- -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------------------- FORM 10-K MARK ONE <TABLE> <C> <S> /X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 </TABLE> FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000 OR <TABLE> <C> <S> / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 </TABLE> FOR THE TRANSITION PERIOD FROM ________________ TO ________________. COMMISSION FILE NUMBER 000-24939 -------------------------- EAST WEST BANCORP, INC. (Exact name of registrant as specified in its charter) <TABLE> <S> <C> DELAWARE 95-4703316 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 415 HUNTINGTON DRIVE, SAN MARINO, 91108 CALIFORNIA (Zip Code) (Address of principal executive offices) </TABLE> REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (626) 799-5700 -------------------------- SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: <TABLE> <S> <C> NAME OF EACH EXCHANGE TITLE OF EACH CLASS ON WHICH REGISTERED NONE NONE </TABLE> SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: Common Stock, $0.001 Par Value (Title of class) ------------------------------ 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 if disclosure of delinquent filers pursuant to Item 405 or Regulation S-K is not contained herein, and will not be contained, to the best of registrant=s knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this Form 10-K. /X/ As of February 28, 2001, the aggregate market value of the common stock held by non-affiliates of the registrant was approximately $524,580,225. Number of shares of common stock of the registrant outstanding as of February 28, 2001: 23,149,264 shares The following documents are incorporated by reference herein: <TABLE> <CAPTION> PART OF FORM 10-K DOCUMENT INCORPORATED INTO WHICH INCORPORATED - --------------------- ----------------------- <S> <C> 2000 Annual Report.......................................... Parts II and IV Definitive Proxy Statement for the Annual Meeting of Stockholders which will be filed within 120 days of the fiscal year ended December 31, 2000....................... Part III </TABLE> - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
TABLE OF CONTENTS <TABLE> <C> <S> <C> PART I................................................................. 3 Item 1. Business........................................... 3 Item 2. Properties......................................... 15 Item 3. Legal Proceedings.................................. 16 Item 4. Submission of Matters to a Vote of Security Holders................................................... 17 Item 4A. Executive Officers of the Registrant............... 17 PART II................................................................ 18 Item 5. Market for Registrant's Common Equity and Related Stockholder Matters................................ 18 Item 6. Selected Financial Data............................ 19 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations..................................... 20 Item 7A. Quantitative and Qualitative Disclosures About Market Risk............................................... 43 Item 8. Financial Statements and Supplementary Data........ 43 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.............................. 43 PART III............................................................... 44 Item 10. Directors and Executive Officers of the Registrant................................................ 44 Item 11. Executive Compensation............................ 44 Item 12. Security Ownership of Certain Beneficial Owners and Management............................................ 44 Item 13. Certain Relationships and Related Transactions.... 44 PART IV................................................................ 45 Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K............................... 45 SIGNATURES............................................................. 87 </TABLE> 2
PART I ITEM 1. BUSINESS ORGANIZATION East West Bancorp, Inc. (the "Company") is a Delaware corporation incorporated on August 26, 1998 pursuant to a Plan of Reorganization and Agreement of Merger to be the holding company for East West Bank (the "Bank"). The Company became the holding company for the Bank as of December 30, 1998, and is subject to the Bank Holding Company Act of 1956, as amended. The principal office of the Company is located at 415 Huntington Drive, San Marino, California 91108, and its telephone number is (626) 799-5700. The Company has four wholly-owned subsidiaries, East West Bank, East West Capital Trust I, East West Captial Trust II and Risk Services, Inc. (dba East West Insurance Agency). The Bank's deposits are insured by the Savings Association Insurance Fund ("SAIF"), as administered by the Federal Deposit Insurance Corporation ("FDIC"), up to applicable limits. The Bank is not a member of the Federal Reserve System. The Bank was the third largest commercial bank headquartered in Los Angeles, California as of December 31, 2000, and one of the largest banks in the United States that focuses on the Chinese-American community. Until June 12, 1998, the Bank was privately owned. At that time, the former shareholders sold all of their interests in the Bank to approximately 160 institutional and accredited investors in a private placement transaction. On February 8, 1999, the Company commenced trading on the Nasdaq National Market under the ticker symbol EWBC. The Bank was chartered by the Federal Home Loan Bank Board in June 1972, as the first federally-chartered savings institution focused primarily on the Chinese-American community, and opened for business at its first office in the Chinatown district of Los Angeles in January 1973. Until the early 1990's, the Bank conducted a traditional savings and loan business by making predominately long-term, single-family residential and commercial and multi-family real estate loans with interest rates tied to the Eleventh District Cost of Funds Index ("COFI"). These loans were made principally within the ethnic Chinese market in Southern California and were funded primarily with retail savings deposits and advances from the Federal Home Loan Bank ("FHLB") of San Francisco. Currently, the Bank specializes in lending for commercial, construction, and residential real estate projects and financing international trade for California companies. The Bank has emphasized commercial lending since its conversion to a state-chartered commercial bank on July 31, 1995. As of December 31, 2000, the Bank had three wholly-owned subsidiaries. The first subsidiary, E-W Services, Inc., is a California corporation organized by the Bank in 1977. E-W Services, Inc. holds property used by the Bank in its operations. At December 31, 2000, the Bank's total investment in E-W Services, Inc. was $10.5 million. The second subsidiary, East-West Investments, Inc., is a California corporation organized by the Bank in 1972. East-West Investments, Inc. primarily acts as a trustee in connection with real estate secured loans. At December 31, 2000, the Bank's total investment in East-West Investments, Inc. was $82,000. The third subsidiary, EWSC Holdings, LLC, is a California limited liability company organized by the Bank in 2000. EWSC Holdings, LLC owns 100% of the voting shares of East West Securities Company, Inc. (the "Fund"). At December 31, 2000, the Bank's total investment in EWSC Holdings, LLC was $811.9 million. The Fund was incorporated under the general laws of the State of Maryland on July 13, 2000 as a closed-end, non-diversified management investment company registered under the Investment Company Act of 1940, as amended. The formation of the Fund provides the Bank with the flexibility to raise additional capital in a tax efficient manner for future business opportunities if desired. At December 31, 2000, the Fund was the sole member in six limited liability companies--EW Assets, LLC, EW Assets 2, LLC, EW Assets 3, LLC, EW Assets 4, LLC, EW Assets 5, LLC and EW Assets 6, LLC. These companies invest primarily in loans and money market deposit accounts. 3
On May 28, 1999, the Bank completed its acquisition of First Central Bank, N.A. for an aggregate cash price of $13.5 million. First Central Bank had three branches in Southern California--one branch located in the Chinatown sector of Los Angeles, one branch in Monterey Park and one branch in Cerritos. The Bank acquired approximately $55.0 million in loans and assumed approximately $92.6 million in deposits. On January 18, 2000, the Bank completed its acquisition of American International Bank for an aggregate cash price of $33.1 million. American International Bank had eight branches in Southern California. The Bank acquired approximately $107.9 million in loans and assumed approximately $170.8 million in deposits. In March 2000 and July 2000, the Company established East West Capital Trust I and East West Capital Trust II (the "Trusts"), respectively, as wholly owned subsidiaries. East West Capital Trust I and East West Capital Trust II are statutory business trusts. In two separate private placement transactions, the Trusts issued $10.8 million of 10.875% capital securities and $10.0 million of 10.945% capital securiites representing undivided preferred beneficial interests in the assets of the Trusts. The Company 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 I Capital for regulatory purposes. On August 22, 2000, the Company completed the acquisition of its other wholly owned subsidiary, Risk Services, Inc. (the "Agency"), in a stock swap transaction. In exchange for all of the outstanding stock of the Agency, the Company issued a total of 103,291 new shares of East West Bancorp, Inc. common stock, par value of $.001. The total cash value of the shares issued was approximately $1.7 million. Risk Services, Inc., with assets of approximately $789 thousand as of the acquisition date, is an unrelated agent providing business and consumer insurance services to the Southern California market. The Agency continues to run its operations autonomously from the operations of the Company. On January 16, 2001, the Bank completed the acquisition of Prime Bank for a combination of shares and cash valued at $16.6 million. Prime Bank was a one-branch commercial bank located in the Century City area of Los Angeles. The Bank acquired approximately $45.0 million in loans and assumed approximately $98.1 million in deposits. BANKING SERVICES Through its network of 30 retail branches, the Bank provides a wide range of personal and commercial banking services to small and medium-sized businesses, business executives, professionals, and other individuals. The Bank offers multilingual services to all of its customers in English, Cantonese, Mandarin and Spanish. The Bank offers a variety of deposit products which includes the traditional range of personal and business checking and savings accounts, time deposits and individual retirement accounts, travelers' checks, safe deposit boxes, and Master Card and Visa merchant deposit services. The Bank's lending activities include residential and commercial real estate, construction, commercial, trade finance, account receivables, inventory and working capital loans. The Bank provides commercial loans to small and medium-sized businesses with annual revenues that generally range from several million to $200 million. In addition, the Bank provides short-term trade finance facilities for terms of less than one year primarily to U.S. importers and manufacturers doing business in the Asia Pacific region. Management believes that these activities have not been adversely affected to a significant degree by the economic crisis in Asia of the last several years. The Bank's commercial borrowers are engaged in a wide variety of manufacturing, wholesale trade, and service businesses. Management has identified four principal operating segments within the Company: retail banking, commercial lending, treasury, and residential lending. Although all four operating segments offer 4
financial products and services, they are managed separately based on each segment's strategic focus. While the retail banking segment focuses primarily on retail operations through the Company's branch network, certain designated branches have responsibility for generating commercial deposits and loans. The commercial lending segment primarily generates commercial loans and deposits through the efforts of commercial lending officers located in the Company's northern and southern California production offices. The treasury department's primary focus is managing the Company's investments, liquidity, and interest rate risk; while the residential lending segment is mainly responsible for the Company's portfolio of single family and multifamily loans. MARKET AREA AND COMPETITION The Bank concentrates on marketing its services in the Los Angeles metropolitan area, Orange County, the San Francisco Bay area, and the Silicon Valley area in Santa Clara County, with a particular focus on regions with a high concentration of ethnic Chinese. The ethnic Chinese markets within the Bank's primary market area have experienced rapid growth in recent periods. Based on information provided by the California State Department of Finance, there were an estimated 4.2 million Asians and Pacific Islanders residing in California as of March 2000. As California continues to gain momentum as the hub of the Pacific Rim, the Bank provides important competitive advantages to its customers participating in the Asia Pacific marketplace. Management believes the Bank's customers benefit from its understanding of Asian markets and cultures, its corporate and organizational ties throughout Asia, as well as its international banking products and services. Management believes that this approach, combined with the extensive ties of its management and Board of Directors to the growing Asian and ethnic Chinese communities, provides the Bank with an advantage in competing for customers in its market area. The banking and financial services industry in California generally, and in the Bank's market areas specifically, are highly competitive. The increasingly competitive environment is a result primarily of changes in regulation, changes in technology and product delivery systems, and the accelerating pace of consolidation among financial services providers. In addition, recent federal legislation may have the effect of further increasing the pace of consolidation within the financial services industry. See "Economic Conditions, Government Policies, Legislation and Regulation." The Bank competes for loans, deposits, and customers with other commercial banks, savings and loan associations, securities and brokerage companies, mortgage companies, insurance companies, finance companies, money market funds, credit unions, and other nonbank financial service providers. Some of these competitors are larger in total assets and capitalization, have greater access to capital markets and offer a broader range of financial services than the Bank. The Bank has 30 offices located in the following counties: Los Angeles, Orange, San Francisco and Santa Clara. Neither the deposits nor loans of the offices of the Bank exceed 1% of the deposits or loans of all financial services companies located in the counties in which the Bank operates. NEW ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board (the "FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. SFAS No. 133, as amended by SFAS No. 138, ACCOUNTING FOR CERTAIN DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES--AN AMENDMENT OF FASB STATEMENT NO. 133, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts and hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial condition and measure those instruments at fair value. Gains or losses resulting from changes in the values of those derivatives would be accounted for depending on the use of the derivative and whether it qualifies for hedge accounting. The key criterion for hedge accounting is that the hedging relationship must be highly effective in achieving offsetting changes in 5
fair value or cash flows. Implementation of SFAS No. 133 became effective for the Company on January 1, 2001. The adoption of this standard did not have a material impact on the Company's results of operations or financial position. In December 1999, the Securities and Exchange Commission (the "Commission") issued Staff Accounting Bulletin ("SAB") No. 101, REVENUE RECOGNITION IN FINANCIAL STATEMENTS, which summarizes the Commission's views in applying generally accepted accounting principles to revenue recognition in financial statements. Under the provisions of SAB No. 101, if a transaction is within the scope of existing specific authoritative literature that provides revenue recognition guidance, such literature should be applied. SAB No. 101 is intended to provide additional or more consistent guidance only in the absence of authoritative literature addressing a specific arrangement or a specific industry as it relates to revenue recognition. It is the view of the Commission that revenue is generally realized or realizable and earned when all of the following criteria are met: (1) persuasive evidence of an arrangement exists, (2) delivery has occurred or services have been rendered, (3) the seller's price to the buyer is fixed or determinable, and (4) collectibility is reasonably assured. Management does not believe that the bulletin has a material impact on the Company's results of operations or financial position. In September 2000, the FASB issued SFAS No. 140, ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS OF LIABILITIES--A REPLACEMENT TO FASB STATEMENT NO. 125. SFAS No. 140 revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures, but carries over most of SFAS 125's provisions without reconsideration. SFAS No. 140 provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. These standards are based on consistent application of a "financial-components approach" that focuses on control. Under this approach, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished. This Statement also provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. SFAS No. 140 is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. This Statement is also effective for recognition and reclassification of collateral and for disclosures relating to securitization transactions and collateral for fiscal years ending after December 15, 2000. Management does not believe that the adoption of this standard will have a material impact on the Company's results of operations or financial position when adopted. ECONOMIC CONDITIONS, GOVERNMENT POLICIES, LEGISLATION, AND REGULATION The Bank's profitability, like most financial institutions, is primarily dependent on interest rate differentials. In general, the difference between the interest rates paid by the Bank on interest-bearing liabilities, such as deposits and other borrowings, and the interest rates received by the Bank on its interest-earning assets, such as loans extended to its clients and securities held in its investment portfolio, comprise the major portion of the Company's earnings. These rates are highly sensitive to many factors that are beyond the control of the Company and the Bank, such as inflation, recession and unemployment, and the impact which future changes in domestic and foreign economic conditions might have on the Company and the Bank cannot be predicted. The business of the Bank is also influenced by the monetary and fiscal policies of the federal government and the policies of regulatory agencies, particularly the Federal Reserve Board. The Federal Reserve Board implements national monetary policies (with objectives such as curbing inflation and combating recession) through its open-market operations in U.S. Government securities by adjusting the required level of reserves for depository institutions subject to its reserve requirements and by varying the target federal funds and discount rates applicable to borrowings by depository institutions. The actions of the Federal Reserve Board in these areas influence the growth of bank 6
loans, investments and deposits and also affect interest rates earned on interest-earning assets and paid on interest-bearing liabilities. The nature and impact on the Company and the Bank of any future changes in monetary and fiscal policies cannot be predicted. From time to time, legislative acts, as well as regulations, are enacted which have the effect of increasing the cost of doing business, limiting or expanding permissible activities, or affecting the competitive balance between banks and other financial services providers. Proposals to change the laws and regulations governing the operations and taxation of banks, bank holding companies, other financial institutions, and financial services providers are frequently made in the U.S. Congress, in the state legislatures and before various regulatory agencies. GENERAL Bank holding companies and banks are extensively regulated under both federal and state law. This regulation is intended primarily for the protection of depositors and the deposit insurance fund and not for the benefit of stockholders of the Company or the Bank. Set forth below is a summary description of the material laws and regulations which relate to the operations of the Company and the Bank. The description is qualified in its entirety by reference to the applicable laws and regulations. In recent years, significant legislative proposals and reforms affecting the financial services industry have been discussed and evaluated by Congress. Such proposals include legislation to revise the Glass-Steagall Act and the BHC Act and to expand permissible activities for banks. In November 1999, the Gramm-Leach-Bliley Act (the "Financial Services Modernization Act") was passed permitting the affiliation of banks, insurance underwriters and investment banking firms. It also provided for possible future additional expansions of permissible activities for banks. See "Financial Services Modernization Legislation." THE COMPANY GENERAL. The Company, as a registered bank holding company, is subject to regulation under the BHC Act. The Company is required to file with the Federal Reserve Board quarterly, semi-annual, and annual reports and such additional information as the Federal Reserve Board may require pursuant to the BHC Act. The Federal Reserve Board may conduct examinations of the Company and its subsidiaries. The Federal Reserve Board may require that the Company terminate an activity or terminate control of or liquidate or divest certain subsidiaries or affiliates when the Federal Reserve Board believes the activity or the control of the subsidiary or affiliate constitutes a significant risk to the financial safety, soundness or stability of any of its banking subsidiaries. The Federal Reserve Board also has the authority to regulate provisions of certain bank holding company debt, including authority to impose interest ceilings and reserve requirements on such debt. Under certain circumstances, the Company must file written notice and obtain approval from the Federal Reserve Board prior to purchasing or redeeming its equity securities. Under the BHC Act and regulations adopted by the Federal Reserve Board, a bank holding company and its nonbanking subsidiaries are prohibited from requiring certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services. Further, the Company is required by the Federal Reserve Board to maintain certain levels of capital. See "--The Bank--Capital Standards." The Company is required to obtain the prior approval of the Federal Reserve Board for the acquisition of more than 5% of the outstanding shares of any class of voting securities or substantially all of the assets of any bank or bank holding company. Prior approval of the Federal Reserve Board is also required for the merger or consolidation of the Company and another bank holding company. 7
The Company is prohibited by the BHC Act, except in certain statutorily prescribed instances, from acquiring direct or indirect ownership or control of more than 5% of the outstanding voting shares of any company that is not a bank or bank holding company and from engaging directly or indirectly in activities other than those of banking, managing or controlling banks or furnishing services to its subsidiaries. However, the Company may engage in any, or acquire shares of companies engaged in, activities that are deemed by the Federal Reserve Board to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Under Federal Reserve Board regulations, 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 Board's policy 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 the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding company's failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the Federal Reserve Board to be an unsafe and unsound banking practice or a violation of the Federal Reserve Board's regulations or both. The Company is a bank holding company within the meaning of Section 3700 of the California Financial Code. As such, the Company and its subsidiaries will be subject to examination by, and may be required to file reports with, the California Department of Financial Institutions ("DFI"). The Company's securities are registered with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). As such, the Company is subject to the information, proxy solicitation, insider trading, and other requirements and restrictions of the Exchange Act. FINANCIAL SERVICES MODERNIZATION LEGISLATION GENERAL. On November 12, 1999, President Clinton signed into law the Gramm-Leach-Bliley Act of 1999 or the Financial Services Modernization Act. The Financial Services Modernization Act repeals the two affiliation 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 restricts officer, director, or employee interlocks between a member bank and any company or person "primarily engaged" in specified securities activities. In addition, the Financial Services Modernization Act also contains 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 BHC Act framework to permit a holding company system to engage in a full range of financial activities through a new entity known as a Financial Holding Company. The law also: - Broadens the activities that may be conducted by national banks, banking subsidiaries of bank holding companies, and their financial subsidiaries; - Provides an enhanced framework for protecting the privacy of consumer information; - Adopts a number of provisions related to the capitalization, membership, corporate governance, and other measures designed to modernize the Federal Home Loan Bank system; - Modifies the laws governing the implementation of the Community Reinvestment Act; and - Addresses a variety of other legal and regulatory issues affecting both day-to-day operations and long-term activities of financial institutions. 8
The Company and the Bank do not believe that the Financial Services Modernization Act will have a material adverse effect on operations in the near-term. However, to the extent that it permits banks, securities firms, and insurance companies to affiliate, the financial services industry may experience further consolidation. The Financial Services Modernization Act is intended to grant to community banks certain powers as a matter of right that larger institutions have accumulated on an ad hoc basis. Nevertheless, this act may have the result of increasing the amount of competition that the Company and the Bank face from larger institutions and other types of companies offering financial products, many of which may have substantially more financial resources than the Company and the Bank. FINANCIAL HOLDING COMPANIES. Bank holding companies that elect to become a financial holding company may affiliate with securities firms and insurance companies and engage in other activities that are financial in nature or are incidental or complementary to activities that are financial in nature. "Financial in nature" activities include: - securities underwriting, - dealing and market making, - sponsoring mutual funds and investment companies, - insurance underwriting and agency, - merchant banking, and - activities that the Federal Reserve Board, in consultation with the Secretary of the Treasury, determines from time to time to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. A bank holding company must meet three requirements before becoming a financial holding company: - all of the bank holding company's depository institution subsidiaries must be well capitalized, well managed, and, except in limited circumstances, in compliance with the Community Reinvestment Act; and - the bank holding company must file with the Federal Reserve a declaration of its election to become a financial holding company, including a certification that its depository institution subsidiaries meet the prior two criteria. Failure to comply with the financial holding company requirements could lead to divestiture of subsidiary banks or require all activities of such company to conform to those permissible for a bank holding company. No Federal Reserve Board approval is required for a financial holding company to acquire a company (other than a bank holding company, bank or savings association) engaged in activities that are financial in nature or incidental to activities that are financial in nature, as determined by the Federal Reserve Board. A bank holding company that is not also a financial holding company can only engage in banking and such other activities determined by the Federal Reserve Board to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. The Company elected to become a Financial Holding Company on July 17, 2000. MERCHANT BANKING RESTRICTIONS. The Federal Reserve Board and the Treasury have adopted rules governing merchant banking or venture capital investments made by financial holding companies. Generally, the rules: - define the types of venture ownership interests that may be acquired; 9
- limit control of assets to a portfolio company (a company engaged in activities not permissible under the Bank Holding Company Act); - require the financial holding company to conduct activities unless it controls a securities affiliate or an issuance affiliate with a registered investment advisor; - prohibit the financial holding company from routinely managing or operating the portfolio company unless intervention is necessary to address a material risk to the value or operation of the portfolio company; - establish a 10-year holding period before divestiture, except that an investment in or held through a private equity fund may be held for the duration of the fund; - apply an aggregate limit on the carrying value of all merchant banking investments without prior Federal Reserve Board approval to the lesser of (i) 30 percent of Tier 1 capital or $6 billion or (ii) the lesser of 20 percent of Tier 1 capital or $4 billion excluding interests in private equity funds; - require prior approval to exceed the 10-year holding period limit; and - apply cross-marketing restrictions to merchant banking investments and the financial holding company's subsidiary depository institutions. In January 2001, federal regulators proposed new capital requirements for merchant banking activities. The proposal would employ a sliding scale based on each banking organization's aggregate equity investments and Tier 1 capital. It would require them to hold 8 cents for every $1 of equity investments up to 15% of Tier 1 capital. The proposal would then require banks to hold 12 cents for every $1 of investments for the next 10%. For investments exceeding 25%, banks would have to hold 25 cents for every $1. The proposed rule would exempt the first 15% of investments that banking companies make through small-business investment corporation subsidiaries. However, the proposed rule's sliding scale would apply for any such investments over 15%. The Company has not yet engaged in merchant banking activities and may never do so. THE BANK GENERAL. The Bank, as a California chartered bank, is subject to primary supervision, periodic examination, and regulation by the DFI and the FDIC. To a lesser extent, the Bank is also subject to certain regulations promulgated by the Federal Reserve Board. If, as a result of an examination of the Bank, the FDIC should determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of the Bank's operations are unsatisfactory or that the Bank or its management is violating or has violated any law or regulation, various remedies are available to the FDIC. Such remedies include the power to enjoin "unsafe or unsound" practices, to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in capital, to restrict the growth of the Bank, to assess civil monetary penalties, to remove officers and directors and ultimately to terminate the Bank's deposit insurance, which for a California chartered bank would result in a revocation of the Bank's charter. The DFI has many of the same remedial powers. Various requirements and restrictions under the laws of the State of California and the United States affect the operations of the Bank. State and federal statutes and regulations relate to many aspects of the Bank's operations, including reserves against deposits, ownership of deposit accounts, interest rates payable on deposits, loans, investments, mergers and acquisitions, borrowings, dividends, locations of branch offices, and capital requirements. Further, the Bank is required to maintain certain levels of capital. See "--Capital Standards." 10
DIVIDENDS AND OTHER TRANSFERS OF FUNDS. Dividends from the Bank constitute the principal source of income to the Company. The Company is a legal entity separate and distinct from the Bank. The Bank is subject to various statutory and regulatory restrictions on its ability to pay dividends to the Company. Under such restrictions, the amount available for payment of dividends to the Company by the Bank totaled $54.4 million at December 31, 2000. In addition, the DFI and the Federal Reserve Board have the authority to prohibit the Bank from paying dividends, depending upon the Bank's financial condition, if such payment is deemed to constitute an unsafe or unsound practice. The FDIC and the Commissioner also have authority to prohibit the Bank from engaging in activities that, in the FDIC's or the Commissioner's opinion, constitute unsafe or unsound practices in conducting its business. It is possible, depending upon the financial condition of the bank in question and other factors, that the FDIC or the Commissioner could assert that the payment of dividends or other payments might, under some circumstances, be an unsafe or unsound practice. Further, the FDIC and the Federal Reserve Board have established guidelines with respect to the maintenance of appropriate levels of capital by banks or bank holding companies under their jurisdiction. Compliance with the standards set forth in such guidelines and the restrictions that are or may be imposed under the prompt corrective action provisions of federal law could limit the amount of dividends which the Bank or the Company may pay. An insured depository institution is prohibited from paying management fees to any controlling persons or, with certain limited exceptions, making capital distributions if after such transaction the institution would be undercapitalized. The Commissioner may impose similar limitations on the conduct of California-chartered banks. See "--Prompt Corrective Regulatory Action and Other Enforcement Mechanisms" and "--Capital Standards" for a discussion of these additional restrictions on capital distributions. The Bank is subject to certain restrictions imposed by federal law on any extensions of credit to, or the issuance of a guarantee or letter of credit on behalf of, the Company or other affiliates, the purchase of, or investments in, stock or other securities thereof, the taking of such securities as collateral for loans, and the purchase of assets of the Company or other affiliates. Such restrictions prevent the Company and such other affiliates from borrowing from the Bank unless the loans are secured by marketable obligations of designated amounts. Further, such secured loans and investments by the Bank to or in the Company or to or in any other affiliate are limited, individually, to 10.0% of the Bank's capital and surplus (as defined by federal regulations), and such secured loans and investments are limited, in the aggregate, to 20.0% of the Bank's capital and surplus (as defined by federal regulations). California law also imposes certain restrictions with respect to transactions involving the Company and other controlling persons of the Bank. Additional restrictions on transactions with affiliates may be imposed on the Bank under the prompt corrective action provisions of federal law. See also "--Prompt Corrective Action and Other Enforcement Mechanisms." CAPITAL STANDARDS. The Federal Reserve Board and the FDIC have adopted risk-based minimum capital guidelines intended to provide a measure of capital that reflects the degree of risk associated with a banking organization's 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 these guidelines, 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 commercial loans. The federal banking agencies require a minimum ratio of qualifying total capital to risk-adjusted assets of 8% and a minimum ratio of Tier 1 capital to risk-adjusted assets of 4%. In addition to the risked-based guidelines, federal banking regulators require banking organizations to maintain a minimum amount of Tier 1 capital to total assets, referred to as the leverage ratio. For a banking organization rated in the highest of the five categories used by regulators to rate banking organizations, the minimum leverage ratio of Tier 1 capital to total assets must be 3%. In addition to these uniform 11
risk-based capital guidelines and leverage ratios that apply across the industry, the regulators have the discretion to set individual minimum capital requirements for specific institutions at rates significantly above the minimum guidelines and ratios. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Capital" for information regarding the Company's regulatory capital ratios at December 31, 2000. PROMPT CORRECTIVE ACTION AND OTHER ENFORCEMENT MECHANISMS. Federal banking agencies possess broad powers to take corrective and other supervisory action to resolve the problems of insured depository institutions, including but not limited to those institutions that fall below one or more prescribed minimum capital ratios. Each federal banking agency has promulgated regulations defining the following five categories in which an insured depository institution will be placed, based on its capital ratios: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. At December 31, 2000, the Bank exceeded the required ratios for classification as "well capitalized." An institution that, based upon its capital levels, is classified as well capitalized, adequately capitalized, or undercapitalized may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition or an unsafe or unsound practice warrants such treatment. At each successive lower capital category, an insured depository institution is subject to more restrictions. The federal banking agencies, however, may not treat a significantly undercapitalized institution as critically undercapitalized unless its capital ratio actually warrants such treatment. In addition to measures taken under the prompt corrective action provisions, commercial banking organizations may be subject to potential enforcement actions by the 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. SAFETY AND SOUNDNESS STANDARDS. The federal banking agencies have adopted guidelines designed to assist the federal banking agencies in identifying and addressing potential safety and soundness concerns before capital becomes impaired. The guidelines set forth operational and managerial standards relating to: (i) internal controls, information systems and internal audit systems, (ii) loan documentation, (iii) credit underwriting, (iv) asset growth, (v) earnings, and (vi) compensation, fees and benefits. In addition, the federal banking agencies have also adopted safety and soundness guidelines with respect to asset quality and earnings standards. These guidelines provide six standards for establishing and maintaining a system to identify problem assets and prevent those assets from deteriorating. Under these standards, an insured depository institution should: (i) conduct periodic asset quality reviews to identify problem assets, (ii) estimate the inherent losses in problem assets and establish reserves that are sufficient to absorb estimated losses, (iii) compare problem asset totals to capital, (iv) take appropriate corrective action to resolve problem assets, (v) consider the size and potential risks of material asset concentrations, and (vi) provide periodic asset quality reports with adequate information for management and the board of directors to assess the level of asset risk. These guidelines also set forth standards for evaluating and monitoring earnings and for ensuring that earnings are sufficient for the maintenance of adequate capital and reserves. PREMIUMS FOR DEPOSIT INSURANCE. Although the Bank is a commercial bank, the Bank's deposit accounts are insured by the SAIF, as administered by the FDIC, up to the maximum amount permitted by law. Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the institution's primary regulator. 12
The FDIC charges an annual assessment for the insurance of deposits based on the risk a particular institution poses to its deposit insurance fund. Under this system as of December 31, 2000, SAIF members paid within a range of 0 to 27 basis points per $100 of insured deposits, depending upon the institution's risk classification. This risk classification is based on an institution's capital group and supervisory subgroup assignment. Pursuant to the Economic Growth and Paperwork Reduction Act of 1996 (the "Paperwork Reduction Act"), the Bank is currently paying, in addition to its normal deposit insurance premium as a member of the SAIF, an amount equal to approximately 1.96 basis points toward the retirement of the Financing Corporation bonds ("Fico Bonds") issued in the 1980's to assist in the recovery of the savings and loan industry. Effective January 1, 2000, members of both the SAIF and the Bank Insurance Fund ("BIF") pay the same rate to retire the Fico Bonds. Under the Paperwork Reduction Act, the FDIC also is not permitted to establish SAIF assessment rates that are lower than comparable BIF assessment rates. Proposals for the merging of the BIF and the SAIF are from time to time discussed by Congress. INTERSTATE BANKING AND BRANCHING. The BHC Act currently permits bank holding companies in any state to acquire banks and bank holding companies located in any other state, subject to certain conditions, including certain nationwide- and state-imposed concentration limits. The Bank has the ability, subject to certain restrictions, to acquire by acquisition or merger branches outside its home state. The establishment of new interstate branches is also possible in those states with laws that expressly permit it. Interstate branches are subject to certain laws of the states in which they are located. Competition may increase further as banks branch across state lines and enter new markets. COMMUNITY REINVESTMENT ACT AND FAIR LENDING DEVELOPMENTS. The Bank is subject to certain fair lending requirements and reporting obligations involving home mortgage lending operations and Community Reinvestment Act ("CRA") activities. 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. A bank may be subject to substantial penalties and corrective measures for a violation of certain fair lending laws. The federal banking agencies may take compliance with such laws and CRA obligations into account when regulating and supervising other activities. A bank's compliance with its CRA obligations is based a performance-based evaluation system which bases CRA ratings on an institution's lending service and investment performance. When a bank holding company applies for approval to acquire a bank or other bank holding company, the Federal Reserve Board will review the assessment of each subsidiary bank of the applicant bank holding company, and such records may be the basis for denying the application. Based on an examination conducted in April 1997, the Bank was rated "Satisfactory" in complying with its CRA obligations. ALLOWANCE FOR LOAN LOSSES. Management of the Bank is committed to maintaining the allowance for loan losses at a level that is considered to be commensurate with estimated and known risks in the portfolio. Although the adequacy of the allowance is reviewed quarterly, management performs an ongoing assessment of the risks inherent in the portfolio. The Bank's total allowance for loan losses is comprised of two components--allocated and unallocated. The Bank utilizes several methodologies to test the overall adequacy of the allowance. The two primary methodologies, the classification migration model and the individual loan review analysis methodology, provide the basis for determining the overall adequacy of the allowance. These methodologies are augmented by ancillary analyses, which include historical loss analyses, peer group comparisons, and analyses based on the federal regulatory interagency policy for loan and lease losses. The classification migration model calculates loss factors by utilizing net losses incurred by the Bank during the preceding five years in conjunction with current internal asset classifications. The model calculates loss factors for every classification category (i.e. pass, special mention, substandard 13
and doubtful) for each loan type, except consumer loans which are analyzed as a homogeneous pool. These calculated loss factors are applied to outstanding loan balances, unused commitments and off-balance sheet exposures, such as letters of credit. While the amount of losses actually observed can vary significantly from estimated amounts derived from the model, the loss migration model is designed to be self-correcting by taking into account the Bank's recent loss experience. In addition, minimum loss rates are also utilized by management as a self-correcting mechanism to compensate for the lack of historical loss information on certain loan types and to reduce differences between estimated and actual observed losses. Specific allowances are established for loans where management believes that the probability of loss is in excess of the amount determined by the application of the migration model. These specific allowances for individual loans are incorporated into the migration model to determine the overall allowance requirement. The individual loan review analysis method provides a more contemporaneous assessment of the portfolio by incorporating individual asset evaluations prepared by both the Bank's credit administration department and an independent external credit review group. Specific monitoring policies and procedures are applied in analyzing the existing loan portfolios which vary according to relative risk profile. Residential single family and consumer loans are relatively homogeneous and no single loan is individually significant in terms of size or potential risk of loss. Therefore, residential and consumer portfolios are analyzed as a pool of loans, and individual loans are criticized or classified based solely on performance. In contrast, the monitoring process for multifamily, commercial real estate, construction, and commercial business loans include a periodic review of individual loans. Depending on loan size and type, loans are reviewed at least annually and more frequently, if warranted by circumstances. For instance, loans that are performing but have shown some signs of weakness are subjected to more stringent reporting and oversight. Real estate loans and commercial business loans which are subject to individual loan review, and out-of-cycle individually reviewed loans, are monitored based on problem loan indicators such as loan payment, delinquencies, loan covenant or reporting violations, and property tax status. The estimated exposure and subsequent charge-offs that result from these individual loan reviews provide the basis for loss factors assigned to the various loan categories. The results from the classification migration model and the individual loan review analysis are then compared to various analyses, including historical losses, peer group comparisons and the federal regulatory interagency policy for loan and lease losses, to determine an overall allowance requirement amount. Factors that are considered in determining the final allowance requirement amount are scope and volume of completed individual loan reviews during the period, trends and applicability of historical loss migration analysis compared to current loan portfolio concentrations, and comparison of allowance levels to actual historical losses. The unallocated portion, or the amount in excess of the allowance requirement, is composed of three elements. The first element consists of an amount that is approximately 10% of the required allowance amount. This element recognizes that a certain degree of estimation risk is associated with the classification migration and individual loan review analysis methodologies. The second element represents the amount that, in management's opinion, is necessary to mitigate the foreign transaction risk associated with credit lines extended to financial institutions in foreign countries. Loss factors, ranging from 0.50% to 5.00% of the total credit facility, are assigned to absorb the loss exposure on this type of credit offering. These loss factors are internally assigned based on the sovereign risk ratings of various countries ranging from BBB to AA. The final element, which consists of an amount that is approximately 5% of the required allowance amount, takes into consideration the recent slowing of the national economy. As a result of the Federal Open Market Committee's recent comments about rising energy costs, eroding consumer confidence, substantial shortfalls in sales and earnings, and stress in some sections of the financial markets, management of the Company has deemed it prudent to carve out an additional 5% of the required allowance amount to compensate for this current economic risk. 14
EMPLOYEES. The Company does not have any employees other than executive officers who are also executive officers of the Bank. Such employees are not separately compensated for their employment with the Company. As of December 31, 2000, the Bank had a total of 421 full-time employees and 54 part-time employees and the Agency had a total of 11 full-time employees and one part-time employee. Employees are not represented by a union or collective bargaining group. The managements of the Bank and Agency believe that their employee relations are satisfactory. ITEM 2. PROPERTIES The Company owns no real property but utilizes the main office of the Bank. The Company pays no rent or other consideration for use of this facility. The Bank owns the land and buildings at 11 of its 29 branch offices and all of its administrative locations, with the exception of the space occupied by the Residential Loan Center. Those locations include: <TABLE> <CAPTION> OFFICE NAME ADDRESS OWNED/LEASED - ----------- ------- ------------ <S> <C> <C> Alhambra Main............................. 1881 West Main St. Owned Alhambra, CA 91801 Alhambra Valley........................... 403 W. Valley Blvd. Owned Alhambra, CA 91803 Arcadia................................... 200 E. Duarte Road Owned Arcadia, CA 91006 Artesia................................... 18512 Gridley Road Owned Artesia, CA 90701 Artesia................................... 18355 Pioneer Blvd. Leased Artesia, CA 90701 Carson.................................... 22020 S. Avalon Blvd. Leased Carson, CA 90745 Commercial Loan Center.................... 475 Huntington Dr. Owned San Marino, CA 91108 Cupertino................................. 10945 Wolfe Road Leased Cupertino, CA 95014 Diamond Bar............................... 379 S. Diamond Bar Blvd. Leased Diamond Bar, CA 91765 El Monte.................................. 9550 Flair Drive Leased El Monte, CA 91731 Geary Street.............................. 4355 Geary Street #101 Owned San Francisco, CA 94111 Glendale.................................. 520 N. Central Ave. Leased Glendale, CA 91203 Headquarters.............................. 415 Huntington Dr. Owned San Marino, CA 91108 Industry.................................. 18645 E. Gale Ave., Suite 100 Leased City of Industry, CA 91748 Lincoln Heights........................... 2601 No. Broadway Owned Los Angeles, CA 90031 Los Angeles--Chinatown.................... 942 North Broadway Leased Los Angeles, CA 90012 Los Angeles Main.......................... 624 S. Grand Ave. Leased Los Angeles, CA 90017 </TABLE> 15
<TABLE> <CAPTION> OFFICE NAME ADDRESS OWNED/LEASED - ----------- ------- ------------ <S> <C> <C> Market Street--Financial District......... 444 Market Street Leased San Francisco, CA 94111 Milpitas.................................. 642 Barber Lane Leased Milpitas, CA 95035 Montebello................................ 2825 Via Campo Leased Montebello, CA 90640 Monterey Park............................. 720 W. Garvey Ave. Leased Monterey Park, CA 91754 Residential Loan Center................... 1635 West Main St. Leased Alhambra, CA 91801 Rolling Hills............................. 27421 Hawthorne Blvd. Owned Rolling Hills Estates, CA 90274 Rosemead.................................. 8168 East Garvey Ave. Leased Rosemead, CA 91770 Rowland Heights........................... 18458 Colima Road Leased Rowland Heights, CA 91748 San Francisco--Chinatown.................. 1241 Stockton St. Leased San Francisco, CA 94133 San Marino................................ 805 Huntington Dr. Owned San Marino, CA 91108 Silverlake................................ 2496 Glendale Blvd. Owned Los Angeles, CA 90039 South Pasadena............................ 1001 Fair Oaks Ave. Owned S. Pasadena, CA 91030 Tarzana................................... 18321 Ventura Blvd. Leased Tarzana, CA 91356 Torrance.................................. 23670 Hawthorne Blvd. Owned Torrance, CA 90505 Westminster............................... 9032 Bolsa Avenue Leased Westminster, CA 92683 </TABLE> The Company added the following banking location as a result of the acquisition of Prime Bank in January 2001: <TABLE> <CAPTION> OFFICE NAME ADDRESS OWNED/LEASED - ----------- ------- ------------ <S> <C> <C> Century City.............................. 1900 Avenue of the Stars Leased Los Angeles, CA 90067 </TABLE> ITEM 3. LEGAL PROCEEDINGS Neither the Company nor the Bank is involved in any material legal proceedings. The Bank, from time to time, is party to litigation which arises in the ordinary course of business, such as claims to enforce liens, claims involving the origination and servicing of loans, and other issues related to the business of the Bank. After taking into consideration information furnished by counsel to the Company and the Bank, management believes that the resolution of such issues would not have a material adverse impact on the financial position, results of operations, or liquidity of the Company or the Bank. 16
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS During the fourth quarter of 2000, no matters were submitted to shareholders for a vote. ITEM 4(A). EXECUTIVE OFFICERS OF THE REGISTRANT The following table sets forth, as of February 28, 2001, the executive officers of the Company, their positions, and their ages. Each officer is appointed by the Board of Directors of the Company or the Bank and serves at their pleasure. <TABLE> <CAPTION> NAME AGE(1) POSITION WITH COMPANY OR BANK - ---- ------ --------------------------------- <S> <C> <C> Dominic Ng....................... 42 Chairman of the Board, President, and Chief Executive Officer of the Company and the Bank Julia Gouw....................... 41 Executive Vice President and Chief Financial Officer of the Company and the Bank Sandra Wong...................... 47 Executive Vice President and Chief Credit Officer of the Bank Donald Chow...................... 49 Executive Vice President, Director of Commercial Lending of the Bank Douglas Krause................... 44 Executive Vice President, General Counsel, and Secretary of the Company and the Bank </TABLE> - ------------------------ (1) As of February 28, 2001 BIOGRAPHICAL INFORMATION The principal occupation during the past five years of each executive officer is set forth below. All executive officers have held their present positions for at least five years, unless otherwise stated. DOMINIC NG has served as a director since 1991, as President and Chief Executive Officer of the Bank since 1992, and as Chairman of the Board in 1998. Mr. Ng has held the same positions with the Company since its formation. Prior to joining the Bank, he was President and CEO of Seyen Investment Inc. While he was a CPA with Deloitte & Touche LLP, he headed the Chinese Business Services Group. Mr. Ng serves on the Board of ESS Technology, Inc. Mr. Ng also serves as a member of the Board of Visitors of The Anderson School at UCLA, the Board of Regents of Loyola Marymount University, and is the Campaign Chairman of United Way of Greater Los Angeles. Mr. Ng has received numerous awards in the professional and philanthropic communities during the past decade. JULIA GOUW has served as Executive Vice President and Chief Financial Officer of the Bank since 1994 and as a director of the Bank since 1997, and has held these same positions with the Company since its formation. Ms. Gouw joined the Bank in 1989 as Vice President and Controller. Prior to joining the Bank, Ms. Gouw was a senior audit manager with KPMG LLP. Ms. Gouw is on the Board of Visitors of UCLA School of Medicine. She is also a member of the Financial Executives' Institute and the California Society of CPA's. SANDRA WONG joined the Bank in November 1998 as Executive Vice President and Chief Credit Officer. Prior to joining the Bank, Ms. Wong was Senior Vice President--Senior Credit Officer, Business Banking Division with Bank of America, where she managed portfolio performance and credit 17
standards for a $3 billion loan portfolio of small business customers. Ms. Wong was employed for over 20 years with Bank of America. DONALD CHOW serves as Executive Vice President and Director of Commercial Lending of the Bank. Mr. Chow joined the Bank in April 1993 as First Vice President and Commercial Lending Manager. Mr. Chow was bestowed the title of Senior Vice President in April 1994. Mr. Chow has over 25 years of experience in commercial lending. Before joining the Bank as Senior Vice-President, Mr. Chow was First Vice President and Senior Credit Officer for Mitsui Manufacturers Bank. Mr. Chow was also employed for over 10 years with Security Pacific National Bank where he held a number of positions, including Vice President and unit leader of commercial real estate lending. DOUGLAS KRAUSE serves as Executive Vice President, General Counsel, and Secretary of the Bank and has held these same positions with the Company since its formation. Prior to joining the Bank in 1996 as Senior Vice President, Mr. Krause was Corporate Senior Vice President and General Counsel of Metrobank since 1991. Prior to that, Mr. Krause was with the law firms of Dewey Ballantine and Jones, Day, Reavis and Pogue specializing in financial services. Mr. Krause is a member of the Consumer Financial Services Committee of the California Bar Association. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS For information concerning the market for the Company's Common Stock and related shareholder matters, see "Common Stock Price Range and Dividends" contained in the 2000 Annual Report, which is incorporated herein by reference, and "Item 1. BUSINESS--Regulation and Supervision--Restrictions on Transfer of Funds to the Company by the Bank." 18
ITEM 6. SELECTED FINANCIAL DATA The following selected financial data should be read in conjunction with the Company's Consolidated Financial Statements and the accompanying notes presented elsewhere herein. <TABLE> <CAPTION> 2000 1999 1998 1997 1996 ---------- ---------- ---------- ---------- ---------- (IN THOUSANDS, EXCEPT PER SHARE DATA) <S> <C> <C> <C> <C> <C> SUMMARY OF OPERATIONS: Interest and dividend income............... $ 186,080 $ 148,027 $ 126,708 $ 107,092 $ 96,876 Interest expense........................... 96,593 76,142 71,043 62,646 57,268 ---------- ---------- ---------- ---------- ---------- Net interest income........................ 89,487 71,885 55,665 44,446 39,608 Provision for loan losses.................. 4,400 5,439 5,356 5,588 4,398 ---------- ---------- ---------- ---------- ---------- Net interest income after provision for loan losses.............................. 85,087 66,446 50,309 38,858 35,210 Noninterest income......................... 14,968 14,693 10,027 8,493 5,571 SAIF recapitalization expense.............. -- -- -- -- 7,040 Noninterest expense........................ 49,960 39,509 32,626 29,010 28,049 ---------- ---------- ---------- ---------- ---------- Income before provision for income taxes... 50,095 41,630 27,710 18,341 5,692 Provision for income taxes................. 14,628 13,603 9,682 7,330 2,486 ---------- ---------- ---------- ---------- ---------- Net income(1).............................. $ 35,467 $ 28,027 $ 18,028 $ 11,011 $ 3,206 ========== ========== ========== ========== ========== Basic earnings per share(1)................ $ 1.58 $ 1.23 $ 0.76 $ 0.46 $ 0.13 Diluted earnings per share(1).............. $ 1.53 $ 1.22 $ 0.76 $ 0.46 $ 0.13 Average number of shares outstanding, basic.................................... 22,448 22,757 23,775 23,775 23,775 Average number of shares outstanding, diluted.................................. 23,168 22,895 23,775 23,775 23,775 AT YEAR END: Total assets............................... $2,485,971 $2,152,630 $2,058,160 $1,734,339 $1,621,547 Loans receivable, net...................... 1,789,988 1,486,641 1,100,579 934,850 862,640 Investment securities...................... 488,290 496,426 682,436 374,810 406,468 Deposits................................... 1,948,562 1,500,529 1,292,937 1,235,072 1,182,886 Federal Home Loan Bank advances............ 268,000 482,000 563,000 211,000 55,000 Stockholders' equity....................... 186,149 150,080 150,830 132,552 122,375 Shares outstanding......................... 22,661 22,423 23,775 23,775 23,775 Book value per share....................... $ 8.21 $ 6.69 $ 6.34 $ 5.58 $ 5.15 FINANCIAL RATIOS: Return on assets(2)........................ 1.51% 1.35% 1.00% 0.70% 0.22% Return on equity(2)........................ 21.57 18.96 12.83 8.91 2.71 Average stockholders' equity to average assets................................... 7.02 7.12 7.80 7.87 8.16 Net interest margin........................ 4.03 3.62 3.22 2.92 2.82 Efficiency ratio(2)(3)..................... 40.91 40.56 46.52 52.47 75.61 ASSET QUALITY RATIOS: Net chargeoffs to average loans............ 0.22% 0.17% 0.11% 0.37% 0.37% Nonperforming assets to year end total assets................................... 0.30 0.75 0.99 1.25 1.28 Allowance for loan losses to year end total gross loans.............................. 1.31 1.38 1.47 1.29 1.15 </TABLE> - -------------------------- (1) Excluding the non-recurring Savings Association Insurance Fund ("SAIF") recapitalization assessment, net income and earnings per share (basic and diluted) for the year ended December 31, 1996 were $7.4 million and $0.31, respectively. (2) Excluding the SAIF recapitalization assessment, the Company's return on assets, return on equity and efficiency ratios were 0.51%, 6.26% and 59.89%, respectively, during the year ended December 31, 1996. (3) Represents noninterest expense, excluding the amortization of intangibles and investments in affordable housing partnerships, divided by the aggregate of net interest income before provision for loan losses and noninterest income, excluding the amortization of intangibles. 19
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion provides information about the results of operations, financial condition, liquidity, and capital resources of East West Bancorp, Inc. and its subsidiaries (the "Company"). This information is intended to facilitate the understanding and assessment of significant changes and trends related to the financial condition of the Company and the results of its operations. This discussion and analysis should be read in conjunction with the Company's Consolidated Financial Statements and the accompanying notes presented elsewhere herein. In addition to historical information, this discussion includes certain "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 which involve inherent risks and uncertainties. A number of important factors could cause the Company's actual results and performance in future periods to differ materially from those discussed in such forward-looking statements. These factors include, but are not limited to, the effect of interest rate and currency exchange fluctuations; competition in the financial services market for both deposits and loans; the Company's ability to efficiently incorporate acquisitions into its operations; the ability of the Company to increase its customer base; and regional and general economic conditions. Given these uncertainties, the reader is cautioned not to place undue reliance on such forward-looking statements. The Company expressly disclaims any obligation to update or revise any forward-looking statements contained herein to reflect any changes in the Company's expectations of results or any change in events. East West Bancorp, Inc. is predominantly a bank holding company. Its primary subsidiary, East West Bank (the "Bank") is a state chartered bank with 30 branch offices located in Los Angeles, Orange, San Francisco and Santa Clara counties. The Bank's results of operations are primarily dependent on its net interest income, which is the difference between the interest income earned on its assets, primarily loans and investments, and the interest expense on its liabilities, primarily deposits and borrowings. Net interest income may be affected significantly by general economic and competitive conditions and policies of regulatory agencies, particularly with respect to market interest rates. The results of operations are also significantly influenced by the level of noninterest expense, such as employee salaries and benefits; noninterest income, such as fees on deposit-related services; and the Bank's provision for loan losses. The Bank has three wholly-owned subsidiaries--E-W Services, Inc., which holds property used by the Bank in its operations, East-West Investments, Inc., which primarily serves as a trustee for the Bank in connection with real estate secured loans, and EWSC Holdings, LLC, which owns 100% of the voting shares of East West Securities Company, Inc., a non-diversified, closed-end, management investment company registered under the Investment Company Act of 1940, as amended. ACQUISITION OF PRIME BANK On January 16, 2001, the Company completed its acquisition of Prime Bank for a combination of shares and cash valued at $16.6 million. Prime Bank, with assets of $108 million and total stockholders' equity of $7.5 million as of December 31, 2000, was a one-branch commercial bank located in the Century City area of Los Angeles. Prime Bank focused on providing a wide range of services to commercial, real estate and professional firms located in the West Los Angeles market based upon a committed relationship approach to business banking. In addition to commercial real estate loans, business term loans and lines of credit, Prime Bank provided specialty depository services to entertainment, title and escrow, and other sectors. RESULTS OF OPERATIONS The Company reported net income of $35.5 million for 2000, compared with $28.0 million for 1999 and $18.0 million for 1998, representing an increase of 27% for 2000 and 55% for 1999. On a per share basis, net income was $1.53, $1.22 and $0.76 for 2000, 1999 and 1998, respectively. During 2000, the 20
increase in net earnings is largely attributable to continued growth in the loan portfolio, a higher net interest margin and a slight increase in noninterest-related revenues partially offset by higher operating expenses. Earnings in 1999 improved over 1998 primarily due to the growth in the loan and investment securities portfolios and a reduction in the Company's cost of funds. The Company's return on average total assets increased to 1.51% in 2000, from 1.35% in 1999 and 1.00% in 1998, while the return on average stockholders' equity increased to 21.57% in 2000, compared with 18.96% in 1999 and 12.83% in 1998. COMPONENTS OF NET INCOME <TABLE> <CAPTION> 2000 1999 1998 -------- -------- -------- (IN MILLIONS) <S> <C> <C> <C> Net interest income.................................. $ 89.5 $ 71.9 $ 55.7 Provision for loan losses............................ (4.4) (5.4) (5.4) Noninterest income................................... 15.0 14.7 10.0 Noninterest expense.................................. (50.0) (39.5) (32.6) Provision for income taxes........................... (14.6) (13.6) (9.7) ------ ------ ------ Net income......................................... $ 35.5 $ 28.0 $ 18.0 ====== ====== ====== Return on average total assets....................... 1.51% 1.35% 1.00% ====== ====== ====== </TABLE> NET INTEREST INCOME The Bank's primary source of revenue is net interest income, which is the difference between interest income on earning assets and interest expense on interest-bearing liabilities. Net interest income in 2000 totaled $89.5 million, a 24% increase over net interest income of $71.9 million in 1999. Total interest and dividend income during 2000 increased 26% to $186.1 million compared with $148.0 million during 1999. The increase in interest and dividend income is derived primarily from a 12% growth in average earning assets and higher yields on all categories of earning assets. Growth in the Bank's average loan portfolio, partially offset by decreases in the other categories of earning assets, triggered the increase in average earning assets. The net growth in average earning assets was funded largely by time deposits, money market accounts, and noninterest-bearing demand deposits. Total interest expense during 2000 increased 27% to $96.6 million compared with $76.1 million a year ago. The increase in interest expense is primarily attributable to higher rates paid on interest-bearing liabilities and growth in average money market accounts and time deposits, partially offset by a decrease in average FHLB advances. Net interest margin, defined as taxable equivalent net interest income divided by average earning assets, increased 41 basis points to 4.03% in 2000, compared with 3.62% in 1999. The increase in net interest margin is primarily due to the increased volume of loans and noninterest-bearing demand deposits and higher overall yields on earning assets, partially offset by higher rates paid on interest bearing liabilities. Average loan growth of 28% during 2000 was most notable in the multifamily residential, commercial real estate, construction and commercial business segments of the portfolio. A marked increase in the average prime rate of 121 basis points during 2000 is the main catalyst for higher overall yields on earning assets during 2000. The Company's overall cost of funds increased 65 basis points to 4.91% during 2000 primarily due to the increase in rates paid on all categories of interest-bearing liabilities, predominantly on time deposits and FHLB advances. The increase in rates paid is due to a rise in overall interest rates. Growth in the average volume of time deposits and money market accounts, partially offset by a sizeable decrease in the volume of FHLB advances, further contributed to the increase in the Company's cost of funds during 2000. 21
Comparing 1999 to 1998, the Company's net interest margin increased 40 basis points to 3.62%, from 3.22% in 1998. Despite a 33 basis point decline in the average prime rate during 1999 resulting in a decrease in loan yields, the overall yield on earning assets increased to 7.46% in 1999, from 7.33% in 1998. This is primarily due to the increased volume of average loans and investment securities during 1999 which more than compensated for the decline in loan yields. Another factor that accounted for the increase in overall yields on earning assets is an increase in the yield on investment securities due to purchases of fixed rate securities during the latter half of 1998. Further contributing to the increase in net interest margin is the growth in noninterest-bearing demand deposits and a decrease in the overall cost of funds due to reduced rates paid on all categories of interest-bearing liabilities. The following table presents the net interest spread, net interest margin, average balances, interest income and expense, and the average yields and rates by asset and liability component for the years ended December 31, 2000, 1999 and 1998: <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, ------------------------------------------------------------------- 2000 1999 -------------------------------- -------------------------------- AVERAGE AVERAGE AVERAGE YIELD/ AVERAGE YIELD/ BALANCE INTEREST RATE BALANCE INTEREST RATE ---------- -------- -------- ---------- -------- -------- (DOLLARS IN THOUSANDS) <S> <C> <C> <C> <C> <C> <C> ASSETS Interest-earning assets: Short-term investments......... $ 12,483 $ 960 7.69% $ 40,262 $ 2,381 5.91% Taxable investment securities(1)(2)............. 513,126 32,521 6.34 609,587 35,560 5.83 Loans receivable(1)(3)......... 1,670,981 150,985 9.04 1,306,306 108,547 8.31 FHLB stock..................... 21,794 1,614 7.41 29,203 1,539 5.27 ---------- ------- ---------- ------- Total interest-earning assets..................... 2,218,384 186,080 8.39 1,985,358 148,027 7.46 ------- ----- ------- ---- Noninterest-earning assets: Cash and due from banks........ 47,343 34,185 Allowance for loan losses...... (23,893) (19,191) Other assets................... 101,109 76,192 ---------- ---------- Total assets................. $2,342,943 $2,076,544 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing liabilities: Checking accounts.............. $ 108,228 1,398 1.29 $ 87,828 1,060 1.21 Money market accounts.......... 107,130 3,836 3.58 51,448 1,594 3.10 Savings deposits............... 218,455 4,213 1.93 216,590 3,954 1.83 Time deposits.................. 1,164,671 63,201 5.43 922,107 42,959 4.66 Short-term borrowings.......... 31,009 2,065 6.66 19,679 1,080 5.49 FHLB advances.................. 325,656 20,503 6.30 491,203 25,495 5.19 Junior subordinated debt securities................... 12,686 1,377 10.85 -- -- -- ---------- ------- ---------- ------- Total interest-bearing liabilities................ 1,967,835 96,593 4.91 1,788,855 76,142 4.26 ------- ----- ------- ---- Noninterest-bearing liabilities: Demand deposits................ 185,731 116,129 Other liabilities.............. 24,953 23,712 Stockholders' equity........... 164,424 147,848 ---------- ---------- Total liabilities and stockholders' equity....... $2,342,943 $2,076,544 ========== ========== Interest rate spread............. 3.48% 3.20% ===== ==== Net interest income and net interest margin................ $89,487 4.03% $71,885 3.62% ======= ===== ======= ==== <CAPTION> YEAR ENDED DECEMBER 31, -------------------------------- 1998 -------------------------------- AVERAGE AVERAGE YIELD/ BALANCE INTEREST RATE ---------- -------- -------- (DOLLARS IN THOUSANDS) <S> <C> <C> <C> ASSETS Interest-earning assets: Short-term investments......... $ 227,112 $13,302 5.86% Taxable investment securities(1)(2)............. 477,338 26,405 5.53 Loans receivable(1)(3)......... 1,004,477 85,806 8.54 FHLB stock..................... 20,140 1,195 5.93 ---------- ------- Total interest-earning assets..................... 1,729,067 126,708 7.33 ------- ---- Noninterest-earning assets: Cash and due from banks........ 25,231 Allowance for loan losses...... (14,253) Other assets................... 60,537 ---------- Total assets................. $1,800,582 ========== LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing liabilities: Checking accounts.............. $ 78,066 1,072 1.37 Money market accounts.......... 28,051 1,010 3.60 Savings deposits............... 213,675 5,048 2.36 Time deposits.................. 845,749 42,369 5.01 Short-term borrowings.......... 119,638 6,767 5.66 FHLB advances.................. 282,091 14,777 5.24 Junior subordinated debt securities................... -- -- -- ---------- ------- Total interest-bearing liabilities................ 1,567,270 71,043 4.53 ------- ---- Noninterest-bearing liabilities: Demand deposits................ 78,802 Other liabilities.............. 14,009 Stockholders' equity........... 140,501 ---------- Total liabilities and stockholders' equity....... $1,800,582 ========== Interest rate spread............. 2.80% ==== Net interest income and net interest margin................ $55,665 3.22% ======= ==== </TABLE> - ------------------------------ (1) Includes net premium amortization on investment securities and loans receivable totaling $704 thousand, $288 thousand, and $1.2 million for the years ended December 31, 2000, 1999, and 1998, respectively. Also includes amortization of deferred loan fees totaling $2.0 million, $2.3 million, and $1.9 million for the years ended December 31, 2000, 1999 and 1998, respectively. (2) Average balances exclude unrealized gains or losses on available for sale securities. (3) Average balances include nonperforming loans. 22
ANALYSIS OF CHANGES IN NET INTEREST MARGIN Changes in the Bank's net interest income are a function of changes in rates and volumes of both interest-earning assets and interest-bearing liabilities. The following table sets forth information regarding changes in interest income and interest expense for the years indicated. The total change for each category of interest-earning asset and interest-bearing liability is segmented into the change attributable to variations in volume (changes in volume multiplied by old rate) and the change attributable to variations in interest rates (changes in rates multiplied by old volume). Nonaccrual loans are included in average loans used to compute this table. <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, ----------------------------------------------------------------- 2000 VS. 1999 1999 VS. 1998 ------------------------------- ------------------------------- CHANGES DUE TO CHANGES DUE TO TOTAL -------------------- TOTAL -------------------- CHANGE VOLUME(1) RATE(1) CHANGE VOLUME(1) RATES(1) -------- --------- -------- -------- --------- -------- (IN THOUSANDS) <S> <C> <C> <C> <C> <C> <C> INTEREST-EARNING ASSETS: Short-term investments..................... $(1,421) $ (2,517) $ 1,096 $(10,921) $(11,051) $ 130 Taxable investment securities.............. (3,038) (6,700) 3,662 9,155 7,649 1,506 Loans receivable, net...................... 42,437 32,320 10,117 22,741 25,011 (2,270) FHLB stock................................. 75 (126) 201 344 458 (114) ------- -------- -------- -------- -------- ------- Total interest income.................. 38,053 22,977 15,076 21,319 22,067 (748) ======= ======== ======== ======== ======== ======= INTEREST-BEARING LIABILITIES: Checking accounts.......................... 338 259 79 (12) (380) 368 Money market accounts...................... 2,242 1,960 282 584 701 (117) Savings deposits........................... 259 34 225 (1,094) 70 (1,164) Time deposits.............................. 20,241 12,446 7,795 590 2,633 (2,043) Short-term borrowings...................... 985 719 266 (5,687) (5,492) (195) FHLB advances.............................. (4,991) (13,569) 8,578 10,718 10,852 (134) Junior subordinated debt securities........ 1,377 1,377 -- -- -- -- ------- -------- -------- -------- -------- ------- Total interest expense................. 20,451 3,226 17,225 5,099 8,384 (3,285) ------- -------- -------- -------- -------- ------- CHANGE IN NET INTEREST INCOME.............. $17,602 $ 19,751 $ (2,149) $ 16,220 $ 13,683 $ 2,537 ======= ======== ======== ======== ======== ======= </TABLE> - ------------------------------ (1) Changes in interest income/expense not arising from volume or rate variances are allocated proportionately to rate and volume. PROVISION FOR LOAN LOSSES The provision for loan losses amounted to $4.4 million for 2000 and $5.4 million for both 1999 and 1998. Provisions for loan losses are charged to income to bring the allowance for credit losses to a level deemed appropriate by management based on the factors discussed under the "Allowance for Loan Losses" section of this report. 23
NONINTEREST INCOME COMPONENTS OF NONINTEREST INCOME <TABLE> <CAPTION> 2000 1999 1998 -------- -------- -------- (IN MILLIONS) <S> <C> <C> <C> Loan fees........................................... $ 1.85 $ 2.28 $ 2.39 Branch fees......................................... 4.84 3.39 2.58 Letters of credit fees and commissions.............. 4.35 4.11 2.79 Net gain on sales of securities available for sale.............................................. 0.12 0.69 1.32 Net gain on trading securities...................... (0.02) 1.90 -- Net gain on sale of affordable housing investments....................................... 1.28 0.40 -- Net gain on sale of branch.......................... -- 0.68 -- Amortization of negative intangibles................ 0.42 0.41 0.41 Other............................................... 2.13 0.83 0.54 ------ ------ ------ Total........................................... $14.97 $14.69 $10.03 ====== ====== ====== </TABLE> Noninterest income includes revenues earned from sources other than interest income. These sources include: ancillary fees on loans, service charges and fees on deposit accounts, fees and commissions generated from trade finance activities and the issuance of letters of credit, net gains on trading securities, and net gains on sales of investment securities available for sale and affordable housing investments. Noninterest income increased 2% to $15.0 million during 2000, primarily due to higher branch service-related fees, gains on sales of affordable housing investments, and other income, partially offset by lower gains on trading securities and sales of investment securities available for sale. Included in noninterest income for 1999 is a one-time gain on sale of the Company's Irvine branch amounting to $676 thousand. There was no such gain recorded in 2000. Ancillary fees on loans include fees and service charges related to appraisal services, loan documentation, processing and underwriting, and secondary market-related activities. Ancillary loan fees decreased 19% to $1.8 million in 2000, from $2.3 million in 1999, primarily due to the Company's reduced secondary marketing activities. The reduction in secondary marketing activities was prompted, in part, by the introduction of new loan portfolio products and, to a larger extent, by the current interest rate environment during 2000 which favored the origination of adjustable rate mortgages over fixed rate mortgages. Branch fees, which represent revenues derived from branch operations, amounted to $4.8 million in 2000, a 43% increase from the $3.4 million earned during 1999. The increase in branch fees is primarily due to higher service-related fee income on transaction accounts resulting from the acquisition of American International Bank in mid-January 2000. Further, sustained growth in revenues from analysis charges on commercial deposit accounts also contributed to the increase in branch fee income. Letters of credit fees and commissions increased 6% to $4.4 million entirely due to the growth in trade finance revenues. Fees related to the issuance and maintenance of standby letters of credit remained at $2.3 million for both 2000 and 1999. Other noninterest income, which include insurance commissions and insurance-related service fees, interest earned on officer life insurance policies, branch rental income, and income from operating leases, increased 157% to $2.1 million. The increase in other noninterest income is primarily due to $395 thousand in insurance commissions and other insurance-related service fee income in connection with the acquisition of Risk Services, Inc. in August 2000. There were no such commissions and service fee income during 1999. In addition, the Company also recorded $305 thousand in revenues from 24
equipment leased to third parties in connection with $1.3 million in operating leases entered into by the Company during 2000. The Company had no operating leases in 1999. The Company also recorded $142 thousand in sublease rental income from its Torrance branch location as part of the Company's acquisition of American International Bank in mid-January 2000. Further contributing to other noninterest income is a $263 thousand increase in interest income on officer life insurance policies relative to such income earned in 1999. At December 31, 2000, the aggregate net cash surrender value of the Company's officer life insurance policies amounted to $17.0 million compared to $11.0 million at December 31, 1999. Other contributions to noninterest income include $123 thousand and $685 thousand in gains on sales of available for sale securities for 2000 and 1999, respectively. Net losses on trading securities totaled $16 thousand during 2000 compared to $1.9 million in trading securities gains during 1999. Comparing 1999 to 1998, noninterest income increased 47% to $14.7 million. Included in noninterest income for 1999 are the one-time $676 thousand gain on sale of the Irvine branch, $1.9 million in gains on trading securities and $402 thousand in gains on sale of an investment in affordable housing partnerships. There were no such gains recorded in 1998. Further contributing to the increase in noninterest income during 1999 is a 48% growth in fee-based service income related to letters of credit fees and commissions and 31% increase in branch service-related fee income. Slightly offsetting these increases was a 4% decrease in ancillary loan fees primarily due to a decline in secondary market activities. NONINTEREST EXPENSE COMPONENTS OF NONINTEREST EXPENSE <TABLE> <CAPTION> 2000 1999 1998 -------- -------- -------- (IN MILLIONS) <S> <C> <C> <C> Compensation and other employee benefits............ $20.29 $18.48 $17.28 Net occupancy....................................... 7.56 5.65 4.97 Data processing..................................... 1.78 1.40 1.25 Amortization of positive intangibles................ 3.32 1.57 1.24 Amortization of affordable housing investments...... 4.08 2.99 1.02 Deposit insurance premiums and regulatory assessments....................................... 0.46 0.86 0.83 Other real estate owned operations, net............. (0.17) (0.34) (0.38) Other............................................... 12.64 8.90 6.42 ------ ------ ------ Total........................................... $49.96 $39.51 $32.63 ====== ====== ====== Efficiency ratio.................................... 41% 41% 47% ====== ====== ====== </TABLE> Noninterest expense, which is comprised primarily of compensation and employee benefits, occupancy and other operating expenses increased 26% to $50.0 million during 2000. Compensation and employee benefits increased 10% to $20.3 million primarily due to the acquisition of American International Bank and also to the addition of several new loan officers with specialized lending experience. Occupancy expenses increased 34% to $7.6 million during 2000 primarily reflecting the operations of the eight branches of American International Bank, an overhead factor which was not present during 1999. Additionally, the impact of normal rent adjustments in existing leases, increased expenses related to the enhancement and maintenance of the Company's computer network system, and increased depreciation from equipment under operating leases further contributed to the rise in occupancy expenses. 25
Data processing expenses increased 27% to $1.8 million during 2000, compared with $1.4 million in 1999, primarily due to the acquisition of American International Bank. The amortization of positive intangibles, which include premiums on deposits acquired and excess of purchase price over fair value of net assets acquired ("goodwill"), increased 111% during 2000. The increase in the amortization of positive intangibles is due to the acquisitions of First Central Bank, American International Bank and East West Insurance Agency. Combined goodwill of $14.2 million and deposit premiums of $8.6 million were recorded by the Company for these transactions which are being amortized straight line over 15 years and 7 years, respectively. The amortization of investments in affordable housing partnerships increased 36% to $4.1 million during 2000, compared with $3.0 million in 1999. The increase in amortization reflects the impact of $5.5 million in additional investment purchases made since year-end 1999, offset by two sale transactions totaling $9.3 million in February 2000 and September 2000. Total investments in affordable housing partnerships amounted to $19.7 million as of December 31, 2000, compared with $26.5 million as of December 31, 1999. Deposit insurance premiums and regulatory assessments decreased 47% to $458 thousand primarily due to a significant decrease in the Savings Association Insurance Fund ("SAIF") Financing Corporation ("FICO") assessment rates effective in 2000. The average annual FICO assessment rate during 2000 was 2.07 basis points per $100 of assessable deposits compared to 5.93 basis points during 1999. Net income related to OREO operations, which includes net rental income collected from OREO properties and net gains or losses on subsequent sales, totaled $174 thousand during 2000, compared with net income of $340 thousand in 1999, primarily due to a 60% decrease in net gains on sales of OREO properties during 2000 in comparison to 1999. Other operating expenses include advertising and public relations, telephone and postage, stationery and supplies, bank and item processing charges, insurance, legal and other professional fees. Other operating expenses increased 42% to $12.6 million in 2000, compared with $8.9 million for 1999. The increase in other operating expenses can be attributed to the Company's continued expansion, which includes the recent acquisitions of First Central Bank, American International Bank and East West Insurance Agency, as well as internal growth. Comparing 1999 to 1998, noninterest expense increased $6.9 million, or 21%, to $39.5 million. The increase is comprised primarily of the following: (1) an increase in compensation and employee benefits of $1.2 million primarily due to internal growth and the acquisition of First Central Bank at the end of May 1999; (2) an increase in occupancy expenses of $675 thousand reflecting four months of operations for the branches and administrative offices of First Central Bank prior to their integration with existing East West Bank locations, and increased expenses related to the outsourcing of computer hardware maintenance, partially offset by the sale of the Irvine branch to People's Bank of California in May 1999; (3) an increase in amortization of positive intangibles of $331 thousand due to the acquisition of First Central Bank; (4) an increase in amortization of affordable housing partnerships of $2.0 million reflecting the impact of $5.1 million in additional investments purchased during 1999; and (5) an increase in other operating expenses of $2.5 million attributed to the Company's overall growth--through organic expansion and through the acquisition of First Central Bank, as well as various expenses directly related to the Company's change in status from a privately held institution to a public company, including legal fees, investor relations expenses, Delaware corporation franchise taxes, SEC and NASDAQ fees, and registrar and transfer agent fees. Despite the Company's growth trend over the past several years, ongoing efforts to closely manage operational expenses continue to favorably impact the Company's efficiency ratio, which represents noninterest expense (excluding the amortization of intangibles and investments in affordable housing 26
partnerships) divided by the aggregate of net interest income before provision for loan losses and noninterest income (excluding the amortization of intangibles). The Company's efficiency ratio remained at 41% in 2000 and 1999, compared to 47% in 1998. PROVISION FOR INCOME TAXES The provision for income taxes increased 8% to $14.6 million during 2000, compared with $13.6 million in 1999. This is primarily due to higher pretax income partially offset by tax credits from qualified affordable housing investments and state tax benefits achieved through the formation and funding of East West Securities Company, Inc., a regulated investment company, in July 2000. Tax credits from qualified affordable housing investments utilized during 2000 totaled $3.9 million, compared to $3.2 million for 1999. The 2000 provision reflects an effective tax rate of 29.2%, compared with 32.7% for 1999. Comparing 1999 to 1998, the provision for income taxes increased 41% to $13.6 million, compared to $9.7 million for 1998. The 1998 provision reflects an effective tax rate of 34.9% and tax credits from affordable housing investments of $1.7 million. BALANCE SHEET ANALYSIS The Company's total assets increased $333.3 million, or 15%, to $2.49 billion, as of December 31, 2000, primarily due to loan growth. The increase in total assets was funded by increases of $448.0 million in deposits, $37.4 million in short-term borrowings and $20.8 million in junior subordinated debt securities, partially offset by decreases in FHLB advances of $214.0 million. INVESTMENT SECURITIES HELD FOR TRADING Investment securities held for trading are investment grade securities which are generally held by the Bank for a period of seven days or less. Net losses from trading securities totaled $16 thousand during 2000 compared with net gains of $1.9 million during 1999. INVESTMENT SECURITIES AVAILABLE FOR SALE Income from investing activities provides a significant portion of the Bank's total income. Management generally maintains an investment portfolio with an adequate mix of fixed rate and adjustable rate securities with relatively short maturities to minimize overall interest rate risk. The Bank has a substantial investment in residential mortgage-backed securities, consisting of pass-through certificates issued by GNMA, FHLMC, FNMA and private issuers. As of December 31, 2000, the carrying value of mortgage-backed securities totaled $384.7 million, or 15% of total assets. At December 31, 2000, the Bank held $695 thousand, $125.2 million, $220.7 million, and $38.1 million of mortgage-backed securities issued by GNMA, FHLMC, FNMA and private issuers, respectively. Mortgage-backed securities with a total carrying value of $221.2 million, or 51% of the total portfolio, had adjustable interest rates at December 31, 2000. At December 31, 2000, $139.9 million of mortgage-backed securities were pledged as collateral for public funds. 27
The following table sets forth the carrying values of investment securities available for sale at December 31, 2000 and 1999: <TABLE> <CAPTION> AT DECEMBER 31, ----------------------- 2000 1999 -------- -------- (IN THOUSANDS) <S> <C> <C> U.S. Treasury securities............................. $ 8,429 $ 975 U.S. Government agency securities.................... 67,382 68,871 Mortgage-backed securities........................... 384,678 426,378 Obligations of states and political subdivisions..... 201 202 Corporate securities................................. 27,600 -- -------- -------- Total investment securities available for sale..... $488,290 $496,426 ======== ======== </TABLE> Total investment securities available for sale decreased 2% to $488.3 million as of December 31, 2000. Total repayments and proceeds from sales of available for sale securities amounted to $80.9 million and $61.1 million, respectively, during 2000. Proceeds from repayments and sales were applied toward additional investment securities purchases, repayments of FHLB advances, and funding a portion of loan originations and loan purchases made during 2000. The Bank recorded net gains totaling $123 thousand and $685 thousand on sales of available for sale securities during 2000 and 1999, respectively. The following table sets forth certain information regarding the carrying values, weighted average yields, and contractual maturity distribution, excluding periodic principal payments, of the Bank's investment securities available for sale portfolio at December 31, 2000: <TABLE> <CAPTION> AFTER FIVE AFTER ONE YEAR YEARS BUT WITHIN ONE BUT WITHIN FIVE WITHIN TEN YEAR YEARS YEARS ------------------- ------------------- ------------------- AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD -------- -------- -------- -------- -------- -------- (DOLLARS IN THOUSANDS) <S> <C> <C> <C> <C> <C> <C> U.S. Treasury..................... $301 5.88% $ 8,128 6.42% $ -- --% U.S. Government agency............ -- -- 10,930 5.77 -- -- Mortgage-backed securities........ -- -- -- -- 60,676 6.19 Obligations of states and political subdivisions.................... 201 4.71 -- -- -- -- Corporate securities.............. -- -- -- -- -- -- ---- ------- ------- Total............................. $502 5.41 $19,058 6.05 $60,676 6.19 ==== ======= ======= <CAPTION> AFTER TEN YEARS TOTAL ------------------- ------------------- AMOUNT YIELD AMOUNT YIELD -------- -------- -------- -------- (DOLLARS IN THOUSANDS) <S> <C> <C> <C> <C> U.S. Treasury..................... $ -- --% $ 8,429 6.40% U.S. Government agency............ 56,452 6.55 67,382 6.42 Mortgage-backed securities........ 324,002 6.77 384,678 6.68 Obligations of states and political subdivisions.................... -- -- 201 4.71 Corporate securities.............. 27,600 8.13 27,600 8.13 -------- -------- Total............................. $408,054 6.83 $488,290 6.72 ======== ======== </TABLE> LOANS The Bank offers a broad range of products designed to meet the credit needs of its borrowers. The Bank's lending activities consist of residential mortgage loans, multifamily residential real estate loans, commercial real estate loans, construction loans, commercial business and trade finance loans, and consumer loans. Net loans receivable increased 20% to $1.79 billion at December 31, 2000. Excluding the $105.2 million of net loans acquired from American International Bank, organic loan growth during 2000 was 13%. The increase in loans was funded primarily through deposit growth and through repayments and sales of investment securities available for sale. The Bank experienced moderate loan demand throughout 2000. The growth in loans, excluding loans acquired from American International Bank, is comprised of increases in single family loans of $56.4 million or 20%, multifamily loans of $12.3 million or 4%, commercial real estate loans of $42.3 million or 8%, commercial business loans, including trade finance products, of $82.3 million or 33%, and consumer loans, including home equity lines of credit, of $16.3 million or 68%. Partially 28
offsetting the growth in these loan categories was a decrease in construction loans of $11.5 million or 10%, primarily as a result of the Bank's increased loan participation activity during 2000. The following table sets forth the composition of the loan portfolio at the end of each of the past five years: <TABLE> <CAPTION> DECEMBER 31, -------------------------------------------------------------------------------- 2000 1999 1998 1997 --------------------- --------------------- --------------------- -------- AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT ---------- -------- ---------- -------- ---------- -------- -------- (DOLLARS IN THOUSANDS) <S> <C> <C> <C> <C> <C> <C> <C> Real estate loans: Residential, one to four units....................... $ 334,775 18.5% $ 278,161 18.4% $ 270,444 24.2% $356,478 Residential, multifamily...... 323,469 17.8 311,193 20.6 167,545 15.0 144,147 Commercial and industrial real estate...................... 640,713 35.3 518,074 34.4 358,850 32.0 269,028 Construction.................. 118,241 6.5 122,363 8.1 78,922 7.0 27,020 ---------- ----- ---------- ----- ---------- ----- -------- Total real estate loans..... 1,417,198 78.1 1,229,791 81.5 875,761 78.2 796,673 ---------- ----- ---------- ----- ---------- ----- -------- Other loans: Business, commercial.......... 350,282 19.3 248,865 16.5 223,318 20.0 138,408 Automobile.................... 6,409 0.4 5,284 0.4 4,972 0.4 5,259 Other consumer................ 40,547 2.2 23,834 1.6 15,156 1.4 9,137 ---------- ----- ---------- ----- ---------- ----- -------- Total other loans........... 397,238 21.9 277,983 18.5 243,446 21.8 152,804 ---------- ----- ---------- ----- ---------- ----- -------- Total gross loans....... 1,814,436 100.0% 1,507,774 100.0% 1,119,207 100.0% 949,477 ===== ===== ===== Unearned fees, premiums and discounts, net................ (600) (289) (2,122) (2,354) Allowance for loan losses....... (23,848) (20,844) (16,506) (12,273) ---------- ---------- ---------- -------- Loans receivable, net....... $1,789,988 $1,486,641 $1,100,579 $934,850 ========== ========== ========== ======== <CAPTION> DECEMBER 31, ------------------------------ 1997 1996 -------- ------------------- PERCENT AMOUNT PERCENT -------- -------- -------- (DOLLARS IN THOUSANDS) <S> <C> <C> <C> Real estate loans: Residential, one to four units....................... 37.5% $425,270 48.7% Residential, multifamily...... 15.2 141,649 16.2 Commercial and industrial real estate...................... 28.3 214,599 24.5 Construction.................. 2.8 11,607 1.3 ----- -------- ----- Total real estate loans..... 83.8 793,125 90.7 ----- -------- ----- Other loans: Business, commercial.......... 14.6 71,672 8.2 Automobile.................... 0.6 3,877 0.4 Other consumer................ 1.0 5,953 0.7 ----- -------- ----- Total other loans........... 16.2 81,502 9.3 ----- -------- ----- Total gross loans....... 100.0% 874,627 100.0% ===== ===== Unearned fees, premiums and discounts, net................ (1,903) Allowance for loan losses....... (10,084) -------- Loans receivable, net....... $862,640 ======== </TABLE> RESIDENTIAL MORTGAGE LOANS. The Company offers first mortgage loans secured by one-to-four unit residential properties located in the Bank's primary lending area. At December 31, 2000, $334.8 million or 19% of the loan portfolio was secured by one-to-four family residential real estate mortgages, compared to $278.2 million or 18% at December 31, 1999. During 2000, the Bank's secondary marketing activities were significantly curtailed due, in part, to the Bank's introduction of new portfolio products, and also as a response to the rising interest rate environment which favored the origination of adjustable rate loans over fixed rate loans. Prior to 2000, as part of the Bank's lending strategy, substantially all new fixed-rate single family residential loans were sold into the secondary market. In a declining interest rate environment, the Bank anticipates an escalation in its secondary marketing activities. MULTIFAMILY AND COMMERCIAL REAL ESTATE LOANS. The Bank continues to place emphasis in the origination of multifamily and commercial real estate loans. Although real estate lending activities are collateralized by real property, these transactions are subject to similar credit evaluation, underwriting and monitoring standards as those applied to commercial business loans. Multifamily and commercial real estate loans accounted for $323.5 million or 18% and $640.7 million or 35%, respectively, of the Bank's loan portfolio at December 31, 2000. At year-end 1999, multifamily and commercial real estate loans amounted to $311.2 million or 21% and $518.1 million or 34%, respectively. CONSTRUCTION LOANS. The Bank offers loans to finance the construction of income-producing or owner-occupied buildings. The Bank limits its exposure in construction loans to no more than 25% of total loans. At December 31, 2000, construction loans accounted for $118.2 million or 7% of the Bank's loan portfolio. This compares with $122.4 million or 8% of the loan portfolio at December 31, 1999. 29
COMMERCIAL BUSINESS LOANS. The Bank finances small and middle-market businesses in a wide spectrum of industries throughout California. The Bank offers commercial loans for working capital, accounts receivable and inventory lines. At December 31, 2000, commercial business loans accounted for $236.1 million or 13% of the Bank's loan portfolio compared to $145.0 million or 10% at December 31, 1999. TRADE FINANCE. The Bank offers a variety of international finance and trade services and products, including letters of credit, revolving lines of credit, import loans, bankers' acceptances, working capital lines, domestic purchase financing, and pre-export financing. Total fee income generated from trade finance activities has grown significantly from $26 thousand in 1994 to $2.1 million in 2000. A substantial portion of this business involves California-based customers engaged in import activities. At December 31, 2000, loans to finance international trade totaled $114.2 million or 6% of the Bank's loan portfolio. Of this amount, almost all loans were made to borrowers on the import side of international trade. At December 31, 1999, such loans amounted to $103.9 million or 7% of the Bank's loan portfolio. These financings are generally made through letters of credit ranging from $100 thousand to $1 million. All trade finance transactions are U.S. dollar denominated. AFFORDABLE HOUSING. The Bank is engaged in a variety of lending and credit enhancement programs to finance the development of affordable housing projects, which generally are eligible for federal low income housing tax credits. As of December 31, 2000, the Bank had outstanding $162.6 million of letters of credit, which were issued to enhance the ratings of revenue bonds used to finance affordable housing projects. This compares to $131.7 million as of year-end 1999. Credit facilities for individual projects generally range in size from $1 million to $10 million. The following table presents the maturity schedule of the Bank's loan portfolio at December 31, 2000. All loans are shown maturing based upon contractual maturities, and include scheduled repayments but not potential prepayments. Demand loans, loans having no stated schedule of repayments and no stated maturity, and overdrafts are reported as due within one year. Loan balances have not been reduced for undisbursed loan proceeds, unearned discounts, and the allowance for loan losses. Nonaccrual loans of $3.7 million are included in the within one year category. <TABLE> <CAPTION> AFTER ONE WITHIN BUT WITHIN MORE THAN ONE YEAR FIVE YEARS FIVE YEARS TOTAL -------- ---------- ---------- ---------- (IN THOUSANDS) <S> <C> <C> <C> <C> Residential, one to four units..................... $ 10,021 $ 35,063 $289,691 $ 334,775 Residential, multifamily........................... 12,337 79,522 231,610 323,469 Commercial and industrial real estate.............. 85,838 386,867 168,008 640,713 Construction....................................... 81,963 35,980 298 118,241 Business, commercial............................... 223,717 79,477 47,088 350,282 Other consumer..................................... 11,189 6,194 29,573 46,956 -------- -------- -------- ---------- Total............................................ $425,065 $623,103 $766,268 $1,814,436 ======== ======== ======== ========== </TABLE> As of December 31, 2000, excluding nonaccrual loans, outstanding loans scheduled to be repriced within one year, after one but within five years, and in more than five years, are as follows: <TABLE> <CAPTION> AFTER ONE WITHIN BUT WITHIN MORE THAN ONE YEAR FIVE YEARS FIVE YEARS TOTAL -------- ---------- ---------- ---------- (IN THOUSANDS) <S> <C> <C> <C> <C> Total fixed rate................................... $122,073 $224,839 $ 36,143 $ 383,055 Total variable rate................................ 1,332,781 98,504 96 1,431,381 -------- -------- -------- ---------- Total............................................ $1,454,854 $323,343 $ 36,239 $1,814,436 ======== ======== ======== ========== </TABLE> 30
NONPERFORMING ASSETS Loans are continually monitored by management and the Board of Directors. The Bank's policy is to place a loan on nonaccrual status if either (i) principal or interest payments are past due in excess of 90 days; or (ii) the full collection of principal or interest becomes uncertain, regardless of the length of past due status. When a loan reaches nonaccrual status, any interest accrued on the loan is reversed and charged against current income. In general, subsequent payments received are applied to the outstanding principal balance of the loan. Nonaccrual loans that demonstrate a satisfactory payment trend for several months are returned to full accrual status subject to management's assessment of the full collectibility of the account. Nonaccrual loans totaled $3.7 million at December 31, 2000, compared to $10.9 million at year-end 1999. Nonaccrual loans as a percentage of total loans outstanding were 0.20% and 0.73% at December 31, 2000 and 1999, respectively. During 2000, loans totaling $2.8 million were placed on nonaccrual status. These additions to nonaccrual loans were by offset by $4.3 million in payoffs, $4.3 million in gross chargeoffs, $650 thousand in loans brought current, and two loans totaling $767 thousand that were transferred to other real estate owned. Loans placed on nonaccrual loans during 2000 were comprised of $420 thousand in residential single family loans, $1.5 million in commercial real estate loans, $824 thousand in commercial business loans, and $54 thousand in consumer home equity loans. Restructured loans or loans that have had their original terms modified totaled $3.0 million at December 31, 2000, compared with $4.7 million at year-end 1999. The net decrease in restructured loans is due to the transfer of one commercial real estate loan totaling $1.2 million to nonaccrual status and $600 thousand in payments received during 2000, partially offset by the addition of two commercial loans totaling $114 thousand. Other real estate owned ("OREO") includes properties acquired through foreclosure or through full or partial satisfaction of loans. The difference between the fair value of the real estate or other collateral, less the estimated costs of disposal, and the loan balance at the time of transfer to OREO is reflected in the allowance for loan losses as a charge-off. Any subsequent declines in fair value of the OREO after the date of transfer are recorded through a provision for writedowns on OREO. Routine holding costs, net of any income and gains and losses on disposal, are reported as noninterest expense. Other real estate owned totaled $801 thousand and $577 thousand at December 31, 2000 and 1999, respectively. During 2000, additions to OREO totaling $1.1 million were comprised of a parcel of commercial land acquired from American International Bank and four single family residential properties. The Bank sold five properties with a combined book value of $849 thousand during 2000. Net gains amounting to $213 thousand were recognized on these OREO sales. The Bank is actively marketing the remaining properties. 31
The following table sets forth information regarding nonaccrual loans, restructured loans and other real estate owned as of the dates indicated: <TABLE> <CAPTION> DECEMBER 31, ---------------------------------------------------- 2000 1999 1998 1997 1996 -------- -------- -------- -------- -------- (DOLLARS IN THOUSANDS) <S> <C> <C> <C> <C> <C> Nonaccrual loans................................ $3,652 $10,933 $ 9,762 $ 8,490 $11,613 Loans past due 90 days or more but not on nonaccrual.................................... -- -- 129 2,403 206 ------ ------- ------- ------- ------- Total nonperforming loans................... 3,652 10,933 9,891 10,893 11,819 ------ ------- ------- ------- ------- Restructured loans.............................. 2,972 4,700 5,936 7,487 5,485 Other real estate owned, net.................... 801 577 4,600 3,217 3,491 ------ ------- ------- ------- ------- Total nonperforming assets.................. $7,425 $16,210 $20,427 $21,597 $20,795 ====== ======= ======= ======= ======= Total nonperforming assets to total assets...... 0.30% 0.75% 0.99% 1.25% 1.28% Allowance for loan losses to nonperforming loans......................................... 653.01 190.65 166.88 112.67 85.32 Nonperforming loans to total gross loans........ 0.20 0.73 0.88 1.15 1.35 </TABLE> At December 31, 2000 and 1999, the Bank had classified $12.4 million and $20.9 million, respectively, of its loans as impaired, with specific reserves of $1.3 million for both periods. The Bank's average recorded investment in impaired loans at December 31, 2000 and 1999 was $12.9 million and $21.4 million, respectively. During 2000 and 1999, gross interest income that would have been recorded on impaired loans, had they performed in accordance with their original terms, totaled $1.5 million and $2.0 million, respectively. Of this amount, actual interest recognized on impaired loans, on a cash basis, was $1.1 million and $1.6 million, respectively. ALLOWANCE FOR LOAN LOSSES The allowance for loan losses is increased by the provision for loan losses which is charged against current period operating results, and is decreased by the amount of net chargeoffs during the period. While management believes that the allowance for loan losses is adequate at December 31, 2000, future additions to the allowance will be subject to continuing evaluation of estimated and known, as well as inherent, risks in the loan portfolio. At December 31, 2000, the allowance for loan losses amounted to $23.8 million, or 1.31% of total loans, compared with $20.8 million, or 1.38% of total loans, at December 31, 1999. The $3.0 million increase in the allowance for loan losses at December 31, 2000 is primarily due to $2.3 million in allowance for loan losses acquired from American International Bank. The remaining $700 thousand increase in the allowance during 2000 is comprised of $4.4 million in additional loss provisions less $3.7 million in net chargeoffs recorded during the period. 32
The following table summarizes activity in the allowance for loan losses for the periods indicated: <TABLE> <CAPTION> AT OR FOR THE YEAR ENDED DECEMBER 31, ---------------------------------------------------------- 2000 1999 1998 1997 1996 ---------- ---------- ---------- -------- -------- (DOLLARS IN THOUSANDS) <S> <C> <C> <C> <C> <C> Allowance balance, beginning of year........ $ 20,844 $ 16,506 $ 12,273 $ 10,084 $ 8,735 Allowance from acquisition.................. 2,256 1,150 -- -- -- Provision for loan losses................... 4,400 5,439 5,356 5,588 4,398 Actual charge-offs: 1-4 family residential real estate........ 46 26 196 469 530 Multifamily real estate................... -- 44 588 1,595 1,919 Commercial and industrial real estate..... 3 -- 60 1,079 985 Business, commercial...................... 4,511 2,786 1,689 986 92 Automobile................................ 32 19 130 5 28 Other..................................... -- 2 3 2 17 ---------- ---------- ---------- -------- -------- Total charge-offs....................... 4,592 2,877 2,666 4,136 3,571 ---------- ---------- ---------- -------- -------- Recoveries: 1-4 family residential real estate........ 227 17 172 12 49 Multifamily real estate................... 9 207 1 275 174 Commercial and industrial real estate..... 7 29 845 385 284 Business, commercial...................... 660 358 480 41 3 Automobile................................ 34 14 45 19 9 Other..................................... 3 1 -- 5 3 ---------- ---------- ---------- -------- -------- Total recoveries........................ 940 626 1,543 737 522 ---------- ---------- ---------- -------- -------- Net charge-offs....................... 3,652 2,251 1,123 3,399 3,049 ---------- ---------- ---------- -------- -------- Allowance balance, end of year.............. $ 23,848 $ 20,844 $ 16,506 $ 12,273 $ 10,084 ========== ========== ========== ======== ======== Average loans outstanding................... $1,670,981 $1,306,306 $1,004,477 $915,202 $819,868 ========== ========== ========== ======== ======== Total loans outstanding, end of year........ $1,814,436 $1,507,774 $1,119,207 $949,477 $874,627 ========== ========== ========== ======== ======== Net charge-offs to average loans............ 0.22% 0.17% 0.11% 0.37% 0.37% Allowance for loan losses to total gross loans at end of year...................... 1.31 1.38 1.47 1.29 1.15 </TABLE> Net chargeoffs totaled $3.7 million, or 0.22% of average loans outstanding, during 2000. This compares to net chargeoffs of $2.3 million, or 0.17% of average loans outstanding, during 1999. The Bank continues to record loan loss provisions to compensate for both the continued growth of the Bank's loan portfolio, which grew 20% in 2000 and 35% in 1999, and the changing composition of the overall loan portfolio, reflecting a shift towards commercial real estate and commercial business loans. At December 31, 2000, the combined volume of commercial real estate and commercial business loans represented approximately 55% of the total loan portfolio, compared to 51% at December 31, 1999. 33
The following table reflects management's allocation of the allowance for loan losses by loan category and the ratio of each loan category to total loans as of the dates indicated: <TABLE> <CAPTION> AT DECEMBER 31, -------------------------------------------------------------------------- 2000 1999 1998 1997 ------------------- ------------------- ------------------- -------- AMOUNT % AMOUNT % AMOUNT % AMOUNT -------- -------- -------- -------- -------- -------- -------- (DOLLARS IN THOUSANDS) <S> <C> <C> <C> <C> <C> <C> <C> 1-4 family residential real estate......................... $ 142 18.5% $ 345 18.4% $ 500 24.2% $ 894 Multifamily real estate.......... 1,768 17.8 2,735 20.6 2,435 15.0 3,022 Commercial and industrial real estate......................... 4,472 35.3 3,110 34.4 1,373 32.0 1,059 Construction..................... 2,370 6.5 2,597 8.1 2,339 7.0 404 Business, commercial............. 10,461 19.3 9,244 16.5 7,679 20.0 5,249 Automobile....................... 23 0.4 30 0.4 45 0.4 33 Consumer and other............... 21 2.2 9 1.6 22 1.4 32 Other risks...................... 4,591 2,774 2,113 1,580 ------- ----- ------- ----- ------- ----- ------- Total........................ $23,848 100.0% $20,844 100.0% $16,506 100.0% $12,273 ======= ===== ======= ===== ======= ===== ======= <CAPTION> AT DECEMBER 31, ------------------------------ 1997 1996 -------- ------------------- % AMOUNT % -------- -------- -------- (DOLLARS IN THOUSANDS) <S> <C> <C> <C> 1-4 family residential real estate......................... 37.5% $ 996 48.7% Multifamily real estate.......... 15.2 3,445 16.2 Commercial and industrial real estate......................... 28.3 2,044 24.5 Construction..................... 2.8 66 1.3 Business, commercial............. 14.6 1,357 8.2 Automobile....................... 0.6 27 0.4 Consumer and other............... 1.0 23 0.7 Other risks...................... 2,126 ----- ------- ----- Total........................ 100.0% $10,084 100.0% ===== ======= ===== </TABLE> Despite a 20% increase in the volume of single family loans at December 31, 2000 from year-end 1999 levels, allocated reserves on single family loans decreased $203 thousand, or 59%, to $142 thousand. This is directly correlated to a 50% decrease in the loss factor for single family loans that are not classified (i.e. rated "pass"). The loss factor for pass single family loans as of December 31, 2000 was 3 basis points compared to 6 points at December 31, 1999. At December 31, 2000, approximately 99% of the loans within this category were rated "pass." Allocated reserves on multifamily loans decreased $967 thousand, or 35%, to $1.8 million as of December 31, 2000 despite a 4% increase in the volume of loans within this category since December 31, 1999. This is primarily due to a 22% and 62% decline in the loss factors for multifamily loans that are rated "pass" and "special mention," respectively. The loss factors for pass and special mention multifamily loans as of December 31, 2000 were 25 basis points and 5.0%, respectively, compared to 32 basis points and 13.2%, respectively, at December 31, 1999. At December 31, 2000, over 98% of the loans within this category were rated "pass" while approximately 1% were rated "special mention." Allocated reserves on commercial real estate loans increased $1.4 million, or 44%, to $4.5 million as of December 31, 2000 primarily due to a 24% increase in the volume of loans in this loan category since year-end 1999. Further contributing to the increase in allocated reserves on commercial real estate loans is an increase in the volume of special mention loans to $8.9 million at December 31, 2000, from $3.2 million at December 31, 1999. Allocated reserves on construction loans decreased $227 thousand, or 9%, to $2.4 million at December 31, 2000 primarily due to the absence of classified loans (i.e. rated "substandard" or "doubtful") at December 31, 2000, compared to $4.0 million at December 31, 1999. Substandard construction loans are subject to a minimum loss rate of 20.0%. This was partially offset by a $7.2 million increase in special mention loans at December 31, 2000, relative to year-end 1999 levels, which are subject to a minimum loss rate of 5.0%. Allocated reserves on commercial business loans increased $1.2 million, or 13%, to $10.5 million at December 31, 2000 for two reasons: (1) a 41% increase in loan volume since year-end 1999 and (2) a 60% increase in special mention loans to $41.3 million at December 31, 2000, partially offset by a 44% decrease in substandard loans to $9.2 million, relative to year-end 1999 levels. The allowance for loan losses of $23.8 million at December 31, 2000 exceeded the Bank's allocated allowance by $4.6 million, or 19% of the total allowance. This compares to an unallocated allowance of $2.8 million, or 13%, as of December 31, 1999. The $4.6 million unallocated allowance at 34
December 31, 2000 is essentially comprised of three elements. First, the Bank has set aside $1.9 million, or approximately 10% of the allocated allowance amount of $19.3 million at December 31, 2000, to compensate for the estimation risk associated with the classification migration and individual loan review analysis methodologies. The second element, which accounts for approximately $1.4 million of the unallocated allowance, has been established for the foreign transaction risk associated with credit lines totaling $86.5 million extended to financial institutions in foreign countries. Loss factors, ranging from 0.5% to 5.0% of the total credit facility, have been assigned to absorb the loss exposure on this type of credit offering. These loss factors are internally determined based on the sovereign risk ratings of the various countries which generally range from BBB to AA. The third and final element, which accounts for approximately $965 thousand of the unallocated allowance, represents a 5% economic risk factor to compensate for the recent slowing of the national economy, as evidenced by tightening local job markets, rising energy costs, eroding consumer confidence, and substantial shortfalls in sales and earnings. Management of the Bank has deemed it prudent to set aside a portion of the unallocated allowance to compensate for this current economic risk. DEPOSITS The Bank offers a wide variety of retail deposit account products to both consumer and commercial deposit customers. Time deposits, consisting primarily of retail fixed-rate certificates of deposit, comprised 67% of the deposit portfolio at December 31, 2000 and 1999. Non-time deposits, which include noninterest bearing demand accounts, interest-bearing checking accounts, savings deposits and money market accounts, accounted for the remaining 33% of the deposit portfolio at December 31, 2000 and 1999. Deposits increased $448.0 million, or 30%, to $1.95 billion at December 31, 2000. The increase in deposits reflects $170.8 million in deposits acquired from American International Bank in January 2000. Excluding this transaction, internal deposit growth amounted to $277.3 million, or 19%, over December 31, 1999. This internal deposit growth was primarily due to a 22% increase in time deposits of $216.1 million, resulting from the growth in brokered deposits and various promotions associated with the Chinese New Year holiday. Although the Company occasionally promotes certain time deposit products, its efforts are largely concentrated in increasing the volume of low-cost transaction accounts which generate higher fee income and are a less costly source of funds in comparison to time deposits. Excluding deposits acquired from American International Bank, noninterest-bearing demand deposits increased $30.5 million, or 24%, checking accounts increased $9.0 million, or 10%, and money market accounts increased $27.9 million, or 40%, primarily due to new and existing commercial account relationships. Included in time deposits at December 31, 2000 are $154.5 million of brokered deposits, compared with $82.7 million as of December 31, 1999. The increase of $71.8 million essentially reflects the continued replacement of Federal Home Loan Bank advances with brokered deposits as an alternate source of funding. The transition to brokered deposits as an alternate source of funding has enabled the Bank to release some investment securities which were previously pledged as collateral against FHLB advances. Public deposits increased 10% to $122.3 million as of December 31, 2000, compared with $119.8 million at year-end 1999. The balance of public funds at December 31, 2000 is comprised almost entirely of deposits from the State of California. Notwithstanding the increases in brokered and public deposits during 2000, the Bank's principal market strategy continues to be based on its reputation as a community bank that provides quality products and personal customer service. Time deposits greater than $100 thousand totaled $741.1 million, accounting for 38% of the deposit portfolio at December 31, 2000. These accounts, consisting primarily of deposits by consumers and public funds, had a weighted average interest rate of 6.16% at December 31, 2000. The following 35
table provides the remaining maturities at December 31, 2000 of time deposits greater than $100 thousand (in thousands): <TABLE> <S> <C> 3 months or less............................................ $284,437 Over 3 months through 6 months.............................. 267,741 Over 6 months through 12 months............................. 136,796 Over 12 months.............................................. 52,170 -------- Total................................................... $741,144 ======== </TABLE> BORROWINGS The Bank regularly uses short-term borrowings and FHLB advances to manage its liquidity position. Short-term borrowings, which consist of federal funds purchased and securities sold under agreements to repurchase increased to $38.0 million at December 31, 2000, compared to $600 thousand at December 31, 1999. At December 31, 2000 and 1999, the balance of short-term borrowings consisted entirely of federal funds purchased. The increase in federal funds purchased during 2000 was primarily due to partial repayments of FHLB advances. The following table provides information on securities sold under agreements to repurchase for the past three years: <TABLE> <CAPTION> AS OF AND FOR THE YEAR ENDED DECEMBER 31, ------------------------------------ 2000 1999 1998 -------- -------- -------- (DOLLARS IN THOUSANDS) <S> <C> <C> <C> Average balance outstanding during the year.... $ -- $ 9,159 $118,588 Maximum amount outstanding at any month-end during the year.............................. $ -- $33,000 $191,635 Weighted average interest rate during the year......................................... --% 5.05% 5.62% Total short-term borrowings at end of year..... $ -- $ -- $ 33,000 Weighted average interest rate at end of year......................................... --% --% 5.75% </TABLE> FHLB advances decreased 44% to $268.0 million at December 31, 2000, compared to $482.0 million at December 31, 1999. The decrease in FHLB advances is directly correlated to the growth in brokered deposits and short-term borrowings as alternate sources of funding. Cash acquired from American International Bank and runoffs on investment securities available for sale also contributed to the decrease in FHLB advances during 2000. At December 31, 2000 and 1999, FHLB advances had a weighted average interest rate of 6.49% and 5.87%, respectively. Only $24.0 million, or 9% of outstanding FHLB advances at December 31, 2000, had remaining maturities greater than one year. 36
CAPITAL RESOURCES The primary source of capital for the Company is the retention of net after tax earnings. At December 31, 2000, stockholders' equity totaled $186.1 million, an increase of 24% from $150.1 million as of December 31, 1999. The increase is due primarily to: (1) net income of $35.5 million during 2000; (2) net issuance of common stock totaling $4.4 million from the exercise of stock options and stock warrants; (3) net issuance of common stock totaling $496 thousand in connection with the Company's Employee Stock Purchase Program; (4) stock compensation costs amounting to $421 thousand related to the Company's Restricted Stock Award Program; (5) net issuance of common stock totaling $869 thousand in connection with the acquisition of Risk Services, Inc.; and (6) a decrease of $5.5 million in unrealized losses on available-for-sale securities. These transactions were offset by (1) repurchases of $8.4 million or 361,878 shares of common stock in connection with the Company's stock repurchase programs; and to a much lesser degree, from forfeitures of restricted stock awards and (2) payment of quarterly 2000 cash dividends totaling $2.7 million. Management is committed to maintaining capital at a level sufficient to assure shareholders, customers and regulators that the Company and its bank subsidiary are financially sound. The Company and its bank subsidiary are subject to risk-based capital regulations adopted by the federal banking regulators in January 1990. These guidelines are used to evaluate capital adequacy and are based on an institution's asset risk profile and off-balance sheet exposures. According to the regulations, institutions whose Tier 1 and total capital ratios meet or exceed 6% and 10%, respectively, are deemed to be "well-capitalized." At December 31, 2000, the Company's Tier 1 and total capital ratios were 9.6% and 10.9%, respectively, compared to 9.3% and 10.6%, respectively, at December 31, 1999. The following table compares the Company's and the Bank's actual capital ratios at December 31, 2000, to those required by regulatory agencies for capital adequacy and well-capitalized classification purposes: <TABLE> <CAPTION> MINIMUM WELL EAST WEST EAST WEST REGULATORY CAPITALIZED BANCORP BANK REQUIREMENTS REQUIREMENTS --------- --------- ------------ ------------ <S> <C> <C> <C> <C> Total Capital (to Risk-Weighted Assets)................................ 10.9% 10.7% 8.0% 10.0% Tier 1 Capital (to Risk-Weighted Assets)................................ 9.6 9.5 4.0 6.0 Tier 1 Capital (to Average Assets)....... 7.7 7.9 4.0 5.0 </TABLE> During the first quarter of 2000, the Company filed a $50 million universal shelf registration statement with the Securities and Exchange Commission. Pursuant to this filing, the Company may offer new common stock, trust preferred, preferred stock and/or other debentures to augment its capital resources. The timing and amount of offerings will depend on market and general business conditions. The Company intends to utilize the net proceeds from the sale of securities for general business purposes, which include supporting the growth of its commercial banking activities and possible future acquisitions. Additionally, the Company has issued a total of $20.8 million of junior subordinated deferrable interest debentures in two separate private placement transactions. These securities qualify as Tier 1 capital for regulatory reporting purposes. On July 13, 2000, East West Securities Company, Inc. was incorporated under the general laws of the State of Maryland as a closed-end, non-diversified management investment company registered under the Investment Company Act of 1940, as amended. The formation of this entity provides the Bank with the flexibility to raise additional capital in a tax efficient manner for future business opportunities, if desired. In August 2000, the Securities and Exchange Commission completed an examination of East West Securities Company, Inc. The Company received the Commission's findings in a letter dated 37
September 11, 2000. The Commission staff determined that the Fund should not be eligible to be registered as an investment company due to the failure to meet certain statutory requirements of the Investment Company Act of 1940 and requested that the Fund voluntarily de-register. In its response to the Commission, dated October 11, 2000, the Company stated that it disagrees with certain factual statements and conclusions of law contained in the Commission's findings and sets forth the basis for its belief based on advice of counsel, which was included, that the Fund was formed in compliance with regulatory requirements. In response, the Commission has issued another letter to the Company, dated December 12, 2000, which is essentially similar to the Commission's initial letter. The Company has declined the Commission's requests to voluntarily de-register the Fund. The Company expects to receive further correspondence from the Commission. If the Company were to accommodate the Commission's requests to voluntarily de-register the Fund, the Company would forego the state tax benefits that are currently being realized through the Fund. Further, the Company would forfeit its flexibility to raise additional capital in a tax efficient manner for future business opportunities though the Fund. Management believes, based on the advice of counsel, that the impact of de-registration would be prospective only and not retroactive. The Fund would continue to be a registered investment company under the Investment Company Act of 1940, from the date of registration to the effective date of de-registration. ASSET LIABILITY AND MARKET RISK MANAGEMENT LIQUIDITY Liquidity management involves the Bank's ability to meet cash flow requirements arising from fluctuations in deposit levels and demands of daily operations, which include funding of securities purchases, providing for customers' credit needs and ongoing repayment of borrowings. The Bank's liquidity is actively managed on a daily basis and reviewed periodically by the Asset/Liability Committee and the Board of Directors. This process is intended to ensure the maintenance of sufficient funds to meet the needs of the Bank, including adequate cash flow for off-balance sheet instruments. The Bank's primary sources of liquidity are derived from financing activities which include the acceptance of customer and broker deposits, federal funds facilities, repurchase agreement facilities and advances from the Federal Home Loan Bank of San Francisco. These funding sources are augmented by payments of principal and interest on loans, the routine liquidation of securities from the available-for-sale portfolio and securitizations of eligible loans. Primary uses of funds include withdrawal of and interest payments on deposits, originations and purchases of loans, purchases of investment securities, and payment of operating expenses. During the years ended December 31, 2000 and 1999, the Company experienced net cash inflows of $22.5 million and $41.8 million, respectively, from operating activities. The increase in net cash inflows from operating activities for both periods was due primarily to the growth in interest income on loans and investment securities. Net proceeds from sales of loans held for sale also contributed to operating cash inflows during 1999. Net cash outflows from investing activities totaled $116.7 million and $233.9 million, respectively, during 2000 and 1999, primarily due to the growth in the Bank's loan portfolio. Financing activities provided net cash inflows of $113.0 million and $74.4 million, respectively, during 2000 and 1999, primarily due to deposit growth. As a means of augmenting its liquidity, the Bank has established federal funds lines with four correspondent banks and several master repurchase agreements with major brokerage companies. At December 31, 2000, the Bank's available borrowing capacity includes approximately $43.3 million in repurchase arrangements, $47.0 million in federal funds line facilities, and $246.0 million in unused FHLB advances. Management believes its liquidity sources to be stable and adequate. At December 31, 2000, management was not aware of any information that was reasonably likely to have a material effect on the Bank's liquidity position. 38
The liquidity of the parent company, East West Bancorp, Inc. is primarily dependent on the payment of cash dividends by its subsidiary, East West Bank, subject to limitations imposed by the Financial Code of the State of California. During 2000, total dividends paid by the Bank to East West Bancorp, Inc. totaled $9.6 million, compared with $17.5 million during 1999. As of December 31, 2000, approximately $54.4 million of undivided profits of the Bank was available for dividends to the Company. INTEREST RATE SENSITIVITY MANAGEMENT The Bank's success is largely dependent upon its ability to manage interest rate risk, which is the impact of adverse fluctuations in interest rates on the Bank's net interest income and net portfolio value. Although in the normal course of business the Bank manages other risks, such as credit and liquidity risk, management considers interest rate risk to be its most significant market risk and could potentially have the largest material effect on the Bank's financial condition and results of operations. The fundamental objective of the asset liability management process is to manage the Bank's exposure to interest rate fluctuations while maintaining adequate levels of liquidity and capital. The Bank's strategy is formulated by the Asset/Liability Committee, which coordinates with the Board of Directors to monitor the Bank's overall asset and liability composition. The Committee meets regularly to evaluate, among other things, the sensitivity of the Bank's assets and liabilities to interest rate changes, the book and market values of assets and liabilities, unrealized gains and losses on its available-for-sale portfolio (including those attributable to hedging transactions), purchase and securitization activity, and maturities of investments and borrowings. The Bank's overall goal is to minimize the adverse impact of immediate incremental changes in market interest rates (rate shock) on net interest income and net portfolio value. Net portfolio value is defined as the present value of assets, minus the present value of liabilities and off-balance sheet instruments. The attainment of this goal requires a balance between profitability, liquidity and interest rate risk exposure. To minimize the adverse impact of changes in market interest rates, the Bank simulates the effect of instantaneous interest rate changes on net interest income and net portfolio value on a monthly basis. The table below shows the estimated impact of changes in interest rates on net interest income and market value of equity as of December 31, 2000 and 1999, assuming a parallel shift of 100 to 200 basis points in both directions. <TABLE> <CAPTION> NET INTEREST INCOME NET PORTFOLIO VALUE VOLATILITY(1) VOLATILITY(2) DECEMBER 31, DECEMBER 31, CHANGE IN INTEREST RATES ------------------------- ---------------------- (BASIS POINTS) 2000 1999 2000 1999 ------------------------ ----------- -------- -------- -------- <S> <C> <C> <C> <C> +200........................................... 7.4% 2.6% (10.7)% (13.0)% +100........................................... 4.6% 2.1% (5.0)% (5.3)% - -100........................................... (4.6)% (2.7)% 2.1% 8.5% - -200........................................... (9.2)% (5.9)% (0.8)% 8.5% </TABLE> - ------------------------------ (1) The percentage change represents net interest income for twelve months in a stable interest rate environment versus net interest income in the various rate scenarios. (2) The percentage change represents the net portfolio value of the Bank in a stable rate environment versus net portfolio value in the various rate scenarios. 39
All interest-earning assets, interest-bearing liabilities and related derivative contracts are included in the interest rate sensitivity analysis at December 31, 2000 and 1999. At December 31, 2000 and 1999, the Bank's estimated changes in net interest income and net portfolio value were within the ranges established by the Board of Directors. The primary analytical tool used by the Bank to gauge interest rate sensitivity is a simulation model used by many major banks and bank regulators, and is based on the actual maturity and repricing characteristics of interest-rate sensitive assets and liabilities. The model attempts to predict changes in the yields earned on assets and the rates paid on liabilities in relation to changes in market interest rate As an enhancement to the primary simulation model, prepayment assumptions and market rates of interest provided by independent broker/dealer quotations, an independent pricing model and other available public sources are incorporated into the model. Adjustments are made to reflect the shift in the Treasury and other appropriate yield curves. The model also factors in projections of anticipated activity levels by Bank product line and takes into account the Bank's increased ability to control rates offered on deposit products in comparison to its ability to control rates on adjustable-rate loans tied to published indices. The following tables provide the outstanding principal balances and the weighted average interest rates of the Bank's non-derivative financial instruments as of December 31, 2000 and 1999. The Bank does not consider these financial instruments to be materially sensitive to interest rate fluctuations. Historically, the balances of these financial instruments have remained fairly constant over various economic conditions. The information presented below is based on the repricing date for variable rate instruments and the expected maturity date for fixed rate instruments. <TABLE> <CAPTION> EXPECTED MATURITY OR REPRICING DATE BY YEAR ------------------------------------------------------------------------------ AFTER FAIR VALUE AT 2001 2002 2003 2004 2005 2005 TOTAL DEC. 31, 2000 ---------- -------- -------- -------- -------- -------- ---------- ------------- (DOLLARS IN THOUSANDS) <S> <C> <C> <C> <C> <C> <C> <C> <C> AT DECEMBER 31, 2000: ASSETS: Short-term investments........ $ 4,500 $ -- $ -- $ -- $ -- $ -- $ 4,500 $ 4,500 Weighted average rate....... 6.50% --% --% --% --% --% 6.50% Investment securities available-for-sale (fixed rate)....................... $ 45,424 $ 47,364 $ 33,865 $25,084 $21,014 $101,436 $ 274,187 $ 267,050 Weighted average rate....... 6.12% 6.17% 6.11% 6.15% 6.15% 6.19% 6.16% Investment securities available-for-sale (variable rate)....................... $ 226,109 $ -- $ -- $ -- $ -- $ -- $ 226,109 $ 221,240 Weighted average rate....... 7.09% --% --% --% --% --% 7.09% Total gross loans............. $1,456,774 $139,424 $106,963 $48,110 $26,958 $ 36,206 $1,814,436 $1,812,765 Weighted average rate....... 9.17% 8.18% 8.51% 8.13% 8.31% 8.10% 8.98% LIABILITIES: Checking accounts............. $ 111,228 $ -- $ -- $ -- $ -- $ -- $ 111,228 $ 111,228 Weighted average rate....... 1.39% --% --% --% --% --% 1.39% Money market accounts......... $ 122,079 $ -- $ -- $ -- $ -- $ -- $ 122,079 $ 122,079 Weighted average rate....... 4.19% --% --% --% --% --% 4.19% Savings deposits.............. $ 212,411 $ -- $ -- $ -- $ -- $ -- $ 212,411 $ 212,411 Weighted average rate....... 2.05% --% --% --% --% --% 2.05% Time deposits................. $1,207,805 $ 53,043 $ 6,505 $ 1,737 $ 2,389 $ 29,910 $1,301,388 $1,299,899 Weighted average rate....... 5.84% 5.99% 5.94% 5.27% 6.09% 7.00% 5.87% Short-term borrowings......... $ 38,000 $ -- $ -- $ -- $ -- $ -- $ 38,000 $ 38,013 Weighted average rate....... 6.60% --% --% --% --% --% 6.60% FHLB advances................. $ 244,000 $ 10,000 $ 14,000 $ -- $ -- $ -- $ 268,000 $ 268,074 Weighted average rate....... 6.53% 6.33% 5.94% --% --% --% 6.49% Junior subordinated debt securities.................. $ -- $ -- $ -- $ -- $ -- $ 20,750 $ 20,750 $ 22,797 Weighted average rate....... --% --% --% --% --% 10.91% 10.91% </TABLE> 40
<TABLE> <CAPTION> EXPECTED MATURITY OR REPRICING DATE BY YEAR ------------------------------------------------------------------------------ AFTER FAIR VALUE AT 2000 2001 2002 2003 2004 2004 TOTAL DEC. 31, 1999 ---------- -------- -------- -------- -------- -------- ---------- ------------- (DOLLARS IN THOUSANDS) <S> <C> <C> <C> <C> <C> <C> <C> <C> AT DECEMBER 31, 1999: ASSETS: Short-term investments........... $ 10,000 $ -- $ -- $ -- $ -- $ -- $ 10,000 $ 10,000 Weighted average rate.......... 4.00% --% --% --% --% --% 4.00% Investment securities available- for-sale (fixed rate).......... $ 49,783 $41,527 $35,429 $30,313 $24,322 $110,906 $ 292,280 $ 275,783 Weighted average rate.......... 6.13% 6.14% 6.14% 6.14% 6.15% 6.16% 6.15% Investment securities available- for-sale (variable rate)....... $ 225,040 $ -- $ -- $ -- $ -- $ -- $ 225,040 $ 220,643 Weighted average rate.......... 6.43% --% --% --% --% --% 6.43% Total gross loans................ $1,299,273 $78,110 $44,223 $32,686 $27,286 $ 26,196 $1,507,774 $1,511,241 Weighted average rate.......... 8.42% 8.10% 8.02% 8.16% 8.21% 7.65% 8.37% LIABILITIES: Checking accounts................ $ 89,545 $ -- $ -- $ -- $ -- $ -- $ 89,545 $ 89,545 Weighted average rate.......... 1.22% --% --% --% --% --% 1.22% Money market accounts............ $ 69,434 $ -- $ -- $ -- $ -- $ -- $ 69,434 $ 69,434 Weighted average rate.......... 3.38% --% --% --% --% --% 3.38% Savings deposits................. $ 211,818 $ -- $ -- $ -- $ -- $ -- $ 211,818 $ 211,818 Weighted average rate.......... 1.85% --% --% --% --% --% 1.85% Time deposits.................... $ 930,167 $36,894 $ 1,250 $ 667 $ 2,202 $ 30,000 $1,001,180 $1,002,176 Weighted average rate.......... 4.70% 5.03% 5.06% 5.09% 5.50% 7.00% 4.79% Short-term borrowings............ $ 600 $ -- $ -- $ -- $ -- $ -- $ 600 $ 600 Weighted average rate.......... 5.75% --% --% --% --% --% 5.75% FHLB advances.................... $ 468,000 $ -- $ -- $14,000 $ -- $ -- $ 482,000 $ 482,507 Weighted average rate.......... 5.86% --% --% 5.94% --% --% 5.87% </TABLE> Expected maturities of assets are contractual maturities adjusted for projected payment based on contractual amortization and unscheduled prepayments of principal as well as repricing frequency. Expected maturities for deposits are based on contractual maturities adjusted for projected rollover rates and changes in pricing for deposits with no stated maturity dates. The Bank utilizes assumptions supported by documented analyses for the expected maturities of its loans and repricing of its deposits. It also relies on third party data providers for prepayment projections for amortizing securities. The actual maturities of these instruments could vary significantly if future prepayments and repricing differ from the Bank's expectations based on historical experience. The fair values of short-term investments approximate their book values due to their short maturities. The fair values of available for sale securities are based on bid quotations from third party data providers. The fair values of loans are estimated for portfolios with similar financial characteristics and takes into consideration discounted cash flows based on expected maturities or repricing dates utilizing estimated market discount rates as projected by third party data providers. Transaction deposit accounts, which include checking, money market and savings accounts, are presumed to have equal book and fair values because the interest rates paid on these accounts are based on prevailing market rates. The fair value of time deposits is based upon the discounted value of contractual cash flows, which is estimated using current rates offered for deposits of similar remaining terms. The fair value of short-term borrowings approximates book value due to their short maturities. The fair value of FHLB advances is estimated by discounting the cash flows through maturity or the next repricing date based on current rates offered by the FHLB for borrowings with similar maturities. The fair value of junior subordinated debt securities is estimated by discounting the cash flows through maturity based on current rates offered on the 30-year Treasury bond. The Asset/Liability Committee is authorized to utilize a wide variety of off-balance sheet financial techniques to assist in the management of interest rate risk. Derivative positions are integral components of the Bank's asset/liability management strategy. Therefore, the Bank does not believe it is meaningful to separately analyze the derivatives components of its risk management activities in 41
isolation from their related positions. The Bank uses derivative instruments, primarily interest rate swap and cap agreements, as part of its management of asset and liability positions in connection with its overall goal of minimizing the impact of interest rate fluctuations on the Bank's net interest margin or its stockholders' equity. These contracts are entered into for purposes of reducing the Bank's interest rate risk and not for trading purposes. The Bank enters into interest rate swap agreements for the purposes of converting fixed rate commercial real estate loans and certain brokered deposits to floating rate assets and liabilities. Effective November 6, 2000, the Company terminated interest rate swap agreements with a total notional amount of $28.5 million. These interest rate swaps were previously utilized by the Company as a hedge against fixed rate commercial real estate loans. The termination of these swap agreements was in line with the Company's asset liability strategy and the changing outlook of the Federal Reserve Board towards the future direction of interest rates. An internal analysis performed by the Company indicated that the interest rate swaps had a minimal impact on the Company's net portfolio value even if interest rates had continued to rise. The total loss amount recorded by the Company upon termination of the swap agreements was $138 thousand. At December 31, 2000 and 1999, the total gross notional amount of interest rate swaps was $30.0 million and $58.5 million, respectively. At December 31, 2000, the net unrealized loss on the entire swap agreement portfolio was $149 thousand compared to a net unrealized loss of $1.4 million at December 31, 1999. The Bank has also entered into interest rate cap agreements which are primarily linked to the three-month LIBOR. Prior to October 1, 1999, the Bank used interest rate caps for purposes of hedging against market fluctuations in the Bank's available-for-sale securities portfolio. Due to the volatility of the correlation between the Treasury yield curve and fixed rate mortgage-backed securities, the Bank ceased using interest rate caps to hedge against fluctuations in the investment securities available for sale portfolio, effective October 1, 1999. The resulting net gain realized from this transaction amounted to $65 thousand for the three months ended December 31, 1999. The Bank continues to record interest rate caps at their estimated fair values, with resulting gains or losses recorded in current earnings. The unrealized gains and losses reflected in accumulated other comprehensive income (loss) in stockholders' equity as of September 30, 1999 are amortized into interest income or expense over the expected remaining lives of the interest rate cap agreements. The total net realized loss on interest rate caps amounted to $16 thousand for the year ended December 31, 2000. The following table summarizes the expected maturities, weighted average pay and receive rates, and the unrealized gains and losses of the Bank's interest rate contracts as of December 31, 2000 and 1999. The fair values reflected in the table are based on quoted market prices from broker dealers making a market for these derivatives. <TABLE> <CAPTION> EXPECTED MATURITY ---------------------------------------------------- AVERAGE AFTER UNREALIZED EXPECTED 2001 2002 2003 2004 2004 TOTAL GAIN(LOSS) MATURITY -------- -------- -------- -------- -------- -------- ---------- --------- (DOLLARS IN THOUSANDS) <S> <C> <C> <C> <C> <C> <C> <C> <C> AT DECEMBER 31, 2000: Interest rate swap agreements: Notional amount........................ $ -- $ -- $ -- $ -- $30,000 $30,000 $(149) 8.6 Years Weighted average receive rate.......... --% --% --% --% 7.00% 7.00% Weighted average pay rate.............. --% --% --% --% 6.61% 6.61% Interest rate cap agreements: Notional amount........................ $18,000 $18,000 $ -- $ -- $ -- $36,000 $ -- 1.1 Years LIBOR cap rate......................... 6.50% 7.50% --% --% --% 6.75% </TABLE> 42
<TABLE> <CAPTION> EXPECTED MATURITY ---------------------------------------------------- AVERAGE AFTER UNREALIZED EXPECTED 2000 2001 2002 2003 2003 TOTAL GAIN(LOSS) MATURITY -------- -------- -------- -------- -------- -------- ---------- --------- (DOLLARS IN THOUSANDS) <S> <C> <C> <C> <C> <C> <C> <C> <C> AT DECEMBER 31, 1999: Interest rate swap agreements: Notional amount........................ $ -- $10,000 $18,500 $ -- $30,000 $58,500 $(1,408) 6.1 Years Weighted average receive rate.......... --% 5.24% 5.29% --% 7.00% 6.16% Weighted average pay rate.............. --% 6.46% 6.45% --% 6.10% 6.27% Interest rate cap agreements: Notional amount........................ $ -- $18,000 $18,000 $ -- $ -- $36,000 $ -- 2.1 Years LIBOR cap rate......................... --% 6.50% 7.50% --% --% 6.75% </TABLE> BUSINESS SEGMENTS For information regarding the Company's business segments, see Footnote 21, entitled "Segment Information," of the 2000 Annual Report which is incorporated herein by reference. ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES OF MARKET RISKS For quantitative and qualitative disclosures regarding market risks in the Bank's portfolio, see, "Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations--Asset Liability and Market Risk Management." ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA For financial statements of the Company, see "Supplementary Financial Information," and "Consolidated Financial Statements and Notes," including the "Independent Auditor's Report" thereon, in the 2000 Annual Report, which is incorporated herein by reference. See "ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K" below for financial statements filed as a part of this report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 43
PART III. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Except as hereinafter noted, the information concerning directors and executive officers of the Company is incorporated by reference from the section entitled "Election of Directors" of the Company's Proxy Statement, which is filed as Exhibit No. 99 to this Annual Report on Form 10-K. For information concerning executive officers of the Company, see "ITEM 4(A). EXECUTIVE OFFICERS OF THE REGISTRANT." ITEM 11. EXECUTIVE COMPENSATION Information concerning executive compensation is incorporated by reference from the section entitled "Compensation of Directors and Executive Officers" of the Company's Proxy Statement, which is filed as Exhibit No. 99 to this Annual Report on Form 10-K. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information concerning security ownership of certain beneficial owners and Management is incorporated by reference from the sections entitled "Principal Shareholders," and "Election of Directors" of the Company's Proxy Statement, which is filed as Exhibit No. 99 to this Annual Report on Form 10-K. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information concerning certain relationships and related transactions is incorporated by reference from the section entitled "Certain Transactions" of the Company's Proxy Statement, which is filed as Exhibit No. 99 to this Annual Report on Form 10-K. 44
PART IV. ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) FINANCIAL STATEMENTS AND SCHEDULES (1) The following financial statements included in the registrant's 2000 Annual Report to Shareholders are incorporated herein by reference. Page number references are to the 2000 Annual Report to Shareholders. <TABLE> <CAPTION> PAGE -------- <S> <C> East West Bancorp, Inc. and Subsidiaries: Report of Management........................................ 47 Independent Auditors' Report................................ 49 Consolidated Balance Sheets at December 31, 2000 and 1999... 50 Consolidated Statements of Income for the Years Ended December 31, 2000, 1999, and 1998......................... 51 Consolidated Statements of Changes in Stockholders' Equity for the Years Ended December 31, 2000, 1999, and 1998..... 52 Consolidated Statements of Cash Flows for the Years Ended December 31, 2000, 1999 and 1998.......................... 53 Notes to Consolidated Financial Statements.................. 55 </TABLE> (2) The following additional information for the years 2000, 1999 and 1998 is submitted herewith: All schedules are omitted because they are not applicable, not material or because the information is included in the financial statements or the notes thereto. (b) REPORTS ON FORM 8-K The Company filed no reports on Form 8-K during the last quarter of 2000. 45
(c) EXHIBITS <TABLE> <CAPTION> EXHIBIT NO. EXHIBIT DESCRIPTION - ------- ------------------- <S> <C> 2 Plan of Reorganization and Merger Agreement between East West Bancorp, Inc., East-West Bank and East West Merger Co., Inc.* 3(i) Certificate of Incorporation of the Registrant* 3(ii) Bylaws of the Registrant* 4.1 Specimen Certificate of Registrant* 4.2 Registration Rights Agreement* 4.3 Warrant Agreement* 10.1 Employment Agreement with Dominic Ng*+ 10.2 Employment Agreement with Julia Gouw*+ 10.5 Employment Agreement with Douglas P. Krause*+ 10.6 East West Bancorp, Inc. 1998 Stock Incentive Plan and Forms of Agreements*+ 10.6.1 Amendment to East West Bancorp, Inc. 1998 Stock Incentive Plan and Forms of Agreements#+ 10.7 East West Bancorp, Inc. 1998 Employee Stock Purchase Plan*+ 10.9 Employment Agreement with Sandra Wong#+ 10.10 Employment Agreement with Donald Sang Chow#+ 10.10.1 Amendment to Employment Agreement with Donald Sang Chow#+ 21.1 Subsidiaries of the Registrant 23.1 Independent Auditors' Consent 99 Proxy Statement for Annual Meeting of Stockholders to be held on May 16, 2001 </TABLE> - ------------------------ * Incorporated by reference from Registrant's Registration Statement on Form S-4 filed with the Commission on November 13, 1998 (File No. 333-63605). # Incorporated by reference from Registrant's Annual Report on Form 10-K for the year ended December 31, 1999, filed with the Commission on March 30, 2000 (File No. 000-24939). + Denotes management contract or compensatory plan or arrangement. 46
REPORT OF MANAGEMENT February 16, 2001 To our Shareholders: FINANCIAL STATEMENTS The management of East West Bancorp, Inc. and subsidiaries (the "Company") is responsible for the preparation, integrity, and fair presentation of its published financial statements and all other information presented in this annual report. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and, as such, include amounts based on informed judgments and estimates made by management. INTERNAL CONTROL Management is responsible for establishing and maintaining effective internal control over financial reporting, including safeguarding of assets, for financial presentations in conformity with both accounting principles generally accepted in the United States of America and the Federal Financial Institutions Examination Council Instructions for Consolidated Reports of Condition and Income (Call Report instructions). The internal control contains monitoring mechanisms, and actions are taken to correct deficiencies identified. There are inherent limitations in the effectiveness of any internal control, including the possibility of human error and the circumvention or overriding of controls. Accordingly, even effective internal control can provide only reasonable assurance with respect to consolidated financial statement preparation. Further, because of changes in conditions, the effectiveness of internal control may vary over time. Management assessed the Company's internal control over financial reporting, including safeguarding of assets, for financial presentations in conformity with both accounting principles generally accepted in the United States of America and Call Report instructions as of December 31, 2000. This assessment was based on criteria for effective internal control over financial reporting, including safeguarding of assets, described in INTERNAL CONTROL--INTEGRATED FRAMEWORK issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management believes that the Bank maintained effective internal control over financial reporting, including safeguarding of assets, presented in conformity with both accounting principles generally accepted in the United States of America and Call Report instructions, as of December 31, 2000. The Audit Committee of the Board of Directors is comprised entirely of outside directors who are independent of the Company's management. The Audit Committee is responsible for recommending to the Board of Directors the selection of independent auditors. It meets periodically with management, the independent auditors, and the internal auditors to ensure that they are carrying out their responsibilities. The Committee is also responsible for performing an oversight role by reviewing and monitoring the financial, accounting and auditing procedures of the Company in addition to reviewing the Company's financial reports. The independent auditors and the internal auditors have full and free access to the Audit Committee, with or without the presence of management, to discuss the adequacy of internal control over financial reporting and any other matters which they believe should be brought to the attention of the Committee. 47
COMPLIANCE WITH LAWS AND REGULATIONS Management is also responsible for ensuring compliance with the federal laws and regulations concerning loans to insiders and the federal and state laws and regulations concerning dividend restrictions, both of which are designated by the Federal Deposit Insurance Corporation ("FDIC") as safety and soundness laws and regulations. Management assessed its compliance with the designated safety and soundness laws and regulations and has maintained records of its determinations and assessments as required by the FDIC. Based on this assessment, management believes that the Company has complied, in all material respects, with the designated safety and soundness laws and regulations for the year ended December 31, 2000. <TABLE> <S> <C> DOMINIC NG JULIA S. GOUW Chairman, President and Executive Vice President and Chief Executive Officer Chief Financial Officer </TABLE> 48
INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders of East West Bancorp, Inc. and Subsidiaries San Marino, California We have audited the accompanying consolidated balance sheets of East West Bancorp, Inc. and subsidiaries (the "Company") as of December 31, 2000 and 1999, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2000 and 1999, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2000 in conformity with accounting principles generally accepted in the United States of America. DELOITTE & TOUCHE LLP Los Angeles, California February 16, 2001 (March 20, 2001 as to Note 23) 49
EAST WEST BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) <TABLE> <CAPTION> DECEMBER 31, DECEMBER 31, 2000 1999 ------------ ------------ <S> <C> <C> ASSETS Cash and cash equivalents................................... $ 63,048 $ 43,497 Investment securities available for sale, at fair value (with amortized cost of $500,296 in 2000 and $517,320 in 1999)..................................................... 488,290 496,426 Loans receivable, net of allowance for loan losses of $23,848 in 2000 and $20,844 in 1999....................... 1,789,988 1,486,641 Investment in Federal Home Loan Bank stock, at cost......... 14,845 26,954 Other real estate owned..................................... 801 577 Investments in affordable housing partnerships.............. 19,676 26,485 Premises and equipment, net................................. 26,630 22,646 Premiums on deposits acquired, net.......................... 7,696 3,812 Excess of purchase price over fair value of net assets acquired, net............................................. 16,497 6,770 Accrued interest receivable and other assets................ 47,993 30,503 Deferred tax assets......................................... 10,507 8,319 ---------- ---------- TOTAL................................................... $2,485,971 $2,152,630 ---------- ---------- LIABILITIES AND STOCKHOLDERS' EQUITY Customer deposit accounts Noninterest-bearing....................................... $ 201,456 $ 128,552 Interest-bearing.......................................... 1,747,106 1,371,977 ---------- ---------- Total deposits.......................................... 1,948,562 1,500,529 Short-term borrowings....................................... 38,000 600 Federal Home Loan Bank advances............................. 268,000 482,000 Notes payable............................................... -- 1,532 Accrued expenses and other liabilities...................... 22,897 15,861 Junior subordinated debt securities......................... 20,750 -- ---------- ---------- Total liabilities......................................... 2,298,209 2,000,522 ---------- ---------- FAIR VALUE OF NET ASSETS ACQUIRED IN EXCESS OF PURCHASE PRICE, NET................................................ 1,613 2,028 COMMITMENTS AND CONTINGENCIES (Note 14) STOCKHOLDERS' EQUITY Common stock (par value of $0.001 per share) Authorized--50,000,000 shares Issued--24,508,331 shares and 23,908,731 shares in 2000 and 1999, respectively Outstanding--22,660,590 shares and 22,422,868 shares in 2000 and 1999, respectively............................. 25 24 Additional paid-in capital.................................. 118,039 111,306 Retained earnings........................................... 99,764 67,001 Deferred compensation....................................... (1,344) (863) Treasury stock, at cost--1,847,741 shares and 1,485,863 shares in 2000 and 1999, respectively.................................... (23,060) (14,659) Accumulated other comprehensive loss, net of tax............ (7,275) (12,729) ---------- ---------- Total stockholders' equity.................................. 186,149 150,080 ---------- ---------- TOTAL..................................................... $2,485,971 $2,152,630 ========== ========== </TABLE> See notes to consolidated financial statements. 50
EAST WEST BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT PER SHARE DATA) <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, ------------------------------ 2000 1999 1998 -------- -------- -------- <S> <C> <C> <C> INTEREST AND DIVIDEND INCOME Loans receivable, including fees.......................... $150,985 $108,547 $85,806 Investment securities available for sale.................. 32,521 35,451 26,405 Investment securities held for trading.................... -- 109 -- Short-term investments.................................... 960 2,381 13,302 Federal Home Loan Bank stock.............................. 1,614 1,539 1,195 -------- -------- ------- Total interest and dividend income...................... 186,080 148,027 126,708 -------- -------- ------- INTEREST EXPENSE Customer deposit accounts................................. 72,648 49,567 49,499 Short-term borrowings..................................... 2,065 1,080 6,767 Federal Home Loan Bank advances........................... 20,503 25,495 14,777 Junior subordinated debt securities....................... 1,377 -- -- -------- -------- ------- Total interest expense.................................. 96,593 76,142 71,043 -------- -------- ------- NET INTEREST INCOME BEFORE PROVISION FOR LOAN LOSSES........ 89,487 71,885 55,665 PROVISION FOR LOAN LOSSES................................... 4,400 5,439 5,356 -------- -------- ------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES......... 85,087 66,446 50,309 -------- -------- ------- NONINTEREST INCOME Loan fees................................................. 1,845 2,282 2,389 Branch fees............................................... 4,839 3,388 2,579 Letters of credit fees and commissions.................... 4,353 4,111 2,785 Net gain on sales of investment securities available for sale.................................................... 123 685 1,320 Net gain (loss) on trading securities..................... (16) 1,904 -- Net gain on sales of investment in affordable housing partnerships............................................ 1,279 402 -- Net gain on sale of branch................................ -- 676 -- Amortization of fair value of net assets acquired in excess of purchase price................................ 415 415 415 Other operating income.................................... 2,130 830 539 -------- -------- ------- Total noninterest income................................ 14,968 14,693 10,027 -------- -------- ------- NONINTEREST EXPENSE Compensation and employee benefits........................ 20,286 18,481 17,281 Net occupancy............................................. 7,563 5,649 4,974 Data processing........................................... 1,783 1,399 1,245 Amortization of premiums on deposits acquired and excess of purchase price over fair value of net assets acquired................................................ 3,318 1,572 1,241 Amortization of investments in affordable housing partnerships............................................ 4,081 2,991 1,017 Deposit insurance premiums and regulatory assessments..... 458 862 825 Other real estate owned operations, net................... (174) (340) (380) Other operating expenses.................................. 12,645 8,895 6,423 -------- -------- ------- Total noninterest expense............................... 49,960 39,509 32,626 -------- -------- ------- INCOME BEFORE PROVISION FOR INCOME TAXES.................... 50,095 41,630 27,710 PROVISION FOR INCOME TAXES.................................. 14,628 13,603 9,682 -------- -------- ------- NET INCOME.................................................. $ 35,467 $ 28,027 $18,028 -------- -------- ------- BASIC EARNINGS PER SHARE.................................... $ 1.58 $ 1.23 $ 0.76 DILUTED EARNINGS PER SHARE.................................. $ 1.53 $ 1.22 $ 0.76 AVERAGE NUMBER OF SHARES OUTSTANDING--BASIC................. 22,448 22,757 23,775 AVERAGE NUMBER OF SHARES OUTSTANDING--DILUTED............... 23,168 22,895 23,775 </TABLE> See notes to consolidated financial statements. 51
EAST WEST BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY <TABLE> <CAPTION> ACCUMULATED OTHER ADDITIONAL COMPREHENSIVE COMMON PAID-IN RETAINED DEFERRED TREASURY LOSS, NET OF STOCK CAPITAL EARNINGS COMPENSATION STOCK TAX -------- ---------- -------- ------------ -------- ------------- (DOLLARS IN THOUSANDS) <S> <C> <C> <C> <C> <C> <C> BALANCE, JANUARY 1, 1998........... $24 $109,976 $23,690 $ -- $ -- $ (1,138) Comprehensive income Net income for the year.......... 18,028 Net unrealized gain on securities..................... 250 Comprehensive income............... --- -------- ------- ------- -------- -------- BALANCE, DECEMBER 31, 1998......... 24 109,976 41,718 -- -- (888) Comprehensive income Net income for the year.......... 28,027 Net unrealized loss on securities..................... (11,841) Comprehensive income............... Stock compensation cost............ 249 Issuance of 105,003 shares under Restricted Stock Plan............ 1,112 (1,112) Issuance of 28,728 shares under Employee Stock Purchase Plan..... 218 Purchase of 1,485,863 shares of treasury stock................... (14,659) Dividends paid on common stock..... (2,744) --- -------- ------- ------- -------- -------- BALANCE, DECEMBER 31, 1999......... 24 111,306 67,001 (863) (14,659) (12,729) Comprehensive income Net income for the year.......... 35,467 Net unrealized gain on securities..................... 5,454 Comprehensive income............... Stock compensation cost............ 16 405 Tax benefit from option exercise... 55 Issuance of 16,444 shares under Stock Option Plan................ 164 Issuance of 1,500 shares under Restricted Stock Plan............ 18 (18) Issuance of 53,584 shares under Employee Stock Purchase Plan..... 496 Issuance of 424,781 shares under Stock Warrants Plan.............. 1 4,247 Issuance of 103,291 shares for acquisition of Risk Services, Inc.............................. 1,737 (868) Purchase of 361,878 shares of treasury stock................... (8,401) Dividends paid on common stock..... (2,704) --- -------- ------- ------- -------- -------- BALANCE, DECEMBER 31, 2000......... $25 $118,039 $99,764 $(1,344) $(23,060) $ (7,275) === ======== ======= ======= ======== ======== <CAPTION> TOTAL COMPREHENSIVE STOCKHOLDERS' INCOME EQUITY ------------- ------------- (DOLLARS IN THOUSANDS) <S> <C> <C> BALANCE, JANUARY 1, 1998........... $132,552 Comprehensive income Net income for the year.......... $ 18,028 18,028 Net unrealized gain on securities..................... 250 250 -------- Comprehensive income............... $ 18,278 ======== -------- BALANCE, DECEMBER 31, 1998......... 150,830 Comprehensive income Net income for the year.......... $ 28,027 28,027 Net unrealized loss on securities..................... (11,841) (11,841) -------- Comprehensive income............... $ 16,186 ======== Stock compensation cost............ 249 Issuance of 105,003 shares under Restricted Stock Plan............ -- Issuance of 28,728 shares under Employee Stock Purchase Plan..... 218 Purchase of 1,485,863 shares of treasury stock................... (14,659) Dividends paid on common stock..... (2,744) -------- BALANCE, DECEMBER 31, 1999......... 150,080 Comprehensive income Net income for the year.......... $ 35,467 35,467 Net unrealized gain on securities..................... 5,454 5,454 -------- Comprehensive income............... $ 40,921 ======== Stock compensation cost............ 421 Tax benefit from option exercise... 55 Issuance of 16,444 shares under Stock Option Plan................ 164 Issuance of 1,500 shares under Restricted Stock Plan............ -- Issuance of 53,584 shares under Employee Stock Purchase Plan..... 496 Issuance of 424,781 shares under Stock Warrants Plan.............. 4,248 Issuance of 103,291 shares for acquisition of Risk Services, Inc.............................. 869 Purchase of 361,878 shares of treasury stock................... (8,401) Dividends paid on common stock..... (2,704) -------- BALANCE, DECEMBER 31, 2000......... $186,149 ======== </TABLE> <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, ------------------------------ 2000 1999 1998 -------- -------- -------- (IN THOUSANDS) <S> <C> <C> <C> DISCLOSURE OF RECLASSIFICATION AMOUNT: Unrealized holding gain (loss) arising during period, net of tax expense (benefit) of $3,685 in 2000, $(7,620) in 1999 and $595 in 1998.......................................... $5,528 $(11,430) $1,109 Less: Reclassification adjustment for gain included in net income, net of tax expense of $49 in 2000, $274 in 1999 and $461 in 1998.......................................... (74) (411) (859) ------ -------- ------ Net unrealized gain (loss) on securities, net of tax expense (benefit) of $3,636 in 2000, $(7,894) in 1999 and $134 in 1998...................................................... $5,454 $(11,841) $ 250 ====== ======== ====== </TABLE> See notes to consolidated financial statements. 52
EAST WEST BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS <TABLE> <CAPTION> YEAR ENDED DECMEBER 31, ----------------------------------------- 2000 1999 1998 ------------ ------------ ----------- (IN THOUSANDS) <S> <C> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES Net income......................................... $ 35,467 $ 28,027 18,028 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization.................... 8,751 4,139 4,539 Net loan fees deferred........................... 1,777 2,246 2,377 Stock compensation costs......................... 421 249 -- Deferred tax benefit............................. (794) (2,477) (1,690) Provision for loan losses........................ 4,400 5,439 5,356 Provision for other real estate owned losses..... -- 169 341 Net gain on sales of investment securities and other assets................................... (1,353) (2,925) (2,685) Net (gain) loss on trading securities............ 16 (1,904) -- Federal Home Loan Bank stock dividends........... (1,727) (1,608) (921) Proceeds from sale of trading securities......... -- 117,366 -- Purchases of trading securities.................. -- (115,527) -- Proceeds from sale of loans held for sale........ 12,384 46,225 92,729 Originations of loans held for sale.............. (12,565) (37,341) (91,987) Increase in accrued interest receivable and other assets, net of effects from purchases of First Central Bank and American International Bank... (14,054) (2,379) (14,373) Increase (decrease) in accrued expenses and other liabilities, net of effects from purchases of First Central Bank and American International Bank........................................... (9,530) 2,115 3,410 ------------ ------------ ----------- Total adjustments............................ (12,274) 13,787 (2,904) ------------ ------------ ----------- Net cash provided by operating activities.... 23,193 41,814 15,124 ------------ ------------ ----------- CASH FLOWS FROM INVESTING ACTIVITIES Net change in loans................................ (7,543) (190,959) (169,644) Purchases of: Investment securities available for sale......... (46,194) (420,587) (883,989) Loans receivable................................. (196,185) (208,171) (41,230) Federal Home Loan Bank stock..................... (508) (1,809) (18,072) Investments in affordable housing partnerships... (5,544) (10,707) (3,411) Premises and equipment........................... (3,617) (1,476) (1,389) Proceeds from sale of: Investment securities available for sale......... 61,052 177,758 279,504 Other real estate owned.......................... 1,062 5,278 1,695 Investments in affordable housing partnerships... 9,551 3,267 -- Premises and equipment........................... 1 4 13 Repayments, maturity and redemption of investment securities available for sale.................... 80,891 409,499 332,678 Redemption of Federal Home Loan Bank stock......... 15,211 9,337 -- Repayments on foreclosed properties................ 38 250 -- Investment in nonbank entity....................... (250) (250) -- Payment for purchase of First Central Bank, net of cash received.................................... -- (5,295) -- Payment for purchase of American International Bank, net of cash received....................... (25,174) -- -- Net cash acquired from acquisition of Risk Services, Inc.................................... 549 -- -- ------------ ------------ ----------- Net cash used in investing activities........ (116,660) (233,861) (503,845) ------------ ------------ ----------- </TABLE> 53
EAST WEST BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) <TABLE> <CAPTION> YEAR ENDED DECMEBER 31, ----------------------------------------- 2000 1999 1998 ------------ ------------ ----------- (IN THOUSANDS) <S> <C> <C> <C> CASH FLOWS FROM FINANCING ACTIVITIES: Net change in deposits............................. $ 277,269 $ 190,523 57,865 Proceeds from sale of deposits..................... -- 17,795 -- Net increase (decrease) in short-term borrowings... 37,400 (32,400) (106,000) Proceeds from Federal Home Loan Bank advances...... 16,711,300 19,810,100 4,150,821 Repayment of Federal Home Loan Bank advances....... (16,925,300) (19,891,100) (3,798,820) Proceeds from issuance of junior subordinated debt securities....................................... 20,750 -- -- Payment of debt issue cost......................... (672) -- -- Repayment of notes payable on affordable housing investments...................................... (1,532) (3,320) (1,615) Proceeds from common stock options exercised....... 164 -- -- Proceeds from stock warrants exercised............. 4,248 -- -- Proceeds from stock purchase plan.................. 496 218 -- Repurchases of common stock........................ (8,401) (14,659) -- Dividends paid on common stock..................... (2,704) (2,744) -- ------------ ------------ ----------- Net cash provided by financing activities.... 113,018 74,413 302,251 ------------ ------------ ----------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS........................................ 19,551 (117,634) (186,470) CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR......... 43,497 161,131 347,601 ------------ ------------ ----------- CASH AND CASH EQUIVALENTS, END OF YEAR............... $ 63,048 $ 43,497 $ 161,131 ============ ============ =========== SUPPLEMENTAL CASH FLOW INFORMATION Interest paid...................................... $ 93,840 $ 76,624 70,565 Income tax payments, net........................... 14,246 17,350 10,225 Noncash investing and financing activities: Other real estate acquired through foreclosure... 1,112 4,080 4,706 Loans made to facilitate sales of other real estate owned................................... -- 2,945 1,488 Investment in affordable housing partnerships acquired through notes payable................. -- 3,033 1,820 Issuance of common stock in connection with the acquisition of Risk Services, Inc., net of deferred compensation.......................... 869 -- -- </TABLE> See notes to consolidated financial statements. 54
EAST WEST BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES East West Bancorp, Inc., a registered bank holding company (the "Company"), offers a full range of banking services to individuals and small to large businesses through its subsidiary bank, East West Bank and its subsidiaries (the "Bank"), which operates 30 branches located throughout California. The Company specializes in financing international trade and lending for commercial, construction, and residential real estate projects. The Company's revenues are derived from providing financing for residential and commercial real estate and business customers, as well as investing activities. Funding for lending and investing activities is obtained through acceptance of customer deposits, Federal Home Loan Bank advances and other borrowing activities. REVERSE STOCK SPLIT--In June 1998, the Articles of Incorporation of the Bank were amended to decrease the authorized common shares of the Bank from 200,000,000 shares to 50,000,000 shares. The amendment was made in conjunction with the 118,875 for 550,000 reverse stock split effective June 11, 1998. CHANGE IN OWNERSHIP--On June 12, 1998, previous shareholders of the Bank sold all of the Bank's common stock to various institutional and accredited investors. No person or group of persons acting in concert was permitted to purchase more than 9.9% of the number of outstanding shares of the Bank's common stock immediately after the sale. Since there was not a control group in this transaction, generally accepted principles did not require the assets and liabilities of the Bank to be revalued. FORMATION OF BANK HOLDING COMPANY--On August 27, 1998, at the direction of the Board of Directors of the Bank, the Company was incorporated under the laws of the State of Delaware for the purpose of becoming a bank holding company by acquiring all of the outstanding common stock of the Bank. This reorganization, which was accounted for in a manner similar to a pooling of interests and completed on December 30, 1998, provided the Company with greater operating and financial flexibility and permits expansion into a broader range of financial services and other business activities. BRANCH SALE--On May 21, 1999, the Company completed the sale of its Irvine branch to another bank. The assets and liabilities assumed by the acquiring bank were $83 thousand and $17.1 million, respectively. The net gain from the sale of this branch amounted to $676 thousand. FORMATION OF REGULATED INVESTMENT COMPANY--On July 13, 2000, East West Securities Company, Inc. (the "Fund"), was incorporated under the general laws of the State of Maryland as a closed-end, non-diversified, management investment company registered under the Investment Company Act of 1940, as amended. The formation of the Fund provides the Bank with the flexibility to raise additional capital in a tax efficient manner for future business opportunities, if desired. There can be no assurance as to the timing or ability of the Bank to raise capital through this entity. EWSC Holdings, LLC, a California limited liability company and wholly owned subsidiary of the Bank, owns 100% of the voting shares of the Fund. The Fund is the sole member in six limited liability companies, namely EW Assets, LLC, EW Assets 2, LLC, EW Assets 3, LLC, EW Assets 4, LLC, EW Assets 5, LLC, and EW Assets 6, LLC. These companies invest primarily in loans and money market deposit accounts. BASIS OF PRESENTATION--The consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and general practices within the banking industry. The following is a summary of significant principles used in the preparation of the accompanying financial statements. In preparing the financial statements, management of the Company has made a number of estimates and assumptions relating to the reporting of assets and 55
liabilities, including the allowance for loan losses, the disclosure of contingent assets and liabilities and the disclosure of income and expenses for the periods presented in conformity with accounting principles generally accepted in the United States of America. Actual results could differ from those estimates. PRINCIPLES OF CONSOLIDATION--The financial statements include the accounts of the Company and its subsidiaries, East West Bank and Risk Services, Inc. (see Note 2). Intercompany transactions and accounts have been eliminated in consolidation. INVESTMENT SECURITIES--Investment securities available for sale are reported at estimated fair value, with unrealized gains and losses, net of the related tax effect, excluded from operations and reported as a separate component of other comprehensive income. Amortization of premiums and accretion of discounts on debt securities are recorded as yield adjustments on such securities using the effective interest method. The specific identification method is used for purposes of determining cost in computing realized gains and losses on investment securities sold. DERIVATIVE FINANCIAL INSTRUMENTS--The Company is a party to certain derivative transactions, including interest rate swaps and interest rate caps. These contracts were entered into for purposes of reducing the Company's interest rate risk. The carrying values of derivative financial instruments are included in other assets. INTEREST RATE SWAP AGREEMENTS--Interest rate swaps were entered into for the purposes of modifying the interest rate characteristics of certain loans and deposits of the Company. The interest rate swaps involve no exchange of principal either at inception or upon maturity; rather, they involve the periodic exchange of interest payments arising from an underlying notional principal amount. Interest rate swaps are accounted for using settlement accounting and are reported at their initial cost, and unrealized gains or losses resulting from changes in their fair value are not recorded in the financial statements. Revenues or expenses associated with these agreements are accounted for on an accrual basis and are recognized as adjustments to interest income on loans receivable or interest expense on deposits, based on the interest rates currently in effect for such contracts. INTEREST RATE CAP AGREEMENTS--Prior to October 1, 1999, the Company used interest rate caps for purposes of hedging against fluctuations in the fair value of the Company's investment securities available-for-sale portfolio. The interest rate caps involve the payment of a one-time premium to a counterparty who, if interest rates rise above a predetermined level, will make payments to the Company at an agreed-upon rate for the term of the agreement or until such time as interest rates fall below the cap level. The premiums paid for the interest rate caps were amortized to interest income on investments over the term of the agreements. The interest rate caps were reported at their estimated fair values, with unrealized gains and losses recognized as a separate component of accumulated other comprehensive income or loss (net of tax effects) consistent with the hedged securities. Amounts receivable on the cap agreements were accrued and recognized as interest income on investments. Effective October 1, 1999, the Company ceased using interest rate caps to hedge against fluctuations in the investment securities available for sale portfolio. Interest rate caps continue to be recorded at their estimated fair values, with resulting gains or losses recorded in current earnings. The unrealized gains and losses reflected in accumulated other comprehensive income (loss) in stockholders' equity as of September 30, 1999 are amortized into interest income or expense over the expected remaining lives of the interest rate cap agreements. LOANS RECEIVABLE--Loans receivable, which management has the intent and ability to hold for the foreseeable future or until maturity, are stated at their outstanding principal, reduced by an allowance for loan losses and net deferred loan fees or costs on originated loans and unamortized premiums or discounts on purchased loans. Discounts or premiums on purchased loans are amortized to income using the interest method over the remaining period to contractual maturity adjusted for anticipated 56
prepayments. Interest on loans is calculated using the simple-interest method on daily balances of the principal amount outstanding. Accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions and collection efforts, that the borrower's financial condition is such that collection of interest is doubtful. Generally, loans are placed on nonaccrual status when they become 90 days past due. When interest accrual is discontinued, all unpaid accrued interest is reversed against current earnings. In general, subsequent payments received are applied to the outstanding principal balance of the loan. A loan is returned to accrual status when the borrower has demonstrated a satisfactory payment trend subject to management's assessment of the borrower's ability to repay the loan. Loans held for sale are carried at the lower of aggregate cost or market value. Origination fees on loans held for sale, net of certain costs of processing and closing the loans, are deferred until the time of sale and are included in the computation of the gain or loss from the sale of the related loans. A valuation allowance is established if the market value of such loans is lower than their cost and operations are charged for valuation adjustments. Nonrefundable fees and direct costs associated with the origination or purchase of loans are deferred and netted against outstanding loan balances. The deferred net loan fees and costs are recognized in interest income as an adjustment to yield over the loan term using the effective interest method. A loan is impaired when it is probable that a creditor will be unable to collect all amounts due (principal and interest) according to the contractual terms of the loan agreement. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as an expedient, at the loan's observable market price or the fair value of the collateral if the loan is collateral dependent, less costs to sell. LEASE FINANCING TRANSACTIONS--Loans receivable include the Company's share of aggregate rentals on lease financing transactions and residual values, net of unearned income. Lease financing transactions are primarily direct financing leases. Unearned income on lease financing transactions is amortized utilizing the interest method. PROVISION AND ALLOWANCE FOR LOAN LOSSES--The determination of the balance in the allowance for loan losses is based on an analysis of the loan portfolio and reflects an amount that, in management's judgment, is adequate to provide for probable losses after giving consideration to estimated losses on specifically identified impaired loans, as well as the characteristics of the loan portfolio, current economic conditions, past credit loss experience and such other factors as deserve current recognition in estimating credit losses. The allowance for loan losses is increased by charges to income and decreased by charge-offs (net of recoveries). Consumer and other homogeneous smaller balance loans are reviewed on a collective basis for impairment. OTHER REAL ESTATE OWNED--Other real estate owned represents real estate acquired through foreclosure and is recorded at fair value at the time of foreclosure. Loan balances in excess of fair value of the real estate acquired at the date of foreclosure are charged against the allowance for loan losses. After foreclosure, valuations are periodically performed by management and the real estate is carried at the lower of carrying value or fair value less costs to sell. Any subsequent operating expenses or income, reduction in estimated values, and gains or losses on disposition of such properties are charged to current operations. Revenue recognition upon disposition of the property is dependent on the sale having met certain criteria relating to the buyer's initial investment in the property sold. REAL ESTATE INVESTMENT--The Company owns limited partnership interests in projects of affordable housing for lower income tenants. The investments in which the Company has significant influence are recorded using the equity method of accounting. The remaining investments are being amortized using 57
the level-yield method over the life of the related tax credits. The tax credits are being recognized in the consolidated financial statements to the extent they are utilized on the Company's tax returns. PREMISES AND EQUIPMENT--Company premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed based on the straight-line method over the estimated useful lives of the various classes of assets. The ranges of useful lives for the principal classes of assets are as follows: <TABLE> <S> <C> Buildings and building improvements.......... 25 years Furniture, fixtures and equipment............ 3 to 10 years Term of lease or useful life, whichever is Leasehold improvements....................... shorter </TABLE> INTANGIBLE ASSETS--Excess of purchase price over fair value of net assets acquired and fair value of net assets acquired in excess of purchase price, also known as goodwill, is amortized using the straight-line method over 15 to 25 years. Premiums on deposits, which represent the intangible value of depositor relationships resulting from deposit liabilities assumed in acquisitions, are amortized using the straight-line method over 7 to 10 years. In accordance with Statement of Financial Accounting Standards ("SFAS") No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF, goodwill and premiums on deposits are assessed periodically for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. In management's opinion, no significant events or changes in circumstances have occurred that would indicate impairment of these assets. STOCK OF FEDERAL HOME LOAN BANK OF SAN FRANCISCO--As a member of the Federal Home Loan Bank ("FHLB") of San Francisco, the Company is required to own common stock in the FHLB of San Francisco based upon the Company's balance of residential mortgage loans and outstanding FHLB advances. FHLB stock is carried at cost and may be sold back to the FHLB at its carrying value. Both cash and stock dividends received are reported as dividend income. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE--The Company enters into sales of securities under repurchase agreements with primary dealers, which provide for the repurchase of the same security with substantially the same terms as the security sold. The repurchase agreements are typically collateralized by mortgage-backed securities that are normally held by a third party custodian. In the event that the fair market value of the securities decreases below the carrying amount of the related repurchase agreement, the counterparty is required to designate an equivalent value of additional securities. These agreements are accounted for as financings, and the obligations of the Company to repurchase the securities are reflected as liabilities. The securities underlying the agreements remain in the asset accounts in the consolidated balance sheets. JUNIOR SUBORDINATED DEBT SECURITIES--During 2000, the Company established East West Capital Trust I and East West Capital Trust II (the "Trusts") as wholly owned subsidiaries. In two separate private placement transactions, the Trusts issued $10.8 million of 10.875% capital securities and $10.0 million of 10.945% capital securities representing undivided preferred beneficial interests in the assets of the Trusts. The Company 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 I Capital for regulatory purposes. INCOME TAXES--Deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each year-end, based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. STOCK-BASED COMPENSATION--The Company has adopted SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, which establishes financial accounting and reporting standards for stock-based employee 58
compensation plans. These standards include the recognition of compensation expense over the vesting period of the fair value of all stock-based awards on the date of grant. SFAS No. 123 permits entities to continue to apply the provisions of Accounting Principles Board ("APB") Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and provide only the pro forma net income and pro forma net earnings per share disclosures as if the fair-value based method defined in SFAS No. 123 had been applied. Under APB Opinion No. 25, compensation expense for fixed options would be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. The Company has elected to continue to apply the provisions of APB Opinion No. 25 in accounting for its stock option plan and provide the pro forma disclosure requirements of SFAS No. 123 in the footnotes to its consolidated financial statements. In addition to stock options, the Company also grants restricted stock awards to certain officers and employees. The Company records the cost of the restricted shares at market. The restricted stock grant is reflected as a component of common stock and additional paid-in capital with an offsetting amount of deferred compensation in the consolidated statement of stockholders' equity. The restricted shares awarded become fully vested after three years of continued employment from the date of grant. The Company becomes entitled to an income tax deduction in an amount equal to the taxable income reported by the holders of the restricted shares when the restrictions are released and the shares are issued. The deferred compensation cost reflected in stockholders' equity is being amortized as compensation expense over three years using the straight-line method. Restricted shares are forfeited if officers and employees terminate prior to the lapsing of restrictions. The Company records forfeitures of restricted stock as treasury share repurchases and any compensation cost previously recognized is reversed in the period of forfeiture. TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS OF LIABILITIES--A sale is recognized when the Company relinquishes control over a financial asset and is compensated for such asset. The difference between the net proceeds received and the carrying amount of the financial assets being sold or securitized is recognized as a gain or loss on sale. EARNINGS PER SHARE--Basic EPS is computed by dividing 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 from issuance of common stock that then shared in the earnings of the Company. The basic and diluted earnings per share and the presentation of common stock and additional paid-in capital for all periods presented have been adjusted to reflect the 118,875 for 550,000 reverse stock split, which was effective June 11, 1998. COMPREHENSIVE INCOME--The term "comprehensive income" describes the total of all components of comprehensive income including net income. "Other comprehensive income" refers to revenues, expenses, and gains and losses that are included in comprehensive income but are excluded from net income as they have been recorded directly in equity under the provisions of other Financial Accounting Standard Board statements. The Company presents the comprehensive income disclosure as a part of the statements of changes in stockholders' equity by identifying each element of other comprehensive income, including net income. RECENT ACCOUNTING PRONOUNCEMENTS ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES--In June 1998, the Financial Accounting Standards Board (the "FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. SFAS No. 133, as amended by SFAS No. 138, ACCOUNTING FOR CERTAIN DERIVATIVE INSTRUMENTS AND CERTAIN HEDGING ACTIVITIES--AN AMENDMENT OF FASB STATEMENT NO. 133, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It 59
requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial condition and measure those instruments at fair value. Gains or losses resulting from changes in the values of those derivatives would be accounted for depending on the use of the derivative and whether it qualifies for hedge accounting. The key criterion for hedge accounting is that the hedging relationship must be highly effective in achieving offsetting changes in fair value or cash flows. Implementation of SFAS No. 133 will be effective for the Company on January 1, 2001. The adoption of this standard will not have a material impact on the Company's results of operations or financial position. REVENUE RECOGNITION IN FINANCIAL STATEMENTS--On December 3, 1999, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin ("SAB") No. 101, REVENUE RECOGNITION IN FINANCIAL STATEMENTS, which summarizes the SEC's views in applying generally accepted accounting principles to revenue recognition in financial statements. Under the provisions of SAB No. 101, if a transaction is within the scope of existing specific authoritative literature that provides revenue recognition guidance, such literature should be applied. SAB No. 101 is intended to provide additional or more consistent guidance only in the absence of authoritative literature addressing a specific arrangement or a specific industry as it relates to revenue recognition. It is the view of the SEC that revenue is generally realized or realizable and earned when all of the following criteria are met: (1) persuasive evidence of an arrangement exists, (2) delivery has occurred or services have been rendered, (3) the seller's price to the buyer is fixed or determinable, and (4) collectibility is reasonably assured. Management does not believe that the bulletin has a material impact on the Company's results of operations or financial position. ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS OF LIABILITIES--In September 2000, the FASB issued SFAS No. 140, ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS OF LIABILITIES--A REPLACEMENT TO FASB STATEMENT NO. 125. SFAS No. 140 revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures, but carries over most of SFAS 125's provisions without reconsideration. SFAS No. 140 provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. These standards are based on consistent application of a "financial-components approach" that focuses on control. Under this approach, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished. This Statement also provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. SFAS No. 140 is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. This Statement is also effective for recognition and reclassification of collateral and for disclosures relating to securitization transactions and collateral for fiscal years ending after December 15, 2000. Management does not believe that the adoption of this standard will have a material impact on the Company's results of operations or financial position when adopted. RECLASSIFICATIONS--Certain reclassifications have been made to the prior year financial statements to conform to the current year presentation. 2. BUSINESS COMBINATIONS ACQUISITION OF FIRST CENTRAL BANK, N.A.--On May 28, 1999, the Bank acquired all of the issued and outstanding stock of First Central Bank, N.A. First Central Bank was a national bank with three branches in Southern California. The Bank acquired approximately $55.0 million in loans and assumed approximately $92.6 million in deposits as a result of this transaction. 60
The acquisition was accounted for under the purchase method of accounting, and accordingly, all assets and liabilities were adjusted to and recorded at their estimated fair values as of the acquisition date. The estimated tax effect of differences between tax bases and market values (except for intangible assets) has been reflected in deferred income taxes. Summarized below are the assets and liabilities recorded at fair value at the date of acquisition: <TABLE> <CAPTION> VALUES OF ASSETS ACQUIRED AND LIABILITIES ASSUMED (IN THOUSANDS) --------------- <S> <C> Cash, cash equivalents and other investments................ $ 46,570 Loans receivable............................................ 54,305 Property and equipment...................................... 363 Excess of purchase price over fair value of net assets acquired.................................................. 3,513 Premium on deposits acquired................................ 2,450 Other assets................................................ 914 -------- Total assets............................................ 108,115 -------- Deposits.................................................... 92,569 Other liabilities........................................... 1,240 Deferred income taxes....................................... 833 -------- Total liabilities....................................... 94,642 -------- Purchase price and other acquisition costs............ $ 13,473 ======== </TABLE> ACQUISITION OF AMERICAN INTERNATIONAL BANK--On January 18, 2000, the Company completed its $33.1 million acquisition of American International Bank ("AIB") in an all-cash transaction. American International Bank, with assets of $202 million, was a state-chartered bank with eight branches in Southern California. AIB specialized in servicing small-to-medium sized companies involved in international trade and other areas, as well as offering a full range of personal banking products and services to a predominantly Chinese-American customer base. The acquisition of AIB was accounted for under the purchase method of accounting, and accordingly, all assets and liabilities were adjusted to and recorded at their estimated fair values as of the acquisition date. The estimated tax effect of differences between tax bases and market values has been reflected in deferred income taxes. 61
Summarized below are the assets and liabilities recorded at fair value at the date of acquisition: <TABLE> <CAPTION> VALUES OF ASSETS ACQUIRED AND LIABILITIES ASSUMED (IN THOUSANDS) --------------- <S> <C> Cash, cash equivalents and other investments................ $ 86,738 Loans receivable............................................ 105,225 Property and equipment...................................... 3,505 Excess of purchase price over fair value of net assets acquired.................................................. 10,243 Premium on deposits acquired................................ 6,100 Other assets................................................ 5,039 Deferred tax assets, net.................................... 3,449 -------- Total assets............................................ 220,299 -------- Deposits.................................................... 170,765 Other liabilities........................................... 16,399 -------- Total liabilities....................................... 187,164 -------- Purchase price and other acquisition costs............ $ 33,135 ======== </TABLE> ACQUISITION OF RISK SERVICES, INC. (DBA EAST WEST INSURANCE AGENCY)--On August 22, 2000, the Company completed the acquisition of Risk Services, Inc. (the "Agency') in a stock swap transaction. Risk Services, Inc., with assets of $789 thousand as of the acquisition date, is an unrelated agent providing business and consumer insurance services to the Southern California market. The Agency continues to run its operations autonomously as a wholly owned subsidiary of East West Bancorp, Inc. In exchange for all of the outstanding stock of Risk Services, Inc., the Company issued a total of 103,291 new shares of East West Bancorp, Inc. common stock, par value of $.001. The total cash value of the shares issued was approximately $1.7 million. Approximately half of the shares issued for the acquisition of the Agency, or 51,645 shares, are held in escrow by the Company and are subject to a three-and-a-half year earn-out period pursuant to the provisions of the Agreement and Plan of Merger dated August 8, 2000. The distribution of the shares held in escrow is scheduled in four phases and is contingent on the Agency achieving specified revenue and pre-tax earnings levels over the next three-and-a-half years following the completion of the acquisition. The acquisition of the Agency was accounted for under the purchase method of accounting, and accordingly, all assets and liabilities were adjusted to and recorded at their estimated fair values as of the acquisition date. 62
Summarized below are the assets and liabilities recorded at fair value at the date of acquisition: <TABLE> <CAPTION> VALUES OF ASSETS ACQUIRED AND LIABILITIES ASSUMED (IN THOUSANDS) --------------- <S> <C> Cash, cash equivalents and other investments................ $ 549 Property and equipment...................................... 78 Excess of purchase price over fair value of net assets acquired.................................................. 357 Other assets................................................ 106 ------ Total assets............................................ 1,090 ------ Other liabilities........................................... 221 ------ Total liabilities....................................... 221 ------ Purchase price and other acquisition costs............ $ 869 ====== </TABLE> 3. CASH AND CASH EQUIVALENTS Cash and cash equivalents include cash, amounts due from banks, and short-term investments with maturities of less than three months. Short-term investments, which include federal funds sold and securities purchased under agreements to resell, are recorded at cost, which approximates market. Information concerning securities purchased under agreements to resell is summarized as follows: <TABLE> <CAPTION> 2000 1999 (IN THOUSANDS) -------- -------- <S> <C> <C> Balance at year-end...................................... $ -- $ -- Average balance during the year.......................... 4,904 32,358 Maximum month-end balance during the year................ 38,000 101,000 Weighted average interest rate during the year........... 6.85% 5.79% Weighted average interest rate at end of year............ --% --% </TABLE> Securities purchased under agreements to resell are collateralized by mortgage-backed securities and mortgage or commercial loans. The collateral is generally held by a third party custodian. The purchase is overcollateralized to ensure against unfavorable market price movements. In the event that the fair market value of the securities decreases below the carrying amount of the related repurchase agreement, the counterparty is required to designate an equivalent value of 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. 63
4. INVESTMENT SECURITIES AVAILABLE FOR SALE An analysis of the available-for-sale investment securities portfolio is presented as follows: <TABLE> <CAPTION> GROSS GROSS ESTIMATED AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE --------- ---------- ---------- --------- (IN THOUSANDS) <S> <C> <C> <C> <C> As of December 31, 2000: US Treasury securities............................ $ 8,310 $119 $ -- $ 8,429 US Government agency securities................... 72,290 -- (4,908) 67,382 Obligations of states and political subdivisions.................................... 200 1 -- 201 Mortgage-backed securities........................ 390,592 99 (6,013) 384,678 Corporate securities.............................. 28,904 -- (1,304) 27,600 -------- ---- -------- -------- Total........................................... $500,296 $219 $(12,225) $488,290 ======== ==== ======== ======== As of December 31, 1999: US Treasury securities............................ $ 985 $ -- $ (10) $ 975 US Government agency securities................... 75,610 -- (6,739) 68,871 Obligations of states and political subdivisions.................................... 200 2 -- 202 Mortgage-backed securities........................ 440,525 51 (14,198) 426,378 -------- ---- -------- -------- Total........................................... $517,320 $ 53 $(20,947) $496,426 ======== ==== ======== ======== </TABLE> The scheduled maturities of investment securities available for sale at December 31, 2000 are presented as follows: <TABLE> <CAPTION> AMORTIZED ESTIMATED COST FAIR VALUE --------- ---------- (IN THOUSANDS) <S> <C> <C> Due within one year..................................... $ 500 $ 502 Due after one year through five years................... 19,009 19,058 Due after five years through ten years.................. 61,095 60,676 Due after ten years..................................... 419,692 408,054 -------- -------- Total............................................... $500,296 $488,290 ======== ======== </TABLE> Expected maturities of mortgage-backed securities can differ from contractual maturities because borrowers have the right to prepay obligations. In addition, such factors as prepayments and interest rates may affect the yields on the carrying values of mortgage-backed securities. Proceeds from sales of securities during 2000, 1999 and 1998 were $61.1 million, $177.8 million and $279.5 million, respectively, with related gross realized gains of $261 thousand, $685 thousand and $1.4 million. Gross realized losses on securities sales amounted to $138 thousand, $0, and $31 thousand during 2000, 1999 and 1998. At December 31, 2000 and 1999, investment securities with a carrying value of $445.0 million and $492.1 million, respectively, were pledged to secure public deposits, securities sold under agreements to repurchase, FHLB advances, interest rate swap agreements and for other purposes required or permitted by law. 5. DERIVATIVE FINANCIAL INSTRUMENTS Derivative positions are integral components of the Company's asset and liability management activities. Therefore, the Company does not believe it is meaningful to separately analyze the derivatives component of its risk management activities in isolation from related positions. 64
The Company uses derivative instruments, primarily interest rate swap and cap agreements, as part of its management of asset and liability positions in connection with its overall goal of minimizing the impact of interest rate fluctuations on the Company's net interest margin or its stockholders' equity. Derivatives are used as hedges against market fluctuations in the Company's available-for-sale securities portfolio and to effectively convert certain fixed rate commercial real estate loans and brokered deposits to floating rate assets and liabilities. For the years ended December 31, 2000 and 1999, the interest rate swaps were designated for purposes of converting fixed rate loans and certain brokered deposits to floating rate assets and liabilities. Effective November 6, 2000, the Company terminated interest rate swap agreements with a total notional amount of $28.5 million. These interest rate swaps were previously utilized by the Company as a hedge against fixed rate commercial real estate loans. The termination of these swap agreements was in line with the Company's asset liability strategy and the changing outlook of the Federal Reserve Board towards the future direction of interest rates. An internal analysis performed by the Company indicated that the interest rate swaps had a minimal impact on the Company's net portfolio value even if interest rates had continued to rise. The total loss amount recorded by the Company upon termination of the swap agreements was $138 thousand. Interest rate cap agreements were designated as hedges against the available-for-sale securities portfolio during the year ended December 31, 1998 and the nine months ended September 30, 1999. Due to the volatility of the correlation between the Treasury yield curve and fixed rate mortgage-backed securities, the Company ceased using interest rate cap agreements to hedge against fluctuations in the investment securities available-for-sale portfolio effective October 1, 1999. Accordingly, trading gains of $65 thousand for the three months ended December 31, 1999 and trading losses of $232 thousand for the year ended December 31, 2000 were recorded in current earnings, respectively. The following table reflects summary information on derivative contracts used to hedge the Company's interest rate risk as of December 31, 2000 and 1999. Amounts included in the estimated fair value column do not include gains or losses from changes in the value of the underlying asset or liability being hedged. Notional amounts are not exchanged but serve as a point of reference for calculating payments and do not represent exposure to credit or market risk. Amounts shown as unamortized premiums paid for interest rate swaps represent the cost basis of such instruments resulting from a prior mark-to-market adjustment upon sale of a previously hedged item, and subsequent redesignation to the current hedged item. <TABLE> <CAPTION> DECEMBER 31, 2000 ------------------------------------------------------------ UNAMORTIZED GROSS GROSS ESTIMATED NOTIONAL PREMIUM UNREALIZED UNREALIZED FAIR AMOUNT PAID GAINS LOSSES VALUE -------- ----------- ---------- ---------- --------- (IN THOUSANDS) <S> <C> <C> <C> <C> <C> Interest rate swap agreements: Maturing on July 21, 2009, pay 7.00% fixed and receive 3-month LIBOR....... $15,000 $ -- $ -- $ (86) $(86) Maturing on June 23, 2009, pay 7.00% fixed and receive 3-month LIBOR....... 15,000 -- -- (63) (63) Interest rate cap agreements reclassified as trading securities: Maturing on October 24, 2002, 7.00% LIBOR cap............................. 18,000 209 -- (199) 10 Maturing on April 10, 2001, 6.50% LIBOR cap............................. 18,000 33 -- (19) 14 </TABLE> 65
<TABLE> <CAPTION> DECEMBER 31, 1999 ------------------------------------------------------------ UNAMORTIZED GROSS GROSS ESTIMATED NOTIONAL PREMIUM UNREALIZED UNREALIZED FAIR AMOUNT PAID GAINS LOSSES VALUE -------- ----------- ---------- ---------- --------- (IN THOUSANDS) <S> <C> <C> <C> <C> <C> Interest rate swap agreements: Maturing on July 21, 2009, pay 7.00% fixed and receive 3-month LIBOR....... $15,000 $ -- $-- $(706) $(706) Maturing on June 23, 2009, pay 7.00% fixed and receive 3-month LIBOR....... 15,000 -- -- (623) (623) Maturing on November 13, 2002, pay 6.31% fixed and receive 3-month LIBOR....... 14,000 286 -- (96) 190 Maturing on October 10, 2001, pay 6.46% fixed and receive 3-month LIBOR....... 10,000 -- 34 -- 34 Maturing on January 17, 2002, pay 6.89% fixed and receive 3-month LIBOR....... 4,500 -- -- (17) (17) Interest rate cap agreements reclassified as trading securities: Maturing on October 24, 2002, 7.00% LIBOR cap............................. 18,000 326 -- (128) 198 Maturing on April 10, 2001, 6.50% LIBOR cap............................. 18,000 132 -- (74) 58 </TABLE> The estimated fair values of derivative financial instruments were determined using quoted market prices from dealers. The Company is exposed to credit-related losses in the event of nonperformance by counterparties to financial instruments but does not expect any counterparties to fail to meet their obligations. The Company deals only with highly rated counterparties. The current credit exposure of derivatives is represented by the estimated fair value of contracts having positive fair values at the reporting date. 6. LOANS AND ALLOWANCE FOR LOAN LOSSES The following is a summary of loans receivable: <TABLE> <CAPTION> DECEMBER 31, ----------------------- 2000 1999 ---------- ---------- (IN THOUSANDS) <S> <C> <C> Real estate loans: Residential, one to four units..................... $ 334,775 $ 278,161 Residential, multifamily........................... 323,469 311,193 Commercial and industrial real estate.............. 640,713 518,074 Construction....................................... 118,241 122,363 ---------- ---------- Total real estate loans.......................... 1,417,198 1,229,791 ---------- ---------- Other loans: Business, commercial............................... 350,282 248,865 Automobile......................................... 6,409 5,284 Other consumer..................................... 40,547 23,834 ---------- ---------- Total other loans................................ 397,238 277,983 ---------- ---------- Total gross loans.............................. 1,814,436 1,507,774 Unearned fees, premiums and discounts, net........... (600) (289) Allowance for loan losses............................ (23,848) (20,844) ---------- ---------- Loans receivable, net.......................... $1,789,988 $1,486,641 ========== ========== </TABLE> 66
Loans held for sale were $1.1 million and $736 thousand at December 31, 2000 and 1999, respectively. Accrued interest on loans receivable amounted to $12.1 million and $9.2 million at December 31, 2000 and 1999, respectively. An analysis of the activity in the allowance for loan losses is as follows: <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, ------------------------------ 2000 1999 1998 -------- -------- -------- (IN THOUSANDS) <S> <C> <C> <C> Balance, beginning of year....................... $20,844 $16,506 $12,273 Allowance from acquisition....................... 2,256 1,150 -- Provision for loan losses........................ 4,400 5,439 5,356 Chargeoffs....................................... (4,592) (2,877) (2,666) Recoveries....................................... 940 626 1,543 ------- ------- ------- Balance, end of year............................. $23,848 $20,844 $16,506 ======= ======= ======= </TABLE> The following is a summary of interest foregone on impaired loans for the years ended December 31: <TABLE> <CAPTION> 2000 1999 1998 -------- -------- -------- (IN THOUSANDS) <S> <C> <C> <C> Interest income that would have been recognized had impaired loans performed in accordance with their original terms............................ $ 1,475 $ 1,980 $1,057 Less: Interest income recognized on impaired loans........................................... (1,138) (1,562) (890) ------- ------- ------ Interest foregone on impaired loans............... $ 337 $ 418 $ 167 ======= ======= ====== </TABLE> There were no commitments to lend additional funds to borrowers whose loans are included above. The following table provides information on impaired loans for the periods indicated: <TABLE> <CAPTION> AS OF AND FOR THE YEAR ENDED DECEMBER 31, ------------------------------ 2000 1999 1998 -------- -------- -------- (IN THOUSANDS) <S> <C> <C> <C> Recorded investment with related allowance....... $ 2,641 $ 7,773 $ 745 Recorded investment with no related allowance.... 9,781 13,078 9,239 ------- ------- ------- Total recorded investment...................... 12,422 20,851 9,984 Allowance on impaired loans...................... (1,318) (1,254) (350) ------- ------- ------- Net recorded investment in impaired loans...... $11,104 $19,597 $ 9,634 ======= ======= ======= Average total recorded investment in impaired loans.......................................... $12,875 $21,368 $10,522 </TABLE> Loans serviced for others amounted to approximately $198.8 million and $208.5 million at December 31, 2000 and 1999, respectively. CREDIT RISK AND CONCENTRATION--Substantially all of the Company's real estate loans are secured by real properties located in California. In addition, although most of the Company's trade finance activities are related to trade with Asia, all of the Company's loans are made to companies domiciled in the United States. 67
7. REAL ESTATE INVESTMENTS The Company has invested in certain limited partnerships that were formed to develop and operate several apartment complexes designed as high-quality affordable housing for lower income tenants throughout the United States. The Company's ownership in each limited partnership varies from 1% to 19.8%. Four of the investments are being accounted for using the equity method of accounting, since the Company exercises significant control over these partnerships. The remaining investments are being amortized on a level yield method over the life of the related tax credits. Each of the partnerships must meet the 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 credit may be denied for any period in which the project is not in compliance and a portion of the credit previously taken is subject to recapture with interest. The remaining federal tax credits to be utilized over a multiple-year period is $18.6 million as of December 31, 2000. The Company's usage of tax credits approximated $3.9 million and $3.2 million during 2000 and 1999, respectively. Investment amortization amounted to $4.1 million and $3.0 million for the years ended December 31, 2000 and 1999, respectively. 8. PREMISES AND EQUIPMENT Premises and equipment consist of the following: <TABLE> <CAPTION> DECEMBER 31, ------------------- 2000 1999 -------- -------- (IN THOUSANDS) <S> <C> <C> Land.................................................... $ 11,587 $ 9,796 Office buildings........................................ 11,784 11,084 Leasehold improvements.................................. 3,339 2,704 Furniture, fixtures and equipment....................... 11,600 9,682 Equipment under operating leases........................ 1,299 -- -------- -------- 39,609 33,266 Accumulated depreciation and amortization............... (12,979) (10,620) -------- -------- Net................................................... $ 26,630 $ 22,646 ======== ======== </TABLE> 9. CUSTOMER DEPOSIT ACCOUNTS Customer deposit account balances are summarized as follows: <TABLE> <CAPTION> DECEMBER 31, ----------------------- 2000 1999 ---------- ---------- (IN THOUSANDS) <S> <C> <C> Demand deposits (non-interest bearing)............... $ 201,456 $ 128,552 Checking accounts (interest bearing)................. 111,228 89,545 Money market accounts................................ 122,079 69,434 Savings deposits..................................... 212,411 211,818 ---------- ---------- 647,174 499,349 ---------- ---------- Time deposits: Less than $100,000................................. 560,244 487,335 $100,000 or greater................................ 741,144 513,845 ---------- ---------- 1,301,388 1,001,180 ---------- ---------- Total deposits................................... $1,948,562 $1,500,529 ========== ========== </TABLE> 68
At December 31, 2000, the scheduled maturities of time deposits are as follows: <TABLE> <CAPTION> $100,000 OR LESS THAN GREATER $100,000 TOTAL -------- --------- ---------- (IN THOUSANDS) <S> <C> <C> <C> 2001........................................ $688,974 $507,980 $1,196,954 2002........................................ 16,600 44,747 61,347 2003........................................ 5,007 3,906 8,913 2004........................................ 108 1,605 1,713 2005 and thereafter......................... 30,455 2,006 32,461 -------- -------- ---------- Total..................................... $741,144 $560,244 $1,301,388 ======== ======== ========== </TABLE> Accrued interest payable was $2.1 million and $958 thousand at December 31, 2000 and 1999, respectively. Interest expense on customer deposits by account type is summarized as follows: <TABLE> <CAPTION> DECEMBER 31, ------------------------------ 2000 1999 1998 -------- -------- -------- (IN THOUSANDS) <S> <C> <C> <C> Checking accounts................................ $ 1,398 $ 1,056 $ 1,072 Money market accounts............................ 3,836 1,593 1,010 Savings deposits................................. 4,213 3,960 5,048 Time deposits: Less than $100,000............................. 25,398 21,533 23,234 $100,000 or greater............................ 37,803 21,425 19,135 ------- ------- ------- Total........................................ $72,648 $49,567 $49,499 ======= ======= ======= </TABLE> 10. SHORT-TERM BORROWINGS Short-term borrowings include federal funds purchased and securities sold under agreements to repurchase. Federal funds purchased generally mature within one business day from the date of transaction while securities sold under agreements to repurchase generally mature within 90 days from the transaction date. At December 31, 2000 and 1999, total short-term borrowings consisted entirely of federal funds purchased amounting to $38 million and $600 thousand, respectively. Information concerning securities sold under agreements to repurchase is summarized as follows: <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, ------------------- 2000 1999 -------- -------- (IN THOUSANDS) <S> <C> <C> Balance at year-end....................................... $ -- $ -- Average balance during the year........................... $ -- $ 9,159 Highest month-end balance during the year................. $ -- $33,000 Weighted average interest rate during the year............ --% 5.05% Weighted average interest rate at end of year............. --% --% </TABLE> 69
11. FEDERAL HOME LOAN BANK ADVANCES FHLB advances and their related weighted average interest rates are summarized as follows: <TABLE> <CAPTION> DECEMBER 31, ----------------------------------------- 2000 1999 ------------------- ------------------- (IN THOUSANDS) <S> <C> <C> <C> <C> Maturing during Year Ending December 31, 2000..................................... $ -- --% $468,000 5.87% 2001..................................... 244,000 6.53% -- --% 2002..................................... 10,000 6.33% -- --% 2003..................................... 14,000 5.94% 14,000 5.94% -------- ---- -------- ----- Total.................................. $268,000 6.49% $482,000 5.87% ======== ==== ======== ===== </TABLE> At December 31, 2000 and 1999, all outstanding FHLB advances have fixed interest rates for a specific term. Some advances are secured by certain real estate loans with remaining principal balances of approximately $592.9 million and $600.4 million at December 31, 2000 and 1999, respectively. 12. CAPITAL RESOURCES SHELF REGISTRATION During the first quarter of 2000, the Company filed a $50 million universal shelf registration statement with the Securities and Exchange Commission. Pursuant to this filing, the Company may offer new common stock, trust preferred, preferred stock and/or other debentures to augment its capital resources. The timing and amount of offerings will depend on market and general business conditions. The Company intends to utilize the net proceeds from the sale of securities for general business purposes, which include supporting the growth of its commercial banking activities and possible future acquisitions. At December 31, 2000, the Company has not offered new common stock, trust preferred, preferred stock and/or other debentures pursuant to this shelf registration. JUNIOR SUBORDINATED DEBT SECURITIES On March 23, 2000, East West Capital Trust I, a statutory business trust and wholly owned subsidiary of the Company, issued $10.8 million of junior subordinated deferrable interest debentures. These securities have a scheduled maturity date of March 8, 2030 and an interest rate of 10.875% per annum. Interest payments are due on March 8 and September 8 of each year. On July 26, 2000, East West Capital Trust II, also a statutory business trust and wholly owned subsidiary of the Company, issued $10.0 million in junior subordinated deferrable interest debentures. The scheduled maturity date of these securities is July 19, 2030. These securities bear an interest rate of 10.945% per annum and interest payments are due on January 19 and July 19 of each year. Interest payments on these securities are deductible for tax purposes. These securities, which are not registered with the Securities and Exchange Commission, are recorded in the liability section of the consolidated balance sheet in accordance with accounting principles generally accepted in the United States of America. For regulatory reporting purposes, these securities qualify for Tier 1 capital treatment. REGULATED INVESTMENT COMPANY On July 13, 2000, East West Securities Company, Inc., was incorporated as a closed-end, non-diversified management investment company registered under the Investment Company Act of 70
12. CAPITAL RESOURCES (CONTINUED) 1940, as amended. The formation of this entity provides the Company with the flexibility to raise additional capital in a tax efficient manner for future business opportunities, if desired. 13. INCOME TAXES The provision for income taxes consists of the following components: <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, ------------------------------ 2000 1999 1998 -------- -------- -------- (IN THOUSANDS) <S> <C> <C> <C> Current income tax expense: Federal........................................ $13,432 $11,155 $ 8,801 State.......................................... 1,989 4,925 2,571 ------- ------- ------- Total current income tax expense............. 15,421 16,080 11,372 ------- ------- ------- Deferred income tax expense (benefit): Federal........................................ (350) (2,062) (1,837) State.......................................... (443) (415) 147 ------- ------- ------- Total deferred income tax benefit............ (793) (2,477) (1,690) ------- ------- ------- Provision for income taxes..................... $14,628 $13,603 $ 9,682 ======= ======= ======= </TABLE> The difference between the effective tax rate implicit in the consolidated financial statements and the statutory federal income tax rate can be attributed to the following: <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, ------------------------------------ 2000 1999 1998 -------- -------- -------- <S> <C> <C> <C> Federal income tax provision at statutory rate....... 35.0% 35.0% 35.0% State franchise taxes, net of federal tax effect..... 2.0 7.0 6.4 Low income housing tax credits....................... (7.7) (7.7) (6.1) Other, net........................................... (0.1) (1.6) (0.4) ----- ----- ----- Effective income tax rate............................ 29.2% 32.7% 34.9% ===== ===== ===== </TABLE> During the year ended December 31, 2000, the Company realized state tax benefits through the formation and funding of a regulated investment company in July 2000. There were no such benefits realized during the years ended December 31, 1999 and 1998. 71
13. INCOME TAXES (CONTINUED) The tax effects of temporary differences that give rise to significant portions of the deferred tax (assets) liabilities are presented below: <TABLE> <CAPTION> DECEMBER 31, ------------------- 2000 1999 -------- -------- (IN THOUSANDS) <S> <C> <C> Deferred tax liabilities: Core deposit premium.................................. $ 4,707 $ 2,749 Depreciation.......................................... 2,575 3,111 FHLB stock dividends.................................. 3,924 3,184 Deferred loan fees.................................... 4,447 4,125 Other, net............................................ 3,904 3,194 -------- -------- Total gross deferred tax liabilities................ 19,557 16,363 -------- -------- Deferred tax assets: Bad debt deduction.................................... (9,706) (8,151) Purchased loan discounts.............................. (1,577) (1,455) Deferred compensation accrual......................... (1,310) (1,058) California franchise tax.............................. (724) (1,443) Unrealized loss on securities......................... (5,134) (8,860) Federal net operating loss carryforwards.............. (4,678) -- State net operating loss carryforwards................ (240) -- Other, net............................................ (6,695) (3,715) -------- -------- Total gross deferred tax assets......................... (30,064) (24,682) -------- -------- Net deferred tax assets............................. $(10,507) $ (8,319) ======== ======== </TABLE> At December 31, 2000, the Company has federal net operating loss carryforwards of approximately $15.0 million which expire through 2020 and state operating loss carryforwards of approximately $3.9 million which expire through 2005. These net operating loss carryforwards were acquired by the Company in connection with its acquisition of American International Bank. Federal and state tax laws, related to a change in ownership such as the acquisition of American International Bank, place limitations on the annual amount of operating loss carryovers that can be utilized to offset post-acquisition operating income. Under Internal Revenue Code Section 382, which has been adopted under California law, if during any three-year period there is more than a 50% change in ownership of the Bank, then the future use of any pre-change net operating losses or built-in losses of the Bank would be subject to an annual percentage limitation based on the value of the Bank at an ownership change date. 14. COMMITMENTS AND CONTINGENCIES CREDIT EXTENSIONS--In the normal course of business, there are various outstanding commitments to extend credit which are not reflected in the accompanying consolidated financial statements. While the Company does not anticipate losses as a result of these transactions, commitments are included in determining the appropriate level of the allowance for loan losses. Loan commitments are agreements to lend to a customer provided there is no violation of any condition established in the agreement. Commitments generally have fixed expiration dates or other termination clauses. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future funding requirements. The Company 72
14. COMMITMENTS AND CONTINGENCIES (CONTINUED) uses the same credit policies in making commitments and conditional obligations as it does in extending loan facilities to customers. The Company evaluates each customer's 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 management's credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties. As of December 31, 2000 and 1999, undisbursed loan commitments amounted to $311.0 million and $290.8 million, respectively. In addition, the Company committed to fund mortgage loan applications in process amounting to $41.4 million and $34.8 million as of December 31, 2000 and 1999, respectively. Commercial letters of credit are issued to facilitate domestic and foreign trade transactions while standby letters of credit are issued to make payments on behalf of customers when certain specified future events occur. As of December 31, 2000 and 1999, commercial and standby letters of credit totaled $183.1 million and $151.7 million, respectively. LEASE COMMITMENTS--The Company conducts a portion of its operations utilizing leased premises and equipment under operating leases. Rental expense amounted to $2.6 million, $1.6 million and $1.4 million for the years ended December 31, 2000, 1999 and 1998, respectively. Future minimum rental payments under noncancelable operating leases are as follows: <TABLE> <CAPTION> YEAR ENDING DECEMBER 31, (IN THOUSANDS) - ------------ -------------- <S> <C> 2001........................................................ $ 2,308 2002........................................................ 1,923 2003........................................................ 1,688 2004........................................................ 1,438 2005........................................................ 1,309 Thereafter.................................................. 2,222 ------- Total................................................... $10,888 ======= </TABLE> LITIGATION--Neither the Company nor the Bank is involved in any material legal proceedings. The Bank, from time to time, is a party to litigation which arises in the ordinary course of business, such as claims to enforce liens, claims involving the origination and servicing of loans, and other issues related to the business of the Bank. After taking into consideration information furnished by counsel to the Company and the Bank, management believes that the resolution of such issues would not have a material adverse impact on the financial position, results of operations, or liquidity of the Company or the Bank. REGULATED INVESMENT COMPANY--In August 2000, the Securities and Exchange Commission completed an examination of East West Securities Company, Inc. The Company received the Commission's findings in a letter dated September 11, 2000. The Commission staff determined that the Fund should not be eligible to be registered as an investment company due to the failure to meet certain regulatory requirements of the Investment Company Act of 1940 and requested that the Fund voluntarily de-register. In its response to the Commission, dated October 11, 2000, the Company stated that it disagrees with certain factual statements and conclusions of law contained in the Commission's findings and sets forth the basis for its belief based on advice of counsel, which was included, that the Fund was formed in compliance with regulatory requirements. In response, the Commission has issued another letter to the Company, dated December 12, 2000, which is essentially similar to the 73
14. COMMITMENTS AND CONTINGENCIES (CONTINUED) Commission's initial letter. The Company has declined the Commission's requests to voluntarily de-register the Fund. The Company expects to receive further correspondence from the Commission. If the Company were to accommodate the Commission's requests to voluntarily de-register the Fund, the Company would forego the state tax benefits that are currently being realized through the Fund. Estimated professional fees totaling $600 thousand, contingent upon realization of these state tax benefits, are due and payable in the first quarter of 2001. Further, the Company would forfeit its flexibility to raise additional capital in a tax efficient manner for future business opportunities through the Fund. Management believes, based on the advice of counsel, that the impact of de-registration would be prospective only and not retroactive. The Fund would continue to be a registered investment company under the Investment Company Act of 1940, from the date of registration to the effective date of de-registration. 15. STOCK COMPENSATION PLANS STOCK OPTIONS The Company adopted the 1998 Stock Incentive Plan (the "Plan") on June 25, 1998. Pursuant to an amendment under the Plan, the Company may grant stock options, restricted stock, or any form of award deemed appropriate not to exceed 2,902,000 shares of common stock over a ten-year period. The stock options awarded under the Plan are granted with a four-year or three-year vesting period and a ten-year contractual life. At December 31, 2000 and 1999, 35,000 and 60,000 options have been granted respectively to nonemployee directors under the Plan. A summary of the Company's stock options as of and for the years ended December 31, 2000, 1999, and 1998 is presented below: <TABLE> <CAPTION> 2000 1999 1998 -------------------- -------------------- -------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE SHARES PRICE SHARES PRICE SHARES PRICE --------- -------- --------- -------- --------- -------- <S> <C> <C> <C> <C> <C> <C> Outstanding at beginning of year......... 1,753,474 $10.00 1,715,150 $10.00 -- $ -- Granted.................................. 338,000 15.39 72,200 10.42 1,716,850 10.00 Exercised................................ (16,444) 10.00 -- -- -- -- Forfeited................................ (57,839) 11.90 (33,876) 10.00 (1,700) 10.00 --------- ------ --------- ------ --------- ------ Outstanding at end of year............... 2,017,191 $10.86 1,753,474 $10.02 1,715,150 $10.00 ========= ====== ========= ====== ========= ====== Options exercisable at year-end.......... 834,749 426,834 None Weighted-average fair value of options granted during the year................ $ 8.55 $ 5.18 $ 4.08 </TABLE> 74
The following table summarizes information about stock options outstanding at December 31, 2000: <TABLE> <CAPTION> OPTIONS OUTSTANDING OPTIONS EXERCISABLE ----------------------------------------- ---------------------- NUMBER WEIGHTED WEIGHTED NUMBER WEIGHTED OF AVERAGE AVERAGE OF AVERAGE OUTSTANDING REMAINING EXERCISE EXERCISABLE EXERCISE RANGE OF EXERCISE PRICES OPTIONS CONTRACTUAL LIFE PRICE OPTIONS PRICE - ------------------------ ----------- ---------------- -------- ----------- -------- <C> <C> <S> <C> <C> <C> 10 to $$12........ 1,724,191 7.5 years $10.02 832,999 $10.00 12 to $$14........ 17,000 9 years 12.21 1,750 12.25 14 to $$16........ 255,000 9.3 years 15.80 -- -- 16 to $$18........ -- -- -- -- -- 18 to $$20........ 16,000 9.8 years 18.94 -- -- 20 to $$22........ 5,000 9.9 years 20.63 -- -- --------- --------- ------ ------- ------ 10 to $$22........ 2,017,191 7.8 years $10.86 834,749 $10.00 ========= ========= ====== ======= ====== </TABLE> The following table summarizes information about stock options outstanding at December 31, 1999: <TABLE> <CAPTION> OPTIONS OUTSTANDING OPTIONS EXERCISABLE ----------------------------------------- ---------------------- NUMBER WEIGHTED WEIGHTED NUMBER WEIGHTED OF AVERAGE AVERAGE OF AVERAGE OUTSTANDING REMAINING EXERCISE EXERCISABLE EXERCISE RANGE OF EXERCISE PRICES OPTIONS CONTRACTUAL LIFE PRICE OPTIONS PRICE - ------------------------ ----------- ---------------- -------- ----------- -------- <C> <C> <S> <C> <C> <C> 10 to $$11........ 1,736,474 8.5 years $10.00 426,834 $10.00 11 to $$12........ 10,000 10 years 11.44 -- -- 12 to $$13........ 7,000 9.9 years 12.25 -- -- --------- --------- ------ ------- ------ 10 to $$13........ 1,753,474 8.5 years $10.02 426,834 $10.00 ========= ========= ====== ======= ====== </TABLE> The Company applies APB Opinion No. 25 and related interpretations in accounting for the Plan, and accordingly, no compensation expense has been recognized in the consolidated financial statements since the stock options were granted at fair value. Had the Company determined compensation expense based on the fair value at the grant date consistent with SFAS No. 123, the Company's net income and earnings per share ("EPS") would have been reduced to the pro forma amounts indicated below: <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, -------------------------------------- 2000 1999 1998 ---------- ---------- ---------- (IN THOUSANDS, EXCEPT PER SHARE DATA) <S> <C> <C> <C> Net Income As Reported............................... $35,467 $28,027 $18,028 Pro Forma................................. $34,450 $27,241 $17,519 Basic EPS As Reported............................... $ 1.58 $ 1.23 $ 0.76 Pro Forma................................. $ 1.53 $ 1.20 $ 0.74 Diluted EPS As Reported............................... $ 1.53 $ 1.22 $ 0.76 Pro Forma................................. $ 1.49 $ 1.19 $ 0.74 </TABLE> The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions in 2000, 1999 and 1998, respectively: dividend yield of 0.8%, 1.2% and 1.2%; expected volatility of 47.5%, 43.5% and 30.4%; risk-free interest rate of 5.1%, 6.7% and 4.8%; and expected lives of 6.0 years, 6.0 years and 6.5 years. 75
RESTRICTED STOCK As part of the 1998 Stock Incentive Plan, the Company granted restricted stock with a three-year vesting period and a ten-year contractual life to certain officers and employees during 1999 and 2000. Noncash compensation cost amounted to $405 thousand and $249 thousand for the years ended December 31, 2000 and 1999, respectively. The Company was not entitled to any income tax deduction in 2000 and 1999 in connection with the restricted stock award, since no restrictions have lapsed and no shares have been issued. A summary of the Company's Restricted Stock as of December 31, 2000 and 1999, and changes during the years then ended are as follows: <TABLE> <CAPTION> 2000 1999 ------------------- ------------------- WEIGHTED WEIGHTED AVERAGE AVERAGE SHARES PRICE SHARES PRICE -------- -------- -------- -------- <S> <C> <C> <C> <C> Outstanding at beginning of year......... 94,140 $10.62 -- $ -- Granted.................................. 1,500 12.00 105,003 10.59 Forfeited................................ (11,878) 10.56 (10,863) 10.59 ------- ------ ------- ------ Outstanding at end of year............... 83,762 $10.65 94,140 $10.59 ======= ====== ======= ====== </TABLE> STOCK PURCHASE PLAN The Company has adopted the 1998 Employee Stock Purchase Plan (the "Purchase Plan"), providing eligible employees of the Company and its subsidiaries participation in the ownership of the Company through the right to purchase shares of the Company's common stock at a discount. Under the terms of the Purchase Plan, employees can purchase shares of the Company's common stock at 85% of the per-share market price at the date of grant, subject to an annual limitation of common stock valued at $25,000. The Purchase Plan qualifies as a noncompensatory plan under Section 423 of the Internal Revenue Code, and accordingly, no compensation expense is recognized under the plan. The Purchase Plan covers a total of 1,000,000 shares of the Company's common stock. During 2000 and 1999, 53,584 shares totaling $496 thousand and 28,728 shares totaling $218 thousand, respectively, were sold to employees under the Purchase Plan. WARRANTS In connection with the securities offering and change in ownership of the Bank, warrants to purchase 475,500 shares of common stock of the Company were issued to the placement agent in June 1998. The warrants are exercisable for a five-year period at an exercise price of $10 per share. At December 31, 2000, warrants to purchase a total of 50,719 shares of common stock remain outstanding. 16. EMPLOYEE BENEFIT PLAN The Company sponsors a defined contribution plan for the benefit of its employees. The Company's contributions to the plan are determined annually by the Board of Directors in accordance with plan requirements. For tax purposes, eligible participants may contribute up to a maximum of 15% of their compensation, not to exceed the dollar limit imposed by the Internal Revenue Service. For the plan years ended December 31, 2000, 1999 and 1998, the Company contributed $578 thousand, $459 thousand, and $400 thousand, respectively. 76
17. STOCKHOLDERS' EQUITY AND EARNINGS PER SHARE STOCK REPURCHASE PROGRAM During 1999, the Company's Board of Directors authorized the Company to repurchase up to $21.0 million of its common stock under three different Stock Repurchase Programs. During the years ended December 31, 2000 and 1999, the Company has repurchased 361,878 shares and 1,485,863 shares of common stock with a cost of $8.4 million and $14.7 million, respectively. A portion of the shares repurchased during the year ended December 31, 2000, specifically 100,000 shares at a total cost of $2.4 million, were purchased in a private transaction in connection with the exercise of stock warrants that were issued to the placement agent in June 1998. The repurchase of these shares are exclusive of the three aforementioned Stock Repurchase Programs. QUARTERLY DIVIDENDS The Company has declared and paid a cash dividend of $0.03 per share during the four quarters of 2000 and 1999 to its shareholders totaling $2.7 million per year. EARNINGS PER SHARE The calculation of earnings per share and diluted earnings per share for 2000, 1999 and 1998 is presented below: <TABLE> <CAPTION> NET NUMBER PER SHARE INCOME OF SHARES AMOUNTS --------- ---------- ---------- (IN THOUSANDS, EXCEPT PER SHARE DATA) <S> <C> <C> <C> 2000 Basic EPS................................... $35,467 22,448 $1.58 Effect of dilutive securities: Stock Options............................. -- 571 Restricted Stock.......................... -- 33 Stock Warrants............................ -- 116 ------- ------ Diluted EPS................................. $35,467 23,168 $1.53 ======= ====== 1999 Basic EPS................................... $28,027 22,757 $1.23 Effect of dilutive securities: Stock Options............................. -- 69 Restricted Stock.......................... -- 51 Stock Warrants............................ -- 18 ------- ------ Diluted EPS................................. $28,027 22,895 $1.22 ======= ====== 1998 Basic EPS................................... $18,028 23,775 $0.76 Effect of dilutive securities............... -- -- ------- ------ Diluted EPS................................. $18,028 23,775 $0.76 ======= ====== </TABLE> 77
18. REGULATORY REQUIREMENTS RISK-BASED CAPITAL The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies, including the Federal Deposit Insurance Corporation ("FDIC"). Failure to meet minimum capital requirements can initiate certain mandatory actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. As of December 31, 2000 and 1999, the most recent notification from the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain specific total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table below. There are no conditions or events since that notification which management believes have changed the category of the Bank. The actual and required capital amounts and ratios at December 31, 2000 and 1999 are presented as follows: <TABLE> <CAPTION> TO BE WELL CAPITALIZED FOR CAPITAL UNDER PROMPT ADEQUACY CORRECTIVE ACTUAL PURPOSES ACTION PROVISIONS ------------------- ------------------- ------------------- AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO -------- -------- -------- -------- -------- -------- (IN THOUSANDS) <S> <C> <C> <C> <C> <C> <C> AS OF DECEMBER 31, 2000: Total Capital (to Risk-Weighted Assets) Consolidated Company...................... $213,678 10.9% $157,588 8.0% $196,985 10.0% East West Bank............................ $209,937 10.7% $157,422 8.0% $196,777 10.0% Tier I Capital (to Risk-Weighted Assets) Consolidated Company...................... $189,830 9.6% $ 78,794 4.0% $118,191 6.0% East West Bank............................ $186,089 9.5% $ 78,711 4.0% $118,066 6.0% Tier I Capital (to Average Assets) Consolidated Company...................... $189,830 7.7% $ 98,249 4.0% $122,812 5.0% East West Bank............................ $186,089 7.9% $ 94,788 4.0% $118,485 5.0% AS OF DECEMBER 31, 1999: Total Capital (to Risk-Weighted Assets) Consolidated Company...................... $174,917 10.6% $132,223 8.0% $165,279 10.0% East West Bank............................ $174,885 10.6% $132,200 8.0% $165,250 10.0% Tier I Capital (to Risk-Weighted Assets) Consolidated Company...................... $154,255 9.3% $ 66,112 4.0% $ 99,168 6.0% East West Bank............................ $154,226 9.3% $ 66,100 4.0% $ 99,150 6.0% Tier I Capital (to Average Assets) Consolidated Company...................... $154,255 7.3% $ 84,444 4.0% $105,555 5.0% East West Bank............................ $154,226 7.3% $ 84,505 4.0% $105,631 5.0% </TABLE> 78
RESERVE REQUIREMENT The Company is required to maintain a percentage of its deposits as reserves at the Federal Reserve Bank. The daily average reserve requirement was approximately $7.4 million and $1.0 million at December 31, 2000 and 1999, respectively. 19. FAIR VALUES OF FINANCIAL INSTRUMENTS The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data to develop estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. <TABLE> <CAPTION> DECEMBER 31, --------------------------------------------------- 2000 1999 ------------------------ ------------------------ CARRYING CARRYING OR CONTRACT ESTIMATED OR CONTRACT ESTIMATED AMOUNT FAIR VALUE AMOUNT FAIR VALUE ----------- ---------- ----------- ---------- (IN THOUSANDS) <S> <C> <C> <C> <C> Assets: Cash and cash equivalents....................... $ 63,048 $ 63,048 $ 43,497 $ 43,497 Investment securities available for sale........ 488,290 488,290 496,426 496,426 Loans receivable, net........................... 1,789,988 1,788,317 1,486,641 1,490,108 FHLB stock...................................... 14,845 14,845 26,954 26,954 Accrued interest receivable..................... 15,138 15,138 11,988 11,988 Liabilities: Customer deposit accounts: Demand accounts............................... 647,174 647,174 499,349 499,349 Time deposits............................... 1,301,388 1,299,899 1,001,180 1,002,176 Short-term borrowings........................... 38,000 38,013 600 600 FHLB advances................................... 268,000 268,074 482,000 482,507 Junior subordinated debt securities............. 20,750 22,797 -- -- Accrued interest payable........................ 5,010 5,010 958 958 Off-balance sheet financial instruments: Commercial letters of credit.................... 14,842 19 13,394 17 Standby letters of credit....................... 168,300 1,968 138,281 1,340 Commitments to extend credit.................... 310,974 1,733 290,797 1,601 Derivatives: Interest rate swaps........................... -- (149) 286 (1,122) Interest rate caps............................ 24 24 256 256 </TABLE> The methods and assumptions used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value are explained below: CASH AND CASH EQUIVALENTS--The carrying amounts approximate fair values due to the short-term nature of these instruments. INVESTMENT SECURITIES AND DERIVATIVE INSTRUMENTS--The fair value is based on quoted market price from securities brokers or dealers in the respective instruments. LOANS AND ACCRUED INTEREST RECEIVABLE--Fair values are estimated for portfolios of loans with similar financial characteristics, primarily fixed and adjustable rate interest terms. The fair values of fixed rate 79
19. FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED) mortgage loans are based upon discounted cash flows utilizing applicable risk-adjusted spreads relative to the current pricing for 15- and 30-year conventional loans as well as anticipated prepayment schedules. The fair values of adjustable rate mortgage loans are based upon discounted cash flows utilizing discount rates that approximate the risk-adjusted pricing of available mortgage-backed securities having similar rates and repricing characteristics as well as anticipated prepayment schedules. No adjustments have been made for changes in credit within the loan portfolio. It is management's opinion that the allowance for loan losses pertaining to performing and nonperforming loans results in a fair valuation of such loans. The carrying amount of accrued interest receivable approximates fair value due to its short term nature. FHLB STOCK--The carrying amount approximates fair value, as the stock may be sold back to the Federal Home Loan Bank at carrying value. DEPOSITS AND ACCRUED INTEREST PAYABLE--The fair values of deposits are estimated based upon the type of deposit products. Demand accounts, which include passbooks and transaction accounts, are presumed to have equal book and fair values, since the interest rates paid on these accounts are based on prevailing market rates. The estimated fair values of time deposits are based upon the contractual discounted cash flows estimated in current rate for the deposits over the remaining terms. The carrying amount of accrued interest payable approximates fair value due to its short term nature. SHORT-TERM BORROWINGS--The fair values are estimated by discounting the amounts contractually due under such agreements using the prevailing federal funds rate at each reporting date. FHLB ADVANCES--The fair values of FHLB advances are estimated based on the discounted value of contractual cash flows, using rates currently offered by the Federal Home Loan Bank of San Francisco for fixed-rate credit advances with similar remaining maturities at each reporting date. JUNIOR SUBORDINATED DEBT SECURITIES--The fair values of junior subordinated debt securities are estimated by discounting the cash flows through maturity based on prevailing rates offered on the 30-year Treasury bond at each reporting date. COMMITMENTS TO EXTEND CREDIT, COMMERCIAL AND STANDBY LETTERS OF CREDIT--The fair values of commitments are estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparty's credit standing. The fair value estimates presented herein are based on pertinent information available to management as of each reporting date. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date, and therefore, current estimates of fair value may differ significantly from the amounts presented herein. 20. RELATED PARTY TRANSACTIONS The Company enters into certain related party transactions with its affiliates in the normal course of business. These transactions are conducted at market terms. One of the Company's directors is a guarantor of an extension of credit to two corporations in which the director is an executive officer and the beneficial owner of over 10% of a class of equity securities of the two corporations. At December 31, 1999, the total approved commitment amounted to $1.1 million with an outstanding balance of $410 thousand. This loan was repaid in full during 2000. No extension of credit was outstanding for any related party as of December 31, 2000. 80
21. SEGMENT INFORMATION Management utilizes an internal reporting system to measure the performance of various operating segments within the Company and the Company overall. Four principal operating segments have been identified by the Company for purposes of management reporting: retail banking, commercial lending, treasury, and residential lending. Information related to the Company's remaining centralized functions and eliminations of intersegment amounts have been aggregated and included in "Other." Although all four operating segments offer financial products and services, they are managed separately based on each segment's strategic focus. While the retail banking segment focuses primarily on retail operations through the Company's branch network, certain designated branches have responsibility for generating commercial deposits and loans. The commercial lending segment primarily generates commercial loans and deposits through the efforts of commercial lending officers located in the Company's northern and southern California production offices. The treasury department's primary focus is managing the Company's investments, liquidity, and interest rate risk; the residential lending segment is mainly responsible for the Company's portfolio of single family and multifamily residential loans. Operating segment results are based on the Company's internal management reporting process, which reflects assignments and allocations of capital, certain operating and administrative costs and the provision for loan losses. Net interest income is based on the Company's internal funds transfer pricing system which assigns a cost of funds or a credit for funds to assets or liabilities based on their type, maturity or repricing characteristics. Noninterest income and noninterest expense, including depreciation and amortization, directly attributable to a segment are assigned to that business. Indirect costs, including overhead expense, are allocated to the segments based on several factors, including, but not limited to, full-time equivalent employees, loan volume and deposit volume. The provision for credit losses is allocated based on new loan originations for the period. The Company evaluates overall performance based on profit or loss from operations before income taxes not including nonrecurring gains and losses. Future changes in the Company's management structure or reporting methodologies may result in changes in the measurement of operating segment results. Results for prior periods have been restated for comparability for changes in management structure or reporting methodologies. The following tables present the operating results and other key financial measures for the individual operating segments for the years ended December 31, 2000, 1999 and 1998: <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, 2000 --------------------------------------------------------------------- RETAIL COMMERCIAL RESIDENTIAL BANKING LENDING TREASURY LENDING OTHER TOTAL -------- ---------- -------- ----------- -------- --------- <S> <C> <C> <C> <C> <C> <C> (IN THOUSANDS) Interest income................ $ 47,428 $ 61,379 $ 35,029 $ 38,903 $ 3,341 $ 186,080 Charge for funds used.......... (32,425) (43,763) (34,071) (32,540) (854) (143,653) -------- -------- -------- -------- -------- --------- Interest spread on funds used....................... 15,003 17,616 958 6,363 2,487 42,427 -------- -------- -------- -------- -------- --------- Interest expense............... (52,902) (5,301) (38,390) -- -- (96,593) Credit on funds provided....... 88,784 10,141 44,728 -- -- 143,653 -------- -------- -------- -------- -------- --------- Interest spread on funds provided................... 35,882 4,840 6,338 -- -- 47,060 -------- -------- -------- -------- -------- --------- Net interest income........ $ 50,885 $ 22,456 $ 7,296 $ 6,363 $ 2,487 $ 89,487 ======== ======== ======== ======== ======== ========= Depreciation and amortization................. $ 4,228 $ 486 $ 321 $ 684 $ 3,032 $ 8,751 Segment profit................. 22,160 14,391 6,846 4,985 1,713 50,095 Segment assets................. 516,398 765,746 507,642 534,086 162,099 2,485,971 </TABLE> 81
<TABLE> <CAPTION> YEAR ENDED DECEMBER 31, 1999 --------------------------------------------------------------------- RETAIL COMMERCIAL RESIDENTIAL BANKING LENDING TREASURY LENDING OTHER TOTAL -------- ---------- -------- ----------- -------- --------- <S> <C> <C> <C> <C> <C> <C> (IN THOUSANDS) Interest income................ $ 28,868 $ 45,700 $ 38,959 $ 32,029 $ 2,471 $ 148,027 Charge for funds used.......... (17,048) (27,271) (33,472) (22,689) (149) (100,629) -------- -------- -------- -------- -------- --------- Interest spread on funds used....................... 11,820 18,429 5,487 9,340 2,322 47,398 -------- -------- -------- -------- -------- --------- Interest expense............... (40,032) (3,016) (33,094) -- -- (76,142) Credit on funds provided....... 58,161 5,417 37,051 -- -- 100,629 -------- -------- -------- -------- -------- --------- Interest spread on funds provided................... 18,129 2,401 3,957 -- -- 24,487 -------- -------- -------- -------- -------- --------- Net interest income........ $ 29,949 $ 20,830 $ 9,444 $ 9,340 $ 2,322 $ 71,885 ======== ======== ======== ======== ======== ========= Depreciation and amortization................. $ 2,550 $ 251 $ 346 $ (258) $ 1,250 $ 4,139 Segment profit................. 7,332 16,511 9,919 7,379 489 41,630 Segment assets................. 384,718 655,739 533,387 487,299 91,487 2,152,630 </TABLE> <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, 1998 --------------------------------------------------------------------- RETAIL COMMERCIAL RESIDENTIAL BANKING LENDING TREASURY LENDING OTHER TOTAL -------- ---------- -------- ----------- -------- --------- <S> <C> <C> <C> <C> <C> <C> (IN THOUSANDS) Interest income................ $ 16,273 $ 29,502 $ 40,901 $ 37,368 $ 2,664 $ 126,708 Charge for funds used.......... (9,949) (17,035) (36,871) (31,353) (577) (95,785) -------- -------- -------- -------- -------- --------- Interest spread on funds used....................... 6,324 12,467 4,030 6,015 2,087 30,923 -------- -------- -------- -------- -------- --------- Interest expense............... (41,839) (2,738) (26,466) -- -- (71,043) Credit on funds provided....... 59,171 4,096 32,518 -- -- 95,785 -------- -------- -------- -------- -------- --------- Interest spread on funds provided................... 17,332 1,358 6,052 -- -- 24,742 -------- -------- -------- -------- -------- --------- Net interest income........ $ 23,656 $ 13,825 $ 10,082 $ 6,015 $ 2,087 $ 55,665 ======== ======== ======== ======== ======== ========= Depreciation and amortization................. $ 2,267 $ 227 $ 1,799 $ 647 $ (401) $ 4,539 Segment profit................. 3,292 11,996 8,605 3,676 141 27,710 Segment assets................. 246,336 412,647 839,309 433,538 126,330 2,058,160 </TABLE> 82
22. EAST WEST BANCORP, INC. (PARENT COMPANY ONLY) BALANCE SHEETS <TABLE> <CAPTION> DECEMBER 31, ------------------- 2000 1999 -------- -------- (IN THOUSANDS) <S> <C> <C> ASSETS: Cash and cash equivalents................................... $ 2,441 $ -- Loans receivable............................................ 500 -- Investment in subsidiaries.................................. 203,425 150,051 Investment in nonbank entity................................ 500 250 Goodwill.................................................... 351 -- Other assets................................................ 721 36 -------- -------- Total assets............................................ $207,938 $150,337 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY: LIABILITIES Junior subordinated debt securities......................... $ 20,750 $ -- Other liabilities........................................... 1,039 257 -------- -------- Total liabilities....................................... 21,789 257 ======== ======== STOCKHOLDERS' EQUITY Common stock (par value $0.001 per share) Authorized--50,000,000 shares Issued--24,508,331 shares and 23,908,731 shares in 2000 and 1999, respectively Outstanding--22,660,590 shares and 22,422,868 shares in 2000 and 1999, respectively............................. 25 24 Additional paid in capital.................................. 118,039 111,306 Retained earnings........................................... 99,764 67,001 Deferred compensation....................................... (1,344) (863) Treasury stock, at cost: 1,847,741 shares and 1,485,863 shares in 2000 and 1999, respectively..................... (23,060) (14,659) Accumulated other comprehensive loss, net of tax............ (7,275) (12,729) -------- -------- Total stockholders' equity.............................. 186,149 150,080 -------- -------- Total liabilities and stockholders' equity............ $207,938 $150,337 ======== ======== </TABLE> STATEMENTS OF INCOME <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, ------------------------------ 2000 1999 1998 -------- -------- -------- (IN THOUSANDS) <S> <C> <C> <C> Dividends from subsidiaries................................. $ 9,578 $17,494 $ 73 Interest income............................................. 10 -- -- Other income................................................ 14 -- -- ------- ------- ------- Total income............................................ 9,602 17,494 73 ------- ------- ------- Interest expense............................................ 1,377 -- -- Other expense............................................... 1,052 977 73 ------- ------- ------- Total expense........................................... 2,429 977 73 ------- ------- ------- Income before income taxes and equity in undistributed income of subsidiaries.................................... 7,173 16,517 -- Income tax benefit.......................................... 1,008 448 -- Equity in undistributed income of subsidiaries.............. 27,286 11,062 18,028 ------- ------- ------- Net income.............................................. $35,467 $28,027 $18,028 ======= ======= ======= </TABLE> 83
STATEMENTS OF CASH FLOWS <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, ------------------------------ 2000 1999 1998 -------- -------- -------- (IN THOUSANDS) <S> <C> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES: Net income.................................................. $ 35,467 $ 28,027 $ 18,028 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed income of subsidiaries.......... (27,286) (11,062) (18,028) Depreciation and amortization........................... 20 -- -- Net change in other assets.............................. (13) 6 (42) Net change in other liabilities......................... 779 215 42 Stock compensation cost................................. 421 249 -- -------- -------- -------- Net cash provided by operating activities............. 9,388 17,435 -- -------- -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Net change in loans receivable.............................. (500) -- -- Investment in nonbank entity................................ (250) (250) -- Capital contribution to subsidiary.......................... (20,078) -- -- -------- -------- -------- Net cash used in investing activities................. (20,828) (250) -- -------- -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of junior subordinated debt securities................................................ 20,750 -- -- Payment of debt issue cost.................................. (672) -- -- Proceeds from common stock options exercised................ 164 -- -- Proceeds from stock purchase plan........................... 496 218 -- Proceeds from stock warrants exercised...................... 4,248 -- -- Repurchases of common stock................................. (8,401) (14,659) -- Dividends paid on common stock.............................. (2,704) (2,744) -- -------- -------- -------- Net cash provided by (used in) financing activities... 13,881 (17,185) -- -------- -------- -------- Net increase in cash and cash equivalents................... 2,441 -- -- Cash and cash equivalents, beginning of year................ -- -- -- -------- -------- -------- Cash and cash equivalents, end of year...................... $ 2,441 $ -- $ -- ======== ======== ======== SUPPLEMENTAL CASH FLOW DISCLOSURES Noncash financing activity: Issuance of shares in connection with the acquisition of Risk Services, Inc., net of deferred compensation....... 869 -- -- </TABLE> 84
23. SUBSEQUENT EVENTS ACQUISITION OF PRIME BANK On January 16, 2001, the Company completed its acquisition of Prime Bank in a combination of shares and cash valued at $16.6 million. The acquisition of Prime Bank was accounted for under the purchase method of accounting, and accordingly, all assets and liabilities were adjusted to and recorded at their estimated fair values as of the acquisition date. The estimated tax effect of differences between tax bases and market values has been reflected in deferred income taxes. The Company recorded total goodwill of approximately $5.6 million and core deposit premium of $3.9 million, which are being amortized using the straight-line method over 15 years and 7 years, respectively. At December 31, 2000, Prime Bank had total assets of $128.4 million (unaudited) and total stockholders' equity of $9.0 million (unaudited). STOCK REPURCHASE PROGRAM On January 16, 2001, the Company's Board of Directors authorized the Company to repurchase another $7 million of its common stock. In connection with this latest repurchase program, the Company has repurchased a total of 275,000 shares of common stock at an aggregate cost of $6.4 million through March 20, 2001. QUARTERLY CASH DIVIDEND The Company has declared and paid a cash dividend of $0.03 per share on February 14, 2001 in the amount of $695 thousand. 24. QUARTERLY FINANCIAL INFORMATION (UNAUDITED) <TABLE> <CAPTION> QUARTERS ENDED --------------------------------------------------- DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31, ------------ ------------- -------- --------- (IN THOUSANDS, EXCEPT PER SHARE DATA) <S> <C> <C> <C> <C> 2000 Interest and dividend income..................... $48,430 $47,289 $46,120 $44,241 Interest expense................................. 25,856 24,711 23,769 22,257 ------- ------- ------- ------- Net interest income.............................. 22,574 22,578 22,351 21,984 Provision for loan losses........................ 300 1,300 1,400 1,400 ------- ------- ------- ------- Net interest income after provision for loan losses......................................... 22,274 21,278 20,951 20,584 Noninterest income............................... 3,446 3,660 3,469 4,393 Noninterest expense.............................. 13,799 12,250 12,177 11,734 ------- ------- ------- ------- Income before provision for income taxes......... 11,921 12,688 12,243 13,243 Provision for income taxes....................... 2,309 3,910 3,879 4,530 ------- ------- ------- ------- Net income....................................... $ 9,612 $ 8,778 $ 8,364 $ 8,713 ======= ======= ======= ======= Basic earnings per share......................... $ 0.42 $ 0.39 $ 0.37 $ 0.39 Diluted earnings per share....................... 0.40 0.38 0.37 0.38 </TABLE> 85
<TABLE> <CAPTION> QUARTERS ENDED --------------------------------------------------- DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31, ------------ ------------- -------- --------- (IN THOUSANDS, EXCEPT PER SHARE DATA) <S> <C> <C> <C> <C> 1999 Interest and dividend income..................... $39,525 $37,822 $36,018 $34,662 Interest expense................................. 19,819 19,211 18,681 18,431 ------- ------- ------- ------- Net interest income.............................. 19,706 18,611 17,337 16,231 Provision for loan losses........................ 1,433 1,320 1,486 1,200 ------- ------- ------- ------- Net interest income after provision for loan losses......................................... 18,273 17,291 15,851 15,031 Noninterest income............................... 3,590 3,544 4,227 3,332 Noninterest expense.............................. 10,475 10,637 9,580 8,817 ------- ------- ------- ------- Income before provision for income taxes......... 11,388 10,198 10,498 9,546 Provision for income taxes....................... 3,502 3,169 3,398 3,534 ------- ------- ------- ------- Net income....................................... $ 7,886 $ 7,029 $ 7,100 $ 6,012 ======= ======= ======= ======= Basic and diluted earnings per share............. $ 0.35 $ 0.31 $ 0.31 $ 0.26 </TABLE> 86
SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. <TABLE> <S> <C> <C> Dated: March 27, 2001 EAST WEST BANCORP, INC. (Registrant) By: /s/ DOMINIC NG ----------------------------------------- Dominic Ng CHAIRMAN OF THE BOARD, PRESIDENT AND CHIEF EXECUTIVE OFFICER </TABLE> Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated. <TABLE> <C> <S> <C> Chairman of the Board, /s/ DOMINIC NG President, Chairman, and ------------------------------------ Chief Executive Officer March 27, 2001 Dominic Ng (principal executive officer) Executive Vice President, /s/ JULIA GOUW Chief Financial Officer, ------------------------------------ and Director (principal March 27, 2001 Julia Gouw financial and accounting officer) /s/ HERMAN LI ------------------------------------ Director March 27, 2001 Herman Li /s/ JACK C. LIU ------------------------------------ Director March 27, 2001 Jack C. Liu /s/ JAMES P. MISCOLL ------------------------------------ Director March 27, 2001 James P. Miscoll /s/ KEITH W. RENKEN ------------------------------------ Director March 27, 2001 Keith W. Renken /s/ EDWARD ZAPANTA ------------------------------------ Director March 27, 2001 Edward Zapanta </TABLE> 87