and bond markets which also compete with us as an investment alternative.

 

1  Legal lending limits to each customer are limited to a percentage of a bank’s shareholders’ equity, allowance for loan losses, and capital notes and debentures; the exact percentage depends upon the nature of the loan transaction.

 

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Our ability to compete is based primarily on the basis of relationship, customer service and responsiveness to customer needs. Our “preferred lender” status with the Small Business Administration allows us to approve SBA loans faster than many of our competitors. We distinguish ourselves with the availability and accessibility of our senior management to customers and prospects. In addition, our knowledge of our markets and industries assists us in locating, recruiting and retaining customers. Our ability to compete also depends on our ability to continue to attract and retain our senior management and experienced relationship managers.

Employees

As of December 31, 2016, we had 291 full-time employees. Our employees are not represented by any union or other collective bargaining agreement.

Financial and Statistical Disclosure

Certain of our statistical information are presented within “Item 6. Selected Financial Data,” “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Item 7A. Quantitative and Qualitative Disclosure About Market Risk.” This information should be read in conjunction with the consolidated financial statements contained in “Item 8. Financial Statements and Supplementary Data.”

Executive Officers of the Registrant

The names, ages as of December 31, 2016, recent business experience and positions or offices held by each of the executive officers of the Company are as follows:

 

Name and Position Held

   Age     

Recent Business Experience

David I. Rainer, Chief Executive Officer and Chairman of the Board      59      Chief Executive Officer and Director of California United Bank since inception in 2005 and of CU Bancorp from inception in 2012. He became Chairman of the Board in June 2009. Mr. Rainer recently completed a second three year term as a member of the Board of Directors of the Federal Reserve Bank of San Francisco, Los Angeles Branch.
K. Brian Horton, President and Director      56      President and Director of CU Bancorp and California United Bank since December 1, 2014. Prior to joining the Company, Mr. Horton was a Director and President of 1st Enterprise Bank (which was acquired by the Company on November 30, 2014). He was a co-founder of 1st Enterprise.
Anne A. Williams, Executive Vice President, Chief Operating Officer, Chief Credit Officer and Director of California United Bank      57      Executive Vice President and Chief Credit Officer of California United Bank since 2005 and of CU Bancorp since 2012. Chief Operating Officer of California United Bank since 2008. Director of California United Bank since January 2009.
Karen A. Schoenbaum, Executive Vice President and Chief Financial Officer      54      Executive Vice President and Chief Financial Officer of California United Bank since October 2009. Executive Vice President and Chief Financial Officer of CU Bancorp since 2012.
Robert E. Sjogren, Executive Vice President, Chief Risk Officer      51      Executive Vice President and Chief Risk Officer of California United Bank and of CU Bancorp since July 2016. Previously Mr. Sjogren was the Chief Operating Officer of Pacific Mercantile Bank and before that served as its General Counsel.
Anita Y. Wolman, Executive Vice President, Chief Administrative Officer, General Counsel and Corporate Secretary     
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   Executive Vice President and General Counsel of California United Bank since January 2009 and of CU Bancorp since 2012. She has served as General Counsel of the Bank since its inception.

 

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Supervision and Regulation

General

CU Bancorp and the Bank are subject to significant regulation and restrictions by federal and state laws and regulatory agencies. This regulation is intended primarily for the protection of depositors and the deposit insurance fund, and secondarily for the stability of the U.S. banking system. It is not intended for the benefit of shareholders of financial institutions. The following discussion of statutes and regulations is a summary and does not purport to be complete nor does it address all applicable statutes and regulations. This discussion is also qualified in its entirety by reference to the full text and to the implementation and enforcement of the statutes and regulations referred to in this discussion.

Our profitability, like most financial institutions, is primarily dependent on interest rate differentials (“spreads”). In general, the difference between the interest rates paid by the Bank on interest-bearing liabilities, such as deposits and other borrowings, and the interest rates received by the Bank on interest-earning assets, such as loans extended to customers and securities held in the investment portfolio, will comprise the major portion of our earnings. These rates are highly sensitive to many factors that are beyond our control, such as inflation, recession and unemployment, and the impact which future changes in domestic and foreign economic conditions might have on us cannot be predicted.

Our business is also influenced by the monetary and fiscal policies of the federal government and the policies of regulatory agencies, particularly the Board of Governors of the Federal Reserve System (the “Federal Reserve”). The Federal Reserve implements national monetary policies through its open-market operations in U.S. Government securities by adjusting the required level of reserves for depository institutions subject to its reserve requirements, and by varying the target federal funds and discount rates applicable to borrowings by depository institutions. The monetary policies of the Federal Reserve in these areas influence the growth of loans, investments, and deposits and also affect interest earned on interest-earning assets and paid on interest-bearing liabilities. The nature and impact of any future changes in monetary and fiscal policies on us cannot be predicted.

Initiatives may be proposed or introduced before Congress, the California Legislature, and other government bodies in the future that may further alter the structure, regulation, and competitive relationship among financial institutions and may subject us to increased supervision and disclosure, compliance costs and reporting requirements. In addition, the various bank regulatory agencies often adopt new rules and regulations and policies to implement and enforce existing legislation.

It cannot be predicted whether, or in what form, any such legislation or regulatory changes in policy may be enacted or the extent to which the business of the Bank would be affected thereby. In addition, the outcome of examinations, any litigation, or any investigations initiated by state or federal authorities may result in necessary changes in our operations and increased compliance costs.

Legislation and Regulatory Developments

Dodd Frank Wall Street Reform and Consumer Protection Act

The federal banking agencies continue to implement the remaining requirements in the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) as well as promulgating other regulations and guidelines intended to assure the financial strength and safety and soundness of banks and the stability of the U.S. banking system. Following on the implementation in 2014 and effectiveness in 2015 of new capital rules (“the New Capital Rules”) and the so called Volcker Rule restrictions on certain proprietary trading and investment activities, developments in 2016 which may impact the Bank included the implementation of an additional “capital conservation buffer” of 0.625% in 2016 for minimum risk-weighted asset ratios under the New Capital Rules. — See “Capital Adequacy Requirements” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Capital Resources”.

 

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On February 3, 2017, President Donald Trump issued an executive order designed to reduce the perceived regulatory burdens of the Dodd-Frank Act. The executive order proclaims that the policy of President Trump’s administration will be to regulate the United States financial system in a manner consistent with a number of “principles” of regulation. President Trump’s order directs the Secretary of the Treasury to consult with the heads of the member agencies of the Financial Stability Oversight Council on the extent to which existing laws, treaties, regulations, guidance, reporting and recordkeeping requirements, and other government policies promote his administration’s regulatory principles and to identify what actions have been taken, and are currently being taken, to promote and support these principles.

In light of President Trump’s executive order, the Company cannot predict which provisions of the Dodd-Frank Act will be repealed, put into effect, delayed or enforced under the current Administration and, therefore, cannot predict the effect, if any, that the Dodd-Frank Act will have on the Company’s future operations and financial condition.

Capital Adequacy Requirements

Bank holding companies and banks are subject to similar regulatory capital requirements administered by state and federal banking agencies. The basic capital rule changes in the New Capital Rules adopted by the federal bank regulatory agencies were fully effective on January 1, 2015, but many elements are being phased in over multiple future years. The risk-based capital guidelines for bank holding companies and, additionally for banks, prompt corrective action regulations (See “Prompt Corrective Action Provisions”), require capital ratios that vary based on the perceived degree of risk associated with a banking organization’s operations for both transactions reported on the balance sheet as assets, such as loans, and those recorded as off-balance sheet items, such as commitments, letters of credit and recourse agreements. The risk-based capital ratio is determined by classifying assets and certain off-balance sheet financial instruments into weighted categories, with higher levels of capital being required for those categories perceived as representing greater risks and dividing its qualifying capital by its total risk-adjusted assets and off-balance sheet items. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weighting, and other factors. To the extent that the new rules are not fully phased in, the prior capital rules continue to apply.

The New Capital Rules revised the previous risk-based and leverage capital requirements for banking organizations to meet requirements of the Dodd-Frank Act and to implement the international Basel Committee on Banking Supervision Basel III agreements. Many of the requirements in the New Capital Rules and other regulations and rules are applicable only to larger or internationally active institutions and not to all banking organizations, including institutions currently with less than $10 billion or assets, which includes the Company and the Bank.

Under the risk-based capital guidelines in place prior to the effectiveness of the New Capital Rules, which trace back to the 1988 Basel I accord, there were three fundamental capital ratios: a total risk-based capital ratio, a Tier 1 risk-based capital ratio and a Tier 1 leverage ratio. To be deemed “well capitalized” a bank must have a total risk-based capital ratio, a Tier 1 risk-based capital ratio, a leverage ratio and a common equity Tier 1 capital ratio of at least ten percent, eight percent, five percent and six and a half percent, respectively.

The following table sets forth the regulatory capital guidelines and the actual capitalization levels for the Company and the Bank as of December 31, 2016:

 

     Well-
Capitalized
    Basel III
Minimum with
Buffer
    CU Bancorp     California United Bank  
     (greater than or equal to)              

Total Risk-Based Capital Ratio

     10.0     8.625     11.44     11.04

Tier 1 Risk-Based Capital Ratio

     8.0     6.625     10.68     10.28

Leverage Ratio

     5.0     NA       9.72     9.35

Common Equity Tier 1 Capital Ratio

     6.5     5.125     9.61     10.28

 

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Pursuant to federal regulations, banks must maintain capital levels commensurate with the level of risk to which they are exposed, including the volume and severity of problem loans. Federal regulators may, however, set higher capital requirements when a bank’s particular circumstances warrant and have required many banks and bank holding companies subject to enforcement actions to maintain capital ratios in excess of the minimum ratios otherwise required to be deemed well capitalized, in which case institutions may no longer be deemed well capitalized and may therefore be subject to restrictions on taking brokered deposits. As of December 31, 2016, both the Bank’s and the Company’s leverage capital ratios exceeded regulatory minimums.

The following are the New Capital Rules which became applicable to the Company and the Bank beginning January 1, 2015:

 

   

an increase in the minimum Tier 1 capital ratio from 4.00% to 6.00% of risk-weighted assets;

 

   

a new category and a required 4.50% of risk-weighted assets ratio is established for “common equity Tier 1” as a subset of Tier 1 capital limited to common equity;

 

   

a minimum non-risk-based leverage ratio is set at 4.00%;

 

   

changes in the permitted composition of Tier 1 capital to exclude trust preferred securities subject to certain grandfathering exceptions for organizations like the Company which were under $15 billion in assets as of December 31, 2009, mortgage servicing rights and certain deferred tax assets and include unrealized gains and losses on available for sale debt and equity securities unless the organization opts out of including such unrealized gains and losses, which election the Company made in 2016;

 

   

the risk-weights of certain assets for purposes of calculating the risk-based capital ratios are changed for high volatility commercial real estate acquisition, development and construction loans, certain past due non-residential mortgage loans and certain mortgage-backed and other securities exposures; and

 

   

an additional capital conservation buffer of 2.5% of risk weighted assets above the regulatory minimum capital ratios is being phased in until 2019 beginning at 0.625% of risk-weighted assets for 2016, 1.25% of risk-weighted assets for 2017, and 1.875% of risk-weighted assets for 2018, and must be met to avoid limitations on the ability of the Bank to pay dividends, repurchase shares or pay discretionary bonuses.

Including the capital conservation buffer of 2.5%, the New Capital Rules would result in the following minimum ratios to be considered well capitalized when fully phased in: (i) a Tier 1 risk-based capital ratio of 8.5%, (ii) a common equity Tier 1 capital ratio of 7.0%, (iii) a total risk-based capital ratio of 10.5%, and (iv) a leverage ratio of 5.0%. At December 31, 2016, the respective capital ratios of the Company and the Bank exceeded the minimum percentage requirements to be deemed “well-capitalized” for regulatory purposes — See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Capital Resources.”

While the New Capital Rules sets higher regulatory capital standards for the Company and the Bank, bank regulators may also continue their past policies of expecting banks to maintain additional capital beyond the new minimum requirements. The need to maintain more and higher quality capital, and greater liquidity going forward than historically has been required, and generally increased regulatory scrutiny with respect to capital levels, could limit the Company’s business activities, including lending, and its ability to expand, either organically or through acquisitions. It could also result in the Company being required to take steps to increase its regulatory capital that may be dilutive to shareholders or limit its ability to pay dividends or otherwise return capital to shareholders, or sell or refrain from acquiring assets, the capital requirements for which are not justified by the assets’ underlying risks. Moreover, U.S. federal banking agencies have been taking into account expectations regarding the ability of banks to meet these new requirements, including under stressed conditions, in approving actions that represent uses of capital, such as dividend increases, share repurchases and acquisitions.

See “Management’s Discussion and Analysis — Capital Resources.”

 

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Management believes that as of December 31, 2016, the Company and the Bank would meet all requirements under the New Capital Rules applicable to them on a fully phased-in basis if such requirements were currently in effect.

Under Dodd Frank, trust preferred securities and cumulative perpetual preferred stock are excluded from Tier 1 capital, unless such securities were issued prior to May 19, 2010 by a bank holding company with less than $15 billion in assets. CU Bancorp assumed approximately $12.4 million of junior subordinated debt securities issued to various business trust subsidiaries of Premier Commercial Bancorp and funded through the issuance of approximately $12.0 million of floating rate capital trust preferred securities. These junior subordinated debt securities were issued prior to May 19, 2010. Because CU Bancorp has less than $15 billion in assets, the trust preferred securities that CU Bancorp assumed from Premier Commercial Bancorp will continue to be included in Tier 1 capital, subject to a limit of 25% of Tier 1 capital elements.

The 16,400 shares of 1st Enterprise Non-Cumulative Perpetual Preferred Stock, Series D that were converted into the right to receive 16,400 shares of the Company’s Non-Cumulative Perpetual Preferred Stock, Series A in the merger of 1st Enterprise Bank with and into the Bank will continue to constitute Tier 1 capital, because non-cumulative perpetual preferred stock remained classified as Tier 1 capital following the enactment of Dodd Frank.

Other Recent Regulatory Developments

In 2016, the federal banking agencies adopted other rules and released various regulatory guidance, including, but not limited to:

 

  (i) the release by the Interagency Federal Financial Institutions Examinations Council (“FFIEC”) of a revised “Information Security” booklet, which is one of the eleven booklets which make up the FFIEC Information Technology Examination Handbook (IT Handbook). The revised “Information Security” booklet provides guidance to examiners and addresses factors necessary to assess the level of security risks to a financial institution’s information systems..

 

  (ii) the release by the FFIEC of final revisions to the Uniform Interagency Consumer Compliance Rating System to reflect the regulatory, supervisory, technological, and market changes that occurred in the years since the system was established. The revisions are designed to more fully align the rating system with the FFIEC agencies’ current risk-based, tailored examination approaches.

 

  (iii) the effectiveness in October 2016 of a new Protections for Prepaid Account Customers rule promulgated by the Consumer Financial Protection Bureau (“CFPB”) requiring financial institutions to limit consumers’ losses when funds are stolen or cards are lost, to investigate and resolve errors, and to give customers free and easy access to account information. The CFPB also finalized new “Know Before You Owe” disclosures for prepaid accounts to give consumers clear, upfront information about fees and other key details. The Bank does not offer prepaid cards.

 

  (iv.) The CFPB and other regulatory agencies have issued final rules changing the reporting requirements for lenders under the HMDA. The new rules expand the range of transactions subject to these requirements to include most securitized residential mortgage loans and credit lines. The rules also increase the overall amount of data required to be collected and submitted, including additional data points about the applicable loans and expanded data about the borrowers. The Bank will be required to begin collecting the expanded data on January 1, 2018.

Securities Registration and Listing

CU Bancorp’s common stock is registered with the Securities and Exchange Commission (“SEC”) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). As such, CU Bancorp is subject to the information, proxy solicitation, insider trading, corporate governance, and other disclosure requirements and

 

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restrictions of the Exchange Act, as well as the Securities Act of 1933 (the “Securities Act”), both administered by the SEC. We are required to file annual, quarterly and other current reports with the SEC. The SEC maintains an internet site, http://www.sec.gov, at which all forms accessed electronically may be accessed. Our SEC filings are also available on our website at www.cubancorp.com.

Our securities are listed on the NASDAQ Capital Market and trade under the symbol “CUNB”. As a company listed on the NASDAQ Capital Market, CU Bancorp is subject to NASDAQ standards for listed companies. CU Bancorp is also subject to the Sarbanes-Oxley Act of 2002, the Federal Deposit Insurance Corporation Improvement Act (“FDICIA”), provisions of the Dodd-Frank Act, and other federal and state laws and regulations which address, among other issues, requirements for executive certification of financial presentations, corporate governance requirements for board, audit and compensation committees and their members, as well as disclosure of controls and procedures and internal control over financial reporting, auditing and accounting, executive compensation, and enhanced and timely disclosure of corporate information. NASDAQ has also adopted corporate governance rules, which are intended to allow shareholders and investors to more easily and efficiently monitor the performance of companies and their directors.

Corporate Governance and the JOBS Act

Pursuant to the Sarbanes-Oxley Act, publicly-held companies such as the Company have significant requirements, particularly in the area of external audits, financial reporting and disclosure, conflicts of interest, and corporate governance. The Dodd-Frank Act has added new corporate governance and executive compensation requirements, including mandated resolutions for public company proxy statements such as an advisory vote on executive compensation (more frequently referred to as “say-on-pay” votes) or executive compensation payable in connection with a merger (more frequently referred to as “say-on-golden parachute” votes) and new stock exchange listing standards.

However, CU Bancorp is an “emerging growth company,” as defined in Section 2(a) of the Securities Act of 1933, as amended (the “Securities Act”), as modified by the Jumpstart Our Business Startups Act of 2012 ( the “JOBS Act”) and as a result, CU Bancorp is not yet subject to all of these regulations. CU Bancorp also will not be subject to certain requirements of Section 404 of the Sarbanes-Oxley Act, including the additional level of review of its internal control over financial reporting as may occur when outside auditors attest as to its internal control over financial reporting. The Bank is subject to an additional level of review of its internal controls over financial reporting under FDICIA.

Further, an emerging growth company may elect to delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies, but must make such election when the company is first required to file a registration statement. Such an election is irrevocable during the period a company is an emerging growth company. At inception, CU Bancorp elected to take advantage of the benefits of this extended transition period to comply with new or amended accounting pronouncements in the same manner as a private company, although prior to 2013 there were no such accounting pronouncements. During 2013, however, the Company “opted-in” to compliance with new or amended accounting pronouncements in the same fashion as other public companies. As a result, for the year ended December 31, 2016, the Company’s financial statements are comparable to companies which complied with such new or revised accounting standards when originally effective.

CU Bancorp may remain an emerging growth company until the earlier of: (i) the last day of the fiscal year in which it has total annual gross revenues of $1.0 billion or more; (ii) the last day of the fiscal year following the fifth anniversary of the date of the first sale of common equity securities pursuant to an effective registration statement under the Securities Act of 1933, which is fiscal year 2017; (iii) the date on which CU Bancorp has, during the previous three-year period, issued more than $1.0 billion in non-convertible debt; or (iv) the date on which CU Bancorp is deemed to be a “large accelerated filer” under Securities and Exchange Commission regulations (generally, at least $700 million of voting and non-voting equity held by non-affiliates).

 

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Dividends

It is the Federal Reserve’s policy that bank holding companies should generally pay dividends on common stock only out of income available over the past year, and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition. It is also the Federal Reserve’s policy that bank holding companies should not maintain dividend levels that undermine their ability to be a source of strength to its banking subsidiaries. The Federal Reserve has also discouraged payment ratios that are at maximum allowable levels unless both asset quality and capital are very strong.

The terms of our Subordinated Debentures also limit our ability to pay dividends on our common stock. If we are not current in our payment of dividends in our payment of interest on our Subordinated Debentures, we may not pay dividends on our common stock.

Quarterly dividends are paid to the U.S. Department of the Treasury pursuant to the terms of the CU Bancorp Preferred Stock. The payment of preferred dividends does not require approval from the Federal Reserve and other regulatory agencies.

California law additionally limits the Company’s ability to pay dividends. A corporation may make a distribution/dividend from retained earnings to the extent that the retained earnings exceed (a) the amount of the distribution plus (b) the amount, if any, of dividends in arrears on shares with preferential dividend rights. Alternatively, a corporation may make a distribution/dividend, if, immediately after the distribution, the value of its assets equals or exceeds the sum of (a) its total liabilities plus (b) the liquidation preference of any shares which have a preference upon dissolution over the rights of shareholders receiving the distribution/dividend.

The Bank is a legal entity that is separate and distinct from its holding company. The Company is dependent on the performance of the Bank for funds which may be received as dividends from the Bank for use in the operation of the Company and the ability of the Company to pay dividends to shareholders. Subject to the regulatory restrictions which currently further restrict the ability of the Bank to declare and pay dividends, future cash dividends by the Bank will depend upon management’s assessment of future capital requirements, contractual restrictions, and other factors. When effective, the new minimum capital rule may restrict dividends by the Bank, if the additional capital conservation buffer is not achieved.

The powers of the board of directors of the Bank to declare a cash dividend to the Company is subject to California law, which restricts the amount available for cash dividends to the lesser of a bank’s retained earnings or net income for its last three fiscal years (less any distributions to shareholders made during such period). Where the above test is not met, cash dividends may still be paid, with the prior approval of the DBO in an amount not exceeding the greatest of (1) retained earnings of the bank; (2) the net income of the bank for its last fiscal year; or (3) the net income of the bank for its current fiscal year.

Bank Holding Company Regulation

As a bank holding company, CU Bancorp is registered with and subject to regulation and periodic examination by the Federal Reserve under the Bank Holding Company Act of 1956, as amended, or the BHCA. We are also required to file with the Federal Reserve periodic reports of our operations and such additional information regarding the Company and its subsidiaries as the Federal Reserve may require. CU Bancorp is also a bank holding company within the meaning of Section 1280 of the California Financial Code and is subject to examination by, and may be required to file reports with, the DBO.

Federal Reserve policy historically has required bank holding companies to act as a source of financial strength to their bank subsidiaries and to commit capital and financial resources to support those subsidiaries in circumstances where it might not otherwise do so. Dodd-Frank codified this policy as a statutory requirement. Under this requirement, CU Bancorp is expected to commit resources to support the Bank, including at times

 

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when we may not be in a financial position to do so. Similarly, under the cross-guarantee provisions of the Federal Deposit Insurance Act, the FDIC can hold any FDIC-insured depository institution liable for any loss suffered or anticipated by the FDIC in connection with (i) the default of a commonly controlled FDIC-insured depository institution or (ii) any assistance provided by the FDIC to such a commonly controlled institution.

Pursuant to the BHCA, we are required to obtain the prior approval of the Federal Reserve before we acquire all or substantially all of the assets of any bank or ownership or control of voting shares of any bank if, after giving effect to such acquisition, we would own or control, directly or indirectly, more than 5 percent of such bank. In connection with such transactions, the Federal Reserve is required to consider certain competitive, management, financial, anti-money laundering compliance and other impacts.

Under the BHCA, we may not engage in any business other than managing or controlling banks or furnishing services to our subsidiaries that the Federal Reserve deems to be so closely related to banking as “to be a proper incident thereto.” We are also prohibited, with certain exceptions, from acquiring direct or indirect ownership or control of more than 5 percent of the voting shares of any company unless the company is engaged in banking activities or the Federal Reserve determines that the activity is so closely related to banking as to be a proper incident to banking. The Federal Reserve’s approval must be obtained before the shares of any such company can be acquired and, in certain cases, before any approved company can open new offices.

The BHCA and regulations of the Federal Reserve also impose certain constraints on the redemption or purchase by a bank holding company of its own shares of stock.

Banking subsidiaries of bank holding companies are also subject to certain restrictions imposed by federal and state law in dealing with their holding companies and other affiliates, specifically under Sections 23A and 23B of the Federal Reserve Act and Federal Reserve Regulation W (and similar state statutes). Subject to certain exceptions set forth in the Federal Reserve Act, a bank can make a loan or extend credit to an affiliate, purchase or invest in the securities of an affiliate, purchase assets from an affiliate, accept securities of an affiliate as collateral for a loan or extension of credit to any person or company, issue a guarantee or accept letters of credit on behalf of an affiliate only if the aggregate amount of the above transactions of such subsidiary does not exceed 10 percent of such subsidiary’s capital stock and surplus on an individual basis or 20 percent of such subsidiary’s capital stock and surplus on an aggregate basis. Such transactions must be on terms and conditions that are consistent with safe and sound banking practices and on terms no less favorable than those available from unaffiliated persons. A bank holding company banking subsidiary may not purchase a “low-quality asset,” as that term is defined in the Federal Reserve Act, from an affiliate. Such restrictions also prevent a holding company and its other affiliates from borrowing from a banking subsidiary of the holding company unless the loans are secured by collateral. Dodd-Frank significantly expands the coverage and scope of the limitations on affiliate transactions within a banking organization.

The Federal Reserve has cease and desist powers over parent bank holding companies and non-banking subsidiaries where the action of a parent bank holding company or its non-financial institutions represent an unsafe or unsound practice or violation of law. The Federal Reserve has the authority to regulate debt obligations, other than commercial paper, issued by bank holding companies by imposing interest ceilings and reserve requirements on such debt obligations.

In addition to these explicit limitations, the federal regulatory agencies have general authority to prohibit a banking subsidiary or bank holding company from engaging in an unsafe or unsound banking practice. Depending upon the circumstances, the agencies could take the position that paying a dividend would constitute an unsafe or unsound banking practice.

Subject to certain exceptions, the Bank Holding Company Act and the Change in Bank Control Act, together with the applicable regulations, require Federal Reserve approval (or, depending on the circumstances, no notice of disapproval) prior to any person or company acquiring “control” of a bank or bank holding company.

 

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As a bank holding company, we are required to obtain prior approval from the Federal Reserve before (i) acquiring all or substantially all of the assets of a bank or bank holding company, (ii) acquiring direct or indirect ownership or control of more than 5% of the outstanding voting stock of any bank or bank holding company (unless we own a majority of such bank’s voting shares), or (iii) merging or consolidating with any other bank or bank holding company. In determining whether to approve a proposed bank acquisition, federal bank regulators will consider, among other factors, the effect of the acquisition on competition, the public benefits expected to be received from the acquisition, the projected capital ratios and levels on a post-acquisition basis, and the acquiring institution’s record of addressing the credit needs of the communities it serves, including the needs of low and moderate income neighborhoods, consistent with the safe and sound operation of the bank, under the CRA. In its most recent examination of its CRA activities the Bank maintained its “Outstanding” rating.

Stock Redemptions and Repurchases

It is an essential principle of safety and soundness that a banking organization’s redemption and repurchases of regulatory capital instruments, including common stock, from investors be consistent with the organization’s current and prospective capital needs. In assessing such needs, the board of directors and management of a bank holding company should consider the Dividend Factors discussed previously under “Dividends”. The risk-based capital rules directs bank holding companies to consult with the Federal Reserve before redeeming any equity or other capital instrument included in Tier 1 or Tier 2 capital prior to stated maturity, if such redemption could have a material effect on the level or composition of the organization’s capital base. Bank holding companies experiencing financial weaknesses, or that are at significant risk of developing financial weaknesses, must consult with the appropriate Federal Reserve supervisory staff before redeeming or repurchasing common stock or other regulatory capital instruments for cash or other valuable consideration. Similarly, any bank holding company considering expansion, either through acquisitions or through new activities, also generally must consult with the appropriate Federal Reserve supervisory staff before redeeming or repurchasing common stock or other regulatory capital instruments for cash or other valuable consideration. In evaluating the appropriateness of a bank holding company’s proposed redemption or repurchase of capital instruments, the Federal Reserve will consider the potential losses that the holding company may suffer from the prospective need to increase reserves and write down assets from continued asset deterioration and the holding company’s ability to raise additional common stock and other Tier 1 capital to replace capital instruments that are redeemed or repurchased. A bank holding company must inform the Federal Reserve of a redemption or repurchase of common stock or perpetual preferred stock for cash or other value resulting in a net reduction of the bank holding company’s outstanding amount of common stock or perpetual preferred stock below the amount of such capital instrument outstanding at the beginning of the quarter in which the redemption or repurchase occurs. In addition, a bank holding company must advise the Federal Reserve sufficiently in advance of such redemptions and repurchases to provide reasonable opportunity for supervisory review and possible objection should the Federal Reserve determine a transaction raises safety and soundness concerns.

Regulation Y requires that a bank holding company that is not well capitalized or well managed, or that is subject to any unresolved supervisory issues, provide prior notice to the Federal Reserve for any repurchase or redemption of its equity securities for cash or other value that would reduce by 10% or more the holding company’s consolidated net worth aggregated over the preceding 12-month period.

Annual Reporting; Examinations

The holding company is required to file an annual report with the Federal Reserve, and such additional information as the Federal Reserve may require. The Federal Reserve may examine a bank holding company and any of its subsidiaries, and charge the company for the cost of such an examination.

 

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Imposition of Liability for Undercapitalized Subsidiaries

FDICIA requires bank regulators to take “prompt corrective action” to resolve problems associated with insured depository institutions. In the event an institution becomes “undercapitalized,” it must submit a capital restoration plan. The capital restoration plan will not be accepted by the regulators unless each company “having control of” the undercapitalized institution “guarantees” the subsidiary’s compliance with the capital restoration plan until it becomes “adequately capitalized.” For purposes of this statute, the holding company has control of the Bank. Under FDICIA, the aggregate liability of all companies controlling a particular institution is limited to the lesser of five percent of the depository institution’s total assets at the time it became undercapitalized or the amount necessary to bring the institution into compliance with applicable capital standards. FDICIA grants greater powers to bank regulators in situations where an institution becomes “significantly” or “critically” undercapitalized or fails to submit a capital restoration plan. For example, a bank holding company controlling such an institution can be required to obtain prior Federal Reserve approval of proposed distributions, or might be required to consent to a merger or to divest the troubled institution or other affiliates.

State Law Restrictions

As a California corporation, the holding company is subject to certain limitations and restrictions under applicable California corporate law. For example, state law restrictions in California include limitations and restrictions relating to indemnification of directors, distributions and dividends to shareholders (discussed above), transactions involving directors, officers or interested shareholders, maintenance of books, records, and minutes, and observance of certain corporate formalities.

Bank Regulation

The Bank, as a California state-chartered bank, is subject to primary supervision and examination by the DBO, as well as the FDIC. Under the Federal Deposit Insurance Act (“FDI Act”) and the California Financial Code, California state chartered commercial banks may generally engage in any activity permissible for national banks. Therefore, the Bank may form subsidiaries to engage in the many so-called “closely related to banking” or “nonbanking” activities commonly conducted by national banks in operating subsidiaries or subsidiaries of bank holding companies. Further, pursuant to amendments enacted by the GLB Act, California banks may conduct certain “financial” activities in a subsidiary to the same extent as may a national bank, provided the bank is and remains “well-capitalized,” “well-managed” and in satisfactory compliance with the CRA, which requires banks to help meet the credit needs of the communities in which they operate. The Bank currently has no financial subsidiaries.

Specific federal and state laws and regulations which are applicable to banks regulate, among other things, the scope of their business, their investments, their reserves against deposits, the timing of the availability of deposited funds, the nature and amount of and collateral for certain loans, borrowings, capital requirements, certain check-clearing activities, branching, and mergers and acquisitions.

California banks are also subject to various federal statutes and regulations including Federal Reserve Regulation O, Federal Reserve Act Sections 23A and 23B and Regulation W and similar state statutes, which restrict or limit loans or extensions of credit to “insiders,” including officers, directors and principal shareholders, and loans or extension of credit by banks to affiliates or purchases of assets from affiliates, including parent bank holding companies, except pursuant to certain exceptions and terms and conditions at least as favorable to those prevailing for comparable transactions with unaffiliated parties.

The Bank is a member of the Federal Home Loan Bank (“FHLB”) of San Francisco. Among other benefits, each FHLB serves as a reserve or central bank for its members within its assigned region and makes available loans or advances to its members. Each FHLB is financed primarily from the sale of consolidated obligations of the FHLB system. As an FHLB member, the Bank is required to own a certain amount of capital stock in the FHLB. At December 31, 2016, the Bank was in compliance with the FHLB’s stock ownership requirement and our investment in FHLB capital stock totaled $9.1 million.

 

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In addition to the foregoing, the following summary identifies some of the more significant laws, regulations, and policies that affect our operations; it is not intended to be a complete listing or description of all laws and regulations that apply to us and is qualified in its entirety by reference to the applicable laws and regulations.

Supervision and Enforcement Authority

The federal and California regulatory structure gives the bank regulatory agencies extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. The regulatory agencies have adopted guidelines to assist in identifying and addressing potential safety and soundness concerns before an institution’s capital becomes impaired. The guidelines establish operational and managerial standards generally relating to: (1) internal controls, information systems, and internal audit systems; (2) loan documentation; (3) credit underwriting; (4) interest-rate exposure; (5) asset growth and asset quality; and (6) compensation, fees and benefits. Further, the regulatory agencies have adopted safety and soundness guidelines for asset quality and for evaluating and monitoring earnings to ensure that earnings are sufficient for the maintenance of adequate capital and reserves. If, as a result of an examination, the DBO or the FDIC should determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of the Bank’s operations are unsatisfactory or that the Bank or its management is violating or has violated any law or regulation, the DBO and the FDIC, and separately the FDIC, as insurer of the Bank’s deposits, have residual authority to:

 

   

Require affirmative action to correct any conditions resulting from any violation or practice;

 

   

Direct an increase in capital and the maintenance of higher specific minimum capital ratios, which may preclude the Bank from being deemed well-capitalized and restrict its ability to accept certain brokered deposits;

 

   

Restrict the Bank’s growth geographically, by products and services, or by mergers and acquisitions;

 

   

Enter into informal or formal enforcement orders, including memoranda of understanding, written agreements and consent or cease and desist orders or prompt corrective action orders to take corrective action and cease unsafe and unsound practices;

 

   

Require prior approval of senior executive officer or director changes; remove officers and directors and assess civil monetary penalties; and

 

   

Terminate FDIC insurance, revoke the charter and/or take possession of and close and liquidate the Bank or appoint the FDIC as receiver.

Prompt Corrective Action Authority

The Federal Deposit Insurance Act requires the federal bank regulatory agencies to take “prompt corrective action” with respect to a depository institution if that institution does not meet certain capital adequacy standards, including requiring the prompt submission of an acceptable capital restoration plan. Depending on the bank’s capital ratios, the agencies’ regulations define five categories in which an insured depository institution will be placed: well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. At each successive lower capital category, an insured bank is subject to more restrictions, including restrictions on the bank’s activities, operational practices or the ability to pay dividends or executive bonuses. Based upon its capital levels, a bank that is classified as well-capitalized, adequately capitalized, or undercapitalized may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition, or an unsafe or unsound practice, warrants such treatment.

 

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The prompt corrective action standards were also changed as the New Capital Rules ratios became effective. Under the new standards, in order to be considered well-capitalized, the bank will be required to meet the new common equity Tier 1 ratio of 6.5%, an increased Tier 1 ratio of 8% (increased from 6%), a total capital ratio of 10% (unchanged) and a leverage ratio of 5% (unchanged).

The federal banking agencies also may require banks and bank holding companies subject to enforcement actions to maintain capital ratios in excess of the minimum ratios otherwise required to be deemed well-capitalized, in which case institutions may no longer be deemed to be well-capitalized and may therefore be subject to certain restrictions such as taking brokered deposits.

The prompt corrective action standards were changed when the new capital rule ratios become effective as discussed under “Legislation and Regulatory Developments.”

Brokered Deposit Restrictions

Well-capitalized institutions are not subject to limitations on brokered deposits, while an adequately capitalized institution is able to accept, renew or roll over brokered deposits only with a waiver from the FDIC and subject to certain restrictions on the yield paid on such deposits. Undercapitalized institutions are generally not permitted to accept, renew, or roll over brokered deposits. CUB is eligible to accept brokered deposits but, except with regard to ICS™ products, does not utilize brokered deposits at this time and has no current intention of doing so in the near term.

Loans to One Borrower

With certain limited exceptions, the maximum amount that a California bank may lend to any borrower at any one time (including the obligations to the bank of certain related entities of the borrower) may not exceed 25 percent (and unsecured loans may not exceed 15 percent) of the bank’s shareholders’ equity, allowance for loan loss, and any capital notes and debentures of the bank. The Bank by policy has lower “house limits” that it generally will not exceed without the approval of the Chief Credit Officer and the Chief Executive Officer or the President and in limited circumstances (absence of approving officers) by the Chairman of the Board of Directors Loan Committee and the Chief Credit Officer or by the Chairman of the Board of Directors Loan Committee and the CEO or the President.

Extensions of Credit to Insiders and Transactions with Affiliates

The Federal Reserve Act and Federal Reserve Regulation O place limitations and conditions on loans or extensions of credit to a bank or bank holding company’s executive officers, directors and principal shareholders (i.e., in most cases, those persons who own, control or have power to vote more than 10 percent of any class of voting securities); any company controlled by any such executive officer, director or shareholder; or any political or campaign committee controlled by such executive officer, director or principal shareholder.

Such loans and leases must comply with loan-to-one-borrower limits; require prior full board approval when aggregate extensions of credit to the person exceed specified amounts; must be made on substantially the same terms (including interest rates and collateral) and follow credit-underwriting procedures no less stringent than those prevailing at the time for comparable transactions with non-insiders; must not involve more than the normal risk of repayment or present other unfavorable features; and in the aggregate must not exceed the bank’s unimpaired capital and unimpaired surplus. The California Financial Code and DBO regulations adopt and apply Regulation O to the Bank and provide additional limitations on loans to affiliates.

 

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Affiliate Transactions

The Bank also is subject to certain restrictions imposed by Federal Reserve Act Sections 23A and 23B, as amended by Dodd-Frank, and Federal Reserve Regulation W on any extensions of credit by the Bank to, or the issuance of a guarantee or letter of credit on behalf of, any affiliates or insiders, the purchase of, or investments in, stock or other securities thereof, the taking of such securities as collateral for loans, and the purchase of assets of any affiliates or insiders.

Additional restrictions on transactions with affiliates may be imposed on the Bank under the FDI Act’s prompt corrective action regulations and the supervisory authority of the federal and state banking agencies.

Deposit Insurance

The FDIC is an independent federal agency that insures deposits, up to prescribed statutory limits, of federally insured banks and savings institutions and safeguards the safety and soundness of the banking and savings industries. The FDIC insures our customer deposits through the Deposit Insurance Fund (the “DIF”) up to prescribed limits for each depositor. Pursuant to Dodd-Frank, the maximum deposit insurance amount has been permanently increased to $250,000 per depositor. As required by Dodd-Frank, the FDIC adopted a DIF restoration plan which became effective on January 1, 2011. Among other things, the plan: (1) raises the minimum designated reserve ratio, which the FDIC is required to set each year, to 1.35 percent and removes the upper limit on the designated reserve ratio and consequently on the size of the fund; (2) requires that the fund reserve ratio reach 1.35 percent by 2020; (3) eliminates the requirement that the FDIC provide dividends from the fund when the reserve ratio is between 1.35 percent and 1.5 percent; and (4) continues the FDIC’s authority to declare dividends when the reserve ratio at the end of a calendar year is at least 1.5 percent. The FDIC has set a long-term goal of getting its reserve ratio up to 2% of insured deposits by 2027.

In 2016 our FDIC insurance assessment was $1.5 million. The FDIC may terminate a depository institution’s deposit insurance upon a finding that the institution’s financial condition is unsafe or unsound or that the institution has engaged in unsafe or unsound practices that pose a risk to the DIF or that may prejudice the interest of the bank’s depositors. The termination of deposit insurance for a bank would also result in the revocation of the bank’s charter by the DBO.

Depositor Preference

The Federal Deposit Insurance Act provides that, in the event of the “liquidation or other resolution” of an insured depository institution, the claims of depositors of the institutions, including the claims of the FDIC as subrogee of insured depositors, and certain claims for administrative expenses of the FDIC as a receiver, will have priority over other general unsecured claims against the institution. If an insured depository institution fails, insured and uninsured depositors, along with the FDIC, will have priority in payment ahead of unsecured non-deposit creditors, with respect to any extensions of credit they have made to such insured depository institution.

Anti-Money Laundering and OFAC Regulation

A major focus of governmental policy on financial institutions in recent years has been aimed at combating money laundering and terrorist financing. The Bank Secrecy Act of 1970 (“BSA”) and subsequent laws and regulations require the Bank to take steps to prevent the use of the Bank or its systems from facilitating the flow of illegal or illicit money and to file suspicious activity reports.

An institution such as the Bank must provide anti-money laundering (“AML”) training to employees, designate an AML compliance officer and annually audit the AML program to assess its effectiveness. The federal regulatory agencies continue to issue regulations and new guidance with respect to the application and

 

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requirements of BSA and AML. The United States has imposed economic sanctions that affect transactions with designated foreign countries, nationals and others. Based on their administration by Treasury’s Office of Foreign Assets Control (“OFAC”), these are typically known as the “OFAC” rules. Failure of a financial institution to maintain and implement adequate BSA, AML and OFAC programs, or to comply with all of the relevant laws or regulations, could have serious legal and reputational consequences for the institution.

As discussed previously in “Recent Events” in 2016 the Bank entered into a Consent Order with the FDIC and the DBO requiring the Bank to take corrective actions and enhancements to address certain deficiencies within the BSA/AML compliance program. No criminal activity has been identified as a result of such deficiencies, and no financial penalty was levied. The Bank has already taken significant steps toward the improvement of its BSA/AML program including additional investment in employees, continued emphasis on education, training and the importance of compliance by all employees and the hiring of a highly experienced BSA/AML professional and a Chief Risk Officer to oversee these efforts. Management and the Board have expressed their full intention to comply with all parts of the Consent Order at the earliest possible date. The Bank expects risks in this area to continually evolve and regulatory expectations to escalate.

Community Reinvestment Act

Under the CRA, the Bank has a continuing and affirmative obligation consistent with safe and sound banking practices to help meet the credit needs of its entire community, including low and moderate income neighborhoods. CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with CRA. CRA generally requires the federal banking agencies to evaluate the record of a financial institution in meeting the credit needs of its local communities and to take that record into account in its evaluation of certain applications by such institution, such as applications for charters, branches and other deposit facilities, relocations, mergers, consolidations and acquisitions or engage in certain activities pursuant to the GLB Act. The Bank currently falls under the “large bank” category for CRA purposes. An unsatisfactory rating may be the basis for denying an application. Based on its most recent examination report in 2016, the Bank maintained an overall CRA rating of “Outstanding,” the highest rating possible.

Consumer Compliance and Fair Lending Laws

The Bank is subject to a number of federal and state laws designed to protect borrowers and promote lending to various sectors of the economy and population. These laws include the USA PATRIOT Act of 2001, the Bank Secrecy Act, the Foreign Account Tax Compliance Act (effective 2013), the CRA, the Fair Debt Collection Practices Act, as amended by the Fair and Accurate Credit Transactions Act, the Equal Credit Opportunity Act, the Truth in Lending Act, the Fair Housing Act, the Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act, the National Flood Insurance Act, various state law counterparts, and the Consumer Financial Protection Act of 2010, which constitutes part of Dodd-Frank and is discussed in further detail below. The enforcement of Fair Lending laws has been an increasing area of focus for regulators. Fair Lending laws related to extensions of credit are included in The Equal Credit Opportunity Act and the Fair Housing Act, which prohibit discrimination in residential real estate and credit transactions based on race, color, national origin, sex, marital status, familial status, religion, age, physical ability, the fact that all or part of the applicant’s income derives from a public assistance program or the fact that the applicant has exercised any right under the Consumer Credit Protection Act.

In addition, federal law and certain state laws (including California) currently contain client privacy protection provisions. These provisions limit the ability of banks and other financial institutions to disclose non-public information about consumers to affiliated companies and non-affiliated third parties.

 

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Dodd-Frank provided for the creation of the CFPB as an independent entity within the Federal Reserve with broad rulemaking, supervisory and enforcement authority over consumer financial products and services, including deposit products, residential mortgages, home-equity loans and credit cards. The bureau’s functions include investigating consumer complaints, conducting market research, rulemaking, supervising and examining bank consumer transactions, and enforcing rules related to consumer financial products and services. CFPB regulations and guidance apply to all financial institutions and banks with $10 billion or more in assets are subject to examination by the CFPB. Banks with less than $10 billion in assets, including the Bank, will continue to be examined for compliance by their primary federal banking agency.

Customer Information Security

The Federal Reserve and other bank regulatory agencies have adopted guidelines for safeguarding confidential, personal customer information. These guidelines require each financial institution, under the supervision and ongoing oversight of its board of directors or an appropriate committee thereof, to create, implement and maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information, protect against any anticipated threats or hazard to the security or integrity of such information and protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer. We have adopted a customer information security program designed to comply with such requirements.

Privacy

The Gramm-Leach-Bliley Act of 1999 and the California Financial Information Privacy Act require financial institutions to implement policies and procedures regarding the disclosure of nonpublic personal information about consumers to non-affiliated third parties. In general, the statutes require explanations to consumers on policies and procedures regarding the disclosure of such nonpublic personal information and, except as otherwise required by law, prohibit disclosing such information except as provided in the Bank’s policies and procedures. CUB has implemented privacy policies addressing these restrictions which are distributed regularly to all existing and new customers of the Bank.

Available Information

We maintain an Internet website for CU Bancorp at www.cubancorp.com and a website for CUB at www.californiaunitedbank.com. At www.cubancorp.com and via the “Investor Relations” link at the Bank’s website, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to such reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are available, free of charge, as soon as reasonably practicable after such forms are electronically filed with, or furnished to, the SEC. The public may read and copy any materials we file with the SEC at the SEC’s Public Reference Room, located at 100 F Street, NE, Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet website at http://www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. You may obtain copies of the Company’s filings on the SEC site. These documents may also be obtained in print upon request by our shareholders to our Investor Relations Department.

We have adopted a written code of ethics that applies to all directors, officers and employees of the Company, including our principal executive officer and senior financial officers, in accordance with Section 406 of the Sarbanes-Oxley Act of 2002 and the rules of the Securities and Exchange Commission promulgated thereunder. The code of ethics, which we call our Principles of Business Conduct and Ethics, is available on our corporate website, www.cubancorp.com in the section entitled “Corporate Governance.” In the event that we make changes in, or provide waivers from, the provisions of this code of ethics that the SEC requires us to disclose, we intend to disclose these events on our corporate website in such section. In the Corporate

 

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Governance section of our corporate website, we have also posted the charters for our Audit and Risk Committee and our Compensation, Nominating and Corporate Governance Committee. In addition, information concerning purchases and sales of our equity securities by our executive officers and directors is posted on our website.

Our Investor Relations Department can be contacted at CU Bancorp, 818 W. 7th Street, Suite 220, Los Angeles, CA, 90017, Attention: Investor Relations, or by telephone at (213) 430-7000.

All website addresses given in this document are for information only and are not intended to be an active link or to incorporate any website information into this document.

ITEM 1A — RISK FACTORS

In addition to the other information on the risks we face and our management of risk contained in this Annual Report on Form 10-K or in our other SEC filings, the following are significant risks which may affect us. Events or circumstances arising from one or more of these risks could adversely affect our business, financial condition, operating results and prospects and the value and price of our common stock could decline. The risks identified below are not intended to be a comprehensive list of all risks we face and additional risks that we may currently view as not material may also impair our business operations and results.

Readers and prospective investors in our securities should carefully consider the following risk factors as well as the other information contained or incorporated by reference in this report. This report is qualified in its entirety by these risk factors.

RISKS RELATED TO THE BANKING INDUSTRY

Difficult Economic and Market Conditions Have Adversely Affected Our Industry in the Past and May in the Future

Our financial performance generally, and the ability of borrowers to pay interest on and repay the principal of outstanding loans and the value of the collateral securing those loans, is highly dependent upon the business and economic conditions in the markets in which we operate and in the United States as a whole. Economic pressures on consumers and businesses may adversely affect our business, financial condition, results of operations and stock price. In particular, we may face the following risks in connection with these events:

 

   

Our banking operations are concentrated primarily in southern California. Deterioration of economic conditions in Southern California could impair borrowers’ ability to service their loans, decrease the level and duration of deposits by customers, and erode the value of loan collateral. These conditions could increase the amount of our non-performing assets and have an adverse effect on our efforts to collect our non-performing loans or otherwise liquidate our non-performing assets (including other real estate owned) on terms favorable to us, if at all, and could also cause a decline in demand for our products and services, or a lack of growth or a decrease in deposits, any of which may cause us to incur losses, adversely affect our capital, and hurt our business.

Disruptions in the Real Estate Market Could Materially and Adversely Affect Our Business

While overall the U.S. economy has experienced a prolonged low interest rate environment The Southern California real estate market has recovered from what had been a substantial decline and now appears to be at new highs. At December 31, 2016, 58% and 9% of our total gross loans were comprised of commercial real estate and construction loans, respectively. Of the commercial real estate loans, 42% was non-owner-occupied. Any new downturn in the real estate market could materially and adversely affect our business because a significant portion of our loans are secured by real estate. Our ability to recover on defaulted loans by selling the real estate collateral would then be diminished and we would be more likely to suffer losses on loans. Substantially all of our real property collateral is located in Southern California. If there is a decline in real estate

 

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values, especially in Southern California, the collateral for our loans would provide less security. Real estate values could be affected by, among other things, a decline in economic conditions, an increase in foreclosures, a decline in real property sale volumes, a significant increase in interest rates, increased levels of unemployment, drought, earthquakes, brush fires and other natural disasters particular to California. Furthermore, due to the recovery of the California real estate market, many of our customers have been selling real estate and generating deposits in the Bank; in the event of a commercial real estate downturn these could be withdrawn and reinvested in commercial real estate reducing the Bank’s overall deposits.

Additional Requirements Imposed by the Dodd-Frank Act and Related Regulation Could Adversely Affect Us

The Dodd-Frank Act imposed additional regulatory requirements including the following:

 

   

the establishment of strengthened capital and liquidity requirements for banks and bank holding companies, including minimum leverage and risk-based capital requirements no less than the strictest requirements in effect for depository institutions as of the date of enactment;

 

   

the requirement by statute that bank holding companies serve as a source of financial strength for their depository institution subsidiaries;

 

   

enhanced regulation of financial markets, including the derivative and securitization markets, and the elimination of certain proprietary trading activities by banks;

 

   

additional corporate governance and executive compensation requirements; enhanced financial institution safety and soundness regulations,

 

   

revisions in FDIC insurance assessments; and

 

   

the creation of new regulatory bodies, such as the Bureau of Consumer Financial Protection and the Financial Services Oversight Counsel.

Some of the provisions remain subject to final rulemaking and/or implementation. Accordingly, we cannot fully assess its impact on our operations and costs.

Current and future executive, legal and regulatory requirements, restrictions, and regulations, including those imposed under Dodd-Frank, may adversely impact our profitability and may have a material and adverse effect on our business, financial condition, and results of operations. We may also be required to invest significant management attention and resources to evaluate and make changes required by the legislation and related regulations and may make it more difficult for us to attract and retain qualified executive officers and employees.

Significant Changes in Banking Laws or Regulations and Federal Monetary Policy Could Materially Affect Our Business

The banking industry is subject to extensive federal and state regulation, and significant new laws and regulations or changes in, or repeals of, existing laws and regulations may cause results to differ materially. Also, federal monetary policy, particularly as implemented through the Federal Reserve System, significantly affects our credit conditions, primarily through open market operations in U.S. government securities, the discount rate for member bank borrowing, and bank reserve requirements. A material change in these conditions would affect our results. Federal and state regulatory agencies also frequently adopt changes to their regulations or change the manner in which existing regulations are applied. For further discussion of the regulation of financial services, see “Supervision and Regulation.”

We cannot predict the substance or impact of any change in regulation, whether by regulators or as a result of legislation, or in the way such statutory or regulatory requirements are interpreted or enforced. Compliance

 

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with such current and potential regulation and scrutiny may significantly increase our costs, impede the efficiency of our internal business practices, require us to increase our regulatory capital and limit our ability to pursue business opportunities in an efficient manner.

We are subject to extensive laws, regulations and supervision, and may become subject to future laws, regulations and supervision, if any, that may be enacted, which could limit or restrict our activities, may hamper our ability to increase our assets and earnings, and could adversely affect our profitability.

Bank Clients Could Move Their Money to Alternative Investments Causing Us to Lose a Lower Cost Source of Funding

Demand deposits can decrease when clients perceive alternative investments, as providing a better risk/return tradeoff. Technology and other changes have made it more convenient for bank customers to transfer funds into alternative investments or other deposit accounts offered by other out-of-area financial institutions or non-bank service providers. Additionally, if the economy continues to trend upward, customers may withdraw deposits to utilize them to fund business expansion or equity investment. Moreover, should interest rates rise this may impact the Bank’s ability to maintain its current percentage of non-interest bearing deposits. When clients move money out of bank demand deposits, particularly non-interest bearing deposits, we lose a relatively low cost source of funds, increasing our funding costs and reducing our net interest income.

Several rating agencies publish unsolicited ratings of the financial performance and relative financial health of many banks, including CUB, based on publicly available data. As these ratings are publicly available, a decline in the Bank’s ratings may result in deposit outflows or the inability of the Bank to raise deposits in the secondary market as broker-dealers and depositors may use such ratings in deciding where to deposit their funds.

Our Business Is Subject To Interest Rate Risk and Fluctuations in Interest Rates Could Reduce Our Net Interest Income and Adversely Affect Our Business.

A substantial portion of our income is derived from the differential, or “spread,” between the interest earned on loans, investment securities and other interest-earning assets, and the interest paid on deposits, borrowings and other interest-bearing liabilities. The interest rate risk inherent in our lending, investing, and deposit taking activities is a significant market risk to us and our business. Income associated with interest earning assets and costs associated with interest-bearing liabilities may not be affected uniformly by fluctuations in interest rates. The magnitude and duration of changes in interest rates, events over which we have no control, may have an adverse effect on net interest income. Prepayment and early withdrawal levels, which are also impacted by changes in interest rates, can significantly affect our assets and liabilities. Increases in interest rates may adversely affect the ability of our floating rate borrowers to meet their higher payment obligations, which could in turn lead to an increase in non-performing assets and net charge-offs.

Generally, the interest rates on our interest-earning assets and interest-bearing liabilities do not change at the same rate, to the same extent, or on the same basis. Even assets and liabilities with similar maturities or periods of re-pricing may react in different degrees to changes in market interest rates. Interest rates on certain types of assets and liabilities may fluctuate in advance of changes in general market interest rates, while interest rates on other types of assets and liabilities may lag behind changes in general market rates. Certain assets, such as adjustable rate loans, may have features such as floors that limit changes in interest rates on a short-term basis.

After a seven year stimulus campaign known as quantitative easing, in December 2015 the Federal Reserve decided to raise short-term interest rates for the first time since the 2008 financial crisis. An additional increase was implemented in December, 2016.

 

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We seek to minimize the adverse effects of changes in interest rates by structuring our asset-liability composition to obtain the maximum spread. We use interest rate sensitivity analysis and a simulation model to assist us in managing asset-liability composition. However, such management tools have inherent limitations that impair their effectiveness.

The Fiscal and Monetary Policies Of the Federal Government and Its Agencies Could Have a Material Adverse Effect On Our Earnings.

The Federal Reserve regulates the supply of money and credit in the U.S. Its policies determine in large part the cost of funds for lending and investing and the return earned on those loans and investments, both of which affect the net interest margin. They can also materially decrease the value of financial assets we hold. Federal Reserve policies can also adversely affect borrowers, potentially increasing the risk that they may fail to repay their loans, or could adversely create asset bubbles which result from prolonged periods of accommodative policy, and which in turn result in volatile markets and rapidly declining collateral values. Changes in Federal Reserve policies are beyond our control and difficult to predict.

Inflation and Deflation May Adversely Affect Our Financial Performance

The Consolidated Financial Statements and related financial data presented in this report have been prepared in accordance with accounting principles generally accepted in the United States. These principles require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation or deflation. The primary impact of inflation on our operations is reflected in increased operating costs. Conversely, deflation will tend to erode collateral values and diminish loan quality. Virtually all of our assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on our performance than the general levels of inflation or deflation

The Company Has Liquidity Risk

Liquidity risk is the risk that the Company will have insufficient cash or access to cash to satisfy current and future financial obligations, including demands for loans and deposit withdrawals, funding operating costs, and for other corporate purposes. An inability to raise funds through deposits, borrowings, the sale of loans and other sources could have a material adverse effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity due to a market downturn or adverse regulatory action against us. Our ability to acquire deposits or borrow could also be impaired by factors that are not specific to us, such as a severe disruption of the financial markets or negative views and expectations about the prospects for the financial services industry as a whole. The Company mitigates liquidity risk by establishing and accessing lines of credit with various financial institutions and having back-up access to the brokered Certificate of Deposits “CD’s” markets (which it has not utilized other than on a testing basis). Results of operations could be affected if the Company were unable to satisfy current or future financial obligations. See Part II, Item 7, “Liquidity” for more information.

Severe Weather, Natural Disasters, Acts of War or Terrorism and Other External Events Could Significantly Impact the Company’s Business

Severe weather, floods, drought, fire, natural disasters such as earthquakes, or tsunamis, acts of war or terrorism and other adverse external events could have a significant impact on the Company’s ability to conduct business. Such events could affect the stability of the Bank’s deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss of revenue and/or cause the Company to incur additional expenses. Although management has established disaster recovery policies and procedures, the occurrence of any such event in the future could have a material adverse effect on the Company’s business, which, in turn, could have a material adverse effect on the Company’s financial condition and results of operations.

 

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The Financial Condition of Other Financial Institutions Could Adversely Affect Us

Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial industry, including brokers and dealers, commercial banks, investment banks, and other institutions. Many of these transactions expose us to credit risk in the event of default of our counterparty. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the financial instrument exposure due to us. Any such losses could have a material adverse effect on our financial condition and results of operations.

We Currently Hold a Significant Amount of Bank-Owned Life Insurance.

At December 31, 2016, we held $51 million of bank-owned life insurance (BOLI) on current and former senior employees and executives, with a cash surrender value of $51 million, as compared with $50 million of BOLI, with a cash surrender value of $50 million, at December 31, 2015. The eventual repayment of the cash surrender value is subject to the ability of the various insurance companies to pay death benefits or to return the cash surrender value to us if needed for liquidity purposes. We continually monitor the financial strength of the various companies with whom we carry these policies. However, any one of these companies could experience a decline in financial strength, which could impair its ability to pay benefits or return our cash surrender value. If we need to liquidate these policies for liquidity purposes, we would be subject to taxation on the increase in cash surrender value and penalties for early termination, both of which would adversely impact earnings.

RISKS RELATED TO CREDIT

We May Suffer Losses in Our Loan Portfolio Despite Our Underwriting Practices

We mitigate the risks inherent in our loan portfolio by adhering to sound and proven underwriting practices, managed by experienced and knowledgeable credit professionals. These practices include analysis of a borrower’s prior credit history, financial statements, tax returns, and cash flow projections, valuations of collateral based on reports of independent appraisers and verifications of liquid assets. Although we believe that our underwriting criteria is appropriate for the various kinds of loans we make, we may incur losses on loans that meet our underwriting criteria, and these losses may exceed the amounts set aside as reserves in our allowance for loan loss.

The Repayment of Our Income Property Loans, Consisting of Commercial and Multi-family Real Estate Loans, May be Dependent on Factors Outside Our Control or the Control of Our Borrowers.

We originate commercial and multi-family real estate loans for individuals and businesses for various purposes, which are secured by commercial properties. Repayment of these loans is often dependent upon income generated, or expected to be generated, by the property securing the loan in amounts sufficient to cover operating expenses and debt service, which may be adversely affected by changes in the economy or local market conditions.

For example, if the cash flow from the borrower’s project is reduced as a result of the financial impairment of a lessee who cannot pay the rent, or as a result of leases not being obtained or renewed in a timely manner or at all, the borrower’s ability to repay the loan may be impaired. Commercial and multi-family real estate loans also expose us to greater credit risk than loans secured by residential real estate because the collateral securing these loans typically cannot be sold as easily as residential real estate. In addition, many of our commercial and multi-family real estate loans are not fully amortizing and contain large balloon payments upon maturity. Such balloon payments may require the borrower to either sell or refinance the underlying property in order to make the payment, which may increase the risk of default or non-payment.

 

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If we foreclose on a commercial or multi-family real estate loan, our holding period for the collateral may be longer than for residential mortgage loans because there are fewer potential purchasers of the collateral. Additionally, commercial and multi-family real estate loans generally have relatively large balances to single borrowers or groups of related borrowers. Accordingly, if we make any errors in judgment in the collectability of our commercial and multi-family real estate loans, any resulting charge-offs may be larger on a per loan basis. As of December 31, 2016, our commercial and multi-family real estate loans totaled $1.2 billion, or 58 percent of our total loans.

Repayment Of Our Commercial And Industrial Loans Is Often Dependent On The Cash Flows Of The Borrower, Which May Be Unpredictable, and The Collateral Securing These Loans May Not Be Sufficient To Repay the Loan In The Event Of Default

We make our commercial and industrial loans primarily based on the identified cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. Collateral securing commercial and industrial loans are generally the working assets of a business that fluctuate in value, may depreciate over time, and could be difficult to appraise. For example, in the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect the amounts due from its customers, and for loans secured by inventory, the sale or liquidation of the inventory may be dependent not only on the quality of the inventory but also on finding a willing buyer. As of December 31, 2016, our commercial and industrial loans totaled $503 million, or 25 percent of our total loans.

Supervisory Guidance on Commercial Real Estate Concentrations Could Restrict Our Activities and Impose Financial Requirements or Limits on the Conduct of Our Business

The Federal Regulatory Agencies have issued guidance on sound risk management practices for concentrations in commercial real estate lending intended to help ensure that institutions pursuing a significant commercial real estate lending strategy remain healthy and profitable while continuing to serve the credit needs of their communities. Recently there have been concerns about commercial real estate lending and underwriting expressed by the agencies along with historical concerns that rising commercial real estate loan concentrations may expose institutions to unanticipated earnings and capital volatility in the event of adverse changes in commercial real estate markets. Existing guidance reinforces and enhances existing regulations and guidelines for safe and sound real estate lending by providing supervisory criteria, including numerical indicators to assist in identifying institutions with potentially significant commercial real estate loan concentrations that may warrant greater supervisory scrutiny. The guidance does not limit banks’ commercial real estate lending, but rather guides institutions in developing risk management practices and levels of capital that are commensurate with the level and nature of their commercial real estate concentrations. Our lending and risk management practices will be taken into account in supervisory evaluation of capital adequacy. As of December 31, 2016, the Bank’s commercial real estate concentration, as defined by the regulatory supervisory guidance, exceeded the regulatory threshold of 300% of total risk based capital. The regulatory definition of a commercial real estate concentration excludes owner-occupied commercial real estate loans, but includes unsecured commercial and industrial loans for the purpose of real estate that are not secured by real estate. The Bank’s commercial real estate portfolio, as defined by regulatory guidance, is 47% of total loans at December 31, 2016, as compared to 42% at December 31, 2015. If our risk management practices with regard to this portion of our portfolio are found to be deficient, it could result in increased reserves and capital costs or a need to reduce this type of lending which could negatively impact earnings.

We Have a Concentration in Loans Secured by Commercial Real Estate Which Could Make Us Vulnerable to Changes in the Commercial Real Estate Market.

Our commercial real estate loan portfolio (including owner-occupied nonresidential properties, other nonresidential properties, construction, land development and other land, and multifamily residential properties)

 

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has increased from 62% at December 31, 2015 to 68% at December 31, 2016. While our risk management practices are designed to monitor these loans as well as the market conditions closely and analyze the impact of various stress scenarios on these loans, it is possible that an adverse change in the Southern California commercial real estate market could result in credit losses or the need to increase reserves or capital which could have a negative impact on the Company’s income, capital, prospects or reputation.

Our Allowance for Loan Loss May Not be Adequate to Cover Actual Losses

We maintain an allowance for loan loss on organic loans, which is a reserve established through a provision for loan losses charged to expense, that represents management’s best estimate of risk of losses within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for possible loan losses and risks inherent in the loan portfolio. The level of the allowance reflects management’s continuing evaluation of industry concentrations; specific credit risks; limited loan loss experience; current loan portfolio quality; present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio as well as levels utilized by peers. The determination of the appropriate level of the allowance for loan loss inherently involves a high degree of subjectivity and requires the Bank to make significant estimates of current credit risks and future trends, all of which may undergo material changes.

Deterioration in economic conditions affecting borrowers and collateral, new information regarding existing loans, identification of problem loans and other factors, both within and outside of the Company’s control, may require an increase in the allowance for loan loss. In addition, bank regulatory agencies periodically review the Bank’s allowance for loan loss and may require an increase in the provision for loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. In addition, if charge-offs in future periods exceed the allowance for loan loss; the Bank will need additional provisions to increase the allowance for loan loss. Any increases in the allowance for loan loss will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on the Company’s financial condition and results of operations. See the section captioned “Allowance for Loan Loss” in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations located elsewhere in this report for further discussion related to the Company’s process for determining the appropriate level of the allowance for loan loss.

In June 2016, the FASB issued Accounting Standards Update (“ASU”) 2016-13, Financial Instruments — Credit Losses (Topic 326), which introduces new guidance for the accounting for credit losses on instruments within its scope. The new guidance introduces an approach based on expected losses to estimate credit losses on certain types of financial instruments. It also modifies the impairment model for available-for-sale (AFS) debt securities and provides for a simplified accounting model for purchased financial assets with credit deterioration since their origination. Current expected credit losses (“CECL”) model, will apply to: (1) financial assets subject to credit losses and measured at amortized cost, and (2) certain off-balance sheet credit exposures. This includes loans, held-to-maturity debt securities, loan commitments, financial guarantees, and net investments in leases, as well as reinsurance and trade receivables. Upon initial recognition of the exposure, the CECL model requires an entity to estimate the credit losses expected over the life of an exposure (or pool or exposures). The estimate of expected credit losses (ECL) should consider historical information, current information, and reasonable and supportable forecasts, including estimates of prepayments. Financial instruments with similar risk characteristics should be grouped together when estimating ECL. ASU 2016-13 is effective for public entities for interim and annual periods beginning after December 15, 2019. Early application of the guidance will be permitted for all entities for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Upon adoption, the Company expects the level of ECL will likely be higher, however, the Company is still in the early stages of developing an implementation plan and evaluating the magnitude of the increase and the impact of this ASU on its consolidated financial statements. This model could result in an adverse impact on the Company’s earnings, capital and other regulatory limits that are based on capital.

 

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Liabilities from Environmental Regulations Could Materially and Adversely Affect Our Business and Financial Condition

In the course of the Bank’s business, the Bank may foreclose and take title to real estate, and could be subject to environmental liabilities with respect to these properties. The Bank may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clear up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. In addition, as the owner or former owner of any contaminated site, the Bank may be subject to common law claims by third parties based on damages, and costs resulting from environmental contamination emanating from the property. If the Bank ever becomes subject to significant environmental liabilities, the Company’s business, financial condition, liquidity, and results of operations could be materially and adversely affected.

California’s Current Drought may Impact the Economy

At December 31, 2016, California continued to experience a severe drought in all areas of the State. This extended drought has produced chronic and significant shortages to municipal and industrial, environmental, agricultural, and wildlife refuge water supplies and led to historically low groundwater levels. This recent dry hydrology set many new Statewide records, including the driest five-year period of statewide precipitation (2012-2016). The exceptionally dry conditions in 2015 and 2016 resulted in low reservoir storages which created a challenge to deliver critical water supplies and provide adequate cold water for instream fisheries resources.

The cumulative effect of these sustained dry conditions is demonstrated in reduced natural runoff for streamflow, limited surface water storage in reservoirs, increased groundwater pumping, and significant effects to fish and wildlife populations.

While the early 2017 water year has seen above-average precipitation and snowpack, the ability to predict at this time whether 2017 will be wet or dry is limited. Recent wet weather, particularly throughout Northern California, has resulted in Governor Jerry Brown declaring a state of emergency in 50 counties across California. The latest National Weather Service Climate Prediction Center seasonal drought outlook, valid for January 19, 2017 through April 30, 2017, shows drought in south-west California remaining, but improving. Due to winter storms, the U.S. Drought Monitor has removed the designation of “exceptional drought” for California.

More than half of the state, however, is still experiencing moderate to extreme drought conditions, with the drought in parts of Ventura, Santa Barbara, Kern and Los Angeles counties more severe than in the rest of the state. Despite considerable improvements in reservoir and snowpack conditions, groundwater aquifers, forests, and endangered fish species may take several years to recover from drought impacts. While we do not have a portfolio of agricultural loans which would be most impacted by the drought, the effects of increased costs for water and municipal restrictions on the level of use could have an adverse effect on the operations of some of our client base, the extent of which is yet unknown, and it is possible that the overall economy of California may be negatively affected by the lingering impact of this drought and lack of water or the increased cost of the resource, which could have a negative impact on the Company’s results, loan quality and collateral.

RISK RELATED TO LEGISLATION AND REGULATION

Significant Changes in Banking Laws or Regulations and Federal Monetary Policy Could Materially Affect Our Business

The banking industry is subject to extensive federal and state regulations, and significant new laws or changes in, or repeals of, existing laws which may cause results to differ materially. Also, federal monetary policy, particularly as implemented through the Federal Reserve System, significantly affects our credit conditions, primarily through open market operations in U.S. government securities, the discount rate for

 

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member bank borrowing, and bank reserve requirements. A material change in these conditions would affect our results. Parts of our business are also subject to federal and state securities laws and regulations. Significant changes in these laws and regulations would also affect our business. For further discussion of the regulation of financial services, including a description of significant recently-enacted legislation and other regulatory initiatives taken in response to the recent financial crisis, see “Supervision and Regulation”.

New Capital and Liquidity Standards Adopted By The U.S. Banking Regulators Have Resulted In Banks and Bank Holding Companies Needing To Maintain More And Higher Quality Capital And Greater Liquidity Than Has Historically Been The Case.

New capital standards, both as a result of the Dodd-Frank Act and the new U.S. Basel III-based capital rules have had a significant effect on banks and bank holding companies. The New Capital Rules require bank holding companies and their bank subsidiaries to maintain substantially more capital, with a greater emphasis on common equity. For additional information, see “Capital Requirements” under Part I, Item 1 “Business.”

The need to maintain more and higher quality capital, as well as greater liquidity, going forward than historically has been required, and generally increased regulatory scrutiny with respect to capital levels, could limit the Company’s business activities, including lending, and its ability to expand, either organically or through acquisitions. It could also result in being required to take steps to increase its regulatory capital that may be dilutive to shareholders or limit its ability to pay dividends or otherwise return capital to shareholders, or sell or refrain from acquiring assets, the capital requirements for which are not justified by the assets’ underlying risks.

We Face a Risk Of Noncompliance and Enforcement Action With the Bank Secrecy Act and Other Anti-Money Laundering Statutes and Regulations

The Bank Secrecy Act of 1970, the USA PATRIOT Act of 2001, and other laws and regulations require financial institutions, among other duties, to institute and maintain an effective anti-money laundering program and file suspicious activity and currency transaction reports as appropriate. The Financial Crimes Enforcement Network, a bureau of the U.S. Department of the Treasury, is authorized to impose significant civil money penalties for violations of those requirements and engages in coordinated enforcement efforts with the individual federal banking regulators, as well as the U.S. Department of Justice, Drug Enforcement Administration, and U.S. Internal Revenue Service (“IRS”). We are also subject to increased scrutiny of compliance with the rules enforced by the Office of Foreign Assets Control. If our policies, procedures and systems are deemed deficient, we could be subject to liability, including fines and regulatory actions, which may include restrictions on our ability to pay dividends and the necessity to obtain regulatory approvals to proceed with certain aspects of our business plan, including any acquisition plans which could be identified. Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have serious reputational consequences for us. Any of these results could materially and adversely affect our business, financial condition, results of operations and prospects.

The Company and the Bank are Operating Under Enhanced Regulatory Supervision that Could Materially and Adversely Affect Our Business

On September 23, 2016, the Bank entered into a Stipulation to the Issuance of a Consent Order with its bank regulatory agencies, the FDIC and the CDBO, agreeing to the issuance of a consent order (the “Consent Order”) relating to weaknesses in the Bank’s Bank Secrecy Act and Anti-Money Laundering (collectively “BSA”) compliance program.

Under the terms of the Consent Order the Bank and/or its Board of Directors is required to take certain actions which include, but are not limited to: a) Increasing Board supervision of the BSA compliance program; b) Notification to the regulatory agencies prior to appointment of a new BSA Officer or the executive to whom the BSA Officer reports; c) Formulation of a written action plan describing the actions to be taken to correct BSA/AML related deficiencies, a revised, written BSA/AML compliance program and review and enhancement of the

 

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Bank’s BSA risk assessment; d) Performance of a review of BSA staffing needs; e) Enhancement of internal controls to ensure full compliance with the BSA; f) Establishment of an independent testing program for compliance with the BSA rules and regulations; and g) Obtaining regulatory agency consent for expansionary activities such as new branches, offices, delivery channels, products and services.

The Consent Order is expected to result in additional BSA compliance expenses for the Bank and the Company. It may also have the effect of limiting or delaying the Bank’s and the Company’s ability to obtain regulatory approval for certain expansionary activities..

While the Bank has undertaken substantial activities to address these issues, should the FDIC or the DBO determine we have not complied with the Consent Order they could impose additional regulatory action(s), including civil money penalties against the Bank and its officers and directors or enforcement of the Consent Order through court proceedings, which could have a material and adverse effect on our business, reputation, results of operations, financial condition, cash flows and stock price.

Limits on Our Ability to Lend

The Bank’s legal lending limit as of December 31, 2016 was approximately $74 million for secured loans and $44 million for unsecured loans. While we believe we can accommodate the needs of substantially all of our target market, we compete with many financial institutions with larger lending limits.

Increases in Deposit Insurance Premiums and Special FDIC Assessments Will Negatively Impact Our Earnings.

We may pay higher FDIC premiums in the future. The Dodd-Frank Act increased the minimum FDIC deposit insurance reserve ratio from 1.15 percent to 1.35 percent. The FDIC has adopted a plan under which it will meet this ratio by December 31, 2018, nearly two years before the statutory deadline of September 30, 2020. The Dodd-Frank Act requires the FDIC to offset the effect of the increase in the minimum reserve ratio on institutions with assets less than $10.0 billion. In March 2016, the FDIC adopted a final rule which imposes on banks with at least $10 billion in assets a surcharge of 4.5 cents per $100 of their assessment base, after making certain adjustments. In addition to the minimum reserve ratio, the FDIC must set a designated reserve ratio. The FDIC has set a designated reserve ratio of 2.0, which exceeds the minimum reserve ratio.

As required by the Dodd-Frank Act, the FDIC has adopted final regulations under which insurance premiums are based on an institution’s total assets minus its Tier 1 capital, instead of its deposits. Although our FDIC insurance premiums were initially reduced by these regulations, the benefit from the reduction in the FDIC insurance premiums was dampened by an increase in the deposit premium costs resulting from the Consent Order.

BUSINESS STRATEGY RISK

We Compete Against Larger Banks and Other Institutions

We face substantial competition for deposits and loans in our market place. Competition for deposits primarily comes from other commercial banks, savings institutions, thrift and loan associations, money market and mutual funds and other investment alternatives. Competition for loans comes from other commercial banks, savings institutions, mortgage banking firms, thrift and loan associations and other financial intermediaries. Our larger competitors, by virtue of their larger capital resources, have substantially greater lending limits than we have. They also provide certain services for their customers, including trust, wealth management and international banking, which we only are able to offer indirectly through our correspondent relationships. In addition, they have greater resources and are able to offer longer maturities and on occasion, lower rates on fixed rate loans as well as more aggressive underwriting.

 

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We May Not Be Able to Complete Future Acquisitions.

We must generally satisfy a number of meaningful conditions before we can complete an acquisition of another bank or BHC, including federal and/or state regulatory approvals. In determining whether to approve a proposed bank or BHC acquisition, bank regulators will consider, among other factors, the effect of the acquisition on competition, financial condition and future prospects, including current and projected capital ratios and levels, the competence, experience and integrity of management and record of compliance with laws and regulations, the convenience and needs of the communities to be served, including the acquiring institution’s record of compliance under the CRA, the effectiveness of the acquiring institution in combating money laundering activities and protests from various stakeholders of both the Company and its acquisition partner. The Consent Order may limit the Company’s ability to obtain regulatory approval for such transactions.

There is Risk Related to Acquisitions

We have engaged in expansion through acquisitions and may consider acquisitions in the future, subject to regulatory approval. We cannot predict the frequency, size or timing of any future acquisitions, and we typically do not comment publicly on a possible acquisition until we have signed a definitive agreement. There can be no assurance that our future acquisitions, if any, will have the anticipated positive results.

There are risks associated with any such expansion. These risks include, among others, incorrectly assessing the asset quality of a bank acquired in a particular transaction, encountering greater than anticipated costs in integrating acquired businesses, facing resistance from customers or employees, being unable to profitably deploy assets acquired in the transaction or litigation resulting from circumstances occurring at the acquired entity prior to the date of acquisition or resulting from the acquisition. Our earnings, financial condition, and prospects after a merger or acquisition depend in part on our ability to successfully integrate the operations of the acquired company. We may be unable to integrate operations successfully or to achieve expected cost savings. Any cost savings which are realized may be offset by losses in revenues or other charges to earnings. To the extent we issue capital stock in connection with additional transactions, if any, these transactions and related stock issuances may have a dilutive effect on earnings per share and share ownership.

While our management is experienced in acquisition strategy and implementation, acquisitions involve inherent uncertainty and we cannot determine all potential events, facts and circumstances that could result in loss or give assurances that our investigation or mitigation efforts will be sufficient to protect against any such loss.

Although we have historically shown the ability to grow organically as well as through acquisition, our ability to grow may be limited if we cannot make acquisitions. We compete with other financial institutions with respect to proposed acquisitions.

Issuing Additional Shares Of Our Common Stock To Acquire Other Banks and Bank Holding Companies May Result In Dilution For Existing Shareholders and May Adversely Affect the Market Price Of Our Stock.

In connection with our growth strategy, we have issued, and may issue in the future, shares of our common stock to acquire additional banks or bank holding companies that may complement our organizational structure. Resales of substantial amounts of common stock in the public market and the potential of such sales could adversely affect the prevailing market price of our common stock and impair our ability to raise additional capital through the sale of equity securities. We usually must pay an acquisition premium above the fair market value of acquired assets for the acquisition of banks or bank holding companies. Paying this acquisition premium, in addition to the dilutive effect of issuing additional shares, may also adversely affect the prevailing market price of our common stock.

 

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Impairment of Goodwill or Amortizable Intangible Assets Associated With Acquisitions Would Result In a Charge to Earnings

Goodwill is initially recorded at fair value and is not amortized, but is reviewed at least annually or more frequently if events or changes in circumstances indicate that the carrying value may not be fully recoverable. If our estimates of goodwill fair value change, we may determine that impairment charges are necessary. Estimates of fair value are determined based on a complex model using cash flows and company comparisons. If management’s estimates of future cash flows are inaccurate, the fair value determined could be inaccurate and impairment may not be recognized in a timely manner.

Our Decisions Regarding the Fair Value of Assets Acquired Could Be Different Than Initially Estimated Which Could Materially and Adversely Affect Our Business, Financial Condition, Results of Operations, and Future Prospects

We acquired portfolios of loans in the 1st Enterprise, Premier Commercial Bancorp and California Oaks State Bank acquisitions. Although these loans were marked down to their estimated fair value pursuant to ASC 805 Business Combinations, there is no assurance that the acquired loans will not suffer further deterioration in value resulting in additional charge-offs. The fluctuations in national, regional and local economic conditions may increase the level of charge-offs in the loan portfolios that we acquired from 1st Enterprise, Premier Commercial Bancorp and California Oaks State Bank and correspondingly reduce our net income. These fluctuations are not predictable, cannot be controlled and may have a material adverse impact on our operations and financial condition, even if other favorable events occur.

We May Need to Raise Capital to Support Growth or Acquisition

While the Company’s and the Bank’s capital levels are currently in excess of that required to be considered “well-capitalized” by regulatory agencies, organic growth or a strategic opportunity may require the Company to raise additional capital and/or to maintain capital levels in excess of “well-capitalized”.

We Are Dependent on Key Personnel and the Loss of One or More of Those Key Personnel May Materially and Adversely Affect Our Prospects

Competition for qualified employees and personnel in the banking industry is intense and there are a limited number of qualified persons with knowledge of, and experience in, the California community banking industry. The process of recruiting personnel with the combination of skills and attributes required to carry out our strategies is often lengthy. Our success depends to a significant degree upon our ability to attract and retain qualified management, loan origination, finance, administrative, marketing, compliance and technical personnel and upon the continued contributions of our management and personnel. In particular, our success has been and continues to be highly dependent upon the abilities of key executives and certain other employees.

The Company Plans to Continue to Grow and there are Risks Associated with Growth

The Company intends to increase deposits and loans and may continue to review strategic opportunities which could, if implemented, expand its businesses and operations. Continued growth, including organic growth, may present operating and other problems that could adversely affect our business, financial condition and results of operations. Growth may place a strain on our administrative and operational, personnel and financial resources and increase demands on our systems and controls. Our ability to manage growth successfully will depend on its ability to attract qualified personnel and maintain cost controls and asset quality while attracting additional loans and deposits on favorable terms, as well as on factors beyond our control, such as economic conditions and interest rate trends. If we grow too quickly and are not able to attract qualified personnel, control costs and maintain asset quality, this continued rapid growth could materially adversely affect our financial performance.

 

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Our Deposit Portfolio Includes Significant Concentrations

As a business bank, we provide services to a number of customers whose deposit levels vary considerably and may also have a significant amount of seasonality. At December 31, 2016, 79 customers maintained balances (aggregating all related accounts, including multiple business entities and personal funds of business owners) in excess of $6 million. This amounted to $1.2 billion or approximately 48 percent of the Bank’s total customer deposit base. These deposits can and do fluctuate substantially and may include substantial complexity requiring ongoing monitoring and services. While the loss of any combination of these depositors could have a material impact on the Bank’s results, the Bank expects, in the ordinary course of business, that these deposits will fluctuate and believes it is capable of mitigating this risk, as well as the risk of losing one of these depositors, through additional liquidity, and business generation in the future. However, if a significant number of these customers leave the Bank it could have a material adverse impact on the Bank.

If We Cannot Attract Deposits and Quality Loans Our Growth May Be Inhibited

Our ability to increase our asset base depends in large part on our ability to attract additional deposits at favorable rates. We seek additional deposits by providing outstanding customer service and offering deposit products that are competitive with those offered by other financial institutions in our markets. In addition, our income depends in large part in attracting quality loan customers and loans in which to invest the deposits.

Additional BSA Related Expenses and Our Ability to Comply with the Consent Order May Inhibit Our Growth

Our ability to grow organically or through a strategic opportunity may be inhibited by BSA related expenses, or by the Consent Order. The Consent Order resulted in additional BSA compliance expenses for the Bank and the Company. It may also have the effect of limiting or delaying the Bank’s and the Company’s ability to obtain regulatory approval for certain expansionary activities, should the Company desire to engage in such activities.

SBA Lending is Subject to Government Funding Which can be Limited or Uncertain.

The Bank engages in SBA lending through programs designed by the federal government to assist the small business community in obtaining financing from financial institutions that are given government guarantees as an incentive to make the loans. SBA lending is subject to federal legislation that can affect the availability and funding of the program. From time to time, this dependence on legislative funding causes limitations and uncertainties with regard to the continued funding of such programs, which could potentially have an adverse financial impact on our business.

OPERATIONAL AND REPUTATIONAL RISK

We Have a Continuing Need to Adapt to Technological Changes

The banking industry is undergoing rapid technological changes with frequent introductions of new technology-driven products and services. The effective use of technology allows us to:

 

   

serve our customers better;

 

   

increase our operating efficiency by reducing operating costs;

 

   

provide a wider range of products and services to our customers; and

 

   

attract new customers

Our future success will partially depend upon our ability to successfully use technology to provide products and services that will satisfy our customers’ demands for convenience, as well as to create additional operating efficiencies while at the same time maintaining appropriate fraud and cyber-security controls. Our larger

 

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competitors already have existing infrastructures or substantially greater resources to invest in technological improvements. We generally arrange for such services through service bureau arrangements or other arrangements with third parties.

Our Controls and Procedures Could Fail or Be Circumvented

Management regularly reviews and updates our internal controls, disclosure controls, procedures and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, but not absolute, assurances of the effectiveness of these systems and controls, and that the objectives of these controls have been met. Any failure or circumvention of our controls and procedures, and any failure to comply with regulations related to controls and procedures could adversely affect our business, results of operations and financial condition.

The Occurrence of Fraudulent Activity, Breaches of Our Information Security or Cybersecurity-Related Incidents Could Have a Material Adverse Effect On Our Business, Financial Condition or Results of Operations.

As a financial institution, we are susceptible to fraudulent activity, information security breaches and cybersecurity-related incidents that may be committed against us or our clients, which may result in financial losses or increased costs to us or our clients, disclosure or misuse of our information or our client information, misappropriation of assets, privacy breaches against our clients, litigation, or damage to our reputation. Such fraudulent activity may take many forms, including check fraud, electronic fraud, wire fraud, phishing, social engineering and other dishonest acts. Information security breaches and cybersecurity-related incidents may include fraudulent or unauthorized access to systems used by us or our clients, denial or degradation of service attacks, and malware or other cyber-attacks. In recent periods, there continues to be a rise in electronic fraudulent activity, security breaches and cyber-attacks within the financial services industry, especially in the commercial banking sector due to cyber criminals targeting commercial bank accounts. Consistent with industry trends, we have also experienced an increase in attempted electronic fraudulent activity, as well as attempts at security breaches and cybersecurity-related incidents in recent periods. Moreover, in recent periods, several large corporations, including financial institutions and retail companies, have suffered major data breaches, in some cases exposing not only confidential and proprietary corporate information, but also sensitive financial and other personal information of their customers and employees and subjecting them to potential fraudulent activity. Some of our clients may have been affected by these breaches, which increase their risks of identity theft, credit card fraud and other fraudulent activity that could involve their accounts with us.

Information pertaining to us and our clients is maintained, and transactions are executed, on the networks and systems of us, our clients and certain of our third party partners, such as our online banking or reporting systems. The secure maintenance and transmission of confidential information, as well as execution of transactions over these systems, are essential to protect us and our clients against fraud and security breaches and to maintain our clients’ confidence. Breaches of information security also may occur, and in infrequent cases have occurred, through intentional or unintentional acts by those having access to our systems or our clients’ or counterparties’ confidential information, including employees. Furthermore, our cardholders use their debit and commercial credit cards to make purchases from third parties or through third party processing services. As such, we are subject to risk from data breaches of such third party’s information systems or their payment processors. Such a data security breach could compromise our account information. We may suffer losses associated with such fraudulent transactions , as well as for other costs related to data security breaches.

In addition, increases in criminal activity levels and sophistication, advances in computer capabilities, new discoveries, vulnerabilities in third-party technologies (including browsers and operating systems) or other developments could result in a compromise or breach of the technology, processes and controls that we use to prevent fraudulent transactions and to protect data about us, our clients and underlying transactions, as well as the technology used by our clients to access our systems. Although we have developed, and continue to invest in,

 

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systems and processes that are designed to detect and prevent security breaches and cyber-attacks and periodically test our security, our inability to anticipate, or failure to adequately mitigate, breaches of security could result in: losses to us or our clients; our loss of business and/or clients; damage to our reputation; the incurrence of additional expenses; disruption to our business; our inability to grow our online services or other businesses; additional regulatory scrutiny or penalties; or our exposure to civil litigation and possible financial liability — any of which could have a material adverse effect on our business, financial condition and results of operations.

More generally, publicized information concerning security and cyber-related problems could inhibit the use or growth of electronic or web-based applications or solutions as a means of conducting commercial transactions. Such publicity may also cause damage to our reputation as a financial institution. As a result, our business, financial condition or results of operations could be adversely affected.

We Could Be Liable For Breaches of Security In Our Online Banking Services. Fear of Security Breaches (including Cybersecurity breaches) Could Limit the Growth of Our Online Services

We offer various internet-based services to our clients, including online banking services. The secure transmission of confidential information over the Internet is essential to maintain our clients’ confidence in our online services. In certain cases, we are responsible for protecting customers’ proprietary information as well as their accounts with us. We have security measures and processes in place to defend against these cybersecurity risks but these cyber attacks are rapidly evolving (including computer viruses, malicious code, phishing or other information security breaches), and we may not be able to anticipate or prevent all such attacks, which could result in the unauthorized release, gathering, monitoring, misuse, loss or destruction of our or our customers’ confidential, proprietary and other information. Advances in computer capabilities, new discoveries or other developments could result in a compromise or breach of the technology we use to protect client transaction data. In addition, individuals, groups or sovereign countries may seek to intentionally disrupt our online banking services or compromise the confidentiality of customer information with criminal intent. Although we have developed systems and processes that are designed to recognize and assist in preventing security breaches (and periodically test our security), failure to protect against or mitigate breaches of security could adversely affect our ability to offer and grow our online services, constitute a breach of privacy or other laws, result in costly litigation and loss of customer relationships, negatively impact the Bank’s reputation, and could have an adverse effect on our business, results of operations and financial condition. We may not be insured against all types of losses as a result of breaches and insurance coverage may be inadequate to cover all losses resulting from breaches of security. We may also incur substantial increases in costs in an effort to minimize or mitigate cyber security risks and to respond to cyber incidents.

Our Operations Could be Disrupted

The potential for operational risk exposure exists throughout our organization. Integral to our performance is the continued efficacy of our technology and information systems, operational infrastructure and relationships with third parties and our colleagues in our day-to-day and ongoing operations. Failure by any or all of these resources subjects us to risks that may vary in size, scale and scope. This includes, but is not limited to, operational or systems failures, disruption of client operations and activities, ineffectiveness or exposure due to interruption in third party support as expected, as well as, the loss of key employees or failure on the part of key employees to perform properly.

Managing Reputational Risk Is Important To Attracting and Maintaining Customers, Investors, and Employees

Threats to our reputation can come from many sources, including adverse sentiment about financial institutions generally, unethical practices, employee misconduct, failure to deliver minimum standards of service or quality, compliance deficiencies, and questionable, illegal, or fraudulent activities of our customers. We have

 

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policies and procedures in place that seek to protect our reputation and promote ethical conduct, but these policies and procedures may not be fully effective. Negative publicity regarding our business, employees, or customers, with or without merit, may result in the loss of customers, investors, and employees, costly litigation, a decline in revenues and increased governmental regulation.

We Rely On Communications, Information, Operating and Financial Control Systems Technology from Third-Party Service Providers

We rely heavily on third-party service providers for much of our communications, information, operating and financial control systems technology, including customer relationship management, internet banking, website, general ledger, deposit, loan servicing and wire origination systems. Any failure or interruption or breach in security of these systems could result in failures or interruptions in our customer relationship management, internet banking, website, general ledger, deposit, loan servicing and/or wire origination systems. We cannot assure you that such failures or interruptions will not occur or, if they do occur, that they will be adequately addressed by us or the third parties on which we rely. The Company may not be insured against all types of losses as a result of third party failures and insurance coverage may be inadequate to cover all losses resulting from system failures or other disruptions. The occurrence of any failures or interruptions could have a material adverse effect on our business, financial condition, results of operations and cash flows. If any of our third-party service providers experience financial, operational or technological difficulties, or if there is any other disruption in our relationships with them, we may be required to locate alternative sources of such services, and we cannot assure you that we could negotiate terms that are as favorable to us, or could obtain services with similar functionality as found in our existing systems without the need to expend substantial resources, if at all. Any of these circumstances could have a material adverse effect on our business, financial condition, results of operations and cash flows.

Additionally, the bank regulatory agencies expect financial institutions to be responsible for all aspects of our vendors’ performance, including aspects which they delegate to third parties. Disruptions or failures in the physical infrastructure or operating systems that support our businesses and clients, or cyber attacks or security breaches of the networks, systems or devices that our clients use to access our products and services could result in client attrition, regulatory fines, penalties or intervention, reputational damage, reimbursement or other compensation costs, and/or additional compliance costs, any of which could materially adversely affect our results of operations or financial condition.

The Costs and Effects of Litigation, Investigations or Similar Matters, or Adverse Facts and Developments Related Thereto, Could Materially Affect Our Business, Operating Results and Financial Condition

We may be involved from time to time in a variety of litigation, investigations or similar matters arising out of our business. Our insurance may not cover all claims that may be asserted against it and indemnification rights to which we are entitled may not be honored, and any claims asserted against us, regardless of merit or eventual outcome, may harm our reputation. Should the ultimate judgments or settlements in any litigation or investigation significantly exceed our insurance coverage, they could have a material adverse effect on our business, financial condition and results of operations. In addition, premiums for insurance covering the financial and banking sectors are rising. We may not be able to obtain appropriate types or levels of insurance in the future, nor may we be able to obtain adequate replacement policies with acceptable terms or at historic rates, if at all.

We May Incur Fines, Penalties And Other Negative Consequences From Regulatory Violations, Which Are Possibly Even Inadvertent Or Unintentional Violations.

We maintain systems and procedures designed to ensure that we comply with applicable laws and regulations, but there can be no assurance that these will be effective. We may incur fines, penalties and other negative consequences from regulatory violations. We may suffer other negative consequences resulting from findings of noncompliance with laws and regulations, that may also damage our reputation, and this in turn might materially affect our business and results of operations.

 

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Further, some legal/regulatory frameworks provide for the imposition of fines or penalties for noncompliance even though the noncompliance was inadvertent or unintentional and even though there were in place at the time systems and procedures designed to ensure compliance.

We Are Subject to Losses Due to the Errors or Fraudulent Behavior of Employees or Third Parties.

We are exposed to many types of operational risk, including the risk of fraud by employees and outsiders, clerical record keeping errors and transactional errors. Our business is dependent on our employees as well as third-party service providers to process a large number of increasingly complex transactions. We could be materially adversely affected if one of our employees causes a significant operational breakdown or failure, either as a result of human error or where an individual purposefully sabotages or fraudulently manipulates our operations or systems. When we originate loans, we rely upon information supplied by loan applicants and third parties, including the financial and other information contained in the loan application package, property and collateral appraisals and valuations, and title information, if applicable, and employment and income documentation provided by third parties. If any of this information is misrepresented and such misrepresentation is not detected prior to loan funding, we generally bear the risk of loss associated with the misrepresentation. Any of these occurrences could result in a diminished ability of us to operate our business, potential liability to customers, reputational damage and regulatory intervention, which could negatively impact our business, financial condition and results of operations.

CU BANCORP RELATED RISKS

CU Bancorp is an Emerging Growth Company within the Meaning of the Securities Act. Certain Exemptions from Reporting Requirements that are Available to Emerging Growth Companies Could Make Its Common Stock Less Attractive to Investors.

The Company is an “emerging growth company,” as defined in Section 2(a) of the Securities Act of 1933, as amended (the “Securities Act”), as modified by the Jumpstart Our Business Startups Act of 2012 ( the “JOBS Act”). CU Bancorp is eligible to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies, including, but not limited to, reduced disclosure about its executive compensation and omission of compensation discussion and analysis, and an exemption from the requirement of holding a non-binding advisory vote on executive compensation. While CU Bancorp is subject to the requirements of FDICIA, it is not subject to certain requirements of Section 404 of the Sarbanes-Oxley Act of 2002 (the “Sarbanes- Oxley Act”), including the additional level of review of its internal control over financial reporting as may occur when outside auditors attest as to its internal control over financial reporting. As a result, its shareholders may not have access to certain information they may deem important.

Statutory Restrictions and Restrictions by Our Regulators on Dividends and Other Distributions from the Bank May Adversely Impact Us by Limiting the Amount of Distributions CU Bancorp May Receive

The ability of the Bank to pay dividends to us is limited by various regulations and statutes and our ability to pay dividends on our outstanding stock is limited by various regulations and statutes, including California law.

Various statutory provisions restrict the amount of dividends that the Bank can pay to us without regulatory approval.

The Federal Reserve Board has previously issued Federal Reserve Supervision and Regulation Letter SR-09-4 that states that bank holding companies are expected to inform and consult with the Federal Reserve supervisory staff prior to taking any actions that could result in a diminished capital base, including any payment or increase in the rate of dividends. Further, if we are not current in our payment of interest on our Subordinated Debentures, we may not pay dividends on our common stock.

 

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If the Bank were to liquidate, the Bank’s creditors would be entitled to receive distributions from the assets of the Bank to satisfy their claims against the Bank before Bancorp, as a holder of the equity interest in the Bank, would be entitled to receive any of the assets of the Bank as a distribution or dividend.

The restrictions described above could have a negative effect on the value of our common stock. Moreover, holders of our common stock are entitled to receive dividends only when, as and if declared by our Board of Directors. We have never paid cash dividends on our common stock.

Our Series A Preferred Stock Diminishes the Cash Available To Our Common Shareholders.

On November 30, 2014, the Company entered into an Assignment and Assumption Agreement with the Secretary of the Treasury, pursuant to which the Company issued to the U.S. Treasury 16,400 shares of its Non-Cumulative Perpetual Preferred Stock, Series A, having a liquidation preference of $1,000 per share and the Company assumed the obligations of 1st Enterprise Bank in connection with its issuance of the same number and type of securities to the Treasury (which shares were retired in connection therewith). The issuance was pursuant to the Treasury’s SBLF program, a $30 billion fund established under the Small Business Jobs Act of 2010, which encourages lending to small businesses by providing capital to qualified community banks with assets of less than $10 billion.

The Series A Preferred Stock is entitled to receive non-cumulative dividends payable quarterly on each January 1, April 1, July 1 and October 1. The dividend rate was fixed at a 1% rate through February 2016.

Effective March 2016, the dividend rate became fixed at 9%. However, the dividend yield through November 30, 2018 approximates 7% as a result of business combination accounting. This increase in the Series A Preferred Stock annual dividend rate could have a material adverse effect on our liquidity and could also adversely affect our ability to pay dividends on our common shares.

Our Accounting Policies and Processes Are Critical To How We Report Our Financial Condition and Results Of Operations. They Require Management To Make Estimates About Matters That Are Uncertain.

Accounting policies and processes are fundamental to how we record and report our financial condition and results of operations. Some of these policies require use of estimates and assumptions that may affect the value of our assets or liabilities and financial results. Several of our accounting policies are critical because they require management to make difficult, subjective and complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or using different assumptions. Pursuant to U.S. GAAP, we are required to make certain assumptions and estimates in preparing our financial statements, including in determining credit loss reserves, reserves related to litigation and the fair value of certain assets and liabilities, among other items. If assumptions or estimates underlying our financial statements are incorrect, we may experience material losses.

Management has identified certain accounting policies as being critical because they require management’s judgment to ascertain the valuations of assets, liabilities and contingencies. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset, valuing an asset or liability, or recognizing or reducing a liability. We have established policies and control procedures that are intended to ensure these critical accounting estimates and judgments are controlled and applied consistently. Because of the uncertainty surrounding our judgments and the estimates pertaining to these matters, we cannot guarantee that we will not be required to adjust accounting policies or restate prior period financial statements. See “Critical Accounting Policies” in the MD&A and Note 1, “Significant Accounting Policies,” to the Consolidated Financial Statements in this Form 10-K.

Our Disclosure Controls and Procedures May Not Prevent or Detect All Errors or Acts of Fraud.

Our disclosure controls and procedures are designed to provide reasonable assurance that information required to be disclosed by us in reports we file or submit under the Exchange Act is accurately accumulated and

 

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communicated to management, and recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms. We believe that any disclosure controls and procedures or internal controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.

These inherent limitations include the realities that judgments in decision making can be faulty, that alternative reasoned judgments can be drawn, or that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by an unauthorized override of the controls. Accordingly, because of the inherent limitations in our control system, misstatements due to error or fraud may occur and not be detected, which could result in a material weakness in our internal controls over financial reporting and the restatement of previously filed financial statements.

RISKS RELATED TO OUR STOCK

The Price of Our Common Stock May Be Volatile or May Decline

The trading price of our common stock may fluctuate widely as a result of a number of factors, many of which are outside our control. In addition, the stock market is subject to fluctuations in the share prices and trading volumes that affect the market prices of the shares of many companies. These broad market fluctuations could positively or adversely affect the market price of our common stock and may not be predictable. Among the factors that could affect our stock price, certain of which are beyond our control, are:

 

   

actual or anticipated quarterly fluctuations in our operating results and financial condition;

 

   

publication of research reports and recommendations by financial analysts;

 

   

failure to meet analysts’ revenue or earnings estimates;

 

   

speculation in the press or investment community;

 

   

strategic actions by us or our competitors, such as acquisitions or restructurings;

 

   

actions by institutional shareholders;

 

   

fluctuations in the stock price and operating results of our competitors;

 

   

general market conditions and, in particular, developments related to market conditions for the financial services industry;

 

   

political events, elections or changes in government or administration;

 

   

proposed or adopted regulatory changes or developments;

 

   

anticipated or pending investigations, proceedings or litigation that involve or affect us;

 

   

deletion from a well known index; or

 

   

domestic and international economic factors unrelated to our performance.

The stock market and, in particular, the market for financial institution stocks, may experience significant volatility based on its history. As a result, the market price of our common stock may be volatile. In addition, the trading volume in our common stock may fluctuate more than usual and cause significant price variations to occur. The trading price of the shares of our common stock and the value of our other securities will depend on many factors, which may change from time to time, including, without limitation, our financial condition, performance, creditworthiness and prospects, future sales of our equity or equity related securities, and other factors identified above in “ Forward-Looking Statements.” A significant decline in our stock price could result in substantial losses for individual shareholders and could lead to costly and disruptive securities litigation.

 

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The Holders Of Our Preferred Stock and Trust Preferred Securities Have Rights That Are Senior To Those Of Our Holders Of Common Stock And That May Impact Our Ability To Pay Dividends On Our Common Stock.

At December 31, 2016, our subsidiary trusts had outstanding $12.4 million of trust preferred securities. These securities are effectively senior to shares of common stock due to the priority of the underlying junior subordinated debt. As a result, we must make payments on our trust preferred securities before any dividends can be paid on our common stock; moreover, in the event of our bankruptcy, dissolution, or liquidation, the obligations outstanding with respect to our trust preferred securities must be satisfied before any distributions can be made to our shareholders. While we have the right to defer dividends on the trust preferred securities for a period of up to five years, if any such election is made, no dividends may be paid to our common or preferred shareholders during that time.

On November 30, 2014, the Company issued and sold 16,400 shares of Series A Preferred Stock to the Treasury in connection with the acquisition of 1st Enterprise Bank and in replacement for similar securities previously issued to the Treasury by 1st Enterprise pursuant to the Treasury’s SBLF program. The Series A Preferred Stock is entitled to receive non-cumulative dividends payable quarterly. Such dividends are not cumulative, but the Company may only declare and pay dividends on its common stock if it has declared and paid dividends for the current dividend period on the Series A Preferred Stock.

There Are Also Various Regulatory Restrictions On The Ability Of California United Bank To Pay Dividends Or Make Other Payments To CU Bancorp. In Particular, Federal And State Banking Laws Regulate The Amount Of Dividends That May Be Paid By California United Bank Without Prior Approval.

The Dodd-Frank Act requires federal banking agencies to establish more stringent risk-based capital guidelines and leverage limits applicable to banks and bank holding companies. The final Basel III capital standards issued in 2013 by the FRB provide that distributions (including dividend payments and redemptions) on additional Tier 1 capital instruments may only be paid out of net income, retained earnings, or surplus related to other additional Tier 1 capital instruments. The final Basel III capital standards also introduce a new capital conservation buffer on top of the minimum risk-based capital ratios. Failure to maintain a capital conservation buffer above certain levels will result in restrictions on CU Bancorp’s ability to make dividend payments, redemptions or other capital distributions. These requirements, and any other new regulations or capital distribution constraints, could adversely affect the ability of California United Bank to pay dividends to CU Bancorp and, in turn, affect CU Bancorp’s ability to pay dividends on the CU Bancorp common stock and/or the CU Bancorp preferred stock.

The Federal Reserve Board may also, as a supervisory matter, otherwise limit CU Bancorp’s ability to pay dividends on the CU Bancorp common stock and/or the CU Bancorp preferred stock.

In addition, the CU Bancorp common stock and the CU Bancorp preferred stock may be fully subordinate to interests held by the U.S. government in the event of a receivership, insolvency, liquidation, or similar proceeding, including a proceeding under the “orderly liquidation authority” provisions of the Dodd-Frank Act.

CU Bancorp May Be Unable To, Or Choose Not To, Pay Dividends On Its Common Stock.

To date, CU Bancorp has not paid any cash dividends on its common stock. Payment of stock or cash dividends on its common stock in the future will depend on the following factors, among others:

 

   

CU Bancorp may not have sufficient earnings since its primary source of income, the payment of dividends to it by California United Bank, is subject to federal and state laws that limit the ability of California United Bank to pay dividends;

 

   

Federal Reserve Board policy requires bank holding companies to pay cash dividends on common stock only out of net income available over the past year and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition;

 

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Before dividends may be paid on CU Bancorp’s common stock in any year, payments must be made on its subordinated debentures or the CU Bancorp preferred stock issued in connection with the merger with 1st Enterprise;

 

   

CU Bancorp’s board of directors may determine that, even though funds are available for dividend payments, retaining the funds for internal uses, such as expansion of its operations, is a better strategy;

If CU Bancorp fails to pay dividends, capital appreciation, if any, of its common stock may be the sole opportunity for gains on an investment in its common stock. In addition, in the event California United Bank becomes unable to pay dividends to it, CU Bancorp may not be able to service its debt, pay its other obligations or pay dividends on its common stock. Accordingly, CU Bancorp’s inability to receive dividends from its bank subsidiary could also have a material adverse effect on its business, financial condition and results of operations and the value of CU Bancorp common stock. Further, the terms of the CU Bancorp preferred stock that was exchanged for 1st Enterprise preferred stock in the merger limit CU Bancorp’s ability to pay dividends on its common stock.

CU Bancorp’s Stock Trading Volume May Not Provide Adequate Liquidity for Investors.

Although shares of CU Bancorp’s common stock are listed for trading on The NASDAQ Capital Market, the average daily trading volume in the common stock varies and may be less than that of other larger financial services companies. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of a sufficient number of willing buyers and sellers of the common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which CU Bancorp has no control. Given the daily average trading volume of CU Bancorp’s common stock, significant sales of the common stock in a brief period of time, or the expectation of these sales, could cause a decline in the price of its common stock.

ITEM 2 — PROPERTIES

The principal executive offices of the Company are located in Los Angeles, California, and are leased by the Company. All of our branch locations are leased from unaffiliated parties.

We believe that our existing facilities are adequate for our present purposes. The Company leases all its facilities and believes that if necessary, it could secure suitable alternative facilities on similar terms without adversely affecting operations. For additional information on properties, see Note 7 to the Consolidated Financial Statements included in Item 8 of this Form 10-K.

ITEM 3 — LEGAL PROCEEDINGS

The Company is not a defendant in any material pending legal proceedings and no such proceedings are known to be contemplated. No director, officer, affiliate, more than 5.0% shareholder of the Company or any associate of these persons is a party adverse to the Company or has a material interest adverse to the Company in any material legal proceeding. See Note 21 — Commitments and Contingencies to the Consolidated Financial Statements included in Item 8 of this 10-K.

ITEM 4 — MINE SAFETY DISCLOSURES

Not applicable

 

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PART II

ITEM 5 — MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Common Stock

The Company’s shares of common stock trade on the NASDAQ Capital Market under the symbol “CUNB”. The Company’s common stock began trading on the NASDAQ exchange on October 10, 2012, prior to that date the stock traded on the OTCBB.

There are 75,000,000 shares of common stock authorized at no par value, of which 17,759,006 and 17,175,389 shares were issued and outstanding at December 31, 2016 and 2015, respectively.

Preferred Stock

The Company has 50,000,000 shares of serial preferred stock authorized. At December 31, 2016 and 2015, the Company has 16,400 shares of Series A, non-cumulative perpetual preferred stock authorized, issued and outstanding. Each Series A preferred stock has a liquidation preference of $1,000 per share.

Sales Price Information

The information in the following table indicates the highest and lowest sales prices and volume of trading for the Company’s common stock for the two year period starting January 1, 2015 through December 31, 2016 for each quarterly period, and is based upon information provided by NASDAQ. The information does not include transactions for which no public records are available. The bid and ask trading prices of the stock may be higher or lower than the prices reported below. These prices are based on the actual prices of stock transactions without retail mark-ups, mark-downs, commissions or adjustments.

 

Period Ended

   High Price      Low Price      Approximate Number of
Shares Traded
 

March 31, 2015

   $ 23.00      $ 20.06        1,562,718  

June 30, 2015

   $ 23.00      $ 18.52        2,229,554  

September 30, 2015

   $ 23.48      $ 20.59        1,501,514  

December 31, 2015

   $ 27.66      $ 21.82        2,112,266  

March 31, 2016

   $ 25.00      $ 20.69        1,968,399  

June 30, 2016

   $ 24.05      $ 20.35        2,923,703  

September 30, 2016

   $ 25.25      $ 22.25        1,708,758  

December 31, 2016

   $ 35.95      $ 22.35        3,322,407  

According to information provided by NASDAQ, the most recent trade in our common stock prior to the date of finalizing this Form 10-K occurred on March 6, 2017 at a sales price of $38.10 per share. The high “bid” and low “asked” prices as of March 6, 2017 were $38.20 and $37.55, respectively.

Shareholders

As of March 6, 2017, the Company had 624 common shareholders of record, as listed with its transfer agent.

Dividends

In December 2016, the Board of Directors approved a quarterly dividend payment on the preferred stock in the amount of $369 thousand to the United States Department of the Treasury. To date, the Company has not paid any cash dividends on common stock.

 

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The applicable limitations on the payment of dividends are further discussed in Part II, Item 8, Financial Statements and Supplementary Data, Note 22, Regulatory Matters.

Common Stock Redemptions

In 2016, 2015 and 2014, the Company redeemed 52,591, 44,311 and 26,317 shares respectively, of employee restricted stock to pay the tax obligation of employees in connection with their restricted stock vesting. The total value of the employee tax obligation remitted by the Company was $1.4 million, $971 thousand and $471 thousand for the years ending December 31, 2016, 2015 and 2014, respectively. The Company purchased 17,242 shares of common stock at an average price per share of $31.10 during the 2016 fourth quarter.

The following table represents stock repurchases made by the Company during the fourth quarter of 2016:

 

Purchase Dates:    Total
Number of Shares

Purchased (1)
     Average Price
Paid Per  Share
 

October 1 – October 31, 2016

     —          —    

November 1 – November 30, 2016

     —          —    

December 1 – December 31, 2016

     17,242      $ 31.10  
  

 

 

    

 

 

 

Total

     17,242      $ 31.10  
  

 

 

    

 

 

 

 

(1) Shares repurchased pursuant to net settlement by employees, in satisfaction of income tax withholding obligations incurred through the vesting of Company restricted stock. We did not repurchase any shares as part of publicly announced plans or programs.

Securities Authorized for Issuance Under Equity Compensation Plans

The following table provides information as of December 31, 2016 with respect to the shares of our common stock that may be issued under existing equity compensation plans. This table does not reflect the number of restricted shares of stock that have been issued under the Company’s equity compensation plans. The number of shares of common stock remaining available for future issuance under the equity compensation plans has been reduced by both stock option grants and restricted stock issued under the plans.

 

Plan

   Number of securities to
be issued upon exercise
of outstanding options
     Weighted-average
exercise price of
outstanding options
     Number of securities remaining available for
future issuance under equity compensation
plans (excluding securities reflected in the
second column)
 

Equity Compensation Plans Approved by Security Holders:

        

2007 Equity and Incentive Compensation Plan

     47,697      $ 12.69        441,571  
  

 

 

    

 

 

    

 

 

 

Total

     47,697      $ 12.69        441,571  
  

 

 

    

 

 

    

 

 

 

Performance Graph

The following Performance Graph and related information shall not be deemed “soliciting material” or to be “filed” with the Securities and Exchange Commission, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933 or Securities Exchange Act of 1934, each as amended, except to the extent that the Company specifically incorporates it by reference into such filing. The following Performance Graph was prepared for the Company by SNL Financial.

 

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The following graph compares the yearly percentage change in CU Bancorp’s cumulative total shareholder return on common stock, the cumulative total return of the NASDAQ Composite and the SNL Bank and Thrift Index.

The graph assumes an initial investment value of $100 on December 31, 2011. Points on the graph represent the performance as of the last business day of each of the years indicated. The graph is not necessarily indicative of future price performance.

LOGO

 

     Period Ending  

Index

   12/31/11      12/31/12      12/31/13      12/31/14      12/31/15      12/31/16  

CU Bancorp

     100.00        116.52        173.93        215.82        252.34        356.22  

NASDAQ Composite

     100.00        117.45        164.57        188.84        201.98        219.89  

SNL Bank and Thrift

     100.00        134.28        183.86        205.25        209.39        264.35  

 

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ITEM 6 — SELECTED FINANCIAL DATA

The following table presents the Company’s selected financial and other data for the dates indicated (dollars in thousands except per share and other data). The consolidated balance sheet and statements of income data have been derived from the Company’s audited consolidated financial statements.

Certain of the information presented below under the captions “Selected Financial Ratios” and “Selected Asset Quality Ratios” is unaudited. The selected financial and other data is qualified in its entirety by, and should be read in conjunction with, “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Item 8. Financial Statements and Supplementary Data.”

 

    As of and for the Years ended December 31,  
    2016     2015     2014     2013     2012  

Consolidated Statements of Income Data:

         

Interest income

  $ 101,252     $ 90,142     $ 55,177     $ 50,846     $ 37,496  

Interest expense

    3,146       2,723       1,922       2,079       1,797  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

    98,106       87,419       53,255       48,767       35,699  

Provision for loan losses

    3,264       5,080       2,239       2,852       1,768  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income after provision for loan losses

    94,842       82,339       51,016       45,915       33,931  

Non-interest income

    12,012       11,730       7,709       6,518       3,961  

Non-interest expense

    (63,444     (59,965     (43,385     (37,640     (34,500
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income before provision for income tax expense

    43,410       34,104       15,340       14,793       3,392  

Provision for income tax expense

    15,953       12,868       6,432       5,008       1,665  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Income

  $ 27,457     $ 21,236     $ 8,908     $ 9,785     $ 1,727  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Per Share and Other Data:

         

Basic earnings per share

  $ 1.52     $ 1.21     $ 0.77     $ 0.93     $ 0.21  

Diluted earnings per share

    1.50       1.18       0.75       0.90       0.21  

Book value per common share (1)

    18.09       16.87       15.78       12.45       11.68  

Tangible book value per common share (2)

    14.10       12.67       11.37       11.11       10.37  

Weighted average shares outstanding — Basic

    17,252,046       16,543,787       11,393,445       10,567,436       8,283,599  

Weighted average shares outstanding — Diluted

    17,550,864       16,983,221       11,667,733       10,836,861       8,410,749  

Consolidated Balance Sheet Data:

         

Investment securities available-for-sale

  $ 469,950     $ 315,785     $ 226,962     $ 106,488     $ 118,153  

Investment securities held-to-maturity

    42,027       42,036       47,147       —         —    

Loans, net

    2,030,852       1,817,481       1,612,113       922,591       846,082  

Total Assets

    2,994,760       2,634,642       2,265,117       1,407,816       1,249,637  

Deposits

    2,607,389       2,286,791       1,947,693       1,232,423       1,078,076  

Non-interest bearing demand deposits

    1,400,097       1,288,085       1,032,634       632,192       543,527  

Securities sold under agreements to repurchase

    18,816       14,360       9,411       11,141       22,857  

Shareholders’ equity

    338,185       306,807       279,192       137,924       125,623  

Selected Financial Ratios

         

Return on Average Assets (3)

    0.92     0.80     0.59     0.74     0.16

Return on Average Tangible Common Equity (4)

    11.07     9.86     6.50     8.34     1.73

Equity to Assets Ratio (5)

    11.29     11.65     12.33     9.80     10.05

Tangible Common Equity to Tangible Asset Ratio (6)

    8.56     8.49     8.66     8.84     9.03

Loans to Deposits Ratio

    78.63     80.16     83.42     75.72     79.30

Efficiency Ratio (7)

    58     61     71     68     87

Net Interest Margin (8)

    3.71     3.83     3.79     3.96     3.63

Selected Asset Quality Ratios

         

Allowance for loan loss as a % of total loans

    0.94     0.86     0.78     1.14     1.03

Allowance for loan loss as a % of total loans (excluding loans acquired in acquisitions)

    1.18     1.25     1.39     1.50     1.54

Non Performing Assets to Total Assets

    0.04     0.09     0.21     0.68     1.09

Net Charge-offs/(Recoveries) to Average Loans

    (0.02 )%      0.12     0.02     0.12     0.08

Regulatory Capital Ratios (California United Bank)

         

Total Risk-Based Capital Ratio

    11.0     11.2     11.2     12.0     11.6

Tier 1 Risk-Based Capital Ratio

    10.3     10.5     10.6     11.0     10.7

Common Equity Tier 1 Ratio

    10.3     10.5     —       —       —  

Tier 1 Leverage Ratio

    9.4     9.3     12.4     8.9     8.6

Regulatory Capital Ratios (CU Bancorp Consolidated)

 

     

Total Risk-Based Capital Ratio

    11.4     11.5     11.6     12.8     12.4

Tier 1 Risk-Based Capital Ratio

    10.7     10.9     11.0     11.8     11.5

Common Equity Tier 1 Ratio

    9.6     9.6     —       —       —  

Tier 1 Leverage Ratio

    9.7     9.7     12.9     9.6     9.1

 

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(1) Book value per common share is calculated by dividing shareholders’ equity by the total number of shares issued and outstanding.
(2) Tangible book value per common share is calculated by dividing tangible shareholders’ equity (shareholders’ equity less preferred stock, goodwill and core deposit and leasehold right intangibles) by the total number of shares issued and outstanding.
(3) Return on average assets is calculated by dividing the net income available to common shareholders by the daily average outstanding assets of the Company.
(4) Return on average tangible common equity is calculated by dividing the Company’s net income available to common shareholders by the Company’s average tangible common equity (total average shareholders’ equity less average serial preferred stock, average goodwill, and average core deposit and leasehold right intangibles).
(5) The equity to assets ratio was calculated by dividing the Company’s shareholders’ equity by the Company’s total assets.
(6) The tangible common equity to assets ratio was calculated by dividing tangible shareholders’ equity by the Company’s total tangible assets (total assets less goodwill and core deposit and leasehold right intangibles).
(7) The efficiency ratio represents non-interest expense as a percent of net interest income plus non-interest income, excluding gain on sale of securities, net.
(8) The net interest margin represents net interest income as a percent of interest earning assets.

 

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ITEM 7 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management’s discussion and analysis of financial condition and results of operations is intended to provide a better understanding of the significant changes in trends relating to the Company’s financial condition, results of operation, liquidity and interest rate sensitivity. This section should be read in conjunction with the disclosures regarding “Forward-Looking Statements” set forth in “Item I. Business — Forward-Looking Statements,” as well as the discussion set forth in “Item 8. Financial Statements and Supplementary Data,” including the notes to consolidated financial statements.

OVERVIEW

The year 2016 was another year of strong financial performance for the Company. The Company’s return on average tangible common equity increased to 11.07%, return on average assets increased to 0.92% and the efficiency ratio was 58%. This led to record net income in 2016 of $27 million and diluted earnings per share of $1.50, an increase of 29% and 27%, respectively, from 2015. Activities to enhance BSA Compliance and address the BSA Consent Order resulted in $1.7 million in non-recurring charges in 2016. The Company continued to focus on low-cost core deposits, which provide an important part of the value of its franchise. In 2016 the Company’s total deposits increased $321 million to $2.6 billion, and despite the prime rate increase in December of 2015 and 2016, the cost of deposits in the fourth quarter of 2016 remained within 0.01% of the year-ago quarter. Total assets have grown by $730 million in the two years since the merger of the Company and 1st Enterprise Bank, buttressing the Company’s commitment to organic growth. Compared to 2015, total loans grew $217 million or 12% to $2.1 billion — surpassing the $2 billion mark for the first time in the Company’s history. Furthermore, the Company experienced net recoveries and in 2016, the Company again demonstrated its ability to combine growth with discipline in credit underwriting; witnessed by the ratio of non-performing assets to total assets of 0.04% at December 31, 2016.

Full Year 2016 Highlights

 

   

Net income in 2016 was $27 million, up 29% from the prior year

 

   

Return on average tangible common equity of 11.07%, up from 9.86% in the prior year

 

   

Efficiency ratio improved to 58%, from 61% in the prior year

 

   

Tangible book value per share increased $1.43 per share, or 11% to $14.10 from the prior year

 

   

Total assets increased $360 million to $3 billion, up 14% from the prior year

 

   

Total deposits increased to $2.6 billion, an increase of $321 million or 14% from prior year

 

   

Non-interest bearing demand deposits were 54% of total deposits at December 31, 2016

 

   

Year-end 2016 average deposits per branch increased to $290 million

 

   

Total loans increased to $2 billion, an increase of $217 million or 12% from 2015

 

   

Record net organic loan growth of $388 million in 2016

 

   

Nonperforming assets to total assets at 0.04%, at December 31, 2016

 

   

Continued status as well-capitalized, the highest regulatory category

The Company’s increase in total assets over the last 10 years is due to the Company’s execution of its primary business model focusing on businesses, non-profits, entrepreneurs, professionals and investors, supplemented by the mergers with 1st Enterprise Bank (“1st Enterprise”) in November 2014, Premier Commercial Bancorp (“PC Bancorp”) in July of 2012 and California Oaks State Bank (“COSB”) in December of 2010. The Company is organized and operated as a single reporting segment, principally engaged in commercial business

 

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banking. At December 31, 2016, the Company conducted its lending and deposit operations through nine branch offices, located in the counties of Los Angeles, Ventura, Orange and San Bernardino in Southern California. The consolidated financial statements, as they appear in this document, represent the grouping of revenue and expense items as they are presented to executive management for use in strategically directing the Company’s operations. The Company’s growth in loans and deposit liabilities during 2016 was the direct result of the successful execution of its organic growth strategies, with an emphasis on maintaining strong ties to existing customer relationships, as well as developing new customer relationships. New customer relationships are developed from referrals from Board members, current customers, and the local communities the Company actively supports. In addition, the Company targets potential customers whose current bank may be unable to provide the same level of customer support that the customer has come to desire.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). The preparation of these 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.

Various elements of our accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions, and other subjective assessments. We have identified several accounting policies that, due to judgments, estimates, and assumptions inherent in those policies, are essential to an understanding of our consolidated financial statements. These policies relate to the accounting for business combinations, evaluation of goodwill for impairment, methodologies that determine our allowance for loan loss, the valuation of impaired loans, the classification and valuation of investment securities, accounting for derivatives financial instruments and hedging activities, and accounting for income taxes.

We believe that our most critical accounting policies upon which our financial condition depends, and which involve the most complex or subjective decisions or assessment, are as follows:

Business Combinations

The Company has a number of fair value adjustments recorded within the consolidated financial statements at December 31, 2016 that relate to the business combinations with COSB, PC Bancorp and 1st Enterprise on December 31, 2010, July 31, 2012 and November 30, 2014, respectively. These fair value adjustments includes goodwill, fair value adjustments on loans, core deposit intangible assets, other intangible assets, fair value adjustments to acquired lease obligations and fair value adjustments on derivatives. The assets and liabilities acquired through acquisitions have been accounted for at fair value as of the date of the acquisition. The goodwill that was recorded on the transactions represented the excess of the purchase price over the fair value of net assets acquired. Goodwill is not amortized and is reviewed for impairment on October 1st of each year. If certain events occur or circumstances change that result in the Company’s fair value declining below its book value, the Company would perform an impairment analysis at that time.

Allowance for Loan Loss

The allowance for loan loss (“Allowance”) is established by a provision for loan losses that is charged against income, increased by charges to expense and decreased by charge-offs (net of recoveries). Loan charge-offs are charged against the Allowance when management believes the collectability of loan principal becomes unlikely. Subsequent recoveries, if any, are credited to the Allowance.

 

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The Allowance is an amount that management believes will be adequate to absorb estimated charge-offs related to specifically identified loans, as well as probable loan charge-offs inherent in the balance of the loan portfolio, based on an evaluation of the collectability of existing loans and prior loss experience. Management carefully monitors changing economic conditions, the concentrations of loan categories and collateral, the financial condition of the borrowers, the history of the loan portfolio, as well as historical peer group loan loss data to determine the adequacy of the Allowance. The Allowance is based upon estimates, and actual charge-offs may vary from the estimates. No assurance can be given that adverse future economic conditions will not lead to delinquent loans, increases in the provision for loan losses and/or charge-offs. These evaluations are inherently subjective, as they require estimates that are susceptible to significant revisions as conditions change. In addition, regulatory agencies, as an integral part of their examination process, may require additions to the Allowance based on their judgment about information available at the time of their examinations. Management believes that the Allowance as of December 31, 2016 is adequate to absorb known and probable losses inherent in the loan portfolio.

The Allowance consists of specific and general components. The specific component relates to loans that are categorized as impaired. For loans that are categorized as impaired, a specific allowance is established when the realizable value of the impaired loan is lower than the recorded investment of that loan. The general component covers non-impaired loans and is based on the type of loan and historical charge-off experience adjusted for qualitative factors.

While the general allowance covers all non-impaired loans and is based on historical loss experience adjusted for the various qualitative factors as discussed in Note 6 — Loans, the change in the Allowance from one reporting period to the next may not directly correlate to the rate of change of nonperforming loans for the following reasons:

 

   

A loan moving from the impaired performing status to an impaired non-performing status does not mandate an automatic increase in allowance. The individual loan is evaluated for a specific allowance requirement when the loan moves to the impaired status, not when the loan moves to non-performing status. In addition, the impaired loan is reevaluated at each subsequent reporting period. Impairment is measured based on the present value of the expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, the Company may measure impairment based on the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent.

 

   

Not all impaired loans require a specific allowance. The payment performance of the borrower may require an impaired classification, but the collateral evaluation may support adequate collateral coverage. For a number of impaired loans in which borrower performance is in question, the collateral coverage may be sufficient. In those instances, a specific allowance is not assessed.

Investment Securities

The Company currently classifies its investment securities under the available-for-sale and held-to-maturity classifications. Under the available-for-sale classification, securities can be sold in response to certain conditions, such as changes in interest rates, changes in the credit quality of the securities, when the credit quality of a security does not conform with current investment policy guidelines, fluctuations in deposit levels or loan demand or a need to restructure the portfolio to better match the maturity or interest rate characteristics of liabilities with assets. Securities classified as available-for-sale are accounted for at their current fair value rather than amortized cost. Unrealized gains or losses are excluded from net income and reported as a separate component of accumulated other comprehensive income (loss) included in shareholders’ equity. If the Company has the intent and the ability at the time of purchase to hold certain securities until maturity, they are classified as held-to-maturity and are stated at amortized cost.

 

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As of each reporting date, the Company evaluates the securities portfolio to determine if there has been an other-than-temporary impairment (“OTTI”) on each of the individual securities in the investment securities portfolio. If it is probable that the Company will be unable to collect all amounts due according to the contractual terms of a debt security not impaired at acquisition, an OTTI shall be considered to have occurred. Once an OTTI is considered to have occurred, the credit portion of the loss is required to be recognized in current earnings, while the non-credit portion of the loss is recorded as a separate component of shareholders’ equity.

In estimating whether an other-than-temporary impairment loss has occurred, management considers, among other things, (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, (iii) the current liquidity and volatility of the market for each of the individual security categories, (iv) the current slope and shape of the Treasury yield curve, along with where the economy is in the current interest rate cycle, (v) the spread differential between the current spread and the long-term average spread for that security category, (vi) the projected cash flows from the specific security type, (vii) any financial guarantee and financial condition of the guarantor and (viii) the intent and ability of the Company to retain its investment in the issue for a period of time sufficient to allow for any anticipated recovery in fair value.

If it’s determined that an OTTI exists on a debt security, the Company then determines if (a) it intends to sell the security or (b) it is more likely than not that it will be required to sell the security before its anticipated recovery. If either of the conditions is met, the Company will recognize the amount of the OTTI in earnings equal to the difference between the security’s fair value and its adjusted cost basis. If neither of the conditions is met, the Company determines (a) the amount of the impairment related to credit loss and (b) the amount of the impairment due to all other factors. The difference between the present value of the cash flows expected to be collected and the amortized cost basis is the credit loss. The credit loss is the portion of the other-than-temporary impairment that is recognized in earnings and is a reduction to the cost basis of the security. The portion of total impairment related to all other factors is included in other comprehensive income. Significant judgment is required in this analysis that includes, but is not limited to assumptions regarding the collectability of principal and interest, future default rates, future prepayment speeds, the amount of current delinquencies that will result in defaults and the amount of eventual recoveries expected on the underlying collateral.

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 interest method over the expected maturity term of the securities. For mortgage-backed securities, 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 amount of prepayments varies from time to time based on the interest rate environment and the rate of turnover of mortgages. The Company’s investment in the common stock of Pacific Coast Bankers Bank (“PCBB”) and The Independent Banker’s Bank (“TIB”) is carried at cost, evaluated for impairment and is included in other assets on the accompanying consolidated balance sheets.

Derivative Financial Instruments and Hedging Activities

All derivative instruments (interest rate swap contracts) are recognized on the consolidated balance sheet at their current fair value. Every derivative instrument (including certain derivative instruments embedded in other contracts) is required to be recorded in the balance sheet as either an asset or liability measured at its fair value. ASC Topic 815 requires that changes in the derivative’s fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Accounting for qualifying hedges allows a derivative’s gains and losses to offset related results on the hedged item in the income statement, and requires that a company must formally document, designate and assess the effectiveness of transactions that receive hedge accounting.

On the date a derivative contract is entered into by the Company, the Company will designate the derivative contract as either a fair value hedge (i.e. a hedge of the fair value of a recognized asset or liability), a cash flow

 

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hedge (i.e. a hedge of the variability of cash flows to be received or paid related to a recognized asset or liability), or a stand-alone derivative (i.e. and instrument with no hedging designation). For a derivative designated as a fair value hedge, the changes in the fair value of the derivative and of the hedged item attributable to the hedged risk are recognized in earnings. If the derivative is designated as a cash flow hedge, the effective portions of changes in the fair value of the derivative are recorded in other comprehensive income and are recognized in the income statement when the hedged item affects earnings. Changes in the fair value of derivatives that do not qualify for hedge accounting are reported currently in earnings, as other non-interest income. At inception and on an ongoing basis, the derivatives that are used in hedging transactions are assessed for effectiveness as to how effective they are in offsetting changes in fair values or cash flows of hedged items.

The Company will discontinue hedge accounting prospectively when it is determined that the derivative is no longer effective in offsetting change in the fair value of the hedged item, the derivative expires or is sold, is terminated, or management determines that designation of the derivative as a hedging instrument is no longer appropriate. When hedge accounting is discontinued, the Company will continue to carry the derivative on the balance sheet at its fair value (if applicable), but will no longer adjust the hedged asset or liability for changes in fair value. The adjustments of the carrying amount of the hedged asset or liability will be accounted for in the same manner as other components of the carrying amount of that asset or liability, and the adjustments are amortized to interest income over the remaining life of the hedged item upon the termination of hedge accounting.

Income Taxes

The Company provides for current federal and state income taxes payable and for deferred taxes that result from differences between financial accounting rules and tax laws governing the timing of recognition of various income and expense items. The Company recognizes deferred income tax assets and liabilities for the future tax effects of such temporary differences based on the difference between the financial statement and tax bases of the existing assets and liabilities using the statutory rate expected in the years in which the differences are expected to reverse. The effect on deferred taxes of any enacted change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is established to the extent necessary to reduce the deferred tax asset to the level at which it is “more likely than not” that the tax assets or benefits will be realized. Realization of tax benefits for deductible temporary differences and loss carryforwards depends on having sufficient taxable income of an appropriate character within the carryback and carryforward period and that current tax law will allow for the realization of those tax benefits.

The Company is required to account for uncertainty associated with the tax positions it has taken or expects to be taken on past, current and future tax returns. Where there may be a degree of uncertainty as to the tax realization of an item, the Company may only record the tax effects (expense or benefits) from an uncertain tax position in the consolidated financial statements if, based on its merits, the position is more likely than not to be sustained on audit by the taxing authorities. The Company does not believe that it has any material uncertain tax positions taken to date that are not more likely than not to be realized. Interest and penalties related to uncertain tax positions are recorded as part of other operating expense.

Recent Accounting Pronouncements

See Note 1, Summary of Significant Accounting Policies in Item 8, Financial Statements and Supplementary Data.

 

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RESULTS OF OPERATIONS

Key Profitability Measures

The following table presents key profitability measures for the periods indicated and the dollar and percentage changes between the periods (dollars in thousands, except per share data):

 

     Years Ended December 31,     Increase / (Decrease)  
     2016     2015     $     %  

Net Income Available to Common Shareholders

   $ 26,240     $ 20,062     $ 6,178       30.8
  

 

 

   

 

 

   

 

 

   

Earnings per share

        

Basic

   $ 1.52     $ 1.21     $ 0.31       25.6

Diluted

   $ 1.50     $ 1.18     $ 0.32       27.1

Return on average assets (1)

     0.92     0.80     0.12     15.0

Return on average tangible common equity (2)

     11.07     9.86     1.21     12.3

Net interest margin (3)

     3.71     3.83     (0.11)     (2.9)

Efficiency ratio (4)

     57.75     61.48     (3.73)     (6.07)

 

     Years Ended December 31,     Increase / (Decrease)  
     2015     2014     $     %  

Net Income Available to Common Shareholders

   $ 20,062     $ 8,784     $ 11,278       128.4
  

 

 

   

 

 

   

 

 

   

Earnings per share

        

Basic

   $ 1.21     $ 0.77     $ 0.44       57.1

Diluted

   $ 1.18     $ 0.75     $ 0.43       57.3

Return on average assets (1)

     0.80     0.59     0.21     35.6

Return on average tangible common equity (2)

     9.86     6.50     3.36     51.7

Net interest margin (3)

     3.83     3.79     0.04     1.1

Efficiency ratio (4)

     61.48     71.11     (9.63)     (13.54)

 

(1) Return on average assets is calculated by dividing the net income available to common shareholders by the average assets for the period.
(2) Return on average tangible common equity is calculated by dividing the Company’s net income available to common shareholders by the average tangible common equity for the period. See the tables below for return on average tangible common equity calculation and reconciliation to average shareholders’ equity.
(3) The net interest margin represents net interest income as a percent of interest bearing assets
(4) Efficiency ratio represents non-interest expense as a percent of net interest income plus non-interest income, excluding gain on sale of securities, net.

 

 

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Non-GAAP Financial Measure — Average Tangible Common Equity (“TCE”) Calculation and Reconciliation to Total Average Shareholders’ Equity

The Company utilizes the term TCE, a non-GAAP financial measure. The Company’s management believes TCE is useful because it is a measure utilized by both regulators and market analysts in evaluating a consolidated bank holding company’s financial condition and capital strength. TCE represents common shareholders’ equity less goodwill and certain other intangible assets. Return on Average Tangible Common Equity represents year-to-date net income available to common shareholders as a percent of average tangible common equity. A calculation of the Company’s Return on Average Tangible Common Equity is provided in the table below for the periods indicated (dollars in thousands):

 

     Year Ended December 31,  
     2016      2015      2014  

Average Tangible Common Equity Calculation

        

Total average shareholders’ equity

   $ 325,737      $ 292,577      $ 152,500  

Less: Average serial preferred stock

     17,068        16,457        1,390  

Less: Average goodwill

     64,603        64,014        13,659  

Less: Average core deposit and leasehold right intangibles

     6,986        8,644        2,366  
  

 

 

    

 

 

    

 

 

 

Average Tangible Common Equity

   $ 237,080      $ 203,462      $ 135,085  
  

 

 

    

 

 

    

 

 

 

Net Income Available to Common Shareholders

   $ 26,240      $ 20,062      $ 8,784  

Return on Average Tangible Common Equity

     11.07%        9.86%        6.50%  

Operations Performance Summary

Year Ended December 31, 2016 Compared to Year Ended December 31, 2015

Net income available to common shareholders for the year ended December 31, 2016 was $26 million, or $1.50 per diluted share, compared to $20 million, or $1.18 per diluted share for the year ended December 31, 2015. The $6.2 million increase, or 30.8%, was primarily due to $13 million increase in net interest income after provision for loan losses, as a result of strong organic loan growth since the prior period, offset by a $3.5 million increase in non-interest expense and a $3.1 million increase in provision for income tax expense. Included in the increase of non-interest expense was $1.9 million of non-recurring expenses related to the BSA Consent Order and the closing of the Simi Valley administrative office during 2016. Salaries and employee benefits increased $2.3 million in 2016 as the number of active full time employees increased from 266 at December 31, 2015 to 288 at December 31, 2016. Further, there was no merger-related expenses in 2016, compared to $921 thousand in 2015. During the third quarter of 2016, the Company early adopted ASU 2016-09, Compensation — Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, effective January 1, 2016, which had a positive impact of $1.4 million to net income, as a reduction to provision for income tax expense for the year ended 2016.

Year Ended December 31, 2015 Compared to Year Ended December 31, 2014

Net income available to common shareholders for the year ended December 31, 2015 was $20 million, or $1.18 per diluted share, compared to $8.8 million, or $0.75 per diluted share for the year ended December 31, 2014. The $11 million increase, or 128.4%, was primarily due to $31 million increase in net interest income after provision for loan losses and a $4.0 million increase in non-interest income, offset by a $17 million increase in non-interest expense and a $6.4 million increase in provision for income tax expense. These increases were primarily related to the successful execution of the merger with 1st Enterprise at the end of November 2014 coupled with a strong net organic loan growth of $349 million in 2015. Salaries and employee benefits increased $10 million in 2015, due to a full year of larger employee base as a result of the merger. Occupancy expense also increased $1.7 million for the same period due to a full year of additional locations. Further, core deposit

 

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intangible amortization increased $1.3 million in 2015, mainly due to a full year of amortization of a $7.1 million core deposit intangible recognized from the 1st Enterprise merger. Provision for loan losses also increased $2.8 million, as a result of strong organic loan growth and net charge-offs of $2.0 million in 2015. Merger expenses were lower by $1.8 million compared to 2014. Each of these increases and or decreases is more fully described below.

Average Balances, Interest Income and Expense, Yields and Rates

Years Ended December 31, 2016 and 2015

The following table presents the Company’s average balance sheets, together with the total dollar amounts of interest income and interest expense and the weighted average interest yield/rate for the periods presented. All average balances are daily average balances (dollars in thousands).

 

     Years Ended December 31,  
     2016     2015  
     Average
Balance
     Interest
Income/
Expense
     Average
Yield/
Rate
    Average
Balance
     Interest
Income/
Expense
     Average
Yield/
Rate
 

Interest earning Assets:

                

Loans (1)

   $ 1,924,603      $ 93,589        4.86   $ 1,707,654      $ 84,537        4.95

Investment securities (2)

     400,733        5,793        1.45     287,436        4,518        1.57

Deposits in other financial institutions

     309,709        1,870        0.59     289,364        1,087        0.37
  

 

 

    

 

 

      

 

 

    

 

 

    

Total interest earning assets

     2,635,045        101,252        3.84     2,284,454        90,142        3.95
     

 

 

         

 

 

    

Non-interest earning assets

     210,356             210,736        
  

 

 

         

 

 

       

Total assets

   $ 2,845,401           $ 2,495,190        
  

 

 

         

 

 

       

Interest bearing Liabilities:

                

Interest bearing transaction accounts

   $ 290,104        416        0.14     258,444        413        0.16

Money market and savings deposits

     767,826        2,051        0.27     690,065        1,652        0.24

Certificates of deposit

     46,945        139        0.30     61,275        190        0.31
  

 

 

    

 

 

      

 

 

    

 

 

    

Total interest bearing deposits

     1,104,875        2,606        0.24     1,009,784        2,255        0.22

Securities sold under agreements to repurchase

     22,739        53        0.23     13,966        30        0.21

Subordinated debentures

     9,795        487        4.89     9,637        438        4.48
  

 

 

    

 

 

      

 

 

    

 

 

    

Total borrowings

     32,534        540        1.66     23,603        468        1.98
  

 

 

    

 

 

      

 

 

    

 

 

    

Total interest bearing liabilities

     1,137,409        3,146        0.28     1,033,387        2,723        0.26
     

 

 

         

 

 

    

Non-interest bearing demand deposits

     1,364,164             1,151,075        
  

 

 

         

 

 

       

Total funding sources

     2,501,573             2,184,462        

Non-interest bearing liabilities

     18,091             18,151        

Shareholders’ equity

     325,737             292,577        
  

 

 

         

 

 

       

Total liabilities and shareholders’ equity

   $ 2,845,401           $ 2,495,190        
  

 

 

         

 

 

       

Excess of interest-earning assets over funding sources

      $ 98,106           $ 87,419     
     

 

 

         

 

 

    

Net interest margin (3)

           3.71           3.83

Core net interest margin (4)

           3.60           3.69

 

(1) Average balances of loans are calculated net of deferred loan fees and fair value discounts, but would include non-accrual loans which have a zero yield.
(2) Average balances of investment securities available-for-sale are presented on an amortized cost basis and thus do not include the unrealized market gain or loss on the securities.

 

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(3) Net interest margin is computed by dividing net interest income by average total interest earning assets.
(4) Core net interest margin is computed by dividing net interest income, excluding accelerated accretion of fair value discounts earned on early loan payoffs of acquired loans and interest recovered or reversed on non-accrual loans or other significant items based on management’s judgement, by average total interest-earning assets. See the reconciliation table for core net interest margin.

Average Balances, Interest Income and Expense, Yields and Rates

Years Ended December 31, 2015 and 2014

The following table presents the Company’s average balance sheets, together with the total dollar amounts of interest income and interest expense and the weighted average interest yield/rate for the periods presented. All average balances are daily average balances (dollars in thousands).

 

    Years Ended December 31,  
    2015     2014  
    Average
Balance
    Interest
Income/
Expense
    Average
Yield/
Rate
    Average
Balance
    Interest
Income/
Expense
    Average
Yield/
Rate
 

Interest earning Assets:

           

Loans (1)

  $ 1,707,654     $ 84,537       4.95   $ 1,010,030     $ 51,882       5.14

Investment securities (2)

    287,436       4,518       1.57     129,841       2,369       1.82

Deposits in other financial institutions

    289,364       1,087       0.37     265,076       926       0.34
 

 

 

   

 

 

     

 

 

   

 

 

   

Total interest earning assets

    2,284,454       90,142       3.95     1,404,947       55,177       3.93
   

 

 

       

 

 

   

Non-interest earning assets

    210,736           95,818      
 

 

 

       

 

 

     

Total assets

  $ 2,495,190         $ 1,500,765      
 

 

 

       

 

 

     

Interest bearing Liabilities:

           

Interest bearing transaction accounts

  $ 258,444       413       0.16     153,327       278       0.18

Money market and savings deposits

    690,065       1,652       0.24     390,185       963       0.25

Certificates of deposit

    61,275       190       0.31     61,048       216       0.35
 

 

 

   

 

 

     

 

 

   

 

 

   

Total interest bearing deposits

    1,009,784       2,255       0.22     604,560       1,457       0.24

Securities sold under agreements to repurchase

    13,966       30       0.21     13,579       34       0.25

Subordinated debentures

    9,637       438       4.48     9,556       431       4.45
 

 

 

   

 

 

     

 

 

   

 

 

   

Total borrowings

    23,603       468       1.98     23,135       465       2.01
 

 

 

   

 

 

     

 

 

   

 

 

   

Total interest bearing liabilities

    1,033,387       2,723       0.26     627,695       1,922       0.31
   

 

 

       

 

 

   

Non-interest bearing demand deposits

    1,151,075           704,437      
 

 

 

       

 

 

     

Total funding sources

    2,184,462           1,332,132      

Non-interest bearing liabilities

    18,151           16,133      

Shareholders’ equity

    292,577           152,500      
 

 

 

       

 

 

     

Total liabilities and shareholders’ equity

  $ 2,495,190         $ 1,500,765      
 

 

 

       

 

 

     

Excess of interest-earning assets over funding sources

    $ 87,419         $ 53,255    
   

 

 

       

 

 

   

Net interest margin (3)

        3.83         3.79

Core net interest margin (4)

        3.69         3.64

 

(1) Average balances of loans are calculated net of deferred loan fees and fair value discounts, but would include non-accrual loans which have a zero yield.
(2) Average balances of investment securities available-for-sale are presented on an amortized cost basis and thus do not include the unrealized market gain or loss on the securities.

 

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(3) Net interest margin is computed by dividing net interest income by average total interest earning assets.
(4) Core net interest margin is computed by dividing net interest income, excluding accelerated accretion of fair value discounts earned on early loan payoffs of acquired loans and interest recovered or reversed on non-accrual loans or other significant items based on management’s judgement, by average total interest-earning assets. See the reconciliation table for core net interest margin.

Net Changes in Average Balances, Composition, Yields and Rates

Years Ended December 31, 2016 and 2015

The following table set forth the composition of average interest earning assets and average interest bearing liabilities by category and by the percentage of each category to the total for the periods indicated, including the change in average balance, composition, and yield/rate between these respective periods (dollars in thousands):

 

   

Years Ended December 31,

       
   

2016

    2015     Increase (Decrease)  
   

Average
Balance

  %
of
Total
    Average
Yield/
Rate
    Average
Balance
    %
of
Total
    Average
Yield/
Rate
    Average
Balance
    %
of
Total
    Average
Yield/
Rate
 

Interest earning Assets:

                 

Loans (1)

  $1,924,603     73.0     4.86   $ 1,707,654       74.7     4.95   $ 216,949       (1.7 )%      (0.09 )% 

Investment securities (2)

  400,733     15.2     1.45     287,436       12.6     1.57     113,297       2.6     (0.12 )% 

Deposits in other financial institutions

  309,709     11.8     0.59     289,364       12.7     0.37     20,345       (0.9 )%      0.22
 

 

 

 

 

     

 

 

   

 

 

     

 

 

     

Total interest earning assets

  $2,635,045     100.0     3.84   $ 2,284,454       100.0     3.95   $ 350,591       —       (0.11 )% 
 

 

 

 

 

     

 

 

   

 

 

     

 

 

     

Interest-Bearing Liabilities:

                 

Non-interest bearing demand deposits

  $1,364,164     54.5     —       $ 1,151,075       52.7     —       $ 213,089       1.8     —    

Interest bearing transaction accounts

  290,104     11.6     0.14     258,444       11.9     0.16     31,660       (0.3 )%      (0.02 )% 

Money market and savings deposits

  767,826     30.7     0.27     690,065       31.6     0.24     77,761       (0.9 )%      0.03

Certificates of deposit

  46,945     1.9     0.30     61,275       2.8     0.31     (14,330     (0.9 )%      (0.01 )% 
 

 

 

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total deposits

  2,469,039     98.7     0.11     2,160,859       99.0     0.10     308,180       (0.3 )%      0.01

Securities sold under agreements to repurchase

  22,739     0.9     0.23     13,966       0.6     0.21     8,773       0.3     0.02

Subordinated debentures

  9,795     0.4     4.89     9,637       0.4     4.48     158       —       0.41
 

 

 

 

 

     

 

 

   

 

 

     

 

 

     

Total borrowings

  32,534     1.3     1.66     23,603       1.0     1.98     8,931       0.3     (0.32 )% 
 

 

 

 

 

     

 

 

   

 

 

     

 

 

     

Total funding sources

  $2,501,573     100.0     0.13   $ 2,184,462       100.0     0.12   $ 317,111       —       0.01
 

 

 

 

 

     

 

 

   

 

 

     

 

 

     

Excess of interest earning assets over funding sources

  $133,472       $ 99,992         $ 33,480      

Net interest margin (3)

        3.71         3.83         (0.12 )% 

Core net interest margin (4)

        3.60         3.69         (0.09 )% 

 

(1) Average balances of loans are calculated net of deferred loan fees and fair value discounts, but would include non-accrual loans which have a zero yield.
(2) Average balances of investment securities available-for-sale are presented on an amortized cost basis and thus do not include the unrealized market gain or loss on the securities.
(3) Net interest margin is computed by dividing net interest income by average total interest earning assets.

 

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(4) Core net interest margin is computed by dividing net interest income, excluding accelerated accretion of fair value discounts earned on early loan payoffs of acquired loans and interest recovered or reversed on non-accrual loans or other significant items based on management’s judgement, by average total interest-earning assets. See the reconciliation table for core net interest margin.

Net Changes in Average Balances, Composition, Yields and Rates

Years Ended December 31, 2015 and 2014

The following table sets forth the composition of average interest earning assets and average interest bearing liabilities by category and by the percentage of each category to the total for the periods indicated, including the change in average balance, composition and yield/rate between these respective periods (dollars in thousands):

 

    Years Ended December 31,                    
    2015     2014     Increase (Decrease)  
    Average
Balance
    %
of
Total
    Average
Yield/
Rate
    Average
Balance
    %
of
Total
    Average
Yield/
Rate
    Average
Balance
    %
of
Total
    Average
Yield/
Rate
 

Interest earning Assets:

                 

Loans (1)

  $ 1,707,654       74.7     4.95   $ 1,010,030       71.9     5.14   $ 697,624       2.9     (0.19 )% 

Investment securities (2)

    287,436       12.6     1.57     129,841       9.2     1.82     157,595       3.3     (0.25 )% 

Deposits in other financial institutions

    289,364       12.7     0.37     265,076       18.9     0.34     24,288       (6.2 )%      0.03
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

     

Total interest earning assets

  $ 2,284,454       100.0     3.95   $ 1,404,947       100.0     3.93   $ 879,507       —       0.02
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

     

Interest-Bearing Liabilities:

                 

Non-interest bearing demand deposits

  $ 1,151,075       52.7     —       $ 704,437       52.9     —       $ 446,638       (0.2 )%      —    

Interest bearing transaction accounts

    258,444       11.9     0.16     153,327       11.5     0.18     105,117       0.4     (0.02 )% 

Money market and savings deposits

    690,065       31.6     0.24     390,185       29.3     0.25     299,880       2.3     (0.01 )% 

Certificates of deposit

    61,275       2.8     0.31     61,048       4.6     0.35     227       (1.8 )%      (0.04 )% 
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total deposits

    2,160,859       99.0     0.10     1,308,997       98.3     0.11     851,862       0.7     (0.01 )% 

Securities sold under agreements to repurchase

    13,966       0.6     0.21     13,579       1.0     0.25     387       (0.4 )%      (0.04 )% 

Subordinated debentures

    9,637       0.4     4.48     9,556       0.7     4.45     81       (0.3 )%      0.03
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

     

Total borrowings

    23,603       1.0     1.98     23,135       1.7     2.01     468       (0.7 )%      (0.03 )% 
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

     

Total funding sources

  $ 2,184,462       100.0     0.12   $ 1,332,132       100.0     0.14   $ 852,330       —       (0.02 )% 
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

     

Excess of interest earning assets over funding sources

  $ 99,992         $ 72,815         $ 27,177      

Net interest margin (3)

        3.83         3.79         0.04

Core net interest margin (4)

        3.69         3.64         0.05

 

(1) Average balances of loans are calculated net of deferred loan fees and fair value discounts, but would include non-accrual loans which have a zero yield.
(2) Average balances of investment securities available-for-sale are presented on an amortized cost basis and thus do not include the unrealized market gain or loss on the securities.
(3) Net interest margin is computed by dividing net interest income by average total interest earning assets.
(4) Core net interest margin is computed by dividing net interest income, excluding accelerated accretion of fair value discounts earned on early loan payoffs of acquired loans and interest recovered or reversed on non-accrual loans or other significant items based on management’s judgement, by average total interest-earning assets. See the reconciliation table for core net interest margin.

 

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Volume and Rate Variance Analysis of Net Interest Income

Years Ended December 31, 2016, 2015 and 2014

The following table presents the dollar amount of changes in interest income and interest expense due to changes in average balances of interest earning assets and interest bearing liabilities and changes in interest rates. For each category of interest earning assets and interest bearing liabilities, information is provided on changes attributable to: (i) changes in volume (i.e. changes in average balance multiplied by prior period rate) and (ii) changes in rate (i.e. changes in rate multiplied by prior period average balance). For purposes of this table, changes attributable to both rate and volume which cannot be segregated have been allocated proportionately based on the absolute dollar amounts of the changes due to volume and rate (dollars in thousands):

 

     December 31,
2016 vs. 2015
    December 31,
2015 vs. 2014
 
     Volume     Rate     Total     Volume      Rate     Total  

Interest Income:

             

Loans

   $ 10,740     $ (1,688   $ 9,052     $ 35,904      $ (3,249   $ 32,655  

Investment securities

     1,781       (506     1,275       2,867        (718     2,149  

Deposits in other financial institutions

     76       707       783       77        84       161  
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total interest income

     12,597       (1,487     11,110       38,848        (3,883     34,965  
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Interest Expense:

             

Interest bearing transaction accounts

     51       (48     3       185        (50     135  

Money market and savings deposits

     186       213       399       759        (70     689  

Certificates of deposit

     (44     (7     (51     —          (26     (26
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total deposits

     193       158       351       944        (146     798  
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Securities sold under agreements to repurchase

     19       4       23       1        (5     (4

Subordinated debentures

     8       41       49       4        3       7  
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total borrowings

     27       45       72       5        (2     3  
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total interest expense

     220       203       423       949        (148     801  
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Net Interest Income

   $ 12,377     $ (1,690   $ 10,687     $ 37,899      $ (3,735   $ 34,164  
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Non-GAAP Financial Measure - Reconciliation of Core Net Interest Income and Core Net Interest Margin to Net Interest Income and Net Interest Margin

The following table represents a reconciliation of GAAP net interest income and core net interest margin to net interest income and net interest margin used by the Company. The table presents the information for the periods indicated (dollars in thousands):

 

     Years Ended
December 31,
 
     2016     2015     2014  

Net Interest Income

   $ 101,252     $ 90,142     $ 53,255  

Less:

Interest recovered on non-accrual loans

     75       95       227  

Accelerated accretion of fair value adjustments on early loan payoffs and other associated payoff benefits

     3,116       2,896       1,789  
  

 

 

   

 

 

   

 

 

 

Core Net Interest Income

   $ 98,061     $ 87,151     $ 51,239  
  

 

 

   

 

 

   

 

 

 

Net interest margin

     3.71     3.83     3.79

Core net interest margin

     3.60     3.69     3.64

 

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Composition of Net Deferred Loan Fees and Net Fair Value Discounts

The following table reflects the composition of the net deferred loan fees and net fair value discounts at December 31, 2016 and 2015 (dollars in thousands):

 

     Years Ended
December 31,
 
     2016      2015  

Accretable loan discount

   $ 9,772      $ 14,856  

Non-Accretable loan discount

     390        2,061  
  

 

 

    

 

 

 

Remaining loan discount on acquired loans

     10,162        16,917  

Net deferred loan fees on organic loans

     5,830        4,575  
  

 

 

    

 

 

 

Total

   $ 15,992      $ 21,492  
  

 

 

    

 

 

 

Year Ended December 31, 2016 Compared to Year Ended December 31, 2015

The net interest margin decreased 12 basis points to 3.71% for the year ended December 31, 2016, compared to 3.83% for the year ended December 31, 2015. The decrease in net interest margin is mainly due to average loans being a lower percentage of average earning assets in 2016 than in 2015, as well as compression in average loan yields compared to prior year. However, net interest income grew by $10.7 million or 12% from prior year. The Company’s net interest income was positively impacted in both 2016 and 2015 by the recognition of fair value discount earned on early payoffs of acquired loans. In 2016, the Company recorded $2.2 million in discount earned on early payoffs of acquired loans and other associated payoff benefits aggregating to $920 thousand, with a positive impact on the net interest margin of 12 basis points. In 2015, the Company recorded $2.2 million in discount earned on early payoffs of acquired loans and other associated payoff benefits aggregating to $816 thousand, with a positive impact on the net interest margin of 14 basis points.

Year Ended December 31, 2015 Compared to Year Ended December 31, 2014

The net interest margin increased 4 basis points to 3.83% for the year ended December 31, 2015, compared to 3.79% for the year ended December 31, 2014. While the Company has continued to experience compression in the loan yields as new loans have been originated at lower interest rates than those loans that have been paid off in 2014 and 2015, growth in the average loans and a shift to more loans in the mix of interest earning assets, has helped support the slight increase in net interest margin. The Company’s net interest income was positively impacted in both 2015 and 2014 by the recognition of fair value discount earned on early payoffs of acquired loans. In 2015, the Company recorded $2.2 million in discount earned on early payoffs of acquired loans and other associated payoff benefits aggregating to $816 thousand, with a positive impact on the net interest margin of 14 basis points. In 2014 the Company recorded $1.8 million in discount earned on early loan payoffs of acquired loans and a $227 thousand recovery of interest income on an acquired loan that was on non-accrual status, with a positive impact on the net interest margin of 15 basis points.

Provision for Loan Losses

The Company maintains an Allowance to provide for probable losses inherent in the loan portfolio. Additions to the Allowance are made by charges to operating expense in the form of a provision for loan losses. Loan charge-offs are charged against the Allowance when management believes the collectability of the loan principal becomes remote. Subsequent recoveries, if any, are credited to the Allowance.

Provision for loan losses was $3.2 million, $5.1 million and $2.2 million for the year ended December 31, 2016, 2015 and 2014, respectively. The Company had $388 million, $349 million and $197 million of net organic loan growth for 2016, 2015 and 2014, respectively. The Company had net recoveries of $428 thousand in 2016, and net charge-offs of $2.0 million and $232 thousand in 2015 and 2014, respectively. See further discussion in Balance Sheet Analysis, Allowance for Loan Loss.

 

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Non-Interest Income

The following table lists the major components of the Company’s non-interest income (dollars in thousands):

 

     Years Ended
December 31,
     Increase
(Decrease)
    Years Ended
December 31,
    Increase
(Decrease)
 
     2016      2015      $     %     2015      2014     $     %  

Gain (Loss) on sale of securities, net

   $ 258      $ 112      $ 146       130.4   $ 112      $ (47   $ 159       338.3

Gain on sale of SBA loans, net

     1,359        1,797        (438     (24.4 )%      1,797        1,221       576       47.2

Deposit account service charge income

     4,814        4,644        170       3.7     4,644        2,744       1,900       69.2

Letters of credit income

     1,116        743        373       50.2     743        400       343       85.8

Transaction referral income

     416        516        (100     (19.4 )%      516        570       (54     (9.5 )% 

Interchange fees

     540        404        136       33.7     404        173       231       133.5

Dividend income in equity securities

     1,164        1,324        (160     (12.1 )%      1,324        446       878       196.9

BOLI Income

     1,303        1,295        8       0.6     1,295        660       635       96.2

Other non-interest income

     1,042        895        147       16.4     895        1,542       (647     (42.0 )% 
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total Non-Interest Income

   $ 12,012      $ 11,730      $ 282       2.4   $ 11,730      $ 7,709     $ 4,021       52.2
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Year Ended December 31, 2016 Compared to Year Ended December 31, 2015

Non-interest income increased modestly by $282 thousand or 2.4%. The decrease in the gain on sale of SBA loans was offset by a $170 thousand increase to deposit account service charge income and a $370 thousand increase of letters of credit income. The number of SBA loans the Company originated remained consistent over the last two years, although premiums have been down in second half of 2016, ranging from 106% to 115%, compared to 2015 premium range of 107% to 118%. Further, the decrease in gain on sale of SBA loans in the second half of 2016 is attributable to a decrease in SBA real estate lending, which had higher individual balances than SBA commercial and industrial lending. The increase in deposit account service charge income and letters of credit income are directionally consistent with the continued growth in the Company’s deposit and loan balances.

Year Ended December 31, 2015 Compared to Year Ended December 31, 2014

Non-interest income increased $4.0 million or 52% mainly due to a $576 thousand increase in gain on sale of SBA loans, a $1.9 million increase in deposit account service charge income, a $635 thousand increase in BOLI income and a $878 thousand increase in dividend income on equity securities. The increase in the gain on sale of SBA loan is driven by a higher volume of SBA loan sales in 2015 with a premium range of 107% to 118%. The increase in deposit account service charge income is almost entirely driven by the increase in DDA account analysis fees. The increase in dividend income is from the Federal Home Loan Bank of San Francisco due to a special dividend of $296 thousand received in the second quarter of 2015 and a consistent increase in the quarterly dividend rate throughout 2015.

 

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Non-Interest Expense

The following table lists the major components of the Company’s non-interest expense (dollars in thousands):

 

     Years Ended
December 31,
     Increase
(Decrease)
    Years Ended
December 31,
     Increase
(Decrease)
 
     2016      2015      $     %     2015      2014      $     %  

Salaries and employee benefits

   $ 37,285      $ 34,989      $ 2,296       6.6   $ 34,989      $ 24,820      $ 10,169       41.0

Stock based compensation expense

     3,567        2,966        601       20.3     2,966        1,699        1,267       74.6

Occupancy

     6,039        5,792        247       4.3     5,792        4,112        1,680       40.9

Data processing

     2,594        2,495        99       4.0     2,495        1,968        527       26.8

Legal and professional

     3,782        2,411        1,371       56.9     2,411        2,006        405       20.2

FDIC deposit assessment

     1,425        1,466        (41     (2.8 )%      1,466        844        622       73.7

Merger expenses

     —          498        (498     (100.0 )%      498        2,302        (1,804     (78.4 )% 

OREO loss and expenses

     85        245        (160     (65.3 )%      245        15        230       1,533.3

Office services expenses

     1,488        1,526        (38     (2.5 )%      1,526        1,026        500       48.7

Core deposit intangible amortization

     1,280        1,680        (400     (23.8 )%      1,680        391        1,289       329.7

Other operating expenses

     5,899        5,897        2       —       5,897        4,202        1,695       40.3
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total non-interest expense

   $ 63,444      $ 59,965      $ 3,479       5.8   $ 59,965      $ 43,385      $ 16,580       38.2
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Year Ended December 31, 2016 Compared to Year Ended December 31, 2015

Non-interest expense increased by $3.5 million, or 5.8% mainly due to a $2.3 million increase in salaries and employee benefits, a $601 thousand increase in stock based compensation, as the Company’s active full-time equivalent employees increased to 288 at December 31, 2016, compared to 266 at December 31, 2015. While the largest portion of this increase relates to BSA activities, other increases in full-time equivalent employees were made to support the high level of customer service CUB provides commensurate with its growth over the last two years. Additionally, the Company recorded $1.9 million in non-recurring expenses in 2016 related to the BSA Consent Order and the closing of an office. The Company originally estimated $2.0 million for one-time BSA costs; actual incurred in 2016 was $1.7 million. Some small amount of one-time costs is expected in the first quarter of 2017, but at this time the total is not expected to exceed the original estimate.

The following table shows the Company’s various non-recurring, non-interest expense of $1.7 million related to the BSA Consent Order, and $203 thousand in occupancy expense related to the closure of the Simi Valley administrative office in 2016 (dollars in thousands):

 

     Year Ended
December 31,

2016
 

Nonrecurring Costs Associated with BSA and Office Closure

  

Non-Interest Expense

  

Salaries and employee benefits

   $ 136  

Occupancy

     276  

Legal and professional

     1,210  

Other operating expenses

     304  
  

 

 

 

Total Non-Interest Expense

   $ 1,926  
  

 

 

 

 

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Further, the increases in the above expense categories related to nonrecurring costs are offset by a decrease in merger expenses and core deposit intangible amortization in the amounts of $498 thousand and $400 thousand, respectively.

Year Ended December 31, 2015 Compared to Year Ended December 31, 2014

Non-interest expense increased by $17 million, or 38.2% mainly due to a $10 million increase in salaries and employee benefits, a $1.3 million increase in stock based compensation expense, a $1.7 million increase in occupancy expenses, a $1.3 million increase in core deposit intangible amortization, and a $1.7 million increase in other operating expenses, offset by a decrease in merger expenses of $1.8 million. The increase in salaries and employee benefits was attributable to increase in salaries of $7.8 million and increase in bonus expense in the amount of $1.2 million. The number of active full time employees increased from 250 at December 31, 2014 to 266 at December 31, 2015. The increase in stock compensation expense in 2015 is due to approximately two-thirds of the total grants in 2014 were granted after 1st Enterprise merger, thus a full year of expense for these grants in 2015 compared to only a month or less of expense in 2014. Additionally, the fair value of the restricted stock grant increased in 2015 due to an increase in the Company’s stock price, from an average price of $19.73 in 2014 compared to $25.02 in 2015. Overall increase to total non-interest expense is primarily due to the acquisition of 1st Enterprise in the fourth quarter of 2014.

Income Taxes

The Company’s effective tax rate was 36.7%, 37.7% and 41.9% for the years ended December 31, 2016, 2015 and 2014, respectively. The effective tax rate is impacted by BOLI income, interest income from tax exempt securities and loans, investments in Qualified Affordable Housing Projects “LIHTC” that generate tax credits and benefits for the Company, and beginning in 2016, excess tax benefits from the exercise or vesting of share-based awards. In the third quarter of 2016, the Company elected the early adoption of ASU 2016-09, retroactively effective as of January 1, 2016. As a result of the application of this standard, excess tax benefits from exercise or vesting of share-based awards are now included as a reduction in provision for income tax expense in the period in which the exercise or vesting occurs. The variance between 2016 and 2015 is primarily related to the early adoption of ASU 2016-09. For the full year of 2016, the effective tax rate was 36.7% which benefitted from the exercising of 505,274 options during 2016, with a discrete tax benefit of $1.4 million; without the excess tax benefit, the effective tax rate would have been 40.1%. The actual tax rate may be volatile, dependent upon the volume of stock events and differential in stock price between grant and event. The higher effective tax rate in 2014 is primarily related to non-deductible merger cost as a result of the acquisition of 1st Enterprise. The Company operates in the Federal and California jurisdictions and the blended statutory tax rate for Federal and California income taxes is 42.05%.

FINANCIAL CONDITION

Balance Sheet Analysis

Total assets increased $360 million from $2.6 billion at December 31, 2015 to $3.0 billion at December 31, 2016 with an increase of $154 million in total investment securities and an increase of $217 million in loans, mainly driven by a $321 million increase in total deposits during the period. The increase in loans from the prior year was due to strong organic loan growth. Net organic loan growth during the period was $388 million, partially offset by $171 million in pay downs and pay offs in the acquired loan portfolios. Loan growth during the period was concentrated primarily in Owner-Occupied Nonresidential Property loans of $43 million, Other Nonresidential Property loans of $97 million, Construction Land Development and Other Land loans of $68 million and Multifamily Residential Property loans of $39 million. The increase in investment securities during 2016 was due to purchases made in the third and fourth quarter of 2016 in conjunction with the increase in yields seen in the later part of the year.

 

 

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Funding the asset growth for the Company in 2016 was the growth in deposits of $321 million and earnings of $26 million. Further, the deposit growth of $321 million is the result of a $112 million increase in non-interest bearing demand deposits, a $72 million increase in interest bearing transaction accounts and a $166 million increase in money market and savings deposits, offset by a decrease of $29 million in certificates of deposit. Non-interest bearing deposits represented 54%, and 56% of total deposits at December 31, 2016 and 2015, respectively.

Investment Securities

In order to maintain the Company’s goal of maintaining a high degree of both on-balance sheet and off-balance sheet liquidity, the Company maintains a portion of its investment securities in both readily saleable securities and/or securities that can be pledged as collateral for one or a combination of the Company’s credit facilities. The Company invests in U.S. Treasury Notes, U.S. Agency and U.S. Sponsored Agency issued AAA and AA rated investment-grade callable and non-callable bonds, mortgage-backed pass through securities, asset backed securities and collateralized mortgage obligation “CMO” securities and investment grade municipal securities.

The Company also maintains investable funds with other financial institutions in the form of overnight interest bearing money market accounts and short term maturity certificates of deposit with insured financial institutions. Throughout both 2016 and 2015, the Company has maintained a significant portion of its overnight liquidity directly with the Federal Reserve Bank. At December 31, 2016, the Company had $90 million on deposit with the Federal Reserve.

Securities owned by the Company may also be pledged in connection with the Company’s securities sold under agreements to repurchase program that is offered to the Company’s business deposit customers in which a minimum of 102% of the borrowings are collateralized by the fair market value of the investment securities. As of December 31, 2016 and 2015, the carrying value of securities pledged in connection with securities sold under agreements to repurchase was $48 million and $47 million, respectively. Securities with a market value of $17 million and $12 million were pledged to secure a certificate of deposit of $10 million with the State of California Treasurer’s office throughout 2016 and 2015. Securities with a market value of $78 million and $81 million were pledged to secure outstanding standby letters of credit confirmed/issued by a correspondent bank for the benefit of our customers in the amounts of $42 million and $45 million at December 31, 2016 and December 31, 2015, respectively. Securities with a market value of $716 thousand and $893 thousand were pledged to secure local agency deposits at December 31, 2016 and 2015, respectively. Securities with a market value of $26 million and $19 million were pledged to secure our Federal Reserve credit facility at December 31, 2016 and 2015, respectively. Securities with a market value of $16 million and $19 million were pledged in connection with its credit facility with the Federal Home Loan Bank “FHLB” at December 31, 2016 and 2015, respectively. Securities with a market value of $16 million were pledged in connection with bankruptcy accounts at December 31, 2016 and 2015. Securities with a market value of $2 million were pledged in connection with interest rate swaps acquired from the 1st Enterprise merger at December 31, 2016 and 2015.

 

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As of December 31, 2016 and 2015, the Company’s investment securities portfolio consisted of the following, by issuer (dollars in thousands):

Securities Portfolio at Fair Value, by Issuer

 

     December 31,
2016
     December 31,
2015
 

Small Business Administration “SBA”

   $ 122,850      $ 93,491  

U.S. Treasury

     68,965        80,745  

Government National Mortgage Association “GNMA”

     46,270        58,765  

Corporate Bonds — Various Companies

     —          4,023  

Federal National Mortgage Association “FNMA”

     132,282        57,759  

Municipals — Various State and Political Subdivisions

     41,602        43,001  

Federal Home Loan Bank “FHLB”

     5,982        1,014  

Federal Home Loan Mortgage Corporation “FHLMC”

     87,040        11,331  

Federal Deposit Insurance Corporation “FDIC”

     —          348  

Sallie Mae “SLMA”

     6,896        7,647  
  

 

 

    

 

 

 

Total

   $ 511,887      $ 358,124  
  

 

 

    

 

 

 

The Municipal Bonds in the above table were issued by one hundred and fourteen separate municipalities.

The securities issued by the U.S. Treasury of $69 million, SBA of $123 million and GNMA of $46 million, are fully guaranteed as to the timely payment of both principal and interest by the United States Government.

Composition of Securities Available-for-Sale and Held-to-Maturity, at Fair Value

 

     At December 31,  
(Dollars in thousands)    2016     2015     2014  
Available-for-Sale    Amount      Percent     Amount      Percent     Amount      Percent  

U.S. Govt Agency and Sponsored Agency — Note Securities

   $ 9,969        1.9   $ 1,014        0.3   $ 2,038        0.7

U.S. Treasury Note

     68,965        13.5     80,746        22.6     20,025        7.3

U.S. Govt Agency — SBA Securities

     122,850        24.0     93,490        26.1     54,487        19.9

U.S. Govt Agency — GNMA Mortgage-Backed Securities

     22,370        4.4     30,700        8.6     29,342        10.7

U.S. Govt Sponsored Agency — CMO & Mortgage-Backed Securities

     238,900        46.7     97,154        27.1     107,228        39.12

Corporate Securities

     —          —       4,023        1.1     4,120        1.5

Municipal Securities