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CUNB > SEC Filings for CUNB > Form 10-Q on 13-Aug-2013All Recent SEC Filings

Show all filings for CU BANCORP

Form 10-Q for CU BANCORP


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.




We have made forward-looking statements in this document about the Company, for which the Company claims the protection of the safe harbor provisions contained in the Private Securities Litigation Reform Act of 1995.

A number of factors, many of which are beyond the Company's ability to control or predict, could cause future results to differ materially from those contemplated by such forward-looking statements. These factors include:
(1) changes in general economic, political, or industry conditions and the related credit and market conditions and the impact they have on the Company and its customers, including changes in consumer spending, borrowing and savings habits; (2) the impact on financial markets and the economy of the level of U.S. and European debt; (3) the effects of and changes in trade and monetary and fiscal policies and laws, including the interest rate policies of the Board of Governors of the Federal Reserve System; (4) continued delay in the pace of economic recovery and continued stagnant or decreasing employment levels;
(5) the effect of the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and the rules and regulations to be promulgated by supervisory and oversight agencies implementing the new legislation, taking into account that the precise timing, extent and nature of such rules and regulations and the impact on the Company is uncertain; (6) the impact of revised capital requirements under Basel III; (7) significant changes in applicable laws and regulations, including those concerning taxes, banking and securities; (8) changes in the level of nonperforming assets, charge-offs, other real estate owned and provision expense; (9) changes in inflation, interest rates, and market liquidity which may impact interest margins and impact funding sources; (10) the Company's ability to attract new employees and retain and motivate existing employees; (11) increased competition in the Company's markets and our ability to increase market share and control expenses; (12) changes in the financial performance and/or condition of the Company's customers, or changes in the performance or creditworthiness of our customers' suppliers or other counterparties, which could lead to decreased loan utilization rates, delinquencies, or defaults and could negatively affect our customers' ability to meet certain credit obligations; (13) a substantial and permanent loss of client accounts; (14) soundness of other financial institutions which could adversely affect the Company; (15) protracted labor disputes in the Company's markets;
(16) the impact of natural disasters, terrorist activities or international hostilities on the operations of our business or the value of collateral;
(17) the effect of acquisitions and integration of acquired businesses and de novo branching efforts; (18) changes in accounting policies or procedures as may be required by the Financial Accounting Standards Board or regulatory agencies;
(19) the impact of cyber security attacks or other disruptions to the Company's information systems and any resulting compromise of data or disruptions in service; and (20) the success of the Company at managing the risks involved in the foregoing.

Forward-looking statements speak only as of the date they are made, and the Company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the statements are made.

For a more complete discussion of these risks and uncertainties, see the Company's Annual Report on Form 10-K for the year ended December 31, 2012 and particularly, Item 1A, titled "Risk Factors."

Recent Developments

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 rules most of 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

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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.

Tax Legislation

The State of California recently enacted legislation that significantly modifies and eliminates most of the tax deduction and tax credits that could be utilized by companies operating in California Enterprise Zones. Under the recently enacted legislation, the net interest income deductions on loans made by financial institutions to borrowers that operate in a qualified California Enterprise Zones will be eliminated as a tax deduction for California income taxes effective January 1, 2014. In addition, the hiring tax credits related to the hiring of qualified employees in California Enterprise Zones is also eliminated. The Company was taking advantage of these deduction and tax credits in 2012 and 2013.

The elimination of the net interest income deductions on loans within designated enterprise zones, within the State of California, and the elimination of new tax credits on the hiring on qualified employees that work in an Enterprise Zone by the Company, will increase the Company's effective tax rate beginning in 2014.

Regulatory Capital

Final Basel III Capital Rule: On July 2, 2013, the Board of Governors of the Federal Reserve System ("Federal Reserve") approved a final rule (the "Final Rule") that revises the current capital rules for U.S. banking organizations including the capital rules for the Company and California United Bank. The FDIC adopted the rule as an "interim final rule" on July 9, 2013. The Final Rule implements the regulatory capital reforms recommended by the Basel Committee on Banking Supervision from December 2010, commonly referred to as "Basel III," as well as additional capital reforms required by the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank Act"). Key reforms include increased requirements for both the quantity and quality of capital held by banks so that they are more capable of absorbing losses and withstanding periods of financial distress, and the establishment of alternative standards of creditworthiness in place of credit ratings. The Company will be required to begin complying with the new capital rules on January 1, 2015 with the transition period for the capital conservation capital buffers (discussed below) on January 1, 2016. It is generally expected that additional regulations will be implemented by bank regulatory agencies relative to capital requirements.

Increased Capital Requirements. Consistent with Basel III and the earlier proposals (the "Proposals"), the Final Rule requires banking organizations to maintain the following minimum risk-based capital ratios, when fully-phased in: (i) a new ratio of common equity Tier 1 capital to risk-weighted assets (common equity Tier 1 capital ratio) of 4.5%; (ii) a ratio of Tier 1 capital to risk-weighted assets (Tier 1 capital ratio) of 6%, increased from 4%; and (iii) a ratio of total capital to risk-weighted assets (total capital ratio) of 8%. The Final Rule also imposes a new leverage ratio of Tier 1 capital to average total consolidated assets of 4% which will apply to the Company.

Capital Buffer Requirement. In addition to the minimum risk-based capital ratios, the Final Rule establishes a capital conservation buffer applicable to all banking organizations that consists of common equity Tier 1 capital equal to at least 2.5% of risk-weighted assets when fully phased in. The phase-in period for the capital conservation capital buffers for all banking organizations will begin on January 1, 2016. The common equity Tier 1 capital conservation buffer for 2016 will be 0.625%, increasing to 1.25% in 2017, increasing to 1.875% in 2018 and increasing to 2.5% in 2019. The minimum common equity Tier 1 capital ratio plus the capital conservation buffer will be 4.5% in 2015, 5.125% in 2016, 5.75% in 2017, 6.375% in 2018 and 7.0% in 2019.

Capital Definitions. The Final Rule revises the definition of capital with an emphasis on the inclusion of common equity Tier 1 capital and establishes strict eligibility criteria for regulatory capital instruments. Deductions from, and adjustments to, capital are generally stricter than under the current capital rules, including with respect to goodwill and other intangibles, mortgage servicing assets, deferred tax assets, and non-significant investments in the capital of unconsolidated financial institutions. The new definitions of regulatory capital and capital ratios are incorporated into the agencies' prompt corrective action (PCA) framework. In addition, the Final Rule amends the agencies' current capital rules to improve the methodology for calculating risk-weighted assets to increase risk sensitivity.

Regulatory Capital Treatment of AOCI. Accumulated Other Comprehensive Income ("AOCI") generally includes the net accumulated unrealized gains and losses on certain assets and liabilities, such as investment securities classified as available-for-sale, that have not been included in net income, yet are included within equity capital under U.S. generally accepted accounting principles. Under the agencies' current general risk-based capital rules, most components of AOCI are not reflected in a banking organization's regulatory capital. The Final Rule permits a non-advanced approaches banking organization such as the Company to make a one-time election to "opt out" of including most elements of AOCI in regulatory capital and instead effectively use the existing treatment under the general risk-based capital rules. The AOCI opt-out election must be made in a bank's first call report or a company's first FR Y-9 series report, as applicable, that is filed after the banking organization becomes subject to the Final Rule, after January 1, 2015.

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Grandfathering of Certain Trust Preferred Securities. The Final Rule permanently grandfathers non-qualifying capital instruments (such as trust preferred securities and cumulative perpetual preferred stock) issued before May 19, 2010 for inclusion in the Tier 1 capital of banking organizations with total consolidated assets less than $15 billion as of December 31, 2009 such as the Company. As a result the Company's trust preferred securities will continue to be included in Tier 1 capital.

Additional Deductions from Capital. Banking organizations will continued to be required to deduct goodwill and certain other intangible assets, from Common Equity Tier I Capital. Under the new rule, Mortgage Servicing Assets "MSAs" and Deferred Tax Assets "DTAs" are subject to stricter limitations than those applicable under the current general capital rules. DTAs arising from temporary differences and MSAs are each subject to an individual limit of 10 percent of common equity Tier 1 capital elements and are subject to an aggregate limit of 15 percent of common equity Tier 1 capital elements. The amount of these items in excess of the 10 and 15 percent thresholds are to be deducted from common equity Tier 1 capital. Amounts of DTAs and MSAs that are not deducted due to the threshold limits must be assigned to the 250 percent risk weight.

Changes in Risk-Weightings. The Final Rules have adopted similar risk weighting for residential mortgage loans as existing under the current general risk-based capital rules. The risk weights for residential mortgage loans under the existing general risk-based capital rules, assign a risk weight of either 50 percent (for most first-lien exposures) that are not past due, reported as nonaccrual or restructured, or 100 percent for other residential mortgage exposures. These same risk weights are incorporated into the new Final Rules. Most commercial loans would continue to be risk-weighted at 100 percent; "high volatility" commercial real estate loans would be risk-weighted at 150 percent. Changes are also being made in risk weighting of certain past-due credits, requiring a 150 percent risk weighting for those not collateralized or guaranteed.

The new capital standard rules are to become effective in stages for smaller, less complex banking organizations beginning on January 1, 2015 and being phased in through 2019. Requirements to maintain higher levels of capital and or to maintain higher levels of liquid assets may adversely impact the Company's net income and return on equity, restrict the ability to pay dividends and require the raising of additional capital.

These new capital rules incorporate selected changes to the Basel III provision contained in the Company's December 31, 2012 Form 10K, Part I, Item 1 - Business
- Bank Regulation - Basel Capital and Liquidity Initiatives.


As of June 30, 2013, the Company's Tier 1 leverage ratio, Tier 1 risk-based capital ratio, and Total risk-based capital ratio were 9.85%, 11.69% and 12.60%, respectively As of June 30, 2013, the Bank's Tier 1 leverage ratio, Tier 1 risk-based capital ratio, and Total risk-based capital ratio were 9.27%, 10.99% and 11.91%, respectively. This compares with the Bank's Tier 1 leverage ratio, Tier 1 risk-based capital ratio, and Total risk-based capital ratio at June 30, 2012 of 8.57%, 11.98% and 13.20%, 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:

Eight of the Company's and Bank's eleven directors at June 30, 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 Company's Board of Directors has Audit and Risk, 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 170 at June 30, 2013.


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 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.

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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 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

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.

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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 . . .

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