Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED

 

For the quarterly period ended June 30, 2011

 

o

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

 

FOR THE TRANSITION PERIOD FROM              TO              

 

COMMISSION FILE NUMBER: 1-10521

 

CITY NATIONAL CORPORATION

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

 

Delaware

 

95-2568550

(State of Incorporation)

 

(I.R.S. Employer Identification No.)

 

City National Plaza

555 South Flower Street, Los Angeles, California, 90071

(Address of principal executive offices)(Zip Code)

 

(213) 673-7700

(Registrant’s telephone number, including area code)

 

 

(Former name, former address and former fiscal year, if changed since last report)

 

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 the filing requirements for at least the past 90 days.  Yes  x  No  o

 

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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  x No  o

 

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

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

(Do not check if a smaller
reporting company)

 

Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  o  Yes  x  No

 

As of July 29, 2011, there were 53,195,181 shares of Common Stock outstanding (including unvested restricted shares).

 

 

 



Table of Contents

 

TABLE OF CONTENTS

 

PART I

 

 

Item 1.

Financial Statements

3

Item 2.

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

51

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

86

Item 4.

Controls and Procedures

90

 

 

 

PART II

 

 

Item 1A.

Risk Factors

92

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

92

Item 4.

Reserved

92

Item 6.

Exhibits

93

 

2



Table of Contents

 

PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

 

CITY NATIONAL CORPORATION

CONSOLIDATED BALANCE SHEETS

 

 

 

June 30,

 

December 31,

 

June 30,

 

(in thousands, except share amounts) 

 

2011

 

2010

 

2010

 

 

 

(Unaudited)

 

 

 

(Unaudited)

 

Assets

 

 

 

 

 

 

 

Cash and due from banks

 

$

181,203

 

$

126,882

 

$

184,277

 

Due from banks - interest-bearing

 

725,304

 

142,807

 

336,244

 

Federal funds sold 

 

123,000

 

165,000

 

404,760

 

Securities available-for-sale - cost $6,250,759, $5,658,120, and $4,668,089 at June 30, 2011, December 31, 2010 and June 30, 2010, respectively:

 

 

 

 

 

 

 

Securities pledged as collateral

 

 

 

198,577

 

Held in portfolio

 

6,348,055

 

5,720,675

 

4,562,566

 

Trading securities

 

125,829

 

255,397

 

129,287

 

Loans and leases, excluding covered loans

 

11,663,123

 

11,386,628

 

11,483,044

 

Less: Allowance for loan and lease losses

 

265,933

 

257,007

 

290,492

 

Loans and leases, excluding covered loans, net

 

11,397,190

 

11,129,621

 

11,192,552

 

Covered loans, net of allowance for loan losses

 

1,657,004

 

1,790,133

 

2,034,591

 

Net loans and leases

 

13,054,194

 

12,919,754

 

13,227,143

 

Premises and equipment, net

 

134,511

 

128,426

 

121,960

 

Deferred tax asset

 

88,179

 

105,398

 

99,894

 

Goodwill

 

486,383

 

486,070

 

479,982

 

Customer-relationship intangibles, net

 

39,824

 

42,564

 

44,838

 

Affordable housing investments

 

113,486

 

99,670

 

101,999

 

Customers’ acceptance liability

 

1,737

 

1,715

 

2,515

 

Other real estate owned ($114,907, $120,866 and $98,841 covered by FDIC loss share at June 30, 2011, December 31, 2010 and June 30, 2010, respectively)

 

162,541

 

178,183

 

153,292

 

FDIC indemnification asset

 

261,734

 

295,466

 

394,012

 

Other assets

 

680,109

 

685,111

 

790,101

 

Total assets

 

$

22,526,089

 

$

21,353,118

 

$

21,231,447

 

Liabilities

 

 

 

 

 

 

 

Demand deposits 

 

$

9,403,425

 

$

8,457,178

 

$

8,173,386

 

Interest checking deposits 

 

1,689,494

 

1,863,004

 

2,171,369

 

Money market deposits 

 

6,720,604

 

6,344,749

 

5,742,069

 

Savings deposits 

 

332,020

 

291,299

 

294,327

 

Time deposits-under $100,000 

 

293,573

 

338,112

 

434,626

 

Time deposits-$100,000 and over 

 

826,004

 

882,520

 

1,157,136

 

Total deposits 

 

19,265,120

 

18,176,862

 

17,972,913

 

Short-term borrowings 

 

149,771

 

153,444

 

3,400

 

Long-term debt 

 

701,829

 

704,971

 

985,974

 

Reserve for off-balance sheet credit commitments.

 

23,325

 

21,529

 

19,310

 

Acceptances outstanding 

 

1,737

 

1,715

 

2,515

 

Other liabilities 

 

256,560

 

264,203

 

272,753

 

Total liabilities 

 

20,398,342

 

19,322,724

 

19,256,865

 

Redeemable noncontrolling interest 

 

43,737

 

45,676

 

47,622

 

Commitments and contingencies

 

 

 

 

 

 

 

Equity

 

 

 

 

 

 

 

Common stock, par value $1.00 per share; 75,000,000 shares authorized; 53,885,886 shares issued at June 30, 2011, December 31, 2010 and June 30, 2010

 

53,886

 

53,886

 

53,886

 

Additional paid-in capital 

 

485,064

 

487,868

 

483,983

 

Accumulated other comprehensive income 

 

56,293

 

36,853

 

58,050

 

Retained earnings 

 

1,547,989

 

1,482,037

 

1,418,486

 

Treasury shares, at cost - 1,410,483, 1,639,203 and 1,796,485 shares at June 30, 2011, December 31, 2010 and June 30, 2010, respectively

 

(84,311

)

(101,065

)

(112,634

)

Total shareholders’ equity

 

2,058,921

 

1,959,579

 

1,901,771

 

Noncontrolling interest

 

25,089

 

25,139

 

25,189

 

Total equity 

 

2,084,010

 

1,984,718

 

1,926,960

 

Total liabilities and equity 

 

$

22,526,089

 

$

21,353,118

 

$

21,231,447

 

 

 See accompanying Notes to the Unaudited Consolidated Financial Statements.

 

3



Table of Contents

 

CITY NATIONAL CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 

 

 

For the three months ended

 

For the six months ended

 

 

 

June 30,

 

June 30,

 

(in thousands, except per share amounts)

 

2011

 

2010

 

2011

 

2010

 

Interest Income

 

 

 

 

 

 

 

 

 

Loans and leases

 

$

169,992

 

$

174,354

 

$

332,931

 

$

343,904

 

Securities available-for-sale

 

39,406

 

32,866

 

76,739

 

65,066

 

Trading securities

 

233

 

24

 

319

 

(28

)

Due from banks - interest-bearing

 

407

 

424

 

705

 

770

 

Federal funds sold and securities purchased under resale agreements

 

98

 

135

 

252

 

157

 

Total interest income

 

210,136

 

207,803

 

410,946

 

409,869

 

Interest Expense

 

 

 

 

 

 

 

 

 

Deposits

 

10,016

 

12,584

 

20,206

 

25,748

 

Federal funds purchased and securities sold under repurchase agreements

 

2

 

1,704

 

2

 

3,639

 

Subordinated debt

 

4,635

 

4,664

 

9,283

 

9,304

 

Other long-term debt

 

4,655

 

6,845

 

9,337

 

13,666

 

Other short-term borrowings

 

1

 

8

 

1

 

9

 

Total interest expense

 

19,309

 

25,805

 

38,829

 

52,366

 

Net interest income

 

190,827

 

181,998

 

372,117

 

357,503

 

Provision for credit losses on loans and leases, excluding covered loans

 

 

32,000

 

 

87,000

 

Provision for losses on covered loans

 

1,716

 

46,516

 

20,832

 

46,516

 

Net interest income after provision

 

189,111

 

103,482

 

351,285

 

223,987

 

Noninterest Income

 

 

 

 

 

 

 

 

 

Trust and investment fees

 

36,687

 

33,976

 

72,325

 

67,485

 

Brokerage and mutual fund fees

 

4,864

 

5,461

 

10,525

 

10,742

 

Cash management and deposit transaction charges

 

10,905

 

12,008

 

22,630

 

24,584

 

International services

 

9,015

 

8,374

 

17,331

 

14,882

 

FDIC loss sharing (expense) income, net

 

(10,684

)

28,339

 

(2,079

)

37,425

 

Gain (loss) on disposal of assets

 

8,422

 

(2,814

)

10,846

 

(1,423

)

Gain on sale of securities

 

1,689

 

355

 

1,819

 

2,489

 

Gain on acquisition

 

8,164

 

25,228

 

8,164

 

25,228

 

Other

 

23,169

 

12,215

 

44,727

 

19,606

 

Impairment loss on securities:

 

 

 

 

 

 

 

 

 

Total other-than-temporary impairment loss on securities

 

(4,132

)

(13,992

)

(4,296

)

(14,995

)

Less: Portion of loss recognized in other comprehensive income

 

3,838

 

13,486

 

3,838

 

13,486

 

Net impairment loss recognized in earnings

 

(294

)

(506

)

(458

)

(1,509

)

Total noninterest income

 

91,937

 

122,636

 

185,830

 

199,509

 

Noninterest Expense

 

 

 

 

 

 

 

 

 

Salaries and employee benefits

 

112,139

 

99,110

 

223,151

 

194,569

 

Net occupancy of premises

 

13,665

 

13,347

 

27,011

 

26,252

 

Legal and professional fees

 

14,790

 

13,754

 

24,867

 

22,937

 

Information services

 

8,335

 

7,538

 

15,832

 

15,054

 

Depreciation and amortization

 

6,904

 

6,363

 

13,652

 

12,710

 

Amortization of intangibles

 

2,104

 

2,128

 

4,272

 

4,575

 

Marketing and advertising

 

7,626

 

5,798

 

14,144

 

11,046

 

Office services and equipment

 

4,672

 

4,272

 

9,278

 

8,070

 

Other real estate owned

 

22,162

 

16,892

 

36,651

 

34,089

 

FDIC assessments

 

8,524

 

7,662

 

18,330

 

14,183

 

Other operating

 

10,911

 

9,823

 

22,041

 

19,136

 

Total noninterest expense

 

211,832

 

186,687

 

409,229

 

362,621

 

Income before income taxes

 

69,216

 

39,431

 

127,886

 

60,875

 

Income taxes

 

20,650

 

(2,859

)

38,536

 

1,559

 

Net income

 

$

48,566

 

$

42,290

 

$

89,350

 

$

59,316

 

Less: Net income attributable to noncontrolling interest

 

1,095

 

972

 

2,187

 

2,300

 

Net income attributable to City National Corporation

 

$

47,471

 

$

41,318

 

$

87,163

 

$

57,016

 

Less: Dividends and accretion on preferred stock

 

 

 

 

5,702

 

Net income available to common shareholders

 

$

47,471

 

$

41,318

 

$

87,163

 

$

51,314

 

Net income per share, basic

 

$

0.89

 

$

0.78

 

$

1.64

 

$

0.98

 

Net income per share, diluted

 

$

0.88

 

$

0.78

 

$

1.62

 

$

0.97

 

Shares used to compute net income per share, basic

 

52,462

 

52,012

 

52,392

 

51,852

 

Shares used to compute net income per share, diluted

 

52,977

 

52,542

 

52,931

 

52,336

 

Dividends per share

 

$

0.20

 

$

0.10

 

$

0.40

 

$

0.20

 

 

See accompanying Notes to the Unaudited Consolidated Financial Statements.

 

4



Table of Contents

 

CITY NATIONAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

 

For the six months ended

 

 

 

June 30,

 

(in thousands)

 

2011

 

2010

 

Cash Flows From Operating Activities

 

 

 

 

 

Net income

 

$

89,350

 

$

59,316

 

Adjustments to net income:

 

 

 

 

 

Provision for credit losses on loans and leases, excluding covered loans

 

 

87,000

 

Provision for losses on covered loans

 

20,832

 

46,516

 

Amortization of intangibles

 

4,272

 

4,575

 

Depreciation and amortization

 

13,652

 

12,710

 

Share-based employee compensation expense

 

9,468

 

8,109

 

Deferred income tax benefit

 

2,686

 

17,813

 

(Gain) loss on disposal of assets

 

(10,846

)

1,423

 

Gain on sale of securities

 

(1,819

)

(2,489

)

Gain on acquisition

 

(8,164

)

(25,228

)

Impairment loss on securities

 

458

 

1,509

 

Other, net

 

(9,418

)

(15,184

)

Net change in:

 

 

 

 

 

Trading securities

 

129,818

 

25,015

 

Other assets and other liabilities, net

 

51,709

 

154,439

 

Net cash provided by operating activities

 

291,998

 

375,524

 

Cash Flows From Investing Activities

 

 

 

 

 

Purchase of securities available-for-sale

 

(2,017,983

)

(1,684,200

)

Sales of securities available-for-sale

 

53,304

 

432,021

 

Maturities and paydowns of securities available-for-sale

 

1,367,512

 

907,157

 

Loan originations, net of principal collections

 

(108,530

)

629,454

 

Net payments for premises and equipment

 

(19,637

)

(10,361

)

Net cash acquired in acquisitions

 

28,066

 

94,706

 

Other investing activities, net

 

59,628

 

10,235

 

Net cash (used in) provided by investing activities

 

(637,640

)

379,012

 

Cash Flows From Financing Activities

 

 

 

 

 

Net increase in deposits

 

961,463

 

51,966

 

Net decrease in federal funds purchased and securities sold under repurchase agreements

 

 

(449,079

)

Net decrease in short-term borrowings, net of transfers from long-term debt

 

(3,105

)

(30,529

)

Net decrease in long-term debt

 

(757

)

(353

)

Proceeds from exercise of stock options

 

4,507

 

17,761

 

Tax benefit from exercise of stock options

 

992

 

3,281

 

Redemption of preferred stock

 

 

(200,000

)

Repurchase of common stock warrants

 

 

(18,500

)

Cash dividends paid

 

(21,211

)

(13,467

)

Other financing activities, net

 

(1,429

)

(3,261

)

Net cash provided by (used in) financing activities

 

940,460

 

(642,181

)

Net increase in cash and cash equivalents

 

594,818

 

112,355

 

Cash and cash equivalents at beginning of year

 

434,689

 

812,926

 

Cash and cash equivalents at end of period

 

$

1,029,507

 

$

925,281

 

Supplemental Disclosures of Cash Flow Information:

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

Interest

 

$

40,129

 

$

39,413

 

Income taxes

 

26,072

 

 

Non-cash investing activities:

 

 

 

 

 

Transfer of loans to other real estate owned

 

$

64,191

 

$

66,653

 

Assets acquired (liabilities assumed) in acquisitions:

 

 

 

 

 

Securities available-for-sale

 

$

10,441

 

$

17,183

 

Covered loans

 

55,313

 

330,566

 

Covered other real estate owned

 

7,463

 

15,161

 

Deposits

 

(126,795

)

(541,499

)

Other borrowings

 

(3,165

)

(30,539

)

 

See accompanying Notes to the Unaudited Consolidated Financial Statements.

 

5



Table of Contents

 

CITY NATIONAL CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

AND COMPREHENSIVE INCOME

(Unaudited)

 

 

 

City National Corporation Shareholders’ Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

Common

 

 

 

 

 

Additional

 

other

 

 

 

 

 

Non-

 

 

 

 

 

shares

 

Preferred

 

Common

 

paid-in

 

comprehensive

 

Retained

 

Treasury

 

controlling

 

Total

 

(in thousands, except share amounts)

 

issued

 

stock

 

stock

 

capital

 

income (loss)

 

earnings

 

shares

 

interest

 

equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, January 1, 2010

 

53,885,886

 

$

196,048

 

$

53,886

 

$

513,550

 

$

(3,049

)

$

1,377,639

 

$

(151,751

)

$

26,441

 

$

2,012,764

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (1) 

 

 

 

 

 

 

57,016

 

 

1,070

 

58,086

 

Other comprehensive income, net of tax (2) 

 

 

 

 

 

61,099

 

 

 

 

61,099

 

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1,070

 

119,185

 

Dividends and distributions to noncontrolling interest

 

 

 

 

 

 

 

 

(1,070

)

(1,070

)

Issuance of shares under share-based compensation plans

 

 

 

 

(22,687

)

 

 

39,109

 

 

16,422

 

Preferred stock accretion

 

 

3,952

 

 

 

 

(3,952

)

 

 

 

Redemption of preferred stock

 

 

(200,000

)

 

 

 

 

 

 

(200,000

)

Repurchase of common stock warrants

 

 

 

 

(18,500

)

 

 

 

 

(18,500

)

Share-based employee compensation expense

 

 

 

 

8,090

 

 

 

 

 

8,090

 

Tax benefit from share-based compensation plans

 

 

 

 

2,181

 

 

 

 

 

2,181

 

Cash dividends:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Preferred

 

 

 

 

 

 

(1,750

)

 

 

(1,750

)

Common

 

 

 

 

 

 

(10,467

)

 

 

(10,467

)

Net change in deferred compensation plans

 

 

 

 

425

 

 

 

8

 

 

433

 

Change in redeemable noncontrolling interest

 

 

 

 

924

 

 

 

 

 

924

 

Other

 

 

 

 

 

 

 

 

(1,252

)

(1,252

)

Balance, June 30, 2010

 

53,885,886

 

$

 

$

53,886

 

$

483,983

 

$

58,050

 

$

1,418,486

 

$

(112,634

)

$

25,189

 

$

1,926,960

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, January 1, 2011

 

53,885,886

 

$

 

$

53,886

 

$

487,868

 

$

36,853

 

$

1,482,037

 

$

(101,065

)

$

25,139

 

$

1,984,718

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (1) 

 

 

 

 

 

 

87,163

 

 

1,067

 

88,230

 

Other comprehensive income, net of tax (2) 

 

 

 

 

 

19,440

 

 

 

 

19,440

 

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1,067

 

107,670

 

Dividends and distributions to noncontrolling interest

 

 

 

 

 

 

 

 

(1,067

)

(1,067

)

Issuance of shares under share-based compensation plans

 

 

 

 

(14,229

)

 

 

16,754

 

 

2,525

 

Share-based employee compensation expense

 

 

 

 

9,363

 

 

 

 

 

9,363

 

Tax benefit from share-based compensation plans

 

 

 

 

1,037

 

 

 

 

 

1,037

 

Cash dividends:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common

 

 

 

 

 

 

(21,211

)

 

 

(21,211

)

Net change in deferred compensation plans

 

 

 

 

600

 

 

 

 

 

600

 

Change in redeemable noncontrolling interest

 

 

 

 

349

 

 

 

 

 

349

 

Other

 

 

 

 

76

 

 

 

 

(50

)

26

 

Balance, June 30, 2011

 

53,885,886

 

$

 

$

53,886

 

$

485,064

 

$

56,293

 

$

1,547,989

 

$

(84,311

)

$

25,089

 

$

2,084,010

 

 


(1)          Net income excludes net income attributable to redeemable noncontrolling interest of $1,120 and $1,230 for the six-month periods ended June 30, 2011 and 2010, respectively.  Redeemable noncontrolling interest is reflected in the mezzanine section of the consolidated balance sheets. See Note 17 of the Notes to the Unaudited Consolidated Financial Statements.

 

(2)          See Note 9 for additional information on other comprehensive income.

 

See accompanying Notes to the Unaudited Consolidated Financial Statements.

 

6



Table of Contents

 

CITY NATIONAL CORPORATION

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 1. Summary of Significant Accounting Policies

 

Organization

 

City National Corporation (the “Corporation”) is the holding company for City National Bank (the “Bank”). The Bank delivers banking, trust and investment services through 79 offices in Southern California, the San Francisco Bay area, Nevada, New York City and Nashville, Tennessee. As of June 30, 2011, the Corporation had five consolidated investment advisory affiliates and a noncontrolling interest in two other firms. The Corporation also had one unconsolidated subsidiary, Business Bancorp Capital Trust I. Because the Bank comprises substantially all of the business of the Corporation, references to the “Company” mean the Corporation and the Bank together. The Corporation is approved as a financial holding company pursuant to the Gramm-Leach-Bliley Act of 1999.

 

Consolidation

 

The consolidated financial statements of the Company include the accounts of the Corporation, its non-bank subsidiaries, the Bank and the Bank’s wholly owned subsidiaries, after the elimination of all material intercompany transactions.  The Company has both redeemable and non-redeemable noncontrolling interest. A noncontrolling interest is the portion of equity in a subsidiary not attributable to a parent.  Preferred stock of consolidated bank affiliates that is owned by third parties is reflected as Noncontrolling interest in the equity section of the consolidated balance sheets. Redeemable noncontrolling interest includes noncontrolling ownership interests that are redeemable at the option of the holder or outside the control of the issuer.  The redeemable equity ownership interests of third parties in the Corporation’s investment advisory affiliates are not considered to be permanent equity and are reflected as Redeemable noncontrolling interest in the mezzanine section between liabilities and equity in the consolidated balance sheets. Noncontrolling interests’ share of subsidiary earnings is reflected as Net income attributable to noncontrolling interest in the consolidated statements of income.

 

The Company’s investment management and wealth advisory affiliates are organized as limited liability companies.  The Corporation generally owns a majority position in each affiliate and certain management members of each affiliate own the remaining shares. The Corporation has contractual arrangements with its affiliates whereby a percentage of revenue is allocable to fund affiliate operating expenses (“operating share”) while the remaining portion of revenue (“distributable revenue”) is allocable to the Corporation and the noncontrolling owners. All majority-owned affiliates that meet the prescribed criteria for consolidation are consolidated.  The Corporation’s interests in two investment management affiliates in which it holds a noncontrolling share are accounted for using the equity method. Additionally, the Company has various interests in variable interest entities (“VIEs”) that are not required to be consolidated. See Note 16 for a more detailed discussion on VIEs.

 

Use of Estimates

 

The Company’s accounting and reporting policies conform to generally accepted accounting principles (“GAAP”) and practices in the financial services industry. To prepare the financial statements in conformity with GAAP, management must make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements, and income and expenses during the reporting period. Circumstances and events that differ significantly from those underlying the Company’s estimates and assumptions could cause actual financial results to differ from those estimates. The material estimates included in the financial statements relate to the allowance for loan and lease losses, the reserve for off-balance sheet credit commitments, valuation of stock options and restricted stock, income taxes, goodwill and intangible asset impairment, securities available-for-sale impairment, private equity and alternative investment impairment, valuation of assets and liabilities acquired in business combinations, subsequent valuations of acquired impaired loans, FDIC indemnification assets, valuation of noncontrolling interest and the valuation of financial assets and liabilities reported at fair value.

 

The Company has applied its critical accounting policies and estimation methods consistently in all periods presented in these financial statements.

 

7



Table of Contents

 

Note 1. Summary of Significant Accounting Policies (Continued)

 

Basis of Presentation

 

The Company is on the accrual basis of accounting for income and expenses. The results of operations reflect any adjustments, all of which are of a normal recurring nature, unless otherwise disclosed in this Form 10-Q, and which, in the opinion of management, are necessary for a fair presentation of the results for the periods presented. In accordance with the usual practice of banks, assets and liabilities of individual trust, agency and fiduciary funds have not been included in the financial statements. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.

 

The results for the 2011 interim period are not necessarily indicative of the results expected for the full year. The Company has not made any significant changes in its critical accounting policies or in its estimates and assumptions from those disclosed in its 2010 Annual Report other than the adoption of new accounting pronouncements and other authoritative guidance that became effective for the Company on or after January 1, 2011. Refer to Accounting Pronouncements for discussion of accounting pronouncements adopted in 2011.

 

Certain prior period amounts have been reclassified to conform to the current period presentation.

 

Accounting Pronouncements

 

During the six months ended June 30, 2011, the following accounting pronouncements applicable to the Company were issued or became effective:

 

·                  In January 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2010-06, Fair Value Measurements (Topic 820), Improving Disclosures about Fair Value Measurements (“ASU 2010-06”). ASU 2010-06 enhances disclosure requirements under Accounting Standards Codification (“ASC”) Topic 820, Fair Value Measurements and Disclosures (“ASC 820”), to include disclosure of transfers in and out of Level 1 and 2, and detail of activity in Level 3 fair value measurements. The ASU also provides clarification of existing disclosure requirements pertaining to the level of disaggregation used in fair value measurements, and disclosures about inputs and valuation techniques used for both recurring and nonrecurring fair value measurements. The new guidance, except for the requirement to provide the Level 3 activity on a gross basis, was adopted by the Company on January 1, 2010. The expanded disclosure requirements pertaining to Level 3 activity became effective for the Company on January 1, 2011. Adoption of the new guidance did not have a material effect on the Company’s consolidated financial statements.

 

·              In April 2011, the FASB issued ASU 2011-02, Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructurings (“ASU 2011-02”).  In evaluating whether a restructuring constitutes a troubled debt restructuring (“TDR”), a creditor (“lender”) must separately conclude that both of the following exist: (1) the restructuring constitutes a concession and (2) the debtor (“borrower”) is experiencing financial difficulties. Determining whether a modification is a TDR requires significant judgment. ASU 2011-02 clarifies the guidance on whether a lender has granted a concession, and on the lender’s evaluation of whether a borrower is experiencing financial difficulties. ASU 2011-02 is effective for interim and annual periods beginning on or after June 15, 2011, and applies retrospectively to restructurings occurring on or after the beginning of the annual period of adoption. Thus, an entity will be required to apply the guidance to determine whether modifications that were not previously considered TDRs and that have occurred since the beginning of the year would now be considered TDRs. Adoption of the new guidance is not expected to have a significant effect on the Company’s financial statements.

 

8



Table of Contents

 

Note 1. Summary of Significant Accounting Policies (Continued)

 

·              In April 2011, the FASB issued ASU 2011-03, Transfers and Servicing (Topic 860): Reconsideration of Effective Control for Repurchase Agreements (“ASU 2011-03”).  ASC 860, Transfers and Servicing, provides the criteria for determining whether a transfer of financial assets is accounted for as a secured borrowing or as a sale. Under the guidance, an entity that maintains effective control over transferred assets must account for the transfer as a secured borrowing. ASU 2011-03 eliminates the requirement for entities to consider whether a transferor has the ability to repurchase the financial assets in a repurchase agreement for purposes of determining whether the transferor has maintained effective control. The ASU does not change the other criteria applicable to the assessment of effective control. ASU 2011-03 is effective for transactions, or modification of existing transactions, that occur on or after the first interim or annual period beginning on or after December 15, 2011. The new guidance is not expected to have a material effect on the Company’s consolidated financial statements.

 

·              In May 2011, the FASB issued ASU 2011-04, Fair Value Measurements (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs (“ASU 2011-04”). ASU 2011-04 represents the converged guidance of the FASB and International Accounting Standards Board on fair value. The new guidance establishes a common framework for measuring fair value and for disclosing information about fair value measurements. While ASU 2011-04 is largely consistent with existing fair value measurement principles, it does expand disclosure requirements and amends certain guidance. ASU 2011-04 clarifies existing guidance pertaining to the applicability of the concepts of highest and best use and valuation premise in a fair value measurement, and on measuring the fair value of an instrument classified in shareholders’ equity. The ASU provides a framework for considering whether a premium or discount can be applied in a fair value measurement, and provides additional guidance on the application of fair value measurements to financial assets and liabilities with offsetting positions in market risk or counterparty credit risks. The expanded disclosure requirements include more detailed disclosures about the valuation processes used in fair value measurements within Level 3 of the fair value hierarchy, and categorization by level of the fair value hierarchy for items that are not measured at fair value in the statement of financial position but for which fair value is required to be disclosed in accordance with ASC Topic 825, Financial Instruments.  The ASU is effective for interim and annual periods beginning after December 15, 2011.  Adoption of ASU 2011-04, when effective, will result in expanded fair value disclosures in the Company’s consolidated financial statements.

 

·                  In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220), Presentation of Comprehensive Income (“ASU 2011-05”). ASU 2011-05 revises the manner in which entities present comprehensive income in their financial statements. The new guidance requires entities to report components of comprehensive income in either (1) a continuous statement of comprehensive income or (2) two separate but consecutive statements. Under the two-statement approach, the first statement would include components of net income, which is consistent with the income statement format used today, and the second statement would include components of other comprehensive income (“OCI”). Under either method, entities must display adjustments for items that are reclassified from OCI to net income in both net income and OCI. The ASU does not change the items that must be reported in OCI. ASU 2011-05 is effective for interim and annual periods beginning after December 15, 2011. After adoption, the guidance must be applied retrospectively for all periods presented in the financial statements. The new guidance is not expected to have a material effect on the Company’s consolidated financial statements.

 

Note 2. Business Combinations

 

Nevada Commerce Bank

 

On April 8, 2011, the Bank acquired the banking operations of Nevada Commerce Bank (“NCB”), based in Las Vegas, Nevada, in a purchase and assumption agreement with the Federal Deposit Insurance Corporation (“FDIC”). Excluding the effects of acquisition accounting adjustments, the Bank acquired approximately $138.9 million in assets and assumed $121.9 million in liabilities.  The Bank acquired most of NCB’s assets, including loans and other real estate owned (“OREO”) with a fair value of $56.4 million and $7.5 million, respectively, and assumed deposits with a fair value of $118.4 million. The Bank received approximately $2.7 million in cash from the FDIC.

 

9



Table of Contents

 

Note 2. Business Combinations (Continued)

 

The Bank did not immediately acquire banking facilities, furniture or equipment as part of the purchase and assumption agreement, but had a 90 day option to purchase any or all owned bank premises including furniture, fixtures and equipment and to assume any or all leases for leased bank premises from the FDIC.

 

In connection with the acquisition of NCB, the Bank entered into loss-sharing agreements with the FDIC under which the FDIC will reimburse the Bank for 80 percent of eligible losses with respect to covered assets. Covered assets include acquired loans (“covered loans”) and OREO (“covered OREO”) that are covered under loss-sharing agreements with the FDIC. The term of the loss-sharing agreements is 10 years for single-family residential loans and eight years for all other loans. The expected reimbursements under the loss-sharing agreements were recorded as an indemnification asset at their estimated fair value of $33.8 million. The difference between the fair value of the FDIC indemnification asset and the undiscounted cash flow the Bank expects to collect from the FDIC is accreted into noninterest income.

 

The Bank recognized a gain of $8.2 million on the acquisition of NCB. The gain represents the amount by which the fair value of the assets acquired and consideration received from the FDIC exceeds the liabilities assumed. The gain is reported in Gain on acquisition in the consolidated statements of income. The Bank recognized approximately $0.3 million of acquisition-related expense. This expense is included in Legal and professional fees in the consolidated statements of income.

 

The consolidated statement of income for 2011 includes the operating results produced by the acquired assets and assumed liabilities of NCB from its acquisition date through June 30, 2011, which are not material to total operating results for the three and six month periods ended June 30, 2011. Due primarily to the Bank acquiring certain assets and liabilities of NCB which are not material to the Company’s consolidated balance sheet, the significant amount of fair value adjustments, and the FDIC loss-sharing agreements, the historical results of the acquired bank is not material to the Company’s results, and consequently, no pro forma information is presented.

 

San Jose, California Branch

 

On February 11, 2011, the Company purchased a branch banking office in San Jose, California from another financial institution. The Company acquired approximately $8.4 million in deposits. The Company recorded $0.3 million of goodwill and a core deposit intangible of $0.1 million with its acquisition of the branch.

 

Datafaction, Inc.

 

On November 15, 2010, the Corporation acquired Datafaction Inc. (“Datafaction”), a provider of accounting and imaging software for business managers and professional services firms, in an all-cash transaction. Datafaction’s product and service offerings are expected to complement the cash management solutions available to the Company’s business clients. The Company recognized goodwill of approximately $6.2 million and a customer contract intangible of approximately $2.2 million related to the acquisition.

 

Sun West Bank and 1st Pacific Bank of California

 

On May 28, 2010, the Bank acquired the banking operations of Sun West Bank (“SWB”) in Las Vegas, Nevada in a purchase and assumption agreement with the FDIC. Excluding the effects of acquisition accounting adjustments, the Bank acquired approximately $340.0 million in assets and assumed $310.1 million in liabilities. The Bank acquired most of SWB’s assets, including loans and OREO with a fair value of $127.6 million and $12.1 million, respectively, and assumed deposits with a fair value of $304.3 million. The Bank received approximately $29.2 million in cash from the FDIC at acquisition and recognized a gain of $24.7 million on the acquisition of SWB in the second quarter of 2010.

 

On May 7, 2010, the Bank acquired the banking operations of 1st Pacific Bank of California (“FPB”) in a purchase and assumption agreement with the FDIC. Excluding the effects of acquisition accounting adjustments, the Bank acquired approximately $318.6 million in assets and assumed $264.2 million in liabilities. The Bank acquired most of FPB’s assets, including loans with a fair value of $202.8 million and assumed deposits with a fair value of $237.2 million. The Bank paid $12.3 million in cash to the FDIC at acquisition. During the second quarter of 2010, the Bank recognized a gain of $0.5 million on the acquisition of FPB. During the third quarter of 2010, the Bank recognized an additional gain of $2.1 million when the first loss tranche under the FPB loss-sharing agreement was amended by the FDIC.

 

10



Table of Contents

 

Note 2. Business Combinations (Continued)

 

In connection with the acquisitions of SWB and FPB, the Bank entered into loss-sharing agreements with the FDIC under which the FDIC reimburses the Bank for 80 percent of eligible losses with respect to covered assets. The term of the loss-sharing agreements is 10 years for single-family residential loans and eight years for all other loans. The expected reimbursements under the loss-sharing agreements were recorded as indemnification assets at their estimated fair value of $104.6 million for SWB and $36.5 million for FPB at acquisition date. The difference between the fair value of the FDIC indemnification asset and the undiscounted cash flows that the Bank expects to collect from the FDIC is accreted into noninterest income.

 

The Bank recognized a $3.6 million liability in the acquisition of FPB relating to a requirement that the Bank reimburse the FDIC if actual cumulative losses are lower than the cumulative losses originally estimated by the FDIC at the time of acquisition. There was no similar liability recognized in the acquisition of SWB.

 

Note 3. Fair Value Measurements

 

Accounting guidance defines fair value for financial reporting purposes as the price that would be received to sell an asset or paid to transfer a liability in an orderly market transaction between market participants at the measurement date (reporting date). Fair value is based on an exit price in the principal market or most advantageous market in which the reporting entity could transact.

 

For each asset and liability required to be reported at fair value, management has identified the unit of account and valuation premise to be applied for purposes of measuring fair value. The unit of account is the level at which an asset or liability is aggregated or disaggregated for purposes of applying fair value measurement. The valuation premise is a concept that determines whether an asset is measured on a standalone basis or in combination with other assets. The Company measures its assets and liabilities on a standalone basis then aggregates assets and liabilities with similar characteristics for disclosure purposes.

 

Fair Value Hierarchy

 

Management employs market standard valuation techniques in determining the fair value of assets and liabilities. Inputs used in valuation techniques are based on assumptions that market participants would use in pricing an asset or liability. The inputs used in valuation techniques are prioritized as follows:

 

Level 1—Quoted market prices in an active market for identical assets and liabilities.

 

Level 2—Observable inputs including quoted prices (other than Level 1) in active markets for similar assets or

liabilities, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability such as interest rates, yield curves,

volatilities and default rates, and inputs that are derived principally from or corroborated by observable market data.

 

Level 3—Unobservable inputs reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability based on the best information available.

 

If the determination of fair value measurement for a particular asset or liability is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. Management’s assessment of the significance of a particular input to the fair value measurement requires judgment and considers factors specific to the asset or liability measured.

 

11



Table of Contents

 

Note 3. Fair Value Measurements (Continued)

 

The Company records securities available-for-sale, trading securities and derivative contracts at fair value on a recurring basis.  Certain other assets such as impaired loans, OREO, goodwill, customer-relationship intangibles and investments carried at cost are recorded at fair value on a nonrecurring basis.  Nonrecurring fair value measurements typically involve assets that are periodically evaluated for impairment and for which any impairment is recorded in the period in which the remeasurement is performed.

 

The following tables summarize assets and liabilities measured at fair value as of June 30, 2011, December 31, 2010 and June 30, 2010 by level in the fair value hierarchy:

 

 

 

 

 

Fair Value Measurements at Reporting Date Using

 

(in thousands)

 

Balance as of
June 30, 2011

 

Quoted Prices in
Active Markets
Level 1

 

Significant Other
Observable
Inputs
Level 2

 

Significant
Unobservable
Inputs
Level 3

 

Measured on a Recurring Basis

 

 

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

 

Securities available-for-sale

 

 

 

 

 

 

 

 

 

U.S. Treasury

 

$

13,076

 

$

13,076

 

$

 

$

 

Federal agency - Debt

 

1,847,232

 

 

1,847,232

 

 

Federal agency - MBS

 

534,726

 

 

534,726

 

 

CMOs - Federal agency

 

3,453,901

 

 

3,453,901

 

 

CMOs - Non-agency

 

91,083

 

 

91,083

 

 

State and municipal

 

357,804

 

 

357,804

 

 

Other debt securities

 

44,121

 

 

23,315

 

20,806

 

Equity securities and mutual funds

 

6,112

 

6,112

 

 

 

Trading securities

 

125,829

 

121,141

 

4,688

 

 

Mark-to-market derivatives (1)

 

44,488

 

3,308

 

41,180

 

 

Total assets at fair value

 

$

6,518,372

 

$

143,637

 

$

6,353,929

 

$

20,806

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

Mark-to-market derivatives (2)

 

$

29,501

 

$

1,226

 

$

28,275

 

$

 

Other liabilities

 

161

 

 

161

 

 

Total liabilities at fair value

 

$

29,662

 

$

1,226

 

$

28,436

 

$

 

 

 

 

 

 

 

 

 

 

 

Measured on a Nonrecurring Basis

 

 

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

 

Collateral dependent impaired loans (3)

 

 

 

 

 

 

 

 

 

Commercial (4)

 

$

3,822

 

$

 

$

3,822

 

$

 

Commercial real estate mortgages

 

2,505

 

 

2,505

 

 

Residential mortgages

 

4,656

 

 

4,175

 

481

 

Real estate construction

 

10,136

 

 

1,610

 

8,526

 

Equity lines of credit

 

2,064

 

 

1,178

 

886

 

Other real estate owned (5)

 

61,103

 

 

41,264

 

19,839

 

Private equity investments

 

7,293

 

 

 

7,293

 

Total assets at fair value

 

$

91,579

 

$

 

$

54,554

 

$

37,025

 

 


(1)

Reported in Other assets in the consolidated balance sheets.

(2)

Reported in Other liabilities in the consolidated balance sheets.

(3)

Impaired loans for which fair value was calculated using the collateral valuation method.

(4)

Includes lease financing.

(5)

Other real estate owned balance of $162.5 million in the consolidated balance sheets includes $114.9 million of covered OREO and is net of estimated disposal costs.

 

12



Table of Contents

 

Note 3. Fair Value Measurements (Continued)

 

 

 

 

 

Fair Value Measurements at Reporting Date Using

 

(in thousands)

 

Balance as of
December 31,
2010

 

Quoted Prices in
Active Markets
Level 1

 

Significant Other
Observable
Inputs
Level 2

 

Significant
Unobservable
Inputs
Level 3

 

Measured on a Recurring Basis

 

 

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

 

Securities available-for-sale

 

 

 

 

 

 

 

 

 

U.S. Treasury

 

$

14,113

 

$

14,113

 

$

 

$

 

Federal agency - Debt

 

1,142,328

 

 

1,142,328

 

 

Federal agency - MBS

 

551,346

 

 

551,346

 

 

CMOs - Federal agency

 

3,497,147

 

 

3,497,147

 

 

CMOs - Non-agency

 

118,295

 

 

118,295

 

 

State and municipal

 

343,380

 

 

343,380

 

 

Other debt securities

 

43,630

 

 

22,648

 

20,982

 

Equity securities and mutual funds

 

10,436

 

10,436

 

 

 

Trading securities

 

255,397

 

249,861

 

5,536

 

 

Mark-to-market derivatives (1)

 

46,712

 

3,258

 

43,454

 

 

Total assets at fair value

 

$

6,022,784

 

$

277,668

 

$

5,724,134

 

$

20,982

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

Mark-to-market derivatives (2)

 

$

26,437

 

$

1,215

 

$

25,222

 

$

 

Other liabilities

 

160

 

 

160

 

 

Total liabilities at fair value

 

$

26,597

 

$

1,215

 

$

25,382

 

$

 

 

 

 

 

 

 

 

 

 

 

Measured on a Nonrecurring Basis

 

 

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

 

Collateral dependent impaired loans (3)

 

 

 

 

 

 

 

 

 

Commercial (4)

 

$

1,528

 

$

 

$

1,528

 

$

 

Commercial real estate mortgages

 

31,684

 

 

21,236

 

10,448

 

Residential mortgages

 

9,061

 

 

8,210

 

851

 

Real estate construction

 

98,059

 

 

98,059

 

 

Equity lines of credit

 

3,092

 

 

 

2,224

 

868

 

Collateral dependent impaired covered loans (3)

 

 

 

 

 

 

 

 

 

Commercial

 

2,557

 

 

 

2,557

 

Other real estate owned (5)

 

88,993

 

 

65,605

 

23,388

 

Private equity investments

 

10,804

 

 

 

10,804

 

Total assets at fair value

 

$

245,778

 

$

 

$

196,862

 

$

48,916

 

 


(1)

Reported in Other assets in the consolidated balance sheets.

(2)

Reported in Other liabilities in the consolidated balance sheets.

(3)

Impaired loans for which fair value was calculated using the collateral valuation method.

(4)

Includes lease financing.

(5)

Other real estate owned balance of $178.2 million in the consolidated balance sheets includes $120.9 million of covered OREO and is net of estimated disposal costs.

 

13



Table of Contents

 

Note 3. Fair Value Measurements (Continued)

 

 

 

 

 

Fair Value Measurements at Reporting Date Using

 

(in thousands)

 

Balance as of
June 30, 2010

 

Quoted Prices in
Active Markets
Level 1

 

Significant Other
Observable
Inputs
Level 2

 

Significant
Unobservable
Inputs
Level 3

 

Measured on a Recurring Basis

 

 

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

 

Securities available-for-sale

 

 

 

 

 

 

 

 

 

U.S. Treasury

 

$

19,145

 

$

19,145

 

$

 

$

 

Federal agency - Debt

 

1,090,846

 

 

1,090,846

 

 

Federal agency - MBS

 

466,713

 

 

466,713

 

 

CMOs - Federal agency

 

2,528,237

 

 

2,528,237

 

 

CMOs - Non-agency

 

217,078

 

 

217,078

 

 

State and municipal

 

360,422

 

 

360,422

 

 

Other debt securities

 

67,147

 

 

42,003

 

25,144

 

Equity securities and mutual funds

 

11,555

 

11,555

 

 

 

Trading securities

 

129,287

 

113,483

 

15,804

 

 

Mark-to-market derivatives (1)

 

60,619

 

4,976

 

55,643

 

 

Total assets at fair value

 

$

4,951,049

 

$

149,159

 

$

4,776,746

 

$

25,144

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

Mark-to-market derivatives (2)

 

$

31,736

 

$

1,629

 

$

30,107

 

$

 

Total liabilities at fair value

 

$

31,736

 

$

1,629

 

$

30,107

 

$

 

 

 

 

 

 

 

 

 

 

 

Measured on a Nonrecurring Basis

 

 

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

 

Collateral dependent impaired loans (3)

 

 

 

 

 

 

 

 

 

Commercial (4)

 

$

2,996

 

$

 

$

2,746

 

$

250

 

Commercial real estate mortgages

 

35,656

 

 

21,243

 

14,413

 

Residential mortgages

 

7,364

 

 

6,985

 

379

 

Real estate construction

 

111,339

 

 

85,460

 

25,879

 

Other real estate owned (5)

 

50,797

 

 

43,592

 

7,205

 

Private equity investments

 

4,427

 

 

 

4,427

 

Total assets at fair value

 

$

212,579

 

$

 

$

160,026

 

$

52,553

 

 


(1)

Reported in Other assets in the consolidated balance sheets.

(2)

Reported in Other liabilities in the consolidated balance sheets.

(3)

Impaired loans for which fair value was calculated using the collateral valuation method.

(4)

Includes lease financing.

(5)

Other real estate owned balance of $153.3 million in the consolidated balance sheets includes $98.8 million of covered OREO and is net of estimated disposal costs.

 

At June 30, 2011, $6.52 billion, or approximately 29 percent, of the Company’s total assets were recorded at fair value on a recurring basis, compared with $6.02 billion or approximately 28 percent at December 31, 2010, and $4.95 billion or approximately 23 percent at June 30, 2010. The majority of these financial assets were valued using Level 1 or Level 2 inputs.  Less than 1 percent of total assets was measured using Level 3 inputs.  Approximately $29.7 million, $26.6 million and $31.7 million of the Company’s total liabilities at June 30, 2011, December 31, 2010 and June 30, 2010, respectively, were recorded at fair value on a recurring basis using Level 1 or Level 2 inputs.  At June 30, 2011, $91.6 million, or less than 1 percent of the Company’s total assets, were recorded at fair value on a nonrecurring basis, compared with $245.8 million, or 1 percent, at December 31, 2010, and $212.6 million, or 1 percent, at June 30, 2010.  These assets were measured using Level 2 and Level 3 inputs.  There were no transfers of assets or liabilities between Level 1 and Level 2 of the fair value hierarchy during the six months ended June 30, 2011.

 

14



Table of Contents

 

Note 3. Fair Value Measurements (Continued)

 

For assets measured at fair value on a nonrecurring basis, the following table presents the total net losses (gains), which include charge-offs, recoveries, specific reserves, OREO valuation write-downs and write-ups, gains and losses on sales of OREO, and impairment write-downs on private equity investments, recognized in the three and six months ended June 30, 2011 and 2010:

 

 

 

For the three months ended
June 30,

 

For the six months ended
June 30,

 

(in thousands)

 

2011

 

2010

 

2011

 

2010

 

Collateral dependent impaired loans

 

 

 

 

 

 

 

 

 

Commercial

 

$

 

$

4,279

 

$

606

 

$

6,896

 

Commercial real estate mortgages

 

(340

)

141

 

(7,454

)

17,448

 

Residential mortgages

 

47

 

353

 

189

 

1,206

 

Real estate construction

 

3,417

 

(125

)

1,199

 

10,120

 

Equity lines of credit

 

546

 

51

 

510

 

51

 

Installment

 

(197

)

 

4,317

 

 

Other real estate owned

 

16,869

 

10,068

 

25,991

 

22,616

 

Private equity investments

 

200

 

30

 

200

 

428

 

Total net losses recognized

 

$

20,542

 

$

14,797

 

$

25,558

 

$

58,765

 

 


(1)

Net losses on OREO includes $14.6 million and $22.8 million of net losses related to covered OREO for the three and six months ended June 30, 2011, respectively, a significant portion of which is reimbursable by the FDIC.

 

Level 3 assets measured at fair value on a recurring basis consist of collateralized debt obligation senior notes.  The fair value of these securities is determined using an internal cash flow model that incorporates management’s assumptions about risk-adjusted discount rates, prepayment expectations, projected cash flows and collateral performance. These assumptions are not directly observable in the market. Unrealized gains and losses on securities available-for-sale are reported as a component of Accumulated other comprehensive income (“AOCI”) in the consolidated balance sheets.  Activity in Level 3 assets measured at fair value on a recurring basis for the six months ended June 30, 2011 and 2010 is summarized in the following table:

 

Level 3 Assets Measured on a Recurring Basis

 

 

 

For the six months ended

 

 

 

June 30, 2011

 

June 30, 2010

 

(in thousands)

 

Securities
Available-for-Sale

 

Securities
Available-for-Sale

 

Balance, beginning of period

 

$

20,982

 

$

26,779

 

Total realized/unrealized gains (losses):

 

 

 

 

 

Included in other comprehensive income

 

1,585

 

(1,358

)

Settlements

 

(1,728

)

(221

)

Other (1)

 

(33

)

(56

)

Balance, end of period

 

$

20,806

 

$

25,144

 

 


(1)

Other rollforward activity consists of amortization of premiums recognized on the initial purchase of the securities available-for-sale.

 

There were no purchases, sales or issuances of Level 3 assets measured on a recurring basis during the six months ended June 30, 2011 and 2010.  Paydowns of $1.7 million and $0.2 million were received on Level 3 assets measured on a recurring basis for the six months ended June 30, 2011 and 2010, respectively. There were no gains or losses for the six months ended June 30, 2011 and 2010 included in earnings that were attributable to the change in unrealized gains or losses relating to assets still held as of June 30, 2011 and 2010.

 

15



Table of Contents

 

Note 3. Fair Value Measurements (Continued)

 

Level 3 assets measured at fair value on a nonrecurring basis include certain collateral dependent impaired loans, OREO for which fair value is not solely based on market observable inputs, and certain private equity and alternative investments.  Non-observable inputs related to valuing loans and OREO may include adjustments to external appraised values based on an internally generated discounted cash flow analysis or management’s assumptions about market trends or other factors that are not directly observable. Private equity and alternative investments do not have readily determinable fair values. These investments are carried at cost and evaluated for impairment on a quarterly basis.  Due to the lack of readily determinable fair values for these investments, the impairment assessment is based primarily on a review of investment performance and the likelihood that the capital invested would be recovered.

 

Fair Value of Financial Instruments

 

A financial instrument is broadly defined as cash, evidence of an ownership interest in another entity, or a contract that imposes a contractual obligation on one entity and conveys a corresponding right to a second entity to require delivery or exchange of a financial instrument. The table below summarizes the estimated fair values for the Company’s financial instruments as of June 30, 2011 and June 30, 2010.  The disclosure does not include estimated fair value amounts for assets and liabilities which are not defined as financial instruments but which have significant value. These assets and liabilities include the value of customer-relationship intangibles, goodwill, and affordable housing investments carried at cost, other assets, deferred taxes and other liabilities. Accordingly, the total of the fair values presented does not represent the underlying value of the Company.

 

Following is a description of the methods and assumptions used in estimating the fair values for each class of financial instrument:

 

Cash and due from banks, Due from banks—interest bearing and Federal funds sold For these short-term instruments, the carrying amount is a reasonable estimate of fair value.

 

Securities available-for-sale and Trading securities For securities held as available-for-sale, the fair value is determined by quoted market prices, where available, or on observable market inputs appropriate for the type of security. If quoted market prices or observable market inputs are not available, discounted cash flows may be used to determine an appropriate fair value. Fair values for trading securities are based on quoted market prices or dealer quotes.  The fair value of trading securities for which quoted prices are not available is based on observable market inputs.

 

Loans and leases Loans are not recorded at fair value on a recurring basis. Nonrecurring fair value adjustments are periodically recorded on impaired loans that are measured for impairment based on the fair value of collateral. Due to the lack of activity in the secondary market for the types of loans in the Company’s portfolio, a model-based approach is used for determining the fair value of loans for purposes of the disclosures in the following table. The fair value of loans is estimated by discounting future cash flows using discount rates that incorporate the Company’s assumptions concerning current market yields, credit risk and liquidity premiums. Loan cash flow projections are based on contractual loan terms adjusted for the impact of current interest rate levels on borrower behavior, including prepayments. Loan prepayment assumptions are based on industry standards for the type of loans being valued. Projected cash flows are discounted using yield curves based on current market conditions. Yield curves are constructed by product type using the Bank’s loan pricing model for like-quality credits.  The discount rates used in the Company’s model represent the rates the Bank would offer to current borrowers for like-quality credits. These rates could be different from what other financial institutions could offer for these loans.

 

Covered loans The fair value of covered loans is based on estimates of future loan cash flows and appropriate discount rates, which incorporate the Company’s assumptions about market funding cost and liquidity premium. The estimates of future loan cash flows are determined using the Company’s assumptions concerning the amount and timing of principal and interest payments, prepayments and credit losses.

 

FDIC indemnification asset The fair value of the FDIC indemnification asset is estimated by discounting estimated future cash flows based on estimated current market rates.

 

16



Table of Contents

 

Note 3. Fair Value Measurements (Continued)

 

Investment in FHLB and FRB stock Investments in government agency stock are recorded at cost.  Ownership of these securities is restricted to member banks and the securities do not have a readily determinable market value.  Purchases and sales of these securities are at par value with the issuer.  The fair value of investments in FRB and FHLB stock is equal to the carrying amount.

 

Derivative contracts The fair value of non-exchange traded (over-the-counter) derivatives is obtained from third party market sources.  The Company provides client data to the third party source for purposes of calculating the credit valuation component of the fair value measurement of client derivative contracts. The fair values of interest rate contracts include interest receivable and payable and cash collateral, if any.

 

Deposits The fair value of demand and interest checking deposits, savings deposits, and certain money market accounts is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit (“CD”) is determined by discounting expected future cash flows using the rates offered by the Bank for deposits of similar type and remaining maturity at the measurement date.  This value is compared to the termination value of each CD given the bank’s standard early withdrawal penalties. The fair value reported is the higher of the discounted present value of each CD and the termination value after the recovery of prepayment penalties. The Bank reviews pricing for its CD products weekly. This review gives consideration to market pricing for products of similar type and maturity offered by other financial institutions.

 

Federal funds purchased and Securities sold under repurchase agreements The carrying amount is a reasonable estimate of fair value.

 

Other short-term borrowings The fair value of the current portion of long-term debt classified in short-term borrowings is obtained through third-party pricing sources.  The carrying amount of the remaining other short-term borrowings is a reasonable estimate of fair value.

 

Structured securities sold under repurchase agreements The fair value of structured repurchase agreements is based on market pricing for synthetic instruments with the same term and structure.  These values are validated against dealer quotes for similar instruments.

 

Long-term debt The fair value of long-term debt is obtained through third-party pricing sources.

 

FDIC clawback liability The FDIC clawback liability represents an estimated payment by the Company to the FDIC if actual cumulative losses on acquired covered assets are lower than the cumulative losses originally estimated by the FDIC at the time of acquisition. The fair value of the FDIC clawback liability is estimated by discounting estimated future cash flows based on estimated current market rates.

 

Commitments to extend credit The fair value of these commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties, or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date. The Company does not make fixed-rate loan commitments.

 

Commitments to affordable housing funds, private equity funds and alternative investments The fair value of commitments to invest in affordable housing funds, private equity funds and alternative investments is based on the estimated cost to terminate them or otherwise settle the obligation.

 

17



Table of Contents

 

Note 3. Fair Value Measurements (Continued)

 

The carrying amounts and fair values of the Company’s financial instruments as of June 30, 2011 and June 30, 2010 were as follows:

 

 

 

June 30, 2011

 

June 30, 2010

 

 

 

Carrying

 

Fair

 

Carrying

 

Fair

 

(in millions)

 

Amount

 

Value

 

Amount

 

Value

 

Financial Assets:

 

 

 

 

 

 

 

 

 

Cash and due from banks

 

$

181.2

 

$

181.2

 

$

184.3

 

$

184.3

 

Due from banks - interest bearing

 

725.3

 

725.3

 

336.2

 

336.2

 

Federal funds sold

 

123.0

 

123.0

 

404.8

 

404.8

 

Securities available-for-sale

 

6,348.1

 

6,348.1

 

4,761.1

 

4,761.1

 

Trading securities

 

125.8

 

125.8

 

129.3

 

129.3

 

Loans and leases, net of allowance

 

11,397.2

 

11,719.2

 

11,192.6

 

11,494.6

 

Covered loans, net of allowance

 

1,657.0

 

1,660.7

 

2,034.6

 

2,027.6

 

FDIC indemnification asset

 

261.7

 

232.1

 

394.0

 

389.0

 

Investment in FHLB and FRB stock

 

114.9

 

114.9

 

128.1

 

128.1

 

Derivative assets

 

44.5

 

44.5

 

60.6

 

60.6

 

 

 

 

 

 

 

 

 

 

 

Financial Liabilities:

 

 

 

 

 

 

 

 

 

Deposits

 

$

19,265.1

 

$

19,269.4

 

$

17,972.9

 

$

17,977.1

 

Federal funds purchased and securities sold under repurchase agreements

 

 

 

2.7

 

2.7

 

Structured securities sold under repurchase agreements

 

 

 

175.0

 

185.3

 

Other short-term borrowings

 

149.8

 

151.1

 

0.7