PART I
Item 1. Business.
Business of Bancorp
Overview
Cathay General Bancorp is a corporation that was organized in
1990 under the laws of the State of Delaware. We are the holding company of Cathay Bank, a California state-chartered commercial bank. Our principal current business activity is to hold all of the outstanding stock of Cathay Bank. In the future, we
may become an operating company or acquire savings institutions, other banks, or companies engaged in bank-related activities and may engage in or acquire such other businesses, or activities as may be permitted by applicable law. Our only office,
and our principal place of business, is currently located at the main office of our wholly owned subsidiary, Cathay Bank, at 777 North Broadway, Los Angeles, California 90012. Our telephone number is (213) 625-4700. We plan to move our
principal office to 9650 Flair Drive, El Monte, California 91731 in the second half of 2008. Our common stock is traded on the NASDAQ Global Select Market and our trading symbol is CATY.
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We continue to look for opportunities to expand the Banks branch network by seeking new branch
locations and by acquiring other financial institutions to diversify our customer base in order to compete for new deposits and loans, and to be able to serve our customers more effectively. We completed two acquisitions in 2006 and one acquisition
in 2007. In May 2006, we completed the acquisition of New York-based Great Eastern Bank for $56.3 million in cash and 1,181,164 shares of our common stock. In October 2006, we acquired Illinois-based New Asia Bancorp in a merger for $12.9 million in
cash and 291,165 shares of our common stock. In March 2007, we completed an all cash acquisition of New Jersey-based United Heritage Bank for $9.4 million.
Subsidiaries of Bancorp
In addition to its wholly-owned bank subsidiary, the Bancorp has the following subsidiaries:
Cathay Capital Trust I, Cathay Statutory Trust I, Cathay Capital Trust
II, Cathay Capital Trust III and Cathay Capital Trust IV.
The Bancorp established Cathay Capital Trust I in June 2003, Cathay Statutory Trust I in September 2003, Cathay Capital Trust II in December 2003, Cathay Capital Trust III in March 2007,
and Cathay Capital Trust IV in May 2007 (collectively, the Trusts) as wholly owned subsidiaries. The Trusts are statutory business trusts. The Trusts issued capital securities representing undivided preferred beneficial interests in the
assets of the Trusts. The Trusts exist for the purpose of issuing the capital securities and investing the proceeds thereof, together with proceeds from the purchase of the common stock of the Trusts by the Bancorp, in Junior Subordinated Notes
issued by the Bancorp. The Bancorp guarantees, on a limited basis, payments of distributions on the capital securities of the Trusts and payments on redemption of the capital securities of the Trusts. The Bancorp is the owner of all the beneficial
interests represented by the common securities of the Trusts. The purpose of issuing the capital securities was to provide the Company with a cost-effective means of obtaining Tier 1 Capital for regulatory purposes.
Because the Bancorp is not the primary beneficiary of the Trusts, the
financial statements of the Trusts are not included in the consolidated financial statements of the Company. The capital securities of the Trusts are currently included in the Tier 1 capital of the Bancorp for regulatory capital purposes. On
March 1, 2005, the Federal Reserve adopted a final rule that retains trust preferred securities in the Tier I capital of bank holding companies, but with stricter quantitative limits and clearer qualitative standards. Under the rule, after a
five-year transition period, the aggregate amount of trust preferred securities and certain other capital elements will be limited to 25% of Tier I capital elements, net of goodwill, less any associated deferred tax liability. The amount of trust
preferred securities and certain other elements in excess of the limit could be included in Tier II capital, subject to restrictions. In the last five years before maturity, the outstanding amount must be excluded from Tier I capital and included in
Tier II capital. Bank holding companies with significant international operations would generally be expected to limit trust preferred securities and certain other capital elements to 15% of Tier I capital elements, net of goodwill. We do not expect
that this rule will have a materially adverse effect on our capital positions.
GBC Venture Capital, Inc.
The business purpose of GBC Venture Capital, Inc. is to hold equity interests (such as options or warrants) received as part of business relationships and to make equity investments in
companies and limited partnerships subject to applicable regulatory restrictions.
Competition
Our
primary business is to act as the holding company for the Bank. Accordingly, we face the same competitive pressures as those expected by the Bank. For a discussion of those risks, see Business of the Bank
Competition
below
under this Item 1.
Employees
Due to the limited nature of the Bancorps activities, the Bancorp
currently does not employ any persons other than Bancorps management, which includes the Chief Executive Officer and President, the Chief Operating Officer, the Chief Financial Officer, Executive Vice Presidents, the Secretary, Assistant
Secretary, and the General Counsel. See also Business of the Bank
Employees
below under this Item 1.
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Business of the Bank
General
Cathay Bank was incorporated under the laws of the State of California on August 22, 1961, and was licensed by the California Department of Financial
Institutions (previously known as the California State Banking Department), and commenced operations as a California state-chartered bank on April 19, 1962. Cathay Bank is an insured bank under the Federal Deposit Insurance Act, but it is not a
member of the Federal Reserve System.
The Banks head
office is located in the Chinatown area of Los Angeles, at 777 North Broadway, Los Angeles, California 90012. In addition, as of December 31, 2007, the Bank had branch offices in Southern California (21 branches), Northern California (10
branches), New York (nine branches), Massachusetts (one branch), Texas (two branches), Washington (three branches), Illinois (three branches), New Jersey (one branch), Hong Kong (one branch) and a representative office in Shanghai and in Taipei.
Deposit accounts at the Hong Kong branch are not insured by the Federal Deposit Insurance Corporation (the FDIC). Each branch office has loan approval rights subject to the branch managers authorized lending limits. Current
activities of the Shanghai and Taipei representative offices are limited to coordinating the transportation of documents to the Banks head office and performing liaison services.
Our primary market area is defined by the Community Reinvestment Act delineation, which includes the contiguous areas
surrounding each of the Banks branch offices. It is the Banks policy to reach out and actively offer services to low and moderate income groups in the delineated branch service areas. Many of the Banks employees speak both English
and one or more Chinese dialects or Vietnamese, and are thus able to serve the Banks Chinese, Vietnamese, and English speaking customers.
As a commercial bank, Cathay Bank accepts checking, savings, and time deposits, and makes commercial, real estate, personal, home improvement, automobile,
and other installment and term loans. From time to time, the Bank invests available funds in other interest-earning assets, such as U.S. Treasury securities, U.S. government agency securities, state and municipal securities, mortgage-backed
securities, asset-backed securities, corporate bonds, and other security investments. The Bank also provides letters of credit, wire transfers, forward currency spot and forward contracts, travelers checks, safe deposit, night deposit, Social
Security payment deposit, collection, bank-by-mail, drive-up and walk-up windows, automatic teller machines (ATM), Internet banking services, and other customary bank services.
The Bank primarily services individuals, professionals, and small to
medium-sized businesses in the local markets in which its branches are located and provides commercial mortgage loans, commercial loans, Small Business Administration (SBA) loans, residential mortgage loans, real estate construction
loans, equity lines of credit; and installment loans to individuals for automobile, household, and other consumer expenditures.
Through Cathay Wealth Management, Cathay Bank provides its customers the ability to trade stocks online and to purchase mutual funds, annuities, equities,
bonds, and short-term money market instruments, through PrimeVest Financial Services. These products are not insured by the FDIC.
Securities
The Banks securities portfolio is managed in accordance with a written Investment Policy which addresses strategies, types, and levels of allowable
investments, and which is reviewed and approved by our Board of Directors.
Our investment portfolio is managed to meet our liquidity needs through proceeds from scheduled maturities and is also utilized for pledging requirements for deposits of state and local subdivisions, securities sold
under repurchase agreements, and Federal Home Loan Bank (FHLB) advances. The portfolio is
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comprised of U.S. government agency securities, mortgage-backed securities, collateralized mortgage obligations, obligations of states and political
subdivisions, corporate debt instruments, and equity securities. At December 31, 2007, the aggregate investment securities portfolio, with a carrying value of $2.35 billion, was classified as investment grade securities. We do not include
federal funds sold and certain other short-term securities as investment securities. These other investments are included in cash and cash equivalents.
Information concerning the carrying value, maturity distribution, and yield analysis of the Companys securities available-for-sale portfolios as
well as a summary of the amortized cost and estimated fair value of the Banks securities by contractual maturity is included in this Annual Report on Form 10-K at Part II Item 7 Managements Discussion
and Analysis of Financial Condition and Results of Operations, and in Note 5 to the Consolidated Financial Statements.
Loans
Cathay Banks Board of Directors and senior management establish, review, and modify Cathay Banks lending policies. These policies include a
potential borrowers financial condition, ability to repay the loan, character, existence of secondary repayment source (such as guaranty), quality and availability of collateral, capital, leverage capacity of the borrower, market conditions
for the borrowers business or project, and prevailing economic trends and conditions. For mortgage loans, our lending policies require an independent appraisal of the real property in accordance with applicable regulatory guidelines. Loan
originations are obtained through a variety of sources, including existing customers, walk-in customers, referrals from brokers or existing customers, and advertising. While loan applications are accepted at all branches, the Banks centralized
document department supervises the application process including documentation of loans, review of appraisals, and credit reports.
Commercial Mortgage Loans.
These loans are typically secured by first deeds of trust on commercial properties, including primarily commercial
retail properties, shopping centers, and owner-occupied industrial facilities, and, secondarily, office buildings, multiple-unit apartments, and multi-tenanted industrial properties.
The Bank also makes medium-term commercial mortgage loans which are generally secured by commercial or industrial buildings
where the borrower uses the property for business purposes or derives income from tenants.
Commercial Loans.
The Bank provides financial services to diverse commercial and professional businesses in its market areas. Commercial loans consist primarily of short-term loans (normally with a maturity of
up to one year) to support general business purposes, or to provide working capital to businesses in the form of lines of credit to finance trade. The Bank continues to focus primarily on commercial lending to small-to-medium size businesses within
the Banks geographic market areas. Commercial loan pricing is generally at a rate tied to the prime rate, as quoted in
The Wall Street Journal
, or the Banks reference rate.
SBA Loans.
The Bank originates SBA loans in California, under the
preferred lender status. Preferred lender status is granted to a lender which has made a certain number of SBA loans and which, in the opinion of the SBA, has staff qualified and experienced in small business loans. As a preferred
lender, the Banks SBA Lending Group has the authority to issue, on behalf of the SBA, the SBA guaranty on loans under the 7(a) program which may result in shortening the time it takes to process a loan. In addition, under this program, the SBA
delegates loan underwriting, closing, and most servicing and liquidation authority and responsibility to selected lenders.
The Bank utilizes both the 504 program, which is focused toward long-term financing of buildings and other long-term fixed assets, and the 7(a) program,
which is the SBAs primary loan program and which can be used for financing of a variety of general business purposes such as acquisition of land and buildings, equipment, inventory and working capital needs of eligible businesses generally
over a 5- to 25-year term. The collateral
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position in the SBA loans is enhanced by the SBA guaranty in the case of 7(a) loans, and by lower loan-to-value ratios under the 504 program. The Bank has
sold and may, in the future, sell the guaranteed portion of certain of its SBA 7(a) loans in the secondary market. SBA loan pricing is generally at a rate tied to the prime rate, as quoted in
The Wall Street Journal
.
Residential Mortgage Loans.
The Bank originates
single-family-residential mortgage loans. The single-family-residential mortgage loans are comprised of conforming, nonconforming, and jumbo residential mortgage loans, and are secured by first or subordinate liens on single (one-to-four) family
residential properties. The Banks products include a fixed-rate residential mortgage loan and an adjustable-rate residential mortgage loan. Mortgage loans are underwritten in accordance with the Banks guidelines, on the basis of the
borrowers financial capabilities, historical loan quality, and other relevant qualifications. As of December 31, 2007, approximately 71% of the Banks residential mortgages were for properties located in California.
Real Estate Construction Loans.
The Banks real estate
construction loan activity focuses on providing short-term loans to individuals and developers, primarily for the construction of multi-unit projects. Residential real estate construction loans are typically secured by first deeds of trust and
guarantees of the borrower. The economic viability of the projects, borrowers credit worthiness, and borrowers and contractors experience are primary considerations in the loan underwriting decision. The Bank utilizes approved
independent licensed appraisers and monitors projects during the construction phase through construction inspections and a disbursement program tied to the percentage of completion of each project. The Bank also occasionally makes unimproved
property loans to borrowers who intend to construct a single-family-residence on their lots generally within twelve months. In addition, the Bank also makes commercial real estate construction loans to high net worth clients with adequate liquidity
for construction of office and warehouse properties. Such loans are typically secured by first deeds of trust and are guaranteed by the borrower.
Home Equity Lines of Credit.
The Bank offers variable rate home equity lines of credit that are secured by the borrowers home. The pricing on
our variable-rate home equity line of credit is generally at a rate tied to the prime rate, as quoted in
The Wall Street Journal
, or the Banks reference rate. Borrower may use this line of credit for home improvement financing, debt
consolidation and other personal uses.
Installment
Loans
. Installment loans tend to be fixed rate and longer-term (one-to-six year maturities). These loans are funded primarily for the purpose of financing the purchase of automobiles and other personal uses of the borrower.
Distribution and Maturity of Loans.
Information concerning loan type
and mix, distribution of loans and maturity of loans is included in this Annual Report on Form 10-K at Part II Item 7 Managements Discussion and Analysis of Financial Condition and Results of Operations, and in
Note 6 to the Consolidated Financial Statements.
Asset
Quality
The Banks lending and credit policies
require management to review regularly the Banks loan portfolio so that the Bank can monitor the quality of its assets. If during the ordinary course of business, management becomes aware that a borrower may not be able to meet the contractual
or payment obligations under a loan, then that loan is supervised more closely with consideration given to placing the loan on non-accrual status, the need for an additional allowance for loan losses, and (if appropriate) partial or full charge-off.
Under the Banks current policy, a loan will be placed on
a non-accrual status if interest or principal is past due 90 days or more, or in cases where management deems the full collection of principal and interest unlikely. When a loan is placed on non-accrual status, any current year unpaid accrued
interest is reversed against current income and any unpaid accrued interest from the prior year is reversed against the allowance for loan losses. Thereafter, any payment is generally first applied towards the principal balance. Depending on the
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circumstances, management may elect to continue the accrual of interest on certain past due loans if partial payment is received and/or the loan is well
collateralized, and in the process of collection. The loan is generally returned to accrual status when the borrower has brought the past due principal and interest payments current and, in the opinion of management, the borrower has demonstrated
the ability to make future payments of principal and interest as scheduled. A non-accrual loan may also be returned to accrual status if all principal and interest contractually due are reasonably assured of repayment within a reasonable period and
there has been a sustained period of payment performance. Information concerning non-accrual, past due, and restructured loans is included in this Annual Report on Form 10-K at Part II Item 7 Managements Discussion and
Analysis of Financial Condition and Results of Operations, and in Note 6 to the Consolidated Financial Statements.
Non-Performing Loans and Allowance for Credit Losses.
Information concerning non-performing loans, allowance for credit losses, loans charged-off,
loan recoveries, and other real estate owned is included in this Annual Report on Form 10-K at Part II Item 7 Managements Discussion and Analysis of Financial Condition and Results of Operations, and in Note 6
and Note 7 to the Consolidated Financial Statements.
Deposits
The Bank offers a variety of
deposit products in order to meet its customers needs. As of December 31, 2007, the Bank offered passbook accounts, checking accounts, money market deposit accounts, certificates of deposit, individual retirement accounts, college
certificates of deposit, and public funds deposits. These products are priced in order to promote growth of deposits.
The Banks deposits are generally obtained from residents within the Companys geographic market area. The Bank utilizes traditional marketing
methods to attract new customers and deposits, by offering a wide variety of products and services and utilizing various forms of advertising media. From time to time, the Bank may offer special deposit promotions. Information concerning types of
deposit accounts, average deposits and rates, and maturity of time deposits of $100,000 or more is included in this Annual Report on Form 10-K at Part II Item 7 Managements Discussion and Analysis of
Financial Condition and Results of Operations, and in Note 10 to the Consolidated Financial Statements.
Borrowings
Borrowings from time to time include securities sold under agreements to repurchase, the purchase of federal funds, funds obtained as advances from the
FHLB, borrowing from other financial institutions, subordinated debt, and Junior Subordinated Notes. Information concerning the types, amounts, and maturity of our borrowings is included in Note 11 and Note 12 to the Consolidated Financial
Statements.
Return on Equity and Assets
Information concerning the return on average assets,
return on average stockholders equity, the average equity to assets ratio and the dividend payout ratio is included in Part II Item 7 Managements Discussion and Analysis of Financial Condition and
Results of Operations.
Interest Rates and
Differentials
Information concerning the
interest-earning asset mix, average interest-earning assets, average interest-bearing liabilities, and the yields on interest-earning assets and interest-bearing liabilities is included in Part II Item 7
Managements Discussion and Analysis of Financial Condition and Results of Operations.
Analysis of Changes in Net Interest Income
An analysis of changes in net interest income due to changes in rate and volume is included in Part II Item 7
Managements Discussion and Analysis of Financial Condition and Results of Operations.
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Commitments and Letters of Credit
Information concerning the Banks outstanding loan commitments and
letters of credit is included in Note 15 to the Consolidated Financial Statements.
Expansion
We
continue to look for opportunities to expand the Banks branch network by seeking new branch locations and by acquiring other financial institutions to diversify our customer base in order to compete for new deposits and loans, and to be able
to serve our customers more effectively. We acquired Great Eastern Bank and New Asia Bancorp in 2006 and United Heritage Bank in 2007.
In 2007, we opened three new branches: one in Southern California, one in Texas, and one in Washington. We also converted our Hong Kong representative
office into a full service branch in May 2007.
Subsidiaries of Cathay Bank
Cathay
Real Estate Investment Trust (CB REIT) is a real estate investment trust subsidiary of the Bank that was formed in February 2003 to provide the Bank with flexibility in raising capital. During 2003, the Bank contributed $1.13 billion in
loans and securities to CB REIT in exchange for 100% of the common stock of CB REIT. CB REIT sold $4.4 million in 2003 and $4.2 million in 2004 of its 7.0% Series A Non-Cumulative preferred stock to accredited investors. During 2005, CB REIT
repurchased $131,000 of its preferred stock. At December 31, 2007, total assets of CB REIT were consolidated with the Company and totaled approximately $1.52 billion. See discussion below in Part I Item 1A Risk
Factors of this Annual Report on Form 10-K.
GBC Real
Estate Investments, Inc. is a wholly-owned subsidiary of the Bank. The purpose of this subsidiary is to engage in real estate investment activities. To date, there have been no transactions involving this subsidiary.
Cathay Trade Services, Asia Limited (Trade Services), is a
wholly-owned subsidiary of the Bank. Trade Services is a Hong Kong based non-financial institution that serves as a vehicle to reissue, in Hong Kong, letters of credit for the account of its U.S. based import customers in favor of beneficiaries.
GB Capital Trust II (GB REIT) was incorporated in
January 2002 to provide General Bank with flexibility in raising capital. As a result of our merger with GBC Bancorp in 2003, the Bank owns 100% of the voting common trust units issued by the GB REIT. At December 31, 2007, total assets of GB
REIT were consolidated with the Company and were approximately $917 million.
Cathay Community Development Corporation (CCDC) is a wholly-owned subsidiary of the Bank and was incorporated on September 14, 2006. The primary mission of CCDC is to help in the development of
low-income neighborhoods in the Bank's California and New York service areas by providing or facilitating the availability of capital to businesses and real estate developers working to renovate these neighborhoods. On October 6, 2006, CCDC
formed a wholly-owned subsidiary, Cathay New Asia Community Development Corporation (CNACDC), for the purpose of assuming New Asia Banks pre-existing New Markets Tax Credit activities in the greater Chicago area by providing or
facilitating the availability of capital to businesses and real estate developers working to renovate these neighborhoods. Both CCDC and CNACDC will seek to obtain community development entity status and CNACDC will also seek to participate in the
U.S. Treasury Department's New Markets Tax Credit program.
Cathay Holdings LLC (CHLLC) incorporated in December, 2007, is a wholly-owned subsidiary of the Bank. The purpose of this subsidiary is to hold other real estate owned in the state of Texas that was transferred from the Bank. As
of December 31, 2007, CHLLC owned two properties in Texas for a total of $15.8 million.
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In 2007, the Bank dissolved Cathay Investment Company and GBC Investment & Consulting Company,
Inc. As a result of the establishment of a representative office by the Bank in Taipei in 2005, it was no longer necessary for the Bank to continue maintaining the two subsidiaries.
Competition
The banking business in California and the other markets served by the Bank is highly competitive. The Bank competes for deposits and loans with other
commercial banks, savings and loan associations, brokerage houses, insurance companies, mortgage companies, credit unions, credit card companies, and other financial and non-financial institutions and entities. The Bank also competes with other
banks of similar size that are focused on servicing the same communities that are served by the Bank. In addition, the Bank competes with other entities (both governmental and private industry) that are seeking to raise capital through the issuance
and sale of debt and equity securities. Many of these competitors have substantially greater financial, marketing, and administrative resources than the Bank and may also offer services that are not offered directly by the Bank, all of which results
in greater and more intense competition for the Bank.
In
addition, current federal legislation encourages increased competition between different types of financial institutions and has encouraged new entrants to enter the financial services market. Competitive conditions are expected to continue to
intensify as legislation is enacted which will have the effect of, among other things, (i) eliminating historical barriers that limited participation by certain institutions in certain markets, (ii) increasing the cost of doing business
for banks, and/or (iii) affecting the competitive balance between banks and other financial and non-financial institutions and entities. Technological factors, such as on-line banking and brokerage services, and economic factors are also
expected to increase competitive conditions.
To compete with
other financial institutions in its primary service areas, the Bank relies principally upon local promotional activities, personal contacts by its officers, directors, employees, and stockholders, extended hours on weekdays, Saturday banking, Sunday
banking in certain locations, Internet banking, an Internet website (
www.cathaybank.com
), and certain other specialized services. The content of our website is not incorporated into and is not part of this Annual Report on Form 10-K.
If a proposed loan exceeds the Banks internal lending
limits, the Bank has, in the past, and may in the future, arrange the loans on a participation basis with correspondent banks. The Bank also assists customers requiring other services not offered by the Bank to obtain these services from its
correspondent banks.
In California, at least two
Chinese-American banks of comparable size compete for loans and deposits with the Bank and at least two super-regional banks compete with the Bank for deposits. In addition, there are many other Chinese-American banks in both Southern and Northern
California. Banks from the Pacific Rim countries, such as Taiwan, Hong Kong, and China also continue to open branches in the Los Angeles area, thus increasing competition in the Banks primary markets. See discussion below in Part I
Item 1A Risk Factors of this Annual Report on Form 10-K.
Employees
As of
December 31, 2007, the Company and its subsidiaries employed approximately 1,156 persons, including 363 banking officers. None of the employees are represented by a union. We believe that our relations with our employees are good.
Available Information
We invite you to visit us at our website at
www.cathaybank.com
, to
access free of charge Bancorp's Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports, all of which are made available as soon as reasonably practicable after we electronically file
such
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material with or furnish it to the Securities and Exchange Commission (the SEC). In addition, you can write to us to obtain a free copy of any of
those reports at Cathay General Bancorp, 777 North Broadway, Los Angeles, California 90012, Attn: Investor Relations. These reports are also available through the SECs Public Reference Room, located at 100 F Street NE, Washington, DC 20549 and
online at the SECs website, located at
www.sec.gov
. Investors can obtain information about the operation of the SECs Public Reference Room by calling 800-SEC-0300.
Regulation and Supervision
General
The Bancorp and the Bank are subject to significant regulation and restrictions by federal and state regulatory agencies. The following discussion of
statutes and regulations is a summary and does not purport to be complete. This discussion is qualified in its entirety by reference to the statutes and regulations referred to in this discussion. No assurance can be given that these statutes and
regulations will not change in the future.
Bank Holding
Company Regulation
The Bancorp is a bank holding
company within the meaning of the Bank Holding Company Act (BHCA) and is registered as such with the Federal Reserve Board. A bank holding company is required to file with the Federal Reserve Board annual reports and other information
regarding its business operations and those of its nonbanking subsidiaries. It is also subject to supervision and examination by the Federal Reserve Board. Examinations are designed to inform the Federal Reserve Board of the financial condition and
nature of the operations of the bank holding company and its subsidiaries and to monitor compliance with the BHCA and other laws affecting the operations of bank holding companies. To determine whether potential weaknesses in the condition or
operations of bank holding companies might pose a risk to the safety and soundness of their subsidiary banks, examinations focus on whether a bank holding company has adequate systems and internal controls in place to manage the risks inherent in
its business, including credit risk, interest rate risk, market risk (for example, from changes in value of portfolio instruments and foreign currency), liquidity risk, operational risk, legal risk, and reputation risk.
Bank holding companies may be subject to potential enforcement actions by the
Federal Reserve Board for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation or any condition imposed in writing by the Federal Reserve Board or any written agreement with the Federal Reserve
Board. Enforcement actions may include the issuance of cease and desist orders, the imposition of civil money penalties, the issuance of directives to increase capital, formal and informal agreements, or removal and prohibition orders against
institution-affiliated parties.
Bank holding
companies are subject to capital maintenance requirements on a consolidated basis that are parallel to those required for banks. See
Capital Adequacy Requirements
below. Further, a bank holding company is required to serve as a
source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe or unsound manner. In addition, it is the Federal Reserve Boards view that, in serving as a source of strength to its
subsidiary banks, a bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and should maintain financial flexibility and
capital-raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding companys failure to meet its source-of-strength obligations may constitute an unsafe and unsound practice or a violation of the Federal
Reserve Boards regulations, or both.
The
source-of-strength doctrine most directly affects bank holding companies where a bank holding companys subsidiary bank fails to maintain adequate capital levels. In such a situation, the subsidiary bank will be required by the banks
federal regulator to take prompt corrective action. The prompt corrective action regulatory framework is discussed below. See
Prompt Corrective Action Provisions
below. Under the prompt
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corrective action program, the subsidiary bank will be required to submit to its federal regulator a capital restoration plan and to comply with the plan.
Each parent company that controls the subsidiary bank will be required to provide assurances of compliance by the bank with the capital restoration plan. However, the aggregate liability of such parent companies will not exceed the lesser of
(i) 5% of the banks total assets at the time it became undercapitalized and (ii) the amount necessary to bring the bank into compliance with the plan. Failure to restore capital under a capital restoration plan can result in the
banks being placed into receivership if it becomes critically undercapitalized. A bank subject to prompt corrective action also may affect its parent bank holding company in other ways. These include possible restrictions or prohibitions on
dividends to the parent bank holding company by the bank; subordinated debt payments to the parent; and other transactions between the bank and the holding company. In addition, the regulators may impose restrictions on the ability of the holding
company itself to make distributions; require divestiture of holding company affiliates that pose a significant risk to the bank; and require divestiture of the undercapitalized subsidiary bank.
A bank holding company is generally required to give the Federal Reserve
Board prior notice of any redemption or repurchase of its own equity securities, if the consideration to be paid, together with the consideration paid for any repurchases in the preceding year, is equal to 10% or more of the companys
consolidated net worth.
A bank holding company is required to
obtain Federal Reserve Board approval before acquiring, directly or indirectly, ownership or control of any voting shares of any bank if it would thereby directly or indirectly own or control more than 5% of the voting stock of that bank, unless it
already owns a majority of the voting stock. Prior approval from the Federal Reserve is also required in connection with the acquisition of control of a bank or another bank holding company, or business combinations with another bank holding
company.
The business activities and investments of bank
holding companies are also regulated by the BHCA. Bank holding companies, as a general rule, are prohibited from acquiring direct or indirect control of more than 5% of the outstanding voting shares of any company that is not engaged in the business
of banking or managing or controlling banks or furnishing services to or performing services for its subsidiary banks. However, subject to prior approval or notification to the Federal Reserve Board, bank holding companies are permitted to engage in
activities that are so closely related to banking as to be deemed a proper incident thereto. As a general rule, such closely related activities do not include underwriting or dealing in securities or underwriting of insurance. More
expansive non-banking activities are permitted for bank holding companies that qualify as financial holding companies under the BHCA, but the Bancorp has not sought this status even though it qualifies to do so. See section below
entitled
Financial Modernization Act.
The
Bancorp is also a bank holding company within the meaning of Section 3700 of the California Financial Code. Therefore, the Bancorp and any of its subsidiaries are subject to examination by, and may be required to file reports with, the
California Department of Financial Institutions.
Financial Modernization Act
The
Gramm-Leach-Bliley Financial Modernization Act became effective March 11, 2000 (the Financial Modernization Act). It repealed two provisions of the Glass-Steagall Act: Section 20, which restricted the affiliation of Federal
Reserve member banks with firms engaged principally in specified securities activities; and Section 32, which restricted officer, director, or employee interlocks between a member bank and any company or person primarily
engaged in specified securities activities. In addition, it also contained provisions that expressly preempt any state law restricting the establishment of financial affiliations, primarily related to insurance. The general effect of the law
is to establish a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms, and other financial service providers by revising and expanding the BHCA framework to permit a holding company system to
engage in a full range of financial activities through a bank holding company that qualifies as a financial holding company. Financial activities
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are broadly defined to include not only banking, insurance, and securities activities, but also merchant banking and additional activities that the Federal
Reserve Board, in consultation with the Secretary of the Treasury, determines to be financial in nature, incidental to such financial activities, or complementary activities that do not pose a substantial risk to the safety and soundness of
depository institutions or the financial system generally.
In
order for the Bancorp to engage in expanded financial activities permissible under the Financial Modernization Act, it must elect to qualify as a financial holding company. The Bancorp currently meets the requirements to make this
election, but its management has thus far decided not to do so, as the Bancorp has no present intention to engage in the expanded range of financial activities permitted to financial holding companies.
Bank Regulation
Federal law mandates frequent examinations of all banks, with the costs of
examinations to be assessed against the bank being examined. The Banks primary federal regulator is the FDIC. The FDIC has substantial enforcement powers over the banks that it regulates. Civil and criminal penalties may be imposed on such
institutions and persons associated with those institutions for violations of laws or regulations.
As a California commercial bank whose deposits are insured by the FDIC, the Bank is subject to regulation, supervision, and regular examination by the
California Department of Financial Institutions and the FDIC, and must comply with applicable regulations of the Federal Reserve Board. The regulations of these agencies govern most aspects of the Banks business, including the making of
periodic reports, its activities relating to dividends, investments, loans, borrowings, capital requirements, certain check-clearing activities, branching, mergers and acquisitions and numerous other areas. Supervision, legal action, and examination
by these agencies is generally intended to protect depositors, creditors, borrowers and the deposit insurance fund and generally is not intended for the protection of stockholders. The activities of the Bank are also regulated by state law.
California law authorizes the Bank to engage in the
commercial banking business, which generally encompasses lending, deposit-taking, and all other kinds of banking business in which banks, including national banks, customarily engage in the United States. In addition, California banks
are authorized by state law to invest in subsidiaries that engage in real estate development and conduct certain real estate related activities (including property management and real estate appraisal) and in management consulting and data
processing services for third parties. Such operating subsidiaries are not permitted by California law to engage in insurance activities. However, federal law prohibits the Bank and its subsidiaries from engaging in any banking activities in which a
national bank (acting as principal rather than agent) cannot engage, unless the activity is found by the FDIC not to pose a significant risk to the deposit insurance fund. This prohibition does not extend to those activities in which the Bank (or a
subsidiary of the Bank) is authorized under state law to engage as agent, advisor, custodian, administrator, or trustee for its customer. The FDIC has found real estate development not to pose a significant risk to the deposit insurance fund if
conducted within specified parameters.
In addition, under the
Financial Modernization Act, the Bank can engage in expanded financial activities through specially qualified financial subsidiaries to the same extent as a national bank. In order to form a financial subsidiary, the Bank must be
well-capitalized and would be subject to the same capital deduction, risk management and affiliate transaction rules as apply to national banks. Generally, a financial subsidiary is permitted to engage in activities that are financial in
nature or incidental thereto, even though they are not permissible for the national bank to conduct directly within the bank. The definition of financial in nature includes, among other items, underwriting, dealing in or making a
market in securities, including, for example, distributing shares of mutual funds. The subsidiary may not, however, engage as principal in underwriting insurance (other than credit life insurance), issue annuities, or engage in real estate
development or investment or merchant banking. Presently, none of the Banks subsidiaries are financial subsidiaries.
The Bank operates branches and/or loan production offices in California, New York, Illinois, Massachusetts, Texas, Washington, New Jersey and Hong Kong.
While the California Department of Financial Institutions
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remains the Banks primary state regulator, the Banks operations in these jurisdictions are subject to examination and supervision by local bank
regulators, and transactions with customers in those jurisdictions are subject to local laws, including consumer protection laws.
The Bank also operates a representative office in Taipei and in Shanghai. The operations of these offices (and limits on the scope of their activities)
and the Hong Kong branch are subject to local law in those jurisdictions in addition to regulation and supervision by the California Department of Financial Institutions and the FDIC.
Deposit Insurance
The FDIC is an independent federal agency that insures deposits, up to prescribed statutory limits, of federally insured banks and savings institutions
and safeguards the safety and soundness of the banking and savings industries. Previously, the FDIC administered two separate insurance funds, the Bank Insurance Fund (BIF), which generally insured commercial bank and state savings bank
deposits, and the Savings Association Insurance Fund (SAIF), which generally insured savings association deposits. Under the Federal Deposit Insurance Reform Act of 2005 (the FDI Reform Act), which was signed into law in
February 2006:
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the BIF and the SAIF were merged into a new combined fund, called the Deposit Insurance Fund (DIF), effective March 31, 2006;
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the current $100,000 deposit insurance coverage cap was indexed for inflation (with adjustments every five years commencing January 1, 2011);
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deposit insurance coverage for retirement accounts was increased to $250,000 per participant subject to adjustment for inflation; and
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a cap was imposed on the level of the DIF, providing for the payment of dividends when the DIF grows beyond a specified threshold.
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The FDIC has also been given greater latitude over management of the DIFs reserve ratio
to help dampen sharp fluctuations in assessment rates. Pursuant to enabling regulations enacted in November of 2006, the FDIC set the designated reserve ratio for 2006 at 1.25% of estimated insured deposits and has maintained the designated reserve
ratio for 2007 at 1.25%.
The FDI Reform Act has revised the
prior risk-based system for assessing premiums, with the intention of more closely linking premiums to the risk posed by institutions to the DIF. The FDIC will evaluate risk to the DIF based on three primary factors: supervisory ratings for all
institutions; financial ratios for most institutions; and long-term debt issuer ratings for large institutions that have such ratings. As a result of these rules, the assessment rates that took effect at the beginning of 2007 for nearly all of the
industry were varied between five and seven cents for every $100 of domestic deposits.
Banks in existence on December 31, 1996, that paid assessments prior to that date (or their successors) were entitled to a one-time credit against future assessments based on their past contributions to the BIF.
As a result, most banks had assessment credits that would initially offset all of their deposit premiums for 2007. In 2007, the Bank received a refund of $4.0 million for premiums paid prior to 1996 that was offset to its deposit insurance premium
for 2007.
Banks must pay a fluctuating amount towards the
retirement of the Financing Corporation bonds (commonly referred to as FICO bonds) which had been issued in the 1980s to assist in the recovery of the savings and loan industry. The current FICO assessment rate as of January 1, 2008, for
institutions insured by the DIF is $0.0114 per $100 of assessable deposit. As of January 1, 2007 the FICO assessment rate for institutions insured by the DIF was $0.0122 per $100 of assessable deposits. The FICO assessments are adjusted
quarterly and do not vary depending on an institutions capitalization or supervisory evaluations. These assessments will continue until the Financing Corporation bonds mature in 2017.
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Capital Adequacy Requirements
The Bank (as well as the Bancorp) is subject to capital adequacy
regulations. Those regulations incorporate both risk-based and leverage capital requirements. These capital adequacy regulations define capital in terms of core capital elements, or Tier 1 capital, and supplemental capital
elements, or Tier 2 capital. Tier 1 capital is generally defined as the sum of the core capital elements less goodwill and certain other deductions, notably the unrealized net gains or losses (after tax adjustments) on available for sale
investment securities carried at fair value. The following items are included as core capital elements: (i) common shareholders equity; (ii) qualifying non-cumulative perpetual preferred stock and related surplus, including trust
preferred securities (but not in excess of 25% of Tier 1 capital); and (iii) minority interests in the equity accounts of consolidated subsidiaries. Supplementary capital elements include: (i) allowance for loan and lease losses (but not
more than 1.25% of an institutions risk-weighted assets); (ii) perpetual preferred stock and related surplus not qualifying as core capital; (iii) hybrid capital instruments, perpetual debt and mandatory convertible debt instruments;
and (iv) term subordinated debt and intermediate-term preferred stock and related surplus. The maximum amount of supplemental capital elements which qualifies as Tier 2 capital is limited to 100% of Tier 1 capital.
The minimum required ratio of qualifying total capital to total risk-weighted
assets, or the total risk-based capital ratio, is 8.0%, at least one-half of which must be in the form of Tier 1 capital, and the minimum required ratio of Tier 1 capital to total risk-weighted assets, or the Tier 1 risk-based capital ratio, is
4.0%. Risk-based capital ratios are calculated to provide a measure of capital that reflects the degree of risk associated with a banking organizations operations for both transactions reported on the balance sheet as assets, and transactions,
such as letters of credit and recourse arrangements, which are recorded as off-balance sheet items. Under the risk-based capital guidelines, the nominal dollar amounts of assets and credit-equivalent amounts of off-balance sheet items are multiplied
by one of several risk adjustment percentages, which range from 0% for assets with low credit risk, such as certain U.S. Treasury securities, to 100% for assets with relatively high credit risk, such as business loans. As of December 31, 2007,
the Banks total risk-based capital ratio was 10.49% and its Tier 1 risk-based capital ratio was 9.04%. As of December 31, 2007, the Bancorps Total Risk-Based Capital ratio was 10.52% and its Tier 1 risk-based capital ratio was 9.09%
The risk-based capital requirements also take into account
concentrations of credit (
i.e.
, relatively large proportions of loans involving one borrower, industry, location, collateral or loan type) and the risks of non-traditional activities (those that have not customarily been part of
the banking business). The regulations require institutions with high or inordinate levels of risk to operate with higher minimum capital standards and authorize the regulators to review an institutions management of such risks in assessing an
institutions capital adequacy.
The risk-based capital
regulations also include exposure to interest rate risk as a factor that the regulators will consider in evaluating a banks capital adequacy. Interest rate risk is the exposure of a banks current and future earnings and equity capital
arising from adverse movements in interest rates. While interest risk is inherent in a banks role as financial intermediary, it introduces volatility to bank earnings and to the economic value of the institution.
Since 1997, the federal banking regulators have also required financial
institutions with significant exposure to market risk to maintain adequate capital to support that exposure. In September of 2006, the federal banking agencies proposed revisions to the market risk capital rules to enhance the rules
sensitivity to market risk and to require public disclosure of certain qualitative and quantitative market risk information. Financial institutions covered by this aspect of the capital rules are those with trading assets constituting 10% or more of
total assets, or $1 billion or more, or such other institutions as the appropriate federal bank regulatory agency deems appropriate to include. Neither the Bancorp nor the Bank is currently subject to the market risk capital rules.
The Bancorp and the Bank are also required to maintain a leverage capital
ratio designed to supplement the risk-based capital guidelines. Banks and bank holding companies that have received the highest rating of the five categories used by regulators to rate banks and that are not anticipating or experiencing any
significant growth
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must maintain a ratio of Tier 1 capital (net of all intangibles) to adjusted total assets of at least 3%. All other institutions are required to maintain a
leverage ratio of at least 100 to 200 basis points above the 3% minimum, for a minimum of 4% to 5%. Pursuant to federal regulations, banks must maintain capital levels commensurate with the level of risk to which they are exposed, including the
volume and severity of problem loans. Federal regulators may, however, set higher capital requirements when a banks particular circumstances warrant. As of December 31, 2007, the Banks leverage capital ratio was 7.79%, and the
Bancorps leverage capital ratio was 7.83%, both ratios exceeding regulatory minimums.
The federal regulatory authorities risk-based capital guidelines are based upon the 1988 capital accord of the Basel Committee on Banking Supervision (Basel I). In June 2004, the Basel Committee on
Banking Supervision published a new capital accord, referred to as Basel II, for adoption by those countries adhering to the overall Basel framework. Basel II emphasizes internal assessment of credit, market, and operational risk,
supervisory assessment and market discipline in determining minimum capital requirements.
In November 2007, the federal banking agencies adopted a final rule to implement Basel II in the United States that requires compliance for U.S. banks with over $250 billion in assets or total on-balance-sheet foreign
exposure of $10 billion or more (referred to as core banks). The final rule will be effective as of April 1, 2008. It adopts the most complex regime of risk-based capital referred to by the Basel Committee on Banking Supervision as
the advanced measurement approach. Other banks can elect to be governed by Basel II. The advanced measurement approach would not apply to the Bancorp or the Bank, and management does not contemplate electing to calculate its risk-based capital based
on the Basel II capital framework.
One of the tensions created
by the adoption of the advanced measurement approach for core-banks has been the prediction that this approach would lower capital requirements by banks adopting this approach. This has raised significant concern by other U.S. banks as they may be
at a competitive disadvantage under Basel I. To address these concerns and provide more flexibility to U.S. banks that have not adopted the advanced measurement approach, the agencies agreed to proceed promptly to issue a proposed rule that would
provide all non-core banks with the option to continue under Basel I standards or to adopt a standardized approach under Basel II. The standardized approach would provide non-core banks with an alternative that affords more
risk-sensitive capital requirements and simpler approaches for both credit risk and operational risk. The proposal is also expected to provide greater differentiation across corporate exposures based on borrowers underlying credit quality and
to recognize a broader spectrum of credit-risk mitigation techniques. The agencies intend that the proposed standardized option would be finalized before the core banks begin the first transition period year under Basel II. Neither the Bancorp nor
the Bank have made any decision as to whether they will attempt to adopt the standardized approach.
Prompt Corrective Action Provisions
Federal law requires each federal banking agency to take prompt corrective action when a bank falls below one or more prescribed minimum capital ratios.
The federal banking agencies have by regulation defined the following five capital categories: well capitalized (total risk-based capital ratio of 10%; Tier 1 risk-based capital ratio of 6%; and leverage capital ratio of 5%);
adequately capitalized (total risk-based capital ratio of 8%; Tier 1 risk-based capital ratio of 4%; and leverage capital ratio of 4%) (or 3% if the institution receives the highest rating from its primary regulator);
undercapitalized (total risk-based capital ratio of less than 8%; Tier 1 risk-based capital ratio of less than 4%; or leverage capital ratio of less than 4%) (or 3% if the institution receives the highest rating from its primary
regulator); significantly undercapitalized (total risk-based capital ratio of less than 6%; Tier 1 risk-based capital ratio of less than 3%; or leverage capital ratio less than 3%); and critically undercapitalized (tangible
equity to total assets less than 2%). A bank may be treated as though it were in the next lower capital category if after notice and the opportunity for a hearing, the appropriate federal agency finds an unsafe or unsound condition or practice so
warrants, but no bank may be treated as critically undercapitalized unless its actual capital ratio warrants such treatment. Undercapitalized banks are required to submit capital restoration plans and, during any period of capital
inadequacy, may not pay dividends or make
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other capital distributions, are subject to asset growth and expansion restrictions and may not be able to accept brokered deposits. At each successively
lower capital category, banks are subject to increased restrictions on operations.
Dividends
Holders of the Bancorps common stock are entitled to receive dividends as and when declared by the board of directors out of funds legally available therefor under the laws of the State of Delaware. Delaware corporations such as the
Bancorp may make distributions to their stockholders out of their surplus, or out of their net profits for the fiscal year in which the dividend is declared and for the preceding fiscal year. However, dividends may not be paid out of a
corporations net profits if, after the payment of the dividend, the corporations capital would be less than the capital represented by the issued and outstanding stock of all classes having a preference upon the distribution of assets.
The Federal Reserve Board has advised bank holding companies
that it believes that payment of cash dividends in excess of current earnings from operations is inappropriate and may be cause for supervisory action. As a result of this policy, banks and their holding companies may find it difficult to pay
dividends out of retained earnings from historical periods prior to the most recent fiscal year or to take advantage of earnings generated by extraordinary items such as sales of buildings or other large assets in order to generate profits to enable
payment of future dividends. Further, the Federal Reserve Boards position that holding companies are expected to provide a source of managerial and financial strength to their subsidiary banks potentially restricts a bank holding
companys ability to pay dividends.
The Bank is a legal
entity that is separate and distinct from its holding company. The Bancorp receives income through dividends paid by the Bank. Subject to the regulatory restrictions described below, future cash dividends by the Bank will depend upon
managements assessment of future capital requirements, contractual restrictions, and other factors.
The powers of the board of directors of the Bank to declare a cash dividend to its holding company is subject to California law, which restricts the
amount available for cash dividends to the lesser of a bank's retained earnings or net income for its last three fiscal years (less any distributions to shareholders made during such period). Where the above test is not met, cash dividends may still
be paid, with the prior approval of the California Department of Financial Institutions in an amount not exceeding the greatest of (1) retained earnings of the bank; (2) the net income of the bank for its last fiscal year; or (3) the
net income of the bank for its current fiscal year. The amount of retained earnings available for cash dividends to the Bancorp immediately after December 31, 2007, is restricted to approximately $203.7 million under this regulation.
Bank regulators also have authority to prohibit a bank from
engaging in business practices considered to be unsafe or unsound. It is possible, depending upon the financial condition of a bank and other factors, that such regulators could assert that the payment of dividends or other payments might, under
certain circumstances, be an unsafe or unsound practice, even if technically permissible.
Safety and Soundness Standards and Enforcement Actions
The federal banking agencies have adopted guidelines establishing safety and soundness standards for all insured depository institutions. Those guidelines
set forth managerial and operational standards relating to (i) internal controls and information systems, (ii) internal audit systems, (iii) loan documentation, (iv) credit underwriting, (v), interest rate exposure,
(vi) asset growth, (vii) asset quality, (viii) earnings and (ix) compensation and benefits. In general, the standards are designed to assist the federal banking agencies in identifying and addressing problems at insured
depository institutions before capital becomes impaired. If an institution fails to meet safety and soundness standards, the appropriate federal banking agency may require the institution to submit a compliance plan and institute enforcement
proceedings if an acceptable compliance plan is not submitted or the deficiency is not corrected.
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In addition to these measures and the prompt corrective action provisions, banks may be subject to
potential actions by federal regulators for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation or any condition imposed in writing by the agency or any written agreement with the agency.
Enforcement actions may include the issuance of cease and desist orders, termination of insurance of deposits, the imposition of civil money penalties, the issuance of directives to increase capital, formal and informal agreements, or removal and
prohibition orders against institution-affiliated parties.
Initiatives Prompted by Subprime Crisis
In response to the recent subprime mortgage crisis, federal and state regulatory agencies have focused attention on nontraditional mortgage products both with an aim toward enhancing prudential regulatory relief and providing
relief to adversely affected borrowers.
Guidance on
Nontraditional Mortgage Products
On
September 29, 2006, the federal banking agencies issued final guidance on residential mortgage products that allow borrowers to defer repayment of principal or interest, including interest only mortgage loans, and payment
option adjustable rate mortgages where a borrower has flexible payment options, including payments that have the potential for negative amortization. The guidance does not apply to home equity lines of credit. While acknowledging that
innovations in mortgage lending can benefit some consumers, the federal banking agencies in their joint press release stated their concern that these and other practices described in the guidance can present unique risks that institutions must
appropriately manage. The guidance states that management should (1) ensure that loan terms and underwriting standards are consistent with prudent lending practices, including consideration of a borrowers repayment capacity,
(2) recognize that many nontraditional mortgages are untested in a stressed environment and warrant strong risk management standards as well as appropriate capital and loan loss reserves, and (3) ensure that borrowers have sufficient
information to clearly understand loan terms and associated risks prior to making a product or payment choice. It is uncertain at this time what effect the final guidance may have on financial institutions originating such residential mortgage
products. As of December 31, 2007, the Bank retained 838 loans with a balance of $239.7 million under reduced documentation programs and one loan with a balance of $79,000 under a simultaneous second-lien loan program. No nontraditional
residential mortgages were sold by the Bank during 2007.
In
October 2007, California enacted legislation directing the California Department of Financial Institutions to apply this guidance to state-licensed financial institutions, such as the Bank.
Guidance on Subprime Mortgage Lending
On June 29, 2007, the federal banking agencies issued guidance on
subprime mortgage lending to address issues related to adjustable rate mortgage products marketed to subprime borrowers. Although the guidance focuses on subprime borrowers, the principles contained in the guidance are also relevant to adjustable
rate mortgages offered to non-subprime borrowers. Consistent with the Guidance on Nontraditional Mortgage Products (discussed above), this guidance continues to encourage financial institutions to evaluate a borrowers repayment capacity. In
addition, it emphasizes the need to evaluate a borrowers debt-to-income ratio. The guidance recommends that institutions refer to
Real Estate Guidelines
(12 CFR Part 208, subpart C)
,
which provide underwriting standards for all
real estate loans.
The guidance promotes consumer protection
principles relevant to the marketing of mortgage loans and states that financial institutions should provide consumers with information about costs, terms, features and risks of the loan to the borrower.
The federal banking agencies announced their intention to scrutinize more
closely underwriting, risk management and consumer compliance processes, policies and procedures of its supervised financial institutions
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and their intention to take action against institutions that engage in predatory lending practices, violate consumer protection laws or fair lending laws,
engage in unfair or deceptive acts or practices or otherwise engage in unsafe or unsound lending practices.
Guidance on Loss Mitigation Strategies for Servicers of Residential Mortgages
On September 5, 2007, the federal banking agencies issued a statement encouraging regulated institutions and
state-supervised entities that service residential mortgages to pursue strategies to mitigate losses while preserving homeownership to the extent possible and appropriate. The guidance recognizes that many mortgage loans, including subprime loans,
have been transferred into securitization trusts and servicing for such loans is governed by contract documents. The guidance advises servicers to review governing documentation to determine the full extent of their authority to restructure loans
that are delinquent or are in default or are in imminent risk of default.
The guidance encourages that servicers take proactive steps to preserve homeownership in situations where there are heightened risks to homeowners losing their homes to foreclosures. Such steps may include loan
modification; deferral of payments; extensions of loan maturities, conversion of adjustable rate mortgages into fixed-rate or fully indexed, fully amortizing adjustable rate mortgages; capitalization of delinquent amounts; or any combination of
these actions.
Consumer Relief Initiative for Borrowers
In October 2007, Treasury Secretary Paulson announced
the Homeowner Assistance Initiative to encourage mortgage servicers, mortgage counselors, government officials and non-profit groups to coordinate their efforts to help struggling borrowers restructure their mortgage payments and stay in their
homes. The initiative, called HOPE NOW, is aimed at coordinating and improving outreach to borrowers, developing best practices for mortgage counselors across the country and ensuring that groups able to help homeowners work out new loan
arrangements with lenders have adequate resources to carry out this mission.
Economic Stimulus for Home Buyers and Home Owners
Congress has recently enacted an economic stimulus plan that President Bush signed into law on February 13, 2008. While the main thrust of the plan
is to stimulate the economy with a significant infusion of cash to consumers, the plan also addresses the current lack of illiquidity in the mortgage market. The plan would temporarily increase the maximum size of mortgage loans (the conforming loan
limit) that Fannie Mae and Freddie May purchase from the current $417,000 cap to a maximum of $729,750. The plan would also permanently raise the cap on the Federal Housing Administration's conforming loan limit from $362,000 to $729,750. These
changes are intended, among other purposes, to provide more liquidity for originators of such larger mortgage loans, to make lower interest rates available to homebuyers for such loans and to enable homeowners to refinance such loans at lower
interest rates.
Pending Legislation and Regulatory
Proposals
As a result of the subprime mortgage
crisis, federal and state legislative agencies are considering a broad variety of legislative and regulatory proposals covering mortgage loan products, loan terms and underwriting standards, risk management practices and consumer protection. It is
unclear which, if any, of these initiatives will be adopted, what effect they will have on the Bancorp or the Bank and whether any of these initiatives will change the competitive landscape in the mortgage industry.
Guidance on Real Estate Concentrations
On December 6, 2006, the federal banking agencies issued a guidance on
sound risk management practices for concentrations in commercial real estate lending. The particular focus is on exposure to commercial real
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estate loans that are dependent on the cash flow from the real estate held as collateral and that are likely to be sensitive to conditions in the commercial
real estate market (as opposed to real estate collateral held as a secondary source of repayment or as an abundance of caution). The purpose of the guidance is not to limit a banks commercial real estate lending but to guide banks in
developing risk management practices and capital levels commensurate with the level and nature of real estate concentrations. The FDIC and other bank regulatory agencies will be focusing their supervisory resources on institutions that may have
significant commercial real estate loan concentration risk. A bank that has experienced rapid growth in commercial real estate lending, has notable exposure to a specific type of commercial real estate loan, or is approaching or exceeding the
following supervisory criteria may be identified for further supervisory analysis with respect to real estate concentration risk:
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Total reported loans for construction, land development and other land represent 100% or more of the banks capital; or
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Total commercial real estate loans (as defined in the Guidance) represent 300% or more of the banks total capital and the outstanding balance of the
banks commercial real estate loan portfolio has increased 50% or more during the prior 36 months.
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The strength of an institutions lending and risk management practices with respect to such concentrations will be taken into account in supervisory
evaluation of capital adequacy. The Banks total commercial real estate loans to total capital as defined in the Guidance were 514% at December 31, 2006 and 534% at December 31, 2007. It is uncertain at this time what effect this
guidance may have on the Bank.
FFIEC Guidance on
Pandemic Planning
The Federal Financial Institutions
Examination Council (FFIEC) issued guidance on December 12, 2007, for use by financial institutions in identifying the continuity planning that should be in place to minimize the potential adverse effects of a pandemic. This
guidance expanded upon the contents of an Interagency Advisory on Influenza Pandemic Preparedness issued in March 2006. The guidance asserts that pandemic planning presents unique challenges to financial institutions. It further explains that unlike
most natural or technical disasters and malicious acts, the impact of a pandemic is much more difficult to determine because of the anticipated difference in scale and duration, and as a result of these differences, no individual or organization is
safe from the potential adverse effects of a pandemic event. The guidance cites experts who believe the most significant challenge may be the severe staffing shortages that will likely result from a pandemic outbreak.
The guidance states that the FFIEC agencies believe the potentially
significant effects a pandemic could have on an institution justify establishing plans to address how each institution will manage a pandemic event.
Accordingly, the guidance recommends that an institutions business continuity plan should include:
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A preventive program to reduce the likelihood an institutions operations will be significantly affected by a pandemic event;
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A documented strategy that provides for scaling pandemic efforts commensurate with the particular stages of a pandemic outbreak;
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A comprehensive framework of facilities, systems, or procedures to continue critical operations if large numbers of staff members are unavailable for prolonged periods;
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A testing program to ensure the institutions pandemic planning practices and capabilities are effective and will allow critical operations to continue; and
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An oversight program to ensure ongoing review and updates to the pandemic plan.
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The Bancorp and the Bank currently have business continuity plans, but neither the Bancorp nor the Bank has yet made a decision about how to
incorporate pandemic planning into their business continuity plans.
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Transactions with Affiliates
Federal banking law imposes restrictions on extensions of credit by the Bank to the Bancorp or its nonbanking affiliates,
the purchase by the Bank of assets of, or securities issued by, the Bancorp or its nonbanking affiliates, and the taking by the Bank of securities issued by the Bancorp as collateral for loans made by the Bank. Such restrictions prevent the Bancorp
and its nonbanking affiliates from borrowing from the Bank unless the loans are secured by marketable obligations of designated amounts. Further, these secured loans and investments by the Bank to or in the Bancorp, or to or in any nonbanking
affiliate, are limited, individually, to 10% of the Banks capital and surplus, and these secured loans and investments are limited, in the aggregate, to 20% of the Banks capital and surplus. California law also imposes certain
restrictions with respect to transactions involving persons or entities controlling the Bank, such as the Bancorp, and requires that such transactions be approved in advance by the California Department of Financial Institutions. Additional
restrictions on transactions with affiliates may be imposed on the Bank under the prompt corrective action provisions of federal law discussed above. See Prompt Corrective Action Provisions below.
Loans-to-One-Borrower
With certain limited exceptions, the maximum amount that a California bank
may lend to any borrower at any one time (including the obligations to the bank of certain related entities of the borrower) may not exceed 25% (and unsecured loans may not exceed 15%) of the banks shareholder equity, allowance for loan
losses, and any capital notes and debentures of the bank.
Extension of Credit to Insiders
Federal law place limitations and conditions on loans or extensions of credit to:
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a banks or bank holding companys executive officers, directors, and principal shareholders (
i.e.
, in most cases, those persons who own, control
or have power to vote more than 10% of any class of voting securities);
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any company controlled by any such executive officer, director, or shareholder; or
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any political or campaign committee controlled by such executive officer, director, or principal shareholder.
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Loans and leases extended to any of the above persons must comply with
Californias loan-to-one-borrower limits (described above), require prior full board approval when aggregate extensions of credit to the person exceed specified amounts, must be made on substantially the same terms (including interest rates and
collateral) as, and follow credit-underwriting procedures that are not less stringent than those prevailing at the time for comparable transactions with non-insiders, and must not involve more than the normal risk of repayment, or present other
unfavorable features. A bank is also prohibited from paying an overdraft on an account of an executive officer or director, except pursuant to a written pre-authorized interest-bearing extension of credit plan that specifies a method of repayment or
a written pre-authorized transfer of funds from another account of the executive officer or director at the Bank. In addition, the aggregate limit on extensions of credit to all insiders of a California bank as a group cannot exceed the banks
unimpaired capital and unimpaired surplus.
Community
Reinvestment Act
The Bank is subject to certain
requirements and reporting obligations involving the Community Reinvestment Act (CRA). The CRA generally requires the federal banking agencies to evaluate the record of a financial institution in meeting the credit needs of its local
communities, including low-and moderate-income neighborhoods. The CRA further requires the agencies to take into account a financial institutions record of meeting its community credit needs when evaluating applications for, among other
things, domestic branches, consummating mergers or acquisitions, or holding company formations. In measuring a banks compliance with
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its CRA obligations, the regulators utilize a performance-based evaluation system which bases CRA ratings on the banks actual lending, service, and
investment performance, rather than on the extent to which the institution conducts needs assessments, documents community outreach activities, or complies with other procedural requirements. In connection with its assessment of CRA performance, the
FDIC assigns a rating of outstanding, satisfactory, needs to improve or substantial noncompliance. In its most recently released public reports, from April 2007, the Bank received a
satisfactory rating.
Other Consumer
Protection Laws and Regulations
Examination and
enforcement have become intense, and banks have been advised to monitor carefully compliance with various consumer protection laws and their implementing regulations. The federal Interagency Task Force on Fair Lending issued a policy statement on
discrimination in home mortgage lending describing three methods that federal agencies will use to prove discrimination: overt evidence of discrimination, evidence of disparate treatment, and evidence of disparate impact. Due to heightened
regulatory concern related to compliance with consumer protection laws and regulations generally, the Bank may incur additional compliance costs or be required to expend additional funds for investments in the local communities it serves.
In addition to the other laws and regulations discussed
herein, the Bank is subject to certain consumer and public interest laws and regulations that are designed to protect customers in transactions with banks. While the list set forth below is not exhaustive, these laws and regulations include the
Truth in Lending Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Real Estate Settlement Procedures Act, the Home Mortgage Disclosure
Act, the Fair Credit Reporting Act, the Fair Debt Collection Practices Act, and the Right to Financial Privacy Act. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal
with customers when taking deposits, making loans, collecting loans, and providing other services. Failure to comply with these laws and regulations can subject the Bank to various penalties, including but not limited to enforcement actions,
injunctions, fines or criminal penalties, punitive damages to consumers, and the loss of certain contractual rights.
The Americans with Disabilities Act, in conjunction with similar California legislation, has increased the cost of doing business for banks. The
legislation requires employers with 15 or more employees and all businesses operating commercial facilities or public accommodations to accommodate disabled employees and customers. The Americans with Disabilities Act has two
major objectives: (i) to prevent discrimination against disabled job applicants, job candidates and employees, and (ii) to provide disabled persons with ready access to commercial facilities and public accommodations. Commercial
facilities, such as the Bank, must ensure that all new facilities are accessible to disabled persons, and in some instances may be required to adapt existing facilities to make them accessible.
Interstate Banking and Branching
Federal law regulates the interstate activities of banks and bank holding
companies and establishes a framework for nationwide interstate banking and branching. Since June 1, 1997, a bank in one state has generally been permitted to merge with a bank in another state without the need for explicit state law
authorization. However, states generally were given the ability to prohibit interstate mergers with banks in their own state by opting-out (enacting state legislation applying equality to all out-of-state banks prohibiting such mergers)
prior to June 1, 1997.
Since 1995, adequately capitalized
and managed bank holding companies have been permitted to acquire banks located in any state, subject to two exceptions: first, any state may still prohibit bank holding companies from acquiring a bank which is less than five years old; and second,
no interstate acquisition can be completed by a bank holding company if the acquirer would control more than 10% of the deposits held by insured depository institutions nationwide or 30% or more of the deposits held by insured depository
institutions in any state in which the target bank has branches.
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A bank may establish and operate
de novo
branches in any state in which that bank does not
maintain a branch if that state has enacted legislation to expressly permit all out-of-state banks to establish branches in that state.
Bank Secrecy Act and USA Patriot Act
The Bank Secrecy Act (BSA) is a disclosure law that forms the basis of the federal governments framework to prevent and detect money
laundering and to deter other criminal enterprises. Under the BSA, financial institutions such as the Bank are required to maintain certain records and file certain reports regarding domestic currency transactions and cross-border transportations of
currency. Among other requirements, the BSA requires financial institutions to report imports and exports of currency in the amount of $10,000 or more and, in general, all cash transactions of $10,000 or more. The Bank has established a BSA
compliance policy under which, among other precautions, the Bank keeps currency transaction reports to document cash transactions in excess of $10,000 or in multiples totaling more than $10,000 during one business day, monitors certain potentially
suspicious transactions such as the exchange of a large number of small denomination bills for large denomination bills, and scrutinizes electronic funds transfers for BSA compliance. The BSA also requires that financial institutions report to
relevant law enforcement agencies any suspicious transactions potentially involving violations of law.
The terrorist attacks in September 2001 impacted the financial services industry and led to the Uniting and Strengthening America by Providing Appropriate
Tools Required to Intercept and Obstruct Terrorism Act of 2001, or the USA Patriot Act. Part of the USA Patriot Act is the International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001, or IMLAFATA. Pursuant to IMLAFATA, an
additional purpose was added to the BSA: To assist in the conduct of intelligence or counter-intelligence activities, including analysis, to protect against international terrorism.
IMLAFATA also significantly expanded the role of financial institutions in
combating money laundering. In particular, it required financial institutions to establish anti-money laundering programs, which, at a minimum, include internal policies, procedures, and controls designed to prevent the institution from being used
for money laundering; the designation of a BSA compliance officer; ongoing employee training; and an independent audit program to test the effectiveness of the institutions anti-money laundering programs. The FDIC and the other federal banking
agencies promptly adopted regulations requiring each financial institution to establish comprehensive anti-money laundering compliance programs designed to assure compliance with the BSA and otherwise meeting the statutory requirements for such
programs set forth in IMLAFATA. In addition, these regulations required each financial institution to establish a customer identification program to be implemented as part of the institutions anti-money laundering compliance program. Failure
to establish and maintain such BSA/anti-money laundering programs are grounds for the issuance by federal banking regulators of enforcement actions.
IMLAFATA authorizes the Secretary of the Treasury, in consultation with the heads of other government agencies, to adopt special measures applicable to
banks, bank holding companies, and/or other financial institutions. These measures may include enhanced recordkeeping and reporting requirements for certain financial transactions that are of primary money laundering concern, due diligence
requirements concerning the beneficial ownership of certain types of accounts, and restrictions or prohibitions on certain types of accounts with foreign financial institutions.
Among its other provisions, IMLAFATA requires each financial institution to (i) establish due diligence policies,
procedures, and controls with respect to its private banking accounts and correspondent banking accounts involving foreign individuals and certain foreign banks and (ii) avoid establishing, maintaining, administering, or managing correspondent
accounts in the United States of America for, or on behalf of, a foreign bank that does not have a physical presence in any country. In addition, IMLAFATA contains a provision encouraging cooperation among financial institutions, regulatory
authorities and law enforcement authorities
21
with respect to individuals, entities, and organizations engaged in, or reasonably suspected of engaging in, terrorist acts or money laundering activities.
IMLAFATA expands the circumstances under which funds in a bank account may be forfeited and requires covered financial institutions to respond under certain circumstances to requests for information from federal banking agencies within 120 hours.
IMLAFATA also requires the federal banking agencies to consider the effectiveness of a financial institutions anti-money laundering activities when reviewing an application under the BHCA or in connection with a potential bank merger under the
Bank Merger Act.
Customer Information Security
The federal bank regulatory agencies have adopted guidelines
for safeguarding confidential, personal customer information. The guidelines require each financial institution, under the supervision and ongoing oversight of its Board of Directors or an appropriate committee thereof, to create, implement, and
maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information, protect against any anticipated threats or hazards to the security or integrity of such information and
protect against unauthorized access or use of such information that could result in substantial harm or inconvenience to any customer.
Privacy
The Bank is required under federal law to implement policies and procedures regarding the disclosure of nonpublic personal information about consumers to
non-affiliate third parties. In general, the statute requires a financial institution to (i) provide notice to customers about its privacy policies and practices, (ii) describe the conditions under which the institution may disclose
nonpublic personal information about consumers to nonaffiliated third parties, and (iii) provide a method for consumers to prevent the financial institution from disclosing that information to nonaffiliated third parties by opting
out of that disclosure.
Affiliate Marketing
Restrictions
On November 7, 2007, the federal
banking agencies adopted regulations to implement the affiliate marketing provisions contained in section 214 of the Fair and Accurate Credit Transactions Act of 2003, which amends the Fair Credit Reporting Act. Full compliance is required by
October 1, 2008. The regulations generally prohibit a company from using information received from an affiliate to solicit a consumer for marketing purposes, unless the consumer is given notice and an opportunity and simple method to opt out of
such solicitations. The regulations provide that (i) notice must be given by an affiliate that has or has previously had a pre-existing business relationship with the consumer and (ii) the election of a consumer to opt out must be
effective for a period of at least five years, unless the consumer subsequently revokes the opt-out in writing or, if the consumer agrees, electronically. Bank and Bancorp do not share information with affiliates for the purpose of allowing an
affiliate to market its products or services to consumers. Information shared between affiliates is limited to information permitted to be shared without consumer consent.
Securities Exchange Act of 1934
The Bancorps common stock is publicly held and listed on NASDAQ, and the Bancorp is subject to the periodic reporting, information, proxy
solicitation, insider trading, corporate governance and other
requirements and restrictions of the Securities Exchange Act of 1934 and the regulations of
the Securities and Exchange Commission promulgated hereunder and the listing requirements of NASDAQ.
Sarbanes-Oxley Act
The Sarbanes-Oxley Act of 2002 implemented legislative reforms applicable to companies with securities traded publicly in the United States. The
Sarbanes-Oxley Act is intended to address corporate and accounting fraud and contains provisions dealing with corporate governance and management, disclosure, oversight of the
22
accounting profession, and auditor independence. Although the Bancorp has incurred and expects to continue to incur additional expenses in complying with the
provisions of the Sarbanes-Oxley Act, it does not expect that compliance will have a material effect on its financial condition or results of operations.
Audit Requirements
The Bank is required to have an annual independent audit, alone or as a part of its bank holding companys audit, and to prepare all financial
statements in accordance with U.S. generally accepted accounting principles. The Bank (or the Bancorp) is also required to have an audit committee comprised entirely of independent directors. As required by NASDAQ, the Bancorp has certified that its
audit committee has adopted formal written charters and meets the requisite number of directors, independence, and qualification standards. In addition, because the Bank has more than $3 billion in total assets, it is subject to the FDIC
requirements for audit committees of large institutions. As such, among other requirements, the Bancorp must maintain an audit committee which includes members with banking or related financial management expertise, has access to its own outside
counsel, and does not include members who are large customers of the Bank.
The Sarbanes-Oxley Act of 2002 addresses accounting oversight and corporate governance matters. Management and the Bancorps independent registered public accounting firm are required to assess the effectiveness
of the Bancorps internal control over financial reporting as of December 31, 2007. These assessments are included in Item 9A, Controls and Procedures, below.
Federal Home Loan Bank System
The Bank is a member of the Federal Home Loan Bank (FHLB) of San Francisco. Among other benefits, each FHLB serves as a reserve
or central bank for its members within its assigned region. Each FHLB is financed primarily from the sale of consolidated obligations of the FHLB system. Each FHLB makes available loans or advances to its members in compliance with the policies and
procedures established by the Board of Directors of the individual FHLB. Each member of the FHLB of San Francisco is required to own stock in an amount equal to the greater of (i) a membership stock requirement with an initial cap of $25
million (100% of membership asset value as defined), or (ii) an activity based stock requirement (based on percentage of outstanding advances).
Impact of Monetary Policies
The earnings and growth of the Bank are largely dependent on its ability to maintain a favorable differential or spread between the yield on its
interest-earning assets and the rates paid on its deposits and other interest-bearing liabilities. As a result, the Banks performance is influenced by general economic conditions, both domestic and foreign, the monetary and fiscal policies of
the federal government, and the policies of the regulatory agencies. The Federal Reserve Board implements national monetary policies (such as seeking to curb inflation and combat recession) by its open-market operations in U.S. Government
securities, by adjusting the required level of reserves for financial institutions subject to its reserve requirements and by varying the discount rate applicable to borrowings by banks from the Federal Reserve Banks. The actions of the Federal
Reserve Board in these areas influence the growth of bank loans, investments, and deposits and also affect interest rates charged on loans and deposits. The nature and impact of any future changes in monetary policies cannot be predicted.
Environmental Regulation
In the course of the Banks business, the Bank may foreclose and take
title to real estate, and could be subject to environmental liabilities with respect to these properties. The Bank may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs
incurred by these parties in connection with environmental contamination, or may be required to investigate or clear up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigation
23
or remediation activities could be substantial. In addition, as the owner or former owner of any contaminated site, the Bank may be subject to common law
claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. If the Bank ever becomes subject to significant environmental liabilities, its business, financial condition, liquidity and
results of operations could be materially and adversely affected.
Other Pending and Proposed Legislation
Other legislative and regulatory initiatives which could affect the Bancorp and the Bank and the banking industry in general are pending, and additional initiatives may be proposed or introduced, before the U.S. Congress, the California
legislature, and other governmental bodies in the future. Such proposals, if enacted, may further alter the structure, regulation, and competitive relationship among financial institutions, and may subject the Bancorp and the Bank to increased
regulation, disclosure, and reporting requirements. In addition, the various banking regulatory agencies often adopt new rules and regulations to implement and enforce existing legislation. It cannot be predicted whether, or in what form, any such
legislation or regulations may be enacted or the extent to which the business of the Bancorp or the Bank would be affected thereby.
Item 1A. Risk Factors.
The allowance
for credit losses is an estimate of probable credit losses. Actual credit losses in excess of the estimate could adversely affect our net income and capital.
The allowance for credit losses is based on managements estimate of the probable losses from our credit portfolio. If
actual losses exceed the estimate, the excess losses could adversely affect our net income and capital. Such excess losses could also lead to larger allowances for credit losses in future periods, which could in turn adversely affect net income and
capital in those periods. If economic conditions differ substantially from the assumptions used in the estimate or adverse developments arise with respect to our credits, future losses may occur, and increases in the allowance may be necessary. In
addition, various regulatory agencies, as an integral part of their examination process, periodically review the adequacy of our allowance. These agencies may require us to establish additional allowances based on their judgment of the information
available at the time of their examinations. No assurance can be given that we will not sustain credit losses in excess of present or future levels of the allowance for credit losses.
Fluctuations in interest rates could reduce our net interest income and adversely affect our business.
The interest rate risk inherent in our lending, investing, and deposit
taking activities is a significant market risk to us and our business. Income associated with interest-earning assets and costs associated with interest-bearing liabilities may not be affected uniformly by fluctuations in interest rates. The
magnitude and duration of changes in interest rates, events over which we have no control, may have an adverse effect on net interest income. Prepayment and early withdrawal levels, which are also impacted by changes in interest rates, can
significantly affect our assets and liabilities. Increases in interest rates may adversely affect the ability of our floating rate borrowers to meet their higher payment obligations, which could in turn lead to an increase in non-performing assets
and net charge-offs.
Generally, the interest rates on
interest-earning assets and interest-bearing liabilities of the Company do not change at the same rate, to the same extent, or on the same basis. Even assets and liabilities with similar maturities or periods of repricing may react in different
degrees to changes in market interest rates. Interest rates on certain types of assets and liabilities may fluctuate in advance of changes in general market interest rates, while interest rates on other types of assets and liabilities may lag behind
changes in general market rates. Certain assets, such as fixed and adjustable rate mortgage loans, have features that limit changes in interest rates on a short-term basis and over the life of the asset.
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We seek to minimize the adverse effects of changes in interest rates by structuring our asset-liability
composition to obtain the maximum spread. We use interest rate sensitivity analysis and a simulation model to assist us in estimating the optimal asset-liability composition. However, such management tools have inherent limitations that impair their
effectiveness. There can be no assurance that we will be successful in minimizing the adverse effects of changes in interest rates. See also the sections entitled Risks Elements of the Loan Portfolio under Item 7 and Market
Risk under Item 7A of this Annual Report on Form 10-K.
We
have engaged in and may continue to engage in further expansion through acquisitions, which could negatively affect our business and earnings.
We have engaged in and may continue to engage in expansion through acquisitions. There are risks associated with such expansion. These risks include,
among others, incorrectly assessing the asset quality of a bank acquired in a particular transaction, encountering greater than anticipated costs in integrating acquired businesses, facing resistance from customers or employees, and being unable to
profitably deploy assets acquired in the transaction. Additional country- and region-specific risks are associated with transactions outside the United States, including in China. To the extent we issue capital stock in connection with additional
transactions, these transactions and related stock issuances may have a dilutive effect on earnings per share and share ownership.
Our earnings, financial condition, and prospects after a merger or acquisition depend in part on our ability to successfully integrate the operations of
the acquired company. We may be unable to integrate operations successfully or to achieve expected cost savings. Any cost savings which are realized may be offset by losses in revenues or other charges to earnings.
Inflation and deflation may adversely affect our financial performance.
The consolidated financial statements and related
financial data presented in this report have been prepared in accordance with accounting principles generally accepted in the United States. These principles require the measurement of financial position and operating results in terms of historical
dollars, without considering changes in the relative purchasing power of money over time due to inflation or deflation. The primary impact of inflation on the operations of the Company is reflected in increased operating costs. Conversely, deflation
will tend to erode collateral values and diminish loan quality. Virtually all of our assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on our performance than the general levels of inflation or
deflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the price of goods and services.
As we expand our business outside of California markets, we will encounter risks that could adversely affect us.
We primarily operate in California markets with a concentration of
Chinese-American individuals and businesses; however, one of our strategies is to expand beyond California into other domestic markets that have concentrations of Chinese-American individuals and businesses. We currently have operations in six other
states (New York, Texas, Washington, Massachusetts, Illinois, and New Jersey) and in Hong Kong. In the course of this expansion, we will encounter significant risks and uncertainties that could have a material adverse effect on our operations. These
risks and uncertainties include increased expenses and operational difficulties arising from, among other things, our ability to attract sufficient business in new markets, to manage operations in noncontiguous market areas, to comply with all of
the various local laws and regulations, and to anticipate events or differences in markets in which we have no current experience.
To the extent that we expand through acquisitions, such acquisitions may also adversely harm our business if we fail to adequately address the financial
and operational risks associated with such acquisitions. For example, risks can include difficulties in assimilating the operations, technology, and personnel of the acquired
25
company; diversion of managements attention from other business concerns; inability to maintain uniform standards, controls, procedures and policies;
potentially dilutive issuances of equity securities; incurrence of additional debt and contingent liabilities; use of cash resources; large write-offs; and amortization expenses related to other intangible assets with finite lives.
The risks inherent in real estate and construction lending may adversely affect our net
income.
Real estate securing our lending activities
is principally located in California, and to a lesser extent, in New York, Texas, Massachusetts, Washington, Illinois, and New Jersey. The value of such collateral depends upon conditions in the relevant real estate markets. These include general or
local economic conditions and neighborhood characteristics, unemployment rates, real estate tax rates, the cost of operating the properties, governmental regulations and fiscal policies, and acts of nature including earthquakes, floods, and
hurricanes (which may result in uninsured losses), and other factors beyond our control. The current general decline in real estate sales and prices in many markets across the United States could reduce the value of our collateral such that we may
not be able to realize an amount upon a foreclosure sale equal to the indebtedness secured by the property. Continued declines in real estate sales and prices coupled with a possible economic slowdown or recession and an associated increase in
unemployment could result in higher than expected loan delinquencies or problem assets, a decline in demand for our products and services, or lack of growth or a decrease in deposits, which may cause us to incur losses, adversely affect our capital,
and hurt our business.
The risks inherent in construction
lending may adversely affect our net income. Such risks include, among other things, the possibility that contractors may fail to complete, or complete on a timely basis, construction of the relevant properties; substantial cost overruns in excess
of original estimates and financing; market deterioration during construction; and lack of permanent take-out financing. Loans secured by such properties also involve additional risk because such properties have no operating history. In these loans,
loan funds are advanced upon the security of the project under construction (which is of uncertain value prior to completion of construction) and the estimated operating cash flow to be generated by the completed project. There is no assurance that
such properties will be sold or leased so as to generate the cash flow anticipated by the borrower. The current general decline in real estate sales and prices across the United States, the decline in demand for residential real estate, a possible
economic slowdown or recession, higher rates of unemployment, and reduced availability of mortgage credit, are all factors that can adversely affect the borrowers ability to repay their obligations to us and the value of our security interest
in collateral and thereby adversely affect our net income and financial results.
Adverse economic conditions in California and other regions where we have operations could cause us to incur losses.
Our banking operations are concentrated primarily in California, and secondarily in New York, Texas, Massachusetts, Washington, Illinois, New Jersey, and
Hong Kong. Adverse economic conditions in these regions could impair borrowers ability to service their loans, decrease the level and duration of deposits by customers, and erode the value of loan collateral. These conditions include the
effects of the current general decline in real estate sales and prices in many markets across the United States, a possible economic slowdown or recession, and possible higher rates of unemployment. These conditions could increase the amount of our
non-performing assets and have an adverse effect on our efforts to collect our non-performing loans or otherwise liquidate our non-performing assets (including other real estate owned) on terms favorable to us and could also cause a decline in
demand for our products and services, or a lack of growth or a decrease in deposits, any of which may cause us to incur losses, adversely affect our capital, and hurt our business.
Our use of appraisals in deciding whether to make a loan on or secured by real property does not ensure the value of the real property
collateral.
In considering whether to make a loan on
or secured by real property, we generally require an appraisal of such property. However, the appraisal is only an estimate of the value of the property at the time the appraisal is
26
made. If the appraisal does not reflect the amount that may be obtained upon any sale or foreclosure of the property, we may not realize an amount equal to
the indebtedness secured by the property.
We face substantial
competition from larger competitors.
We face
substantial competition for deposits and loans, as well as other banking services, throughout our market area from the major banks and financial institutions that dominate the commercial banking industry. This may cause our cost of funds to exceed
that of our competitors. Such banks and financial institutions have greater resources than us, including the ability to finance advertising campaigns and allocate their investment assets to regions of higher yield and demand. By virtue of their
larger capital bases, such institutions have substantially greater lending limits than us and perform certain functions, including trust services, which are not presently offered by us. We also compete for loans and deposits, as well as other
banking services, with savings and loan associations, brokerage houses, insurance companies, mortgage companies, credit unions, credit card companies and other financial and non-financial institutions and entities.
Adverse effects of banking regulations or changes in banking regulations could
adversely affect our business by increasing our expenses, limiting our activities, or altering the competitive balance.
We are subject to significant federal and state regulation and supervision, which is primarily for the benefit and protection of our customers or which
serve other public policies and not for the benefit of our stockholders. In the past, our business has been materially affected by such regulation and supervision. This trend is likely to continue in the future. Laws, regulations, or policies
currently affecting us may change at any time. Regulatory authorities may also change their interpretation of existing laws and regulations. It is impossible to predict the competitive impact that any such changes would have on commercial banking in
general or on our business in particular. Such changes may, among other things, increase the cost of doing business, limit permissible activities, or affect the competitive balance between banks and other financial institutions.
Our financial results could be adversely affected by changes in California tax law and
changes in its interpretation relating to registered investment companies and real estate investment trusts.
Our effective income tax rate was lower in 2002 and 2001 than in subsequent years due in large part to income tax benefits derived from a registered
investment company subsidiary of the Bank. We had relied on the California tax law related to registered investment companies and on an outside tax opinion in creating this subsidiary. In the fourth quarter of 2003, a change in that law was enacted
by the California Legislature, which would deny such tax benefits from and after January 1, 2003. On December 31, 2003, the California Franchise Tax Board (FTB) announced its position that certain tax deductions related to regulated
investment companies as well as real estate investment trusts prior to January 1, 2003 would also be disallowed.
In December, 2002, we decided to deregister the registered investment company and, in February, 2003, we completed such deregistration. In addition, in
the fourth quarter of 2003, the Company reversed the net state tax benefits recorded in the first three quarters of 2003 relating to the real estate investment trust (REIT) that was formed as a subsidiary of the Bank during 2003. The Company did not
record any tax benefits relating to the REIT in the fourth quarter of 2003 and did not record any such benefits thereafter.
As previously disclosed, on December 31, 2003, the California Franchise Tax Board (FTB) announced its intent to list certain transactions that in its
view constitute potentially abusive tax shelters. Included in the transactions subject to this listing were transactions utilizing regulated investment companies (RICs) and real estate investment trusts (REITs). While the Company continues to
believe that the tax benefits recorded in 2000, 2001, and 2002 with respect to its regulated investment company were appropriate and fully defensible under California law, the Company participated in Option 2 of the Voluntary Compliance Initiative
of the Franchise Tax Board, and paid all California taxes and interest on these disputed 2000 through 2002 tax benefits, and at the same time filed a claim for refund for these years while avoiding certain potential penalties. The Company
27
retains potential exposure for assertion of an accuracy-related penalty should the FTB prevail in its position in addition to the risk of not being
successful in its refund claims.
The FASB issued
Interpretation No. 48 Accounting for Uncertainty in Income Taxes (FIN 48) which requires that the amount of recognized tax benefit should be the maximum amount which is more-likely-than-not to be realized and that amounts previously
recorded that do not meet the requirements of FIN 48 be charged as a cumulative effect adjustment to retained earnings. As of December 31, 2006, the Company reflected a $12.1 million net state tax receivable related to payments it made in April
2004 under the Voluntary Compliance Initiative program for the years 2000, 2001, and 2002, after giving effect to reserves for loss contingencies on the refund claims. The Company has determined that its refund claim related to the regulated
investment company is not more-likely-than-not to be realized and consequently, charged a total of $8.5 million, comprised of the $7.9 million after tax amount related to its refund claims as well as a $0.6 million after tax amount related to
California net operating losses generated in 2001 as a result of the regulated investment company, to the balance of retained earnings as of the January 1, 2007, effective date of FIN 48.
At the January 1, 2007 adoption date of FIN 48, the total amount of the
Companys unrecognized tax benefits was $5.5 million, of which $1.7 million, if recognized, would affect the effective tax rate. The Company recognized interest and penalties accrued related to unrecognized tax benefits in income tax expense.
At January 1, 2007, the adoption date of FIN 48, the total amount of accrued interest and penalties was $1.7 million.
Our business may be adversely affected by general conditions in the economy and the financial markets.
Our business is subject to general conditions in the economy and the
financial markets and to monetary and fiscal and other governmental policies and actions designed to address those conditions. These conditions may change suddenly and dramatically and may involve declines in economic growth, real estate values,
business activity, or investor or business confidence, and limitations on the availability or increases in the cost of credit and capital. These or a combination of these and other factors that may not be foreseeable can unfavorably affect us and
the business and prospects and liquidity of our customers and thereby adversely affect our profitability in ways that may not be predictable or that we may fail to anticipate.
Natural disasters and geopolitical events beyond our control could adversely affect us.
Natural disasters such as earthquakes, wildfires, extreme weather
conditions, hurricanes, floods, and other acts of nature and geopolitical events involving terrorism or military conflict could adversely affect our business operations and those of our customers and cause substantial damage and loss to real and
personal property. These natural disasters and geopolitical events could impair our borrowers ability to service their loans, decrease the level and duration of deposits by customers, erode the value of loan collateral, and result in an
increase in the amount of our non-performing loans and a higher level of non-performing assets (including real estate owned), net charge-offs, and provision for loan losses, which could adversely affect our earnings.
Adverse conditions in Asia could adversely affect our business.
A substantial number of our customers have economic and cultural ties to
Asia and, as a result, we are likely to feel the effects of adverse economic and political conditions in Asia. In addition, in 2007, we opened a branch in Hong Kong. U.S. and global economic policies, military tensions, and unfavorable global
economic conditions may adversely impact the Asian economies. Pandemics and other public health crises or concerns over the possibility of such crises could create economic and financial disruptions in the region. If economic conditions in Asia
deteriorate, we could, among other things, be exposed to economic and transfer risk, and could experience an outflow of deposits by those of our customers with connections to Asia. Transfer risk may result when an entity is unable to obtain the
foreign exchange needed to meet its obligations or to provide liquidity. This may adversely impact the recoverability of investments with or loans made to such entities. Adverse economic conditions in Asia, and in China or Taiwan in particular, may
also negatively impact asset values and the profitability and liquidity of our customers who operate in this region.
28
Statutory restrictions on dividends and other distributions from the Bank may adversely impact us by limiting the
amount of distributions the Bancorp may receive.
A
substantial portion of the Bancorps cash flow comes from dividends that the Bank pays to us. Various statutory provisions restrict the amount of dividends that the Bank can pay without regulatory approval. In addition, if the Bank were to
liquidate, the Banks creditors would be entitled to receive distributions from the assets of the Bank to satisfy their claims against the Bank before Bancorp, as a holder of the equity interest in the Bank, would be entitled to receive any of
the assets of the Bank.
Our need to continue to adapt to our information
technology systems to allow us to provide new and expanded services could present operational issues and require significant capital spending.
As we continue to offer internet banking and other on-line services to our customers, and continue to expand our existing conventional banking services,
we will need to adapt our information technology systems to handle these changes in a way that meets constantly changing industry and regulatory standards. This can be very expensive and may require significant capital expenditures. In addition, our
success will depend, among other things, on our ability to provide secure and reliable services, anticipate changes in technology, and efficiently develop and introduce services that are accepted by our customers and cost effective for us to
provide. Systems failures, delays, breaches of confidentiality and other problems could harm our reputation and business.
Certain provisions of our charter, bylaws, and rights agreement could make the acquisition of our company more difficult.
Certain provisions of our Charter, Bylaws, and Rights Agreement between us
and American Stock Transfer and Trust Company, as Rights Agent, could make the acquisition of our company more difficult. These provisions include authorized but unissued shares of preferred and common stock that may be issued without stockholder
approval; three classes of directors serving staggered terms; preferred share purchase rights that generally become exercisable if a person or group acquires 15% or more of our common stock or announces a tender offer for 15% or more of our common
stock; special requirements for stockholder proposals and nominations for director; and super-majority voting requirements in certain situations including certain types of business combinations.
Item 1B. Unresolved Staff Comments.
The Company has not received written comments regarding its periodic or current reports from the staff of the Securities and Exchange Commission that were issued 180 days before the end of its 2007 fiscal year and that remain unresolved.
Item 2. Properties.
Cathay General Bancorp
The Bancorp
currently neither owns nor leases any real or personal property. The Bancorp uses the premises, equipment, and furniture of the Bank in exchange for payment of a management fee to the Bank.
Cathay Bank
The Banks head office is located in a 26,527 square foot building in
the Chinatown area of Los Angeles. The Bank owns both the building and the land upon which the building is situated. In June 2006, the Bank acquired a seven story 102,548 square foot office building in South El Monte to serve as its corporate
offices. The building is currently under extensive renovation. The Bank expects to relocate to this new facility in the second half of 2008.
The Bank owns its branch offices in Monterey Park, Alhambra, Westminster, San Gabriel, City of Industry, Cupertino, Artesia, New York City, Flushing (2
locations), and Chicago. In addition, the Bank has certain
29
operating and administrative departments located at 4128 Temple City Boulevard, Rosemead, California, where it owns the building and land with approximately
27,600 square feet of space.
The Bank leases certain other
premises. Expiration dates of the Banks leases range from June 2008 to December 2016. The Banks leased offices include the former headquarter of General Bank, located at 800 West 6th Street, Los Angeles, California 90017, consisting of
approximately 41,501 square feet of rentable area which includes the ground floor and the second, fourteenth, and fifteenth floors of the building. The initial lease term will expire in the year 2009, and the Bank has two five-year options to renew
the lease following the expiration date of the initial term. As of December 31, 2007, the monthly base rent for the facility was $117,000. The monthly base rent is subject to change on specified dates during the 15-year initial lease term.
Our Hong Kong branch is located at 28 Queens Road
Central Hong Kong. The lease for the 3,436 square foot office commenced on December 16, 2006 and has a term of three years. Our representative office in Shanghai is located at Room 1808, 1515 Nanjing Road West, Kerry Centre, Shanghai, China,
and consists of 869 square feet. The lease was renewed for two years from April 15, 2007 to April 14, 2009. The representative office in Taipei is located at Sixth Floor, Suite 3, 146 Sung Chiang Road, Taipei, Taiwan, and consists of 1,806
square feet. The lease was renewed for one year from July 1, 2007 to June 30, 2008.
As of December 31, 2007, the Banks investment in premises and equipment totaled $76.8 million. See Note 9 and Note 15 to the Consolidated Financial Statements.
Item 3. Legal Proceedings.
The Company and its subsidiaries and their property are not currently a party or subject to any material pending legal proceeding.
Item 4. Submission of Matters to a Vote of Security Holders.
There were no matters submitted to a vote of security holders during the fourth quarter of 2007.
30
Executive Officers of Registrant.
The table below sets forth the names, ages, and positions at the Bancorp and the Bank of all executive officers of the Company as of February 15, 2008.
|
|
|
|
|
Name
|
|
Age
|
|
Present Position and Principal Occupation During the Past Five Years
|
Dunson K. Cheng
|
|
63
|
|
Chairman of the Board of Directors of Bancorp and the Bank since 1994; Director and President (Chief Executive Officer) of Bancorp since 1990. President of the Bank since 1985 and Director of
the Bank since 1982.
|
|
|
|
Peter Wu
|
|
59
|
|
Director, Executive Vice Chairman, and Chief Operating Officer of Bancorp and the Bank since October 20, 2003. Director of GBC Bancorp and General Bank from 1981 to October, 2003; Chairman of
the Board of GBC Bancorp and General Bank from January, 2003 to October, 2003; President and Chief Executive Officer of GBC Bancorp and General Bank from January, 2001 to October, 2003.
|
|
|
|
Anthony M. Tang
|
|
54
|
|
Director of Bancorp since 1990; Executive Vice President of Bancorp since 1994; Chief Financial Officer and Treasurer of Bancorp from 1990 until June 2003. Chief Lending Officer of the Bank
since 1985; Director of the Bank since 1986; Senior Executive Vice President of the Bank since December 1998.
|
|
|
|
Heng W. Chen
|
|
55
|
|
Executive Vice President and Chief Financial Officer of Bancorp since June 2003. Executive Vice President of the Bank since June 2003. Chief Financial Officer of the Bank since January 2004.
Executive Vice President-Finance of City National Bank from March 2000 until June 2003.
|
|
|
|
Irwin Wong
|
|
59
|
|
Executive Vice President-Branch Administration of the Bank since 1999.
|
|
|
|
Kim R. Bingham
|
|
51
|
|
Executive Vice President Chief Credit Officer of the Bank since August 2004. First Vice President Private Banking of Mellon Bank from April 2003 to August 2004; Senior Vice
President Credit Administration of City National Bank from 2002 to April 2003.
|
|
|
|
Perry P. Oei
|
|
45
|
|
Senior Vice President of Bancorp and the Bank since January 2004; General Counsel of Bancorp and the Bank since July 2001.
|
31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
The accompanying consolidated financial statements include the accounts of Cathay General Bancorp (the Bancorp), a Delaware corporation, its
wholly-owned subsidiaries, Cathay Bank (the Bank), a California state-chartered bank, six limited partnerships investing in affordable housing projects, and GBC Venture Capital, Inc. (together, the Company). All significant
inter-company transactions and balances have been eliminated in consolidation. The consolidated financial statements of the Company are prepared in conformity with accounting principles generally accepted in the United States of America
(GAAP) and general practices within the banking industry.
Organization and Background.
The business activities of the
Bancorp consist primarily of the operations of the Bank, which owns 100% of the common stock of the following subsidiaries: Cathay Real Estate Investment Trust, GBC Real Estate Investments, Inc., GB Capital Trust II, Cathay Holdings LLC, Cathay
Community Development Corporation and its wholly owned subsidiary, Cathay New Asia Community Development Corporation.
There are limited
operating business activities currently at the Bancorp. The Bank is a commercial bank, servicing primarily the individuals, professionals, and small to medium-sized businesses in the local markets in which its branches are located. Its operations
include the acceptance of checking, savings, and time deposits, and the making of commercial, real estate, and consumer loans. The Bank also offers trade financing, letters of credit, wire transfer, foreign currency spot and forward contracts,
Internet banking, investment services, and other customary banking services to its customers.
Use of Estimates.
The preparation of
the consolidated financial statements in accordance with GAAP requires management of the Company to make a number of estimates and assumptions relating to the reported amount of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the period. Actual results could differ from those estimates. The most significant estimate subject to change relates to the
allowance for loan losses. The following are descriptions of the more significant of these policies.
Allowance for Loan Losses.
Management believes the allowance for loan losses is being maintained at a level considered adequate to provide for estimable and probable loan losses. Additions to the allowance for loan losses are made by charges to operating expense in
the form of a provision for credit losses. All credits judged to be un-collectible are charged against the allowance for loan losses while any recoveries are credited to the allowance for loan losses.
The allowance for loan losses includes allowance allocations calculated in accordance with Statement of Financial Accounting Standards (SFAS)
No. 114, Accounting by Creditors for Impairment of a Loan, as amended by SFAS 118, Accounting by Creditors for Impairment of a Loan, and allowance allocations calculated in accordance with SFAS 5, Accounting for
Contingencies. Management monitors changes in lending policies and procedures, changes in economic and business conditions, changes in the nature and volume of the portfolio and in the terms of loans, changes in the experience, ability and
depth of lending management, changes in the volume and severity of past due, nonaccrual and adversely classified or graded loans, changes in the quality of the loan review system, changes in the value of underlying collateral for
collateral-dependent loans, the existence and effect of any concentrations of credit and the effect of competition, legal and regulatory requirements and other external factors. Management also closely reviews its past, present and expected overall
net loan losses in comparison to the existing level of the allowance. In addition, the Banks regulators, as an integral part of their examination process, periodically review the Banks allowance for loan losses. Such
F-8
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
agencies may require the Bank to make additions to its allowance for loan losses based on the judgments of the information available to them at the time of
their examination. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond the Banks control, including the performance of the Banks loan
portfolio, the economy, changes in interest rates, and the view of the regulatory agencies toward loan classifications.
Securities
Purchased Under Agreements to Resell.
The Company purchases securities under agreement to resell with various terms. These agreements are collateralized by agency securities and mortgage backed securities that are generally held by a third party
custodian. The purchases are over-collateralized to ensure against unfavorable market price movements. In the event that the fair market value of the securities decreases below the collateral requirements under the related repurchase agreements, the
counterparty is required to deliver additional securities. The counterparties to these agreements are nationally recognized investment banking firms that meet credit eligibility criteria and with whom a master repurchase agreement has been duly
executed.
Securities.
Securities are classified as held-to-maturity when management has the ability and intent to hold these
securities until maturity. Securities are classified as available-for-sale when management intends to hold the securities for an indefinite period of time, or when the securities may be utilized for tactical asset/liability purposes, and may be sold
from time to time to manage interest rate exposure and resultant prepayment risk and liquidity needs. Securities are classified as trading securities when management intends to sell the securities in the near term. Securities purchased are
designated as held-to-maturity, available-for-sale, or trading securities at the time of acquisition.
Securities held-to-maturity are
stated at cost, adjusted for the amortization of premiums and the accretion of discounts on a level-yield basis. The carrying value of these assets is not adjusted for temporary declines in fair value since the Company has the positive intent and
ability to hold them to maturity. Securities available-for-sale are carried at fair value, and any unrealized holding gains or losses are excluded from earnings and reported as a separate component of stockholders equity, net of tax, in
accumulated other comprehensive income until realized. Realized gains or losses are determined on the specific identification method. Premium and discounts are amortized or accreted as adjustment of yield on a level-yield basis.
Declines in the fair value of available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as
realized losses. In estimating other-than-temporary impairment losses, management considers, among other things, (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and
near-term prospects of the issuer, and (iii) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. The new cost basis is not changed for
subsequent recoveries in fair value.
Trading securities are reported at fair value, with unrealized gains or losses included in income.
Investment in Federal Home Loan Bank (FHLB) Stock.
As a member of the FHLB system the Bank is required to maintain an
investment in the capital stock of the FHLB. The amount of investment is also affected by the outstanding advances under the line of credit the Bank maintains with the FHLB. FHLB stock is carried at cost and is pledged as collateral to the FHLB. The
carrying amount of the FHLB stock at December 31, 2007, was $65.7 million compared to $34.3 million at December 31, 2006. As of December 31, 2007, 646,335 FHLB stock shares were the minimum stock requirement based on outstanding
FHLB borrowings of $1.4 billion. As of December 31, 2007, the Company owned 657,000 shares of FHLB stock.
Loans.
Loans are
carried at amounts advanced, less principal payments collected and net deferred loan fees. Interest is accrued and earned daily on an actual or 360-day basis. Interest accruals on business loans and
F-9
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
non-residential real estate loans are generally discontinued whenever the payment of interest or principal is 90 days or more past due, based on
contractual terms. Such loans are placed on non-accrual status, unless the loan is well secured, and there is a high probability of recovery in full, as determined by management. When loans are placed on a non-accrual status, any current year unpaid
accrued interest is reversed against current income and any unpaid accrued interest from the prior year is reversed against the allowance for loan losses, and interest is subsequently recognized only to the extent cash is received. The loan is
generally returned to accrual status when the borrower has brought the past due principal and interest payments current and, in the opinion of management, the borrower has demonstrated the ability to make future payments of principal and interest as
scheduled. A non-accrual loan may also be returned to accrual status if all principal and interest contractually due are reasonably assured of repayment within a reasonable period and there has been a sustained period of payment performance. Loan
origination fees and commitment fees, offset by certain direct loan origination costs, are deferred and recognized over the contractual life of the loan as a yield adjustment. The amortization utilizes the interest method. If a loan is placed on
non-accrual status, the amortization of the loan fees and the accretion of discounts are discontinued until such time when the loan is returned to accruing status.
Loans Acquired Through Transfer.
Loans acquired through the completion of a transfer, including loans acquired in a business combination, that have evidence of deterioration of credit quality since origination
and for which it is probable, at acquisition, that the Company will be unable to collect all contractually required payment receivable are initially recorded at fair value (as determined by the present value of expected future cash flows) with no
valuation allowance. The difference between the undiscounted cash flows expected at acquisition and the investment in the loan, or the accretable yield, is recognized as interest income on a level-yield method over the life of the loan.
Contractually required payments for interest and principal that exceed the undiscounted cash flows expected at acquisition, or the nonaccretable difference, are not recognized as a yield adjustment or as a loss accrual or a valuation
allowance. Increases in expected cash flows subsequent to the initial investment are recognized prospectively through adjustment of the yield on the loan over its remaining life. Decreases in expected cash flows are recognized as impairment.
Valuation allowance on these impaired loans reflect only losses incurred after the acquisition.
Impaired Loans.
A loan is
considered impaired when it is probable that the Bank will be unable to collect all amounts due (i.e. both principal and interest) according to the contractual terms of the loan agreement. The measurement of impairment may be based on (1) the
present value of the expected future cash flows of the impaired loan discounted at the loans original effective interest rate, (2) the observable market price of the impaired loan or (3) the fair value of the collateral of a
collateral-dependent loan. The amount by which the recorded investment in the loan exceeds the measure of the impaired loan is recognized by recording a valuation allowance with a corresponding charge to the provision for loan losses. The Company
stratifies its loan portfolio by size and treats smaller performing loans with an outstanding balance less than the Companys defined criteria, generally where the loan amount is less than $100,000, as a homogenous portfolio. Once a loan has
been identified as a possible problem loan, the Company conducts a periodic review of such loan in order to test for impairment. The Company recognizes interest income on impaired loans based on its existing method of recognizing interest income on
non-accrual loans.
Unfunded Loan Commitments.
Unfunded loan commitments are generally related to providing credit facilities to
clients of the Bank, and are not actively traded financial instruments. These unfunded commitments are disclosed as off-balance sheet financial instruments in Note 15 in the Notes to Consolidated Financial Statements.
Letter of Credit Fees.
Issuance and commitment fees received for the issuance of commercial or standby letters of credit are recognized over the
term of the instruments.
F-10
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Premises and Equipment.
Premises and equipment are carried at cost, less accumulated
depreciation. Depreciation is computed on the straight-line method based on the following estimated useful lives of the assets:
|
|
|
Type
|
|
Estimated Useful Life
|
Buildings
|
|
15 to 45 years
|
Building improvements
|
|
5 to 20 years
|
Furniture, fixtures, and equipment
|
|
3 to 25 years
|
Leasehold improvements
|
|
Shorter of useful lives or the terms of the leases
|
Improvements are capitalized and amortized to occupancy expense based on the above table.
Construction in process is carried at cost and includes land acquisition cost, architectural fees, general contractor fees, capitalized interest and other costs related directly to the construction of a property.
Other Real Estate Owned.
Real estate acquired in the settlement of loans is initially recorded and subsequently is carried at fair value, less
estimated costs to sell. Specific valuation allowances on other real estate owned are recorded through charges to operations to recognize declines in fair value subsequent to foreclosure. Gains on sales are recognized when certain criteria relating
to the buyers initial and continuing investment in the property are met.
Investments in Affordable Housing.
The Company is a
limited partner in limited partnerships that invest in low-income housing projects that qualify for Federal and/or State income tax credits. As of December 31, 2007, six of the limited partnerships in which the Company has an equity interest
were determined to be variable interest entities for which the Company is the primary beneficiary. The Company therefore consolidated the financial statements of these six limited partnerships into its consolidated financial statements. As further
discussed in Note 8, the partnership interests are accounted for utilizing the equity method of accounting except for the six limited partnership that are consolidated by the Company.
Investments in venture capital.
The Company invests in limited partnerships that invest in nonpublic companies. These partnerships are commonly
referred to as venture capital investments. These partnership interests represent ownership of less than 5% and are carried under the cost method with other-than-temporary impairment charged against net income.
Goodwill.
Goodwill represents the excess of costs over fair value of assets of businesses acquired. Goodwill and intangible assets acquired in a
purchase business combination and determined to have an indefinite useful life are not amortized, but instead are tested for impairment at least annually in accordance with the provisions of SFAS No. 142. SFAS No. 142 also requires that
intangible assets with estimable useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS No. 144, Accounting for Impairment or Disposal
of Long-Lived Assets.
Core Deposit Premium.
Core deposit premium, which represents the purchase price over the fair value of
the deposits acquired from other financial institutions, is amortized over its estimated useful life to its residual value in proportion to the economic benefits consumed. If a pattern of consumption cannot be reliably determined, straight-line
amortization is used. The Company assesses the recoverability of this intangible asset by determining whether the amortization of the premium balance over its remaining life can be recovered through the remaining deposit portfolio and amortizes core
deposit premium over its estimated useful life.
At December 31, 2007, the unamortized balance of core deposit premium was $35.9
million, which was net of accumulated amortization of $25.1 million. Aggregate amortization expense for core deposit premium was
F-11
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
$7.1 million for year 2007, $6.5 million for year 2006, and $6.0 million for year 2005. As of December 31, 2006, the unamortized balance of the core
deposit premium was $42.7 million, which was net of accumulated amortization of $18.3 million. At December 31, 2007, the estimated aggregate amortization of core deposit premiums annually through 2012 is $6.9 million for 2008, $6.6 million for
2009, $6.0 million for 2010, $5.9 million for 2011, and $5.7 million for 2012.
Securities Sold Under Agreements to Repurchase.
The
Company sells certain securities under agreements to repurchase. The agreements are treated as collateralized financing transactions and the obligations to repurchase securities sold are reflected as a liability in the accompanying consolidated
balance sheets. The securities underlying the agreements remain in the applicable asset accounts.
Stock-Based Compensation.
In
2003, the Company adopted prospectively the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, as amended by FASB Statement No. 148, Accounting for Stock-Based
Compensation Transition and Disclosure, an Amendment of FASB Statement No. 123, and began recognizing the expense associated with stock options granted during 2003 using the fair value method.
On January 1, 2006, the Company adopted revised SFAS No. 123R on a modified prospective basis and recorded in the first quarter of 2006
additional compensation expense of $36,000 for unvested stock options granted before January 1, 2003, based on the estimated fair value of all awards granted to employees before January 1, 2003. In addition, SFAS No. 123R requires an
entity to recognize compensation expense based on an estimate of the number of awards expected to actually vest, exclusive of awards expected to be forfeited. Prior to 2006, the Company recognized forfeitures as they occurred in accordance with SFAS
123. The $138,000 cumulative effect of the change in accounting principle as of January 1, 2006 was recorded as a reduction of compensation expense in the Companys consolidated statement of income.
Stock-based compensation expense for stock options is calculated based on the fair value of the award at the grant date for those options expected to
vest, and is recognized as an expense over the vesting period of the grant using the straight-line method. The Company uses the Black-Scholes option pricing model to estimate the value of granted options. This model takes into account the option
exercise price, the expected life, the current price of the underlying stock, the expected volatility of the Companys stock, expected dividends on the stock and a risk-free interest rate. The Company estimates the expected volatility based on
the Companys historical stock prices for the period corresponding to the expected life of the stock options. Option compensation expense totaled $6.8 million in 2007, $7.3 million in 2006, and $6.8 million in 2005. Stock-based compensation is
recognized ratably over the requisite service period for all awards. Unrecognized stock-based compensation expense related to stock options totaled $13.0 million at December 31, 2007, and is expected to be recognized over the next 2.2 years.
There were no options granted in 2007. The weighted average per share fair value of the options granted was $13.46 during 2006 and $12.83
during 2005 on the date of grant. For options granted during 2006 and 2005, the Company has estimated the expected life of the options to be 6.5 years based on the average of the contractual period and the vesting period. Prior to 2005, the Company
estimated the expected life of the options to be four years. Fair value is determined using the Black-Scholes option pricing model with the following assumptions:
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
Expected life number of years
|
|
6.5
|
|
|
6.2
|
|
Risk-free interest rate
|
|
4.39
|
%
|
|
4.00
|
%
|
Volatility
|
|
33.17
|
%
|
|
34.40
|
%
|
Dividend yield
|
|
1.20
|
%
|
|
1.20
|
%
|
F-12
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
If the compensation cost for all awards granted under the Companys stock option plan had been
determined using the fair value method of SFAS No. 123R, Shared-Based Payment, prior to January 1, 2006, the Companys net income and earnings per share for 2005 would have been reduced to the pro forma amounts indicated
in the table below.
|
|
|
|
|
|
|
2005
|
|
Net income
|
|
|
|
|
As reported
|
|
$
|
104,091
|
|
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects
|
|
|
3,953
|
|
Deduct: Total stock based employee compensation expense determined under fair value based method for all awards, net of related tax effects
|
|
|
(4,200
|
)
|
|
|
|
|
|
Pro forma net income
|
|
$
|
103,844
|
|
|
|
|
|
|
Earnings per share:
|
|
|
|
|
Basic as reported
|
|
$
|
2.07
|
|
Basic pro forma
|
|
|
2.06
|
|
Diluted as reported
|
|
|
2.05
|
|
Diluted pro forma
|
|
|
2.04
|
|
Derivative Financial Instruments.
It is the policy of the Company not to speculate on the
future direction of interest rates. However, the Company enters into financial derivatives in order to seek mitigation of exposure to interest rate risks related to its interest-earning assets and interest-bearing liabilities. The Company believes
that these transactions, when properly structured and managed, may provide a hedge against the inherent interest rate risk in the Companys assets or liabilities and against risk in specific transactions. In such instances, the Company may
protect its position through the purchase or sale of interest rate futures contracts for a specific cash or interest rate risk position. Other hedge transactions may be implemented using interest rate swaps, interest rate caps, floors, financial
futures, forward rate agreements, and options on futures or bonds. Prior to considering any hedging activities, the Company seeks to analyze the costs and benefits of the hedge in comparison to other viable alternative strategies. All hedges require
an assessment of basis risk and must be approved by the Banks Investment Committee.
The Company accounts for its derivative
financial instruments using SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS No. 133), as amended. SFAS No. 133 establishes accounting and reporting standards for financial
derivatives, including certain financial derivatives embedded in other contracts, and hedging activities. It requires the recognition of all financial derivatives as assets or liabilities in the Companys statement of financial condition and
measurement of those financial derivatives at fair value. The accounting treatment of changes in fair value is dependent upon whether or not a financial derivative is designated as a hedge and if so, the type of hedge.
On the date a derivative contract is entered into, the Company designates the derivative as either a hedge of the fair value of a recognized asset or
liability or of an unrecognized firm commitment (fair value hedge), a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability (cash flow hedge), a foreign-currency
fair-value or cash-flow hedge (foreign currency hedge), or a hedge of a net investment in a foreign operation. At the inceptions of all hedging relationships, the Company formally documents the hedging relationship and its risk-management objective
and strategy for undertaking the hedge, the hedging instrument, the item, the nature of the risk being hedged, how the hedging instruments effectiveness in offsetting the hedged risk will be assessed, and a description of the method of
measuring ineffectiveness. This process includes linking all derivatives that are designated as fair-value, cash-flow, or foreign-currency hedges to
F-13
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions. The Company also formally assesses, both at
the hedges inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items. When it is determined that a derivative is not
highly effective as a hedge or that it has ceased to be a highly effective hedge, the Company discontinues hedge accounting prospectively.
The Company recognizes all derivatives on the balance sheet at fair value. Fair value is based on dealer quotes or quoted prices from instruments with similar characteristics. For derivatives designated as cash flow hedges, changes in fair
value are recognized in other comprehensive income until the hedged item is recognized in earnings. For hedges designated as fair value hedges, changes in the fair value of derivatives are reflected in current earnings, together with changes in the
fair value of the related hedged item, if the fair value hedge is highly effective as a hedge. The Company has received rights to acquire stock in the form of warrants as an adjunct to its high technology lending relationships. The warrants in
public companies with a cashless exercise provisions qualify as derivatives under SFAS No. 133. Those warrants that qualify as derivatives are carried at fair value and are included in other assets on the consolidated balance sheets with the
change in fair value included in current earnings.
Income Taxes.
The provision for income taxes is based on income reported for
financial statement purposes, and differs from the amount of taxes currently payable, since certain income and expense items are reported for financial statement purposes in different periods than those for tax reporting purposes.
The Company accounts for income taxes using the asset and liability approach, the objective of which is to establish deferred tax assets and liabilities
for the temporary differences between the financial reporting basis and the tax basis of the Companys assets and liabilities at enacted tax rates expected to be in effect when such amounts are realized or settled. A valuation allowance is
established for deferred tax assets if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized.
Comprehensive Income.
Comprehensive income is defined as the change in equity during a period from transactions and other events and circumstances
from non-owner sources. Comprehensive income generally includes net income, foreign items, minimum pension liability adjustments, unrealized gains and losses on investments in securities available-for-sale, and cash flow hedges. Comprehensive income
and its components are reported and displayed in the Companys consolidated statements of income and comprehensive income. Comprehensive income is a financial reporting concept and does not affect the Companys financial position or
results of operations.
Net Income per Common Share.
Earnings per share (EPS) is computed on a basic and diluted basis.
Basic EPS excludes dilution and is computed by dividing net income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if
securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shares in the earnings of the Company.
Foreign Currency Translation.
The Company considers the functional currency of its foreign operations to be the United States dollar. Accordingly,
the Company remeasures monetary assets and liabilities at year-end exchange rates, while nonmonetary items are remeasured at historical rates. Income and expense accounts are remeasured at the average rates In effect during the year, except for
depreciation, which is remeasured to historical rates. Foreign currency transaction gains and losses are recognized in income in the period of occurrence.
Reclassifications
. As of December 31, 2007, the Company reclassified the reserve for off-balance sheet credit commitments of $4.6 million from the allowance for loan losses to other liabilities. Amounts
presented prior to December 31, 2007 have been restated to conform to the current reporting period.
F-14
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Statement of Cash Flows.
Cash and cash equivalents include short-term highly-liquid
investments that generally have an original maturity of three months or less.
Segment Information and Disclosures.
Accounting
principles generally accepted in the United States of America establish standards to report information about operating segments in annual financial statements and require reporting of selected information about operating segments in interim reports
to stockholders. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. The Company has concluded it has one operating segment.
Recent Accounting Pronouncements
SFAS No. 141, Business Combinations (Revised 2007).
SFAS 141R replaces SFAS 141, Business Combinations, and applies to all transactions and other events in which one entity obtains control over
one or more other businesses. SFAS 141R requires an acquirer, upon initially obtaining control of another entity, to recognize the assets, liabilities and any non-controlling interest in the acquiree at fair value as of the acquisition date.
Contingent consideration is required to be recognized and measured at fair value on the date of acquisition rather than at a later date when the amount of that consideration may be determinable beyond a reasonable doubt. This fair value approach
replaces the cost-allocation process required under SFAS 141 whereby the cost of an acquisition was allocated to the individual assets acquired and liabilities assumed based on their estimated fair value. SFAS 141R requires acquirers to
expense acquisition-related costs as incurred rather than allocating such costs to the assets acquired and liabilities assumed, as was previously the case under SFAS 141. Under SFAS 141R, the requirements of SFAS 146, Accounting for
Costs Associated with Exit or Disposal Activities, would have to be met in order to accrue for a restructuring plan in purchase accounting. Pre-acquisition contingencies are to be recognized at fair value, unless it is a non-contractual
contingency that is not likely to materialize, in which case, nothing should be recognized in purchase accounting and, instead, that contingency would be subject to the probable and estimable recognition criteria of SFAS 5, Accounting for
Contingencies. SFAS 141R is expected to have a significant impact on the Companys accounting for business combinations closing on or after January 1, 2009.
SFAS No. 155,
Accounting for Certain Hybrid Financial Instrument an amendment of FASB Statements No. 133
and 140
.
(SFAS 155). SFAS 155 amends SFAS 133, Accounting for Derivative Instruments and Hedging Activities and SFAS 140, Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities. SFAS 155 (i) permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, (ii) clarifies which interest-only
strips and principal-only strips are not subject to the requirements of SFAS 133, (iii) establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are
hybrid financial instruments that contain an embedded derivative requiring bifurcation, (iv) clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives, and (v) amends SFAS 140 to eliminate
the prohibition on a qualifying special purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. SFAS 155 was effective for the Company on
January 1, 2007. The adoption of SFAS 155 did not have a significant impact on the Company's financial statements.
SFAS
No. 156,
Accounting for Servicing of Financial Assets an amendment of FASB Statement No. 140
(SFAS 156). SFAS 156 amends
SFAS 140.
Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities a replacement of FASB Statement No. 125
,
by requiring, in certain situations, an entity to recognize a servicing asset or servicing liability each time it undertakes an
obligation to service a financial asset by entering into a servicing contract. All separately recognized servicing assets and servicing liabilities are required to be initially measured at fair value. Subsequent measurement methods include
F-15
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
the amortization method, whereby servicing assets or servicing liabilities are amortized in proportion to and over the period of estimated net servicing
income or net servicing loss or the fair value method, whereby servicing assets or servicing liabilities are measured at fair value at each reporting date and changes in fair value are reported in earnings in the period in which they occur. If the
amortization method is used, an entity must assess servicing assets or servicing liabilities for impairment or increased obligation based on the fair value at each reporting date. SFAS 156 was effective for the Company on January 1, 2007.
The adoption of SFAS 156 did not have a significant impact on the Companys financial statements.
In September 2006, the FASB issued
Statement No. 157, Fair Value Measurements (SFAS 157). SFAS 157 clarifies the definition of fair value, together with a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS 157
emphasizes that fair value is a market-based measurement, not an entity-specific measurement and requires a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability.
Market participant assumptions include assumptions about the risk, the effect of a restriction on the sale or use of an asset, and the effect of a nonperformance risk for a liability. SFAS 157 is effective for financial statements issued for fiscal
years beginning after November 15, 2007, and interim periods within those fiscal years. The Company does not expect a material impact on its consolidated financial statements from adoption of SFAS 157.
In February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS
159). SFAS 159 permits a business entity to choose to measure financial instruments and certain other items at fair value to mitigate volatility in reported earnings caused by measuring financial instruments differently without having to apply
complex hedge accounting provisions. The fair value option may be applied instrument by instrument, is irrevocable and is applied only to entire instruments. Following the initial fair value measurement date, a business entity shall report
unrealized gains and losses on financial instruments for which the fair value option has been elected in earnings at each subsequent reporting date. SFAS 159 is effective for financial statements issued for fiscal years beginning after
November 15, 2007, and interim periods within those fiscal years. The Company has not completed its analysis on whether to elect or not to elect the fair value option on the Companys consolidated financial statements at the date of
adoption of SFAS 159.
SFAS No. 160, Noncontrolling Interest in Consolidated Financial Statements, an amendment of ARB
Statement No. 51.
SFAS 160 amends Accounting Research Bulletin (ARB) No. 51, Consolidated Financial Statements, to establish accounting and reporting standards for the non-controlling interest in a subsidiary and
for the deconsolidation of a subsidiary. SFAS 160 clarifies that a non-controlling interest in a subsidiary, which is sometimes referred to as minority interest, is an ownership interest in the consolidated entity that should be reported as a
component of equity in the consolidated financial statements. Among other requirements, SFAS 160 requires consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the non-controlling
interest. It also requires disclosure, on the face of the consolidated income statement, of the amounts of consolidated net income attributable to the parent and to the non-controlling interest. SFAS 160 is effective for the Company on
January 1, 2009, and is not expected to have a significant impact on the Companys financial statements.
SAB No. 109, Written Loan Commitments Recorded at Fair Value Through Earnings.
SAB No. 109 supersedes SAB 105, Application of Accounting Principles to Loan Commitments, and indicates
that the expected net future cash flows related to the associated servicing of the loan should be included in the measurement of all written loan commitments that are accounted for at fair value through earnings. The guidance in SAB 109 is
applied on a prospective basis to derivative loan commitments issued or modified in fiscal quarters beginning after December 15, 2007. SAB 109 is not expected to have a material impact on the Companys financial statements.
F-16
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Emerging Issues Task Force (EITF) Issue No. 06-4, Accounting for Deferred
Compensation and Postretirement Benefit Aspects of Endorsement Split Dollar Life Insurance Arrangements.
EITF 06-4 requires the recognition of a liability and related compensation expense for endorsement split-dollar life insurance
policies that provide a benefit to an employee that extends to post-retirement periods. Under EITF 06-4, life insurance policies purchased for the purpose of providing such benefits do not effectively settle an entitys obligation to the
employee. Accordingly, the entity must recognize a liability and related compensation expense during the employees active service period based on the future cost of insurance to be incurred during the employees retirement. If the entity
has agreed to provide the employee with a death benefit, then the liability for the future death benefit should be recognized by following the guidance in SFAS 106, Employers Accounting for Postretirement Benefits Other Than
Pensions. The Company expects to adopt EITF 06-4 effective as of January 1, 2008. The amount of the adjustment is not expected to be significant.
2. Business Combinations
The Company completed two acquisitions in 2006 and one in 2007 that have all been accounted using
the purchase method of accounting. Accordingly, all assets and liabilities were adjusted to and recorded at their estimated fair values as of the acquisition date. The excess of purchase price over fair value of net assets acquired, if identifiable,
was recorded as a premium on purchased deposits, and if not identifiable, was recorded as goodwill. The estimated tax effect of differences between tax bases and fair value has been reflected in deferred income taxes. The following table presents
information on acquisitions consummated in 2006 and 2007:
|
|
|
|
|
|
|
|
|
|
|
|
United Heritage Bank
|
|
New Asia Bancorp
|
|
Great Eastern Bank
|
|
|
(In thousands)
|
Acquisition Date
|
|
|
March 31, 2007
|
|
|
October 18, 2006
|
|
|
April 7, 2006
|
|
|
|
Assets Acquired:
|
|
|
|
|
|
|
Cash, cash equivalents and short-term investment
|
|
$
|
5,745
|
|
$
|
7,467
|
|
$
|
30,475
|
Securities available-for-sale
|
|
|
14,305
|
|
|
11,394
|
|
|
61,772
|
Loans, net
|
|
|
37,681
|
|
|
115,161
|
|
|
213,841
|
Premises and equipment, net
|
|
|
432
|
|
|
7,851
|
|
|
20,348
|
OREO, net
|
|
|
|
|
|
355
|
|
|
|
Goodwill
|
|
|
3,878
|
|
|
10,765
|
|
|
66,461
|
Core deposit intangible
|
|
|
341
|
|
|
1,505
|
|
|
6,566
|
Other assets
|
|
|
2,371
|
|
|
2,620
|
|
|
7,670
|
|
|
|
|
|
|
|
|
|
|
Total assets acquired
|
|
|
64,753
|
|
|
157,118
|
|
|
407,133
|
|
|
|
|
|
|
|
|
|
|
Liabilities Assumed:
|
|
|
|
|
|
|
|
|
|
Deposits
|
|
|
54,166
|
|
|
114,440
|
|
|
294,047
|
Advances from FHLB
|
|
|
|
|
|
4,500
|
|
|
|
Other liabilities
|
|
|
1,187
|
|
|
14,810
|
|
|
12,113
|
|
|
|
|
|
|
|
|
|
|
Total liabilities assumed
|
|
|
55,353
|
|
|
133,750
|
|
|
306,160
|
|
|
|
|
|
|
|
|
|
|
Net Assets Acquired
|
|
$
|
9,400
|
|
$
|
23,368
|
|
$
|
100,973
|
|
|
|
|
|
|
|
|
|
|
Cash paid
|
|
$
|
9,400
|
|
$
|
12,907
|
|
$
|
56,285
|
Fair value of common stock issued
|
|
|
|
|
|
10,461
|
|
|
44,688
|
|
|
|
|
|
|
|
|
|
|
Total consideration paid
|
|
$
|
9,400
|
|
$
|
23,368
|
|
$
|
100,973
|
|
|
|
|
|
|
|
|
|
|
On April 7, 2006, the Company purchased through a tender offer 84.1% of the common stock of
Great Eastern Bank (GEB) for cash of $40.2 million and 1,181,164 shares of the Companys common stock valued at $44.7 million. The measurement date for the value of the shares of the Companys common stock issued was
March 31, 2006, the earliest date on which the number of shares to be issued became fixed. Following regulatory
F-17
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
approval and a special shareholders meeting of GEB, the merger of GEB into the Bank was completed on May 15, 2006, and the remaining 15.9% of GEBs
common shares was purchased for cash of $16.1 million. The Company made this acquisition to expand its presence in New York City. The assets acquired and liabilities assumed were recorded by the Company at their fair values at April 7, 2006
when 84.1% of GEBs stock was acquired. Because the second step of the acquisition was completed on May 15, 2006, shortly after the acquisition of 84.1% of GEB, the fair values as of April 7, 2006 were used to record both steps of the
acquisition.
On October 18, 2006 the Company completed the acquisition of Chicago-based New Asia Bancorp (NAB) for cash
of $12.9 million and 291,165 shares of the Companys common stock valued at $10.5 million. The Company made this acquisition to expand into the Midwest.
On March 31, 2007, the Company completed the acquisition of New Jersey-based United Heritage Bank (UHB), a one branch bank in Edison, New Jersey, to expand into the New Jersey market. The purchase
price was $9.4 million in cash.
Loans acquired in 2006 as part of the GEB and NAB acquisitions that were determined to be impaired and
therefore within the scope of Statement of Position (SOP) 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer were recorded at their net realizable value of $2.4 million without any allocation of the allowance
for loan losses. The remainder of the loan portfolio was comprised of loans not considered to be impaired and therefore excluded from the scope of SOP 03-3. No loans acquired as part of the acquisition of UHB in 2007 were determined to be impaired.
For each acquisition, we developed an integration plan for the consolidated company that addressed, among other things, requirements for
staffing, systems platforms, branch locations, and other facilities. The established plans are evaluated regularly during the integration process and modified as required. Merger and integration expenses are summarized in the following primary
categories: (i) severance and employee-related charges; (ii) system conversion and integration costs, including contract termination charges; (iii) asset write-downs, lease termination costs for abandoned space and other
facilities-related costs; and (iv) other charges. Other charges include investment banking fees, legal fees, other professional fees relating to due diligence activities and expenses associated with preparation of securities filings, as
appropriate. Costs associated with exiting activities and without future economic benefit were included in the allocation of the purchase price at the acquisition date based on our formal integration plans.
The following table presents the activity in the merger-related liability account that was allocated to the purchase price:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Severance
and
Employee-
related
|
|
|
Asset
Write-
downs
|
|
|
Legal and
Professional
Fees
|
|
|
Lease
Liability
|
|
|
Total
|
|
|
|
(In thousands)
|
|
Balance at December 31, 2005
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
396
|
|
|
$
|
396
|
|
Acquisitions
|
|
|
1,213
|
|
|
|
130
|
|
|
|
1,404
|
|
|
|
536
|
|
|
|
3,283
|
|
Non-cash write-downs and other
|
|
|
|
|
|
|
(130
|
)
|
|
|
|
|
|
|
|
|
|
|
(130
|
)
|
Cash outlays
|
|
|
(1,176
|
)
|
|
|
|
|
|
|
(1,399
|
)
|
|
|
(154
|
)
|
|
|
(2,729
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2006
|
|
|
37
|
|
|
|
0
|
|
|
|
5
|
|
|
|
778
|
|
|
|
820
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Acquisitions
|
|
|
300
|
|
|
|
17
|
|
|
|
421
|
|
|
|
|
|
|
|
738
|
|
Non-cash write-downs and other
|
|
|
|
|
|
|
(17
|
)
|
|
|
|
|
|
|
|
|
|
|
(17
|
)
|
Cash outlays
|
|
|
(337
|
)
|
|
|
|
|
|
|
(426
|
)
|
|
|
(172
|
)
|
|
|
(935
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2007
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
606
|
|
|
$
|
606
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
F-18
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, goodwill will
not be expensed over a fixed period of time, but will be tested for impairment on an annual basis. None of the goodwill is expected to be deductible for income tax purposes. Core deposit intangibles are amortized over their estimated useful life to
their estimated residual value in proportion to the economic benefits consumed. Amortization expense for the core deposit intangible was $7.1 million for 2007, $6.5 million for 2006, and $6.0 million for 2005. Accumulated amortization was $25.1
million at December 31, 2007, and $18.3 million at December 31, 2006.
Goodwill increased $77.3 million in 2006 due to the
acquisitions of GEB and NAB and increased $3.1 million in 2007 primarily due to the acquisition of UHB. The goodwill balance was $319.9 million as of December 2007 and $316.8 million as of December 31, 2006.
In May 2006, the Company purchased an additional 145,000 shares of the stock of Broadway Financial Corporation (the BFC), which is
headquartered in Los Angeles, California, for $1.7 million, thereby increasing its total ownership of BFC to 215,000 shares, or 13.1%. These shares have not been registered under the Securities Act of 1933 and may not be sold, offered for sale,
pledged or hypothecated in the absence of an effective registration or an applicable exemption to registration. The Company accounts for the BFC investment on the cost method due to the restricted nature of the shares and the less than 20%
ownership. As of December 31, 2007, the investment in BFC totaled $1.9 million, net of a $746,000 other-than-temporary impairment write-down in 2007, which amount is included in other assets.
3. Cash and Cash Equivalents
The Company manages its
cash and cash equivalents, which consist of cash on hand, amounts due from banks, federal funds sold, and short-term investments with original maturity of three months or less, based upon the Companys operating, investment, and financing
activities. For the purpose of reporting cash flows, these same accounts are included in cash and cash equivalents.
The Company is required
to maintain reserves with the Federal Reserve Bank. Reserve requirements are based on a percentage of deposit liabilities. The average reserve balances required were $3.5 million for 2007 and $3.5 million for 2006. At December 31, 2006, the
Company maintained $14.2 million in deposits with two other banks under the terms of a loan participation agreement and such amounts are reported in short-term investments. These deposits were withdrawn during 2007.
The following table sets forth information with respect to federal funds sold:
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
|
(In thousands)
|
|
Balance, December 31
|
|
$
|
|
|
|
$
|
18,000
|
|
Annualized weighted-average interest rate, December 31
|
|
|
0.00
|
%
|
|
|
5.07
|
%
|
Average amount outstanding during the year (1)
|
|
$
|
17,990
|
|
|
$
|
4,340
|
|
Weighted-average interest rate for the year
|
|
|
4.93
|
%
|
|
|
4.49
|
%
|
Maximum amount outstanding at any month end
|
|
$
|
111,000
|
|
|
$
|
22,000
|
|
(1)
|
Average balance was computed using daily averages.
|
F-19
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
4. Securities Purchased under Agreements to Resell
Securities purchased under agreements to resell are usually collateralized by U.S. government agency and mortgage-backed securities. The counter-parties
to these agreements are nationally recognized investment banking firms that meet credit requirements of the Company and with whom a master repurchase agreement has been duly executed. As of December 31, 2007, the Company entered into nine
long-term resale agreements totaling $450.0 million. The agreements have terms of ten years with interest rates ranging from 7.15%, to 8.30%. The counterparty has the right to a quarterly call. Among these agreements, $150.0 million are callable
after the first year and $300.0 million are callable after the first three months. When the callable term starts if certain conditions are met, there may be no interest earned for those days when the certain conditions are met. In addition to
long-term agreements, the Company entered into a $66.1 million short term resale agreement at a weighted rate of 4.55% that matured in January 2008.
Securities purchased under agreements to resell were $516.1 million at an annualized weighted average interest rate of 7.55% at December 31, 2007. There were no securities purchased under agreements to resell
during 2006. The following table sets forth information with respect to securities purchased under resell agreements.
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
(In thousands)
|
Balance, December 31
|
|
$
|
516,100
|
|
|
$
|
|
Annualized weighted-average interest rate, December 31
|
|
|
7.55
|
%
|
|
|
|
Average amount outstanding during the year (1)
|
|
$
|
300,788
|
|
|
$
|
|
Weighted-average interest rate for the year
|
|
|
7.79
|
%
|
|
|
|
Maximum amount outstanding at any month end
|
|
$
|
516,100
|
|
|
$
|
|
(1)
|
Average balance was computed using daily averages.
|
For
those securities obtained under the resale agreements, the collateral is either held by a third party custodian or by the counter-party and is segregated under written agreements that recognize the Companys interest in the securities. Interest
income associated with securities purchased under resale agreements totaled $23.4 million for 2007, zero for 2006, and $3,000 for 2005.
F-20
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
5. Securities
Securities Available-for-Sale.
The following table reflects the amortized cost, gross unrealized gains, gross unrealized losses, and fair values of securities available-for-sale as of December 31, 2007,
and December 31, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortized
Cost
|
|
Gross
Unrealized
Gains
|
|
Gross
Unrealized
Losses
|
|
Fair Value
|
|
|
|
|
|
|
|
|
|
(In thousands)
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. government sponsored entities
|
|
$
|
532,894
|
|
$
|
1,735
|
|
$
|
19
|
|
$
|
534,610
|
State and municipal securities
|
|
|
33,657
|
|
|
388
|
|
|
24
|
|
|
34,021
|
Mortgage-backed securities
|
|
|
1,320,963
|
|
|
9,920
|
|
|
5,835
|
|
|
1,325,048
|
Commercial mortgage-backed securities
|
|
|
9,189
|
|
|
|
|
|
271
|
|
|
8,918
|
Collateralized mortgage obligations
|
|
|
215,015
|
|
|
89
|
|
|
3,867
|
|
|
211,237
|
Asset-backed securities
|
|
|
603
|
|
|
|
|
|
2
|
|
|
601
|
Corporate bonds
|
|
|
126,535
|
|
|
|
|
|
841
|
|
|
125,694
|
Preferred stock of government sponsored entities
|
|
|
34,750
|
|
|
403
|
|
|
2,785
|
|
|
32,368
|
Foreign corporate bonds
|
|
|
75,000
|
|
|
168
|
|
|
|
|
|
75,168
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
2,348,606
|
|
$
|
12,703
|
|
$
|
13,644
|
|
$
|
2,347,665
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. treasury securities
|
|
$
|
994
|
|
$
|
|
|
$
|
1
|
|
$
|
993
|
U.S. government sponsored entities
|
|
|
364,988
|
|
|
67
|
|
|
3,556
|
|
|
361,499
|
State and municipal securities
|
|
|
54,843
|
|
|
769
|
|
|
80
|
|
|
55,532
|
Mortgage-backed securities
|
|
|
549,150
|
|
|
687
|
|
|
15,070
|
|
|
534,767
|
Commercial mortgage-backed securities
|
|
|
20,554
|
|
|
|
|
|
588
|
|
|
19,966
|
Collateralized mortgage obligations
|
|
|
251,997
|
|
|
46
|
|
|
6,417
|
|
|
245,626
|
Asset-backed securities
|
|
|
783
|
|
|
|
|
|
3
|
|
|
780
|
Corporate bonds
|
|
|
206,008
|
|
|
325
|
|
|
396
|
|
|
205,937
|
Preferred stock of government sponsored entities
|
|
|
19,350
|
|
|
2,660
|
|
|
|
|
|
22,010
|
Foreign corporate bonds
|
|
|
75,000
|
|
|
126
|
|
|
13
|
|
|
75,113
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
1,543,667
|
|
$
|
4,680
|
|
$
|
26,124
|
|
$
|
1,522,223
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The amortized cost and fair value of securities available-for-sale at December 31, 2007, by
contractual maturities are shown below, except for mortgage-backed securities, collateralized mortgage obligations, and equity securities which are shown by expected maturities. Actual maturities may differ from contractual maturities because
borrowers may have the right to call or repay obligations with or without call or repayment penalties.
|
|
|
|
|
|
|
|
|
Amortized
Cost
|
|
Fair Value
|
|
|
(In thousands)
|
Due in one year or less
|
|
$
|
9,252
|
|
$
|
9,260
|
Due after one year through five years
|
|
|
552,983
|
|
|
554,617
|
Due after five years through ten years
|
|
|
231,026
|
|
|
230,744
|
Due after ten years (1)
|
|
|
1,555,345
|
|
|
1,553,044
|
|
|
|
|
|
|
|
Total
|
|
$
|
2,348,606
|
|
$
|
2,347,665
|
|
|
|
|
|
|
|
(1)
|
Equity securities are reported in this category.
|
F-21
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Proceeds from sales, calls, and repayments of securities available-for-sale were $1.28 billion during
2007, $369.4 million during 2006, and $555.5 million during 2005. In 2007, gains of $2.9 million and losses of $2.1 million were realized on sales and calls of securities available-for-sale compared with $259,000 in gains and $58,000 in losses
realized in 2006, and $3.1 million in gains and $1.6 million in losses realized in 2005.
Declines in the fair value of available-for-sale
securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers, among other things, (i) the length of time and the
extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, and (iii) the intent and ability of the Company to retain its investment in the issuer for a period of time
sufficient to allow for any anticipated recovery in fair value. The new cost basis is not changed for subsequent recoveries in fair value.
The Company periodically evaluates its investments for other-than-temporary impairment. The Company has investments in perpetual floating rate preferred securities issued by Freddie Mac and Fannie Mae with an aggregate par value of $38
million as of December 31, 2007, and $25 million as of December 31, 2006. Based on an evaluation of the length of time and extent to which the market value of the Banks portfolio of preferred stock has been less than market and the
financial condition and near-term prospects of the issuers, the Bank recorded other-than-temporary impairment charges of zero in 2007, $35,000 in 2006, and $115,000 in 2005 to write down the value of these securities to their market value. In the
first quarter of 2007, the Company sold 200,000 shares of its Freddie Mac preferred stock which had been written down by $2.4 million in 2004 and recorded a gain of $2.2 million.
Between 2002 and 2004, the Company purchased a number of collateralized mortgage obligations comprised of interests in non-agency guaranteed residential
mortgages. At December 31, 2007, the remaining par value of these securities was $198.6 million which represents 8.5% of the fair value of the Companys securities available-for-sale and 1.9% of the Companys total assets. At
December 31, 2007, the unrealized loss for these securities was $3.9 million which represented 1.9% of the par amount of these non-agency guaranteed residential mortgages. Based on the Companys analysis at December 31, 2007, there
was no other-than-temporary impairment in these securities due to the low loan to value ratio for the loan underlying these securities, the credit support provided by junior tranches of these securitizations and the continued AAA rating
of these securities. The Company has the ability and intent to hold the securities, including the non-agency collateralized mortgage obligations securities discussed above with unrealized losses of $3.9 million and $1.33 billion of agency mortgaged
back securities with unrealized losses of $5.8 million, for a period of time sufficient for a recovery of cost for those issues with unrealized losses.
The temporarily impaired securities represent 30.6% of the fair value of the Companys securities as of December 31, 2007. Unrealized losses for securities with unrealized losses for less than twelve months
represent 2.3%, and securities with unrealized losses for twelve months or more represent 1.7% of the historical cost of these securities and generally resulted from increases in interest rates subsequent to the date that these securities were
purchased. Except for one corporate bond issue with fair value of $132,000, all of these securities are investment grade, as of December 31, 2007. At December 31, 2007, 102 issues of securities had unrealized losses for 12 months or longer
and 30 issues of securities had unrealized losses of less than 12 months.
F-22
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
At December 31, 2007, management believes the impairment is temporary and, accordingly, no
impairment loss has been recognized in the Companys consolidated statements of income. The table below shows the fair value, unrealized losses, and number of issuances as of December 31, 2007, of the temporarily impaired securities in the
Companys available-for-sale securities portfolio:
Temporarily Impaired Securities as of December 31, 2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Description of securities
|
|
Less than 12 months
|
|
12 months or longer
|
|
Total
|
|
Fair Value
|
|
Unrealized
Losses
|
|
No. of
Issuances
|
|
Fair Value
|
|
Unrealized
Losses
|
|
No. of
Issuances
|
|
Fair Value
|
|
Unrealized
Losses
|
|
No. of
Issuances
|
|
|
(Dollars in thousands)
|
U.S. government sponsored entities
|
|
$
|
481
|
|
$
|
19
|
|
2
|
|
$
|
|
|
$
|
|
|
|
|
$
|
481
|
|
$
|
19
|
|
2
|
State and municipal securities
|
|
|
|
|
|
|
|
|
|
|
1,106
|
|
|
24
|
|
2
|
|
|
1,106
|
|
|
24
|
|
2
|
Mortgage-backed securities
|
|
|
980
|
|
|
5
|
|
7
|
|
|
377,751
|
|
|
5,830
|
|
72
|
|
|
378,731
|
|
|
5,835
|
|
79
|
Commercial mortgage-backed securities
|
|
|
|
|
|
|
|
|
|
|
8,918
|
|
|
271
|
|
1
|
|
|
8,918
|
|
|
271
|
|
1
|
Collateralized mortgage obligations
|
|
|
16,128
|
|
|
166
|
|
5
|
|
|
170,562
|
|
|
3,701
|
|
26
|
|
|
186,690
|
|
|
3,867
|
|
31
|
Asset-backed securities
|
|
|
525
|
|
|
1
|
|
1
|
|
|
76
|
|
|
1
|
|
1
|
|
|
601
|
|
|
2
|
|
2
|
Corporate bonds
|
|
|
125,195
|
|
|
841
|
|
11
|
|
|
|
|
|
|
|
|
|
|
125,195
|
|
|
841
|
|
11
|
Preferred stock of government sponsored entities
|
|
|
17,590
|
|
|
2,785
|
|
4
|
|
|
|
|
|
|
|
|
|
|
17,590
|
|
|
2,785
|
|
4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
160,899
|
|
$
|
3,817
|
|
30
|
|
$
|
558,413
|
|
$
|
9,827
|
|
102
|
|
$
|
719,312
|
|
$
|
13,644
|
|
132
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Securities having a carrying value of $1.88 billion at December 31, 2007, and $884.8 million
at December 31, 2006, were pledged to secure public deposits, other borrowings, treasury tax and loan, Federal Home Loan Bank advances, and securities sold under agreements to repurchase.
6. Loans
Most of the Companys business
activity is predominately with Asian customers located in Southern and Northern California; New York City; Houston and Dallas, Texas; Seattle, Washington; Boston, Massachusetts; Chicago, Illinois; and Edison, New Jersey. The Company has no specific
industry concentration, and generally its loans are collateralized with real property or other pledged collateral of the borrowers. Loans are generally expected to be paid off from the operating profits of the borrowers, refinancing by another
lender, or through sale by the borrowers of the secured collateral.
F-23
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
The components of loans in the consolidated balance sheets as of December 31, 2007, and
December 31, 2006, were as follows:
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
|
(In thousands)
|
|
Type of Loans:
|
|
|
|
|
|
|
|
|
Commercial loans
|
|
$
|
1,435,861
|
|
|
$
|
1,243,756
|
|
Residential mortgage loans
|
|
|
555,703
|
|
|
|
455,949
|
|
Commercial mortgage loans
|
|
|
3,762,689
|
|
|
|
3,226,658
|
|
Equity lines
|
|
|
108,004
|
|
|
|
118,473
|
|
Real estate construction loans
|
|
|
799,230
|
|
|
|
685,206
|
|
Installment loans
|
|
|
15,099
|
|
|
|
13,257
|
|
Other loans
|
|
|
7,059
|
|
|
|
4,247
|
|
|
|
|
|
|
|
|
|
|
Gross loans
|
|
|
6,683,645
|
|
|
|
5,747,546
|
|
|
|
|
|
|
|
|
|
|
Less:
|
|
|
|
|
|
|
|
|
Allowance for loan losses
|
|
|
(64,983
|
)
|
|
|
(60,220
|
)
|
Unamortized deferred loan fees
|
|
|
(10,583
|
)
|
|
|
(11,984
|
)
|
|
|
|
|
|
|
|
|
|
Net loans
|
|
$
|
6,608,079
|
|
|
$
|
5,675,342
|
|
|
|
|
|
|
|
|
|
|
There were no loans held for sale as of December 31, 2007, and December 31, 2006. At
December 31, 2007, all of the Companys eligible real estate loans were pledged to the Federal Home Loan Bank of San Francisco under its blanket lien program.
Loans serviced for others as of December 31, 2007, totaled $245.5 million and were comprised of $61.4 million of commercial loans, $66.6 million of commercial real estate loans, $116.0 million in construction
loans, and $1.5 million of residential mortgages.
The Company has entered into transactions with its directors, executive officers, or
principal holders of its equity securities, or the associates of such persons (Related Parties). Such transactions were made in the ordinary course of business on substantially the same terms and conditions, including interest rates and
collateral, as those prevailing at the same time for comparable transactions with customers who are not related parties. In managements opinion, these transactions did not involve more than normal credit risk or present other unfavorable
features. All loans to Related Parties were current as of December 31, 2007. An analysis of the activity with respect to loans to Related Parties for the years indicated is as follows:
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
|
(In thousands)
|
|
Balance at beginning of year
|
|
$
|
66,871
|
|
|
$
|
106,433
|
|
Additional loans made
|
|
|
238,980
|
|
|
|
128,482
|
|
Payment received
|
|
|
(169,969
|
)
|
|
|
(168,044
|
)
|
|
|
|
|
|
|
|
|
|
Balance at end of year
|
|
$
|
135,882
|
|
|
$
|
66,871
|
|
|
|
|
|
|
|
|
|
|
F-24
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
The allowance for loan losses and the reserve for off-balance sheet credit commitments are
significant estimates that can and do change based on managements process in analyzing the loan portfolio and on managements assumptions about specific borrowers and applicable economic and environmental conditions, among other factors.
An analysis of the activity in the allowance for credit losses for the years indicated is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
|
(In thousands)
|
|
Allowance for Loan Losses
|
|
|
|
|
Balance at beginning of year
|
|
$
|
60,220
|
|
|
$
|
56,438
|
|
|
$
|
58,832
|
|
Provision/(reversal) for credit losses
|
|
|
11,000
|
|
|
|
2,000
|
|
|
|
(500
|
)
|
Transfers to reserve for off-balance sheet credit commitments
|
|
|
(107
|
)
|
|
|
(656
|
)
|
|
|
235
|
|
Loans charged off
|
|
|
(10,074
|
)
|
|
|
(2,030
|
)
|
|
|
(5,215
|
)
|
Recoveries of charged off loans
|
|
|
3,512
|
|
|
|
1,315
|
|
|
|
3,086
|
|
Allowance from acquisitions
|
|
|
432
|
|
|
|
3,153
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at end of year
|
|
$
|
64,983
|
|
|
$
|
60,220
|
|
|
$
|
56,438
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reserve for Off-balance Sheet Credit Commitments
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at beginning of year
|
|
$
|
4,469
|
|
|
$
|
3,813
|
|
|
$
|
4,048
|
|
Provision (reversal) for credit losses/transfers
|
|
|
107
|
|
|
|
656
|
|
|
|
(235
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at end of year
|
|
$
|
4,576
|
|
|
$
|
4,469
|
|
|
$
|
3,813
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Company had identified impaired loans with a recorded investment of approximately $70.0
million as of December, 2007, $22.3 million as of December 31, 2006, and $15.8 million as of December 31, 2005. The average balance of impaired loans was $46.0 million for 2007, $20.5 million for 2006, and $15.6 million for 2005. Interest
collected on impaired loans totaled $3.7 million in 2007, $0.9 million in 2006, and $0.2 million in 2005. The Bank recognizes interest income on impaired loans based on its existing method of recognizing interest income on non-accrual loans. The
following tables present impaired loans and the related allowance as of the dates indicated:
|
|
|
|
|
|
|
|
|
At December 31,
|
|
|
2007
|
|
2006
|
|
|
(In thousands)
|
Balance of impaired loans with no allocated allowance
|
|
$
|
50,249
|
|
$
|
10,522
|
Balance of impaired loans with an allocated allowance
|
|
|
19,701
|
|
|
11,800
|
|
|
|
|
|
|
|
Total recorded investment in impaired loans
|
|
$
|
69,950
|
|
$
|
22,322
|
|
|
|
|
|
|
|
Amount of the allowance allocated to impaired loans
|
|
$
|
4,937
|
|
$
|
4,310
|
|
|
|
|
|
|
|
The impaired loans included in the table above were comprised of $6.7 million in commercial loans
and $63.3 million in real estate loans as of December 31, 2007, and were comprised of $14.4 million in commercial loans and $7.9 million in real estate loans as of December 31, 2006.
Accruing loans past due 90 days or more were $9.3 million at December 31, 2007, $8.0 million at December 31, 2006, and $2.1 million at
December 31, 2005.
F-25
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
The following is a summary of non-accrual loans as of December 31, 2007, 2006, and 2005 and the
related net interest foregone for the years then ended:
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
2006
|
|
2005
|
|
|
(In thousands)
|
Non-accrual Loans
|
|
$
|
58,275
|
|
$
|
22,322
|
|
$
|
15,799
|
|
|
|
|
|
|
|
|
|
|
Contractual interest due
|
|
|
5,324
|
|
|
1,851
|
|
|
1,308
|
Interest recognized
|
|
|
2,756
|
|
|
851
|
|
|
157
|
|
|
|
|
|
|
|
|
|
|
Net interest foregone
|
|
$
|
2,568
|
|
$
|
1,000
|
|
$
|
1,151
|
|
|
|
|
|
|
|
|
|
|
During the fourth quarter of 2006, the Company recognized $1.47 million of interest income, which
is not reflected in the table above for 2006 amounts, from the full payoff of a loan that had been on non-accrual status since 2004. As of December 31, 2007, there were no commitments to lend additional funds to those borrowers whose loans have
been restructured, were considered impaired, or were on non-accrual status.
Approximately $3.0 million of loans acquired in the
acquisition of Great Eastern Bank and New Asia Bank had evidence of deterioration of credit quality since origination and it was probable that all contractually required payments receivable would not be collected on these loans. These loans were
recorded at their fair value of $2.4 million with no associated allowance for loan losses in accordance with AICPA Statement of Position (SOP) 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer. No
loans acquired as part of the acquisition of UHB were determined to be impaired and therefore no loans were within the scope of SOP 03-3. Additional disclosures required by SOP 03-3 are not provided because the amounts are not significant.
As of December 31, 2007, the Company has one aircraft leveraged lease in a Boeing 737, which is leased to Continental Airlines until
2012, with a book value of $4.7 million. As of December 31, 2007, the aircraft was subject to $7.7 million of third-party financing in the form of long-term debt that provides for no recourse against the Company and is secured by a first lien
on the aircraft. The residual value at the end of the lease term is estimated to be $1.9 million based on an independent updated appraisal. For Federal income tax purposes, the Company has the benefit of tax deductions for depreciation on the entire
leased asset and for interest paid on the long-term debt. Deferred taxes are provided to reflect the temporary differences associated with the leveraged lease.
The Companys investment in the leveraged lease at December 31, 2007, was comprised of rentals receivable, net of the principal and interest on the non-recourse debt, of $3.4 million, estimated residual
value of $1.9 million, and deferred income of $0.4 million. Total deferred tax liabilities were $5.8 million at December 31, 2007. No income was recorded on the Continental Airlines leveraged lease during the three years from 2005 to 2007.
Through December 31, 2007, Continental Airlines had made all scheduled lease payments and had performed in accordance with its contractual terms.
7. Other Real Estate Owned
As of December 31, 2007, other real estate owned consisted of five properties with a net
carrying value of $16.1 million compared with a net carrying value of $5.3 million at December 31, 2006.
F-26
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
An analysis of the activity in the valuation allowance for other real estate losses for the years
ended on December 31, 2007, 2006, and 2005 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
2005
|
|
|
(In thousands)
|
Balance, beginning of year
|
|
$
|
283
|
|
|
$
|
|
|
$
|
|
Provision for losses
|
|
|
210
|
|
|
|
283
|
|
|
|
OREO disposal
|
|
|
(283
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, end of year
|
|
$
|
210
|
|
|
$
|
283
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
The following table presents the components of other real estate owned expense (income) for the
year ended:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
|
(In thousands)
|
|
Operating expense
|
|
$
|
153
|
|
|
$
|
344
|
|
|
$
|
109
|
|
Provision for losses
|
|
|
210
|
|
|
|
283
|
|
|
|
|
|
Net gain on disposal
|
|
|
(29
|
)
|
|
|
(31
|
)
|
|
|
(155
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other real estate owned expense (income)
|
|
$
|
334
|
|
|
$
|
596
|
|
|
$
|
(46
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8. Investments in Affordable Housing
The Company has invested in certain limited partnerships that were formed to develop and operate housing for lower-income tenants throughout the United
States. The Companys investments in these partnerships were $94.0 million at December 31, 2007, and $87.3 million at December 31, 2006. At December 31, 2007, six of the limited partnerships and at December 31, 2006, five of
the limited partnerships in which the Company has an equity interest were determined to be variable interest entities for which the Company is the primary beneficiary. The consolidation of these limited partnerships in the Companys
consolidated financial statements increased total assets and liabilities by $22.5 million at December 31, 2007, and by $21.0 million at December 31, 2006. Other borrowings for affordable housing limited partnerships were $19.6 million
at December 31, 2007 and $20.0 million at December 31, 2006; recourse is limited to the assets of the limited partnerships. Unfunded commitments for affordable housing limited partnerships of $19.2 million as of December 31, 2007, and
$21.3 million as of December 31, 2006 were recorded under other liabilities.
Each of the partnerships must meet regulatory
requirements for affordable housing for a minimum 15-year compliance period to fully utilize the tax credits. If the partnerships cease to qualify during the compliance period, the credits may be denied for any period in which the projects are not
in compliance and a portion of the credits previously taken is subject to recapture with interest. The remaining tax credits to be utilized over a multiple-year period are $69.9 million for Federal and $1.9 million for state at December 31,
2007. The Companys usage of tax credits approximated $8.4 million in 2007, $7.7 million in 2006, and $5.2 million in 2005. For the year ended December 31, operations of investments in affordable housing resulted in pretax losses of $6.6
million for 2007, $5.4 million for 2006, and $4.0 million for 2005. Losses in excess of the Banks investment in two limited partnerships have not been recorded in the Companys consolidated financial statements because the Company had
fully satisfied all capital commitments required under the respective limited partnership agreements.
F-27
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
9. Premises and Equipment
Premises and equipment consisted of the following at December 31, 2007, and December 31, 2006:
|
|
|
|
|
|
|
|
|
2007
|
|
2006
|
|
|
(In thousands)
|
Land and land improvements
|
|
$
|
31,468
|
|
$
|
33,794
|
Building and building improvements
|
|
|
32,052
|
|
|
31,037
|
Furniture, fixtures and equipment
|
|
|
25,730
|
|
|
23,393
|
Leasehold Improvement
|
|
|
12,196
|
|
|
9,644
|
Construction in process
|
|
|
5,992
|
|
|
1,826
|
|
|
|
|
|
|
|
|
|
|
107,438
|
|
|
99,694
|
Less: Accumulated depreciation/amortization
|
|
|
30,590
|
|
|
26,760
|
|
|
|
|
|
|
|
Premises and equipment, net
|
|
$
|
76,848
|
|
$
|
72,934
|
|
|
|
|
|
|
|
The amount of depreciation/amortization included in operating expense was $4.3 million in 2007,
$3.8 million in 2006, and $3.8 million in 2005.
10. Deposits
The following table displays deposit balances as of December 31, 2007, and December 31, 2006:
|
|
|
|
|
|
|
|
|
2007
Amount
|
|
2006
Amount
|
|
|
(Dollars in thousands)
|
Demand
|
|
$
|
785,364
|
|
$
|
781,492
|
NOW accounts
|
|
|
231,583
|
|
|
239,589
|
Money market accounts
|
|
|
681,783
|
|
|
657,689
|
Saving accounts
|
|
|
331,316
|
|
|
358,827
|
Time deposits
|
|
|
4,248,321
|
|
|
3,637,709
|
|
|
|
|
|
|
|
Total
|
|
$
|
6,278,367
|
|
$
|
5,675,306
|
|
|
|
|
|
|
|
Time deposits outstanding as of December 31, 2007, mature as follows.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2008
|
|
2009
|
|
2010
|
|
2011
|
|
2012
|
|
Thereafer
|
|
Total
|
|
|
(In thousands)
|
Time deposits, $100,000 and over
|
|
$
|
2,885,058
|
|
$
|
42,167
|
|
$
|
8,504
|
|
$
|
691
|
|
$
|
650
|
|
$
|
|
|
$
|
2,937,070
|
Other time deposits
|
|
|
1,280,379
|
|
|
23,098
|
|
|
7,335
|
|
|
302
|
|
|
123
|
|
|
14
|
|
|
1,311,251
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
4,165,437
|
|
$
|
65,265
|
|
$
|
15,839
|
|
$
|
993
|
|
$
|
773
|
|
$
|
14
|
|
$
|
4,248,321
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
F-28
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Accrued interest payable on customer deposits was $20.4 million at December 31, 2007, and $16.7
million at December 31, 2006. The following table summarizes the interest expense on deposits by account type for the years ended December 31, 2007, 2006, and 2005:
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2007
|
|
2006
|
|
2005
|
|
|
(In thousands)
|
Interest bearing demand
|
|
$
|
2,823
|
|
$
|
2,796
|
|
$
|
1,492
|
Money market accounts
|
|
|
21,531
|
|
|
16,145
|
|
|
7,537
|
Saving accounts
|
|
|
3,258
|
|
|
3,416
|
|
|
1,992
|
Time deposits
|
|
|
181,891
|
|
|
137,734
|
|
|
81,587
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
209,503
|
|
$
|
160,091
|
|
$
|
92,608
|
|
|
|
|
|
|
|
|
|
|
11. Borrowed Funds
Federal Funds Purchased.
Federal funds purchased were $41.0 million at December 31, 2007, and $50.0 million at December 31, 2006. The table below provides comparative data for federal funds purchased:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
|
(Dollars in thousands)
|
|
Average amount outstanding during the year (1)
|
|
$
|
32,190
|
|
|
$
|
43,407
|
|
|
$
|
43,981
|
|
Maximum amount outstanding at month-end (2)
|
|
|
98,000
|
|
|
|
75,000
|
|
|
|
119,000
|
|
Balance, December 31
|
|
|
41,000
|
|
|
|
50,000
|
|
|
|
119,000
|
|
Rate at year-end
|
|
|
4.00
|
%
|
|
|
5.31
|
%
|
|
|
4.21
|
%
|
Weighted-average interest rate for the year
|
|
|
5.01
|
%
|
|
|
5.06
|
%
|
|
|
3.37
|
%
|
(1)
|
Average balances were computed using daily averages.
|
(2)
|
Highest month-end balances were September 2007, April 2006 and December 2005.
|
Securities Sold under Agreements to Repurchase.
Securities sold under agreements to repurchase were $1.4 billion with a weighted average rate of 3.57% at December 31, 2007, compared to $400.0 million with
a weighted average rate of 4.40% at December 31, 2006. Seventeen floating-to-fixed rate agreements totaling $900.0 million are with initial floating rates for a period of time ranging from six months to one year, with the floating rates ranging
from the three-month LIBOR minus 100 basis points to the three-month LIBOR minus 340 basis points. Thereafter, the rates are fixed for the remainder of the term, with interest rates ranging from 4.29% to 5.07%. After the initial floating rate term,
the counterparties have the right to terminate the transaction at par at the fixed rate reset date and quarterly thereafter. Eight fixed-to-floating rate agreements totaling $400.0 million are with initial fixed rates ranging from 2.70% and 3.50%
with initial fixed rate terms ranging from six months to one year. For the remainder of the seven year term, the rates float at 8% minus the three-month LIBOR rate with a maximum rate ranging from 3.50% to 3.75% and minimum rate of 0.0%. After the
initial fixed rate term, the counterparties have the right to terminate the transaction at par at the floating rate reset date and quarterly thereafter. In addition, there were three short term repurchase agreements totaling $91.0 million which
matured before February 1, 2008, with a weighted average interest rate of 5.37% at December 31, 2007. At December 31, 2007, included in long-term transactions are nine repurchase agreements totaling $450.0 million that were callable
but which had not been called. Two repurchase agreements of $50.0 million each have fixed interest rates at 4.75% and 4.79% until their final maturities in March 2011. Seven repurchase agreements of $50.0 million each have fixed interest rates
ranging from 4.29% to 4.61%, until their final maturities in the first half of 2014.
F-29
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
These transactions are accounted for as collateralized financing transactions and recorded at the
amounts at which the securities were sold. The Company may have to provide additional collateral for the repurchase agreements, as necessary. The underlying collateral pledged for the repurchase agreements consists of U.S. government agency security
debt and mortgage-backed securities with a fair value of $1.5 billion as of December 31, 2007, and $437.8 million as of December 31, 2006. The table below provides comparative data for securities sold under agreements to repurchase:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
|
(Dollars in thousands)
|
|
Average amount outstanding during the year (1)
|
|
$
|
941,380
|
|
|
$
|
374,356
|
|
|
$
|
18,449
|
|
Maximum amount outstanding at month-end (2)
|
|
|
1,391,025
|
|
|
|
445,000
|
|
|
|
200,000
|
|
Balance, December 31
|
|
|
1,391,025
|
|
|
|
400,000
|
|
|
|
200,000
|
|
Rate at year-end
|
|
|
3.57
|
%
|
|
|
4.40
|
%
|
|
|
3.41
|
%
|
Weighted-average interest rate for the year
|
|
|
3.72
|
%
|
|
|
4.19
|
%
|
|
|
3.39
|
%
|
(1)
|
Average balances were computed using daily averages.
|
(2)
|
Highest month-end balances were December 2007, July 2006 and December 2005.
|
Advances from the Federal Home Loan Bank.
Total advances from the FHLB of San Francisco increased $660.5 million to $1.38 billion at December 31, 2007, from $714.7 million at December 31, 2006.
Non-puttable advances totaled $675.2 million with a weighted rate of 4.74% and puttable advances totaled $700.0 million with a weighted average rate of 4.42% at December 31, 2007. The FHLB has the right to terminate the puttable transaction at
par on the first anniversary date in the first quarter of 2008 and quarterly thereafter for $300.0 million of the advances and on the second anniversary date in 2009 and quarterly thereafter for $400.0 million of the advances. At December 31,
2007, the total unused borrowing capacity under the Banks line of credit with the FHLB was $73.9 million. The Banks line of credit with the FHLB is non-cancelable as long as the Bank is a member of the FHLB and has pledged adequate
collateral and is available without payment of a commitment fee. The following relates to the outstanding advances at December 31, 2007 and 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
Maturity
|
|
Amount
(In thousands)
|
|
Weighted Average
Interest Rate
|
|
|
Amount
(In thousands)
|
|
Weighted Average
Interest Rate
|
|
Within 90 days
|
|
$
|
530,000
|
|
4.53
|
%
|
|
$
|
565,000
|
|
5.37
|
%
|
91 days through 365 days
|
|
|
|
|
|
|
|
|
1,000
|
|
4.83
|
|
1 2 years
|
|
|
|
|
|
|
|
|
3,500
|
|
5.08
|
|
2 4 years
|
|
|
145,180
|
|
5.51
|
|
|
|
|
|
|
|
4 5 years
|
|
|
700,000
|
|
4.42
|
|
|
|
145,180
|
|
5.51
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
1,375,180
|
|
4.58
|
%
|
|
$
|
714,680
|
|
5.40
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2007, the Company had approved overnight credit lines of $261.0 million
with other financial institutions including an outstanding amount of $41.0 million. Credit lines can be drawn upon if other financial institutions have funds available. There are no commitment fees for these credit lines.
Line of Credit.
On May 31, 2005, the Bancorp entered into a $30.0 million 364-day unsecured revolving loan agreement with a commercial bank
bearing an interest rate of LIBOR plus 90 basis points and a commitment fee of 12.5 basis points on unused commitments. At December 31, 2006, $10.0 million was outstanding with a weighted average rate of 6.26% under this loan. This loan was
paid off in April, 2007.
F-30
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Other Liabilities.
On November 23, 2004, the Company entered into an agreement with its
Chief Executive Officer (CEO) pursuant to which the CEO agreed to defer any bonus amounts in excess of $225,000 for the year ended December 31, 2005 until January 1 of the first year following such time as the CEO separates
from the Company. Accordingly, an amount equal to $610,000 was deferred in 2004 and was accrued in other liabilities in the consolidated balance sheet. The Company agreed to accrue interest on the deferred portion of the bonus at 7.0% per annum
compounded quarterly. The deferred amount will be increased each quarter by the amount of interest computed for that quarter. Beginning on the tenth anniversary of the agreement, the interest rate will equal 275 basis points above the prevailing
interest rate on the ten-year Treasury Note. Interest of $51,000 during 2007, $47,000 during 2006, and $44,000 during 2005 was accrued on this deferred bonus. The balance was $754,000 at December 31, 2007, and $703,000 at December 31,
2006.
12. Capital Resources
On
September 29, 2006, the Bank issued $50.0 million in subordinated debt in a private placement transaction. The debt has a maturity term of 10 years, is unsecured and bears interest at a rate of LIBOR plus 110 basis points. As of
December 31, 2007, $50.0 million was outstanding with a rate of 5.93% under this note compared to $50.0 million at a rate of 6.46% at December 31, 2006. Interest expense on the subordinated debt was $3.3 million in 2007 and $844,000 for
2006. The subordinated debt was issued through the Bank and qualifies as Tier 2 capital for regulatory reporting purpose and is included as a component of long-term debt in the accompanying consolidated balance sheet.
The Bancorp established three special purpose trusts in 2003 and two in 2007 for the purpose of issuing trust preferred securities to outside investors
(Capital Securities). The trusts exist for the sole purpose of issuing the Capital Securities and investing the proceeds thereof, together with proceeds from the purchase of the common stock of the trusts by the Bancorp, in Junior Subordinated Notes
issued by the Bancorp. Subject to some limitations, payment of distributions out of the monies held by the trusts and payments on liquidation of the trusts or the redemption of the Capital Securities are guaranteed by the Bancorp to the extent the
trusts have funds on hand at such time. The obligations of the Bancorp under the guarantees and the Junior Subordinated Debentures are subordinate and junior in right of payment to all indebtedness of the Bancorp and will be structurally
subordinated to all liabilities and obligations of the Bancorps subsidiaries. The Bancorp has the right to defer payments of interest on the Junior Subordinated Notes at any time or from time to time for a period of up to twenty consecutive
quarterly periods with respect to each deferral period. Under the terms of the Junior Subordinated Notes, the Bancorp may not, with certain exceptions, declare or pay any dividends or distributions on its capital stock or purchase or acquire any of
its capital stock if the Bancorp has deferred interest on the Junior Subordinated Notes.
The five special purpose trusts are considered
variable interest entities under FIN 46R. Because the Bancorp is not the primary beneficiary of the trusts, the financial statements of the trusts are not included in the consolidated financial statements of the Company.
The Capital Securities are currently included in the Tier 1 capital of the Bancorp for regulatory capital purposes. On March 1, 2005, the Federal
Reserve adopted a final rule that retains trust preferred securities in the Tier I capital of bank holding companies, but with stricter quantitative limits and clearer qualitative standards. Under the rule, after a five-year transition period, the
aggregate amount of trust preferred securities and certain other capital elements will be limited to 25 percent of Tier 1 capital elements, net of goodwill, less any associated deferred tax liability. The amount of trust preferred securities and
certain other elements in excess of the limit could be included in Tier 2 capital, subject to restrictions. In the last five years before maturity, the outstanding amount must be excluded from Tier 1 capital and included in Tier 2 capital. Bank
holding companies with
F-31
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
significant international operations would generally be expected to limit trust preferred securities and certain other capital elements to 15% of Tier 1
capital elements, net of goodwill. This rule is not expected to have a materially adverse effect on our capital positions.
The Company
issued junior subordinated debt securities of $46.4 million on March 30, 2007, and $20.6 million on May 31, 2007, in connection with pooled offerings of trust preferred securities by two newly formed and wholly-owned subsidiaries, Cathay
Capital Trust III and Cathay Capital Trust IV, both of which are Delaware statutory business trusts. On March 30, 2007, Cathay Capital Trust III issued and sold $45.0 million of trust preferred securities in a private placement to institutional
investors and $1.4 million of common securities to the Bancorp. Similarly, on May 31, 2007, Cathay Capital Trust IV issued and sold $20.0 million of trust preferred securities in a private placement to institutional investors and $619,000 of
common securities to the Bancorp. The trust preferred securities issued by Cathay Capital Trust III have a stated maturity of June 15, 2037, and bear interest at a per annum rate based on the three-month LIBOR plus 148 basis points, payable on
a quarterly basis. The trust preferred securities issued by Cathay Capital Trust IV have a scheduled maturity of September 6, 2037, and bear interest at a per annum rate based on the three-month LIBOR plus 140 basis points, payable on a
quarterly basis.
Interest expense on the Junior Subordinated Notes was $8.0 million for 2007, $4.5 million for 2006, and $3.5 million for
2005.
The table below summarizes the outstanding Junior Subordinated Debentures issued by the Company to each trust as of
December 31, 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Trust Name
|
|
Issuance
Date
|
|
Principal
Balance of
Debentures
|
|
Not
Redeemable
Until
|
|
Stated
Maturity
|
|
Annualized
Coupon
Rate
|
|
Current
Interest
Rate
|
|
Date of Rate
Change
|
|
Payable/
Distribution
Date
|
|
|
(Dollars in thousands)
|
Cathay Capital
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Trust I
|
|
June 26,
2003
|
|
$20,619
|
|
June 30,
2008
|
|
June 30,
2033
|
|
3-month
LIBOR
+ 3.15%
|
|
7.98%
|
|
December 30,
2007
|
|
March 30
June 30
September 30
December 30
|
Cathay Statutory
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Trust I
|
|
September 17,
2003
|
|
20,619
|
|
September 17,
2008
|
|
September 17,
2033
|
|
3-month
LIBOR
+ 3.00%
|
|
7.99%
|
|
December 17,
2007
|
|
March 17
June 17
September 17
December 17
|
Cathay Capital
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Trust II
|
|
December 30,
2003
|
|
12,887
|
|
March 30,
2009
|
|
March 30,
2034
|
|
3-month
LIBOR
+ 2.90%
|
|
7.73%
|
|
December 30,
2007
|
|
March 30
June 30
September 30
December 30
|
Cathay Capital
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Trust III
|
|
March 28,
2007
|
|
46,392
|
|
June 15,
2012
|
|
June 15,
2037
|
|
3-month
LIBOR
+ 1.48%
|
|
6.47%
|
|
December 17,
2007
|
|
March 15
June 15
September 15
December 15
|
Cathay Capital
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Trust IV
|
|
May 31,
2007
|
|
20,619
|
|
September 6,
2012
|
|
September 6,
2037
|
|
3-month
LIBOR
1.40%
|
|
6.55%
|
|
December 30,
2007
|
|
March 6
June 6
September 6
December 6
|
F-32
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
13. Income Taxes
For the years ended December 31, 2007, 2006, and 2005, the current and deferred amounts of the income tax expense are summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
|
(In thousands)
|
|
Current:
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
$
|
62,507
|
|
|
$
|
53,564
|
|
|
$
|
48,608
|
|
State
|
|
|
20,118
|
|
|
|
16,186
|
|
|
|
15,792
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
82,625
|
|
|
$
|
69,750
|
|
|
$
|
64,400
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred:
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
|
(8,834
|
)
|
|
|
(1,897
|
)
|
|
|
(1,980
|
)
|
State
|
|
|
(2,600
|
)
|
|
|
(594
|
)
|
|
|
(30
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(11,434
|
)
|
|
$
|
(2,491
|
)
|
|
$
|
(2,010
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total income tax expense
|
|
$
|
71,191
|
|
|
$
|
67,259
|
|
|
$
|
62,390
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Temporary differences between the amounts reported in the financial statements and the tax basis
of assets and liabilities give rise to deferred taxes. Net deferred tax assets at December 31, 2007, are included in other assets and net deferred tax liabilities at December 31, 2006, are included in other liabilities in the accompanying
consolidated balance sheets and are as follows:
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
|
(In thousands)
|
|
Deferred Tax Assets
|
|
|
|
|
|
|
|
|
Loan loss allowance, due to differences in computation of bad debts
|
|
$
|
28,563
|
|
|
$
|
26,566
|
|
Writedown on equity securities
|
|
|
1,671
|
|
|
|
2,420
|
|
Stock option compensation expense
|
|
|
10,035
|
|
|
|
7,151
|
|
State tax benefit
|
|
|
4,099
|
|
|
|
1,180
|
|
Unrealized loss on securities available-for-sale, net
|
|
|
396
|
|
|
|
9,016
|
|
Other, net
|
|
|
6,602
|
|
|
|
3,548
|
|
|
|
|
|
|
|
|
|
|
Gross deferred tax assets
|
|
|
51,366
|
|
|
|
49,881
|
|
|
|
|
|
|
|
|
|
|
Deferred Tax Liabilities
|
|
|
|
|
|
|
|
|
Core deposit intangibles
|
|
|
(14,317
|
)
|
|
|
(17,072
|
)
|
Leveraged lease
|
|
|
(5,841
|
)
|
|
|
(6,513
|
)
|
Investment in aircraft financing trust and venture capital partnerships
|
|
|
(15,806
|
)
|
|
|
(17,596
|
)
|
Investment in affordable housing partnerships
|
|
|
(1,306
|
)
|
|
|
(3,545
|
)
|
Dividends on Federal Home Loan Bank common stock
|
|
|
(3,727
|
)
|
|
|
(2,764
|
)
|
Other, net
|
|
|
(4,967
|
)
|
|
|
(5,472
|
)
|
|
|
|
|
|
|
|
|
|
Gross deferred tax liabilities
|
|
|
(45,964
|
)
|
|
|
(52,962
|
)
|
|
|
|
|
|
|
|
|
|
Net deferred tax assets (liabilities)
|
|
$
|
5,402
|
|
|
$
|
(3,081
|
)
|
|
|
|
|
|
|
|
|
|
Amounts for the current year are based upon estimates and assumptions as of the date of this
report and could vary from amounts shown on the tax returns as filed.
In assessing the 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
F-33
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
assets is dependent on the generation of future taxable income during the periods in which those temporary differences become deductible. Management
considers the projected future taxable income and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are
deductible, management believes it is more likely than not the Company will realize all benefits related to these deductible temporary differences.
As of December 31, 2007, the Company had income tax receivables of approximately $1.9 million. As of December 31, 2006, the Company had income tax receivables of approximately $15.4 million, of which $12.1 million related to
California income taxes related to 2000, 2001, and 2002 and is further discussed below. These income tax receivables are included in other assets in the accompanying consolidated balance sheets. Other liabilities included current income taxes
payable of $12.4 million as of December 31, 2007, and $8.7 million as of December 31, 2006.
At December 31, 2007, the
Company had federal net operating loss carry forwards of approximately $3.1 million which expire through 2022, New Jersey state net operating loss carry forwards of $2.4 million which expire through 2012 and Illinois state net operating loss carry
forwards of $1.3 million which expire in 2018. The Federal and New Jersey net operating loss carry-forwards were acquired in connection with the Companys acquisition of United Heritage Bank. The Illinois state net operating loss carry forwards
were acquired in connection with the Companys acquisition of New Asia Bancorp. Federal and state tax laws related to a change in ownership place limitations on the annual amount of operating loss carryovers that can be utilized to offset
post-acquisition operating income based on the value of the acquired bank at the ownership change date.
As previously disclosed, on
December 31, 2003, the California Franchise Tax Board (FTB) announced its intent to list certain transactions that in its view constitute potentially abusive tax shelters. Included in the transactions subject to this listing were transactions
utilizing regulated investment companies (RICs) and real estate investment trusts (REITs). While the Company continues to believe that the tax benefits recorded in 2000, 2001, and 2002 with respect to its regulated investment company were
appropriate and fully defensible under California law, the Company participated in Option 2 of the Voluntary Compliance Initiative of the Franchise Tax Board, and paid all California taxes and interest on these disputed 2000 through 2002 tax
benefits, and at the same time filed a claim for refund for these years while avoiding certain potential penalties. The Company retains potential exposure for assertion of an accuracy-related penalty should the FTB prevail in its position in
addition to the risk of not being successful in its refund claims.
The FASB issued Interpretation No. 48 Accounting for Uncertainty
in Income Taxes (FIN 48) which requires that the amount of recognized tax benefit should be the maximum amount which is more-likely-than-not to be realized and that amounts previously recorded that do not meet the requirements of FIN 48
be charged as a cumulative effect adjustment to retained earnings. As of December 31, 2006, the Company reflected a $12.1 million net state tax receivable related to payments it made in April 2004 under the Voluntary Compliance Initiative
program for the years 2000, 2001, and 2002, after giving effect to reserves for loss contingencies on the refund claims. The Company has determined that its refund claim related to its regulated investment company is not more-likely-than-not to be
realized and consequently charged a total of $8.5 million, comprised of the $7.9 million after tax amount related to its refund claims as well as a $0.6 million after tax amount related to California net operating losses generated in 2001 as a
result of its regulated investment company, to the balance of retained earnings as of the January 1, 2007, effective date of FIN 48.
At the January 1, 2007, adoption date of FIN 48, the total amount of the Companys unrecognized tax benefits was $5.5 million, of which $1.6 million, if recognized, would affect the effective tax rate. The Company recognized
interest and penalties accrued related to unrecognized tax benefits in income tax expense. During
F-34
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
2007, upon the expiration of applicable statue of limitations, unrecognized tax benefits of $0.8 million were recognized and recorded as a reduction in
goodwill and unrecognized tax benefits of $0.2 million were recognized as a reduction in income tax expense. A reconciliation of the beginning and ending amounts of gross unrecognized tax benefits is as follows:
|
|
|
|
|
|
|
Unrecognized
Tax Benefits
|
|
|
|
(In thousands)
|
|
Balance at January 1, 2007
|
|
$
|
5,519
|
|
Changes based on tax positions related to the current year
|
|
|
|
|
Change for tax positions in prior years
|
|
|
917
|
|
Reductions for tax positions of prior years
|
|
|
(992
|
)
|
Settlements
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2007
|
|
$
|
5,444
|
|
|
|
|
|
|
At January 1, 2007, the adoption date of FIN 48, the total amount of accrued interest and
penalties was $1.7 million. For the year ended December 31, 2007, the Company recognized $0.2 million in interest and penalties. As of December 31, 2007, the Company had accrued interest and penalties of $1.9 million. In February 2008, the
Company withdrew, with the agreement of the California Franchise Tax Board, a claim related GBC Bancorps 2001 California tax return and reversed $0.5 million of accrued penalties with a corresponding decrease in goodwill. The amount of
additional unrecognized tax benefits expected to be recognized during 2008 is not expected to be significant.
The Companys tax
returns are open for audits by the Internal Revenue Service back to 2004 and by the Franchise Tax Board of the State of California back to 2000. The Company is currently under audit by the California Franchise Tax Board for the years 2000 to 2004.
During the second quarter of 2007, the Internal Revenue Service completed an examination of the Companys 2004 and 2005 tax returns and did not propose any adjustments deemed to be material.
Income tax expense results in effective tax rates that differ from the statutory Federal income tax rate for the years indicated as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
|
(In thousands)
|
|
Tax provision at Federal statutory rate
|
|
$
|
68,831
|
|
|
35.0
|
%
|
|
$
|
64,690
|
|
|
35.0
|
%
|
|
$
|
58,268
|
|
|
35.0
|
%
|
State income taxes, net of Federal income tax benefit
|
|
|
11,374
|
|
|
5.8
|
|
|
|
10,144
|
|
|
5.5
|
|
|
|
10,245
|
|
|
6.2
|
|
Interest on obligations of state and political subdivisions, which are exempt from Federal taxation
|
|
|
(695
|
)
|
|
(0.3
|
)
|
|
|
(945
|
)
|
|
(0.5
|
)
|
|
|
(1,281
|
)
|
|
(0.8
|
)
|
Low income housing tax credit
|
|
|
(8,017
|
)
|
|
(4.1
|
)
|
|
|
(6,504
|
)
|
|
(3.5
|
)
|
|
|
(4,912
|
)
|
|
(3.0
|
)
|
Other, net
|
|
|
(302
|
)
|
|
(0.2
|
)
|
|
|
(126
|
)
|
|
(0.1
|
)
|
|
|
70
|
|
|
0.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total income tax expense
|
|
$
|
71,191
|
|
|
36.2
|
%
|
|
$
|
67,259
|
|
|
36.4
|
%
|
|
$
|
62,390
|
|
|
37.5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
14. Stockholders Equity and Earnings per Share
As a bank holding company, the Bancorps ability to pay dividends will depend upon the dividends it receives from the Bank and on the income it may
generate from any other activities in which it may engage, either directly or through other subsidiaries.
F-35
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Under California banking law, the Bank may not, without regulatory approval, pay a cash dividend that
exceeds the lesser of the Banks retained earnings or its net income for the last three fiscal years, less any cash distributions made during that period. The amount of retained earnings available for cash dividends to the Bancorp immediately
after December 31, 2007, is restricted to approximately $203.7 million under this regulation.
During 2003, the Bank formed Cathay
Real Estate Investment Trust (Trust) to provide the Bank flexibility in raising capital. In 2003 and 2004, the Trust sold to accredited investors $8.6 million of its 7.0% Series A Non-Cumulative preferred stock which pays dividends, if
declared, at the end of each quarter. This preferred stock qualifies as Tier 1 capital under current regulatory guidelines. Dividends of $602,000 in 2007, dividends of $602,000 in 2006, and dividends of $603,000 in 2005 were paid to accredited
investors. For the years ended and as of December 31, 2007, December 31, 2006, and December 31, 2005, the net income and assets of the Trust are eliminated in consolidation.
The Board of Directors of the Bancorp is authorized to issue preferred stock in one or more series and to fix the voting powers, designations,
preferences or other rights of the shares of each such class or series and the qualifications, limitations, and restrictions thereon. Any preferred stock issued by the Bancorp may rank prior to the Bancorp common stock as to dividend rights,
liquidation preferences, or both, may have full or limited voting rights, and may be convertible into shares of the Bancorp common stock. No preferred stock has been issued as of December 31, 2007.
On November 16, 2000, the Bancorps Board of Directors adopted a Rights Agreement between the Bancorp and American Stock Transfer and Trust
Company, as Rights Agent, and declared a dividend of one preferred share purchase right for each outstanding share of the Bancorp common stock. The dividend was payable on January 19, 2001, to stockholders of record at the close of business on
the record date, December 20, 2000. Each preferred share purchase right entitles the registered holder to purchase from the Bancorp one one-thousandth of a share of the Bancorps Series A junior participating preferred stock at a price of
$200, subject to adjustment. In general, the rights become exercisable if, after December 20, 2000, a person or group acquires 15% or more of the Bancorps common stock or announces a tender offer for 15% or more of the common stock. The
Board of Directors is entitled to redeem the rights at one cent per right at any time before any such person acquires 15% or more of the outstanding common stock. The rights will expire in ten years. The complete terms and conditions of the rights
are contained in the Rights Agreement, between the Bancorp and the Rights Agent, which was filed as an exhibit to the Bancorps Form 8-A on December 20, 2000. The Rights Agreement is a successor to the Bancorps prior rights
agreement, which expired at the close of business on December 20, 2000.
F-36
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
The following is the reconciliation of the numerators and denominators of the basic and diluted
earnings per share computations for the years as indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2007
|
|
2006
|
|
2005
|
|
|
Income
(Numerator)
|
|
Shares
(Denominator)
|
|
Per
Share
Amount
|
|
Income
(Numerator)
|
|
Shares
(Denominator)
|
|
Per
Share
Amount
|
|
Income
(Numerator)
|
|
Shares
(Denominator)
|
|
Per
Share
Amount
|
|
|
(In thousands, except shares and per share data)
|
Net Income
|
|
$
|
125,469
|
|
|
|
|
|
|
$
|
117,570
|
|
|
|
|
|
|
$
|
104,091
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic EPS income
|
|
$
|
125,469
|
|
50,418,303
|
|
$
|
2.49
|
|
$
|
117,570
|
|
51,234,596
|
|
$
|
2.29
|
|
$
|
104,091
|
|
50,373,076
|
|
$
|
2.07
|
Effect of dilutive stock options
|
|
|
|
|
557,146
|
|
|
|
|
|
|
|
569,899
|
|
|
|
|
|
|
|
448,017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted EPS income
|
|
$
|
125,469
|
|
50,975,449
|
|
$
|
2.46
|
|
$
|
117,570
|
|
51,804,495
|
|
$
|
2.27
|
|
$
|
104,091
|
|
50,821,093
|
|
$
|
2.05
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options to purchase an additional 2.0 million shares at December 31, 2007, and to
purchase an additional 1.5 million shares at December 31, 2006, and to purchase additional 1.3 million shares at December 31, 2005, were not included in the computation of diluted earnings per share because their inclusion would
have had an anti-dilutive effect.
15. Commitments and Contingencies
Litigation.
The Company is involved in various litigation concerning transactions entered into during the normal course of business. Management, after consultation with legal counsel, does not believe that the
resolution of such litigation will have a material effect upon its consolidated financial condition, results of operations, or liquidity taken as a whole.
Lending.
In the normal course of business, the Company becomes a party to financial instruments with off-balance sheet risk to meet the financing needs of its customers. These financial instruments include
commitments to extend credit in the form of loans or through commercial or standby letters of credit and financial guarantees. Those instruments represent varying degrees of exposure to risk in excess of the amounts included in the accompanying
consolidated balance sheets. The contractual or notional amount of these instruments indicates a level of activity associated with a particular class of financial instrument and is not a reflection of the level of expected losses, if any.
The Companys exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments
to extend credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Unless noted otherwise, the
Company does not require collateral or other security to support financial instruments with credit risk.
F-37
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Financial instruments whose contract amounts represent the amount of credit risk include the
following:
|
|
|
|
|
|
|
|
|
2007
|
|
2006
|
|
|
(In thousands)
|
Commitments to extend credit
|
|
$
|
2,310,887
|
|
$
|
2,178,640
|
Standby letters of credit
|
|
|
62,413
|
|
|
81,292
|
Commercial letters of credit
|
|
|
71,089
|
|
|
79,803
|
Bill of lading guarantees
|
|
|
323
|
|
|
223
|
|
|
|
|
|
|
|
Total
|
|
$
|
2,444,712
|
|
$
|
2,339,958
|
|
|
|
|
|
|
|
Commitments to extend credit are agreements to lend to a customer provided there is no violation
of any condition established in the commitment agreement. These commitments generally have fixed expiration dates and are expected to expire without being drawn upon. The total commitment amounts do not necessarily represent future cash
requirements. The Company evaluates each customers creditworthiness on a case-by-case basis. The amount of collateral obtained if deemed necessary by the Company upon extension of credit is based on managements credit evaluation of the
borrowers.
As of December 31, 2007, the Company does not have fixed-rate or variable-rate commitments with characteristics similar to
options, which provide the holder, for a premium paid at inception to the Company, the benefits of favorable movements in the price of an underlying asset or index with limited or no exposure to losses from unfavorable price movements.
As of December 31, 2007, commitments to extend credit of $2.3 billion include commitments to fund fixed rate loans of $108.7 million and
adjustable rate loans of $2.2 billion.
Commercial letters of credit and bill of lading guarantees are issued to facilitate domestic and
foreign trade transactions while standby letters of credit are issued to make payments on behalf of customers if certain specified future events occur. The credit risk involved in issuing letters of credit and bill of lading guarantees is
essentially the same as that involved in making loans to customers.
Leases.
The Company is obligated under a number of operating
leases for premises and equipment with terms ranging from one to 52 years, many of which provide for periodic adjustment of rentals based on changes in various economic indicators. Rental expense was $7.6 million for 2007, $6.6 million for
2006, and $5.9 million for 2005. The following table shows future minimum payments under operating leases with terms in excess of one year as of December 31, 2007.
|
|
|
|
|
Year Ending December 31,
|
|
Commitments
|
|
|
|
(In thousands)
|
|
2008
|
|
|
7,480
|
(1)
|
2009
|
|
|
5,640
|
|
2010
|
|
|
4,142
|
|
2011
|
|
|
3,446
|
|
2012
|
|
|
2,799
|
|
Thereafter
|
|
|
5,768
|
|
|
|
|
|
|
Total minimum lease payments
|
|
$
|
29,275
|
|
|
|
|
|
|
(1)
|
Includes the lease payment of approximately $53,000 to be made to T.C. Realty, Inc., a corporation owned by Mr. Patrick Lees spouse, as agent for 929 College LLC, a
limited liability company jointly owned by Mr. Lee and his spouse. Mr. Lee is a director of the Bancorp and the Bank. This lease is expected to be terminated in the second half of 2008.
|
F-38
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Rental income was $0.9 million for 2007, $1.2 million for 2006, and $0.6 million for 2005. The
following table shows future rental payments to be received under operating leases with terms in excess of one year as of December 31, 2007:
|
|
|
|
Year Ending December 31,
|
|
Commitments
|
|
|
(In thousands)
|
2008
|
|
|
418
|
2009
|
|
|
188
|
2010
|
|
|
35
|
2011 and thereafter
|
|
|
|
|
|
|
|
Total minimum lease payments to be received
|
|
$
|
641
|
|
|
|
|
16. Derivative Financial Instruments
The Company uses interest rate swaps to mitigate risks associated with changes 1) to the fair value of certain fixed rate certificates of deposit that are
callable either after one year or after two years and 2) to certain cash flows related to future interest payments on variable rate loans. As of December 31, 2007 and December 31, 2006, the Company had no interest rate swaps.
17. Fair Value of Financial Instruments
The
following methods and assumptions were used to estimate the fair value of each class of financial instruments.
Cash and Cash
Equivalents.
For cash and cash equivalents, the carrying amount was assumed to be a reasonable estimate of fair value.
Short-term
Investments.
For short-term investments, the carrying amount was assumed to be a reasonable estimate of fair value.
Securities
purchased under agreements to resell
. The fair value of the agreements to resell is based on dealer quotes.
Securities Available
for Sale.
For securities available-for-sale, fair values were based on quoted market prices at the reporting date. If a quoted market price was not available, fair value was estimated using quoted market prices for similar securities or dealer
quotes.
Loans.
Fair values were estimated for portfolios of loans with similar financial characteristics. Each loan category was
further segmented into fixed and adjustable rate interest terms and by performing and non-performing categories.
The fair value of
performing loans was calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan.
The entire allowance for credit losses was applied to classified loans including non-accruals. Accordingly, they are considered to be carried at fair
value as the allowance for credit losses represents the estimated discount for credit risk for the applicable loans.
F-39
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Deposit Liabilities.
The fair value of demand deposits, savings accounts, and certain money
market deposits was assumed to be the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit was estimated using the rates currently offered for deposits with similar remaining maturities.
Securities Sold under Agreements to Repurchase.
The fair value of the repurchase agreements is based on dealer quotes.
Advances from Federal Home Loan Bank.
The fair value of the advances is based on quotes from the FHLB to settle the advances.
Other Borrowings.
This category includes federal funds purchased, revolving line of credit, and other short-term borrowings. The fair value of
other borrowings is based on current market rates for borrowings with similar remaining maturities.
Subordinated Debt.
The fair
value of subordinated debt is estimated based on the current spreads to LIBOR for subordinated debt.
Junior Subordinated Notes.
The
fair value of the Junior Subordinated Notes is estimated based on the current spreads to LIBOR for junior subordinated notes.
Off-Balance-Sheet Financial Instruments.
The fair value of commitments to extend credit, standby letters of credit, and financial guarantees written were estimated using the fees currently charged to enter into similar agreements,
taking into account the remaining terms of the agreements and the present creditworthiness of the counter-parties. The fair value of guarantees and letters of credit was based on fees currently charged for similar agreements or on the estimated cost
to terminate them or otherwise settle the obligations with the counter-parties at the reporting date.
Fair value estimates were made at
specific points in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Banks entire holdings
of a particular financial instrument. Because no market exists for a significant portion of the Banks financial instruments, fair value estimates were based on judgments regarding future expected loss experience, current economic conditions,
risk characteristics of various financial instruments, and other factors. These estimates were subjective in nature and involved uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in
assumptions could significantly affect the estimates.
F-40
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Fair Value of Financial Instruments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2007
|
|
|
As of December 31, 2006
|
|
|
|
Carrying
Amount
|
|
Fair Value
|
|
|
Carrying
Amount
|
|
Fair Value
|
|
|
|
(In thousands)
|
|
Financial Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and due from banks
|
|
$
|
118,437
|
|
$
|
118,437
|
|
|
$
|
114,798
|
|
$
|
114,798
|
|
Federal funds sold
|
|
|
|
|
|
|
|
|
|
18,000
|
|
|
18,000
|
|
Short-term investments
|
|
|
2,278
|
|
|
2,278
|
|
|
|
16,379
|
|
|
16,379
|
|
Securities purchased under agreements to resell
|
|
|
516,100
|
|
|
520,695
|
|
|
|
|
|
|
|
|
Long-term certificates of deposits
|
|
|
50,000
|
|
|
51,470
|
|
|
|
|
|
|
|
|
Securities available-for-sale
|
|
|
2,347,665
|
|
|
2,347,665
|
|
|
|
1,522,223
|
|
|
1,522,223
|
|
Trading securities
|
|
|
5,225
|
|
|
5,225
|
|
|
|
5,309
|
|
|
5,309
|
|
Loans, net
|
|
|
6,608,079
|
|
|
6,657,249
|
|
|
|
5,675,342
|
|
|
5,640,592
|
|
Investment in Federal Home Loan Bank Stock
|
|
|
65,720
|
|
|
65,720
|
|
|
|
34,348
|
|
|
34,348
|
|
Financial Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deposits
|
|
|
6,278,367
|
|
|
6,291,736
|
|
|
|
5,675,306
|
|
|
5,685,190
|
|
Federal funds purchased
|
|
|
41,000
|
|
|
41,000
|
|
|
|
50,000
|
|
|
50,000
|
|
Securities sold under agreement to repurchase
|
|
|
1,391,025
|
|
|
1,452,737
|
|
|
|
400,000
|
|
|
403,504
|
|
Advances from Federal Home Loan Bank
|
|
|
1,375,180
|
|
|
1,399,658
|
|
|
|
714,680
|
|
|
717,623
|
|
Other borrowings
|
|
|
27,943
|
|
|
27,943
|
|
|
|
29,981
|
|
|
29,981
|
|
Long-term debt
|
|
|
171,136
|
|
|
147,930
|
|
|
|
104,125
|
|
|
106,136
|
|
|
|
|
|
|
As of December 31, 2007
|
|
|
As of December 31, 2006
|
|
|
|
Notional
Amount
|
|
Fair Value
|
|
|
Notional
Amount
|
|
Fair Value
|
|
|
|
(In thousands)
|
|
Off-Balance Sheet Financial Instruments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commitments to extend credit
|
|
$
|
2,310,887
|
|
$
|
(2,879
|
)
|
|
$
|
2,178,640
|
|
$
|
(3,075
|
)
|
Standby letters of credit
|
|
|
62,413
|
|
|
(333
|
)
|
|
|
81,292
|
|
|
(555
|
)
|
Other letters of credit
|
|
|
71,089
|
|
|
(36
|
)
|
|
|
79,803
|
|
|
(45
|
)
|
Bill of lading guarantees
|
|
|
323
|
|
|
(1
|
)
|
|
|
223
|
|
|
(1
|
)
|
18. Employee Benefit Plans
Employee Stock Ownership Plan.
Under the Companys Amended and Restated Cathay Bank Employee Stock Ownership Plan (ESOP), the Company can make annual contributions to a trust in the form of
either cash or common stock of the Company for the benefit of eligible employees. Employees are eligible to participate in the ESOP after completing two years of service for salaried full-time employees or 1,000 hours for each of two
consecutive years for salaried part-time employees. The amount of the annual contribution is discretionary except that it must be sufficient to enable the trust to meet its current obligations. The Company also pays for the administration of this
plan and of the trust. The Company has not made contributions to the trust since 2004 and does not expect to make any contributions in the future. Effective June 17, 2004, the ESOP was amended to provide the participants the election either to
reinvest the dividends on the Company stock allocated to their accounts or to have these dividends distributed to the participant. The ESOP trust purchased 20,594 shares in 2007, 27,970 shares in 2006, and 21,026 shares in 2005, of the
Bancorps common stock at an aggregate cost of $0.6 million in 2007, $1.0 million in 2006 and $0.7 million in 2005. Except for 9,500 shares purchased on the open market in 2006, all purchases during 2005 and during 2007 were through the
Dividend
F-41
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Reinvestment Plan. The distribution of benefits to participants totaled 197,231 shares in 2007, 88,095 shares in 2006, and 57,623 shares in 2005. As of
December 31, 2007, the ESOP owned 1,634,702 shares or 3.31% of the Companys outstanding common stock.
401(k) Plan.
In
1997, the Board approved the Companys 401(k) Profit Sharing Plan, which began on March 1, 1997. Salaried employees who have completed three months of service and have attained the age of 21 are eligible to participate. Enrollment dates
are on January 1st, April 1st, July 1st, and October 1st of each year. Participants may contribute up to 75% of their eligible compensation for the year but not to exceed the dollar limit set by the Internal Revenue
Code. Participants may change their contribution election on the enrollment dates. The Company matches 100% on the first 5% of compensation contributed per pay period by the participant, after one year of service. The vesting schedule for the
matching contribution is 0% for less than two years of service, 25% after two years of service and from then on, at an increment of 25% each year until 100% is vested after five years of service. The Companys contribution amounted to $1.6
million in 2007, $1.4 million in 2006 and $1.2 million in 2005. The Plan allows participants to withdraw all or part of their vested amount in the Plan due to certain financial hardship as set forth in the Internal Revenue Code and Treasury
Regulations. Participants may also borrow up to 50% of the vested amount, up to a maximum of $50,000. The minimum loan amount is $1,000.
19. Equity
Incentive Plans
In 1998, the Board adopted the Cathay Bancorp, Inc. Equity Incentive Plan. Under the Equity Incentive Plan, as amended
in September, 2003, directors and eligible employees may be granted incentive or non-statutory stock options, or awarded restricted stock, for up to 7,000,000 shares of the Companys common stock on a split adjusted basis. In May 2005, the
shareholders of the Company approved the 2005 Incentive Plan which provides that 3,131,854 shares of the Companys common stock may be granted as incentive or non-statutory stock options, or as restricted stock. In conjunction with the approval
of the 2005 Incentive Plan, the Bancorp agreed to cease granting awards under the Equity Incentive Plan. As of December 31, 2007, the only type of options granted by the Company has been non-statutory stock options. These options have been
granted to selected bank officers and non-employee directors at exercise prices equal to the fair market value of a share of the Companys common stock on the date of grant. Such options have a maximum ten-year term and vest in 20% annual
increments (subject to early termination in certain events) except for certain options granted during 2005 and certain non-vested shares granted during 2006 as further discussed below. If such options expire or terminate without having been
exercised, any shares not purchased will again be available for future grants or awards.
Cash received from exercises of stock options
totaled $2.2 million from 136,348 exercised shares for 2007 and $3.3 million from 162,534 exercised shares for 2006. The fair value of stock options vested in 2007 was $7.4 million compared to $5.7 million in 2006. Aggregate intrinsic value for
options exercised was $2.1 million in 2007 and $2.5 million in 2006.
F-42
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
A summary of stock option activity for 2007, 2006, and 2005 follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares
|
|
|
Weighted-Average
Exercise Price
|
|
Weighted-Average
Remaining Contractual
Life (in years)
|
|
Aggregate
Intrinsic
Value (in ,000)
|
Balance, December 31, 2004
|
|
3,692,824
|
|
|
$
|
22.71
|
|
7.5
|
|
$
|
54,649
|
|
|
|
|
|
|
|
|
|
|
|
|
Granted
|
|
1,238,234
|
|
|
|
35.35
|
|
|
|
|
|
Exercised
|
|
(157,788
|
)
|
|
|
15.40
|
|
|
|
|
|
Forfeited
|
|
(457,158
|
)
|
|
|
25.23
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2005
|
|
4,316,112
|
|
|
$
|
26.33
|
|
7.5
|
|
$
|
42,263
|
|
|
|
|
|
|
|
|
|
|
|
|
Granted
|
|
807,630
|
|
|
|
36.58
|
|
|
|
|
|
Exercised
|
|
(162,534
|
)
|
|
|
20.32
|
|
|
|
|
|
Forfeited
|
|
(178,181
|
)
|
|
|
30.99
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2006
|
|
4,783,027
|
|
|
$
|
28.09
|
|
7.0
|
|
$
|
34,011
|
|
|
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
(136,348
|
)
|
|
|
16.34
|
|
|
|
|
|
Forfeited
|
|
(72,399
|
)
|
|
|
33.43
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2007
|
|
4,574,280
|
|
|
$
|
28.36
|
|
6.1
|
|
$
|
24,487
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable, December 31, 2007
|
|
2,996,573
|
|
|
$
|
25.81
|
|
5.5
|
|
$
|
9,959
|
|
|
|
|
|
|
|
|
|
|
|
|
At December 31, 2007, 2,281,458 shares were available under the 2005 Incentive Plan for
future grants. The following table shows stock options outstanding and exercisable as of December 31, 2007, the corresponding exercise prices, and the weighted-average contractual life remaining:
|
|
|
|
|
|
|
|
|
Outstanding
|
Exercise Price
|
|
Shares
|
|
Weighted-Average
Remaining Contractual Life
(in
Years)
|
|
Exercisable Shares
|
$ 8.25
|
|
2,000
|
|
0.7
|
|
2,000
|
10.63
|
|
93,196
|
|
2.1
|
|
93,196
|
11.06
|
|
10,240
|
|
2.0
|
|
10,240
|
11.34
|
|
10,240
|
|
5.0
|
|
10,240
|
15.05
|
|
131,272
|
|
3.1
|
|
131,272
|
16.28
|
|
157,064
|
|
4.2
|
|
157,064
|
17.23
|
|
10,558
|
|
0.0
|
|
10,558
|
17.29
|
|
10,240
|
|
4.0
|
|
10,240
|
19.93
|
|
339,292
|
|
5.1
|
|
268,004
|
21.09
|
|
10,240
|
|
3.0
|
|
10,240
|
22.01
|
|
406,674
|
|
3.1
|
|
406,674
|
24.80
|
|
892,564
|
|
5.9
|
|
706,820
|
28.70
|
|
536,400
|
|
6.1
|
|
324,000
|
32.26
|
|
40,000
|
|
6.5
|
|
24,000
|
32.47
|
|
245,060
|
|
7.2
|
|
196,048
|
33.54
|
|
264,694
|
|
7.4
|
|
211,755
|
33.81
|
|
3,000
|
|
7.5
|
|
1,200
|
37.00
|
|
650,864
|
|
7.1
|
|
263,156
|
38.38
|
|
15,000
|
|
6.9
|
|
9,000
|
36.90
|
|
319,452
|
|
8.1
|
|
65,620
|
36.24
|
|
414,230
|
|
8.1
|
|
82,846
|
38.26
|
|
12,000
|
|
8.3
|
|
2,400
|
|
|
|
|
|
|
|
|
|
4,574,280
|
|
6.1
|
|
2,996,573
|
|
|
|
|
|
|
|
F-43
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
On January 16, 2003, Dunson K. Cheng, Chairman of the Board, President and Chief Executive
Officer of the Company, was granted an option to purchase 153,060 shares and on November 20, 2003 was granted an option to purchase 638,670 shares of the Company's common stock under the Company's Equity Incentive Plan. In March 2005, the
Company determined that these grants, in combination, exceeded by 391,730 shares a limitation in the Equity Incentive Plan as to the number of shares that could be subject to awards made to any one participant in any calendar year.
Effective March 22, 2005, Mr. Cheng agreed to cancel the options as to the 391,730 excess shares, and to waive all rights that he has to
purchase such excess shares upon exercise of the option. Also, on March 22, 2005, the Executive Compensation Committee approved granting to Mr. Cheng an option to purchase a total of 245,060 shares of common stock of the Company at an
exercise price equal to the closing market price of the common stock on the NASDAQ National Market on that date of which 30% vested immediately, 10% would vest on November 20, 2005 and an additional 20% would vest on November 20, 2006,
2007, and 2008, respectively. On May 12, 2005, the Executive Compensation Committee approved granting Mr. Cheng an option under the 2005 Incentive Plan to purchase a total of 264,694 shares of common stock of the Company at an exercise
price equal to the closing market price of the common stock on the NASDAQ National Market on that date of which 40% would vest on November 20, 2005, and an additional 20% would vest on November 20, 2006, 2007, and 2008, respectively.
The Company has granted non-vested stock to its Chairman of the Board, President, and Chief Executive Officer. The shares vest ratably
over certain years if certain annual performance criteria are met. The following table presents information relating to the non-vested stock grants as of December 31, 2007:
|
|
|
|
|
|
|
|
|
Grant date
January 25,
2006
|
|
Grant date
January 31,
2007
|
Grant shares
|
|
|
30,000
|
|
|
20,000
|
Vested ratably over
|
|
|
3 years
|
|
|
2 years
|
Price per share at grant
|
|
$
|
36.24
|
|
$
|
34.66
|
Vested shares
|
|
|
10,000
|
|
|
|
Unvested shares
|
|
|
20,000
|
|
|
20,000
|
The stock compensation expense recorded related to the non-vested stock above was $680,000 in 2007
and $332,000 in 2006. Unrecognized stock-based compensation expense related to non-vested stock awards was $768,000 at December 31, 2007, and is expected to be recognized over the next 13 months.
Prior to 2006, the Company presented the entire amount of the tax benefit on options exercised as operating activities in the consolidated statements of
cash flows. After adoption of SFAS No. 123R in January 2006, the Company reports only the benefits of tax deductions in excess of grant-date fair value as cash flows from financing activity. The following table summarizes the tax benefit from
options exercised:
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
2006
|
|
2005
|
|
|
(In thousands)
|
Benefit of tax deductions in excess of grant-date fair value
|
|
$
|
791
|
|
$
|
777
|
|
$
|
672
|
Benefit of tax deductions on grant-date fair value
|
|
|
103
|
|
|
287
|
|
$
|
111
|
|
|
|
|
|
|
|
|
|
|
Total benefit of tax deductions
|
|
$
|
894
|
|
$
|
1,064
|
|
$
|
783
|
|
|
|
|
|
|
|
|
|
|
F-44
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
20. Condensed Financial Information of Cathay General Bancorp
The condensed financial information of the
Company as of December 31, 2007, and December 31, 2006, and for the years ended December 31, 2007, 2006, and 2005 is as follows:
Balance Sheets
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
|
(In thousands, except share
and per share data)
|
|
Assets
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
1,966
|
|
|
$
|
3,596
|
|
Investment in bank subsidiaries
|
|
|
1,083,753
|
|
|
|
990,769
|
|
Investment in non-bank subsidiaries
|
|
|
3,244
|
|
|
|
4,179
|
|
Other assets
|
|
|
11,196
|
|
|
|
13,067
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
1,100,159
|
|
|
$
|
1,011,611
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
Revolving line of credit
|
|
$
|
|
|
|
$
|
10,000
|
|
Junior subordinated debt
|
|
|
121,136
|
|
|
|
54,125
|
|
Other liabilities
|
|
|
7,104
|
|
|
|
4,412
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
128,240
|
|
|
|
68,537
|
|
|
|
|
|
|
|
|
|
|
Commitments and contigencies
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders equity
|
|
|
|
|
|
|
|
|
Preferred stock, $0.01 par value; 10,000,000 shares authorized, none issued
|
|
|
|
|
|
|
|
|
Common stock, $0.01 par value; 100,000,000 shares authorized, 53,543,752 issued and 49,336,187 outstanding in 2007, and 100,000,000 shares
authorized and 53,309,317 issued and 51,930,955 outstanding in 2006
|
|
|
535
|
|
|
|
533
|
|
Additional paid-in-capital
|
|
|
480,557
|
|
|
|
467,591
|
|
Accumulated other comprehensive income, net
|
|
|
(545
|
)
|
|
|
(12,428
|
)
|
Retained earnings
|
|
|
617,108
|
|
|
|
520,689
|
|
Treasury stock, at cost (4,207,565 shares in 2007 and 1,378,362 shares in 2006)
|
|
|
(125,736
|
)
|
|
|
(33,311
|
)
|
|
|
|
|
|
|
|
|
|
Total stockholders equity
|
|
|
971,919
|
|
|
|
943,074
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and stockholders equity
|
|
$
|
1,100,159
|
|
|
$
|
1,011,611
|
|
|
|
|
|
|
|
|
|
|
F-45
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Statements of Income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
|
(In thousands)
|
|
Cash dividends from Cathay Bank
|
|
$
|
58,500
|
|
|
$
|
98,179
|
|
|
$
|
|
|
Cash dividends from GBC Venture Capital
|
|
|
1,400
|
|
|
|
1,680
|
|
|
|
3,000
|
|
Interest income
|
|
|
76
|
|
|
|
74
|
|
|
|
36
|
|
Interest expense
|
|
|
8,166
|
|
|
|
5,946
|
|
|
|
4,032
|
|
Non-interest income
|
|
|
(1,024
|
)
|
|
|
(381
|
)
|
|
|
(583
|
)
|
Non-interest expense
|
|
|
1,134
|
|
|
|
1,417
|
|
|
|
560
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income tax benefit
|
|
|
49,652
|
|
|
|
92,189
|
|
|
|
(2,139
|
)
|
Income tax benefit
|
|
|
(4,309
|
)
|
|
|
(3,225
|
)
|
|
|
(2,161
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before undistributed earnings of subsidiaries
|
|
|
53,961
|
|
|
|
95,414
|
|
|
|
22
|
|
Undistributed earnings of subsidiaries
|
|
|
71,508
|
|
|
|
22,156
|
|
|
|
104,069
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
125,469
|
|
|
$
|
117,570
|
|
|
$
|
104,091
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
F-46
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Statements of Cash Flows
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
|
(In thousands)
|
|
Cash flows from Operating Activities
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
125,469
|
|
|
$
|
117,570
|
|
|
$
|
104,091
|
|
Adjustments to reconcile net income to net cash provided by operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity in undistributed earnings of subsidiaries
|
|
|
(71,509
|
)
|
|
|
(22,156
|
)
|
|
|
(104,069
|
)
|
Increase in accrued expense
|
|
|
60
|
|
|
|
60
|
|
|
|
60
|
|
Write-downs on venture capital and other investments
|
|
|
933
|
|
|
|
432
|
|
|
|
681
|
|
Loss/(gain) in fair value of warrants
|
|
|
78
|
|
|
|
(816
|
)
|
|
|
|
|
Excess tax benefits from stock options
|
|
|
(791
|
)
|
|
|
(777
|
)
|
|
|
783
|
|
Increase in other assets
|
|
|
(536
|
)
|
|
|
(98
|
)
|
|
|
(943
|
)
|
Increase/(decrease) in other liabilities
|
|
|
6,861
|
|
|
|
(320
|
)
|
|
|
520
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating activities
|
|
|
60,565
|
|
|
|
93,895
|
|
|
|
1,123
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from Investment Activities
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchase of investment securities
|
|
|
|
|
|
|
|
|
|
|
(694
|
)
|
Exercise of warrants to acquire common stock
|
|
|
|
|
|
|
(2,209
|
)
|
|
|
|
|
Proceeds from sale of common stock acquired from exercise of warrants
|
|
|
|
|
|
|
3,679
|
|
|
|
|
|
Equity investment
|
|
|
|
|
|
|
(1,726
|
)
|
|
|
|
|
Acquisitions, net of cash acquired
|
|
|
(9,709
|
)
|
|
|
(70,815
|
)
|
|
|
(87
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in investment activities
|
|
|
(9,709
|
)
|
|
|
(71,071
|
)
|
|
|
(781
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from Financing Activities
|
|
|
|
|
|
|
|
|
|
|
|
|
Repayment of short term borrowing
|
|
|
(10,000
|
)
|
|
|
(27,120
|
)
|
|
|
|
|
Increase in other borrowings
|
|
|
|
|
|
|
15,000
|
|
|
|
20,000
|
|
Issuance of junior subordinated debt
|
|
|
65,000
|
|
|
|
|
|
|
|
|
|
Cash dividends
|
|
|
(20,525
|
)
|
|
|
(18,426
|
)
|
|
|
(18,154
|
)
|
Proceeds from shares issued under the Dividend Reinvestment Plan
|
|
|
2,445
|
|
|
|
2,622
|
|
|
|
3,039
|
|
Proceeds from exercise of stock options
|
|
|
2,228
|
|
|
|
3,302
|
|
|
|
2,430
|
|
Excess tax benefits from share-based payment arrangements
|
|
|
791
|
|
|
|
777
|
|
|
|
|
|
Purchase of treasury stock
|
|
|
(92,425
|
)
|
|
|
|
|
|
|
(24,501
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in financing activities
|
|
|
(52,486
|
)
|
|
|
(23,845
|
)
|
|
|
(17,186
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Decrease in cash and cash equivalents
|
|
|
(1,630
|
)
|
|
|
(1,021
|
)
|
|
|
(16,844
|
)
|
Cash and cash equivalents, beginning of year
|
|
|
3,596
|
|
|
|
4,617
|
|
|
|
21,461
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents, end of year
|
|
$
|
1,966
|
|
|
$
|
3,596
|
|
|
$
|
4,617
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
21. Dividend Reinvestment Plan
The Company has a dividend reinvestment plan which allows for participants reinvestment of cash dividends and certain optional additional
investments in the Companys common stock. Shares issued under the plan and the consideration received were 78,087 shares for $2.4 million in 2007, 75,003 shares for $2.6 million in 2006, and 93,947 shares for $3.0 million in 2005.
F-47
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
22. Regulatory Matters
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can result in certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct material effect on the Banks financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet
specific capital guidelines that involve quantitative measures of the Banks assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Banks capital amounts and classification are
also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. See Note 12 for discussion of possible future disallowance of Capital Securities as Tier 1 capital.
The Federal Deposit Insurance Corporation has established five capital ratio categories: well capitalized, adequately
capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. A well capitalized institution must have a Tier 1 capital ratio of at least 6%, a total risk-based capital ratio
of at least 10%, and a leverage ratio of at least 5%. At December 31, 2007 and 2006, the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that
notification which management believes have changed the well capitalized category of the Bank.
The Bancorps and the Banks
capital and leverage ratios as of December 31, 2007, and December 31, 2006, are presented in the tables below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2007
|
|
|
As of December 31, 2006
|
|
|
|
Company
|
|
|
Bank
|
|
|
Company
|
|
|
Bank
|
|
|
Balance
|
|
Percentage
|
|
|
Balance
|
|
Percentage
|
|
|
Balance
|
|
Percentage
|
|
|
Balance
|
|
Percentage
|
|
|
|
(Dollars in thousands)
|
|
Tier I Capital (to risk- weighted assets)
|
|
$
|
755,431
|
|
9.09
|
%
|
|
$
|
750,698
|
|
9.04
|
%
|
|
$
|
673,705
|
|
9.40
|
%
|
|
$
|
670,206
|
|
9.37
|
%
|
Tier I Capital minimum requirement
|
|
|
332,384
|
|
4.00
|
|
|
|
332,014
|
|
4.00
|
|
|
|
286,744
|
|
4.00
|
|
|
|
286,238
|
|
4.00
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Excess
|
|
$
|
423,047
|
|
5.09
|
%
|
|
$
|
418,684
|
|
5.04
|
%
|
|
$
|
386,961
|
|
5.40
|
%
|
|
$
|
383,968
|
|
5.37
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Capital (to risk- weighted assets)
|
|
$
|
874,056
|
|
10.52
|
%
|
|
$
|
870,257
|
|
10.49
|
%
|
|
$
|
788,284
|
|
11.00
|
%
|
|
$
|
786,092
|
|
10.99
|
%
|
Total I Capital minimum requirement
|
|
|
664,768
|
|
8.00
|
|
|
|
664,027
|
|
8.00
|
|
|
|
573,488
|
|
8.00
|
|
|
|
572,476
|
|
8.00
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Excess
|
|
$
|
209,288
|
|
2.52
|
%
|
|
$
|
206,230
|
|
2.49
|
%
|
|
$
|
214,796
|
|
3.00
|
%
|
|
$
|
213,616
|
|
2.99
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tier I Capital (to average assets) Leverage ratio
|
|
$
|
755,431
|
|
7.83
|
%
|
|
$
|
750,698
|
|
7.79
|
%
|
|
$
|
673,705
|
|
8.98
|
%
|
|
$
|
670,206
|
|
8.95
|
%
|
Minimum leverage requirement
|
|
|
385,812
|
|
4.00
|
|
|
|
385,269
|
|
4.00
|
|
|
|
300,055
|
|
4.00
|
|
|
|
299,409
|
|
4.00
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Excess
|
|
$
|
369,619
|
|
3.83
|
%
|
|
$
|
365,429
|
|
3.79
|
%
|
|
$
|
373,650
|
|
4.98
|
%
|
|
$
|
370,797
|
|
4.95
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total average assets (1)
|
|
$
|
9,645,310
|
|
|
|
|
$
|
9,631,720
|
|
|
|
|
$
|
7,501,371
|
|
|
|
|
$
|
7,485,214
|
|
|
|
Risk-weighted assets
|
|
$
|
8,309,598
|
|
|
|
|
$
|
8,300,343
|
|
|
|
|
$
|
7,168,601
|
|
|
|
|
$
|
7,155,951
|
|
|
|
(1)
|
Average assets represent average balances for the fourth quarter of each year presented.
|
F-48
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
23. Quarterly Results of Operations (Unaudited)
The following table sets forth selected unaudited quarterly financial data:
|
|
|
|
|
|
|
|
|
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Summary of Operations
|
|
|
2007
|
|
2006
|
|
|
Fourth
Quarter
|
|
Third
Quarter
|
|
Second
Quarter
|
|
First
Quarter
|
|
Fourth
Quarter
|
|
Third
Quarter
|
|
|
Second
Quarter
|
|
First
Quarter
|
|
|
(In thousands, except per share data)
|
Interest income
|
|
$
|
164,553
|
|
$
|
159,171
|
|
$
|
149,693
|
|
$
|
141,854
|
|
$
|
136,213
|
|
$
|
129,600
|
|
|
$
|
121,099
|
|
$
|
104,606
|
Interest expense
|
|
|
84,108
|
|
|
79,344
|
|
|
73,196
|
|
|
69,102
|
|
|
63,804
|
|
|
58,917
|
|
|
|
50,049
|
|
|
39,465
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net interest income
|
|
|
80,445
|
|
|
79,827
|
|
|
76,497
|
|
|
72,752
|
|
|
72,409
|
|
|
70,683
|
|
|
|
71,050
|
|
|
65,141
|
Provision/(Reversal) for credit losses
|
|
|
5,700
|
|
|
2,200
|
|
|
2,100
|
|
|
1,000
|
|
|
|
|
|
(1,000
|
)
|
|
|
1,500
|
|
|
1,500
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net-interest income after provision for loan losses
|
|
|
74,745
|
|
|
77,627
|
|
|
74,397
|
|
|
71,752
|
|
|
72,409
|
|
|
71,683
|
|
|
|
69,550
|
|
|
63,641
|
Non-interest income
|
|
|
6,582
|
|
|
8,859
|
|
|
6,162
|
|
|
5,884
|
|
|
5,234
|
|
|
5,404
|
|
|
|
5,751
|
|
|
5,075
|
Non-interest expense
|
|
|
33,612
|
|
|
33,222
|
|
|
32,285
|
|
|
30,229
|
|
|
30,140
|
|
|
29,383
|
|
|
|
29,069
|
|
|
25,326
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income tax expense
|
|
|
47,715
|
|
|
53,264
|
|
|
48,274
|
|
|
47,407
|
|
|
47,503
|
|
|
47,704
|
|
|
|
46,232
|
|
|
43,390
|
Income tax expense
|
|
|
16,799
|
|
|
19,258
|
|
|
17,693
|
|
|
17,441
|
|
|
16,979
|
|
|
17,046
|
|
|
|
17,180
|
|
|
16,054
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
30,916
|
|
|
34,006
|
|
|
30,581
|
|
|
29,966
|
|
|
30,524
|
|
|
30,658
|
|
|
|
29,052
|
|
|
27,336
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic net income per common share
|
|
$
|
0.62
|
|
$
|
0.68
|
|
$
|
0.60
|
|
$
|
0.58
|
|
$
|
0.59
|
|
$
|
0.60
|
|
|
$
|
0.57
|
|
$
|
0.54
|
Diluted net income per common share
|
|
$
|
0.62
|
|
$
|
0.67
|
|
$
|
0.60
|
|
$
|
0.57
|
|
$
|
0.58
|
|
$
|
0.59
|
|
|
$
|
0.56
|
|
$
|
0.54
|
F-49