CLFC Center Financial Corporation (MM)

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

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

For the quarterly period ended September 30, 2011

Commission file number: 000-50050

 

 

Center Financial Corporation

(Exact name of Registrant as specified in its charter)

 

 

 

California		52-2380548
(State of Incorporation)		(IRS Employer Identification No.)
3435 Wilshire Boulevard, Suite 700 Los Angeles, California		90010
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code—(213) 251-2222

Not Applicable

(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 such filing requirements for the past 90 days.

x   Yes     ¨   No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

x   Yes     ¨   No

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 definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer		¨		Accelerated filer		x
Non-accelerated filer		¨   (Do not check if a smaller reporting company)		Smaller Reporting Company		¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.):

Yes   ¨     No   x

As of November 4, 2011, there were 39,919,952 outstanding shares of the issuer’s Common Stock with no par value.

 

 

 

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Table of Contents

FORM 10-Q

Index

 

PART I - FINANCIAL INFORMATION			3
I TEM  1: INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)			3
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS			7
I TEM  2:  MANAGEMENT’S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS			39
FORWARD-LOOKING STATEMENTS			39
EXECUTIVE OVERVIEW			41
EARNINGS PERFORMANCE ANALYSIS			42
FINANCIAL CONDITION ANALYSIS			49
LIQUIDITY AND MARKET RISK/INTEREST RISK MANAGEMENT			63
CAPITAL RESOURCES			66
I TEM  3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK			67
I TEM  4: CONTROLS AND PROCEDURES			67
PART II - OTHER INFORMATION			68
I TEM  1: LEGAL PROCEEDINGS			68
I TEM  1A. RISK FACTORS			68
I TEM  2: UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS			68
I TEM  3: DEFAULTS UPON SENIOR SECURITIES			68
I TEM  4: (REMOVED AND RESERVED)			68
I TEM  5: OTHER INFORMATION			68
I TEM  6: EXHIBITS			69
SIGNATURES			70

 

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PART I—FINANCIAL INFORMATION

 

Item 1:

INTERIM CONSOLIDATED FINANCIAL STATEMENTS

CENTER FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (UNAUDITED)

AS OF SEPTEMBER 30 AND DECEMBER 31

 

		2011				2010
		(Dollars in thousands)
ASSETS
Cash and due from banks		$	41,644			$	28,181
Federal funds sold			870				136,180
Money market funds and interest-bearing deposits in other banks			263,631				94,559
Cash and cash equivalents			306,145				258,920
Securities available for sale, at fair value			310,983				289,551
Non-covered loans held for sale, at the lower of cost or fair value			66,608				60,234
Federal Home Loan Bank and FRB stock, at cost			13,199				15,019
Non-covered loans, net of allowance for loan losses of $47,098 and $52,047 as of September 30, 2011 and December 31, 2010, respectively			1,353,440				1,415,646
Covered loans, net of allowance for loan losses of $1,010 as of September 30, 2011 and December 31, 2010			92,581				116,283
Premises and equipment, net			12,281				13,532
Core deposit intangibles, net			418				464
Customers’ liability on acceptances			3,313				2,287
Non-covered other real estate owned, net			947				937
Covered other real estate owned, net			1,028				1,459
Accrued interest receivable			5,089				5,509
Deferred income taxes, net			19,995				14,383
Investments in affordable housing partnerships			9,876				10,824
Cash surrender value of life insurance			18,147				12,791
Income tax receivable			13,236				14,277
Prepaid regulatory assessment fees			5,387				7,864
FDIC loss share receivable			17,503				23,991
Other assets			6,911				6,308
Total		$	2,257,087			$	2,270,279
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Deposits:
Noninterest-bearing		$	499,556			$	396,973
Interest-bearing			1,297,348				1,374,021
Total deposits			1,796,904				1,770,994
Acceptances outstanding			3,313				2,287
Accrued interest payable			4,317				5,113
Other borrowed funds			132,130				188,670
Long-term subordinated debentures			18,557				18,557
Accrued expenses and other liabilities			7,186				10,646
Total liabilities			1,962,407				1,996,267
Commitments and Contingencies			0				0
Shareholders’ Equity
Preferred stock, no par value, 10,000,000 shares authorized; issued and outstanding, 55,000 shares as of September 30, 2011 and December 31, 2010
Series A, cumulative, issued and outstanding, 55,000 shares as of September 30, 2011 and December 31, 2010			53,607				53,409
Common stock, no par value; 100,000,000 shares authorized; issued and outstanding, 39,919,952 and 39,914,686 shares (including 51,449 and 76,809 shares of unvested restricted stock) as of September 30, 2011 and December 31, 2010, respectively			188,208				187,754
Retained earnings			48,914				32,000
Accumulated other comprehensive income, net of tax			3,951				849
Total shareholders’ equity			294,680				274,012
Total		$	2,257,087			$	2,270,279

See accompanying notes to interim consolidated financial statements.

 

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CENTER FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (UNAUDITED)

FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2011				2010				2011				2010
		(Dollars in thousands, except per share data)
Interest and Dividend Income:
Interest and fees on loans		$	20,668			$	22,472			$	62,584			$	64,430
Interest on federal funds sold			1				127				44				289
Interest on taxable investment securities			2,002				1,499				5,870				7,290
Dividends on equity stock			9				0				32				—
Money market funds and interest-earning deposits			182				41				487				111
Total interest and dividend income			22,862				24,139				69,017				72,120
Interest Expense:
Interest on deposits			3,947				5,137				12,875				15,658
Interest on borrowed funds			1,570				1,747				4,760				5,021
Interest expense on trust preferred securities			143				155				427				438
Total interest expense			5,660				7,039				18,062				21,117
Net interest income before provision for loan losses			17,202				17,100				50,955				51,003
Provision for loan losses			1,200				4,000				12,200				16,000
Net interest income after provision for loan losses			16,002				13,100				38,755				35,003
Noninterest Income:
Customer service fees			1,727				2,043				5,308				6,161
Fee income from trade finance transactions			623				684				1,924				2,062
Wire transfer fees			330				321				987				933
Gain on business acquisition			0				0				0				5,900
Net gain on sale of loans			1,896				257				7,448				1,460
Net gain on sale of securities available for sale			0				0				0				2,209
Loan service fees			526				565				1,896				1,153
Increase in FDIC loss share receivable			308				105				471				105
Other income			560				434				1,509				1,174
Total noninterest income			5,970				4,409				19,543				21,157
Noninterest Expense:
Salaries and employee benefits			5,214				4,653				15,654				13,640
Occupancy			1,260				1,388				3,994				4,020
Furniture, fixtures, and equipment			549				756				1,671				1,903
Data processing			615				832				1,938				1,950
Legal fees			239				567				941				1,152
Accounting and other professional service fees			466				309				1,378				1,170
Business promotion and advertising			206				376				942				1,048
Supplies and communications			280				440				965				1,100
Security service			303				320				905				840
Regulatory assessment			771				1,073				2,821				3,096
Merger related expenses			477				0				1,114				129
Net OREO related expenses			577				170				1,689				1,529
Other operating expenses			1,207				1,508				3,907				3,950
Total noninterest expense			12,164				12,392				37,919				35,527
Income before income tax provision (benefit)			9,808				5,117				20,379				20,633
Income tax provision (benefit)			415				(846	)			1,205				4,400
Net income			9,393				5,963				19,174				16,233
Preferred stock dividends and accretion of preferred stock discount			(757	)			(748	)			(2,261	)			(31,246	)
Net income (loss) available to common shareholders			8,636				5,215				16,913				(15,013	)
Comprehensive income:
Net income		$	9,393			$	5,963			$	19,174			$	16,233
Other comprehensive income (loss) - unrealized gain (loss) on available-for-sale securities, net of income tax (expense) benefit of ($408), ($78), ($1,670) and $49, respectively			758				144				3,102				(91	)
Comprehensive income		$	10,151			$	6,107			$	22,276			$	16,142
Earnings (loss) per common share:
Basic		$	0.22			$	0.13			$	0.42			$	(0.44	)
Diluted		$	0.22			$	0.13			$	0.42			$	(0.44	)
Average common shares outstanding:
Basic			39,876,029				39,902,114				39,865,808				33,762,755
Diluted			39,932,601				39,912,160				39,931,507				33,762,755

See accompanying notes to interim consolidated financial statements.

 

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CENTER FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

FOR THE NINE MONTHS ENDED SEPTEMBER 30

 

		2011				2010
		(Dollars in thousands)
Cash flows from operating activities:
Net income		$	19,174			$	16,233
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Compensation expenses related to stock options and restricted stock awards			454				553
Depreciation and amortization			4,824				3,159
Amortization of deferred fees and accretion of discount			(4,951	)			(190	)
Amortization of premium, net of accretion of discount, on securities available for sale			1,768				(59	)
Provision for loan losses			12,200				16,000
Net gain on sale of securities available for sale			0				(2,209	)
Net increase in loans held for sale			(62,567	)			(45,750	)
Gain on business acquisition			0				(5,900	)
Gain on sale of loans			(7,448	)			(1,460	)
Proceeds from sale of loans acquired for sale			66,919				19,805
Net loss on sale of OREO			238				15
Valuation adjustment on non-covered OREO			398				994
Valuation adjustment on covered OREO			663				29
Deferred tax (expense) benefit			(7,283	)			1,505
Decrease in accrued interest receivable			420				1,392
Net increase in cash surrender value of bank-owned life insurance			(356	)			(299	)
Decrease (increase) in income tax receivable			1,041				(214	)
Decrease in prepaid assessment			—				2,675
Increase in other assets			(1,620	)			(1,035	)
Decrease in accrued interest payable			(796	)			(2,037	)
Decrease in accrued expenses and other liabilities			(2,434	)			(4,454	)
Net cash provided by (used in) operating activities			20,644				(1,247	)
Cash flows from investing activities:
Purchase of securities available for sale			(119,997	)			(88,390	)
Proceeds from principal repayment, maturity or call of securities available for sale			101,570				122,304
Proceeds from sale of securities available for sale			0				59,745
Net decrease in investment in Federal Home Loan Bank and other equity stock			1,820				1,249
Net decrease in non-covered loans			29,236				32,888
Net decrease in covered loans			27,627				11,821
Proceeds from sale of loans acquired for investment			13,094				36,971
Proceeds from recoveries of loans previously charged off			1,410				4,544
Proceeds from FDIC loss share receivable			6,960				1,753
Net increase in premises and equipment			(360	)			(1,889	)
Proceeds from sale of OREO			1,085				5,306
Net cash acquired from business combination, inclusive of settlement received from FDIC			1,283				71,505
Net increase in investments in affordable housing partnerships			0				131
Purchase of bank-owned life insurance			(5,000	)			0
Net cash provided by investing activities			58,728				257,938
Cash flows from financing activities:
Net increase (decrease) in deposits			25,910				(164,697	)
Net decrease in other borrowed funds			(55,995	)			(1,720	)
Payment of cash dividend			(2,062	)			(2,064	)
Net cash used in financing activities			(32,147	)			(168,481	)
Net increase in cash and cash equivalents			47,225				88,210
Cash and cash equivalents, beginning of period			258,920				232,802
Cash and cash equivalents, end of period		$	306,145			$	321,012

 

See accompanying notes to interim consolidated financial statements.

 

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CENTER FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)-(Continued)

FOR THE NINE MONTHS ENDED SEPTEMBER 30

 

		2011				2010
		(Dollars in thousands)
Supplemental disclosure of cash flow information:
Interest paid		$	19,403			$	23,585
Income taxes paid, net of refunds			7,447				826
Supplemental schedule of noncash investing, operating, and financing activities:
Cash dividend accrual for preferred stock		$	344			$	344
Accretion of preferred stock discount			198				176
Transfer of non-covered loans to non-covered loans held for sale			17,218				12,784
Transfer of non-covered loans to non-covered OREO			2,634				4,560
Transfer of covered loans to covered OREO			1,380				1,672
Acquisition:
Assets acquired		$	0			$	219,797
Liabilities assumed			0				232,485

See accompanying notes to interim consolidated financial statements.

 

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CENTER FINANCIAL CORPORATION

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. THE BUSINESS OF CENTER FINANCIAL CORPORATION

Center Financial Corporation (“Center Financial”) is a California corporation registered as a bank holding company under the Bank Holding Company Act of 1956, as amended (the “BHC Act”), and is headquartered in Los Angeles, California. Center Financial was incorporated on April 19, 2000 and acquired all of the issued and outstanding shares of Center Bank (the “Bank”) in October 2002. Currently, Center Financial’s direct subsidiaries include the Bank and Center Capital Trust I. Center Financial exists primarily for the purpose of holding the stock of the Bank and of the other subsidiary and for providing access to capital and funding for the Bank. Center Financial, the Bank, and Center Capital Trust I are collectively referred to herein as the “Company, unless the context indicates otherwise.”

The Bank is a California state-chartered and Federal Deposit Insurance Corporation (“FDIC”) insured financial institution, which was incorporated in 1985 and commenced operations in March 1986. The Bank’s headquarters are located at 3435 Wilshire Boulevard, Suite 700, Los Angeles, California 90010. The Bank provides comprehensive financial services for small to medium sized business owners, primarily in Southern California. The Bank specializes in commercial loans, most of which are secured by real property, to small business customers. In addition, the Bank is a Preferred Lender of Small Business Administration (“SBA”) loans and provides trade finance loans. The Bank’s primary market is the Southern California area, including Los Angeles, Orange, San Bernardino, and San Diego counties, primarily focused in areas with high concentrations of Korean-Americans.

The Bank currently has 21 full-service branch offices, 18 of which are located in California. The Bank also operates two Loan Production Offices in Seattle and Denver. In December 2003, Center Financial formed a wholly owned subsidiary, Center Capital Trust I, a Delaware statutory business trust, for the exclusive purpose of issuing and selling trust preferred securities. Center Financial’s principal source of income is generally dividends from the Bank and equity earnings in the Bank. The expenses of Center Financial, including interest on junior subordinated debentures issued to Center Capital Trust I, legal and accounting fees and NASDAQ listing fees have been and will generally be paid by the cash on hand or from dividends paid by the Bank.

2. BASIS OF PRESENTATION

The interim consolidated financial statements include the accounts of Center Financial and the Bank. Center Capital Trust I is not consolidated as disclosed in Note 12.

The interim consolidated financial statements are presented in accordance with U. S. generally accepted accounting principles (“GAAP”) for unaudited financial statements. The information furnished in these interim statements reflects all adjustments that are, in the opinion of management, necessary for the fair statement of results for the periods presented. All adjustments are of a normal and recurring nature. Results for the three and nine months ended September 30, 2011 are not necessarily indicative of the results that may be expected for any other interim period or for the year as a whole. Certain information and note disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted. The interim consolidated financial statements should be read in conjunction with the audited financial statements and notes included in the Company’s annual report on Form 10-K, as amended, for the year ended December 31, 2010.

Use of estimates

Management has made a number of estimates and assumptions related to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the interim consolidated financial statements and the reported amounts of revenues and expenses during the reporting period to prepare these interim consolidated financial statements in accordance with GAAP. Actual results could differ from those estimates. Material estimates subject to change in the near term include, among other items, the allowance for loan losses, investment securities, the carrying value of other real estate owned, the carrying value of intangible assets, the carrying value of the FDIC loss share receivable and the realization of deferred tax assets.

Reclassifications

Reclassifications have been made to the prior year financial statements to conform to the current presentation.

 

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3. SIGNIFICANT ACCOUNTING POLICIES

Accounting policies are fully described in Note 2 to the consolidated financial statements in Center Financial’s Annual Report on Form 10-K, as amended, for the year ended December 31, 2010 and there have been no material changes noted.

Trouble Debt Restructured Loans

The amendments in ASU 2011-02 require prospective application of the impairment measurement guidance in ASC 310-10-35 for those receivables newly identified as impaired. As a result of adopting the amendments in ASU 2011-02, the Company reassessed all restructurings that occurred on or after January 1, 2011 for identification as a TDR. A loan is classified as a troubled debt restructured when a borrower is experiencing financial difficulties that lead to a restructuring of the loan, and the Company grants concessions to the borrower in the restructuring that it would not otherwise consider. These concessions may include interest rate reductions, principal forgiveness, extension of maturity date and other actions intended to minimize potential losses. Generally, a nonaccrual loan that is restructured remains on nonaccrual for a period of six months to demonstrate that the borrower can meet the restructured terms. However, the borrower’s performance prior to the restructuring or other significant events at the time of restructuring may be considered in assessing whether the borrower can meet the new terms and may result in the loan being returned to accrual status after a shorter performance period. If the borrower’s performance under the new terms is not reasonably assured, the loan remains classified as a nonaccrual loan. The Company usually identified as TDRs certain receivables for which the ALLL had previously been measured under a general ALLL methodology. Upon identifying those receivables as TDRs, the Company identified them as impaired under the guidance in ASC 310-10-35 and established a specific or formula allowance.

4. RECENT ACCOUNTING PRONOUNCEMENTS

In January 2010, the FASB issued FASB ASU 2010-06, Improving Disclosures about Fair Value Measurements,  which amends ASC 820 to require additional disclosures regarding fair value measurements. Specifically, the ASU requires disclosure of the amounts of significant transfers between Level 1 and Level 2 of the fair value hierarchy and the reasons for these transfers, the reasons for any transfers in or out of Level 3, and information in the reconciliation of recurring Level 3 measurements about purchases, sales, issuances and settlements on a gross basis. In addition to these new disclosure requirements, the ASU also amends ASC 820 to clarify certain existing disclosure requirements. For example, the ASU clarifies that reporting entities are required to provide fair value measurement disclosures for each class of assets and liabilities. Previously separate fair value disclosures were required for each major category of assets and liabilities. ASU 2010-06 also clarifies the requirement to disclose information about both the valuation techniques and inputs used in estimating Level 2 and Level 3 fair value measurements. Except for the requirement to disclose information about purchases, sales, issuances, and settlements in the reconciliation of recurring Level 3 measurements on a gross basis, these disclosures are effective for the quarter ended March 31, 2010. The requirement to separately disclose purchases, sales, issuances, and settlements of recurring Level 3 measurements became effective for the Company for the quarter ended March 31, 2011. The Company adopted this new accounting guidance as of January 1, 2010 and 2011, respectively, and the impact of adoption was not material on the consolidated financial statements.

In July 2010, the FASB issued FASB ASU 2010-20, Receivables (Topic 310) – Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses , which required more information about credit quality. The ASU requires an entity to provide additional disclosures including, but not limited to, a rollforward schedule of the allowance for credit losses (with the ending allowance balance further disaggregated based on impairment methodology) and the related ending balance of the finance receivable presented by portfolio segment, and the aging of past due financing receivables at the end of the period, the nature and extent of troubled debt restructurings that occurred during the period and their impact on the allowance for credit losses, the nature and extend of troubled debt restructurings that occurred within the last year, that have defaulted in the current reporting period, and their impact on the allowance for credit losses, the nonaccrual status of financing receivables, and impaired financing receivables, presented by class. The new disclosures of information as of the end of a reporting period are effective for both interim and annual reporting periods ending after December 15, 2010 for public companies. The Company adopted this new accounting guidance as of December 31, 2010.

In December 2010, the FASB issued FASB ASU 2010-29, Disclosure of Supplementary ProForma Information for Business Combinations, a consensus of the FASB Emerging Issues Task Force (Issue No. 10-G), which requires that the pro forma information be presented as if the business combination occurred at the beginning of the prior annual reporting period for purposes of calculating both the current reporting period and the prior reporting period pro forma financial information. The ASU also requires that this disclosure be accompanied by a narrative description of the amount and nature of material nonrecurring pro forma adjustments. The amendments in this ASU are effective for business combinations with effective dates on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Prospective application is required with early adoption permitted. The Company does not anticipate the new guidance will have a material impact on the consolidated financial statements as this relates to only pro-forma disclosure.

 

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In April 2011, the FASB issued FASB ASU 2011-02, Receivables (Topic 310) – A Creditor’s Determination whether a Restructuring Is A Troubled Debt Restructuring , which provides additional guidance for determining whether the creditor has granted a concession and whether the debtor is experiencing financial difficulty. A troubled debt restructuring (TDR) is a restructuring of a debt if the creditor for economic or legal reasons related to the debtor’s financial difficulties grants a concession to the debtor that it would not otherwise consider. Public entities are required to adopt this ASU for interim and annual periods beginning on or after June 15, 2011. For purposes of TDR disclosure, the ASU applies retrospectively to restructurings occurring on or after the beginning of the annual period of adoption, or January 1, 2011 for the Company. However, any changes in the method used to measure impairment apply prospectively. Beginning in the period the ASU is adopted, public entities are subject to the requirements to disclose the activity-based information about TDRs that was previously deferred by ASU 2011-01. The Company adopted this guidance during the quarterly period ending September 30, 2011 as disclosed in Note 7, and the impact of adoption was not material on the consolidated financial statements.

In May 2011, the FASB issued FASB ASU 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in the U.S. GAAP and IFRSs , to provide largely identical guidance about fair value measurement and disclosure requirements with the International Accounting Standards Board’s new International Financial Reporting Standards (“IFRS”) 13, Fair Value Measurement . The new guidance does not extend the use of fair value but, rather, provides guidance about how fair value should be applied where it already is required or permitted under U.S. GAAP. Most of the changes are clarifications of existing guidance or wording changes to align with IFRS 13. A public entity is required to apply this ASU prospectively for interim and annual periods beginning after December 15, 2011. Early adoption is not permitted for a public entity. In the period of adoption, a reporting entity will be required to disclose a change, if any, in valuation technique and related inputs that result from applying the ASU and to quantify the total effect, if practicable. The Company does not anticipate the adoption of this ASU will have a significant impact on the consolidated financial statements.

In June 2011, the FASB issued FASB ASU 2011-05, Presentation of Comprehensive Income . To improve comparability, consistency and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income, the ASU eliminates the option to present other comprehensive income in the statement of changes in equity. Under this ASU, an entity will have the option to present the components of net income and comprehensive income in either one or two consecutive financial statements. An entity should apply the ASU retrospectively. For a public entity, the ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The Company does not anticipate the adoption of this ASU will have a significant impact on the consolidated financial statements.

5. BUSINESS COMBINATION

On December 9, 2010, Center Financial and Nara Bancorp, Inc. (“Nara Bancorp”) entered into a definitive agreement to merge. Under the terms of the merger agreement, Center Financial shareholders will receive a fixed ratio of 0.7804 of a share of Nara Bancorp common stock in exchange for each share of Center Financial common stock they own. At the closing date of the merger, Nara Bancorp shareholders will own approximately 55% of the combined company and Center Financial shareholders will own approximately 45%. The combined company will operate under a new name that will be determined prior to the closing. In addition, at the closing or as soon as possible thereafter, it is anticipated that Nara Bank, a California state-chartered bank and a wholly-owned subsidiary of Nara Bancorp, will merge with and into the Bank, with the Bank as the surviving bank after the bank merger.

The boards of directors of both companies have unanimously approved the transaction. Both our shareholders and Nara Bancorp’s have approved the merger at separate meetings, both held on September 21, 2011. On November 7, 2011, the Company announced receipt of approval from the FDIC of the planned merger of Nara Bank and Center Bank. This represents the final regulatory approval required for the merger of the two companies. Approvals have previously been received from the DFI and the FRB. The merger is expected to close by end of November 2011, subject to customary closing conditions.

 

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6. INVESTMENT SECURITIES

The following table summarizes the amortized cost, fair value and distribution of the Company’s investment securities as of September 30, 2011 and December 31, 2010:

 

		As of September 30, 2011
		Amortized Cost				Gross Unrealized Gain				Gross Unrealized Loss				Fair Value
		(Dollars in thousands)
Available for Sale:
U.S. Treasury		$	300			$	—			$	—			$	300
U.S. Governmental agencies securities and U.S. Government sponsored enterprise securities			37,935				183				—				38,118
U.S. Governmental agencies and U.S. Government sponsored and enterprise mortgage-backed securities			157,440				6,010				(22	)			163,428
Corporate trust preferred security			2,747				—				(1,930	)			817
Mutual funds backed by adjustable rate mortgages			5,000				257				—				5,257
Collateralized mortgage obligations			101,483				1,669				(89	)			103,063
Total securities available for sale		$	304,905			$	8,119			$	(2,041	)		$	310,983

 

		As of December 31, 2010
		Amortized Cost				Gross Unrealized Gain				Gross Unrealized Loss				Fair Value
		(Dollars in thousands)
Available for Sale:
U.S. Treasury		$	300			$	—			$	—			$	300
U.S. Governmental agencies securities and U.S. Government sponsored enterprise securities			58,994				94				(481	)			58,607
U.S. Governmental agencies and U.S. Government sponsored and enterprise mortgage-backed securities			154,149				3,549				(599	)			157,099
Corporate trust preferred security			2,738				—				(1,979	)			759
Mutual funds backed by adjustable rate mortgages			5,000				73				—				5,073
Collateralized mortgage obligations			67,063				816				(166	)			67,713
Total securities available for sale		$	288,244			$	4,532			$	(3,225	)		$	289,551

.

 

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The following table shows the Company’s investments with gross unrealized losses and related fair values, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position as of September 30, 2011 and December 31, 2010.

 

		As of September 30, 2011
		Less than 12 months								12 months or more								Total
		Fair Value				Unrealized Loss				Fair Value				Unrealized Loss				Fair Value				Unrealized Loss
		(Dollars in thousands)
U.S. Governmental agencies securities and U.S. Government sponsored enterprise securities		$	—			$	—			$	—			$	—			$	—			$	—
U.S. Governmental agencies and U.S. Government sponsored enterprise mortgage-backed securities			2,260				(22	)			—				—				2,260				(22	)
Corporate trust preferred security			—				—				817				(1,930	)			817				(1,930	)
Collateralized mortgage obligations			12,041				(61	)			4,165				(28	)			16,206				(89	)
Total		$	14,301			$	(83	)		$	4,982			$	(1,958	)		$	19,283			$	(2,041	)

 

		As of December 31, 2010
		Less than 12 months								12 months or more								Total
		Fair Value				Unrealized Loss				Fair Value				Unrealized Loss				Fair Value				Unrealized Loss
		(Dollars in thousands)
U.S. Governmental agencies and U.S. Government sponsored enterprise securities		$	33,486			$	(481	)		$	—			$	—			$	33,486			$	(481	)
U.S. Governmental agencies and U.S. Government sponsored enterprise mortgage-backed securities			27,084				(599	)			—				—				27,084				(599	)
Corporate trust preferred security			—				—				759				(1,979	)			759				(1,979	)
Collateralized mortgage obligations			20,369				(166	)			—				—				20,369				(166	)
Total		$	80,939			$	(1,246	)		$	759			$	(1,979	)		$	81,698			$	(3,225	)

 

The Company considers numerous factors to determine any other-than-temporary impairment (“OTTI”) for the collateralized debt obligation (“CDO”) trust preferred security including review of trustee reports, monitoring of “break in yield” tests, analysis of current defaults and deferrals and the expectation for future defaults and deferrals. The Company reviews the key financial characteristics for individual issuers (commercial banks or thrifts) in the CDO trust preferred security and considers capital ratios, leverage ratios, nonperforming loan and nonperforming asset ratios, in addition to the credit ratings. The credit ratings of the Company’s CDO trust preferred security were “Ca” (Moody’s) and “C” (Fitch) as of September 30, 2011 and December 31, 2010.

The Company uses cash flow projections for the purpose of assessing OTTI on the CDO trust preferred security which incorporate certain credit events in the underlying collaterals and prepayment assumptions. The projected issuer default rates are assumed at a rate equivalent to 150 basis points applied annually and have a 0% recovery factor after the initial default date. The principal is assumed to be prepaying at 1% annually and at 100% at maturity.

Based on the results from the cash flow model, the CDO trust preferred security did not experience an adverse change in its cash flow status. As such, based on all of these factors, the Company determined that there was no OTTI adjustment required for the securities that have been in a continuous unrealized loss position as of September 30, 2011. The risk of future OTTI will be highly dependent upon the performance of the underlying issuers. The Company does not have the intention to sell and does not believe it will be required to sell the CDO trust preferred security until maturity.

 

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The following table summarizes, as of September 30, 2011, the maturity characteristics of the investment portfolio by investment category. Expected remaining maturities may differ from remaining contractual maturities because obligors may have the right to prepay certain obligations with or without penalties.

 

		Within one Year								After One But  Within Five Years								After Five But  Within Ten Years								After Ten Years								Total
		Amount				Yield				Amount				Yield				Amount				Yield				Amount				Yield				Amount				Yield
		(Dollars in thousands)
Available for Sale (Fair Value):
U.S. Treasury		$	300				0.05	%		$	—				—	%		$	—				—	%		$	—				—	%		$	300				0.05	%
U.S. Governmental agencies securities and U.S Government sponsored enterprise securities			—				—				38,118				1.32				—				—				—				—				38,118				1.32
U.S. Governmental agencies and U.S. Government sponsored and enterprise mortgage-backed securities			—				—				994				4.51				65,572				2.85				96,862				3.28				163,428				3.11
Corporate trust preferred security			—				—				—				—				—				—				817				11.70				817				11.70
Mutual funds backed by adjustable rate mortgages			5,257				3.05				—				—				—				—				—				—				5,257				3.05
Collateralized mortgage obligations			—				—				967				2.37				26,972				1.96				75,124				2.31				103,063				2.22
Total available for sale		$	5,557				2.89			$	40,079				1.42			$	92,544				2.59			$	172,803				2.90			$	310,983				2.62

7. NON-COVERED LOANS AND ALLOWANCE FOR LOAN AND LEASE LOSSES

On April 16, 2010, the California Department of Financial Institution (the “DFI”) closed Innovative Bank, Oakland, California, and appointed the FDIC as its receiver. On the same date, Center Bank assumed the banking operations of Innovative Bank from the FDIC under a purchase and assumption agreement with loss sharing. Non-covered loans refer to loans not covered by the FDIC loss sharing agreement. Loans acquired in an FDIC-assisted acquisition that are subject to a loss sharing agreement are referred to as “covered loans” and reported separately in the interim consolidated statements of financial condition.

Non-covered loans, segregated by class of loans, as of September 30, 2011 and December 31, 2010 consist of the following:

 

		September 30, 2011								December 31, 2010
		Amount				Percent of Total				Amount				Percent of Total
		(Dollars in thousands)
Real Estate:
Construction		$	9,407				0.7	%		$	14,803				1.0	%
Commercial			894,686				60.9				914,003				59.8
Commercial:
Commercial			281,711				19.2				315,285				20.5
Trade Finance			63,860				4.3				71,174				4.7
SBA 1)			112,207				7.6				101,683				6.7
Others:
Consumer			57,514				3.9				71,279				4.7
Other 2)			50,048				3.4				40,039				2.6
Total Non-covered Loans 3)			1,469,433				100.0				1,528,266				100.0
Less:
Allowance for loan losses			47,098								52,047
Net deferred loan fees 4)			(454	)							(523	)
Discount on SBA loans retained			2,741								862
Net Non-covered Loans and Loans Held for Sale		$	1,420,048							$	1,475,880

 

1)	Includes non-covered SBA loans held for sale of $61.6 million and $46.4 million, at the lower of cost or fair value, as of September 30, 2011 and December 31, 2010, respectively.

2)	Consists of term fed funds sold for maturity of greater than 1 day, transactions in process and overdrafts.

3)	Includes loans held for sale of $66.6 million and $60.2 million at the lower of cost or fair value as of September 30, 2011 and December 31, 2010, respectively.

4)	Net deferred loan fees are net of origination costs. In 2011 and 2010, origination costs exceeded fees on SBA loan origination.

 

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The activity in the allowance for loan losses on total loans (including non-covered loans and covered loans and excluding loans held for sale), segregated by portfolio segment, as of and for the three and nine months ended September 30, 2011 and the year ended December 31, 2010 is as follows:

 

			0000000000				0000000000				0000000000				0000000000
Allowance for loan lossess:		Real Estate				Commercial				Consumer / Others				Total
		(Dollars in thousands)
Three months ended September 30, 2011
Beginning balance		$	27,470			$	21,226			$	1,904			$	50,600
Charge-offs			(2,030	)			(1,768	)			(468	)			(4,266	)
Recoveries			381				103				90				574
Provision			726				529				(55	)			1,200
Ending balance		$	26,547			$	20,090			$	1,471			$	48,108
Nine months ended September 30, 2011
Beginning balance		$	29,272			$	22,035			$	1,750			$	53,057
Charge-offs			(10,312	)			(7,291	)			(956	)			(18,559	)
Recoveries			942				254				214				1,410
Provision			6,645				5,092				463				12,200
Ending balance		$	26,547			$	20,090			$	1,471			$	48,108
Period-end amount allocated to loans:
Individually evaluated for impairment		$	7,591			$	8,901			$	75			$	16,567
Collectively evaluated for impairment			18,956				10,179				1,396				30,531
Acquired with deteriorated credit quality			—				1,010				—				1,010
Ending balance		$	26,547			$	20,090			$	1,471			$	48,108
Year ended December 31, 2010
Beginning balance		$	37,604			$	19,000			$	1,939			$	58,543
Charge-offs			(21,243	)			(10,637	)			(767	)			(32,647	)
Recoveries			1,918				3,079				154				5,151
Provision			10,993				10,593				424				22,010
Ending balance		$	29,272			$	22,035			$	1,750			$	53,057
Period-end amount allocated to loans:
Individually evaluated for impairment		$	2,349			$	8,965			$	329			$	11,643
Collectively evaluated for impairment			26,923				12,060				1,421				40,404
Acquired with deteriorated credit quality			—				1,010				—				1,010
Ending balance		$	29,272			$	22,035			$	1,750			$	53,057

 

			0000000000				0000000000				0000000000				0000000000
Financing receivables 1) :		Real Estate				Commercial				Consumer / Others				Total
		(Dollars in thousands)
As of September 30, 2011
Loans individually evaluated for impairment		$	47,586			$	22,899			$	1,244			$	71,729
Loans collectively evaluated for impairment			851,532				373,247				106,317				1,331,096
Loans acquired with deteriorated credit quality			51,725				41,406				486				93,617
Ending balance		$	950,843			$	437,552			$	108,047			$	1,496,442
As of December 31, 2010
Loans individually evaluated for impairment		$	69,287			$	26,830			$	1,460			$	97,577
Loans collectively evaluated for impairment			845,707				414,890				109,858				1,370,455
Loans acquired with deteriorated credit quality			63,500				53,307				486				117,293
Ending balance		$	978,494			$	495,027			$	111,804			$	1,585,325

 

1)	Financing receivables represent unpaid principal balance, which approximates recorded investment.

Loans are considered impaired when it is probable that the Company will be unable to collect all amounts due as scheduled according to the contractual terms of the loan agreement, including contractual interest and principal payments. Impaired loans are measured for impairment based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, alternatively, at the loan’s observable market price or the fair value of the collateral if the loan is collateralized, less costs to sell. Loans are identified for specific allowances from information provided by several sources including asset classification, third party reviews, delinquency reports, periodic updates to financial statements, public records, and industry reports. All loan types are subject to impairment evaluation for a specific allowance once identified as impaired.

 

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The Bank generally writes down nonperforming collateral dependent impaired loans to the value of the underlying collateral. The collateral value is generally updated every six months and the impairment amount is generally charged off during the quarter in which collateral value is updated. The performing impaired loans, such as performing TDRs, are allocated with specific reserve and are not generally charged off. The performing impaired loans typically continue to make contractual payments according to their restructured terms and conditions.

 

		September 30, 2011				December 31, 2010
		(Dollars in thousands)
Impaired loans with specific reserves
Without charge-offs		$	38,166			$	35,109
With charge-offs			9,668				2,575
Impaired loans without specific reserves
Without charge-offs			20,684				49,043
With charge-offs			3,211				10,850
Total impaired loans			71,729				97,577
Allowance on impaired loans			(16,567	)			(11,643	)
Net recorded investment in impaired loans		$	55,162			$	85,934

Non-covered nonperforming loans, net of SBA guarantees totaled $29.0 million as of September 30, 2011, a decrease of $13.2 million as compared to $42.2 million as of December 31, 2010. Non-covered nonperforming loans, net of SBA guarantees as a percentage of total non-covered loans decreased to 1.98% as of September 30, 2011 as compared to 2.76% as of December 31, 2010. Gross interest income of approximately $308,000 and $657,000 would have been additionally recorded for the three and nine months ended September 30, 2011, respectively, compared to $373,000 and $1.6 million for the same periods in 2010, respectively, if these loans had been paid in accordance with their original terms and had been outstanding throughout the applicable period then ended or, if not outstanding throughout the applicable period then ended, since origination.

As of September 30, 2011, the Company held non-covered TDRs of $46.3 million, representing an increase of $7.2 million, or 18.4%, as compared to $39.1 million as of December 31, 2010. The increase in the non-covered TDRs was mainly result of one commercial business loan relationship for $8.0 million that became a TDR during the third quarter of 2011. The debtor has been making loan payments according to its restructured terms and conditions since July 2011.

A TDR is a debt restructuring in which a bank, for economic or legal reasons related to a borrower’s financial difficulties, grants a concession to the borrower that it would not otherwise consider. TDRs may include, but are not necessarily limited to, one or a combination of the following:

 

1.

Transfer from the debtor to the creditor of receivables from third parties, real estate, or other assets to satisfy fully or partially a debt (including a transfer resulting from foreclosure or repossession)

 

2.

Issuance or other granting of an equity interest to the creditor by the debtor to satisfy fully or partially a debt unless the equity interest is granted pursuant to existing terms for converting the debt into an equity interest

3. Modification of terms of a debt, such as one or a combination of any of the following:

 

a.

Reduction (absolute or contingent) of the stated interest rate for the remaining original life of the debt

 

b.

Extension of the maturity date or dates at a stated interest rate lower than the current market rate for new debt with similar risk

 

c.

Reduction (absolute or contingent) of the face amount or maturity amount of the debt as stated in the instrument or other agreement

 

d.

Reduction (absolute or contingent) of accrued interest.

A TDR that has been formally restructured so as to be reasonably assured of repayment and of performance according to its modified terms need not be maintained in a non-accrual or nonperforming status, provided the TDR is supported by a current well documented credit evaluation and positive prospects of repayment under the revised terms. If these conditions can not be met, the Company will classify the TDR as non-accrual or nonperforming.

 

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The TDRs are monitored on a monthly basis to review the performance of the restructured term. When it is determined that the future performance of TDR is uncertain of repayment in accordance with the new restructured term, the loan is placed on non-accrual. The TDRs are usually analyzed for impairment evaluation for a specific allowance when outstanding balance is $100,000 or more. The fair value of the collateral is used for nonperforming TDR and present value of expected future cash flow is used for performing TDR.

As a result of adopting the amendments in ASU 2011-02, the Company reassessed all restructurings that occurred on or after January 1, 2011 for identification as a TDR. The Company usually identified as TDRs certain receivables for which the ALLL had previously been measured under a general ALLL methodology. Upon identifying those receivables as TDRs, the Company identified them as impaired under the guidance in ASC 310-10-35. The amendments in ASU 2011-02 require prospective application of the impairment measurement guidance in ASC 310-10-35 for those receivables newly identified as impaired. At September 30, 2011, the recorded investment in receivables for which the ALLL was previously measured under a general ALLL methodology and are now considered as the TDRs under ASC 310-10-35 was $21.4 million, and the ALLL associated with those receivables, on the basis of current evaluation of loss, was $3.3 million.

92% of the TDRs as of September 30, 2011 are impaired, and $12.1 million were on non-accrual status. The remaining $34.2 million of the Company’s TDRs meet the conditions that qualify these loans as performing as of September 30, 2011.

The following table provides the information of the Company’s TDRs as of September 30, 2011:

 

		For the Three Months Ended September 30, 2011												For the Nine Months Ended September 30, 2011
		Number of  Contracts				Pre-Modification Outstanding Recorded Investment				Post-Modification Outstanding Recorded Investment				Number of  Contracts				Pre-Modification Outstanding Recorded Investment				Post-Modification Outstanding Recorded Investment
Troubled Debt Restructurings
Real Estate:
Construction			—			$	—			$	—				—			$	—			$	—
Commercial			6				7,444				7,451				9				11,316				11,296
Commercial:
Commercial			12				9,647				9,641				19				9,935				10,006
Trade Finance			—				—				—				—				—				—
SBA			1				47				47				2				105				104
Others:
Consumer			—				—				—				—				—				—
Other			—				—				—				—				—				—
Total			19			$	17,138			$	17,139				30			$	21,356			$	21,406
		Number of Contracts				Recorded Investment								Number of Contracts				Recorded Investment
Troubled Debt Restructurings That Subsequently Defaulted
Real Estate:
Construction			—			$	—								—			$	—
Commercial			1				1,000								1				1,000
Commercial:
Commercial			2				144								4				636
Trade Finance			—				—								—				—
SBA			—				—								—				—
Others:
Consumer			—				—								—				—
Other			—				—								—				—
Total			3			$	1,144								5			$	1,636

The most of common types of modification that the Company provided for commercial real estate loans and commercial loans are interest rate reductions and loan payment adjustments. The loan payment adjustment typically involves deferment of principal payment for significant delay that increases uncertainty factor for full repayment of the loans. Generally, a nonaccrual loan that is restructured remains on nonaccrual for a period of six months to demonstrate that the borrower can meet the restructured terms. The subsequent default generally occurs when the borrower’s performance under the restructuring is not reasonably assured, and the loan is classified as a nonaccrual loan. The subsequent defaulted TDR is measured for impairment and subject to a specific or formula allowance.

 

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The following table provides information on non-covered impaired loans, segregated by class of loans, as of and for the three and nine months ended September 30, 2011 and the year ended December 31, 2010, respectively:

 

		Recorded Investment  1)				Unpaid Principal Balance  2)				Related Allowance				For the Nine Months Ended September 30, 2011								For the Three Months Ended September 30, 2011
														Average Recorded Investment				Interest Income Recognized				Average Recorded Investment				Interest Income Recognized
		(Dollars in thousands)
With no related allowance recorded:
Real Estate
Construction		$	1,268			$	1,270			$	—			$	1,322			$	—			$	1,270			$	—
Commercial - Real Estate			16,746				16,706				—				30,824				300				21,356				97
Commercial
Commercial - Business			3,783				3,758				—				6,528				198				3,889				42
Trade Finance			—				—				—				289				—				—				—
SBA			1,234				1,231				—				1,214				52				1,303				20
Others
Consumer			929				930				—				707				13				834				4
Other			—				—				—				—				—				—				—
Total		$	23,960			$	23,895			$	—			$	40,884			$	563			$	28,652			$	163
With an allowance recorded:
Real Estate
Construction		$	—			$	—			$	—			$	1,796			$	—			$	—			$	—
Commercial - Real Estate			29,789				29,611				7,591				24,516				677				31,166				278
Commercial
Commercial - Business			16,495				16,368				7,974				17,888				370				16,966				140
Trade Finance			1,241				1,215				644				1,042				29				1,260				11
SBA			304				326				283				412				12				279				—
Others
Consumer			314				314				75				703				36				481				12
Other			—				—				—				—				—				—				—
Total		$	48,143			$	47,834			$	16,567			$	46,357			$	1,124			$	50,152			$	441
Total
Real Estate
Construction		$	1,268			$	1,270			$	—			$	3,118			$	—			$	1,270			$	—
Commercial - Real Estate			46,535				46,317				7,591				55,340				977				52,522				375
Commercial
Commercial - Business			20,278				20,126				7,974				24,416				568				20,855				182
Trade Finance			1,241				1,215				644				1,331				29				1,260				11
SBA			1,538				1,557				283				1,626				64				1,582				20
Others
Consumer			1,243				1,244				75				1,410				49				1,315				16
Other			—				—				—				—				—				—				—
Total		$	72,103			$	71,729			$	16,567			$	87,241			$	1,687			$	78,804			$	604

 

1)	Includes unpaid principal balance plus any accrued interest, net of deferred fees.

2)	The unpaid principal balance is presented net of charge-offs and recoveries.

 

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														For the Twelve Months Ended December 31, 2010
		Recorded Investment  1)				Unpaid Principal Balance  2)				Related Allowance				Average Recorded Investment				Interest Income Recognized
		(Dollars in thousands)
With no related allowance recorded:
Real Estate
Construction		$	3,514			$	3,501			$	—			$	2,841			$	20
Commercial - Real Estate			45,251				45,042				—				53,451				798
Commercial
Commercial - Business			10,277				10,216				—				8,746				277
Trade Finance			—				—				—				80				4
SBA			490				488				—				383				41
Others
Consumer			646				646				—				538				21
Other			—				—				—				—				—
Total		$	60,178			$	59,893			$	—			$	66,039			$	1,161
With an allowance recorded:
Real Estate
Construction		$	2,606			$	2,607			$	223			$	3,289			$	—
Commercial - Real Estate			18,263				18,137				2,126				26,981				659
Commercial
Commercial - Business			13,758				13,649				8,022				6,111				165
Trade Finance			1,219				1,199				633				915				53
SBA			1,275				1,278				310				710				57
Others
Consumer			817				814				329				637				20
Other			—				—				—				—				—
Total		$	37,938			$	37,684			$	11,643			$	38,643			$	954
Total
Real Estate
Construction		$	6,120			$	6,108			$	223			$	6,130			$	20
Commercial - Real Estate			63,514				63,179				2,126				80,432				1,457
Commercial
Commercial - Business			24,035				23,865				8,022				14,857				442
Trade Finance			1,219				1,199				633				995				57
SBA			1,765				1,766				310				1,093				98
Others
Consumer			1,463				1,460				329				1,175				41
Other			—				—				—				—				—
Total		$	98,116			$	97,577			$	11,643			$	104,682			$	2,115

 

1)	Includes unpaid principal balance plus any accrued interest, net of deferred fees.

2)	The unpaid principal balance is presented net of charge-offs and recoveries.

 

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The following table provides aging information on non-covered past due loans inclusive of loans held for sale, segregated by class of loans, as of September 30, 2011 and December 31, 2010, respectively:

 

As of September 30, 2011		30-59 Days Past Due				60-89 Days Past Due				Non-accrual				Total Past Due and Non-accrual				Current				Total Financing Receivables 1)
		(Dollars in thousands)
Real Estate
Construction		$	—			$	—			$	1,270			$	1,270			$	8,137			$	9,407
Commercial - Real Estate			913				—				19,129				20,042				874,644				894,686
Commercial
Commercial - Business			—				263				7,275				7,538				274,173				281,711
Trade Finance			—				—				355				355				63,505				63,860
SBA			395				2,711				5,534				8,640				103,567				112,207
Others
Consumer			174				329				820				1,323				56,191				57,514
Other			—				—				—				—				50,048				50,048
Total		$	1,482			$	3,303			$	34,383			$	39,168			$	1,430,265			$	1,469,433

 

As of December 31, 2010		30-59 Days Past Due				60-89 Days Past Due				Non-accrual				Total Past Due and Non-accrual				Current				Total Financing Receivables 1)
		(Dollars in thousands)
Real Estate
Construction		$	—			$	—			$	6,108			$	6,108			$	8,695			$	14,803
Commercial - Real Estate			4,569				5,023				29,167				38,759				875,244				914,003
Commercial
Commercial - Business			291				1,018				5,696				7,005				308,280				315,285
Trade Finance			254				28				—				282				70,892				71,174
SBA			1,383				1,074				3,896				6,353				95,330				101,683
Others
Consumer			386				177				651				1,214				70,065				71,279
Other			—				—				—				—				40,039				40,039
Total		$	6,883			$	7,320			$	45,518			$	59,721			$	1,468,545			$	1,528,266

 

1)	Balances represent unpaid principal balance, which approximates recorded investment.

The Company utilizes a risk grading matrix to assign a risk grade to its loan portfolio. The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. Loans, excluding homogeneous loans, are individually analyzed by classifying loans as to credit risk and are graded on a scale of 1 to 7 at least on a quarterly basis. A description of the general characteristics of the seven risk grades is as follows:

Grade 1 - This grade includes loans secured by cash or listed securities. The borrowers generally have significant capital strength with unquestionable ability to service the debt.

Grades 2 and 3 - These grades include “pass grade” loans to borrowers of solid or acceptable credit quality and risk. The borrowers generally have sufficient capital strength with highly reliable or adequate primary source of repayment.

Grade 3A - This grade includes loans on management’s “watch list” and is intended to be utilized on a temporary basis for pass grade borrowers. The borrowers generally experiencing a temporary setback and may have weakening primary source of repayment.

Grade 4 - This grade is for “Special Mention” in accordance with regulatory guidelines. This grade includes borrowers that require close credit monitoring. The borrowers generally have inconclusive earnings histories and access to alternate sources of financing are limited.

 

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Grade 5 - This grade includes “Substandard” loans in accordance with regulatory guidelines. The borrowers typically have well-defined weaknesses with possibility of payment default or some loss if the weakness is not corrected.

Grade 6 - This grade includes “Doubtful” loans in accordance with regulatory guidelines. Such loans are placed on non-accrual status and the liquidation of collateral in full is highly questionable or improbable.

Grade 7 - This grade includes “Loss” loans in accordance with regulatory guidelines. Such loans are deemed uncollectible and are to be charged off or charged down. This classification is not intended to imply that the loan or some portion of it will never be paid.

The following table presents the credit risk profile of non-covered loans exclusive of loans held for sale, segregated by class of loans, as of September 30, 2011 and December 31, 2010, respectively:

 

		As of September 30, 2011
		Grade 1 - 3A				Grade 4				Grade 5				Grade 6				Total
		(Dollars in thousands)
Non-covered loans 1)
Real estate
Construction		$	7,132			$	—			$	2,275			$	—			$	9,407
Commercial - Real Estate			781,775				45,540				62,396				—				889,711
Commercial
Commercial - Business			227,242				17,059				37,394				16				281,711
Trade Finance			62,136				467				1,257				—				63,860
SBA			45,947				786				3,841				—				50,574
Others
Consumer			54,324				—				3,190				—				57,514
Other			50,048				—				—				—				50,048
Total		$	1,228,604			$	63,852			$	110,353			$	16			$	1,402,825

 

		As of December 31, 2010
		Grade 1 - 3A				Grade 4				Grade 5				Grade 6				Total
		(Dollars in thousands)
Non-covered loans 1)
Real estate
Construction		$	7,689			$	—			$	7,114			$	—			$	14,803
Commercial - Real Estate			780,479				47,873				71,498				341				900,191
Commercial
Commercial - Business			255,828				18,759				40,080				618				315,285
Trade Finance			68,598				1,100				1,476				—				71,174
SBA			49,416				880				4,956				9				55,261
Others
Consumer			69,598				—				1,681				—				71,279
Other			40,039				—				—				—				40,039
Total		$	1,271,647			$	68,612			$	126,805			$	968			$	1,468,032

 

1)	Balances represent unpaid principal balance, which approximates recorded investment.

The Company’s allowance for loan loss methodologies incorporate a variety of risk considerations, both quantitative and qualitative, in establishing an allowance for loan losses that management believes is appropriate at each reporting date. Quantitative factors include the Company’s historical loss experience, delinquency and charge-off trends, collateral values, changes in nonperforming loans, and other factors. Quantitative factors also incorporate known information about individual loans, including borrowers’ sensitivity to interest rate movements and to quantifiable external factors including commodity and finished good prices as well as acts of nature (earthquakes, floods, fires, etc.) that occur in a particular period. Qualitative factors include the general economic environment in the Company’s markets and, in particular, the state of certain industries. Size and complexity of individual credits, loan structure, extent and nature of waivers of existing loan policies and pace of portfolio growth are other qualitative factors that are considered in its methodologies. As the Company adds new products, increases the complexity of the loan portfolio, and expands its geographic coverage, the Company will enhance the methodologies to keep pace with the size and complexity of the loan portfolio. Changes in any of the above factors could have significant impact to the allowance for loan loss calculation. The Company believes that its methodologies continue to be appropriate given its size and level of complexity.

 

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The allowance for loan losses reflects management’s judgment of the level of allowance adequate to provide for probable losses inherent in the loan portfolio as of the date of the consolidated statements of financial condition. On a quarterly basis, the Company assesses the overall adequacy of the allowance for loan losses, utilizing a disciplined and systematic approach which includes the application of a specific allowance for identified problem loans, a formula allowance for identified graded loans and an allocated allowance for large groups of smaller balance homogenous loans.

Allowance for Specifically Identified Problem Loans. A specific allowance is established for impaired loans. A loan is impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. The specific allowance is determined based on the present value of expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, the Company may measure impairment based on a loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent. The Company measures impairment based on the fair value of the collateral, adjusted for the cost related to liquidation of the collateral.

Formula Allowance for Identified Graded Loans. Non-homogenous loans such as commercial real estate, construction, commercial business, trade finance and SBA loans that are not subject to the allowance for specifically identified loans discussed above are not reviewed individually and are subject to a formula allowance. The formula allowance is calculated by applying loss factors to outstanding Pass, Special Mention, Substandard and Doubtful loans. The evaluation of the inherent loss for these loans involves a high degree of uncertainty, subjectivity and judgment because probable loan losses are not identified with a specific loan. In determining the formula allowance, the Company relies on a mathematical calculation that incorporates a six-quarter rolling average of historical losses, which has been adjusted from the twelve quarter analysis used historically. The Company started using the six-quarter rolling average beginning in the fourth quarter of 2008 instead of the twelve-quarter rolling average that the Company had historically been applying. Current quarter losses are measured against previous quarter loan balances to develop the loss factor. Loans risk rated Pass, Special Mention and Substandard for the most recent three quarters are adjusted to an annual basis as follows:

 

•

the most recent quarter is weighted 4/1;

 

•

the second most recent is weighted 4/2;

 

•

the third most recent is weighted 4/3.

The formula allowance may be further adjusted to account for the following qualitative factors:

 

•

Changes in lending policies and procedures, including underwriting standards and collection, charge-off, and recovery practices;

 

•

Changes in national and local economic and business conditions and developments, including the condition of various market segments;

 

•

Changes in the nature and volume of the loan portfolio;

 

•

Changes in the experience, ability, and depth of lending management and staff;

 

•

Changes in the trend of the volume and severity of past due and classified loans, and trends in the volume of non-accrual loans and troubled debt restructurings, and other loan modifications;

 

•

Changes in the quality of the Company’s loan review system and the degree of oversight by the directors;

 

•

The existence and effect of any concentrations of credit, and changes in the level of such concentrations; and

 

•

The effect of external factors such as competition and legal and regulatory requirements on the level of estimated losses in the Company’s loan portfolio.

Allowance for Large Groups of Smaller Balance Homogenous Loans. The portion of the allowance allocated to large groups of smaller balance homogenous loans is focused on loss experience for the pool rather than on an analysis of individual loans. Large groups of smaller balance homogenous loans mainly consist of consumer loans to individuals. The allowance for groups of performing loans is based on historical losses over a six-quarter period. In determining the level of allowance for delinquent groups of loans, the Company classifies groups of homogenous loans based on the number of days delinquent and other qualitative factors and trends.

Allowance for Loans held for sale . No allowance is established for loans held for sale.

 

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8. NON-COVERED OTHER REAL ESTATE OWNED (OREO)

The Company had three non-covered OREO properties valued at $947,000 as of September 30, 2011. The changes in non-covered other real estate owned for the three and nine months ended September 30, 2011 and 2010 are as follows:

 

		Three months ended September 30,								Nine months ended September 30,
		2011				2010				2011				2010
		(Dollars in thousands)
Balance at beginning of period		$	133			$	2,778			$	937			$	4,278
Acquisition due to foreclosures at fair value			2,519				3,300				2,634				4,560
Disposition due to sales			(576	)			(1,530	)			(1,458	)			(3,195	)
Valuation Adjustment subsequent to foreclosures			(361	)			—				(398	)			(994	)
Transfer to other receivable			(768	)			—				(768	)			(101	)
Balance at end of period		$	947			$	4,548			$	947			$	4,548

9. COVERED ASSETS AND FDIC LOSS SHARE RECEIVABLE

Covered Loans

Loans acquired in an FDIC-assisted acquisition that are subject to a loss sharing agreement are referred to as “covered loans” and reported separately in the interim consolidated statements of financial condition. Covered loans are reported exclusive of the expected cash flow reimbursements expected from the FDIC.

Acquired loans are valued as of the acquisition date in accordance with FASB ASC 805, Business Combinations . Loans purchased with evidence of credit deterioration since origination for which it is probable that all contractually required payments will not be collected are accounted for under FASB ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality . In addition, because of the significant discounts associated with the acquired portfolios, the Company elected to account for all of the acquired loans, with the exception of a small population of loans, under ASC 310-30 in the amount of $125.2 million at acquisition. Certain cash secured loans and overdrafts in the amount of $0.9 million were not accounted for under ASC 310-30. Under ASC 805 and ASC 310-30, loans are recorded at fair value at the acquisition date, factoring in credit losses expected to be incurred over the life of the loan. Accordingly, an allowance for loan losses is not carried over or recorded as of the acquisition date.

If credit deterioration is experienced subsequent to the initial acquisition fair value amount, such deterioration of the expected cash flows will be measured, and a provision for loan losses will be charged to earnings. The effect of the provision for loan losses on covered loans will be offset, to the extent of the 80% loss share, by an increase to the FDIC loss share receivable. Any increase in the FDIC loss share receivable will be recognized in non-interest income. During the nine months ended September 30, 2011, no additional provision for loan losses has been required related to the covered loan portfolio.

The outstanding principal balance of covered loans, excluding fair value adjustments, as of September 30, 2011 and December 31, 2010 was $117.7 million and $147.6 million, respectively. The following table presents covered loans inclusive of fair value adjustment, segregated by class of loans, as of September 30, 2011 and December 31, 2010:

 

		September 30, 2011				December 31, 2010
		(Dollars in thousands)
Commercial - Real Estate		$	51,705			$	63,500
Commercial - Business			14,100				18,307
SBA			27,300				35,000
Other			486				486
Total covered loans			93,591				117,293
Less:
ALLL due to decrease in expected cash flows			1,010				1,010
Net covered loans		$	92,581			$	116,283

 

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The following table presents the outstanding principal balance and related fair value adjustments of covered loans, segregated by class of loans, as of September 30, 2011 and December 31, 2010:

 

		September 30, 2011								December 31, 2010
		Amount				Percent of Total				Amount				Percent of Total
		(Dollars in thousands)
Real Estate:
Construction		$	—				—	%		$	—				—	%
Commercial - Real Estate			60,234				51.1				74,193				50.3
Commercial:
Commercial - Business			15,490				13.2				20,277				13.7
Trade Finance			—				—				—				—
SBA			41,508				35.3				52,681				35.7
Others:
Consumer			486				0.4				489				0.3
Gross Covered Loans			117,718				100.0				147,640				100.0
Covered loans discount			(24,101	)							(30,344	)
Total Covered Loans			93,617								117,296
Less:
Allowance for loan losses			1,010								1,010
Net deferred loan fees			26								3
Net Covered Loans		$	92,581							$	116,283

In estimating the fair value of the covered loans at the acquisition date, the Company (i) calculated the contractual amount and timing of undiscounted principal and interest payments and (ii) estimated the amount and timing of undiscounted expected principal and interest payments. The difference between these two amounts represents the nonaccretable difference.

On the acquisition date, the amount by which the undiscounted expected cash flows exceed the estimated fair value of the acquired loans is the “accretable yield”. The accretable yield is then measured at each financial reporting date and represents the difference between the remaining undiscounted expected cash flows and the current carrying value of the loans. The accretable yield will change from period to period due to the followings:

 

•

Estimates of the remaining life of acquired loans will affect the amount of future interest income.

 

•

Indices for variable rates of interest on acquired loans may change.

 

•

Estimates of the amount of the contractual principal and interest that will not be collected (nonaccretable difference) may change.

During the first nine months of 2011, there was no change in the estimate of contractual principal and interest that will ultimately be collectible.

The following table presents the carrying amounts for the covered loans as of September 30, 2011 and December 31, 2010, respectively:

 

		September 30, 2011				December 31, 2010
		(Dollars in thousands)
Undiscounted contractual cash flows		$	133,101			$	165,355
Nonaccretable difference			(28,553	)			(36,107	)
Undiscounted cash flows expected to be collected			104,548				129,248
Accretable difference			(12,393	)			(13,880	)
Covered loans under ASC 310-30			92,155				115,368
Covered loans excluded from ASC 310-30			426				915
Total covered loans		$	92,581			$	116,283

 

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Changes in the carrying amount of covered loans and the accretable yield were as follows for the three and nine months ended September 30, 2011 and 2010:

 

		Three months ended September 30, 2011								Nine months ended September 30, 2011
		Carrying amount of Loans				Accretable Yield				Carrying amount of Loans				Accretable Yield
		(Dollars in thousands)
Balance at beginning of period		$	101,597			$	12,453			$	116,283			$	13,880
Acquisition			—				—				—				—
Accretion			1,561				(1,561	)			5,305				(5,305	)
Net payments received			(10,102	)			—				(27,627	)			—
Increase in expected cash flows			—				1,501				—				3,818
Transfer to OREO			(475	)			—				(1,380	)			—
Balance at end of period		$	92,581			$	12,393			$	92,581			$	12,393

 

		Three months ended September 30, 2010								Nine months ended September 30, 2010
		Carrying amount of Loans				Accretable Yield				Carrying amount of Loans				Accretable Yield
		(Dollars in thousands)								(Dollars in thousands)
Balance at beginning of period		$	122,362			$	18,503			$	—			$	—
Acquisition			—				—				126,167				20,412
Accretion			2,207				(2,207	)			4,116				(4,116	)
Net payments received			(11,783	)			—				(15,937	)			—
Increase in expected cash flows			—				—				—				—
Transfer to OREO			(112	)			—				(1,672	)			—
Balance at end of period		$	112,674			$	16,296			$	112,674			$	16,296

Net payment received includes all cash receipts related to the covered loans, net of the disbursements that are required to repurchase the participation sold portion of the SBA loans prior to collecting this guaranteed balance from the SBA.

Credit Quality Indicators —The covered loans acquired are and will continue to be subject to the Bank’s internal and external credit review and monitoring. The covered loans have the same credit quality indicators as the non-covered loans, to enable the monitoring of the borrower’s credit and the likelihood of repayment.

Loans are risk rated based on analysis of the current state of the borrower’s credit quality. The analysis of credit quality includes review of all sources of repayment, the borrower’s current financial and liquidity status and all other relevant information. The Company utilizes a seven-grade risk rating system, where a higher grade represents a higher level of credit risk. The seven-grade risk rating system can be generally classified by the following categories: Pass or Watch (Grade 1-3A), Special Mention (Grade 4), Substandard (Grade 5), Doubtful and Loss (Grade 6-7). The risk ratings reflect the relative strength of the sources of repayment. A detailed description of this risk grading matrix is included in Note 7 above concerning non-covered loans.

 

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The following table presents the credit risk profile of covered loans, by class of loans, as of dates indicated:

 

		As of September 30, 2011
		Grade 1 - 3A				Grade 4				Grade 5				Grade 6				Grade 7				Total
		(Dollars in thousands)
Covered loans 1)
Real estate
Construction		$	—			$	—			$	—			$	—			$	—			$	—
Commercial - Real Estate			30,769				6,655				14,301				—				—				51,725
Commercial
Commercial - Business			8,148				1,250				4,691				17				—				14,106
Trade Finance			—				—				—				—				—				—
SBA			19,456				150				6,992				89				613				27,300
Others
Consumer			486				—				—				—				—				486
Other			—				—				—				—				—				—
Total Covered Loans		$	58,859			$	8,055			$	25,984			$	106			$	613			$	93,617

 

		As of December 31, 2010
		Grade 1 - 3A				Grade 4				Grade 5				Grade 6				Grade 7				Total
		(Dollars in thousands)
Covered loans 1)
Real estate
Construction		$	—			$	—			$	—			$	—			$	—			$	—
Commercial - Real Estate			42,372				7,317				13,574				235				—				63,498
Commercial
Commercial - Business			12,856				1,828				3,422				206				—				18,312
Trade Finance			—				—				—				—				—				—
SBA			28,412				266				4,902				399				1,021				35,000
Others
Consumer			486				—				—				—				—				486
Other			—				—				—				—				—				—
Total Covered Loans		$	84,126			$	9,411			$	21,898			$	840			$	1,021			$	117,296

 

1)	Balances represent unpaid principal balance, net of discount, and exclude accrued interest.

Covered Nonperforming Assets

Covered nonperforming assets totaled $20.1 million as of September 30, 2011 compared to $26.3 million as of December 31, 2010. These covered nonperforming assets are subject to a loss sharing agreement with the FDIC. The covered nonperforming assets as of September 30, 2011 and December 31, 2010 are as follows:

 

		September 30, 2011				December 31, 2010
		(Dollars in thousands)
Covered loans on non-accrual status		$	19,069			$	24,874
Covered other real estate owned			1,028				1,459
Total covered nonperforming assets		$	20,097			$	26,333

Loans accounted for under ASC 310-30 are generally considered accruing and performing loans as the loans accrete the accretable discount to interest income over the estimated life of the loan when cash flows are reasonably estimable. Accordingly, acquired impaired loans that are contractually past due are still considered to be accruing and performing loans. The loans may be classified as nonaccrual if the timing and amount of future cash flows is not reasonably estimable.

Covered OREO

All OREO acquired in FDIC-assisted acquisitions that are subject to a FDIC loss sharing agreement is referred to as “covered OREO” and reported separately in the interim consolidated statements of financial condition. Covered OREO is reported exclusive of expected reimbursement cash flows from the FDIC. Foreclosed covered loan collateral is transferred into covered OREO at the loan’s fair value, inclusive of the acquisition date fair value discount.

Covered OREO was initially recorded at its estimated fair value on the acquisition date based on similar market comparable valuations less estimated selling costs. Any subsequent valuation adjustments due to declines in fair value will be charged to non-interest expense, and will be offset, in part, by non-interest income representing the corresponding increase to the FDIC loss share receivable. Any recoveries of previous valuation adjustments will be credited to non-interest expense with a corresponding charge to non-interest income for the portion of the recovery that is due to the FDIC.

 

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The activities related to the covered OREO for the three and nine months ended September 30, 2011 and 2010, respectively, are as follows:

 

		Three months ended September 30,								Nine months ended September 30,
		2011				2010				2011				2010
		(Dollars in thousands)
Balance at beginning of period		$	1,132			$	1,560			$	1,459			$	—
Acquisition			—				—				—				1,942
Additions to covered OREO			475				112				1,380				1,672
Fair value adjustment during the period			(67	)			—				(663	)			—
Dispositions of covered OREO			(512	)			(213	)			(1,148	)			(2,155	)
Balance at end of period		$	1,028			$	1,459			$	1,028			$	1,459

FDIC Loss Share Receivable

The Company has elected to account for amounts receivable under the loss sharing agreement with the FDIC as an FDIC loss share receivable in accordance with FASB ASC 805, Business Combinations . The FDIC loss share receivable was initially recorded at fair value, based on the discounted value of expected future cash flows under the loss sharing agreement. The difference between the present value and the undiscounted cash flows the Company expects to collect from the FDIC will be accreted into non-interest income over the life of the FDIC loss share receivable.

The FDIC loss share receivable is reviewed quarterly and adjusted for any changes in expected cash flows based on recent performance and expectations for future performance of the covered assets. These adjustments are measured on the same basis as the related covered loans and covered other real estate owned. Any increases in the cash flows of the covered assets over those expected will reduce the FDIC loss share receivable and any decreases in cash flows of the covered assets under those expected will increase the FDIC loss share receivable. Increases and decreases to the FDIC loss share receivable are recorded as adjustments to non-interest income.

The FDIC loss share receivable was determined to be $25.3 million at the acquisition date. Changes in the FDIC loss share receivable for the three and nine months ended September 30, 2011 and 2010, respectively, are as follows:

 

		Three months ended September 30,								Nine months ended September 30,
		2011				2010				2011				2010
		(Dollars in thousands)
Balance at beginning of period		$	21,964			$	25,300			$	23,991			$	—
Acquisition			—				—				—				25,300
Payment received from FDIC			(4,769	)			(1,753	)			(6,960	)			(1,753	)
Accretion			308				105				472				105
Balance at end of period		$	17,503			$	23,652			$	17,503			$	23,652

 

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10. OTHER INTANGIBLE ASSETS

In April 2010, the Company recorded a core deposit intangible of $510,000 for the acquisition of Innovative Bank. The Company amortizes premiums on acquired deposits over the estimated useful life. The Company’s amortization expense for core deposit intangible was $16,000 and $46,000 for the three and nine months ended September 30, 2011, respectively, resulting in a core deposit intangible net of amortization of $418,000 as of September 30, 2011. Estimated amortization expense for five succeeding fiscal years is as follows:

 

Year		Amount
		(Dollars in thousands)
2011 (remaining 3 months)		$	16
2012			62
2013			62
2014			62
2015			62
2016 and thereafter			154
Total		$	418

11. OTHER BORROWED FUNDS

The Company borrows funds from the Federal Home Loan Bank of San Francisco (“FHLB”) and the Treasury, Tax, and Loan Investment Program. Other borrowed funds totaled $132.1 million and $188.7 million as of September 30, 2011 and December 31, 2010, respectively. Interest expense on other borrowed funds was $1.6 million and $4.7 million for the three and nine months ended September 30, 2011, respectively, reflecting average interest rates of 4.18% and 3.86%, compared to $1.7 million and $5.0 million with average interest rates of 4.08% and 4.02%, respectively, for the same periods in 2010. The following table represents the composition of other borrowed funds as of dates indicated:

 

		September 30, 2011				December 31, 2010
		(Dollars in thousands)
FHLB		$	131,385			$	167,213
US Treasury			745				963
Secured financing - SBA loan transfer			—				20,494
Total other borrowed funds		$	132,130			$	188,670

As of September 30, 2011, the Company had outstanding borrowings of $131.4 million from the FHLB with original maturity terms ranging from 4 years to 15 years. Advances of 10-year and 15-year terms are amortizing at predetermined schedules over the life of the advances. Of the $131.4 million outstanding, $120.0 million is composed of five fixed rate term advances, each with an option to be called by the FHLB after the original lockout dates varying from 6 months to 2 years. If market interest rates are higher than the advances’ stated rates at that time, the advances will be called by the FHLB and the Bank will be required to repay the FHLB. If market interest rates are lower after the lockout period, then the advances will not be called by the FHLB. If the fixed rate term advances are not called by the FHLB, they will mature at maturity dates ranging from 5 years to 10 years. The Company may repay the advances with a prepayment penalty at any time. If the advances are called by the FHLB, there is no prepayment penalty.

The Company has pledged, under a blanket lien, all qualifying commercial and residential loans as collateral under the borrowing agreement with the FHLB, with a total carrying value of $849.4 million as of September 30, 2011 as compared to $828.0 million as of December 31, 2010.

 

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Subject to the right of the FHLB to require early repayment of the borrowings discussed above, FHLB advances outstanding, with an average interest rate of 4.45%, as of September 30, 2011, mature as follows:

 

Year		Amount
		(Dollars in thousands)
2011 (remaining 3 months)		$	5,195
2012			105,389
2013			157
2014			167
2015			176
2016 and thereafter			20,301
Total		$	131,385

Borrowings obtained from the Treasury Tax and Loan Investment Program mature within a month from the transaction date. Under the program, the Company receives funds from the U.S. Treasury Department in the form of open-ended notes, up to a total of $2.2 million. The Company has pledged U.S. government agencies and/or mortgage-backed securities with a total carrying value of $1.2 million as of September 30, 2011, as collateral to participate in the program as compared to $1.5 million as of December 31, 2010. The total borrowed amount under the program, outstanding as of September 30, 2011 and December 31, 2010 was $745,000 and $963,000, respectively.

As of December 31, 2010, the Company had SBA loans transferred of $20.5 million which were accounted for as a secured financing pursuant to ASC 860, Transfers and Servicing. At that time, SBA loan transfers were subject to a 90-day recourse provision and, therefore, were not considered sold until the recourse period expired. However, during the first quarter of 2011, SBA removed the recourse provision from the standard transfer agreement. As such, all of the SBA loan transfers executed are qualified as sales, thus, are not accounted for as secured financing from 2011.

12. LONG-TERM SUBORDINATED DEBENTURES

Center Capital Trust I is a Delaware business trust formed by the Company for the sole purpose of issuing trust preferred securities fully and unconditionally guaranteed by the Company. During the fourth quarter of 2003, Center Capital Trust I issued 18,000 Capital Trust Preferred Securities (“TP Securities”), with liquidation value of $1,000 per security, for gross proceeds of $18,000,000. The entire proceeds of the issuance were invested by Center Capital Trust I in $18,000,000 of Junior Long-term Subordinated Debentures (the “Subordinated Debentures”) issued by the Company, with identical maturity, repricing and payment terms as the TP Securities. The Subordinated Debentures represent the sole assets of Center Capital Trust I. The Subordinated Debentures mature on January 7, 2034, with interest based on 3-month LIBOR plus 2.85%, with repricing and payments due quarterly in arrears on January 7, April 7, July 7, and October 7 of each year commencing April 7, 2004. The Subordinated Debentures are redeemable by the Company on any January 7, April 7, July 7, and October 7 on or after April 7, 2009 at the Redemption Price. Redemption Price means 100% of the principal amount of Subordinated Debentures being redeemed plus accrued and unpaid interest on such Subordinated Debentures to the Redemption Date, or in case of redemption due to the occurrence of a Special Event, to the Special Redemption Date if such Redemption Date is on or after April 7, 2009. The TP Securities are subject to mandatory redemption to the extent of any early redemption of the Subordinated Debentures and upon maturity of the Subordinated Debentures on January 7, 2034.

Holders of the TP Securities are entitled to a cumulative cash distribution on the liquidation amount of $1,000 per security at a current rate per annum of 3.10%. Interest rate defined as per annum rate of interest, resets quarterly, equal to LIBOR immediately preceding each interest payment date (January 7, April 7, July 7, and October 7 of each year) plus 2.85%.

The distributions on the TP Securities are treated as interest expense in the consolidated statements of operations. The Company has the option to defer payment of the distributions for a period of up to five years, as long as the Company is not in default on the payment of interest on the Subordinated Debentures. The TP Securities issued in the offering were sold in private transactions pursuant to an exemption from registration under the Securities Act of 1933, as amended. The Company has guaranteed, on a subordinated basis, distributions and other payments due on the TP Securities.

The FRB has adopted a final rule that allows the continued inclusion of trust-preferred securities in the Tier I capital of bank holding companies, provided that the aggregate amount of trust preferred securities and certain other capital elements cannot exceed 25% of Tier I capital elements. In addition, since the Company had less than $15 billion in assets as of December 31, 2009, under the Dodd-Frank Act, the Company will be able to include its existing TP Securities in Tier 1 capital to the extent permitted by FRB guidelines. As of September 30, 2011, trust preferred securities comprised 5.84% of the Company’s Tier I capital.

 

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Center Capital Trust I is not reported on a consolidated basis in accordance with ASC 810, Consolidation . Therefore, the capital securities of $18,000,000 do not appear on the interim consolidated statements of financial condition. Instead, the long-term subordinated debentures of $18,557,000 payable by Center Financial to the Center Capital Trust I and the investment in the Center Capital Trust I’s common stock of $557,000 (included in other assets) are separately reported.

13. COMMITMENTS AND CONTINGENCIES

Off-Balance-Sheet Risk

The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, commercial letters of credit, standby letters of credit and performance bonds. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheets.

The Company’s exposure to credit loss is represented by the contractual notional amount of these instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.

Commitments to extend credit are agreements to lend to a customer provided there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since certain of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of the collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the borrower.

Commercial letters of credit, standby letters of credit, and performance bonds are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in making loans to customers. The Company generally holds collateral supporting those commitments if deemed necessary.

A summary of the notional amounts of the Company’s financial instruments relating to extension of credit with off-balance-sheet risk as of September 30, 2011 and December 31, 2010 is as follows:

 

		September 30, 2011				December 31, 2010
		(Dollars in thousands)
Loans		$	213,192			$	158,828
Standby letters of credit			17,497				27,931
Commercial letters of credit			21,288				30,341
Performance bonds			301				222

Liabilities for losses on outstanding commitments of $245,000 and $244,000, respectively, were reported separately in other liabilities as of September 30, 2011 and December 31, 2010.

Litigation

From time to time, the Company is a party to claims and legal proceedings arising in the ordinary course of business. After taking into consideration information furnished by counsel as to the current status of these claims and proceedings, management does not believe that the aggregate potential liability resulting from such proceedings would have a material adverse effect on the Company’s financial condition or results of operations.

On May 2, 2011, a purported class action was filed in Los Angeles County Superior Court against the Company, the Company’s directors and Nara Bancorp alleging, among other things, that the directors breached their fiduciary duties in connection with their approval of the proposed merger with Nara Bancorp and that the Company breached its fiduciary duties in connection with the disclosures it made regarding the proposed merger. On July 29, 2011, the parties to the litigation agreed to settle all claims asserted in the action, subject to, among other things, the execution of a stipulation of settlement and court approval. As part of the settlement, Nara Bancorp and the Company agreed to make certain supplemental disclosures included in an amendment to the registration statement for the Nara Bancorp shares to be issued at the completion of the merger. In addition, defendants have agreed to pay up to $400,000 in plaintiff’s attorneys’ fees and expenses, if and to the extent approved by the court. The court hearing on the proposed settlement is scheduled on November 16, 2011. Such payment would be due only if the merger is consummated and be payable by the combined company. If approved by the court, the settlement also would result in the release by the plaintiff and the proposed settlement class of all claims that were or could have been brought challenging any aspect of the merger agreement, the merger and any disclosures made in connection therewith (but excluding any properly perfected claims for statutory appraisal in connection with the merger, certain claims arising under the federal securities laws and any claims to enforce the settlement).

 

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14. STOCK-BASED COMPENSATION

The Company has a Stock Incentive Plan which was adopted by the Board of Directors in April 2006, approved by the shareholders in May 2006, and amended by the Board in June 2007 (the “2006 Plan”). The 2006 Plan provides for the granting of incentive stock options to officers and employees, and non-qualified stock options and restricted stock awards to employees (including officers) and non-employee directors. The 2006 Plan replaced the Company’s former stock option plan (the “1996 Plan”) which expired in February 2006, and all options under the 1996 Plan which were outstanding on April 12, 2006 were transferred to and made part of the 2006 Plan. The option prices of all options granted under the 2006 Plan (including options transferred from the 1996 Plan) must be not less than 100% of the fair market value at the date of grant. Options granted generally vest at the rate of 20% per year. All options not exercised generally expire ten years after the date of grant. Vesting of restricted stock awards (“RSAs”) is discretionary with the Board of Directors or the Compensation Committee, but awards granted to date generally vest at the rate of 50% on the third anniversary of the grant date and 25% per year for the next two years. Certain RSAs were granted to a director in 2011 with immediate vesting as part of special compensation in connection with the proposed merger with Nara Bancorp. In addition, RSAs granted to our Chief Executive Officer will vest at earlier of the closing of the proposed merger with Nara Bancorp or December 31, 2011, provided that he remains employed with the Company until such date. RSAs granted to senior executive officers are also subject to restrictions on transfer even after vesting for as long as the Company has preferred stock outstanding to the U.S. Treasury Department pursuant to the TARP Capital Purchase Program.

The Company’s pre-tax stock-based compensation expense for employees and directors was $139,000 and $416,000 ($130,000 and $390,000 after tax effect of non-qualified stock options) for the three and nine months ended September 30, 2011, respectively, as compared to $105,000 and $553,000 ($97,000 and $443,000 after tax effect of non-qualified stock options) for the same periods in 2010, respectively.

Stock Option Awards

The fair value of the stock options granted was estimated on the date of grant using the Black-Scholes option valuation model that uses the assumptions including risk-free interest rate, expected life, expected volatility and expected dividend yield. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant. Beginning in 2006, the expected life (estimated period of time outstanding) of options granted with a 10-year term was determined using the average of the vesting period and term. Expected volatility was based on historical volatility for a period equal to the stock option’s expected life, ending on the day of grant, and calculated on a weekly basis. These assumptions are utilized in the calculation of the compensation expenses. The expenses are the result of previously granted stock options and restricted stocks and those awarded, if any, during the three and nine months ended September 30, 2011 and 2010, respectively. No stock options were granted during the nine months ended September 30, 2011 and 2010.

A summary of the Company’s stock option activity and related information for the three and nine months ended September 30, 2011 and 2010 is set forth in the following table:

 

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						Outstanding Options
		Shares Available For Grant				Number of Shares				Weighted Average Exercise Price
Three months ended September 30, 2011 and 2010
Balance at June 30, 2011			2,443,513				583,344			$	16.01
Options granted			—				—				—
Options forfeited			—				—				—
Options exercised			—				(7,192	)			5.26
Balance at September 30, 2011			2,443,513				576,152				16.14
Balance at June 30, 2010			2,298,917				727,940			$	16.92
Options granted			—				—				—
Options forfeited			10,800				(10,800	)			15.21
Options exercised			—				—				—
Balance at September 30, 2010			2,309,717				717,140				16.95
Nine months ended September 30, 2011 and 2010
Balance at December 31, 2010			2,335,013				691,844			$	16.95
Options granted			—				—				—
Options forfeited			108,500				(108,500	)			22.04
Options exercised			—				(7,192	)			5.26
Balance at September 30, 2011			2,443,513				576,152				16.14
Balance at December 31, 2009			2,266,612				760,245			$	16.93
Options granted			—				—				—
Options forfeited			43,105				(43,105	)			16.59
Options exercised			—				—				—
Balance at September 30, 2010			2,309,717				717,140				16.95

The stock options as of September 30, 2011 and 2010, respectively, have been segregated into three ranges for additional disclosure as follows:

 

		Options Outstanding												Options Exercisable
Range of Exercise Prices		Options Outstanding				Weighted- Average Remaining Contractual Life in Years				Weighted- Average Exercise Price				Options Exercisable				Weighted- Average Remaining Contractual Life in Years				Weighted- Average Exercise Price
$ 2.59 - $ 8.00			45,552				5.10			$	4.98				34,219				4.30			$	5.09
$ 8.01 - $ 20.00			449,600				5.19				16.05				407,100				5.12				16.07
$ 20.01 - $ 25.10			81,000				4.93				22.94				70,700				4.86				23.02
As of September 30, 2011			576,152				5.14				16.14				512,019				5.03				16.29
$ 3.34 - $ 8.00			52,745				5.38			$	5.02				32,078				3.38			$	5.23
$ 8.01 - $ 20.00			478,395				6.15				16.08				387,017				6.01				16.07
$ 20.01 - $ 25.10			186,000				6.08				22.56				162,900				6.07				22.56
As of September 30, 2010			717,140				6.08				16.95				581,995				5.88				17.29

The aggregate intrinsic value of options outstanding and options exercisable as of September 30, 2011 was $2,000 and $1,000 compared to $12,000 and $4,000 as of September 30, 2010, respectively. The aggregate intrinsic value represents the difference between the Company’s closing stock price on the last trading day of the period, which was $4.69 and $5.09 as of September 30, 2011 and 2010, respectively, and the exercise price multiplied by the number of options outstanding. 7,192 options were exercised during the three and nine months ended September 30, 2011 while no options were exercised during the same periods in 2010. Total fair value of vested options was $3.2 million and $1.1 million as of September 30, 2011 and 2010, respectively. The number of options that were not vested as of September 30, 2011 and 2010 was 64,133 and 135,145, respectively.

As of September 30, 2011 and 2010, the Company had approximately $385,000 and $523,000 of unrecognized compensation costs related to unvested options, respectively, which are expected to be recognized over a weighted average period of 0.77 years and 1.80 years, respectively.

 

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Restricted Stock Awards

Restricted stock activity under the 2006 Plan as of and changes during the three and nine months ended September 30, 2011 and 2010 are as follows:

 

		Three Months Ended September 30, 2011								Nine Months Ended September 30, 2011
		Number of Shares				Weighted-Average Grant-Date Fair Value per Share				Number of Shares				Weighted-Average Grant-Date Fair Value per Share
Restricted Stock:
Nonvested, beginning of period			52,349			$	5.91				76,809			$	5.77
Granted			—				—				28,079				7.61
Vested			—				—				(22,088	)			8.26
Cancelled and forfeited			(900	)			5.68				(31,351	)			5.42
Nonvested, at end of period			51,449				5.92				51,449				5.92

 

		Three Months Ended September 30, 2010								Nine Months Ended September 30, 2010
		Number of Shares				Weighted-Average Grant-Date Fair Value per Share				Number of Shares				Weighted-Average Grant-Date Fair Value per Share
Restricted Stock:
Nonvested, beginning of period			57,309			$	5.83				10,050			$	13.59
Granted			8,700				5.50				59,609				5.13
Vested			—				—				(2,950	)			17.00
Cancelled and forfeited			(225	)			11.43				(925	)			14.29
Nonvested, at end of period			65,784				5.76				65,784				5.76

The Company recorded compensation cost of $39,000 and $117,000, respectively, related to the restricted stock granted under the 2006 Plan for the three and nine months ended September 30, 2011 as compared to $20,000 and $62,000, respectively, for the same periods in 2010. As of September 30, 2011 and 2010, the Company had approximately $304,000 and $196,000 of unrecognized compensation costs related to unvested restricted stock, respectively. The costs are expected to be recognized over a weighted-average period of 2.74 years and 2.15 years as of September 30, 2011 and 2010, respectively.

15. COMMON AND PREFERRED STOCK CASH DIVIDENDS

In March 2009, the Company’s board of directors suspended its quarterly cash dividends on the Company’s common stock based on adverse economic conditions and the Company’s then recent losses. The board of directors determined that this is a prudent, safe and sound practice to preserve capital, and does not expect to resume the payment of cash dividends in the foreseeable future. Unless the preferred stock issued to the Treasury Department in the TARP Capital Purchase Program has been redeemed, the Company will not be permitted to resume paying cash dividends without the consent of the Treasury Department until December 2011. In addition, the Bank and the Company had each entered into informal regulatory agreements with the respective regulatory agency or agencies, pursuant to which both the Bank and the Company must obtain prior regulatory approval to pay dividends. The Bank’s MOU with the FDIC and the DFI and the Company’s MOU with the FRB were lifted in September 2011 and October 2011, respectively.

The Company paid a preferred stock dividend of $688,000 on August 15, 2011 and accrued for the preferred stock dividends of $344,000 as of September 30, 2011 which will be included in the next payment scheduled on November 15, 2011.

16. PREFERRED STOCK AND COMMON STOCK WARRANTS

The Company entered into Securities Purchase Agreements with a limited number of institutional and other accredited investors, including insiders, to sell a total of 73,500 shares of mandatorily convertible non-cumulative non-voting perpetual preferred stock, series B, without par value (the “Series B Preferred Stock”) at a price of $1,000 per share, for an aggregate gross purchase price of $73.5 million. This private placement closed on December 31, 2009, and the Company issued an aggregate of 73,500 shares of Series B Preferred Stock upon its receipt of consideration in cash. The Series B Preferred Stock converted into 19,599,981 shares of common stock effective March 29, 2010, following shareholder approval of such conversion. The conversion ratio was equal to the quotient obtained by dividing the $1,000 per share purchase price by the conversion price of $3.75. The shares issued in this private placement were registered on a Form S-3 Registration Statement, as amended, which became effective April 8, 2010, thus removing the restrictions on resale.

 

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The conversion price of $3.75 per share was less than the fair value of $5.23 per share of our common stock on December 29, 2009, the commitment date for the issuance of the Series B Preferred Stock. The Series B Preferred Stock was thus issued with a beneficial conversion feature with an intrinsic value of $1.48 per share or at a discount of $29.0 million. On the effective date of the conversion, the unamortized discount due to the beneficial conversion feature was immediately recognized as a dividend and accounted for as a charge to retained earnings and a reduction of net income available to common shareholders in the earnings per share computation. As this accounting treatment was a mere reclassification within shareholders’ equity, it did not affect shareholders’ equity.

The Company also issued 3,360,000 shares of common stock in a private placement which closed on November 30, 2009 (the “November Private Placement”), at a price per share of $3.71 to non-affiliated investors and $4.69 to certain directors and employees of the Company. The difference in the purchase price was necessary to comply with NASDAQ Listing Rule 5635(c). The Company obtained shareholder approval of the November Private Placement at a special meeting held on March 24, 2010 so that all investors in the November Private Placement could be treated equally. Following receipt of shareholder approval, 85,045 additional shares were issued for no additional consideration to the directors and employees who invested in the November Private Placement, in order to effectuate this result. The shares issued in the November Private Placement were also registered on a Form S-3 Registration Statement which became effective April 8, 2010, thus removing the restrictions on resale.

The Company entered into a purchase agreement with the U.S. Treasury Department on December 12, 2008, pursuant to which the Company issued and sold 55,000 shares of the Company’s fixed-rate cumulative perpetual preferred stock for a total purchase price of $55.0 million, and a 10-year warrant to purchase 864,780 shares of the Company’s common stock at an exercise price of $9.54 per share. The number of shares underlying the warrant was reduced to 432,390 effective December 31, 2009 as a result of the fourth quarter capital raises described above. The Company will pay the U.S. Treasury Department a five percent dividend annually for each of the first five years of the investment and a nine percent dividend thereafter until the shares are redeemed. The cumulative dividend for the preferred stock is accrued for and payable on February 15, May 15, August 15 and November 15 of each year.

The Company allocated total proceeds of $55.0 million, based on the relative fair value of preferred stock and common stock warrants, to preferred stock for $52.9 million and common stock warrants for $2.1 million, respectively, on December 12, 2008. The preferred stock discount is being accreted, on an effective yield method, to preferred stock over 10 years.

 

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17. EARNINGS (LOSS) PER COMMON SHARE

Common stock outstanding as of September 30, 2011 totaled 39,919,952 shares. The following table sets forth the Company’s earnings (loss) per common share calculation for the three and nine months ended September 30, 2011 and 2010, respectively:

 

			0000000				0000000				0000000				0000000				0000000				0000000
		Three Months Ended September 30,
		2011												2010
		(Dollars in thousands, except earnings per share)
		Net Income				Average Number of Shares				Per Share Amounts				Net Income				Average Number of Shares				Per Share Amounts
Basic earnings per share
Net income		$	9,393				39,876			$	0.24			$	5,963				39,902			$	0.15
Less : preferred stock dividends and accretion of preferred stock discount			(757	)			—				(0.02	)			(748	)			—				(0.02	)
Income available to common shareholders			8,636				39,876				0.22				5,215				39,902				0.13
Effect of dilutive securities:
Stock options and restricted stock awards			—				57				—				—				10				—
Diluted earnings per share
Income available to common shareholders		$	8,636				39,933			$	0.22			$	5,215				39,912			$	0.13

 

			00000000				00000000				00000000				00000000				00000000				00000000
		Nine Months Ended September 30,
		2011												2010
		(Dollars in thousands, except earnings per share)
		Net Income				Average Number of Shares				Per Share Amounts				Net Income (Loss)				Average Number of Shares				Per Share Amounts
Basic earnings (loss) per share
Net income		$	19,174				39,866			$	0.48			$	16,233				33,763			$	0.48
Less : preferred stock dividends and accretion of preferred stock discount			(2,261	)			—				(0.06	)			(31,246	)			—				(0.92	)
Income (loss) available to common shareholders			16,913				39,866				0.42				(15,013	)			33,763				(0.44	)
Effect of dilutive securities:
Stock options and restricted stock awards			—				66				—				—				—				—
Diluted earnings (loss) per share
Income (loss) available to common shareholders		$	16,913				39,932			$	0.42			$	(15,013	)			33,763			$	(0.44	)

The number of common shares underlying stock options which were outstanding but not included in the calculation of diluted earnings (loss) per share because they would have had an anti-dilutive effect amounted to approximately 0 and 10,703 shares for the three and nine months ended September 30, 2011, respectively, as compared to 717,000 and 678,000 for the same periods in 2010, respectively.

18. INCOME TAXES

The income tax provision amounted to $415,000 and $1.2 million for the three and nine months ended September 30, 2011 representing effective tax rates of 4.2% and 5.9%, respectively, as compared to income tax (benefit) provision of $(0.8) million and $4.4 million with effective tax rates of (16.5)% and 21.3%, respectively, for the same periods in 2010. The primary reasons for the difference from the federal statutory tax rate of 35% are the reduction in the valuation allowance for deferred taxes, the inclusion of state taxes and reductions related to tax favored investments in low-income housing, dividend exclusions, treatment of share-based payments amortization, an increase in cash surrender value of bank owned life insurance, California enterprise zone interest deductions and hiring credits, and nondeductible merger costs. The Company reduced taxes utilizing the tax credits from investments in the low-income housing projects in the amount of $353,000 and $1.1 million for the three and nine months ended September 30, 2011, respectively, as compared to $378,000 and $1.1 million for the same periods in 2010.

Deferred income tax assets or liabilities reflect the estimated future tax effects attributable to differences as to when certain items of income or expense are reported in the financial statements versus when they are reported in the tax returns. The Company’s net deferred tax assets were $20.0 million, net of a valuation allowance of $3.9 million as of September 30, 2011, and $14.4 million, net of a valuation allowance of $10.7 million as of December 31, 2010, respectively. The valuation allowance of $3.9 million was solely established for the state deferred income tax not expected to be realized. The reduction in the valuation allowance reduced income tax expense by $3.4 million and $6.4 million for the three and nine months ended September 30, 2011. The reduction in 2011 is primarily due to the pre-tax profit generated for the nine months ended September 30, 2011, which increased the cumulative taxable income available for carry-back for federal income tax purpose. As of September 30, 2011, the Company’s deferred tax assets were primarily due to the allowance for loan losses which was partially offset by a bargain purchase gain.

 

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In assessing the future realization of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, the projected future taxable income, and tax planning strategies in making this assessment.

The Internal Revenue Service (the “IRS”) and the Franchise Tax Board (the “FTB”) have examined the Company’s consolidated federal income tax returns for tax years up to and including 2007. As of September 30, 2011, the Company was under examination by the IRS for the 2009 tax year and the FTB for the 2008-2009 tax years. The Company does not anticipate any material changes as a result of the IRS and the FTB examination. In addition, the Company does not have any unrecognized tax benefits subject to significant increase or decrease as a result of uncertainty.

19. FAIR VALUE MEASUREMENTS

Fair Values of Financial Instruments

The Company, using available market information and appropriate valuation methodologies available to management as of September 30, 2011 and December 31, 2010, has determined the estimated fair value of financial instruments. However, considerable judgment is required to interpret market data in order to develop estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. Furthermore, fair values do not reflect any premium or discount that may result from offering the instruments for sale. Potential taxes and other expenses that would be incurred in an actual sale or settlement are not reflected.

The estimated fair values and related carrying amounts of the Company’s financial instruments as of September 30, 2011 and December 31, 2010 are as follows:

 

		September 30, 2011								December 31, 2010
		Carrying or Contract Amount				Estimated Fair Value				Carrying or Contract Amount				Estimated Fair Value
						(Dollars in thousands)
Assets:
Cash and cash equivalents		$	306,145			$	306,145			$	258,920			$	258,920
Investment securities available for sale			310,983				310,983				289,551				289,551
Non-covered loans held for sale, at the lower of cost or fair value			66,608				66,608				60,234				61,162
Federal Home Loan Bank and other equity stock			13,199				13,199				15,019				15,019
Non-covered loans, net			1,353,440				1,344,510				1,415,646				1,522,475
Covered loans, net			92,581				92,581				116,283				116,283
FDIC loss share receivable			17,503				17,503				23,991				23,991
Customers’ liability on acceptances			3,313				3,313				2,287				2,287
Accrued interest receivable			5,089				5,089				5,509				5,509
Income tax receivable			13,236				13,236				14,277				14,277
Liabilities:
Deposits			1,796,904				1,766,578				1,770,994				1,727,320
Other borrowed funds			132,130				138,287				188,670				197,781
Acceptances outstanding			3,313				3,313				2,287				2,287
Accrued interest payable			4,317				4,317				5,113				5,113
Long-term subordinated debentures			18,557				14,512				18,557				14,452
Accrued expenses and other liabilities			7,186				7,186				10,646				10,646
Off-balance sheet items:
Commitments to extend credit			213,192				273				158,828				204
Standby letter of credit			17,497				262				27,931				418
Commercial letters of credit			21,288				80				30,341				114
Performance bonds			301				4				222				3

 

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The methods and assumptions used to estimate the fair value of each class of financial instruments for which it is practicable to estimate as follows:

Cash and Cash Equivalents —The carrying amounts approximate fair value due to the short-term nature of these instruments.

Securities —The fair value of securities is generally determined by quoted market prices and the valuation techniques available under the market approach, income approach and/or cost approach are used. The Company’s evaluations are based on market data and combinations of these approaches for its valuation methods are used depending on the asset class.

Non-covered Loans —Fair values are estimated for portfolios of loans with similar financial characteristics, primarily fixed and adjustable rate interest terms. The fair values of fixed rate loans are based on discounted cash flows utilizing applicable risk-adjusted spreads relative to the current pricing of similar fixed rate loans, as well as anticipated repayment schedules. The fair value of adjustable rate loans is based on the estimated discounted cash flows utilizing the discount rates that approximate the pricing of loans collateralized by similar properties or assets. The estimated fair value is net of allowance for loan losses, deferred loan fees, and deferred gain on SBA loans.

Covered Loans —Covered loans are measured at estimated fair value on the date of acquisition. Carrying value is calculated as the present value of expected cash flows and approximates fair value.

Federal Home Loan Bank and Federal Reserve Bank stock —The carrying amounts approximate fair value, as the stocks may be sold back to the Federal Home Loan Bank and Federal Reserve Bank at carrying value.

FDIC Loss Share Receivable —The fair value of FDIC loss share receivable is based on the discounted value of expected future cash flows under the loss sharing agreement with the FDIC.

Accrued Interest Receivable and Accrued Interest Payable —The carrying amounts approximate fair value due to the short-term nature of these assets and liabilities.

Customer’s Liability on Acceptances and Acceptances Outstanding —The carrying amounts approximate fair value due to the short-term nature of these assets.

Deposits —The fair value of nonmaturity deposits is the amount payable on demand at the reporting date. Nonmaturity deposits include non-interest-bearing demand deposits, savings accounts, NOW accounts, and money market accounts. Discounted cash flows have been used to value term deposits such as certificates of deposit. The discount rate used is based on interest rates currently being offered by the Company on comparable deposits as to amount and term.

Other Borrowed Funds —These funds mostly consist of FHLB advances. The fair values of FHLB advances are estimated based on the discounted value of contractual cash flows, using rates currently offered by the Federal Home Loan Bank of San Francisco for fixed-rate credit advances with similar remaining maturities.

Long-term Subordinated Debentures —The fair value of long-term subordinated debentures are estimated by discounting the cash flows through maturity based on prevailing rates offered on the 30-year Treasury bonds.

Loan Commitments, Letters of Credit, and Performance Bond —The fair value of loan commitments, standby letters of credit, commercial letters of credit and performance bonds is estimated using the fees currently charged to enter into similar agreements.

Fair Value Measurement – Three Levels

Fair value is measured in accordance with a three-level valuation hierarchy for disclosure of fair value measurement. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follow:

 

•        Level 1 –		inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
•        Level 2 –		inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
•        Level 3 –		inputs to the valuation methodology are unobservable and significant to the fair value measurement.

 

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Following is a description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy:

Assets

Securities Available for Sale

U.S. Treasury—The Company measures fair value of these securities by using quoted market prices, a level 1 measurement.

U.S. Governmental agencies securities and U.S. Governmental sponsored enterprise securities—The Company measures fair value of these securities by using quoted market prices for similar securities or dealer quotes, a level 2 measurement.

U.S. Governmental agencies securities and U.S. Governmental sponsored enterprise mortgage-backed securities—The Company measures fair value of these securities by using quoted market prices for similar securities or dealer quotes, a level 2 measurement.

Mutual funds backed by adjustable rate mortgages—The Company measures fair value of residential mortgage-backed securities by using quoted market prices for similar securities or dealer quotes, a level 2 measurement.

Fixed rate collateralized mortgage obligations—The Company measures fair value of collateralized mortgage obligations by using quoted market prices for similar securities or dealer quotes, a level 2 measurement.

Corporate trust preferred security—The Company owns one collateralized debt obligation (“CDO”) security that is backed by trust preferred securities (“TRUPS”) issued by banks and thrifts. The Company measures the fair value of the CDO TRUPS security by using a Level 3 fair value measurement.

Non-covered SBA loans held for sale- Loans held for sale are measured at the lower of cost or fair value. As of September 30, 2011 and December 31, 2010, the Company had $61.6 million and $46.4 million of non-covered SBA loans held for sale, respectively. Management obtains quotes, bids or pricing indication sheets on all or part of these loans directly from the purchasing financial institutions. Premiums received or to be received on the quotes, bids or pricing indication sheets are indicative of the fact that cost is lower than fair value. As of September 30, 2011 and December 31, 2010, the entire balance of loans held for sale was recorded at its cost. The Company records non-covered SBA loans held for sale on a nonrecurring basis with Level 2 inputs.

Non-covered nonperforming loans held for sale - The Company reclassifies certain nonperforming loans when the decision to sell those loans is made. The fair value of nonperforming loans held for sale is generally based upon the quotes, bids or sales contract price which approximate the fair value. Nonperforming loans held for sale are recorded at estimated fair value less anticipated liquidation cost. As of September 30, 2011 and December 31, 2010, the Company had $5.0 million and $13.8 million of nonperforming loans held for sale, respectively. The Company measures nonperforming loans held for sale at fair value on a nonrecurring basis with Level 3 inputs.

Non-covered impaired loans- A loan is considered impaired when it is probable that all of the principal and interest due may not be collected according to the original underwriting terms of the loan. Impaired loans are measured at the lower of its carrying value or at an observable market price if available or at the fair value of the loan’s collateral if the loan is collateral dependent. Fair value of the loan’s collateral when the loan is dependent on collateral, is determined by appraisals or independent valuation, which is then adjusted for the cost associated with liquidating the collateral. The Company measures impaired loans at fair value on a nonrecurring basis with Level 3 inputs.

Non-covered Other Real Estate Owned (OREO)- Non-covered OREO is transferred at fair value and is carried at the lower of its carrying value or its fair value less anticipated disposal cost. Fair value of the non-covered OREO is determined by appraisals or independent valuation, which is then adjusted for the cost associated with liquidating the property. The Company measures non-covered OREO at fair value on a nonrecurring basis with Level 3 inputs.

Covered OREO- Covered OREO was initially recorded at its estimated fair value on the acquisition date based on similar market comparable valuations less estimated selling costs. Any subsequent valuation adjustments due to declines in fair value will be charged to non-interest expense, and will be offset, in part, by non-interest income representing the corresponding increase to the FDIC loss share receivable. Any recoveries of previous valuation adjustments will be credited to non-interest expense with a corresponding charge to non-interest income for the portion of the recovery that is due to the FDIC. The Company measures covered OREO at fair value on a nonrecurring basis with Level 3 inputs.

 

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Assets measured at fair value on a recurring basis by class as of September 30, 2011 and December 31, 2010 are as follows:

 

Assets measured at fair value on a recurring basis						Fair Value Measurements at Reporting Date Using
		Total as of 9/30/2011				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
		(Dollars in thousands)
U.S. Treasury		$	300			$	300			$	—			$	—
U.S. Governmental agencies securities and U.S. Government sponsored enterprise securities			38,118				—				38,118				—
U.S. Governmental agencies and U.S. Government sponsored and enterprise mortgage-backed securities			163,428				—				163,428				—
Corporate trust preferred security			817				—				—				817
Mutual Funds backed by adjustable rate mortgages			5,257				—				5,257				—
Collateralized mortgage obligations			103,063				—				103,063				—
Total available-for-sale securities		$	310,983			$	300			$	309,866			$	817

 

		Total as of 12/31/2010				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
						(Dollars in thousands)
Available-for-sale securities:
U.S. Treasury		$	300			$	300			$	—			$	—
U.S. Governmental agencies and U.S. Government sponsored enterprise securities			58,607								58,607				—
U.S. Governmental agencies and U.S. Government sponsored and enterprise mortgage-backed securities			157,099				—				157,099				—
Corporate trust preferred security			759				—				—				759
Mutual Funds backed by adjustable rate mortgages			5,073				—				5,073				—
Collateralized mortgage obligations			67,713				—				67,713				—
Total available-for-sale securities		$	289,551			$	300			$	288,492			$	759

The following table presents the Company’s reconciliation and statement of operations classification of gains and losses for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and nine months ended September 30, 2011 and 2010, respectively.

 

		Three months ended September 30,
		2011				2010
		(Dollars in thousands)
Balance, beginning of period		$	756			$	1,790
Purchases, Issuances and Settlements			—				—
Gain (Loss) in Earnings (Expenses)			—				—
Gain (Loss) in Other Comprehensive Income			61				(77	)
Transfer in/out of Level 3			—				—
Balance, end of period		$	817			$	1,713

 

		Nine months ended September 30,
		2011				2010
		(Dollars in thousands)
Balance, beginning of period		$	759			$	2,404
Purchases, Issuances and Settlements			—				—
Gain (Loss) in Earnings (Expenses)			—				—
Gain (Loss) in Other Comprehensive Income			58				(691	)
Transfer in/out of Level 3			—				—
Balance, end of period		$	817			$	1,713

The Company transfers its assets and liabilities measured at fair value to a different hierarchy when the valuation techniques and inputs used to develop fair value measurements change. Such transfers are recognized at the end of each quarterly period. There have been no transfers during the three and nine months ended September 30, 2011.

 

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The following table presents the aggregate balance of assets measured at estimated fair value on a nonrecurring basis as of September 30, 2011 and 2010 and the total losses resulting from these fair value adjustments for the nine months ended September 30, 2011 and 2010:

 

		As of September 30, 2011																Total Losses
		Level 1				Level 2				Level 3				Total
						(Dollars in thousands)
Non-covered SBA loans held for sale		$	—			$	705			$	—			$	705			$	80
Non-covered nonperforming loans held for sale			—				—				4,975				4,975				1,720
Non-covered impaired loans			—				—				50,637				50,637				9,057
Non-covered OREO			—				—				947				947				786
Covered OREO			—				—				904				904				664
Total		$	—			$	705			$	57,463			$	58,168			$	12,307

 

		As of September 30, 2010
		Level 1				Level 2				Level 3				Total				Total Losses
						(Dollars in thousands)
Non-covered SBA loans held for sale		$	—			$	23			$	—			$	23			$	4
Non-covered nonperforming loans held for sale			—				—				12,784				12,784				4,558
Non-covered impaired loans			—				—				49,452				49,452				8,906
Non-covered OREO			—				—				1,193				1,193				1,047
Total		$	—			$	23			$	63,429			$	63,452			$	14,515

Liabilities

The Company did not identify any liabilities that are required to be presented at fair value.

20. SUBSEQUENT EVENTS

During the third quarter of 2011, the Company initiated a relatively small bulk sale that included 11 loans aggregating $5.0 million and concluded the transaction in October 2011. Including this $5.0 million, a total loan balance of $10.2 million was transferred to loans held for sale during the third quarter of 2011.

 

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Item 2:

MANAGEMENT’S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

The following is management’s discussion and analysis of the major factors that influenced the Company’s consolidated results of operations for the three and nine months ended September 30, 2011 and 2010 and financial condition as of September 30, 2011 and December 31, 2010. This analysis should be read in conjunction with the Company’s Annual Report on Form 10-K, as amended, for the year ended December 31, 2010 and with the unaudited interim consolidated financial statements and notes as set forth in this report.

FORWARD-LOOKING STATEMENTS

Certain matters discussed under this caption may constitute forward-looking statements under Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements other than statements of historical fact are forward looking statements. There can be no assurance that the results described or implied in such forward-looking statements will, in fact, be achieved and actual results, performance, and achievements could differ materially because the business of the Company involves inherent risks and uncertainties, many of which are difficult to predict and are generally beyond the control of the Company. Risks and uncertainties include, but not limited to, possible future deteriorating economic conditions in the Company’s areas of operation; risk of significant non-earning assets, and net credit losses that could occur, particularly in times of weak economic conditions or times of rising interest rates; interest rate risk associated with volatile interest rates and related asset-liability matching risk; liquidity risks; risks of available-for-sale securities declining significantly in value as interest rates rise or issuers of such securities suffer financial losses; increased competition among depository institutions; the successful integration and operations of the FDIC-assisted acquisition; the company’s ability to sustain profitable operations; the company’s ability to capitalize on strategic growth opportunities; and the company’s ability to enhance its earnings capacity; the economic and regulatory effects of the continuing war on terrorism and other events of war, including the wars in Iraq and Afghanistan; the effect of natural disasters, including earthquakes, fires and hurricanes; and regulatory risks associated with the variety of current and future regulations to which the Company is subject. All of these risks could have a material adverse impact on the Company’s financial condition, results of operations or prospects, and these risks should be considered in evaluating the Company. For additional information concerning these factors, see “Risk Factors”; and “Interest Rate Risk Management” and “Liquidity and Capital Resources” contained in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of our Form 10-K, as amended, for the year ended December 31, 2010, as supplemented by the information contained in this report.

Critical Accounting Policies

Accounting estimates and assumptions are those that the Company considers to be the most critical to an understanding of the Company’s financial statements because they inherently involve significant judgments and uncertainties. The financial information contained in these statements is, to a significant extent, financial information that is based on approximate measures of the financial effects of transactions and events that have already occurred. These critical accounting policies are those that involve subjective decisions and assessments and have the greatest potential impact on the Company’s results of operations. Actual performance that differs from the Company’s estimates and future changes in the key variables could change future valuations and impact net income. There was no significant changes to the Company’s critical accounting policies discussed in the Form 10-K, as amended, for the year ended December 31, 2010.

Recent Developments

Merger Agreement with Nara Bancorp

On December 9, 2010, Center Financial and Nara Bancorp, Inc. (“Nara Bancorp”) entered into a definitive agreement to merge. Under the terms of the merger agreement, Center Financial shareholders will receive a fixed ratio of 0.7804 of a share of Nara Bancorp common stock in exchange for each share of Center Financial common stock they own. At the closing date of merger, Nara Bancorp shareholders will own approximately 55% of the combined company and Center Financial shareholders will own approximately 45%. The combined company will operate under a new name that will be determined prior to the closing. In addition, at the closing or as soon as possible thereafter, it is anticipated that Nara Bank, a California state-chartered bank and a wholly owned subsidiary of Nara Bancorp, will merge with and into the Bank, with the Bank as the surviving bank after the bank merger.

The boards of directors of both companies have unanimously approved the transaction. Both our shareholders and Nara Bancorp’s have approved the merger at separate meetings, both held on September 21, 2011. On November 7, 2011, the company announced receipt of approval from the FDIC of the planned merger of Nara Bank and Center Bank. This represents the final regulatory approval required for the merger of the companies. Approvals have previously been received from the DFI and the FRB. The merger is expected to close by end of November 2011, subject to customary closing conditions.

 

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Please see our current report on Form 8-K filed with the Securities and Exchange Commission (“SEC”) on December 9, 2010 for a more complete description of the merger agreement. In addition, in connection with the proposed merger, Nara Bancorp filed with the SEC a Registration Statement on Form S-4 that includes a Joint Proxy Statement/Prospectus of Center Financial and Nara Bancorp, as well as other relevant documents concerning the proposed transaction. Shareholders are urged to read the Registration Statement and the Joint Proxy Statement/Prospectus regarding the merger and any other relevant documents filed with the SEC, as well as any amendments or supplements to those documents, because they will contain important information. You may obtain a free copy of the Joint Proxy Statement/Prospectus, as well as other filings containing information about Center Financial and Nara Bancorp at the SEC’s Internet website (www.sec.gov). You may also obtain these documents, free of charge, from Center Financial’s website www.centerbank.com under the tab “Investor Relations” and then under the heading “SEC Filings”.

Informal Regulatory Agreements

Effective December 28, 2010, the Bank entered into a memorandum of understanding (“MOU”) with the FDIC and the DFI replacing the previous MOU dated December 18, 2009. The MOU is an informal administrative agreement pursuant to which the Bank had agreed to take various actions and comply with certain requirements to facilitate improvement in its financial condition. In September 2011, the Bank’s MOU with the FDIC and DFI was lifted.

On December 9, 2009, Center Financial entered into an MOU with the Federal Reserve Bank of San Francisco (the “FRB”) pursuant to which the Company agreed, among other things, to (i) take steps to ensure that the Bank complies with the Bank’s MOU; (ii) implement a capital plan addressing specified items and submit the plan to the FRB for approval; (iii) submit annual cash flow projections to the FRB; (iv) refrain from paying cash dividends, receiving cash dividends from the Bank, increasing or guaranteeing debt, redeeming or repurchasing its stock, or issuing any additional trust preferred securities, without prior FRB approval; and (v) submit written quarterly progress reports to the FRB detailing compliance with the MOU. In October 2011, the Company’s MOU with the FRB was lifted.

 

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EXECUTIVE OVERVIEW

The Company recorded consolidated net income of $9.4 million and $19.2 million and income of $0.22 and $0.42 per diluted common share, respectively, for the three and nine months ended September 30, 2011 as compared to consolidated net income of $6.0 million and $16.2 million and income of $0.13 and a loss of $0.44 per diluted common share for the same periods in 2010, respectively. The following were significant highlights related to the results during the three and nine months ended September 30, 2011 as compared to the corresponding periods of 2010:

 

•

The provision for loan losses on non-covered loans was $1.2 million and $12.2 million for the three and nine months ended September 30, 2011, respectively, compared to $4.0 million and $16.0 million for the same periods in 2010, respectively. The decrease for the nine month period was primarily due to a continued stabilization of risk factors as evidenced by four consecutive quarters of declining net charge-offs, and decrease in the level of nonperforming loans.

 

•

Gain on sale of SBA loans of $1.9 million and $7.6 million was recorded during the three and nine months ended September 30, 2011 compared to $257,000 and $1.5 million for the same periods in 2010. The Company sold $81.5 million of SBA loans to secondary market during the nine months ended September 30, 2011 compared to sale of $18.3 million for the same period in 2010.

 

•

Net interest income before provision for loan losses was $17.2 million and $51.0 million for the three and nine months ended September 30, 2011 as compared to $17.1 million and $51.0 million for the same periods in 2010, respectively. The net interest margin for the three and nine months ended September 30, 2011 decreased to 3.19% and 3.19% from 3.20% and 3.25% for the same periods in 2010, respectively. There was virtually no change in net interest income for the three and nine months ended September 30, 2011 compared to the same periods in 2010 due primarily to the decreases in interest income being offset by the decreases in interest expense. The decreases in interest income were mainly due to rate reductions in loans and investment during the nine months period. The decreases in interest expense mainly resulted from rate and volume reductions in time certificates of deposit during the nine months period.

 

•

The income tax provision amounted to $415,000 and $1.2 million for the three and nine months ended September 30, 2011 representing effective tax rates of 4.2% and 5.9%, respectively, as compared to income tax (benefit) provision of $(0.8) million and $4.4 million with effective tax rates of (16.5)% and 21.3%, respectively, for the same periods in 2010. The Company’s net deferred tax assets were $20.0 million, net of a valuation allowance of $3.9 million as of September 30, 2011, and $14.4 million, net of a valuation allowance of $10.7 million as of December 31, 2010, respectively. The valuation allowance of $3.9 million was solely established for the state deferred income tax not expected to be realized. The reduction in the valuation allowance reduced income tax expense by $3.4 million and $6.4 million for the three and nine months ended September 30, 2011 due to the pre-tax profit generated for the nine months ended September 30, 2011, which increased the cumulative taxable income available for carry-back for federal income tax purpose.

 

•

The Company’s efficiency ratio decreased to 52.5% for the three months ended September 30, 2011 compared to 57.6% for the same period in 2010 and increased to 53.8% for the nine months ended September 30, 2011 compared to 49.2% for the same period in 2010. The decrease for the three months ended September 30, 2011 primarily relate to an increase in gain on sale of SBA loans while there was no significant change in net interest income and noninterest expense. The increase for the nine months ended September 30, 2011 was mainly due to an increase in salaries expense coupled with the decrease in noninterest income. Despite the increase in gain on sale of SBA loans of $6.0 million in 2011, noninterest income in 2010 included gain on business acquisition of $5.9 million and gain on sale of available-for-sale securities of $2.2 million.

 

•

Return on average assets increased to 1.63% and 1.12%, respectively, for the three and nine months ended September 30, 2011, compared to 1.04% and 0.97% during the same periods in 2010, respectively. Return on average equity also increased to 12.89% and 9.08%, respectively, for the three and nine months ended September 30, 2011, compared to 8.83% and 8.29% during the same periods in 2010, respectively. The increases in return on average assets and the return on average equity were due primarily to the reduction in provision for loan losses and the increase in noninterest income primarily resulting from the gain on sales of SBA loan in 2011.

The following are important factors in understanding the Company’s financial condition and liquidity:

 

•

The Company’s gross non-covered loans, which included loans held for sale, decreased by $58.8 million, or 3.8%, during the nine months ended September 30, 2011. Net non-covered loans and loans held for sale decreased by $55.8 million, or 3.8%, to $1.42 billion as of September 30, 2011, as compared to $1.48 billion as of December 31, 2010. The decrease in the non-covered loan portfolio mainly resulted from sale of $81.5 million of guaranteed portion of SBA loans, charge-offs of $18.6 million, and notes sale of $13.3 million exclusive of the portion financed by the Company in commercial loans, coupled with the fact that new loan originations were slow due to continued economic instability during the nine months ended September 30, 2011.

 

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•

Total non-covered nonperforming loans decreased to $34.4 million as of September 30, 2011 from $45.5 million as of December 31, 2010 and from $43.2 million as of September 30, 2010. The decrease from December 31, 2010 to September 30, 2011 resulted primarily from the decreases in nonperforming commercial real estate loans of $14.9 million, offset by the increases in nonperforming commercial business loans of $3.6 million. In addition, non-covered nonperforming loans of $17.2 million were reclassified as non-covered loans held for sale during the nine months ended September 30, 2011.

 

•

Total deposits increased slightly by $25.9 million or 1.5% to $1.80 billion as of September 30, 2011 compared to $1.77 billion as of December 31, 2010. Noninterest-bearing demand deposits as a percentage of total deposits increased to 27.8% as of September 30, 2011, compared to 22.4% as of December 31, 2010 and 21.40% as of September 30, 2010.

 

•

The ratio of net covered and non-covered loans to total deposits decreased to 84.2% as of September 30, 2011 as compared to 89.9% as of December 31, 2010.

EARNINGS PERFORMANCE ANALYSIS

As previously noted and reflected in the interim consolidated statements of operations, the Company recorded consolidated net income of $9.4 million and $19.2 million during the three and nine months ended September 30, 2011, respectively, compared to consolidated net income of $6.0 million and $16.2 million during the same periods in 2010, respectively. The Company earns income from two primary sources: net interest income, which is the difference between interest income generated from the successful deployment of earning assets and interest expense created by interest-bearing liabilities; and noninterest income, which is basically fees and charges earned from customer services less the operating costs associated with providing a full range of banking services to customers.

 

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Net Interest Income and Net Interest Margin

The following table presents the net interest spread, net interest margin, average balances, interest income and expense, and average yields and rates by asset and liability component for the three and nine months ended September 30, 2011 and 2010:

 

		Three Months Ended September 30,
		2011												2010 7)
		Average Balance				Interest Income/ Expense				Annualized Average Rate/Yield  1)				Average Balance				Interest Income/ Expense				Annualized Average Rate/Yield  1)
		(Dollars in thousands)
Assets:
Interest-earning assets:
Loans 2)		$	1,518,771			$	20,668				5.40	%		$	1,523,012			$	22,472				5.85	%
Federal funds sold			1,094				1				0.36				228,116				127				0.22
Investments 3)			319,131				2,011				2.50				299,601				1,499				1.99
Money market funds and interest-earning deposits 4)			302,254				182				0.24				72,172				41				0.23
Total interest-earning assets			2,141,250				22,862				4.24				2,122,901				24,139				4.51
Noninterest-earning assets:
Cash and due from banks			37,640												37,695
Bank premises and equipment, net			12,567												13,091
Customers’ acceptances outstanding			2,902												2,100
Accrued interest receivables			4,761												5,012
Other assets			88,803												102,399
Total noninterest-earning assets			146,673												160,297
Total assets		$	2,287,923											$	2,283,198
Liabilities and Shareholders’ Equity:
Interest-bearing liabilities:
Deposits:
Money market and NOW accounts		$	564,554			$	1,275				0.90	%		$	519,943			$	1,499				1.14	%
Savings			90,292				537				2.36				92,288				589				2.53
Time certificates of deposit over $100,000			394,967				1,095				1.10				505,758				1,757				1.38
Other time certificates of deposit			301,363				1,040				1.37				301,881				1,292				1.70
			1,351,176				3,947				1.16				1,419,870				5,137				1.44
Other borrowed funds			148,942				1,570				4.18				169,844				1,747				4.08
Long-term subordinated debentures			18,557				143				3.06				18,557				155				3.31
Total interest-bearing liabilities			1,518,675				5,660				1.48				1,608,271				7,039				1.74
Noninterest-bearing liabilities:
Demand deposits			464,340												379,286
Total funding liabilities			1,983,015								1.13	%			1,987,557								1.41	%
Other liabilities			15,857												27,722
Total noninterest-bearing liabilities			480,197												407,008
Shareholders’ equity			289,051												267,919
Total liabilities and shareholders’ equity		$	2,287,923											$	2,283,198
Net interest income						$	17,202											$	17,100
Cost of deposits											0.86	%											1.13	%
Net interest spread 5)											2.76	%											2.77	%
Net interest margin 6)											3.19	%											3.20	%

 

1)	Average rates/yields for these periods have been annualized.

2)

Loans are net of the allowance for loan losses, deferred fees, and discount on SBA loans retained. Loan fees (costs) included in interest income were approximately ($195,000) for the three months ended September 30, 2011 as compared to $58,000 for the same period in 2010, respectively. Amortized loan fees have been included in the calculation of net interest income. Nonperforming loans have been included in the table for computation purposes, but the foregone interest on such loans is excluded.

3)	Investments include securities available for sale, securities held to maturity, FHLB and FRB stock.

4)	Money market funds and interest-earning deposits include FHLB, FRB, money market funds and interest-bearing deposits in other banks.

5)	Represents the weighted average yield on interest-earning assets less the weighted average cost of interest-bearing liabilities.

6)	Represents net interest income before provision for loan losses as a percentage of average interest-earning assets as adjusted for tax equivalent basis for any tax advantaged income.

7)	The 2010 information has been revised to include the cash balance of Federal Reserve deposits and related interest income consistent with the 2011 presentation.

 

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		Nine Months Ended September 30,
		2011												2010 7)
		Average Balance				Interest Income/ Expense				Annualized Average Rate/Yield  1)				Average Balance				Interest Income/ Expense				Annualized Average Rate/Yield  1)
		(Dollars in thousands)
Assets:
Interest-earning assets:
Loans 2)		$	1,525,759			$	62,584				5.48	%		$	1,539,882			$	64,430				5.59	%
Federal funds sold			24,779				44				0.24				173,785				289				0.22
Investments 3)			314,332				5,902				2.51				325,373				7,290				3.00
Money market funds and interest-earning deposits 4)			273,373				487				0.24				61,412				111				0.24
Total interest-earning assets			2,138,243				69,017				4.32				2,100,452				72,120				4.59
Noninterest-earning assets:
Cash and due from banks			36,591												37,430
Bank premises and equipment, net			12,990												13,099
Customers’ acceptances outstanding			2,360												2,283
Accrued interest receivables			4,812												5,890
Other assets			90,485												82,536
Total noninterest-earning assets			147,238												141,238
Total assets		$	2,285,481											$	2,241,690
Liabilities and Shareholders’ Equity:
Interest-bearing liabilities:
Deposits:
Money market and NOW accounts		$	543,589			$	4,120				1.01	%		$	500,282			$	4,163				1.11	%
Savings			89,111				1,644				2.47				93,068				1,819				2.61
Time certificates of deposit over $100,000			426,845				3,753				1.18				511,853				5,930				1.55
Other time certificates of deposit			310,531				3,358				1.45				275,656				3,746				1.82
			1,370,076				12,875				1.26				1,380,859				15,658				1.52
Other borrowed funds			164,553				4,760				3.87				166,811				5,021				4.02
Long-term subordinated debentures			18,557				427				3.08				18,557				438				3.16
Total interest-bearing liabilities			1,553,186				18,062				1.55				1,566,227				21,117				1.80
Noninterest-bearing liabilities:
Demand deposits			432,014												370,831
Total funding liabilities			1,985,200								1.22	%			1,937,058								1.46	%
Other liabilities			17,919												42,879
Total noninterest-bearing liabilities			449,933												413,710
Shareholders’ equity			282,362												261,753
Total liabilities and shareholders’ equity		$	2,285,481											$	2,241,690
Net interest income						$	50,955											$	51,003
Cost of deposits											0.96	%											1.20	%
Net interest spread 5)											2.77	%											2.79	%
Net interest margin 6 )											3.19	%											3.25	%

 

1)	Average rates/yields for these periods have been annualized.

2)

Loans are net of the allowance for loan losses, deferred fees, and discount on SBA loans retained. Loan fees (costs) included in interest income were approximately ($354,000) for the nine months ended September 30, 2011 as compared to $190,000 for the same period in 2010, respectively. Amortized loan fees have been included in the calculation of net interest income. Nonperforming loans have been included in the table for computation purposes, but the foregone interest on such loans is excluded.

3)	Investments include securities available for sale, securities held to maturity, FHLB and FRB stock.

4)	Money market funds and interest-earning deposits include FHLB, FRB, money market funds and interest-bearing deposits in other banks.

5)	Represents the weighted average yield on interest-earning assets less the weighted average cost of interest-bearing liabilities.

6)	Represents net interest income before provision for loan losses as a percentage of average interest-earning assets as adjusted for tax equivalent basis for any tax advantaged income.

7)	The 2010 information has been revised to include the cash balance of Federal Reserve deposits and related interest income consistent with the 2011 presentation.

 

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The following table sets forth, for the periods indicated, the dollar amount of changes in interest earned and paid for interest-earning assets and interest-bearing liabilities and the amount of change attributable to (i) changes in average daily balances (volume) and (ii) changes in interest rates (rate):

 

		Three Months Ended September 30, 2011 vs. 2010 Increase (Decrease) Due to Change In												Nine Months Ended September 30, 2011 vs. 2010 Increase (Decrease) Due to Change In
		Volume				Rate 1)				Total				Volume				Rate 1)				Total
		(Dollars in thousands)												(Dollars in thousands)
Interest income:
Loans 2)		$	(63	)		$	(1,741	)		$	(1,804	)		$	(587	)		$	(1,259	)		$	(1,846	)
Federal funds sold			(176	)			50				(126	)			(264	)			19				(245	)
Investments			103				409				512				(240	)			(1,148	)			(1,388	)
Money market funds and interest-earning deposits			139				2				141				378				(2	)			376
Total earning assets			3				(1,280	)			(1,277	)			(713	)			(2,390	)			(3,103	)
Interest expense:
Money market and super NOW accounts			121				(345	)			(224	)			344				(387	)			(43	)
Savings deposits			(13	)			(39	)			(52	)			(75	)			(100	)			(175	)
Time certificates of deposit			(346	)			(568	)			(914	)			(451	)			(2,114	)			(2,565	)
Other borrowings			(219	)			42				(177	)			(67	)			(194	)			(261	)
Long-term subordinated debentures			—				(12	)			(12	)			—				(11	)			(11	)
Total interest-bearing liabilities			(457	)			(922	)			(1,379	)			(249	)			(2,806	)			(3,055	)
Net interest income before provision for loan losses		$	460			$	(358	)		$	102			$	(464	)		$	416			$	(48	)

 

1)	Average rates/yields for these periods have been annualized.

2)

Loans are net of the allowance for loan losses, deferred fees, and discount on SBA loans retained. Loan fees (costs) included in interest income were approximately ($195,000) and ($354,000) for the three and nine months ended September 30, 2011, respectively, as compared to $58,000 and $190,000 for the same periods in 2010, respectively. Amortized loan fees have been included in the calculation of net interest income. Nonperforming loans have been included in the table for computation purposes, but the foregone interest on such loans is excluded.

The Company’s net interest income depends on the yields, volumes, and mix of its earning asset components, as well as the rates, volume, and mix associated with its funding sources. The Company’s net interest margin is its taxable-equivalent net interest income expressed as a percentage of its average earning assets.

Total interest and dividend income for the three and nine months ended September 30, 2011 was $22.9 million and $69.0 million, respectively, compared to $24.1 million and $72.1 million for the same periods in 2010. The decrease for the nine months ended September 30, 2011 was due primarily to the reduction in interest rates of loans and investment portfolio. Average yield on earning assets decreased to 4.24% and 4.32% for the three and nine months ended September 30, 2011 from 4.51% and 4.59% for the same periods in 2010, respectively. In addition, interest income on non-accrual loans amounting to approximately $308,000 and $657,000 was not recognized during the three and nine months ended September 30, 2011, compared to $0.4 million and $1.6 million for the same periods in 2010, respectively.

Total interest expense for the three and nine months ended September 30, 2011 decreased to $5.7 million and $18.1 million, respectively, compared to $7.0 million and $21.1 million during the same periods in 2010, respectively. The decreases were due primarily to the decreases in interest rate and average balance for time certificates of deposit during the past year. Average deposit cost decreased to 0.86% and 0.96% for the three and nine months ended September 30, 2011 compared to 1.13% and 1.20% during the same periods in 2010, respectively. Average interest bearing liabilities decreased to $1.55 billion for the nine months ended September 30, 2011 compared to $1.57 billion for the same period in 2010 and average noninterest-bearing demand deposits increased to $432.0 million for the nine months ended September 30, 2011 compared to $370.8 million for the same period in 2010.

As a result, net interest income before provision for loan losses remained virtually unchanged at $17.2 million and $51.0 million for three and nine months ended September 30, 2011, respectively, compared to $17.1 million and $51.0 million for the same periods in 2010, respectively. In addition, the net interest margin decreased to 3.19% and 3.19% for the three and nine months ended September 30, 2011 compared to 3.20% and 3.25% for the same periods in 2010, respectively. Annualized average yield of investments increased to 2.50% from 1.99% for the three months ended September 30, 2011 and 2010, respectively, and decreased to 2.51% from 3.00% for the nine months ended September 30, 2011 and 2010, respectively. Annualized average rate for time certificates of deposit over $100,000 decreased to 1.10% and 1.18%, respectively, for the three and nine months ended September 30, 2011 from 1.38% and 1.55%, respectively, during the same periods in 2010. Management historically evaluated and reported net interest margin excluding the cash balances of Federal Reserve deposits as they believed it to be a more meaningful measurement of trends in the loan and investment yields in relation to costs of deposits and borrowings. The reported net interest margin, which now includes the impact of these deposit balances and related income, is heavily affected this year by the higher balances of Federal Reserve deposits, which earn a nominal interest rate. Excluding the impact of Federal Reserve deposits from the calculation, net interest margin for the three and nine months ended September 2011 were 3.67% and 3.62%.

 

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Provision for Loan Losses

Credit risk is inherent in the business of making loans. The Company sets aside an allowance for loan losses through charges to earnings, which are reflected in the interim consolidated statements of operations as the provision for loan losses. Specifically, the provision for loan losses represents the amount charged against current period earnings to achieve an allowance for loan losses that in management’s judgment is adequate to absorb losses inherent in the Company’s loan portfolio.

The provision for loan losses on non-covered loans was $1.2 million and $12.2 million for the three and nine months ended September 30, 2011 compared to $4.0 million and $16.0 million for the same periods in 2010. The decrease for the nine months period was primarily due to a stabilization of risk factors as indicated by four consecutive quarters of declining net charge-offs as well as quarter over quarter decline in past due and nonperforming loans. Management believes that the $12.2 million loan loss provision for non-covered loans was adequate for the nine months ended September 30, 2011 and that the allowance for loans losses of $47.1 million (excluding $1.0 million for covered loans) as of September 30, 2011 is adequate to absorb losses inherent in the Company’s loan portfolio.

While management believes that the allowance for loan losses, representing 3.21% of total non-covered loans as of September 30, 2011 was adequate, future additions to the allowance will be subject to continuing evaluation of the estimated, inherent and other known risks in the loan portfolio. The procedures for monitoring the adequacy of the allowance, and detailed information on the allowance, are included below in “Allowance for Loan Losses on non-covered loans.”

Noninterest Income

The following table sets forth the various components of the Company’s noninterest income for the periods indicated:

 

			0000000				0000000				0000000				0000000				0000000				0000000
		Three Months Ended September 30,
		2011								2010
		Amount				Percent of Total				Amount				Percent of Total				Increase (Decrease)
																		Amount				Percentage
		(Dollars in thousands)
Customer service fees		$	1,727				28.93	%		$	2,043				46.34	%		$	(316	)			(15.47	)%
Fee income from trade finance transactions			623				10.44				684				15.51				(61	)			(8.92	)
Wire transfer fees			330				5.53				321				7.28				9				2.80
Net gain on sale of loans			1,896				31.76				257				5.83				1,639				637.74
Loan service fees			526				8.81				565				12.81				(39	)			(6.90	)
Increase in FDIC loss share receivable			308				5.16				105				2.38				203				193.33
Other income			560				9.37				434				9.85				126				29.03
Total noninterest income		$	5,970				100.00			$	4,409				100.00			$	1,561				35.40
As a percentage of average earning assets							1.11	%							0.85	%

 

		Nine Months Ended September 30,
		2011								2010
		Amount				Percent of Total				Amount				Percent of Total				Increase (Decrease)
																		Amount				Percentage
		(Dollars in thousands)
Customer service fees		$	5,308				27.16	%		$	6,161				29.12	%		$	(853	)			(13.85	)%
Fee income from trade finance transactions			1,924				9.84				2,062				9.75				(138	)			(6.69	)
Wire transfer fees			987				5.05				933				4.41				54				5.79
Gain on business acquisition			—				—				5,900				27.89				(5,900	)			(100.00	)
Net gain on sale of loans			7,448				38.11				1,460				6.90				5,988				410.14
Net gain on sale of securities available for sale			—				—				2,209				10.44				(2,209	)			(100.00	)
Loan service fees			1,896				9.70				1,153				5.45				743				64.44
Increase in FDIC loss share receivable			471				2.41				105				0.50				366				348.57
Other income			1,509				7.73				1,174				5.54				335				28.53
Total noninterest income		$	19,543				100.00			$	21,157				100.00			$	(1,614	)			(7.63	)
As a percentage of average earning assets							1.22	%							1.39	%

The increase in noninterest income for the three months ended September 30, 2011 compared to the same period in 2010 was primarily due to the gain on sale of SBA loans during third quarter of 2011, and the decrease for nine months ended September 30, 2011 compared to the same period in 2010 was mainly due to the gain on business combination and gain on sale of securities available for sale incurred in 2010 but not in 2011, offset by the increase in gain on sale of SBA loans in 2011. The decrease in customer service fees was due primarily to a decrease in overdraft fee charges for ATM and one-time debit card transactions. The Company sold $81.5 million of SBA loans to the secondary market, realizing gains of $7.6 million during the nine months ended September 30, 2011 compared to the sale of $18.3 million with gains of $1.5 million during the same period in 2010. The increase in loan service fees for the nine months ended September 30, 2011 was a result of increasing SBA loans sold in 2011 compared to 2010. The Company was servicing $324.0 million of sold SBA loans as of September 30, 2011 compared to $305.4 million as of September 30, 2010.

 

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Noninterest income as a percentage of average earning assets remained at a similar level at 1.11% and 1.22%, respectively, for the three and nine months ended September 30, 2011 compared to 0.85% and 1.39%, respectively, for the same periods in 2010.

Noninterest Expense

The following table sets forth the components of noninterest expense for the periods indicated:

 

		Three Months Ended September 30,
		2011								2010
		Amount				Percent of Total				Amount				Percent of Total				Increase (Decrease)
																		Amount				Percent
		(Dollars in thousands)
Salaries and employee benefits		$	5,214				42.87	%		$	4,653				37.55	%		$	561				12.06	%
Occupancy			1,260				10.36				1,388				11.20				(128	)			(9.22	)
Furniture, fixtures, and equipment			549				4.51				756				6.10				(207	)			(27.38	)
Data processing			615				5.06				832				6.71				(217	)			(26.08	)
Legal fees			239				1.96				567				4.58				(328	)			(57.85	)
Accounting and other professional fees			466				3.83				309				2.49				157				50.81
Business promotion and advertising			206				1.69				376				3.03				(170	)			(45.21	)
Supplies and communication			280				2.30				440				3.56				(160	)			(36.36	)
Security service			303				2.49				320				2.58				(17	)			(5.31	)
Regulatory assessment			771				6.34				1,073				8.66				(302	)			(28.15	)
Merger related expenses			477				3.92				—				—				477				100.00
Net OREO related expenses			577				4.74				170				1.37				407				239.41
Other operating expenses			1,207				9.93				1,508				12.17				(301	)			(19.96	)
Total noninterest expense		$	12,164				100.00			$	12,392				100.00			$	(228	)			(1.84	)
As a percentage of average earning assets			2.25	%							2.40	%
Efficiency ratio			52.49								57.61

 

		Nine Months Ended September 30,
		2011								2010
		Amount				Percent of Total				Amount				Percent of Total				Increase (Decrease)
																		Amount				Percent
		(Dollars in thousands)
Salaries and employee benefits		$	15,654				41.29	%		$	13,640				38.39	%		$	2,014				14.77	%
Occupancy			3,994				10.53				4,020				11.32				(26	)			(0.65	)
Furniture, fixtures, and equipment			1,671				4.41				1,903				5.36				(232	)			(12.19	)
Data processing			1,938				5.11				1,950				5.49				(12	)			(0.62	)
Legal fees			941				2.48				1,152				3.24				(211	)			(18.32	)
Accounting and other professional fees			1,378				3.63				1,170				3.29				208				17.78
Business promotion and advertising			942				2.48				1,048				2.95				(106	)			(10.11	)
Supplies and communication			965				2.54				1,100				3.11				(135	)			(12.27	)
Security service			905				2.39				840				2.36				65				7.74
Regulatory assessment			2,821				7.44				3,096				8.71				(275	)			(8.88	)
Merger related expenses			1,114				2.94				129				0.36				985				763.57
Net OREO related expenses			1,689				4.45				1,529				4.30				160				10.46
Other operating expenses			3,907				10.31				3,950				11.12				(43	)			(1.09	)
Total noninterest expense		$	37,919				100.00			$	35,527				100.00			$	2,392				6.73
As a percentage of average earning assets			2.37	%							2.33	%
Efficiency ratio			53.79								49.23

For the three months ended September 30, 2011, the slight decrease in noninterest expenses was due mainly to the decrease in legal fees, regulatory assessment, and data processing fees offset by the increase in merger related expenses and net OREO related expenses. For the nine months ended September 30, 2011, the increase in noninterest expense was due primarily to increases in salaries and employee benefits and merger related expenses compared to the same periods in 2010. The increase in salaries and employee benefits for the nine months ended September 30, 2011 was due mainly to a company-wide salary increases and a reinstatement of 401(K) company matching.

 

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Noninterest expense as a percentage of average earning assets remained at a similar level at 2.25% and 2.37%, respectively, for the three and nine months ended September 30, 2011 compared to 2.40% and 2.33%, respectively, for the same periods in 2010.

The Company’s efficiency ratio, which is defined as noninterest expense divided by the sum of net interest income and noninterest income, decreased to 52.49% from 57.61% for the three months ended September 30, 2011 and 2010, respectively, and increased to 53.79% from 49.23% for the nine months ended September 30, 2011 and 2010, respectively. The decrease for the three months ended September 30, 2011 primarily related to an increase in noninterest income. The increase for the nine months ended September 30, 2011 was mainly to an increases in noninterest expenses while there was no significant change in net interest income.

Provision for Income Taxes

Income tax expense (benefit) consists of current and deferred tax expense (benefit). Current tax expense (benefit) is the result of applying the current tax rate to current taxable income (loss). The deferred portion is intended to reflect income or loss that differs from financial statement pre-tax income or loss because some items of income and expense are recognized in different years for income tax purposes than in the financial statements.

Deferred income tax assets or liabilities reflect the estimated future tax effects attributable to differences as to when certain items of income or expense are reported in the financial statements versus when they are reported in the tax returns. The Company’s net deferred tax asset was $20.0 million as of September 30, 2011 compared to $14.4 million as of December 31, 2010. As of September 30, 2011, the Company’s deferred tax assets were primarily due to the tax basis differences related the allowance for loan losses which was partially offset by a basis difference of the acquired assets and liabilities.

As of September 30, 2011, the Company maintained a valuation reserve of $3.9 million against its deferred tax assets. This was a $6.7 million decline from the valuation reserve balance as of December 31, 2010. This reduction in the valuation reserve reduced income tax expense by $3.4 million and $6.4 million for the three and nine months ended September 30, 2011. The reduction in 2011 is primarily due to the pre-tax profit generated for the nine months ended September 30, 2011, which increased the cumulative taxable income available for carry-back for federal income tax purpose.

The income tax provision amounted to $415,000 and $1.2 million for the three and nine months ended September 30, 2011 representing effective tax rates of 4.2% and 5.9%, respectively, compared to income tax (benefit) provision of $(0.8) million and $4.4 million for the same periods in 2010 representing effective tax rates of (16.5)% and 21.3%, respectively. The primary reasons for the difference from the federal statutory tax rate of 35% are the reduction in the valuation reserve for deferred tax assets as discussed above, inclusion of state taxes and reductions related to tax favored investments in low-income housing, dividend exclusions, treatment of share-based payments amortization, an increase in cash surrender value of bank owned life insurance, California enterprise zone interest deductions and hiring credits, and nondeductible merger costs. The Company reduced taxes utilizing the tax credits from investments in the low-income housing projects in the amount of $1.1 million for the nine months ended September 30, 2011 and 2010, respectively.

It is management’s policy to separately disclose any penalties or interest arising from the application of federal or state income taxes. There were no penalties or interest assessed for the nine months ended September 30, 2011.

The Internal Revenue Service (the “IRS”) and the Franchise Tax Board (the “FTB”) have examined the Company’s consolidated federal income tax returns for tax years up to and including 2007. As of September 30, 2011, the Company was under examination by the IRS for 2009 tax year and the FTB for the 2008-2009 tax years. The Company does not anticipate any material changes as a result of the IRS and the FTB examination. In addition, the Company does not have any unrecognized tax benefits subject to significant increase or decrease as a result of uncertainty.

 

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FINANCIAL CONDITION ANALYSIS

The major components of the Company’s earning asset base are its interest-earning short-term investments, investment securities portfolio and loan portfolio. The detailed composition and growth characteristics of these three portfolios are significant to any analysis of the financial condition of the Company, and the loan portfolio analysis will be discussed in a later section of this Form 10-Q.

Short-term Investments

The Company invests its excess available funds from daily operations in overnight Federal Funds. Over the last few years, the core principles of cash management have been greatly affected by the current rate and regulatory environment and the need to preserve capital. Balances held at the Federal Reserve Bank (“FRB”) are given a preferential risk rating when computing regulatory risk based capital ratios. The risk rating is lower than either federal funds or other correspondent bank balances. FRB began paying interest on excess deposits in 2008 and currently is paying interest rate on reserves similar to the federal funds rate. Therefore, it became a prudent capital preservation strategy to keep excess liquidity on deposit at the FRB.

Investment Portfolio

The following table summarizes the amortized cost, fair value and distribution of the Company’s investment securities as of the dates indicated:

 

		As of September 30, 2011
		Amortized Cost				Gross Unrealized Gain				Gross Unrealized Loss				Fair Value
		(Dollars in thousands)
Available for Sale:
U.S. Treasury		$	300			$	—			$	—			$	300
U.S. Governmental agencies securities and U.S. Government sponsored enterprise securities			37,935				183				—				38,118
U.S. Governmental agencies and U.S. Government sponsored and enterprise mortgage-backed securities			157,440				6,010				(22	)			163,428
Corporate trust preferred security			2,747				—				(1,930	)			817
Mutual funds backed by adjustable rate mortgages			5,000				257				—				5,257
Collateralized mortgage obligations			101,483				1,669				(89	)			103,063
Total securities available for sale		$	304,905			$	8,119			$	(2,041	)		$	310,983

 

		As of December 31, 2010
		Amortized Cost				Gross Unrealized Gain				Gross Unrealized Loss				Fair Value
		(Dollars in thousands)
Available for Sale:
U.S. Treasury		$	300			$	—			$	—			$	300
U.S. Governmental agencies securities and U.S. Government sponsored enterprise securities			58,994				94				(481	)			58,607
U.S. Governmental agencies and U.S. Government sponsored and enterprise mortgage-backed securities			154,149				3,549				(599	)			157,099
Corporate trust preferred security			2,738				—				(1,979	)			759
Mutual funds backed by adjustable rate mortgages			5,000				73				—				5,073
Collateralized mortgage obligations			67,063				816				(166	)			67,713
Total securities available for sale		$	288,244			$	4,532			$	(3,225	)		$	289,551

The Company strives to maintain an investment portfolio with an adequate mix of fixed-rate and adjustable-rate securities with relatively short to moderate maturities to minimize overall interest rate risk. The Company’s investment securities portfolio consists of U.S. Treasury securities, U.S. Government agency securities, U.S. Government sponsored enterprise debt securities, mortgage-backed securities, and corporate debt. The mortgage backed securities and collateralized mortgage obligations (“CMO”) are all agency-guaranteed residential mortgages. The Company regularly models, evaluates and analyzes each agency CMO’s to capture its unique allocation of principal and interest.

 

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As of September 30, 2011, securities available for sale totaled $311.0 million, compared to $289.6 million as of December 31, 2010. Securities available for sale as a percentage of total assets increased to 13.8% as of September 30, 2011 compared to 12.8% as of December 31, 2010.

Available-for-sale securities represented 100.0% of the investment portfolio as of September 30, 2011 and December 31, 2010. For the three and nine months ended September 30, 2011, the yields on the average investment portfolio were 2.50% and 2.51%, respectively, as compared to 1.99% and 3.00% for the same periods in 2010, respectively. Although the Company currently has the intent and the ability to hold the securities in its investment portfolio to maturity, the securities are all marketable and are classified as “available-for-sale” to allow maximum flexibility with regard to interest rate risk and liquidity management.

The following table summarizes, as of September 30, 2011, the maturity characteristics of the investment portfolio, by investment category. Expected remaining maturities may differ from remaining contractual maturities because obligors may have the right to prepay certain obligations with or without penalties.

 

		Within one Year								After One But Within Five Years								After Five But Within Ten Years								After Ten Years								Total
		Amount				Yield				Amount				Yield				Amount				Yield				Amount				Yield				Amount				Yield
		(Dollars in thousands)
Available for Sale (Fair Value):
U.S. Treasury		$	300				0.05	%		$	—				—	%		$	—				—	%		$	—				—	%		$	300				0.05	%
U.S. Governmental agencies securities and U.S Government sponsored enterprise securities			—				—				38,118				1.32				—				—				—				—				38,118				1.32
U.S. Governmental agencies and U.S. Government sponsored and enterprise mortgage-backed securities			—				—				994				4.51				65,572				2.85				96,862				3.28				163,428				3.11
Corporate trust preferred security			—				—				—				—				—				—				817				11.70				817				11.70
Mutual funds backed by adjustable rate mortgages			5,257				3.05				—				—				—				—				—				—				5,257				3.05
Collateralized mortgage obligations			—				—				967				2.37				26,972				1.96				75,124				2.31				103,063				2.22
Total available for sale		$	5,557				2.89			$	40,079				1.42			$	92,544				2.59			$	172,803				2.90			$	310,983				2.62

The following tables show the Company’s investments with gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position as of September 30, 2011 and December 31, 2010:

 

		As of September 30, 2011
		Less than 12 months								12 months or more								Total
		Fair Value				Unrealized Loss				Fair Value				Unrealized Loss				Fair Value				Unrealized Loss
		(Dollars in thousands)
U.S. Governmental agencies securities and U.S. Government sponsored enterprise securities		$	—			$	—			$	—			$	—			$	—			$	—
U.S. Governmental agencies and U.S. Government sponsored enterprise mortgage-backed securities			2,260				(22	)			—				—				2,260				(22	)
Corporate trust preferred security			—				—				817				(1,930	)			817				(1,930	)
Collateralized mortgage obligations			12,041				(61	)			4,165				(28	)			16,206				(89	)
Total		$	14,301			$	(83	)		$	4,982			$	(1,958	)		$	19,283			$	(2,041	)

 

		As of December 31, 2010
		Less than 12 months								12 months or more								Total
		Fair Value				Unrealized Loss				Fair Value				Unrealized Loss				Fair Value				Unrealized Loss
		(Dollars in thousands)
U.S. Governmental agencies and U.S. Government sponsored enterprise securities		$	33,486			$	(481	)		$	—			$	—			$	33,486			$	(481	)
U.S. Governmental agencies and U.S. Government sponsored enterprise mortgage-backed securities			27,084				(599	)			—				—				27,084				(599	)
Corporate trust preferred security			—				—				759				(1,979	)			759				(1,979	)
Collateralized mortgage obligations			20,369				(166	)			—				—				20,369				(166	)
Total		$	80,939			$	(1,246	)		$	759			$	(1,979	)		$	81,698			$	(3,225	)

The Company regularly reviews the composition of the investment portfolio, taking into account market risks, the current and expected interest rate environment, liquidity needs, and overall interest rate risk profile and strategic goals. On a quarterly basis, the Company evaluates each security in the portfolio with an individual unrealized loss to determine if that loss represents an OTTI.

 

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The Company considers the following factors in evaluating the securities: whether the securities were guaranteed by the U.S. government or its agencies and the securities’ public ratings, if available, and how those two factors affect credit quality and recovery of the full principal balance, the relationship of the unrealized losses to increases in market interest rates, the length of time the securities have had temporary impairment, and the Company’s intent and ability to hold the securities for the time necessary to recover the amortized cost. The Company also considers the payment performance, delinquency history and credit support of the underlying collateral for certain securities in the portfolio.

As of September 30, 2011, the Company had a total fair value of $19.3 million of securities with unrealized losses of $2.0 million. We believe these unrealized losses are due to a temporary condition, primarily changes in interest rates, and do not reflect a deterioration of credit quality of the issuers. The market value of securities that have been in a continuous loss position for 12 months or more as of September 30, 2011 was $5.0 million with unrealized losses of $2.0 million.

All individual securities that have been in a continuous unrealized loss position as of September 30, 2011 had investment grade ratings upon purchase. The issuers of these securities have not, to our knowledge, established any cause for default on these securities and the various rating agencies have reaffirmed these securities’ long-term investment grade status as of September 30, 2011. These securities have decreased in value since their purchase dates as market interest rates have changed. However, the Company does not have the intention to sell and does not believe it will be required to sell these securities until maturities.

The Company owns one collateralized debt obligation (“CDO”) security that is backed by trust preferred securities (“TRUPS”) issued by banks and thrifts. As of September 30, 2011, the fair value of the security was $0.8 million.

The CDO TRUPS securities market, since 2007, has continuously been negatively impacted by the liquidity crunch and concern over the banking industry. If the weight of the evidence indicates the market is not orderly, a reporting entity shall place little, if any, weight compared with other indications of fair value on that transaction price when estimating fair value or market risk premiums. Factors that were considered to determine whether there has been a significant decrease in the volume and level of activity for the CDO TRUPS securities market when compared with normal activity include:

 

•

There are few recent transactions.

 

•

Price quotations are not based on current information.

 

•

Price quotations vary substantially either over time or among market makers.

 

•

Indexes that were previously highly correlated with the fair values of the asset or liability are demonstrably uncorrelated with recent indications of fair value for that asset or liability.

 

•

There is a significant increase in implied liquidity risk premiums. Yields or performance indicators (such as delinquency rates or loss severities) for observed transactions or quoted prices when compared with the reporting entity’s estimate of expected cash flows, considering all available market data about credit and other nonperformance risk for the asset or liability.

 

•

There is a wide bid-ask spread or significant increase in the bid-ask spread.

 

•

There is a significant decline or absence of new market issuances for the asset or liability.

 

•

Little information is publicly available.

In order to determine the fair value of the CDO TRUPS security, the Company uses Level 3 fair value measurement. The fair value of the CDO TRUPS security has traditionally been based on the average of at least two quoted market prices obtained from independent brokers. However, as a result of the recent global financial crisis and resulting illiquidity in the U.S. markets, the market for these securities became inactive in 2008 and activity in this market has not yet resumed. The current broker price for the CDO TRUPS securities is based on forced liquidation or distressed sale values in very inactive markets that may not be representative of the economic value of these securities. As such, the fair value of the CDO TRUPS security has been below cost since the advent of the financial crisis. Additionally, most, if not all, of these broker quotes are nonbinding.

The Company considered whether to place little, if any, weight on transactions that are not orderly when estimating fair value. Although length of time and severity of impairment are among the factors to consider when determining whether a security that is other than temporarily impaired, the CDO TRUPS securities have only exhibited deep declines in value since the credit crisis began. The Company therefore believes that this is an indicator that the decline in price is primarily the result of the lack of liquidity in the market for these securities.

The Company uses Moody’s Analytics to compute the fair value of the CDO TRUPS security. Moody’s continues to update their valuation process in order to refine and improve the estimate of default probabilities to align the valuation methodology with industry practices.

 

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Moody’s approach to valuing CDO TRUPS includes asset and liability analyses to arrive at an Estimated Fundamental Value (“EFV”), then applies a liquidity spread to discount the EFV to the value that would be received in an orderly liquidation.

 

•

Asset Credit Quality Analysis: The credit quality of collateral supporting each CDO TRUPS is determined using Probability of Default values for each underlying issuer and Loss Given Default values by asset type.

 

•

Liability Analysis: The EFV of CDO TRUPS liabilities is determined through asset and liability modeling, specifically including (a) Forecasting cash flows generated by underlying collateral, (b) Establishing priority-of-claims distribution to each CDO tranche, and (c) Simulating the distribution of cash flows to each CDO tranche using a Monte Carlo simulation model.

 

•

Liquidity discount factor: A regression model is run based on historical data to determine an appropriate spread for the security in a liquid market. Using that liquid market spread plus current market interest rates, the EFV cash flows are discounted to arrive an orderly liquid exit value

The Company considers numerous factors to determine any OTTI for the CDO TRUPS security including review of trustee reports, monitoring of “break in yield” tests, analysis of current defaults and deferrals and the expectation for future defaults and deferrals. The Company reviews the key financial characteristics for individual issuers (commercial banks or thrifts) in the CDO TRUPS security and considers capital ratios, leverage ratios, nonperforming loan and nonperforming asset ratios, in addition to the credit ratings. The credit ratings of the Company’s CDO TRUPS security were “Ca” (Moody’s) and “C” (Fitch) as of September 30, 2011 and December 31, 2010.

The Company uses cash flow projections for the purpose of assessing OTTI on the CDO TRUPS security which incorporates certain credit events in the underlying collaterals and prepayment assumptions. The projected issuer default rates are assumed at a rate equivalent to 150 basis points applied annually and have a 0% recovery factor after the initial default date. The principal is assumed to be prepaying at 1% annually and at 100% at maturity.

Based on the results from the cash flow model, the CDO TRUPS security did not experience an adverse change in its cash flow status. As such, based on all of these factors, the Company determined that there was no OTTI adjustment required as of September 30, 2011. The risk of future OTTI will be highly dependent upon the performance of the underlying issuers. The Company does not have the intention to sell and does not believe it will be required to sell the CDO TRUPS security before maturity.

 

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Non-covered Loan Portfolio

The following table sets forth the composition of the Company’s non-covered loan portfolio, segregated by class of loans, as of the dates indicated:

 

		September 30, 2011								December 31, 2010
		Amount				Percent of Total				Amount				Percent of Total
		(Dollars in thousands)
Real Estate:
Construction		$	9,407				0.7	%		$	14,803				1.0	%
Commercial			894,686				60.9				914,003				59.8
Commercial:
Commercial			281,711				19.2				315,285				20.5
Trade Finance			63,860				4.3				71,174				4.7
SBA 1)			112,207				7.6				101,683				6.7
Others:
Consumer			57,514				3.9				71,279				4.7
Other 2)			50,048				3.4				40,039				2.6
Total Non-covered Loans 3)			1,469,433				100.0				1,528,266				100.0
Less:
Allowance for loan losses			47,098								52,047
Net deferred loan fees 4)			(454	)							(523	)
Discount on SBA loans retained			2,741								862
Net Non-covered Loans and Loans Held for Sale		$	1,420,048							$	1,475,880

 

1)	Includes non-covered SBA loans held for sale of $61.6 million and $46.4 million, at the lower of cost or fair value, as of September 30, 2011 and December 31, 2010, respectively.

2)	Consists of term fed funds sold for maturity of greater than 1 day, transactions in process and overdrafts.

3)	Real estate commercial loans are loans secured by deeds of trust on real estate. Balance includes non-covered loans held for sale $66.6 million and $60.2 million, at the lower of cost or fair value, as of September 30, 2011 and December 31, 2010, respectively.

4)	Includes advances on trust receipts, clean advances, cash advances, acceptances discounted, and documentary negotiable advances under commitments.

The Company’s total non-covered loans, which included loans held for sale, decreased by $58.8 million, or 3.8%, during the nine months ended September 30, 2011. Net non-covered loans and loans held for sale decreased by $55.8 million, or 3.8%, to $1.42 billion as of September 30, 2011, as compared to $1.48 billion as of December 31, 2010. The decrease in the loan portfolio was mainly the result of sale of $81.5 million of guaranteed portion of SBA loans, charge-offs of $18.6 million, and notes sale of $13.3 million exclusive of the portion financed by the Company in commercial loans, coupled with the fact that new loan originations were slow due to continued economic instability during the nine months ended September 30, 2011. Net non-covered loans and loans held for sale as of September 30, 2011 represented 62.9% of total assets, compared to 65.0% as of December 31, 2010.

The Company’s SBA portfolio increased to $112.2 million as of September 30, 2011 compared to $101.7 million as of December 31, 2010. During the nine months ended September 30, 2011, the Company sold $81.5 million of SBA loans to the secondary market compared to $15.3 million for the same period in 2010. As of September 30, 2011, the Company was servicing $324.0 million of sold SBA loans, compared to $270.0 million and $305.4 million as of December 31, 2010 and September 30, 2010, respectively.

Other loans mainly consist of term fed funds sold and virtually did not change during the past year. It is currently management’s intention to reduce the concentration of real estate loans in the loan portfolio. The Company has determined it has no reportable foreign credit risk.

 

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Covered Loan Portfolio

Total covered loans, inclusive of fair value adjustment, were $93.6 million and $117.3 million as of September 30, 2011 and December 31, 2010, respectively. The following table presents the concentration of the covered loans, segregated by class of loans, as of September 30, 2011 and December 31, 2010:

 

		September 30, 2011								December 31, 2010
		Amount				Percent of Total				Amount				Percent of Total
		(Dollars in thousands)
Real Estate:
Construction		$	—				—	%		$	—				—	%
Commercial - Real Estate			60,234				51.1				74,193				50.3
Commercial:
Commercial - Business			15,490				13.2				20,277				13.7
Trade Finance			—				—				—				—
SBA			41,508				35.3				52,681				35.7
Others:
Consumer			486				0.4				489				0.3
Gross Covered Loans			117,718				100.0				147,640				100.0
Covered loans discount			(24,101	)							(30,344	)
Total Covered Loans			93,617								117,296
Less:
Allowance for loan losses			1,010								1,010
Net deferred loan fees			26								3
Net Covered Loans		$	92,581							$	116,283

The covered loans are subject to a loss sharing agreement with the FDIC. Under the terms of the loss sharing agreement, the FDIC will absorb 80% of losses and share in 80% of loss recoveries. New loans made after acquisition date are not covered by the loss sharing agreement.

Non-covered Nonperforming Assets

Nonperforming assets are defined as loans on non-accrual status, loans 90 days or more past due but not on non-accrual status, restructured loans, and Other Real Estate Owned (“OREO”). Management generally places loans on non-accrual status when they become 90 days past due, unless they are both fully secured and in process of collection. OREO consists of real property acquired through foreclosure or similar means that management intends to offer for sale. Loans may be restructured by management when a borrower has experienced some change in financial status causing an inability to meet the original repayment terms, where the Company believes the borrower will eventually overcome those circumstances and repay the loan in full. Troubled Debt Restructurings (“TDRs”) are considered non-performing assets for regulatory purposes even though they are fully performing and not on non-accrual status, and they are required to be disclosed. Performing TDRs which are not on non-accrual status are not considered non-covered nonperforming assets for purposes of computing the ratio of nonperforming assets as a percentage of total non-covered loans and OREO.

As of September 30, 2011, the Company held non-covered TDRs of $46.3 million, representing an increase of $7.2 million, or 18.4%, as compared to $39.1 million as of December 31, 2010. The increase in the non-covered TDRs was mainly result of one commercial business loan relationship for $8.0 million that became a TDR during the third quarter of 2011. The debtor has been making loan payments according to its restructured terms and conditions since July 2011.

A TDR is a debt restructuring in which a bank, for economic or legal reasons related to a borrower’s financial difficulties, grants a concession to the borrower that it would not otherwise consider. TDRs may include, but are not necessarily limited to, one or a combination of the following:

 

1.

Transfer from the debtor to the creditor of receivables from third parties, real estate, or other assets to satisfy fully or partially a debt (including a transfer resulting from foreclosure or repossession)

 

2.

Issuance or other granting of an equity interest to the creditor by the debtor to satisfy fully or partially a debt unless the equity interest is granted pursuant to existing terms for converting the debt into an equity interest

 

3.

Modification of terms of a debt, such as one or a combination of any of the following:

 

a.

Reduction (absolute or contingent) of the stated interest rate for the remaining original life of the debt

 

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b.

Extension of the maturity date or dates at a stated interest rate lower than the current market rate for new debt with similar risk

 

c.

Reduction (absolute or contingent) of the face amount or maturity amount of the debt as stated in the instrument or other agreement

 

d.

Reduction (absolute or contingent) of accrued interest.

A TDR that has been formally restructured so as to be reasonably assured of repayment and of performance according to its modified terms need not be maintained in a non-accrual or nonperforming status, provided the TDR is supported by a current well documented credit evaluation and positive prospects of repayment under the revised terms. If these conditions can not be met, the Company will classify the TDR as non-accrual or nonperforming.

The TDRs are monitored on a monthly basis to review the performance of the restructured term. When it is determined that the future performance of TDR is uncertain of repayment in accordance with the new restructured term, the loan is placed on non-accrual. The TDRs are usually analyzed for impairment evaluation for a specific allowance when outstanding balance is $100,000 or more. The fair value of the collateral is used for nonperforming TDR and present value of expected future cash flow is used for performing TDR.

As a result of adopting the amendments in ASU 2011-02, the Company reassessed all restructurings that occurred on or after January 1, 2011 for identification as a TDR. The Company usually identified as TDRs certain receivables for which the ALLL had previously been measured under a general ALLL methodology. Upon identifying those receivables as TDRs, the Company identified them as impaired under the guidance in ASC 310-10-35. The amendments in ASU 2011-02 require prospective application of the impairment measurement guidance in ASC 310-10-35 for those receivables newly identified as impaired. At September 30, 2011, the recorded investment in receivables for which the ALLL was previously measured under a general ALLL methodology and are now considered as the TDRs under ASC 310-10-35 was $21.4 million, and the ALLL associated with those receivables, on the basis of current evaluation of loss, was $3.3 million.

92% of the TDRs as of September 30, 2011 are impaired, and $12.1 million were on non-accrual status. The remaining $34.2 million of the Company’s TDRs meet the conditions that qualify these loans as performing as of September 30, 2011.

The following table provides the information of the Company’s TDRs as of September 30, 2011:

 

		For the Three Months Ended September 30, 2011												For the Nine Months Ended September 30, 2011
		Number of Contracts				Pre-Modification Outstanding Recorded Investment				Post-Modification Outstanding Recorded Investment				Number of Contracts				Pre-Modification Outstanding Recorded Investment				Post-Modification Outstanding Recorded Investment
Troubled Debt Restructurings
Real Estate:
Construction			—			$	—			$	—				—			$	—			$	—
Commercial			6				7,444				7,451				9				11,316				11,296
Commercial:
Commercial			12				9,647				9,641				19				9,935				10,006
Trade Finance			—				—				—				—				—				—
SBA			1				47				47				2				105				104
Others:
Consumer			—				—				—				—				—				—
Other			—				—				—				—				—				—
Total			19			$	17,138			$	17,139				30			$	21,356			$	21,406
		Number of Contracts				Recorded Investment								Number of Contracts				Recorded Investment
Troubled Debt Restructurings That Subsequently Defaulted
Real Estate:
Construction			—			$	—								—			$	—
Commercial			1				1,000								1				1,000
Commercial:
Commercial			2				144								4				636
Trade Finance			—				—								—				—
SBA			—				—								—				—
Others:
Consumer			—				—								—				—
Other			—				—								—				—
Total			3			$	1,144								5			$	1,636

The most of common types of modification that the Company provided for commercial real estate loans and commercial loans are interest rate reductions and loan payment adjustments. The loan payment adjustment typically involves deferment of principal payment for significant delay that increases uncertainty factor for full repayment of the loans. Generally, a nonaccrual loan that is restructured remains on nonaccrual for a period of six months to demonstrate that the borrower can meet the restructured terms. The subsequent default generally occurs when the borrower’s performance under the restructuring is not reasonably assured, and the loan is classified as a nonaccrual loan. The initial review for the subsequent default begins when the restructured loan is past due 30 days or more. The subsequent defaulted TDR is measured for impairment and subject to a formula allowance.

 

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The Company’s classification of a loan as non-accrual is an indication that there is reasonable doubt as to the full collectibility of principal or interest on the loan. At this point, the Company stops recognizing income from the interest on the loan and reverses any uncollected interest that had been accrued but unpaid. The remaining balance of the loan will be charged off if the loan deteriorates further due to a borrower’s bankruptcy or similar financial problems, unsuccessful collection efforts or a loss classification by regulators and/or internal credit examiners. These loans may or may not be collateralized, but collection efforts are continuously pursued. Subsequent collection of payments will reduce the principal balance of the loan until the collateral is liquidated or the loan is paid.

The following table provides information with respect to the components of the Company’s non-covered nonperforming assets as of the dates indicated:

 

		September 30, 2011				December 31, 2010				September 30, 2010
		(Dollars in thousands)
Non-covered nonperforming loans:
Real estate:
Construction		$	1,270			$	6,108			$	4,029
Commercial - Real Estate			19,129				29,167				28,639
Commercial
Commercial - Business			7,275				5,696				7,631
Trade Finance			355				—				—
SBA			5,534				3,896				2,653
Other
Consumer			820				651				229
Other			—				—				—
Total non-covered nonperforming loans			34,383				45,518				43,181
Guaranteed portion of nonperforming loans			5,361				3,293				3,022
Total non-covered nonperforming loans, net of SBA guarantees			29,022				42,225				40,159
Non-covered OREO			947				937				4,548
Total non-covered nonperforming assets, net of SBA guarantees		$	29,969			$	43,162			$	44,707
Performing TDR’s not included above		$	34,208			$	21,377			$	23,898
Nonperforming loans, net of SBA guarantees as a percent of total non-covered loans			1.98	%			2.76	%			2.74	%
Nonperforming assets, net of SBA guarantees as a percent of non-covered loans and OREO			2.04	%			2.82	%			3.04	%
Allowance for loan losses to non-covered nonperforming loans, net of SBA guarantees			162.3	%			123.3	%			135.6	%

Total non-covered nonperforming loans decreased to $34.4 million as of September 30, 2011 from $45.5 million as of December 31, 2010 and from $43.2 million as of September 30, 2010. The decrease from December 31, 2010 to September 30, 2011 primarily resulted from decreases in nonperforming commercial real estate loans of $10.0 million. In addition, non-covered nonperforming loans of $17.2 million were reclassified as non-covered loans held for sale during the nine months ended September 30, 2011.

Total non-covered nonperforming assets, net of SBA guarantees were $30.0 million, representing 2.04% of total non-covered loans and OREO as of September 30, 2011 compared to $43.2 million, representing 2.82% of total non-covered loans and OREO as of December 31, 2010. Total non-covered nonperforming loans, net of SBA guarantees, decreased to $29.0 million as of September 30, 2011 from $42.2 million as of December 31, 2010.

Loans are considered impaired when it is probable that the Company will be unable to collect all amounts due as scheduled according to the contractual terms of the loan agreement, including contractual interest and principal payments. Impaired loans are measured for impairment based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, alternatively, at the loan’s observable market price or the fair value of the collateral if the loan is collateralized, less costs to sell. Loans are identified for specific allowances from information provided by several sources including asset classification, third party reviews, delinquency reports, periodic updates to financial statements, public records, and industry reports. All loan types are subject to impairment evaluation for a specific allowance once identified as impaired.

 

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The following table provides information on non-covered impaired loans:

 

		Recorded Investment  1)				Unpaid Principal Balance  2)				Related Allowance				For the Nine Months Ended September 30, 2011								For the Three Months Ended September 30, 2011
														Average Recorded Investment				Interest Income Recognized				Average Recorded Investment				Interest Income Recognized
		(Dollars in thousands)
With no related allowance recorded:
Real Estate
Construction		$	1,268			$	1,270			$	—			$	1,322			$	—			$	1,270			$	—
Commercial - Real Estate			16,746				16,706				—				30,824				300				21,356				97
Commercial
Commercial - Business			3,783				3,758				—				6,528				198				3,889				42
Trade Finance			—				—				—				289				—				—				—
SBA			1,234				1,231				—				1,214				52				1,303				20
Others
Consumer			929				930				—				707				13				834				4
Other			—				—				—				—				—				—				—
Total		$	23,960			$	23,895			$	—			$	40,884			$	563			$	28,652			$	163
With an allowance recorded:
Real Estate
Construction		$	—			$	—			$	—			$	1,796			$	—			$	—			$	—
Commercial - Real Estate			29,789				29,611				7,591				24,516				677				31,166				278
Commercial
Commercial - Business			16,495				16,368				7,974				17,888				370				16,966				140
Trade Finance			1,241				1,215				644				1,042				29				1,260				11
SBA			304				326				283				412				12				279				—
Others
Consumer			314				314				75				703				36				481				12
Other			—				—				—				—				—				—				—
Total		$	48,143			$	47,834			$	16,567			$	46,357			$	1,124			$	50,152			$	441
Total
Real Estate
Construction		$	1,268			$	1,270			$	—			$	3,118			$	—			$	1,270			$	—
Commercial - Real Estate			46,535				46,317				7,591				55,340				977				52,522				375
Commercial
Commercial - Business			20,278				20,126				7,974				24,416				568				20,855				182
Trade Finance			1,241				1,215				644				1,331				29				1,260				11
SBA			1,538				1,557				283				1,626				64				1,582				20
Others
Consumer			1,243				1,244				75				1,410				49				1,315				16
Other			—				—				—				—				—				—				—
Total		$	72,103			$	71,729			$	16,567			$	87,241			$	1,687			$	78,804			$	604

 

1)	Includes unpaid principal balance plus any accrued interest, net deferred fees.

 

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		Recorded Investment  1)				Unpaid Principal Balance  2)				Related Allowance				For the Twelve Months Ended December 31, 2010
														Average Recorded Investment				Interest Income Recognized
		(Dollars in thousands)
With no related allowance recorded:
Real Estate
Construction		$	3,514			$	3,501			$	—			$	2,841			$	20
Commercial - Real Estate			45,251				45,042				—				53,451				798
Commercial
Commercial - Business			10,277				10,216				—				8,746				277
Trade Finance			—				—				—				80				4
SBA			490				488				—				383				41
Others
Consumer			646				646				—				538				21
Other			—				—				—				—				—
Total		$	60,178			$	59,893			$	—			$	66,039			$	1,161
With an allowance recorded:
Real Estate
Construction		$	2,606			$	2,607			$	223			$	3,289			$	—
Commercial - Real Estate			18,263				18,137				2,126				26,981				659
Commercial
Commercial - Business			13,758				13,649				8,022				6,111				165
Trade Finance			1,219				1,199				633				915				53
SBA			1,275				1,278				310				710				57
Others
Consumer			817				814				329				637				20
Other			—				—				—				—				—
Total		$	37,938			$	37,684			$	11,643			$	38,643			$	954
Total
Real Estate
Construction		$	6,120			$	6,108			$	223			$	6,130			$	20
Commercial - Real Estate			63,514				63,179				2,126				80,432				1,457
Commercial
Commercial - Business			24,035				23,865				8,022				14,857				442
Trade Finance			1,219				1,199				633				995				57
SBA			1,765				1,766				310				1,093				98
Others
Consumer			1,463				1,460				329				1,175				41
Other			—				—				—				—				—
Total		$	98,116			$	97,577			$	11,643			$	104,682			$	2,115

 

1)	Includes unpaid principal balance plus any accrued interest, net deferred fees.

During the nine months of 2011, non-covered impaired loans decreased due primarily to charge-offs, reclassification to accrual status, and notes sale. As of September 30, 2011, specific reserves of $16.6 million represented 23.1% of the impaired loans as compared to 11.9% as of December 31, 2010.

Covered Nonperforming Assets

Covered nonperforming assets totaled $20.1 million and $26.3 million as of September 30, 2011 and December 31, 2010, respectively. The decreases in the covered nonperforming assets were mainly result of the increase of charge-offs, the collections of SBA guaranteed portions, and the disposition of the covered OREO. These covered nonperforming assets are subject to loss sharing agreement with the FDIC. The covered nonperforming assets as of September 30, 2011 and December 31, 2010 are as follows:

 

		September 30, 2011				December 31, 2010
		(Dollars in thousands)
Covered loans on non-accrual status		$	19,069			$	24,874
Covered other real estate owned			1,028				1,459
Total covered nonperforming assets		$	20,097			$	26,333

 

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Loans accounted for under ASC 310-30 are generally considered accruing and performing loans as the loans accrete the accretable discount to interest income over the estimate life of the loan when cash flows are reasonably estimable. Accordingly, acquired impaired loans that are contractually past due are still considered to be accruing and performing loans. The loans may be classified as nonaccrual if the timing and amount of future cash flows is not reasonably estimable.

Allowance for Loan Losses on Non-covered Loans

The Company’s allowance for loan loss methodologies incorporate a variety of risk considerations, both quantitative and qualitative, in establishing an allowance for loan loss that management believes is appropriate at each reporting date. Quantitative factors include the Company’s historical loss experience, delinquency and charge-off trends, collateral values, changes in nonperforming loans, and other factors. Quantitative factors also incorporate known information about individual loans, including borrowers’ sensitivity to interest rate movements and to quantifiable external factors including commodity and finished good prices as well as acts of nature (earthquakes, floods, fires, etc.) that occur in a particular period. Qualitative factors include the general economic environment in the Company’s markets and, in particular, the state of certain industries. Size and complexity of individual credits, loan structure, extent and nature of waivers of existing loan policies and pace of portfolio growth are other qualitative factors that are considered in its methodologies. As the Company adds new products, increases the complexity of the loan portfolio, and expands its geographic coverage, the Company will enhance the methodologies to keep pace with the size and complexity of the loan portfolio. Changes in any of the above factors could have significant impact to the allowance for loan loss calculation. The Company believes that its methodologies continue to be appropriate given its size and level of complexity.

The allowance for loan losses reflects management’s judgment of the level of the allowance considered adequate to provide for probable losses inherent in the loan portfolio as of the date of the consolidated statements of financial condition. On a quarterly basis, the Company assesses the overall adequacy of the allowance for loan losses, utilizing a disciplined and systematic approach which includes the application of a specific allowance for identified problem loans, a formula allowance for identified graded loans and an allocated allowance for large groups of smaller balance homogenous loans. To assist management in monitoring the allowance for loan losses, the Company’s independent loan review consultants review the allowance as an integral part of their examination process.

Allowance for Specifically Identified Problem Loans. A specific allowance is established for impaired loans. A loan is impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. The specific allowance is determined based on the present value of expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, the Company may measure impairment based on a loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent. The Company measures impairment based on the fair value of the collateral, adjusted for the cost related to liquidation of the collateral.

Formula Allowance for Identified Graded Loans. Non-homogenous loans such as commercial real estate, construction, commercial business, trade finance and SBA loans that are not subject to the allowance for specifically identified loans discussed above are not reviewed individually and are subject to a formula allowance. The formula allowance is calculated by applying loss factors to outstanding Pass, Special Mention, Substandard and Doubtful loans. The evaluation of the inherent loss for these loans involves a high degree of uncertainty, subjectivity and judgment because probable loan losses are not identified with a specific loan. In determining the formula allowance, the Company relies on a mathematical calculation that incorporates a six-quarter rolling average of historical losses. Current quarter losses are measured against previous quarter loan balances to develop the loss factor. Loans risk rated Pass, Special Mention and Substandard for the most recent three quarters are adjusted to an annual basis as follows:

 

•

the most recent quarter is weighted 4/1;

 

•

the second most recent is weighted 4/2;

 

•

the third most recent is weighted 4/3.

The formula allowance may be further adjusted to account for the following qualitative factors which have been established at a minimum of 50 basis points:

 

•

Changes in lending policies and procedures, including underwriting standards and collection, charge-off, and recovery practices;

 

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•

Changes in national and local economic and business conditions and developments, including the condition of various market segments;

 

•

Changes in the nature and volume of the loan portfolio;

 

•

Changes in the experience, ability, and depth of lending management and staff;

 

•

Changes in the trend of the volume and severity of past due and classified loans, and trends in the volume of non-accrual loans and troubled debt restructurings, and other loan modifications;

 

•

Changes in the quality of the Company’s loan review system and the degree of oversight by the directors;

 

•

The existence and effect of any concentrations of credit, and changes in the level of such concentrations; and

 

•

The effect of external factors such as competition and legal and regulatory requirements on the level of estimated losses in the Company’s loan portfolio.

Allowance for Large Groups of Smaller Balance Homogenous Loans. The portion of the allowance allocated to large groups of smaller balance homogenous loans is focused on loss experience for the pool rather than on an analysis of individual loans. Large groups of smaller balance homogenous loans mainly consist of consumer loans to individuals. The allowance for groups of performing loans is based on historical losses over a six-quarter period. In determining the level of allowance for delinquent groups of loans, the Company classifies groups of homogenous loans based on the number of days delinquent and other qualitative factors and trends.

The following table sets forth the composition of the allowance for loan losses on non-covered loans as of September 30, 2011 and December 31, 2010, respectively:

 

		September 30, 2011				December 31, 2010
		(Dollars in thousands)
Specific (Impaired loans)		$	16,567			$	11,643
Formula (non-homogeneous)			29,821				39,939
Homogeneous			710				465
Total allowance for loan losses		$	47,098			$	52,047

 

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The table below summarizes the activity in the Company’s allowance for loan losses on non-covered loans for the periods indicated:

 

		Nine Months Ended September 30, 2011				Year Ended December 31, 2010				Nine Months Ended September 30, 2010
		(Dollars in thousands)
Balances
Average total non-covered loans outstanding during the period 1)		$	1,469,886			$	1,493,526			$	1,498,908
Total non-covered loans outstanding at end of period 1)		$	1,467,146			$	1,527,928			$	1,466,234
Allowance for Loan Losses on Non-covered Loans:
Balance at beginning of period		$	52,047			$	58,543			$	58,543
Charge-offs:
Construction			1,932				947				419
Commercial - Real Estate			8,380				20,296				16,178
Commercial - Business			5,562				8,114				5,011
Trade Finance			444				1,448				1,448
SBA			1,285				1,075				1,008
Consumer			956				767				563
Other			—				—				—
Total charge-offs			18,559				32,647				24,627
Recoveries
Construction			366				561				123
Commercial - Real Estate			576				1,357				1,357
Commercial - Business			208				2,890				2,817
Trade Finance			—				—				—
SBA			46				189				151
Consumer			214				154				96
Other			—				—				—
Total recoveries			1,410				5,151				4,544
Net loan charge-offs			17,149				27,496				20,083
Provision for loan losses			12,200				21,000				16,000
Balance at end of period		$	47,098			$	52,047			$	54,460
Ratios:
Net loan charge-offs to average total non-covered loans*			1.56	%			1.84	%			1.79	%
Provision for loan losses to average total non-covered loans*			1.11				1.41				1.43
Allowance for loan losses to total non-covered loans at end of period			3.21				3.41				3.71
Allowance for loan losses to total non-covered nonperforming loans			136.98				114.34				126.12
Net loan charge-offs to allowance for loan losses at end of period*			48.68				52.83				49.30
Net loan charge-offs to provision for loan losses			140.57				130.93				125.52

 

*	Ratios are annualized for comparability purposes

 

1)	Total non-covered loans are net of deferred loan fees and discount on SBA loans sold.

Based on a quarterly migration and qualitative analysis which evaluates the loan portfolio credit quality, the allowance for loan losses on non-covered loans decreased to $47.1 million as of September 30, 2011 compared to $52.0 million at December 31, 2010. The Company recorded a provision of $1.2 million and $12.2 million for the three and nine months ended September 30, 2011 compared to $4.0 million and $16.0 million for the same periods in 2010. For the nine months ended September 30, 2011, the Company charged off $18.6 million and recovered $1.4 million resulting in net loan charge-offs of $17.1 million compared to net loan charge-offs of $20.1 million for the same period in 2010.

Management believes the level of the allowance as of September 30, 2011 is adequate to absorb the estimated losses from any known or inherent risks in the loan portfolio. However, no assurance can be given that economic conditions which adversely affect our service areas or other circumstances may not require increased provisions for loan losses in the future.

The ratio of the Company’s allowance for loan losses to total non-covered loans decreased to 3.21% as of September 30, 2011 compared to 3.41% as of December 31, 2010 and 3.71% as of September 30, 2010. The ratio of the allowance for loan losses to total non-covered nonperforming loans increased to 137% as of September 30, 2011 compared to 114% as of December 31, 2010 due to a reduction in non-covered nonperforming loans. Management is committed to maintaining the allowance for loan losses at a level that is considered commensurate with estimated and known risks in the portfolio. Although the adequacy of the allowance is reviewed quarterly, management performs an ongoing assessment of the risks inherent in the portfolio. Commercial real estate is the principal collateral for the Company’s loans.

 

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Deposits

The composition and cost of the Company’s deposit base are important components in analyzing its net interest margin and balance sheet liquidity characteristics, both of which are discussed in greater detail in other sections herein. Net interest margin is improved to the extent that growth in deposits can be concentrated in lower-cost core deposits, namely noninterest-bearing demand, NOW accounts, savings accounts and money market deposit accounts. Liquidity is impacted by the volatility of deposits or other funding instruments, or in other words their propensity to leave the institution for rate-related or other reasons. Potentially, the most volatile deposits in a financial institution are large certificates of deposit (e.g., generally time deposits with balances exceeding $250,000). Because these deposits (particularly when considered together with a customer’s other specific deposits) may exceed FDIC insurance limits, depositors may select shorter maturities to offset perceived risk elements associated with such deposits.

The Company’s weighted average interest bearing deposit cost decreased to 1.26% for the nine months ended September 30, 2011, compared to 1.52% for the same period in 2010. The decrease was primary due to change in mix to increase the proportion of lower cost deposits.

The Company can deter, to some extent, the rate sensitive customers who demand high cost certificates of deposit because of local market competition by using wholesale funding sources. As of September 30, 2011, the Company held brokered deposits in the amount of $33.1 million compared to $101.2 million as of December 31, 2010. The Company also had certificates of deposit with State of California in the amount of $115.0 million as of September 30, 2011 and December 31, 2010.

The following table summarizes deposits and the composition of deposits as a percentage of total deposits as of the dates indicated:

 

		September  30, 2011								December  31, 2010								Change in
																		Amount				Percentage
										(Dollars in thousands)
Demand deposits (noninterest-bearing)		$	499,556				27.8	%		$	396,973				22.4	%		$	102,583				25.8	%
Money market accounts and NOW			503,251				28.0				471,132				26.6				32,119				6.8
Savings			89,579				5.0				87,484				4.9				2,095				2.4
			1,092,386				60.8				955,589				53.9				136,797				14.3
Time certificates of deposit
Less than $100,000			307,011				17.1				334,341				18.9				(27,330	)			(8.2	)
$100,000 or more			397,507				22.1				481,064				27.2				(83,557	)			(17.4	)
Total		$	1,796,904				100.0			$	1,770,994				100.0			$	25,910				1.5

Total deposits increased by $25.9 million or 1.5% as of September 30, 2011 compared to $1.77 billion as of December 31, 2010. During the nine months of 2011, noninterest-bearing demand deposits increased by $102.6 million, or 25.8%, and represented 27.8% of total deposits as of September 30, 2011 compared to 22.4% as of December 31, 2010. MMDA and NOW account balances increased by $32.1 million, or 6.8%, representing 28.0% of total deposits as of September 30, 2011 increasing from 26.6% as of December 31, 2010. Savings account balances increased by $2.1 million, or 2.4%, and represented 5.0% of total deposits as of September 30, 2011 from 4.9% as of December 31, 2010. Time certificates of deposit under $100,000, which are classified as core deposits, decreased by $27.3 million, or 8.2%. Jumbo time certificates of deposit, or time certificates of deposit equal to or greater than $100,000, decreased by $83.6 million, or 17.4%.

Time deposits by maturity dates are as follows as of September 30, 2011:

 

Year		$100,000 or Greater				Less Than $100,000				Total
		(Dollars in thousands)
2011		$	164,532			$	86,175			$	250,707
2012			196,360				205,347				401,707
2013			29,213				12,451				41,664
2014			4,668				1,665				6,333
2015 and thereafter			2,734				1,373				4,107
Total		$	397,507			$	307,011			$	704,518

Information concerning the average balance and average rates paid on deposits by deposit type for the three and nine months ended September 30, 2011 and 2010 is contained in the tables above in the section entitled “Net Interest Income and Net Interest Margin.”

 

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Other Borrowed Funds

The Company regularly uses FHLB advances and short-term borrowings, which consist of notes issued to the U.S. Treasury to manage Treasury Tax and Loan payments. The Company’s outstanding FHLB borrowings were $131.4 million and $167.2 million as of September 30, 2011 and December 31, 2010, respectively. Notes issued to the U.S. Treasury amounted to $745,000 as of September 30, 2011 compared to $963,000 as of December 31, 2010. The total borrowed amount outstanding as of September 30, 2011 and December 31, 2010 was $132.1 million and $188.7 million, respectively.

As of December 31, 2010, the Company had SBA loans transferred of $20.5 million which were accounted for as a secured financing pursuant to ASC 860, Transfers and Servicing. At that time, SBA loan transfers were subject to a 90-day recourse provision and, therefore, were not considered sold until the recourse period expired. However, during the first quarter of 2011, SBA removed the recourse provision from the standard transfer agreement. As such, all of the SBA loan transfers executed are qualified as sales, thus, are not accounted for as secured financing from 2011.

 

		September 30, 2011				December 31, 2010
		(Dollars in thousands)
FHLB		$	131,385			$	167,213
US Treasury			745				963
Secured financing - SBA loan transfer			—				20,494
Total other borrowed funds		$	132,130			$	188,670

In addition, the issuance of long-term subordinated debentures at the end of 2003 of $18.0 million in “pass-through” trust preferred securities created another source of funding.

Contractual Obligations

The following table presents, as of September 30, 2011, the Company’s significant fixed and determinable contractual obligations, within the categories described below, by payment date. These contractual obligations, except for the operating lease obligations, are included in the Consolidated Statements of Financial Condition. The payment amounts represent those amounts contractually due to the recipient.

 

		Remaining 3 months in 2011				2012				2013				2014				2015				2016 &  thereafter				Total
		(Dollars in thousands)
Debt obligations 1)		$	—			$	—			$	—			$	—			$	—			$	18,557			$	18,557
FHLB advances			5,195				105,389				157				167				176				20,301				131,385
Deposits			257,064				420,224				54,228				13,788				5,747				1,883				752,934
Operating lease obligations			649				2,239				1,846				1,364				1,067				1,631				8,796
Total contractual obligations		$	262,908			$	527,852			$	56,231			$	15,319			$	6,990			$	42,372			$	911,672

 

1)	Includes principal payment only and may be redeemed quarterly by the issuer.

LIQUIDITY AND MARKET RISK/INTEREST RISK MANAGEMENT

Liquidity

The objective of liquidity risk management is to ensure that the Company has the continuing ability to maintain cash flows that are adequate to fund operations and meet its other obligations on a timely and cost-effective basis in various market conditions. Changes in each of the composition of its balance sheet, the ongoing diversification of its funding sources, risk tolerance levels and market conditions are among the factors that influence the Company’s liquidity profile. The Company establishes liquidity guidelines and maintains contingency liquidity plans that provide for specific actions and timely responses to liquidity stress situations.

As a means of augmenting the liquidity sources, the Company has available a combination of borrowing sources comprised of FHLB advances, federal funds lines with various correspondent banks, and access to the wholesale markets. The Company believes these liquidity sources to be stable and adequate. As of September 30, 2011, the Company was not aware of any information that was reasonably likely to have a material adverse effect on its liquidity position.

 

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The liquidity of the Company is primarily dependent on the payment of cash dividends by its subsidiary, Center Bank, subject to limitations imposed by the laws of the State of California. Center Financial held $4.2 million in liquid funds with Center Bank as of September 30, 2011 which can be used to pay dividends on Center Financial’s preferred stock, interest on its capital trust pass-through securities and other expenses as needed.

As part of the Company’s liquidity management, the Company utilizes FHLB borrowings to supplement our deposit source of funds. Therefore, there could be fluctuations in these balances depending on the short-term liquidity and longer-term financing need of the Company. The Company’s primary sources of liquidity are derived from financing activities, which include customer and brokered deposits, federal funds facilities, and advances from the FHLB.

Because the Company’s primary sources and uses of funds are deposits and loans, respectively, the relationship between net loans and total deposits provides one measure of the Company’s liquidity. Typically, if the ratio is over 100%, the Company relies more on borrowings, wholesale deposits and repayments from the loan portfolio to provide liquidity. Alternative sources of funds such as FHLB advances and brokered deposits and other collateralized borrowings provide liquidity as needed from liability sources are an important part of the Company’s asset liability management strategy.

 

		As of September 30, 2011				As of December 31, 2010
		(Dollars in thousands)
Net loans		$	1,512,629			$	1,592,163
Deposits		$	1,796,904			$	1,770,994
Net loan to deposit ratio			84.2	%			89.9	%

As of September 30, 2011 and December 31, 2010, the Company’s liquidity ratio, which is the ratio of available liquid funds to net deposits and short-term liabilities, was 19.6% and 18.5%, respectively. The Company’s liquidity ratio increased as cash and other short-term marketable assets continued to increase during the first nine months in 2011. Total available on balance sheet liquidity as of September 30, 2011 was $373.5 million, consisting of excessive cash holdings or balances in due from banks, overnight Fed funds sold, money market funds and unpledged available-for-sale securities, compared to $335.6 million as of December 31, 2010.

As of September 30, 2011, the Company’s net non-core fund dependence ratio was 7.84% under applicable regulatory guidelines, which assumes all certificates of deposit over $250,000 as volatile sources of funds, as compared to 19.8% as of December 31, 2010. The net non-core fund dependence ratio is the ratio of net short-term investment less non-core liabilities divided by long-term assets. All of the ratios as of and for the nine months ended September 30, 2011 were in compliance with internal guidelines. The Company is continuously looking toward the growth of retail core and time deposits to meet its liquidity needs in the future.

As of September 30, 2011, the Company had $375.7 million of available funds in FHLB borrowings, $137.3 million with the FRB and $26.0 million in federal funds lines totaling $539.0 million of available funding sources. Additionally, $55.2 million in investment securities may be pledged as collateral for repurchase agreements and other credit facilities. The Company was approved for the Borrower In Custody arrangement by the FRB in January 2009. Collateral held in such an arrangement may be used to secure advances and/or credit for the discount window program and will provide the Company with additional source of liquidity. This total available funding availability does not include the Company’s ability to purchase brokered deposits, which is limited by the Company’s policy to 20% of total deposits.

 

		FHLB				FRB				Federal Funds Facility				Total
		(Dollars in thousands)
Total capacity		$	506,895			$	137,311			$	26,000			$	670,206
Used			(131,193	)			—				—				(131,193	)
Available		$	375,702			$	137,311			$	26,000			$	539,013

Market Risk/Interest Rate Risk Management

Market risk is the risk of loss from adverse changes in market prices and rates. The Company’s market risk arises primarily from interest rate risk inherent in its lending, investment and deposit taking activities. The Company’s profitability is affected by fluctuations in interest rates. A sudden and substantial change in interest rates may adversely impact the Company’s earnings to the extent that the interest rates borne by assets and liabilities do not change at the same speed, to the same extent or on the same basis. To that end, Management actively monitors and manages its interest rate risk exposure.

 

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The Company’s strategy for asset and liability management is formulated and monitored by the Company’s Asset/Liability Board Committee (the “Board Committee”). This Board Committee is composed of four non-employee directors and the President. The Board Committee meets quarterly to review and adopt recommendations of the Asset/Liability Management Committee (“ALCO”).

The ALCO consists of executive and manager level officers from various areas of the Company including lending, investment, and deposit gathering, in accordance with policies approved by the board of directors. The primary goal of the Company’s ALCO is to manage the financial components of the Company’s balance sheet to optimize the net income under varying interest rate environments. The focus of this process is the development, analysis, implementation, and monitoring of earnings enhancement strategies, which provide stable earnings and capital levels during periods of changing interest rates.

The ALCO meets regularly to review, among other matters, the sensitivity of the Company’s assets and liabilities to interest rate changes, the book and market values of assets and liabilities, unrealized gains and losses, and maturities of investments and borrowings. The ALCO also approves and establishes pricing and funding decisions with respect to overall asset and liability composition, and reports regularly to the Board Committee and the board of directors.

Interest Rate Risk

Interest rate risk occurs when assets and liabilities reprice at different times as interest rates change. In general, the interest the Company earns on its assets and pays on its liabilities are established contractually for specified periods of time. Market interest rates change over time and if a financial institution cannot quickly adapt to changes in interest rates, it may be exposed to volatility in earnings. For instance, if the Company were to fund long-term fixed rate assets with short-term variable rate deposits, and interest rates were to rise over the term of the assets, the short-term variable deposits would rise in cost, adversely affecting net interest income. Similar risks exist when rate sensitive assets (for example, prime rate based loans) are funded by longer-term fixed rate liabilities in a falling interest rate environment.

The Company’s overall strategy is to minimize the adverse impact of immediate incremental changes in market interest rates (rate shock) on net interest income and economic value of equity. Economic value of equity is defined as the present value of assets, minus the present value of liabilities and off-balance sheet instruments. The attainment of this goal requires a balance between profitability, liquidity and interest rate risk exposure. To minimize the adverse impact of changes in market interest rates, the Company simulates the effect of instantaneous interest rate changes on net interest income and economic value of equity (“EVE”) on a quarterly basis. The table below shows the estimated impact of changes in interest rates on our net interest income and market value of equity as of September 30, 2011 and June 30, 2011, respectively, assuming a parallel shift of 100 to 400 basis points in both directions.

 

		Net Interest Income (NII) 1)								Economic Value of Equity (EVE)  2)
Change (In Basis Points)		September 30, 2011 % Change				June 30, 2011 % Change				September 30, 2011 % Change				June 30, 2011 % Change
+400			29.35	%			31.77	%			-30.63	%			-28.02	%
+300			22.77	%			25.30	%			-22.63	%			-20.65	%
+200			15.33	%			16.56	%			-14.49	%			-13.37	%
+100			7.58	%			8.36	%			-6.87	%			-6.53	%
Level
-100			0.40	%			0.06	%			4.53	%			4.70	%
-200			4.87	%			2.53	%			5.93	%			8.58	%
-300			4.79	%			2.40	%			7.67	%			9.77	%
-400			4.71	%			2.31	%			9.41	%			10.99	%

 

1)	The percentage change represents net interest income for twelve months in a stable interest rate environment versus net interest income in the various rate scenarios

2)	The percentage change represents economic value of equity of the Company in a stable interest rate environment versus economic value of equity in the various rate scenarios

All interest-earning assets and interest-bearing liabilities are included in the interest rate sensitivity analysis as of September 30, 2011 and June 30, 2011, respectively. As of September 30, 2011 and June 30, 2011, respectively, our estimated changes in net interest income and economic value of equity were within the ranges established by the Board of Directors. In a declining rate environment, the interest rate floors on the loans contribute to the favorable impact on the net interest income while in the rising rate environment, these interest rate floors also serve to lessen the full benefit of higher interest rates.

 

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The primary analytical tool used by the Company to gauge interest rate sensitivity is a simulation model used by many community banks, which is based upon the actual maturity and repricing characteristics of interest-rate-sensitive assets and liabilities. The model attempts to forecast changes in the yields earned on assets and the rates paid on liabilities in relation to changes in market interest rates. As an enhancement to the primary simulation model, other factors are incorporated into the model, including prepayment assumptions and market rates of interest provided by independent broker/dealer quotations, an independent pricing model, and other available public information. The model also factors in projections of anticipated activity levels of the Company’s product lines. Management believes that the assumptions it uses to evaluate the vulnerability of the Company’s operations to changes in interest rates approximate actual experience and considers them reasonable; however, the interest rate sensitivity of the Company’s assets and liabilities and the estimated effects of changes in interest rates on the Company’s net interest income and EVE could vary substantially if different assumptions were used or if actual experience were to differ from the historical experience on which they are based.

CAPITAL RESOURCES

Shareholders’ equity as of September 30, 2011 was $294.7 million, compared to $274.0 million as of December 31, 2010. The increase was due primarily to net earnings of $19.2 million in the first nine months of 2011. The primary sources of capital have historically been retained earnings and relatively nominal proceeds from the exercise of employee incentive and/or nonqualified stock options. There were 7,192 option shares exercised during the first nine months of 2011. Shareholders’ equity is also affected by changes in unrealized losses on available-for-sale securities.

As part of the TARP Capital Purchase Program, the Company entered into a purchase agreement with the Treasury Department on December 12, 2008, pursuant to which the Company issued and sold 55,000 shares of fixed-rate cumulative perpetual preferred stock for a purchase price of $55.0 million and 10-year warrants to purchase 864,780 shares of the Company’s common stock at an exercise price of $9.54 per share. The number of shares underlying the Warrant was reduced to 432,390 effective December 31, 2009 as a result of capital raises during 2009. The Company will pay the Treasury Department a five percent dividend annually for each of the first five years of the investment and a nine percent dividend thereafter until the shares are redeemed.

The Company is committed to maintaining capital at a level sufficient to assure shareholders, customers and regulators that the Company is financially sound and able to support its growth from its retained earnings. From October 2003 to January 2009 Center Financial paid quarterly cash dividends to its shareholders. On March 25, 2009, the Company’s board of directors suspended its quarterly cash dividends based on adverse economic conditions and the Company’s then recent losses. The Company has determined that this is a prudent, safe and sound practice to preserve capital. The Company would be required to obtain the Treasury Department’s approval to reestablish common stock dividends in the future until December 2011 unless the preferred stock issued to the Treasury Department in the TARP Capital Purchase Program has been redeemed prior to that time. The Company had been also required to obtain prior approval of the FRB to pay dividends pursuant to its MOU with the FRB (see “Informal Regulatory Agreements” above). In October 2011, the Company’s MOU with the FRB was lifted.

The Company is subject to risk-based capital regulations adopted by the federal banking regulators. These guidelines are used to evaluate capital adequacy and are based on an institution’s asset risk profile and off-balance sheet exposures. The risk-based capital guidelines assign risk weightings to assets both on and off-balance sheet and place increased emphasis on common equity. According to the regulations, institutions whose Tier I risk based capital ratio, total risk based capital ratio and leverage ratio meet or exceed 6%, 10% and 5%, respectively, are deemed to be “well-capitalized.” As of September 30, 2011, all of the Company’s capital ratios were above the minimum regulatory requirements for a “well-capitalized” institution.

The MOU the Bank had entered into with the FDIC and the DFI required the development of a capital plan that included maintaining a minimum Tier 1 leverage capital ratio of not less than 9% and a total risk-based capital ratio of not less than 13% while the MOU remained in effect. In September 2011, the Bank’s MOU with the FDIC and the DFI was lifted. The Bank’s regulatory capital ratios as of September 30, 2011 and December 31, 2010 exceeded these requirements, respectively.

The following table compares the Company’s and Bank’s actual capital ratios as of September 30, 2011, to those required by regulatory agencies for capital adequacy and well-capitalized classification purposes:

 

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Regulatory Capital Ratios

 

		Center Financial Corporation				Center Bank				Minimum Regulatory Requirements				Well Capitalized Requirements
Total Capital (to Risk-Weighted Assets)			21.10	%			20.91	%			8.00	%			10.00	%
Tier 1 Capital (to Risk-Weighted Assets)			19.83	%			19.64	%			4.00	%			6.00	%
Tier 1 Capital (to Average Assets)			13.51	%			13.38	%			4.00	%			5.00	%

 

Item 3:

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The information concerning quantitative and qualitative disclosures about market risk is included as part of Part I, Item 2 above. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Market Risk/Interest Rate Risk Management.”

 

Item 4:

CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Disclosure controls and procedures are designed to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that it files under the Exchange Act is accumulated and communicated to management, including the principal executive officer and the principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

An evaluation was performed under the supervision and with the participation of our management, including our principal executive officer and the principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2011. Based on the evaluation, our principal executive officer and the principal financial officer have concluded that our disclosure controls and procedures were effective as of September 30, 2011.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting during the quarter ended September 30, 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II - OTHER INFORMATION

 

Item 1:

LEGAL PROCEEDINGS

In the normal course of business, the Company from time to time is involved in various claims and legal proceedings. With the exception of the potentially adverse outcome in the litigation herein described, after taking into consideration information furnished by counsel as to the current status of these claims and proceedings, management does not believe that any liability resulting from such proceedings would have a material adverse effect on the Company’s financial condition or results of operation.

On May 2, 2011, a purported class action was filed in Los Angeles County Superior Court against the Company, the Company’s directors and Nara Bancorp alleging, among other things, that the directors breached their fiduciary duties in connection with their approval of the proposed merger with Nara Bancorp and that the Company breached its fiduciary duties in connection with the disclosures it made regarding the proposed merger. On July 29, 2011, the parties to the litigation agreed to settle all claims asserted in the action, subject to, among other things, the execution of a stipulation of settlement and court approval. As part of the settlement, Nara Bancorp and the Company agreed to make certain supplemental disclosures included in an amendment to the registration statement for the Nara Bancorp shares to be issued at the completion of the merger. In addition, defendants have agreed to pay up to $400,000 in plaintiff’s attorneys’ fees and expenses, if and to the extent approved by the court. The court hearing on the proposed settlement is scheduled on November 16, 2011. Such payment would be due only if the merger is consummated and be payable by the combined company. If approved by the court, the settlement also would result in the release by the plaintiff and the proposed settlement class of all claims that were or could have been brought challenging any aspect of the merger agreement, the merger and any disclosures made in connection therewith (but excluding any properly perfected claims for statutory appraisal in connection with the merger, certain claims arising under the federal securities laws and any claims to enforce the settlement).

 

Item 1A:

RISK FACTORS

In addition to the other information set forth in this report, you should carefully consider the factors discussed under “Part I – Item 1A – Risk Factors” in the Company’s Annual Report on Form 10-K, as amended, for the year ended December 31, 2010 and the section titled “Risk Factors” in the Company’s 2011 proxy statement. These factors could materially affect the Company’s business, financial condition, liquidity, results of operations and capital position, and could cause the Company’s actual results to differ materially from our historical results or the results contemplated by the forward-looking statements contained in this report. There were no material changes from the risk factors previously disclosed in our 2010 Annual Report on Form 10-K and the proxy statement.

 

Item 2:

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Not applicable

 

Item 3:

DEFAULTS UPON SENIOR SECURITIES

Not applicable

 

Item 4:

(REMOVED AND RESERVED)

 

Item 5:

OTHER INFORMATION

Not applicable

 

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Item 6:

EXHIBITS

 

Exhibit No.		Description
3.1		Restated Articles of Incorporation of Center Financial Corporation 1
3.2		Amended and Restated Bylaws of Center Financial Corporation 2
3.3		Amendment to Bylaws of Center Financial Corporation 3
3.4		Amendment to Articles of Incorporation of Center Financial Corporation 4
4.1		Certificate of Determination for Series A Preferred Stock of Center Financial Corporation 3
10.2		2006 Stock Incentive Plan, as Amended and Restated June 13, 2007 5
10.3		Lease for Corporate Headquarters Office 6
10.4		Indenture dated as of December 30, 2003 between Wells Fargo Bank, National Association, as Trustee, and Center Financial Corporation, as Issuer 7
10.5		Amended and Restated Declaration of Trust of Center Capital Trust I, dated as of December 30, 2003 7
10.6		Guarantee Agreement between Center Financial and Wells Fargo Bank, National Association dated as of December 30, 2003 7
10.7		Deferred compensation plan and list of participants 8
10.8		Split dollar plan and list of participants 8
10.9		Survivor income plan and list of participants 8
10.10		Warrant to Purchase Common Stock 3
10.11		Letter Agreement, dated as of December 12, 2008, including the Securities Purchase Agreement – Standard Terms incorporated by reference therein, between Center Financial Corporation and the United States Department of the Treasury 3
11		Statement of Computation of Per Share Earnings (included in Note 9 to Interim Consolidated Financial Statements included herein.)
31.1		Certification of Principal Executive Officer (Section 302 Certification)
31.2		Certification of Principal Financial Officer (Section 302 Certification)
32		Certification of Periodic Financial Report (Section 906 Certification)
101.INS**		XBRL Instance Document
101.SCH**		XBRL Taxonomy Extension Schema Document
101.CAL**		XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF**		XBRL Taxonomy Extension Definition Linkbase Document
101.LAB**		XBRL Taxonomy Extension Label Linkbase Document
101.PRE**		XBRL Taxonomy Extension Presentation Linkbase Document

 

1	Filed as an Exhibit of the same number to the Form 10-Q for the quarterly period ended June 30, 2008 and incorporated herein by reference

2	Filed as an Exhibit to the Form 8-K filed with the SEC on May 12, 2006 and incorporated herein by reference

3	Filed as an Exhibit to the Form 8-K filed with the SEC on December 16, 2008 and incorporated herein by reference

4	Filed as an Exhibit of the same number to the Form 10-Q for the quarterly period ended March 31, 2010 and incorporated herein by reference

5	Filed as an Exhibit of the same number to the Form 10-Q for the quarterly period ended June 30, 2007 and incorporated herein by reference

6	Filed as an Exhibit of the same number to the Form 10-Q for the quarterly period ended June 30, 2011 and incorporated herein by reference

7	Filed as an Exhibit of the same number to the Form 10-K for the fiscal year ended December 31, 2003 and incorporated herein by reference

8	Filed as an Exhibit of the same number to the Form 10-Q for the quarterly period ended March 31, 2006 and incorporated herein by reference

**	Furnished herewith

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized:

 

		Center Financial Corporation
Date: November 8, 2011		By:		/s/     Richard S. Cupp
				Richard S. Cupp
				President & Chief Executive Officer (Principal Executive Officer)
Date: November 8, 2011		By:		/s/     Hwa Kyung Kim
				Hwa Kyung Kim Controller (Principal Financial Officer)

 

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