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CUNB > SEC Filings for CUNB > Form 10-Q on 14-Nov-2012All Recent SEC Filings

Show all filings for CU BANCORP

Form 10-Q for CU BANCORP


14-Nov-2012

Quarterly Report


ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

See "Cautionary Statement for Purposes of the "Safe Harbor" Provisions of the Private Securities Litigation Reform Act of 1995" below relating to "forward-looking" statements included in this report.

The following is management's discussion and analysis of the major factors that influenced the results of the operations and financial condition of CU Bancorp, the ("Company") for the current period. This analysis should be read in conjunction with the audited financial statements and accompanying notes included in the Bank's 2011 Annual Report on Form 10K and with the unaudited financial statements and notes as set forth in this report.

OVERVIEW

Forward-Looking Information

Certain matters discussed under this caption may constitute forward-looking statements under Section 27A of the Securities Act and Section 21E of the Securities Exchange Act. There can be no assurance that the results described or implied in such forward-looking statements will, in fact, be achieved and actual results, performance, and achievements could differ materially because the business of the Company involves inherent risks and uncertainties. These risks include, but are not limited to, general economic conditions nationally and in California, unanticipated credit losses in the Company's loan portfolio, rapid changes in interest rates and other risks discussed in the Bank's Annual Report on Form 10K.

Recent Developments

Merger

On July 31, 2012 the Company acquired Premier Commercial Bancorp ("PC Bancorp") and its subsidiary Premier Commercial Bank, N.A. ("PCB") headquartered in Anaheim, California through a merger transaction. The shareholders of PC Bancorp approved the plan of merger on July 19, 2012, followed by shareholders of California United Bank ("CUB") on July 23, 2012 as outlined within the Joint Proxy Statement-Prospectus on Form S-4 as filed with the SEC dated June 20, 2012. At the date of acquisition, PC Bancorp had assets of approximately $396.6 million, two offices in Orange County, California, an Anaheim branch and an Irvine/Newport Beach branch. Shareholders of PC Bancorp received 3,721,382 shares equal to approximately $41.87 million in the common stock of CU Bancorp, and PC Bancorp stock option holders received $455,000 in cash in payout of their options.

Regulatory Legislation

In July 2010, the Dodd-Frank Financial Reform Bill ("the Wall Street Reform and Consumer Protection Act") was passed by Congress and signed into law by President Obama. This legislation aims to restore responsibility and accountability to the U.S. financial system. It is unclear how this legislation may impact the financial environment, as regulations implementing the Bill's provisions have been issued periodically and some have not yet been issued or are not yet effective. To date, this legislation has had no significant impact on the Company.

Regulatory Capital Proposals

On June 4, 2012, the Board of Governors of the Federal Reserve System ("Board") issued three notices of proposed rulemaking, or NPRs, that would restructure the Board's current regulatory capital rules into a comprehensive framework and revise current regulatory capital requirements to make them consistent with the Basel III Capital Standards established by the Basel Committee on Banking Supervision and certain provisions of the Dodd Frank Wall Street Reform and Consumer Protection Act.

The first NPR ("Basel III NPR") proposes reforms that would improve the overall quality and quantity of banking organizations' capital. The proposal includes a new common equity tier 1 minimum capital requirement of 4.5% of risk-weighted assets and a common equity tier 1 capital conservation buffer of 2.5% of risk-weighted assets. The proposal also increases the minimum tier 1 capital requirement from 4.0% to 6.0% of risk-weighted assets. The current minimum total risk-based capital requirement of 8% would remain unchanged. The proposal also establishes more conservative standards for including certain instruments (such as trust preferred securities) in regulatory capital.

The Company currently includes in Tier 1 capital, an amount of trust preferred securities equal to no more than 25% of the sum of all core capital elements, which is generally defined as shareholders' equity less goodwill, core deposit intangibles, and a portion of the SBA servicing assets. While our existing subordinated debentures are currently grandfathered as Tier 1 capital under the Dodd-Frank Wall Street Reform and Consumer Protection Act, the proposed regulatory capital guidelines would phase them out of Tier 1 capital over a period of 10 years, until they are fully-phased out on January 1, 2022. The Dodd-Frank guidelines provide that new issuances of trust preferred securities will not qualify as Tier 1 capital.

The second NPR ("Standardized Approach NPR") proposes revised rules for calculating risk-weighted assets to enhance risk sensitivity and increase the capital required for certain types of high-risk loans and securitization exposures. The Standardized Approach NPR introduces disclosure requirements that would apply to U.S. bank holding companies with $50 billion or more in assets.

The third NPR ("Advanced Approaches and Market Risk NPR") would enhance the risk-sensitivity of the advanced approaches risk-based capital rule, including revisions to better address counterparty credit risk and interconnectedness among financial institutions. This NPR would generally apply only to large, internationally active banking organizations or banking organizations with significant trading activity, $250 billion or more in consolidated assets or $10 billion or more in foreign exposure, and would therefore not impact the Company as currently proposed.

While these rules would be effective as of January 1, 2013, full compliance with most aspects of of the rules would be phased-in over a seven year period. The new minimum regulatory capital ratios and changes to the calculation of risk-weighted assets would be required to be fully

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implemented effective January 14, 2014. The capital conservation buffer framework would b phased-in between 2016 and 2018, with full implementation effective January 1, 2019. On August 30, 2012, the proposals were published in the Federal Register and comments were due on all three NPR's by October 22, 2012. However, on November 9, 2012, the U.S. federal banking agencies announced that the original suggested effective date of January 1, 2013 would be delayed. In light of the views and concerns expressed during the comment period, the agencies do not expect that any of the proposed rules will become effective on January 1, 2013.

These NPRs are subject to final rulemaking by the Board and their provisions may change before their implementation. The Company is currently in the process of evaluating the details of these proposals.

Capital

As of September 30, 2012, the Bank's Tier 1 leverage ratio, Tier 1 risk-based capital ratio, and Total risk-based capital ratio at September 30, 2012 were 9.30%, 10.64% and 11.45%, respectively. CU Bancorp consolidated Tier 1 leverage ratio, Tier 1 risk-based capital ratio, and Total risk-based capital ratio at September 30, 2012 were 10.01%, 11.43% and 12.24%, respectively. These ratios placed the Bank and CU Bancorp in the "well-capitalized" category as defined by federal regulations, which require corresponding capital ratios of 5%, 6% and 10%, respectively, to qualify for that designation.

Corporate Governance

As a result of the formation of CU Bancorp, the existing Board of Directors of California United Bank also became Board members of CU Bancorp. As a result of the merger of PC Bancorp into CU Bancorp, and Premier Commercial Bank ("PCB") into California United Bank, two of PC Bancorp's former Board members, Kenneth J. Cosgrove and Robert Matranga, became Board members of both CU Bancorp and California United Bank. In addition, two Board members of California United Bank, Robert Bills and Ron Jones, stepped down from their Board positions at California United Bank, and did not become Board members of CU Bancorp.

The following are some of the key corporate governance practices at both the Company and the Bank, which are oriented to ensure that there are no conflicts of interest and that the Company operates in the best interests of shareholders:

Nine of the Company's and Bank's eleven directors at September 30, 2012 are independent outside directors.

None of the Company's officers and directors have received loans from the Bank.

There are no loans by the Bank to outside companies controlled by or affiliated with officers or directors.

The Bank's Board of Directors has audit and compensation committees comprised solely of independent outside directors.

Number of Employees

The number of active full-time equivalent employees increased from 113 at December 31, 2011 to 167 at September 30, 2012.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and could potentially result in materially different results under different assumptions and conditions. 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:

Allowance for Loan Loss

We maintain an allowance for loan loss to provide for probable losses in the loan portfolio. Additions to the allowance are made by charges to operating expense in the form of a provision for loan losses. All loans or portions thereof that are judged to be uncollectible will be charged against the allowance while any recoveries would be credited to the allowance. We have instituted loan policies designed primarily for internal use, to adequately evaluate and analyze risk factors associated with our loan portfolio and to enable us to assess such risk factors prior to granting new loans and to assess the sufficiency of the allowance. We conduct an evaluation of the loan portfolio on a quarterly basis. This evaluation includes an assessment of the following factors: the results of any current internal and external loan reviews including any regulatory examination, historical loan loss experience, estimated probable loss exposure on substandard credits, concentrations of credit, value of collateral and any known impairment in the borrowers' ability to repay and present economic conditions.

Investment Securities

The Company currently classifies its investment securities under the available-for-sale classification. 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 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 historical cost. Unrealized gains or losses are excluded from net income and reported as a separate component of accumulated other comprehensive income (net of taxes) included in shareholders' equity.

At each reporting date, investment securities are assessed to determine whether there is an other-than-temporary impairment. If it is probable, based on current information, that we will be unable to collect all amounts due according to the contractual terms of a debt security not impaired at acquisition, an other-than-temporary impairment shall be considered to have occurred. Once impairment 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. 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 terms of the

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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 Bank's investment in FHLB stock and other bank stock is carried at cost and is included in other assets on the accompanying balance sheets.

Other Real Estate Owned

Real estate properties that are acquired through, or in lieu of, loan foreclosure are initially recorded at fair value, less estimated costs to sell, at the date of foreclosure, establishing a new cost basis. After foreclosure, valuations are periodically performed by management and the real estate is carried at the lower of the cost basis or fair value less estimated costs to sell. Revenue and expenses from operations and valuation write-downs are included in non-interest expense.

Acquisition Accounting

The assets and liabilities of PC Bancorp that were accounted for at fair value, required either a third party analysis or an internal valuation analysis of the fair value of the assets and liabilities acquired. An analysis was performed on loans, investment securities, interest rate swap contracts, SBA loan servicing assets, contractual lease obligations, deferred compensation, deposits and subordinated debentures as of the acquisition date. Balances that were considered to be at fair value at the date of acquisition were cash and cash equivalents, bank owned life insurance, interest rate swap contracts, other assets (interest receivable) and other liabilities (interest payable).

The Company recorded a net fair value discount of $14.5 million on the loans acquired in the PC Bancorp transaction. $12.3 million of this amount will be accreted into interest income over time. The remaining $2.2 million of the net fair value discount is associated with purchased credit impaired loans and portions or all of this discount will be accreted into income over time once these loans become performing or are paid off.

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                             RESULTS OF OPERATIONS

The following table presents condensed statements of income and related
performance data for the periods indicated and the dollar and percentage changes
between the periods (dollars in thousands, except per share data):



                                               Three Months Ended September 30,                           Nine Months Ended September 30,
                                                                         Increase                                                  Increase
                                             Amounts                    (Decrease)                     Amounts                    (Decrease)
                                        2012          2011           $              %             2012          2011           $              %
Interest Income                       $ 10,400       $ 7,195      $  3,205           44.5 %     $ 25,039      $ 21,414      $  3,625           16.9 %
Interest Expense                           626           312           314          100.6 %        1,101         1,062            39            3.7 %

Net Interest Income                      9,774         6,883         2,891           42.0 %       23,938        20,352         3,586           17.6 %
Provision for loan losses                  521            -            521                           901           661           240           36.3 %
Gain on sale of securities                  -              6            (6 )       (100.0 )%          -            219          (219 )       (100.0 )%
Other non-interest income                1,185           639           546           85.4 %        2,559         1,643           916           55.8 %
Non-interest expense                    11,823         6,473         5,350           82.7 %       24,998        19,426         5,572           28.7 %
Provision for income tax expense
(benefit)                                 (453 )         454          (907 )       (199.8 )%         499           966          (467 )        (48.3 )%

Net Income (Loss)                     $   (932 )     $   601      $ (1,533 )       (255.1 )%    $     99      $  1,161      $ (1,062 )        (91.5 )%

Earnings (Loss) per share
Basic                                 $  (0.10 )     $  0.09      $  (0.19 )       (211.1 )%    $   0.01      $   0.18      $  (0.16 )        (94.1 )%
Diluted                               $  (0.10 )     $  0.09      $  (0.19 )       (211.1 )%    $   0.01      $   0.18      $  (0.16 )        (94.1 )%
Return on average equity (1)             (2.51 )%       3.05 %       (5.56 )%      (182.3 )%        0.13 %        2.08 %       (1.95 )%       (93.8 )%
Return on average assets                 (0.31 )%       0.30 %       (0.61 )%      (203.3 )%        0.01 %        0.20 %       (0.19 )%       (95.0 )%
Net interest rate spread                  3.34 %        3.43 %       (0.09 )%        (2.6 )%        3.34 %        3.52 %       (0.18 )%        (5.1 )%
Net interest margin                       3.57 %        3.61 %       (0.04 )%        (1.1 )%        3.53 %        3.71 %       (0.18 )%        (4.9 )%
Efficiency ratio (2)                    107.59 %       85.84 %       21.75 %         25.3 %        94.02 %       87.79 %        6.23 %          7.1 %

(1) Calculation excludes average accumulated other comprehensive income (loss) from average shareholders' equity. The net income (loss) for the period has been annualized.

(2) Efficiency ratio is defined as non-interest expense divided by the sum of net interest income, deposit account service charge income, and other non-interest income.

Operations Performance Summary

Three Months Ended September 30, 2012 and 2011

The Company reported a net loss from operations of $932,000 (or a net loss of $0.10 per common share on both a basic and diluted basis) for the three months ended September 30, 2012, compared to net income of $601,000 (or $0.09 per common share on both a basic and diluted basis) for the corresponding period in 2011. This represents a $1.5 million or 255.1% decrease between the two periods. The Company's net loss for the quarter was the direct result of merger costs of $2.5 million associated with the acquisition of PC Bancorp. The following describes the changes in the major components of the Company's net loss for the three months ended September 30, 2012 compared to the same period in 2011:

Net interest income increased by $2.9 million to $9.8 million, a 42.0% increase compared to the third quarter of 2011. This was due to an increase of $3.2 million in interest income partially offset by an increase in interest expense of $314,000. Interest income increased between the two periods primarily due to an increase in interest income on loans of $3.3 million, an increase of interest income on interest bearing balances in other financial institutions of $40,000 which was partially offset by a decline in interest income on investment securities of $133,000. Interest expense increased due to a $184,000 increase on interest paid on deposits and an increase of $136,000 associated with the subordinated debt securities acquired from the PC Bancorp acquisition.

The increase in interest income of $3.2 million to $10.4 million for the quarter ending September 30, 2012, compared to the same period of 2011 is primarily the result of an increase in average interest earning assets by $332.2 million coupled with a slight increase in the overall yields on interest-earning assets of 3 basis points to 3.80%. Total average interest-earning assets increased to $1,089.2 million, an increase of $332.2 million or 43.9% compared to third quarter of 2011. Average interest earnings assets increased in all categories of the Company's balance sheet. The increase in average interest earning assets increased interest income by $3.4 million for the third quarter of 2012 compared to 2011. $3.3 million of this interest income increase is attributable to higher average loan balances, $73,000 is attributable to higher average deposits in other financial institutions and $16,000 is attributable to higher average investment security balances.

Loan interest income for the quarter ending September 30, 2012, increased by $3.3 million, or 52.6%, to $9.6 million compared to the quarter ending September 30, 2011. This increase was attributable to both organic loan growth as well as the loans acquired as part of the PC Bancorp acquisition. The Company acquired $278.0 million in loans on July 31, 2012 as part of the acquisition. The increase in average loan balances added $3.3 million to loan interest income as average loan balances increased by $234.9 million, or 52.7% between the two periods. For the quarter ended September 30, 2011, the Company's average quarterly loan portfolio was $445.7 million, and for the quarter ended September 30, 2012 the average quarterly loan portfolio had grown to $680.5 million. Third quarter loan interest income was positively impacted by $513,000 related to the amortization of fair value adjustments related to the PC Bancorp loans acquired, and was negatively impacted by $277,000 related to the interest rate swap contracts acquired in the PC Bancorp acquisition.

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Interest income on investment securities declined by $133,000 to $620,000; a 17.7% decrease for the three months ended September 30, 2012 compared to the same period in 2011. The overall decline in investment securities income was attributable to a decline in the overall yields between the two periods partially offset by a slight increase in the average balances. A decrease of $149,000 in investment securities income was attributable to a decrease of 0.50% in the overall yield. An increase of $16,000 in investment securities income was attributable to an increase of $2.0 million in average balances between these quarters. The decline in the overall yield between the third quarter of 2012 and 2011, resulting in the current yield of 2.10%, was the result of the loss of higher yielding securities due to the following three factors: selling several higher yielding mortgage backed securities during 2011, the runoff of principal balances on the higher yielding mortgage backed securities portfolio due to the increase in prepayments and the early redemption "calls" of a portion of the Company's higher yielding U.S. sponsored agency callable securities by the issuing agencies. The reinvestments of funds in new securities between these periods were at substantially lower rates than the yield on securities that were running off between these periods. Also impacting the investment securities was the acquisition of the $44.4 million of securities on July 31, 2012 from the PC Bancorp acquisition. The overall yield of the PC Bancorp securities was approximately 1.78% at July 31, 2012, after the fair value adjustment, which placed additional downward pressure on the overall yields during the period. In addition, $17.3 million of the securities acquired from the acquisition were sold with no gains or losses recorded during the quarter.

Interest income on interest bearing deposits in other financial institutions increased by $40,000, or 23.7%, to $209,000 for the third quarter of 2012 compared to the same quarter of 2011. The increase in interest income was primarily attributable the increase of $ 95.4 million or a 48.9% increase from the third quarter of 2011 to 2012. The average balance during the third quarter of 2012 was $290.6 million compared to $195.2 million in 2011. The overall yield declined from 0.34% in the third quarter of 2011 to 0.28% in 2012, a decline of 6 basis points. The increase in the average balances attributed $73,000 in income while the decline in the yield decreased interest income by $33,000. The increase in the balances during this period was the result of the Company building higher balances in this category during the first six months of the year and the acquisition of $46.4 million on July 31, 2012 from the PC Bancorp acquisition.

Interest expense on interest bearing deposit accounts increased by $184,000, or 65.2%, to $466,000 for the third quarter of 2012 compared to the same quarter of 2011. The increase in interest expense on deposits was primarily attributable to the increase in the average balances coupled with an increase in the rates paid on deposits acquired from the PC Bancorp acquisition. The overall rate increased from 0.34% in the third quarter of 2011 to 0.37% in the third quarter of 2012, an increase of 3 basis points, and resulted in an increase in interest expense of $24,000. Adding to the increase in deposit interest expense was the increase in the average balances of interest earning deposits between the quarters. Total average interest bearing deposits increased by $173.8 million or 52.6%, to $504.5 million between these two quarters. The increase in the average balance increased interest expense on deposits by $160,000. The increase in average interest bearing deposits was attributable to the organic growth in deposits as well as the acquisition of $253.8 million from PC Bancorp acquisition on July 31, 2012.

Interest expense on borrowings increased by $130,000 to a total of $160,000 for the third quarter of 2012 compared to the same period of 2011. The primary increase is attributable to the acquisition of subordinated debentures related to the PC Bancorp acquisition. The increase in interest expense associated with the subordinated debentures was $ 136,000 which was partially offset by a decline in the interest expense on securities sold under agreements to repurchase ("repos") of $6,000. The interest expense decline in repos was associated with a $6.0 million decline in the average balance.

The Company recorded a provision of $521,000 for loan losses during the third quarter of 2012, while the Company did not record any provision for loan losses during the third quarter of 2011. A provision for the third quarter of 2012 was deemed necessary due to an overall increase of $51 million in the Company's organic loan balances, from $488.2 million at June 30, 2012 to $794.5 million at September 30, 2012, and after consideration of asset quality and net third quarter 2012 loan charge-offs of $44,000. A substantial amount of the growth in the loan portfolio was recorded and accounted for at fair value and is excluded from the loan provision calculation unless there has been deterioration in the loan from the date of acquisition. The Company has an allowance for loan loss for those loans that are accounted for at historical cost (this excludes loans that were accounted for at fair value at December 31, 2010 from the California Oaks State Bank ("COSB") acquisition and loans accounted for at fair value at July 31, 2012 from the PC Bancorp acquisition) of approximately 1.61% of the outstanding non-fair value loan balance. Loans acquired from the both the PC Bancorp and California Oaks State Bank acquisitions were originally accounted for at fair value. During the third quarter of 2012 the Company recorded $97,000 . . .

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