Edgar Filing: BANC OF CALIFORNIA, INC.

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Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended June 30, 2013

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

For the transition period from to

Commission file number 001-35522

BANC OF CALIFORNIA, INC.

(Exact name of registrant as specified in its charter)

Maryland

(State or other jurisdiction of

incorporation or organization)

04-3639825

(IRS Employer Identification No.)

18500 Von Karman Ave, Suite 1100, Irvine, California

(Address of principal executive offices)

92612

(Zip Code)

(949) 236-5211

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date.

As of July 31, 2013 the registrant had outstanding 17,437,784 shares of voting common stock and 579,490 shares of Class B non-voting common stock.

BANC OF CALIFORNIA, INC.

Form 10-Q Quarterly Report

Index



		Page

Part I - Financial Information

Item 1	Financial Statements		4

Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations		50

Item 3	Quantitative and Qualitative Disclosure About Market Risk		80

Item 4	Controls and Procedures		81

Part II - Other Information

Item 1	Legal Proceedings		83

Item 1A	Risk Factors		83

Item 2	Unregistered Sales of Equity Securities and Use of Proceeds		83

Item 3	Defaults Upon Senior Securities.		84

Item 4	Mine Safety Disclosures.		84

Item 5	Other Information.		84

Item 6	Exhibits		85

Signatures			90

Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995

When used in this report and in public shareholder communications, in other documents of Banc of California, Inc. (the “Company,” “we,” “us” and “our”) filed with or furnished to the Securities and Exchange Commission (the “SEC”), or in oral statements made with the approval of an authorized executive officer, the words or phrases “believe,” “will,” “should,” “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimate,” “project,” “plans,” “guidance” or similar expressions are intended to identify “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. You are cautioned not to place undue reliance on any forward-looking statements, which speak only as of the date made. These statements may relate to our future financial performance, strategic plans or objectives, revenue, expense or earnings projections, or other financial items. By their nature, these statements are subject to numerous uncertainties that could cause actual results to differ materially from those anticipated in the statements.

Factors that could cause actual results to differ materially from the results anticipated or projected include, but are not limited to, the following: (i) the occurrence of any event, change or other circumstances that could give rise to the termination of the agreement for the pending sale of certain branches to American West Bank (“AWB”); (ii) the inability to complete the pending sale of certain branches to AWB due to the failure to satisfy the conditions to completion; (iii) risks that the pending sale of certain branches to AWB, or the Company’s recently completed acquisitions of Beach Business Bank, Gateway Bancorp and the Private Bank of California (“PBOC”), may disrupt current plans and operations, the potential difficulties in customer and employee retention as a result of the transactions and the amount of the costs, fees, expenses and charges related to the transactions; (iv) continuation or worsening of current recessionary conditions, as well as continued turmoil in the financial markets; (v) the credit risks of lending activities, which may be affected by further deterioration in real estate markets and the financial condition of borrowers, may lead to increased loan and lease delinquencies, losses and nonperforming assets in our loan portfolio, and may result in our allowance for loan and lease losses not being adequate to cover actual losses and require us to materially increase our loan and lease loss reserves; (vi) the quality and composition of our securities portfolio; (vii) changes in general economic conditions, either nationally or in our market areas; (viii) continuation of the historically low short-term interest rate environment, changes in the levels of general interest rates, and the relative differences between short- and long-term interest rates, deposit interest rates, our net interest margin and funding sources; (ix) fluctuations in the demand for loans and leases, the number of unsold homes and other properties and fluctuations in commercial and residential real estate values in our market area; (x) results of examinations of us by regulatory authorities and the possibility that any such regulatory authority may, among other things, require us to increase our allowance for loan and lease losses, write-down asset values, increase our capital levels, or affect our ability to borrow funds or maintain or increase deposits, which could adversely affect our liquidity and earnings; (xi) legislative or regulatory changes that adversely affect our business, including changes in regulatory capital or other rules; (xii) our ability to control operating costs and expenses; (xiii) staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our work force and potential associated charges; (xiv) errors in our estimates in determining fair value of certain of our assets, which may result in significant declines in valuation; (xv) the network and computer systems on which we depend could fail or experience a security breach; (xvi) our ability to attract and retain key members of our senior management team; (xvii) costs and effects of litigation, including settlements and judgments; (xviii) increased competitive pressures among financial services companies; (xix) changes in consumer spending, borrowing and saving habits; (xx) adverse changes in the securities markets; (xxi) earthquake, fire or other natural disasters affecting the condition of real estate collateral; (xxii) the availability of resources to address changes in laws, rules or regulations or to respond to regulatory actions; (xxiii) inability of key third-party providers to perform their obligations to us; (xxiv) changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board or their application to our business, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods; (xxv) war or terrorist activities; and (xxvi) other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services and the other risks described in this report and from time to time in other documents that we file with or furnish to the SEC, including, without limitation, the risks described under “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2012. You should not place undue reliance on forward-looking statements, and we undertake no obligation to update any such statements to reflect circumstances or events that occur after the date on which the forward-looking statement is made.

PART I – FINANCIAL INFORMATION

ITEM 1 – FINANCIAL STATEMENTS

Banc of California, Inc.

Consolidated Statements of Financial Condition

(In thousands of dollars except share and per share data)

(Unaudited)


	June 30, 2013			December 31, 2012
ASSETS
Cash and due from banks	$	8,153		$	8,254
Interest-bearing deposits		454,182			100,389

Total cash and cash equivalents		462,335			108,643
Time deposits in financial institutions		2,589			5,027
Securities available for sale, at fair value		106,751			121,419
Loans held for sale, carried at fair value		257,949			113,158
Loans and leases receivable, net of allowance of $16,979 at June 30, 2013 and $14,448 at December 31, 2012		1,597,367			1,234,023
Federal Home Loan Bank and other bank stock, at cost		10,838			8,842
Servicing rights, net ($4,620 measured at fair value at June 30, 2013 and $1,739 at December 31, 2012)		5,040			2,278
Accrued interest receivable		7,887			5,002
Other real estate owned (OREO), net		1,537			4,527
Premises, equipment, and capital leases, net		15,533			16,147
Premises and equipment held-for-sale		3,139			—
Bank-owned life insurance		18,792			18,704
Deferred income tax, net		7,199			7,572
Goodwill		7,048			7,048
Income tax receivable		738			5,545
Other intangible assets, net		4,740			5,474
Other assets		25,632			19,293

Total assets	$	2,535,114		$	1,682,702

LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits:
Noninterest-bearing deposits		132,855			194,662
Interest-bearing deposits		1,519,948			1,111,680
Deposits held for sale		457,028			—

Total deposits		2,109,831			1,306,342
Advances from Federal Home Loan Bank		45,000			75,000
Notes payable, net		82,127			81,935
Reserve for loss on repurchased loans		3,974			3,485
Accrued expenses and other liabilities		25,697			27,183

Total liabilities		2,266,629			1,493,945
Commitments and contingent liabilities
SHAREHOLDERS’ EQUITY
Preferred stock, $.01 par value per share, $1,000 per share liquidation preference for a total of $32,000; 50,000,000 shares authorized, 32,000 shares issued and outstanding at June 30, 2013 and December 31, 2012		31,934			31,934
Perpetual preferred stock, $.01 par value per share; Series C, 8% non-cumulative, $1,000 per share liquidation preference, 1,610,000 shares authorized and 1,400,000 and 0 shares outstanding at June 30, 2013 at December 31, 2012		33,734			—
Common stock, $.01 par value per share, 196,863,844 shares authorized; 16,134,900 shares issued and 14,976,979 shares outstanding at June 30, 2013; 12,013,717 shares issued and 10,780,427 shares outstanding at December 31, 2012		162			120
Class B non-voting non-convertible Common stock, $.01 par value per share, 3,136,156 shares authorized; 574,258 shares issued and outstanding at June 30, 2013 and 1,112,188 shares issued and outstanding at December 31, 2012		5			11
Additional paid-in capital		197,272			154,563
Retained earnings		28,678			26,550
Treasury stock, at cost (1,157,921 shares at June 30, 2013 and 1,233,290 shares at December 31, 2012)		(24,088	)		(25,818	)
Accumulated other comprehensive income, net		788			1,397

Total shareholders’ equity		268,485			188,757

Total liabilities and shareholders’ equity	$	2,535,114		$	1,682,702

See accompanying notes to consolidated financial statements (Unaudited)

Banc of California, Inc.

Consolidated Statements of Operations

(In thousands of dollars except share and per share data)

(Unaudited)


	Three months ended June 30,						Six months ended June 30,
	2013			2012			2013			2012
Interest and dividend income
Loans, including fees	$	26,153		$	9,604		$	44,690		$	19,132
Securities		369			694			867			1,431
Dividends and other interest-earning assets		219			80			352			140

Total interest and dividend income		26,741			10,378			45,909			20,703
Interest expense
Deposits		3,303			1,358			5,302			2,707
Federal Home Loan Bank advances		58			92			121			192
Capital leases		20			2			32			2
Notes payable		1,735			495			3,470			495

Total interest expense		5,116			1,947			8,925			3,396

Net interest income		21,625			8,431			36,984			17,307
Provision for loan and lease losses		1,918			279			4,086			970

Net interest income after provision for loan and lease losses		19,707			8,152			32,898			16,337
Noninterest income
Customer service fees		509			378			1,055			739
Loan servicing income		458			—			646			—
Income from bank owned life insurance		50			60			88			129
Net gain (loss) on sales of securities available for sale		1			(32	)		309			(71	)
Net gain on sale of loans		3,724			145			4,036			145
Net gain on mortgage banking activities		20,261			—			36,631			—
Other income		1,069			88			1,235			200

Total noninterest income		26,072			639			44,000			1,142
Noninterest expense
Salaries and employee benefits		25,311			5,177			44,391			10,044
Occupancy and equipment		3,630			1,321			6,823			2,320
Professional fees		2,947			987			5,244			1,530
Data processing		1,365			502			2,275			909
Advertising		890			214			1,412			453
Regulatory assessments		211			362			592			680
Loan servicing and foreclosure expense		148			367			352			705
Operating loss on equity investment		131			77			290			153
Valuation allowance for OREO		—			155			79			169
Net gain on sales of other real estate owned		(37	)		(192	)		(151	)		(508	)
Provision for loan repurchases		732			—			988			—
Amortization of intangible assets		367			—			734			—
All other expense		3,899			973			6,123			1,706

Total noninterest expense		39,594			9,943			69,152			18,161

Income (loss) before income taxes		6,185			(1,152	)		7,746			(682	)
Income tax expense (benefit)		1,822			(413	)		2,454			(320	)

Net income (loss)	$	4,363		$	(739	)	$	5,292		$	(362	)
Preferred stock dividends and discount accretion		—			314			288			714

Net income (loss) available to common shareholders	$	4,363		$	(1,053	)	$	5,004		$	(1,076	)

Basic earnings (loss) per common share	$	0.36		$	(0.09	)	$	0.41		$	(0.09	)

Diluted earnings (loss) per common share	$	0.36		$	(0.09	)	$	0.41		$	(0.09	)

Basic earnings (loss) per class B common share	$	0.36		$	(0.09	)	$	0.41		$	(0.09	)

Diluted earnings (loss) per class B common share	$	0.36		$	(0.09	)	$	0.41		$	(0.09	)

See accompanying notes to consolidated financial statements (Unaudited)

Banc of California, Inc.

Consolidated Statements of Comprehensive Income/(loss)

(In thousands of dollars, except share and per share data)

(Unaudited)


	Three months ended June 30,						Six months ended June 30,
	2013			2012			2013			2012
Net income (loss)	$	4,363		$	(739	)	$	5,292		$	(362	)
Other comprehensive income (loss), before tax:
Change in net unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during the period, net of tax (expense) benefit of $0 and $210 for the three months ended $0 and $551 for the six months ended June 30, 2013 and 2012, respectively		(400	)		299			(300	)		787
Less: reclassification adjustment for (gains) losses included in net income, net of tax (expense) benefit of $0 and $13 for the three months ended and $0 and $29 for the six months ended June 30, 2013 and 2012, respectively		(1	)		19			(309	)		42

Total other comprehensive (loss) income, net of tax	$	(401	)	$	318		$	(609	)	$	829

Comprehensive income (loss)	$	3,962		$	(421	)	$	4,683		$	467

See accompanying notes to consolidated financial statements (Unaudited)

Banc of California, Inc.

Consolidated Statements of Shareholders’ Equity

(In thousands of dollars, except share and per share data)

(Unaudited)


	Preferred Stock			Perpetual Preferred Stock		Common Stock		Class B Non-voting Non-convertible Common Stock			Additional Paid-in Capital			Retained Earnings			Treasury Stock			Accumulated Other Comprehensive Income (Loss)			Total
Balance at January 1, 2012	$	31,934		$	—	$	117	$	11		$	150,786		$	27,623		$	(25,037	)	$	(939	)	$	184,495
Comprehensive income (loss):
Net loss		—			—		—		—			—			(362	)		—			—			(362	)
Other comprehensive income, net		—			—		—		—			—			—			—			829			829
Forfeiture and retirement of 200 shares of common stock		—			—		—		—			3			—			(3	)		—			—
Stock option compensation expense		—			—		—		—			427			—			—			—			427
Restricted stock compensation expense		—			—		—		—			104			—						—			104
Issuance of 5,000 stock awards		—			—							(106	)		—			106			—			—
Purchase of 228 shares of treasury stock		—			—		—		—			—			—			(73	)		—			(73	)
Dividends declared ($0.24 per common share)		—			—		1		—			421			(2,801	)		—			—			(2,379	)
Preferred stock issuance cost		(9	)		—		—		—			—			—			—			—			(9	)
Preferred stock dividends		—			—		—		—			—			(714	)		—			—			(714	)
Tax loss of restricted share awards vesting		—			—		—		—			(17	)		—			—			—			(17	)
Capital raising expenses		—			—		—		—			(6	)		—			—			—			(6	)

Balance at June 30, 2012	$	31,925		$	—	$	118	$	11		$	151,612		$	23,746		$	(25,007	)	$	(110	)	$	182,295

Balance at January 1, 2013	$	31,934		$	—	$	120	$	11		$	154,563		$	26,550		$	(25,818	)	$	1,397		$	188,757
Net income		—			—		—		—			—			5,292			—			—			5,292
Other comprehensive income, net		—			—		—		—			—			—			—			(609	)		(609	)
Issuance of common stock		—			—		42		(6	)		43,450			—			—			—			43,486
Issuance of preferred stock		—			33,734		—		—			—			—			—			—			33,734
Purchase of 6,216 shares of treasury stock		—			—		—		—			—			—			(69	)		—			(69	)
Issuance of stock awards from treasury stock		—			—		—		—			(1,799	)		—			1,799			—			—
Shares purchased under the Dividend Reinvestment Plan		—			—		—		—			186			(186	)		—			—			—
Stock option compensation expense		—			—		—		—			215			—			—			—			215
Restricted stock compensation expense		—			—		—		—			657			—			—			—			657
Dividends declared ($0.24 per common share)		—			—		—		—			—			(2,690	)		—			—			(2,690	)
Preferred stock dividends		—			—		—		—			—			(288	)		—			—			(288	)

Balance at June 30, 2013	$	31,934		$	33,734	$	162	$	5		$	197,272		$	28,678		$	(24,088	)	$	788		$	268,485

See accompanying notes to consolidated financial statements (Unaudited)

Banc of California, Inc.

Consolidated Statements of Cash Flows

(In thousands of dollars)

(Unaudited)


	Six months ended June 30,
	2013			2012
Cash flows from operating activities:
Net income (loss)	$	5,292		$	(362	)
Adjustments to reconcile net income (loss) to net cash from operating activities
Provision for loan losses		4,086			970
Provision for loan repurchases		988			—
Net gain on mortgage banking activities		(36,631	)		—
Gain on sale of loans		(4,036	)		—
Net amortization (accretion) of securities		576			433
Depreciation		1,510			535
Amortization of intangibles		734			—
Amortization of debt		192			34
Stock option compensation expense		215			427
Restricted stock compensation expense		657			104
Stock appreciation right expense		298			—
Bank owned life insurance income		(88	)		(129	)
Operating loss on equity investment		290			153
Net (gain) loss on sale of securities available for sale		(309	)		71
Gain on sale of other real estate owned		(151	)		(508	)
Gain on sale of property and equipment		(2	)		—
Deferred income tax expense		—			517
Increase in valuation allowances on other real estate owned		79			169
Originations of loans held for sale		(867,640	)		—
Proceeds from sales of loans held for sale		752,478			—
Deferred loan (costs) fees		(399	)		355
Premiums and discounts on purchased loans		(8,001	)		(425	)
Accrued interest receivable		(2,885	)		(146	)
Other assets		8,710			8,074
Accrued interest payable and other liabilities		863			(1,023	)

Net cash from operating activities		(143,174	)		9,249

Cash flows from investing activities:
Proceeds from sales of securities available-for-sale		8,539			5,682
Proceeds from maturities, calls, principal repayments of securities available-for-sale		53,897			21,932
Purchases of securities available-for-sale		(48,626	)		(42,229	)
Purchases of equity investment		—			(375	)
Loan originations and principal collections, net		(144,707	)		(65,714	)
Purchase of loans		(374,878	)		(22,385	)
Redemption of Federal Home Loan Bank stock		25			661
Purchase of Federal Home Loan Bank and Other Bank Stocks		(2,021	)		—
Net change in other interest-bearing deposits		2,438			—
Proceeds from sale of loans held for investment		155,209			22,947
Proceeds from sale of other real estate owned		3,474			7,015
Additions to premises and equipment		(4,033	)		(3,092	)
Payment of capital lease obligations		(113	)		(10	)

Net cash from investing activities		(350,796	)		(75,568	)

Cash flows from financing activities:
Net increase in deposits		803,489			65,997
Repayments of Federal Home Loan Bank advances		(55,000	)		(20,000	)
Proceeds from Federal Home Loan Bank advances		25,000			35,000
SBLF expense		—			(7	)
Net proceeds from issuance of common stock		43,486			—
Net proceeds from issuance of preferred stock		33,734			—
Net proceeds from issuance of long term debt		—			31,680
Purchase of treasury stock		(69	)		(82	)
Tax benefit (expenses) from restricted stock vesting		—			(17	)
Dividends paid on preferred stock		(288	)		(714	)
Dividends paid on common stock		(2,690	)		(1,186	)

Net cash from financing activities		847,662			110,671

Net change in cash and cash equivalents		353,692			44,352
Cash and cash equivalents at beginning of year		108,643			44,475

Cash and cash equivalents at end of year	$	462,335		$	88,827

Supplemental cash flow information
Interest paid on deposits and borrowed funds	$	8,893		$	3,380
Income taxes paid		—			—
Income tax refunds received		2,305			—
Supplemental disclosure of noncash activities
Transfer from loans to other real estate owned, net		—			3,614
Equipment acquired under capital leases		714			179
Transfer of loans receivable to loans held for sale		10,358			—

See accompanying notes to consolidated financial statements (Unaudited)

BANC OF CALIFORNIA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

June 30, 2013

(Amounts in thousands of dollars, except share and per share data)

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation: The accompanying unaudited consolidated financial statements include the accounts of Banc of California, Inc. (the Company) and its wholly owned subsidiaries, Pacific Trust Bank (PacTrust Bank), Beach Business Bank (Beach, and together with PacTrust Bank, the Banks) and PTB Property Holdings, LLC, as of June 30, 2013 and December 31, 2012 and for the six months ended June 30, 2013 and 2012, except that the accounts of Beach Business Bank were not included for amounts prior to July 1, 2012. Significant intercompany accounts and transactions have been eliminated in consolidation. Unless the context requires otherwise, all references to the Company include its wholly owned subsidiaries. As discussed in Note 19, on July 1, 2013, the Company completed its acquisition of The Private Bank of California, a California-chartered bank (PBOC), through the merger of PBOC with and into Beach, with Beach surviving the merger and changing its name to “The Private Bank of California”.

Nature of Operations: The principal business of the Company is the ownership of the Banks. PacTrust Bank is a federally chartered stock savings bank and Beach is a California state chartered commercial bank. The Banks are members of the Federal Home Loan Bank (FHLB) system, and maintain insurance on deposit accounts with the Federal Deposit Insurance Corporation (FDIC). PTB Property Holdings, LLC manages and disposes of other real estate owned properties.

The Banks are engaged in the business of retail banking, with operations conducted through 19 banking offices serving San Diego, Los Angeles, Orange and Riverside counties, California and forth-two loan production offices in California, Arizona, Oregon, , Washington and Montana. As of June 30, 2013, single family residential (SFR) loans and Green loans, SFR mortgage lines of credit, accounted for approximately 51.1 percent and 10.9 percent, respectively, of the Company’s loan and lease portfolio, with a high percentage of such loans concentrated in Southern California. The customer’s ability to repay their loans or leases is dependent on the real estate market and general economic conditions in the area.

The accounting and reporting polices of the Company are based upon U.S. generally accepted accounting principles (GAAP) and conform to predominant practices within the banking industry. The Company has not made any significant changes in its critical accounting policies or in its estimates and assumptions from those disclosed in its 2012 Annual Report on Form 10-K other than the adoption of new accounting pronouncements and other authoritative guidance that became effective for the Company on or after January 1, 2013. Refer to Accounting Pronouncements for discussion of accounting pronouncements adopted in 2013.

Basis of Presentation: The accompanying unaudited interim consolidated financial statements have been prepared pursuant to the rules and regulations for reporting on Form 10-Q. Accordingly, certain disclosures required by GAAP are not included herein. These interim statements should be read in conjunction with the consolidated financial statements and notes included in the Annual Report on Form 10-K for the year ended December 31, 2012 filed by the Company with the Securities and Exchange Commission. The December 31, 2012 balance sheet presented herein has been derived from the audited financial statements included in the Annual Report on Form 10-K for the year ended December 31, 2012 filed with the Securities and Exchange Commission, but does not include all of the disclosures required by GAAP.

In the opinion of management of the Company, the accompanying unaudited interim consolidated financial statements reflect all of the adjustments (consisting of normal recurring adjustments) necessary for a fair presentation of the consolidated financial position and consolidated results of operations for the periods presented. Certain reclassifications have been made in the prior period financial statements to conform to the current period presentation.

The results of operations for the three and six months ended June 30, 2013 are not necessarily indicative of the results to be expected for the full year.

Use of Estimates in the Preparation of Financial Statements: The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and disclosures provided, and actual results could differ. The allowance for loan and lease losses, reserve for loss on repurchased loans, servicing rights, other real estate owned, realization of deferred tax assets, goodwill, other intangible assets, mortgage banking derivatives, fair value of assets and liabilities acquired in business combinations, fair value estimate of private label residential mortgage-backed securities, and the fair value of financial instruments are particularly subject to change and such change could have a material effect on the consolidated financial statements.

Income Taxes: Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized. The Company had $8.0 million and $8.4 million of valuation allowance related to its deferred tax assets at June 30, 2013 and December 31, 2012 (See further discussion in Note 11, Income Taxes).

Accounting Pronouncements: During the six months ended June 30, 2013, the following pronouncements applicable to the company were issued or became effective:

In January 2013, the FASB issued ASU 2013-01, Balance Sheet (Topic 210), Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities (“ASU 2013-01” ). ASU 2013-01 clarifies that ordinary trade receivables and other receivables are not in the scope of ASU 2011-11, Balance Sheet (Topic 210), Disclosures about Offsetting Assets and Liabilities (“2011- 11”). Specifically, ASU 2011-11 applies only to derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions that are either offset in accordance with specific criteria contained in the ASC or subject to a master netting arrangement or similar agreement. The amendments in ASU 2013-01 are effective for fiscal years beginning on or after January 1, 2013, and interim periods within those annual periods. Adoption of the new guidance is not expected to have a significant impact on the Company’s consolidated financial statements.

In February 2013, the FASB issued ASU 2013-02, Other Comprehensive Income (Topic 220), Reporting of Amounts Reclassified out of Other Comprehensive Income (“ASU 2013-02”). The provisions in the ASU supersede and replace the presentation requirements for reclassifications out of accumulated other comprehensive income (“AOCI”) in ASUs 2011-05 and 2011-12. ASU 2013-02 requires entities to disclose additional information about reclassification adjustments, including (1) changes in AOCI balances by component and (2) significant items reclassified out of AOCI. The new disclosure requirements are effective for fiscal years, and interim periods within those years, beginning after December 15, 2012. Adoption of the new guidance did not have a significant impact on the Company’s consolidated financial statements.

NOTE 2 – BUSINESS COMBINATIONS AND BRANCH SALES

Beach Business Bank Merger

Effective July 1, 2012, the Company acquired Beach Business Bank pursuant to the terms of the Agreement and Plan of Merger (the Merger Agreement) dated August 30, 2011, as amended October 31, 2011. At the effective time of the transaction, a newly formed and wholly owned subsidiary of the Company (Merger Sub) merged with and into Beach (the Merger), with Beach continuing as the surviving entity in the Merger and a wholly owned subsidiary of the Company. Pursuant and subject to the terms of the Merger Agreement, each outstanding share of Beach common stock (other than specified shares owned by the Company, Merger Sub or Beach, and other than in the case of shares in respect of, or underlying, certain Beach options and other equity awards, which were treated as set forth in the Merger Agreement) was converted into the right to receive $9.21415 in cash and one warrant. Each warrant entitled the holder to purchase 0.33 of a share of Company common stock at an exercise price of $14.00 per share for a period of one year. All of the warrants expired on June 30, 2013 without being exercised. The aggregate cash consideration paid to Beach shareholders in the Merger was approximately $39.1 million. In addition, Beach shareholders received in aggregate warrants to purchase the equivalent of 1,401,959 shares of the Company’s common stock with an estimated fair value of $1.0 million.

Beach (re-named The Private Bank of California effective July 1, 2013) operates branches in Manhattan Beach, Long Beach, and Costa Mesa, California. Beach also has a division named The Doctors Bank^®, which serves physicians and dentists nationwide. Additionally, Beach provides loans to small businesses based on Small Business Administration (SBA) lending programs. Beach’s consolidated assets and equity (unaudited) as of June 30, 2012 totaled $311.9 million and $33.3 million, respectively. The acquired assets and liabilities were recorded at fair value at the date of acquisition and were reflected in the Company’s consolidated June 30, 2013 and December 31, 2012 financial statements as such.

In accordance with GAAP guidance for business combinations, the Company recorded $7.0 million of goodwill and $4.5 million of other intangible assets during the year ended December 31, 2012. The other intangible assets are primarily related to core deposits and are being amortized on an accelerated basis over 2—7 years. For tax purposes purchase accounting adjustments, including goodwill are all non-taxable and/or non-deductible.

The unique market opportunity that was created with the acquisition is that it creates for our Company the opportunity to leverage Beach’s branch network, SBA lending platform, the Doctors Bank product offerings and other programs that can be deployed throughout our market which we expect will help augment our customer base. This acquisition was consistent with the Company’s strategy to build a regional presence in Southern California. The acquisition offers the Company the opportunity to increase profitability by introducing existing products and services to the acquired customer base as well as acquire new customers in the expanded region.

Gateway Bancorp Acquisition

Effective August 18, 2012, the Company acquired Gateway Bancorp, the holding company of Gateway Business Bank (Gateway) pursuant to the terms of the Stock Purchase Agreement (the Purchase Agreement) dated June 3, 2011, as amended on November 28, 2011, February 24, 2012, June 30, 2012, and July 31, 2012. The acquisition was accomplished by the Company’s purchase of all of the outstanding stock of Gateway Bancorp, followed by the merger of Gateway into PacTrust Bank. Under the terms of the Purchase Agreement, the Company purchased all of the issued and outstanding shares of Gateway Bancorp for $15.4 million in cash.

Gateway operated branches in Lakewood and Laguna Hills, California. As part of the acquisition, Mission Hills Mortgage Bankers (MHMB, a division of Gateway), including its 22 loan production offices in California, Arizona, Oregon and Washington, became a division of PacTrust Bank. Gateway’s consolidated assets and equity (unaudited) as of August 17, 2012 totaled $175.5 million and $25.8 million, respectively. The acquired assets and liabilities were recorded at fair value at the date of acquisition and were reflected in the June 30, 2013 and December 31, 2012 consolidated financial statements as such.

In accordance with GAAP guidance for business combinations, the Company recorded $11.6 million of bargain purchase gain and $1.7 million of other intangible assets during the year ended December 31, 2012. The other intangible assets are related to $720 thousand of core deposits, which are being amortized on an accelerated basis over 4—6 years, and $955 thousand of trade name intangible which is being amortized over 20 years. For tax purposes the purchase accounting adjustments and bargain purchase gain are non-taxable and/or non-deductible. Due to circumstances that Gateway faced at the time the acquisition was negotiated, which include regulatory orders and operating losses, the terms negotiated included a purchase price that was $5 million lower than Gateway Bancorp’s equity book value. The discount was further increased to $6.5 million in exchange for the elimination of any contingent liability to the shareholder of Gateway Bancorp related to mortgage repurchase risk. Due to delays in obtaining regulatory approval, the deal closed nine months later than originally planned. This passage of time allowed Gateway to eliminate all regulatory orders, return to profitability, improve asset quality, and increase the book value of equity by reducing the expected discount on assets. As a result, a bargain purchase gain of $11.6 million resulted at the time of purchase.

This acquisition was consistent with the Company’s strategy to build a regional presence in Southern California. The acquisition offers the Company the opportunity to increase profitability by introducing existing products and services to the acquired customer base as well as add new customers in the expanded region.

Pro Forma Information

The following table presents unaudited pro forma information as if the acquisitions had occurred on January 1, 2012 after giving effect to certain adjustments. The unaudited pro forma information for the three and six months ended June 30, 2013 and 2012 includes adjustments for interest income on loans and securities acquired, amortization of intangibles arising from the transaction, interest expense on deposits and borrowings acquired, and the related income tax effects. The unaudited pro forma financial information is not necessarily indicative of the results of operations that would have occurred had the transaction been effected on the assumed date.


	Pro Forma
	Three Months Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
	(In thousands, except per share data)
SUMMARIZED INCOME STATEMENT DATA (unaudited):
Net interest income	$	21,625	$	13,343	$	36,984	$	27,173
Provision for loan and lease losses		1,918		929		4,086		1,820
Non-interest income		26,072		12,369		44,000		22,229
Non-interest expense		39,594		24,143		69,152		45,706
Income before income taxes		6,185		640		7,746		1,876
Income tax expense		1,822		340		2,454		754

Net income	$	4,363	$	300	$	5,292	$	1,122

Basic earning per share	$	0.36	$	0.03	$	0.41	$	0.10
Diluted earnings per share	$	0.36	$	0.03	$	0.41	$	0.10

Excluded from the above pro forma financials is a gain of $11.6 million related to the bargain purchase gain for the Gateway acquisition.

Private Bank of California Acquisition

On August 21, 2012, the Company and Beach entered into a definitive agreement to acquire all the outstanding stock of PBOC and to merge PBOC with and into Beach. At June 30, 2013, PBOC had total assets of $655.5 million, total loans, net of allowance for loan losses, of $388.7 million and total deposits of $561.5 million (unaudited). PBOC provides a range of financial services, including credit and deposit products as well as cash management services, from its headquarters located in the Century City area of Los Angeles, California as well as a full-service branch in Hollywood and loan production offices in downtown Los Angeles and Irvine. PBOC’s target clients include high-net worth and high income individuals, business professionals and their professional service firms, business owners, entertainment service businesses and non-profit organizations.

The Company completed the acquisition of PBOC on July 1, 2013 (See further discussion in Note 19, Subsequent Events). The acquisition will be accounted for under the acquisition method of accounting.

Branch Sales

On May 31, 2013, PacTrust Bank entered into a definitive agreement with AmericanWest Bank, a Washington state chartered bank (“AWB”), pursuant to which PacTrust Bank has agreed to sell eight branches and related assets and deposit liabilities to AWB. The transaction will result in the transfer of deposits to AWB in exchange for a deposit premium of 2.3% applied to certain deposit balances transferred at closing. The deposits to be transferred totaled approximately $457.0 million as of June 30, 2013. Certain other assets related to the branches will be acquired as a part of the transaction including the sale of the real estate for three of the branch locations and certain overdraft and other credit facilities related to the deposit accounts. These deposits and retail branch assets have been classified as held-for-sale in the Consolidated Statements of Financial Condition as of June 30, 2013.

NOTE 3 – FAIR VALUES OF FINANCIAL INSTRUMENTS

Fair Value Hierarchy. ASC 820-10 establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The topic describes three levels of inputs that may be used to measure fair value:

•

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

•

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

•

Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

Securities Available for Sale. The fair values of securities available for sale are generally determined by quoted market prices, if available (Level 1), or by matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3). The fair values of the Company’s Level 3 securities are determined by the Company and an independent third-party provider using a discounted cash flow methodology. The methodology uses discount rates that are based upon observed market yields for similar securities. Prepayment speeds are estimated based upon the prepayment history of each bond and a detailed analysis of the underlying collateral. Gross weighted average coupon, geographic concentrations, loan to value, FICO and seasoning are among the different loan attributes that are factored into our prepayment curve. Default rates and severity are estimated based upon geography of the collateral, delinquency, modifications, loan to value ratios, FICO scores, and past performance.

Impaired Loans and Leases. The fair value of impaired loans and leases with specific allocations of the allowance for loan and lease losses based on collateral values is generally based on recent real estate appraisals (Level 2). These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value. The impaired loans categorized as Level 3 also include unsecured and other secured loans whose fair value based on significantly unobservable inputs such as strength of guarantees, cash flows discounted at the effective loan rate, and management’s judgement.

Loans Held for Sale. The fair value of loans held for sale is based on commitments outstanding from investors as well as what secondary markets are currently offering for portfolios with similar characteristics. Therefore, loans held for sale subjected to recurring fair value adjustments are classified as Level 2.

Derivative Assets and Liabilities. The Company’s derivative assets and liabilities are carried at fair value as required by GAAP and are accounted for as freestanding derivatives. The derivative assets are interest rate lock commitments (IRLCs) with prospective residential mortgage borrowers whereby the interest rate on the loan is locked by borrower prior to funding. These IRLCs are determined to be derivative instruments in accordance with GAAP. The derivative liabilities are hedging instruments typically mortgage-backed to-be-announced (TBA securities) used to hedge the risk of fair value changes affected by interest rates changes relating to the Company’s mortgage banking operations. The Company hedges the period from the interest rate lock (assuming a fall-out factor) to the date of the loan sale. The estimated fair value is based on current market prices for similar instruments. Given the meaningful level of secondary market activity for derivative contracts, active pricing is available for similar assets and accordingly, the Company classifies its derivative assets and liabilities as Level 2.

Servicing Rights – Mortgage. The Company retains servicing on some of its mortgage loans sold and has elected the fair value option for valuation of these mortgage servicing rights. The value is based on a third party model that calculates the present value of the expected net servicing income from the portfolio based on key factors that include interest rates, prepayment assumptions, discount rate and estimated cash flows. Because of the significance of unobservable inputs, these servicing rights are classified as Level 3.

I/O Strips Receivable. The fair value is determined by discounting future cash flows using discount rates and prepayment assumptions that market participants would use for similar financial instruments. Because of the significance of unobservable inputs, the I/O strips receivable are classified as Level 3.

Other Real Estate Owned Assets (OREO). OREO are recorded at the fair value less estimated costs to sell at the time of foreclosure. The fair value of other real estate owned assets is generally based on recent real estate appraisals adjusted for estimated selling costs. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value. Only OREO with a valuation allowance are considered to be carried at fair value. For the six months ended June 30, 2013 and 2012, the Company experienced $79 thousand and $169 thousand in valuation allowance expense for those assets, respectively.

Assets and Liabilities Measured on a Recurring and Non-Recurring Basis

Available-for-sale securities, loans held for sale, derivative assets and liabilities, and mortgage servicing rights are measured at fair value on a recurring basis, whereas impaired loans and leases and other real estate owned are measured at fair value on a non-recurring basis.

The following table sets forth the Company’s financial assets and liabilities measured at fair value on a recurring basis as of the dates indicated:


			Fair Value Measurements Level
			Quoted Prices in		Significant
			Active Markets		Other		Significant
			for Identical		Observable		Unobservable
	Carrying		Assets		Inputs		Inputs
	Value		(Level One)		(Level Two)		(Level Three)
	(In thousands)
June 30, 2013:
Assets
Available-for-sale securities:
U.S. government-sponsored entities and agency securities	$	1,000	$	—	$	1,000	$	—
Private label residential mortgage-backed securities		29,764		—		28,058		1,706
Agency mortgage-backed securities		75,987		—		75,987		—
Loans held for sale		257,949		—		257,949		—
Derivative assets ⁽¹⁾		13,879		—		13,879		—
Mortgage servicing rights ⁽²⁾		4,620		—		—		4,620
Liabilities
Derivative liabilities ⁽³⁾		477		—		477		—
December 31, 2012:
Assets
Available-for-sale securities:
U.S. government-sponsored entities and agency securities	$	2,710	$	—	$	2,710	$	—
State and Municipal securities		9,944		—		9,944		—
Private label residential mortgage-backed securities		41,846		—		39,632		2,214
Agency mortgage-backed securities		66,919		—		66,919		—
Loans held for sale		113,158		—		113,158		—
Derivative assets ⁽¹⁾		2,890		—		2,890		—
Mortgage servicing rights ⁽²⁾		1,739		—		—		1,739
Liabilities
Derivative liabilities ⁽³⁾		988		—		988		—

⁽¹⁾

Included in other assets on the consolidated statements of financial condition

⁽²⁾

Included in servicing rights, net on the consolidated statements of financial condition

⁽³⁾

Included in accrued expenses and other liabilities on the consolidated statements of financial condition

The following table sets forth the Company’s financial assets and liabilities measured at fair value on a non recurring basis as of the dates indicated:


			Fair Value Measurements Level
			Quoted Prices in		Significant
			Active Markets		Other		Significant
			for Identical		Observable		Unobservable
	Carrying		Assets		Inputs		Inputs
	Value		(Level One)		(Level Two)		(Level Three)
	(In thousands)
June 30, 2013:
Assets
Impaired loans:
Real estate 1-4 family first mortgage		11,248		—		4,290		6,958
Multi-family		2,048		—		—		2,048
HELOC’s, home equity loans, and other consumer installment credit		1,055				635		420
Real estate mortgage		725		—		—		725
SBA		13		—		—		13
Other real estate owned assets:
Real estate 1-4 family first mortgage		109		—		—		109
Land		1,428		—		—		1,428
December 31, 2012:
Assets
Impaired loans:
Real estate 1-4 family first mortgage	$	21,778	$	—	$	3,041	$	18,737
Multi-family		5,442		—		—		5,442
Real estate mortgage		2,531		—		829		1,702
HELOC’s, home equity loans, and other consumer installment credit		3		—		—		3
Other real estate owned assets:
Real estate 1-4 family first mortgage		118		—		—		118
Land		3,889		—		—		3,889

There were $4.0 million and no impaired loans and leases with specific allowances tested for impairment using the fair value of the collateral for collateral dependent loans at June 30, 2013 and December 31, 2012, respectively.

Other real estate owned measured at fair value less costs to sell, had a net carrying value of $1.5 million, which was comprised of the outstanding balance of $1.6 million, net of a valuation allowance of $42 thousand at June 30, 2013. At December 31, 2012, real estate owned had a net carrying value of $4.5 million, which is made up of the outstanding balance of $6.6 million, net of a valuation allowance of $2.1 million.

The tables below present a reconciliation of assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the six months ended June 30, 2013:


	Private label residential mortgage-backed securities			Mortgage Servicing Rights			Total
	(In thousands)
Balance of recurring Level 3 securities at January 1, 2013	$	2,214		$	1,739		$	3,953
Transfers out of Level 3		—			—			—
Total gains or losses (realized/unrealized):
Included in earnings—realized		—			—			—
Included in earnings—fair value adjustment		—			330			330
Included in other comprehensive income		3			—			3
Amortization of premium (discount)		—			—			—
Additions		—			2,762			2,762
Sales, issuances and settlements		(511	)		(211	)		(722	)

Balance of recurring Level 3 securities at June 30, 2013	$	1,706		$	4,620		$	6,326

The table below presents a reconciliation of assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the six months ended June 30, 2012:


	Private label residential mortgage-backed securities
	(In thousands)
Balance of recurring Level 3 securities at January 1, 2012	$	91,862
Transfers out of Level 3		—
Total gains or losses (realized/unrealized):
Included in earnings—realized		(71	)
Included in earnings—unrealized		—
Included in other comprehensive income		1,373
Amortization of premium (discount)		(438	)
Purchases		41,031
Sales, issuances and settlements		(23,615	)

Balance of recurring Level 3 securities at June 30, 2012	$	110,142

The following table presents quantitative information about Level 3 fair value measurements on a recurring basis as of the dates indicated:


	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range (Weighted Average)
	($ in thousands)
June 30, 2013:
Private label residential mortgage backed securities	$	1,706	Discounted cash flow	Voluntary prepayment rate Collateral default rate	1.37% to 4.92% (3.15%) 6.23% to 6.26% (6.25%)
				Loss severity at default	55%
Mortage servicing rights		4,620	Discounted cash flow	Discount rate	10.5% to 17.9% (10.6%)
				Prepayment rate	6.1% to 36.1% (9.0%)
December 31, 2012:
Private label residential mortgage backed securities	$	2,214	Discounted cash flow	Voluntary prepayment rate Collateral default rate	3.15% to 8.00% (5.80%) 8.46% to 8.56% (8.5%)
				Loss severity at default	55%
Mortage servicing rights		1,739	Discounted cash flow	Discount rate	10.5% to 11.5% (10.5%)
				Prepayment rate	4.3% to 35.3% (13.8%)

The significant unobservable inputs used in the fair value measurement of the Company’s private label and agency residential mortgage backed securities are prepayment rates, collateral default rates, and loss severity in the event of default. Significant increases

(decreases) in any of those inputs in isolation would result in a significantly lower (higher) fair value measurement. Generally, a change in the assumption used for the collateral default rates is accompanied by a directionally similar change in the assumption used for the loss severity and a directionally opposite change in the assumption used for prepayment rates.

The significant unobservable inputs used in the fair value measurement of the Company’s mortgage servicing rights include the discount rate and estimated cash flows. There may be inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results.

The carrying amounts and estimated fair values of financial instruments as of June 30, 2013 and December 31, 2012 were as follows:


			Fair Value Measurements Level
	Carrying Amount		Level 1		Level 2		Level 3		Total
	(In thousands)
June 30, 2013:
Financial assets
Cash and cash equivalents	$	462,335	$	462,335	$	—	$	—	$	462,335
Time deposits in financial institutions		2,589		2,589		—		—		2,589
Securities available-for-sale		106,751		—		105,045		1,706		106,751
FHLB stock		10,838		—		10,838		—		10,838
Loans and leases receivable, net, excluding loans held for sale		1,597,367		—				1,622,130		1,622,130
Loans held for sale		257,949		—		257,949		—		257,949
Accrued interest receivable		7,887		31		5		7,851		7,887
Derivative assets		13,879		—		13,879		—		13,879
Mortgage servicing rights		5,040		—		—		5,040		5,040
Financial liabilities
Deposits		2,109,831		—		2,092,223		—		2,092,223
Advances from the FHLB		45,000		—		45,093		—		45,093
Notes payable		82,127		85,631		—		—		85,631
Derivative liabilities		477		—		477		—		477
Accrued interest payable		1,671		1,338		333		—		1,671
December 31, 2012:
Financial assets
Cash and cash equivalents	$	108,643	$	108,643	$	—	$	—	$	108,643
Time deposits in financial institutions		5,027		5,027		—		—		5,027
Securities available-for-sale		121,419		—		119,205		2,214		121,419
FHLB stock		8,842		—		8,842		—		8,842
Loans and leases receivable, net, excluding loans held for sale		1,234,023		—		—		1,267,292		1,267,292
Loans held for sale		113,158		—		113,158		—		113,158
Accrued interest receivable		5,002		7		50		4,945		5,002
Derivative assets		2,890		—		2,890		—		2,890
Mortgage servicing rights		2,278		—		—		2,278		2,278
Financial liabilities
Deposits		1,306,342		—		1,305,884		—		1,305,884
Advances from the FHLB		75,000		—		75,166		—		75,166
Notes payable		81,935		86,106		—		—		86,106
Derivative liabilities		988		—		988		—		988
Accrued interest payable		1,639		1,335		304		—		1,639

The methods and assumptions used to estimate fair value are described as follows:

Carrying amount is the estimated fair value for cash and cash equivalents, FHLB stock, and accrued interest receivable and payable. The methods for determining the fair values for securities available for sale, derivatives assets and liabilities, and I/O strips are described above. For fixed rate loans or deposits and for variable rate loans or deposits with infrequent re-pricing or re-pricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. Fair value of long-term debt is based on current rates for similar financing. It was not practicable to determine the fair value of FHLB stock due to restrictions placed on its transferability. The fair value of off-balance-sheet items is not considered material (or is based on the current fees or costs that would be charged to enter into or terminate such arrangements) and is not presented.

NOTE 4 – SECURITIES AVAILABLE FOR SALE

The following tables summarize the amortized cost and fair value of the available-for-sale investment securities portfolio at June 30, 2013 and December 31, 2012, respectively, and the corresponding amounts of gross unrealized gains and losses recognized in accumulated other comprehensive income (loss):


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(In thousands)
June 30, 2013:
Available-for-sale
U.S. government-sponsored entities and agency securities	$	1,000	$	—	$	—		$	1,000
Private label residential mortgage-backed securities		29,563		300		(99	)		29,764
Agency mortgage-backed securities		76,042		192		(247	)		75,987

Total securities available for sale	$	106,605	$	492	$	(346	)	$	106,751

December 31, 2012:
Available-for-sale
U.S. government-sponsored entities and agency securities	$	2,706	$	4	$	—		$	2,710
State and Municipal securities		9,660		284		—			9,944
Private label residential mortgage-backed securities		41,499		475		(128	)		41,846
Agency mortgage-backed securities		66,818		335		(234	)		66,919

Total securities available for sale	$	120,683	$	1,098	$	(362	)	$	121,419

The Company recorded no other-than-temporary impairment (“OTTI”) for securities available for sale at June 30, 2013 or December 31, 2012.

The amortized cost and fair value of the available-for-sale securities portfolio are shown below by expected maturity. In the case of residential mortgage-backed securities, expected maturities may differ from contractual maturities because borrowers generally have the right to call or prepay obligations with or without call or prepayment penalties. For that reason, mortgage-backed securities are not included in the maturity categories.


	June 30, 2013
	Amortized Cost		Fair Value
	(In thousands)
Maturity
Available-for-sale
Within one year	$	1,000	$	1,000
One to five years		—		—
Five to ten years		—		—
Greater than ten years		—		—
Private label residential mortgage backed and FNMA mortgage-backed securities		105,605		105,751

	$	106,605	$	106,751

At June 30, 2013 and December 31, 2012, there were no holdings of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10 percent of shareholders’ equity.

The following table summarizes the investment securities with unrealized losses at June 30, 2013 and December 31, 2012, respectively, by aggregated major security type and length of time in a continuous unrealized loss position:


	Less Than 12 Months					12 Months or Longer					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
	(In thousands)
June 30, 2013:
Available-for-sale
Private label residential mortgage-backed securities	$	7,318	$	(42	)	$	6,281	$	(57	)	$	13,599	$	(99	)
Agency residential mortgage-backed securities		28,645		(209	)		2,201		(38	)		30,846		(247	)

Total available-for-sale	$	35,963	$	(251	)	$	8,482	$	(95	)	$	44,445	$	(346	)

December 31, 2012:
Available-for-sale
Private label residential mortgage-backed securities	$	2,194	$	(13	)	$	10,061	$	(115	)	$	12,255	$	(128	)
Agency residential mortgage-backed securities		37,388		(234	)		—		—			37,388		(234	)

Total available-for-sale	$	39,582	$	(247	)	$	10,061	$	(115	)	$	49,643	$	(362	)

As of June 30, 2013, the Company’s securities available for sale portfolio consisted of 77 securities, 42 of which were in an unrealized loss position. The unrealized losses are related to an increase in prepayment speeds of the agency mortgage-backed securities as discussed below.

The Company’s private label residential mortgage-backed securities that are in an unrealized loss position had a fair value of $13.6 million with unrealized losses of $99 thousand at June 30, 2013. The Company’s agency residential mortgage-backed securities that are in an unrealized loss position had a fair value of $30.8 million with unrealized losses of $247 thousand at June 30, 2013.

The Company monitors its securities portfolio to ensure it has adequate credit support and as of June 30, 2013, the Company believes there is no OTTI and it does not have the intent to sell these securities and it is not likely that it will be required to sell the securities before their anticipated recovery. Of the Company’s $106.8 million securities portfolio, $101.7 million were rated AAA, AA or A and $5.1 million were rated BBB based on the most recent credit rating as of June 30, 2013. The Company considers the lowest credit rating for identification of potential OTTI.

NOTE 5 – LOANS AND LEASES AND ALLOWANCE FOR LOAN AND LEASE LOSSES

As of June 30, 2013 and December 31, 2012 the Company had the following balances in its loan and lease portfolio:


	Non-Traditional			Traditional			Total NTM and			Purchased Credit			Total Loans and
	Mortgages (NTM)			Loans			Traditional Loans			Impaired			Leases Receivable
	($ in thousands)
June 30, 2013:
Commercial
Commercial and industrial	$	—		$	90,767		$	90,767		$	1,938		$	92,705
Real estate mortgage		—			311,262			311,262			15,835			327,097
Multi-family		—			120,026			120,026			838			120,864
SBA		—			28,483			28,483			5,117			33,600
Construction		—			5,980			5,980			—			5,980
Lease financing		—			18,615			18,615			—			18,615
Consumer:
Real estate 1-4 family first mortgage		235,352			474,208			709,560			114,175			823,735
Green Loans (HELOC)—First Liens		169,439			—			169,439			—			169,439
Green Loans (HELOC)—Second Liens		6,528			—			6,528			—			6,528
Other HELOC’s, home equity loans, and other consumer installment credit		113			13,476			13,589			55			13,644

Total Gross Loans	$	411,432		$	1,062,817		$	1,474,249		$	137,958		$	1,612,207

Percentage to total gross loans		25.5	%		65.9	%		91.4	%		8.6	%		100.0	%
Net deferred loan costs													$	828
Unamortized purchase premium														1,311
Allowance for loan losses														(16,979	)

Loans and leases receivable, net													$	1,597,367

December 31, 2012:
Commercial
Commercial and industrial	$	—		$	73,585		$	73,585		$	6,808		$	80,393
Real estate mortgage		—			318,051			318,051			21,837			339,888
Multi-family		—			112,829			112,829			845			113,674
SBA		—			30,512			30,512			5,608			36,120
Construction		—			6,648			6,648			—			6,648
Lease financing		—			11,203			11,203			—			11,203
Consumer:
Real estate 1-4 family first mortgage		162,127			211,527			373,654			65,066			438,833
Green Loans (HELOC)—First Liens		198,351			—			198,351			—			198,351
Green Loans (HELOC)—Second Liens		7,653			—			7,653			—			7,653
Other HELOC’s, home equity loans, and other consumer installment credit		113			13,740			13,853			56			13,796

Total Gross Loans	$	368,244		$	778,095		$	1,146,339		$	100,220		$	1,246,559

Percentage to total gross loans		29.5	%		62.5	%		92.0	%		8.0	%		100.0	%
Net deferred loan costs													$	447
Unamortized purchase premium														1,465
Allowance for loan losses														(14,448	)

Loans and leases receivable, net													$	1,234,023

Non Traditional Mortgage Loans

The Company’s non-traditional mortgage (“NTM”) portfolio is comprised of three interest only products: the Green Account Loans (Green Loans), the hybrid interest only fixed or adjustable rate mortgage (Interest Only) and a small number of loans with the potential for negative amortization. As of June 30, 2013 and December 31, 2012, the non-traditional mortgages totaled $411.4 million or 25.5 percent of the total gross loan portfolio and $368.2 million or 29.5 percent of the total gross loan portfolio, respectively, which is an increase of $43.2 million or 11.7 percent. The following table represents the composition of the NTM portfolio at the dates indicated:


	June 30, 2013								December 31, 2012
	Count		Amount			Percent			Count		Amount			Percent
	($ in thousands)
Green		215	$	175,967			42.8	%		239	$	206,004			56.0	%
Interest-only		301		217,815			52.9			191		142,978			38.8
Negative amortization		39		17,650			4.3			40		19,262			5.2

Total NTM loans		555	$	411,432			100.0	%		470	$	368,244			100.0	%

Total gross loan portfolio			$	1,612,207							$	1,246,559
% of NTM to total gross loan portfolio				25.5	%							29.5	%

Green Loans

Green Loans are single family residence first and second mortgage lines of credit with a linked checking account that allows all types of deposits and withdrawals to be performed. The loans are generally interest only with a 15 year balloon payment due at maturity. At June 30, 2013, Green Loans totaled $176.0 million, a decrease of $30.0 million or 14.6 percent from $206.0 million at December 31, 2012, primarily due to reductions in principal balance and payoffs of $8.2 million and $27.8 million, respectively, partially offset by advances of $5.9 million. As of June 30, 2013 and December 31, 2012, $3.5 million and $5.7 million, respectively, of the Company’s Green Loans were non-performing. As a result of their unique payment feature, Green Loans possess higher credit risk due to the potential of negative amortization; however, management believes the risk is mitigated through the Company’s loan terms and underwriting standards, including its policies on loan-to-value ratios. The Company discontinued the Green Loan products in 2011.

Interest Only Loans

Interest only loans are primarily single family residence first mortgage loans with payment features that allow interest only payment in initial periods before converting to fully amortizing payments. As of June 30, 2013, our interest only loans increased by $74.8 million or 52.3 percent to $217.8 million from $143.0 million at December 31, 2012, primarily due to purchases of $42.6 million and originations of $97.2 million, partially offset by sales of $20.8 million, payoffs and principal reductions of $20.8 million, and reclassification of $23.3 million from NTM interest only to traditional loans due to the expiration of the initial interest only period and conversion to a fully amortizing basis. As of June 30, 2013 and December 31, 2012, $150 thousand and $6.2 million, respectively, of the Company’s interest only loans were non-performing.

Loans with the Potential for Negative Amortization

The negative amortization loan balance decreased to $17.7 million as of June 30, 2013 from $19.3 million as of December 31, 2012. The Company discontinued origination of negative amortization loans in 2007. As of June 30, 2013 and December 31, 2012, none of the Company’s loans that had the potential for negative amortization were non-performing. These loans pose a potentially higher credit risk because of the lack of principal amortization and potential for negative amortization; however, management believes the risk is mitigated through the Company’s loan terms and underwriting standards, including its policies on loan-to-value ratios. The Company discontinued origination of negative amortization loans in 2007.

Risk Management of Non-Traditional Mortgages

The Company has assessed that the most significant performance indicators for non-traditional mortgages (NTMs) are loan-to-value (LTV) and FICO scores. Accordingly, the Company manages credit risk in the NTM portfolio through semi-annual review of the loan portfolio that includes refreshing FICO scores on the Green Loans and home equity lines of credit and ordering third party automated valuation models. The loan review is designed to provide an effective method of identifying borrowers who may be experiencing financial difficulty before they actually fail to make a loan payment. Upon receipt of the updated FICO scores, an exception report is run to identify loans with a decrease in FICO of 10 percent or more and a resulting FICO of 620 or less. The loans are then further analyzed to determine if the risk rating should be downgraded which will increase the reserves the Company will establish for potential losses. A report of the semi-annual loan review is published and regularly monitored.

As these loans are revolving lines of credit, the Company, based on the loan agreement and loan covenants of the particular loan, as well as applicable rules and regulations, could suspend the borrowing privileges or reduce the credit limit at any time the Company reasonably believes that the borrower will be unable to fulfill their repayment obligations under the agreement or certain other conditions are met. In many cases, the decrease in FICO is the first red flag that the borrower may have difficulty in making their future payment obligations.

As a result, the Company proactively manages the portfolio by performing detailed analysis on its portfolio with emphasis on the non-traditional mortgage portfolio. The Company’s Internal Asset Review Committee (IARC) conducts monthly meetings to review the loans classified as special mention, substandard, or doubtful and determines whether suspension or reduction in credit limit is warranted. If the line has been suspended and the borrower would like to have their credit privileges reinstated, they would need to provide updated financials showing their ability to meet their payment obligations.

On the interest only loans, the Company projects future payment changes to determine if there will be an increase in payment of 3.50 percent or greater and then monitor the loans for possible delinquency. The individual loans are monitored for possible downgrading of risk rating, and trends within the portfolio are identified that could affect other interest only loans scheduled for payment changes in the near future.

Non Traditional Mortgage Performance Indicators

In addition to monitoring of credit grades, for NTMs, the Company manages the loan portfolio with attention to borrower credit scores and LTV. The tables below represent the Company’s non-traditional one-to-four SFR mortgage Green Loans first lien portfolio at June 30, 2013 by FICO scores that were obtained during the three months ended June 30, 2013, comparing to the FICO scores that were obtained three months ended December 31, 2012:


	June 30, 2013							December 31, 2012							Changes in count and amounts
	Count		Amount		Percent			Count		Amount		Percent			Count change			Amount change			Percent change
	($ in thousands)
800+		13	$	3,913		2.3	%		8	$	6,985		4.1	%		5		$	(3,072	)		(1.8	)%
700-799		103		93,342		55.2			109		86,999		51.4			(6	)		6,343			3.8
600-699		49		43,100		25.4			48		48,145		28.4			1			(5,045	)		(3.0	)
<600		14		13,967		8.2			14		12,193		7.2			—			1,774			1.0
No FICO		10		15,117		8.9			10		15,117		8.9			—			—			—

Totals		189	$	169,439		100.0	%		189	$	169,439		100.0	%		—		$	—			—	%

The Company updates FICO scores on a semi-annual basis, typically in November and April or as needed in conjunction with proactive portfolio management. The 700-799 FICO score category, obtained during the three months ended June 30, 2013, increased by 3.8 percent to 55.2 percent of total non-traditional one-to-four SFR mortgage Green Loans first lien at June 30, 2013 from 51.4 percent at December 31, 2012 from FICO scores obtained during the months ended December 31, 2012.

Loan to Value

The table below represents the Company’s one-to-four SFR non-traditional mortgage first lien portfolio by LTV as of the dates indicated:


	Green							I/O							Neg Am							Total
	Count		Amount		Percentage			Count		Amount		Percentage			Count		Amount		Percentage			Count		Amount		Percentage
	($ in thousands)
June 30, 2013:
LTV’s (1)
< 61		64	$	62,226		36.7	%		84	$	82,302		37.8	%		13	$	5,167		29.3	%		161	$	149,695		37.0	%
61-80		62		60,684		35.8			100		89,001		40.9			6		4,090		23.2			168		153,775		38.0
81-100		35		28,219		16.7			48		23,080		10.6			14		6,767		38.3			97		58,066		14.3
> 100		28		18,310		10.8			68		23,319		10.7			6		1,626		9.2			102		43,255		10.7

Totals		189	$	169,439		100.0	%		300	$	217,702		100.0	%		39	$	17,650		100.0	%		528	$	404,791		100.0	%

December 31, 2012:
LTV’s (1)
< 61		51	$	59,546		30.0	%		60	$	47,295		33.1	%		11	$	2,442		12.6	%		122	$	109,283		30.3	%
61-80		63		51,934		26.2			72		59,025		41.3			4		1,225		6.4			139		112,184		31.1
81-100		61		62,518		31.5			27		17,578		12.3			11		8,120		42.2			99		88,216		24.5
> 100		37		24,353		12.3			31		18,967		13.3			14		7,475		38.8			82		50,795		14.1

Totals		212	$	198,351		100.0	%		190	$	142,865		100.0	%		40	$	19,262		100.0	%		442	$	360,478		100.0	%

(1)

LTV represents estimated current loan to value ratio, determined by dividing current unpaid principal balance by latest estimated property value received per the Company’s policy

At June 30, 2013, the increase in interest only loans primarily related to purchases of 124 loans with a carrying value of $42.6 million and originations of $97.2 million, partially offset by sales, payoffs, principal reductions, and conversions to traditional loans of $64.9 million.

Allowance for Loan and Lease Losses

The Company has an established credit risk management process that includes regular management review of the loan and lease portfolio to identify any problem loans and leases. During the ordinary course of business, management becomes aware of borrowers that may not be able to meet the contractual requirements of the loan agreements. Such loans are subject to increased monitoring. Consideration is given to placing the loan on non-accrual status, assessing the need for additional allowance for loan and lease losses, and partial or full charge-off. The Company maintains the allowance for loan and lease losses at a level that is considered adequate to cover the estimated and known inherent risks in the loan portfolio and off-balance sheet unfunded credit commitments. The allowance for loan and lease losses includes allowances for loan, lease, and off-balance sheet unfunded credit commitment losses.

The credit risk monitoring system is designed to identify impaired and potential problem loans, and to permit periodic evaluation of impairment and the adequacy level of the allowance for credit losses in a timely manner. In addition, the Board of Directors of the Company has adopted a credit policy that includes a credit review and control system which it believes should be effective in ensuring that the Company maintains an adequate allowance for credit losses. The Board of Directors provides oversight and guidance for management’s allowance evaluation process, including quarterly valuations, and ratification for the management’s determination of whether the allowance is adequate to absorb losses in the loan and lease portfolio. The determination of the amount of the allowance for loan and lease losses and the provision for loan and lease losses is based on management’s current judgment about the credit quality of the loan and lease portfolio and takes into consideration known relevant internal and external factors that affect collectability when determining the appropriate level for the allowance for loan and lease losses. The nature of the process by which the Company determines the appropriate allowance for loan and lease losses requires the exercise of considerable judgment. Additions to the allowance for loan and lease losses are made by charges to the provision for loan and lease losses. Identified credit exposures that are determined to be uncollectible are charged against the allowance for loan and lease losses. Recoveries of previously charged off amounts, if any, are credited to the allowance for loan and lease losses.

The following is a summary of activity in the allowance for loan and lease losses and ending balances of loans evaluated for impairment for the three and six months ended June 30, 2013 and 2012, respectively:


	Three months ended June 30,						Six months ended June 30,
	2013			2012			2013			2012
	(In thousands)
Balance at beginning of period	$	16,015		$	11,173		$	14,448		$	12,780
Loans and leases charged off		(1,027	)		(22	)		(1,932	)		(2,321	)
Recoveries of loans and leases previously charged off		73			18			377			19
Provision for loan and lease losses		1,918			279			4,086			970

Balance at end of period	$	16,979		$	11,448		$	16,979		$	11,448

The following table presents the activity and balance in the allowance for loan and lease losses and the recorded investment in loans and leases by portfolio segment and is based on the impairment method as of and for the three and six months ended June 30, 2013:


	Commercial and Industrial		Commercial Real Estate Mortgage			Multi- Family			SBA			Construction		Lease Financing			Real Estate 1-4 family First Mortgage			HELOC’s, Home Equity Loans, and Other Consumer Credit			Unallocated		TOTAL
	(In thousands)
Allowance for loan and lease losses:
Balance as of March 31, 2013	$	481	$	3,698		$	1,544		$	133		$	294	$	263		$	9,212		$	197		$	193	$	16,015
Charge-offs		—		(260	)		(169	)		(262	)		—		—			(329	)		(7	)		—		(1,027	)
Recoveries		—		19			—			42			—		4			1			7			—		73
Provision		335		1,051			74			266			209		(23	)		(133	)		28			111		1,918

Balance as of June 30, 2013	$	816	$	4,508		$	1,449		$	179		$	503	$	244		$	8,751		$	225		$	304	$	16,979

Balance as of December 31, 2012	$	263	$	3,178		$	1,478		$	118		$	21	$	261		$	8,855		$	274		$	—	$	14,448
Charge-offs		—		(360	)		(553	)		(392	)		—		(23	)		(590	)		(14	)		—		(1,932	)
Recoveries		—		19			88			166			—		6			91			7			—		377
Provision		553		1,671			436			287			482		—			395			(42	)		304		4,086

Balance as of June 30, 2013	$	816	$	4,508		$	1,449		$	179		$	503	$	244		$	8,751		$	225		$	304	$	16,979

Individually evaluated for impairment	$	—	$	—		$	280		$	—		$	—	$	—		$	256		$	35		$	—	$	571
Collectively evaluated for impairment		816		4,508			1,169			179			503		244			8,183			190			304		16,096
Acquired with deteriorated credit quality		—		—			—			—			—		—			312			—			—		312

Total ending allowance balance	$	816	$	4,508		$	1,449		$	179		$	503	$	244		$	8,751		$	225		$	304	$	16,979

Loans:
Individually evaluated for impairment	$	—	$	725		$	2,048		$	13		$	—	$	—		$	11,248		$	1,055		$	—	$	15,089
Collectively evaluated for impairment		90,716		309,561			119,281			28,398			5,957		18,631			869,709			19,046			—		1,461,299
Acquired with deteriorated credit quality		1,938		15,835			838			5,117			—		—			114,175			55			—		137,958

Total ending loan balances	$	92,654	$	326,121		$	122,167		$	33,528		$	5,957	$	18,631		$	995,132		$	20,156		$	—	$	1,614,346


	Commercial and Industrial			Commercial Real Estate Mortgage			Multi- Family			SBA		Construction		Lease Financing		Real Estate 1-4 family First Mortgage			HELOC’s, Home Equity Loans, and Other Consumer Credit			Unallocated		TOTAL
												(In thousands)
Allowance for loan and lease losses:
Balance as of March 31, 2012	$	129		$	2,928		$	1,601		$	—	$	—	$	—	$	6,317		$	198		$	—	$	11,173
Charge-offs		—			—			—			—		—		—		(18	)		(4	)		—		(22	)
Recoveries		—			—			—			—		—		—		17			1			—		18
Provision		(1	)		385			(309	)		—		—		—		212			(8	)		—		279

Balance as of June 30, 2012	$	128		$	3,313		$	1,292		$	—	$	—	$	—	$	6,528		$	187		$	—	$	11,448

Balance as of December 31, 2011	$	128		$	2,234		$	1,541		$	—	$	—	$	—	$	8,635		$	242		$	—	$	12,780
Charge-offs		—			(236	)		—			—		—		—		(2,078	)		(7	)		—		(2,321	)
Recoveries		—			—			—			—		—		—		17			2			—		19
Provision		—			1,315			(249	)		—		—		—		(46	)		(50	)		—		970

Balance as of June 30, 2012	$	128		$	3,313		$	1,292		$	—	$	—	$	—	$	6,528		$	187		$	—	$	11,448

Individually evaluated for impairment	$	—		$	362		$	658		$	—	$	—	$	—	$	537		$	—		$	—	$	1,557
Collectively evaluated for impairment		128			2,951			634			—		—		—		5,991			187			—		9,891
Acquired with deteriorated credit quality		—			—			—			—		—		—		—			—			—		—

Total ending allowance balance	$	128		$	3,313		$	1,292		$	—	$	—	$	—	$	6,528		$	187		$	—	$	11,448

Loans:
Individually evaluated for impairment	$	—		$	3,487		$	5,443		$	—	$	—	$	—	$	14,349		$	41		$	—	$	23,320
Collectively evaluated for impairment		8,929			182,979			76,230			—		—		—		508,762			16,883			—		793,783
Acquired with deteriorated credit quality		—			—			—			—		—		—		22,728			—			—		22,728

Total ending loan balances	$	8,929		$	186,466		$	81,673		$	—	$	—	$	—	$	545,839		$	16,924		$	—	$	839,831

The following table presents loans and leases individually evaluated for impairment by class of loans and leases as of June 30, 2013 and December 31, 2012. The recorded investment represents customer balances net of any partial charge-offs recognized on the loans and leases and net of any deferred fees and costs.


	June 30, 2013						December 31, 2012
	Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses Allocated		Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses Allocated
	(In thousands)
With no related allowance recorded:
Commercial
Commercial and industrial	$	—	$	—	$	—	$	2,168	$	1,879	$	—
Real estate mortgage		1,636		725		—		5,748		3,988		—
Multi-family		494		289		—		—		—		—
SBA		14		13		—		457		30		—

Large accelerated filer

Accelerated filer

Non-accelerated filer

¨ (Do not check if a smaller reporting company)

Smaller reporting company