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CUNB > SEC Filings for CUNB > Form 10-Q on 6-May-2013All Recent SEC Filings

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Form 10-Q for CU BANCORP


6-May-2013

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 Company's 2012 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. 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

Dodd-Frank Wall Street Reform and Consumer Protection Act: 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 and significantly revises and expands the rulemaking, supervisory and enforcement authority of the federal bank regulatory agencies. The numerous rules and regulations that have been promulgated and are yet to be promulgated and finalized under the Dodd-Frank Act are likely to impact our operations and compliance costs.

In general, more stringent capital, liquidity and leverage requirements are expected to impact our business as the Dodd-Frank Act is fully implemented. The federal agencies have issued proposed rules which will apply directly to larger institutions with either more than $50 billion in assets or more than $10 billion in assets, such as Federal Reserve regulations for financial institutions deemed systemically significant, Federal Reserve and FDIC rules requiring stress tests and Federal Reserve rules to implement the Volcker Rule. However, requirements and policies imposed on larger institutions may, in some cases, become "best practice" standards for smaller institutions. Therefore, as a result of the changes required by the Dodd-Frank Act, the profitability of our business activities may be impacted and we may be required to make changes to certain of our business practices. These changes may also require us to devote significant management attention and resources to evaluate and make any changes necessary to comply with new statutory and regulatory requirements.

The federal regulatory agencies have issued some of the rules implementing the Dodd-Frank Act and are in the process of additional regulations, studies and reports as required by Dodd-Frank. We cannot predict the extent to which the interpretations and implementation of this wide-ranging federal legislation by regulations and in supervisory policies and practices may affect us. Many of the requirements of Dodd-Frank will be implemented over time and most will be subject to regulations to be implemented or which will not become fully effective for several years. There can be no assurance that these or future reforms (such as possible new standards for commercial real estate lending or new stress testing guidance for all banks) arising out of these regulations and studies and reports required by Dodd-Frank will not significantly increase our compliance or other operating costs and earnings or otherwise have a significant impact on our business, financial condition and results of operations. Dodd-Frank will likely result in more stringent capital, liquidity and leverage requirements on us and may otherwise adversely affect our business. For example, the provisions that affect the payment of interest on demand deposits and interchange fees are likely to increase the costs associated with deposits, as well as place limitations on certain revenues those deposits may generate. As a result of the changes required by Dodd-Frank, the profitability of our business activities may be impacted and we may be required to make changes to certain of our business practices. These changes may also require us to invest significant management attention and resources to evaluate and make any changes necessary to comply with new statutory and regulatory requirements.

For a more detailed discussion regarding the Dodd-Frank Wall Street Reform and Consumer Protection Act, see the Company's December 31, 2012 Form 10K, Part I, Item 1 - Business - Supervision and Regulation - Recent Legislation and Regulation - Dodd-Frank Wall Street Reform and Consumer Protection Act.


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Regulatory Capital Proposals

Basel III Capital Standards: In June 2012, the federal banking agencies issued a series of proposed rules to conform U.S. regulatory capital requirements and 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 proposed revisions, if adopted, would establish new higher capital ratio requirements, narrow the definitions of capital, impose new operating restrictions on banking organizations with insufficient capital buffers and increase the risk weighting of certain assets. The proposed new capital requirements would apply to all banks, savings associations, bank holding companies with more than $500 million in assets and all savings and loan holding companies regardless of asset size. It is unclear whether, if, or in what form Basel III will be adopted. A summary of the proposed regulatory changes is set forth below.

New and Increased Capital Requirements. The proposed rules would establish a new capital measure called "Common Equity Tier I Capital" consisting of common stock and related surplus, retained earnings, accumulated other comprehensive income and, subject to certain adjustments, minority common equity interests in subsidiaries. Unlike the current rules which exclude unrealized gains and losses on available-for-sale debt securities from regulatory capital, the proposed rules would generally require accumulated other comprehensive income to flow through to regulatory capital. Depository institutions and their holding companies would be required to maintain Common Equity Tier I Capital equal to 4.5% of risk-weighted assets by 2015. Additionally, the proposed regulations would increase the required ratio of Tier I Capital to risk-weighted assets from the current 4% to 6% by 2015. Tier I Capital would consist of Common Equity Tier I Capital plus Additional Tier I Capital which would include non-cumulative perpetual preferred stock. Neither cumulative preferred stock (other than certain preferred stock issued to the U.S. Treasury) nor trust preferred securities would qualify as Additional Tier I Capital but could be included in Tier II Capital along with qualifying subordinated debt. The proposed regulations would also require a minimum Tier I leverage ratio of 4% for all institutions. The minimum required ratio of total capital to risk-weighted assets would remain at 8%.

Capital Buffer Requirement. In addition to increased capital requirements, depository institutions and their holding companies may be required to maintain a capital buffer of at least 2.5% of risk-weighted assets over and above the minimum risk-based capital requirements. Institutions that do not maintain the required capital buffer would be subject to progressively more stringent limitations on the percentage of earnings that can be paid out in dividends or used for stock repurchases and on the payment of discretionary bonuses to senior executive management. The capital buffer requirement would be phased in over a four-year period beginning in 2016. The capital buffer requirement effectively raises the minimum required risk-based capital ratios to 7% Common Equity Tier I Capital, 8.5% Tier I Capital and 10.5% Total Capital on a fully phased-in basis.

Changes to Prompt Corrective Action Capital Categories. The Prompt Corrective Action rules would be amended to incorporate a Common Equity Tier I Capital requirement and to raise the capital requirements for certain capital categories. In order to be adequately capitalized for purposes of the prompt corrective action rules, a banking organization would be required to have at least an 8% Total Risk-Based Capital Ratio, a 6% Tier I Risk-Based Capital Ratio, a 4.5% Common Equity Tier I Risk Based Capital Ratio and a 4% Tier I Leverage Ratio. To be well capitalized, a banking organization would be required to have at least a 10% Total Risk-Based Capital Ratio, an 8% Tier I Risk-Based Capital Ratio, a 6.5% Common Equity Tier I Risk-Based Capital Ratio and a 5% Tier I Leverage Ratio.

Additional Deductions from Capital. Banking organizations would be required to deduct goodwill and certain other intangible assets, net of associated deferred tax liabilities, from Common Equity Tier I Capital. Deferred tax assets arising from temporary timing differences that could not be realized through net operating loss ("NOL") carrybacks would continue to be deducted but deferred tax assets that could be realized through NOL carrybacks would not be deducted but would be subject to 100% risk weighting. Defined benefit pension fund assets, net of any associated deferred tax liability, would be deducted from Common Equity Tier I Capital unless the banking organization has unrestricted and unfettered access to such assets. Reciprocal cross-holdings of capital instruments in any other financial institutions would now be deducted from capital, not just holdings in other depository institutions. For this purpose, financial institutions are broadly defined to include securities and commodities firms, hedge and private equity funds and non-depository lenders. Banking organizations would also be required to deduct non-significant investments (less than 10% of outstanding stock) in other financial institutions to the extent these exceed 10% of Common Equity Tier I Capital subject to a 15% of Common Equity Tier I Capital cap. Greater than 10% investments must be deducted if they exceed 10% of Common Equity Tier I Capital. If the aggregate amount of certain items excluded from capital deduction due to a 10% threshold exceeds 17.65% of Common Equity Tier I Capital, the excess must be deducted.

Changes in Risk-Weightings. The proposed rules would apply a 250% risk-weighting to mortgage servicing rights, deferred tax assets that cannot be realized through NOL carrybacks and significant (greater than 10%) investments in other financial institutions. The proposal also would also change the risk-weighting for residential mortgages and would create a new 150% risk-weighting category for "high volatility commercial real estate loans" which are credit facilities for the acquisition, construction or development of real property other than one- to four-family residential properties or commercial real projects where:
(i) the loan-to-value ratio is not in excess of interagency real estate lending standards; and (ii) the borrower has contributed capital equal to not less than 15% of the real estate's "as completed" value before the loan was made.

The proposed rules were to become effective in stages beginning January 1, 2013 through 2019, however in the fourth quarter of 2012, the implementation of Basel III and these regulations was postponed indefinitely in response to the large number of comment letters received by the agencies with regard to the proposed rulemaking. While the proposed new regulatory capital requirements would likely result in generally higher regulatory capital standards for the Company, it is difficult at this time to predict when or how many of the proposed provisions will ultimately be adopted or whether broader exemptions may be provided for community banks or smaller holding companies. In addition, bank regulators may also continue their past policies of expecting banks to maintain additional capital beyond the new minimum requirements. The regulations ultimately applicable to the Company may be substantially different from the Basel III final framework as proposed initially. Requirements to maintain higher


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levels of capital or to maintain higher levels of liquid assets could adversely impact the Company's net income and return on equity, restrict the ability to pay dividends and require the raising of additional capital. The Company cannot be certain how the regulators will implement requirements of the Dodd-Frank Act that are similar to Basel III.

For a more detailed discussion regarding the Basel III provision see the Company's December 31, 2012 Form 10K, Part I, Item 1 - Business - Bank Regulation - Basel Capital and Liquidity Initiatives.

Capital

As of March 31, 2013, the Bank's Tier 1 leverage ratio, Tier 1 risk-based capital ratio, and Total risk-based capital ratio were 9.13%, 10.90% and 11.78%, respectively. CU Bancorp's consolidated Tier 1 leverage ratio, Tier 1 risk-based capital ratio, and Total risk-based capital ratio at March 31, 2012 were 9.76%, 11.65% and 12.52%, 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

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 March 31, 2013 are independent outside directors.

None of the Company's senior 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, nomination and governance committees comprised solely of independent outside directors.

Number of Employees

The number of active full-time equivalent employees increased from 167 at December 31, 2012 to 172 at March 31, 2013.

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 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 methodologies that that determine our allowance for loan loss, the treatment of non-accrual loans, the classification and valuation of investment securities, the valuation of retained interests and servicing assets related to the sales of SBA loans, accounting for and valuation of derivatives and hedging activities, accounting for business combinations, evaluation of goodwill for impairment, and accounting for income taxes.

Our critical accounting policies are described in greater detail in our 2012 Annual Report on Form 10-K, Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies and Estimates.

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.


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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 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.

Derivative Financial Instruments and Hedging Activities

All derivative instruments are recorded on the consolidated balance sheet at fair value. For derivatives designated as fair value hedges, changes in the fair value of the derivative and hedged item related to the hedged risk are recognized in earnings. ASC Topic 815 establishes the accounting and reporting standards requiring that every derivative instrument (including certain derivative instruments embedded in other contracts) be recorded in the consolidated 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, 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 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. an 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.

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, is exercised 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 consolidated 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.

Business Combinations

The assets and liabilities of PC Bancorp that were acquired in 2012, were accounted for at fair value at the date of acquisition. The Company obtained either a third party analysis or an internal valuation analysis of the fair value of the assets and liabilities acquired. An analysis was performed as of the date of acquisition 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).

For a detailed analysis of the business combinations accounting related to either PC Bancorp or COSB, see the Company's December 31, 2012 Form 10K, Footnote 2, Business Combinations.

Income Taxes

Deferred income tax assets and liabilities are computed using the asset and liability method, which recognizes a liability or asset representing the tax effects, based on current tax law, of future deductible or taxable amounts attributable to events that have been recognized in the financial statements. A valuation allowance may be 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 depends on having sufficient taxable income, available tax loss carrybacks or credits, the reversing of taxable temporary differences and/or tax planning strategies within the reversal period and that current legislative tax law allows for the realization of those tax benefits.


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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 March 31,
                                                                       Increase
                                            Amounts                   (Decrease)
                                       2013         2012           $              %
      Interest Income                $ 12,069      $ 7,478      $  4,591          61.4 %
      Interest Expense                    531          239           292         122.2 %

      Net Interest Income              11,538        7,239         4,299          59.4 %
      Provision for loan losses           134           -            134
      Gain on sale of securities            5           -              5
      Gain on sale of SBA loans           350           -            350
      Other non-interest income         1,071          622           449          72.2 %
      Non-interest expense              9,309        6,905         2,404          34.8 %
      Provision for Income Taxes        1,366          450           916         203.6 %

      Net Income                     $  2,155      $   506      $  1,649         325.9 %

      Earnings per share
      Basic                          $   0.21      $  0.08      $   0.13         162.5 %
      Diluted                        $   0.20      $  0.07      $   0.13         185.7 %
      Return on average equity (1)       6.94 %       2.52 %        4.42 %       175.4 %
      Return on average assets           0.69 %       0.24 %        0.45 %       187.5 %
      Net interest rate spread           3.82 %       3.47 %        0.35 %        10.1 %
      Net interest margin                4.00 %       3.62 %        0.38 %        10.5 %
      Efficiency ratio (2)              71.83 %      87.50 %      (13.68 )%      (15.6 )%

(1) Calculation excludes average accumulated other comprehensive income (loss) . . .

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