As filed with the Securities and Exchange Commission on August 9, 1999 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------------- FORM 10-Q Mark One [X]QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 1999 or [_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to . Commission file number 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 incorporation or organization) Identification No.) 415 Huntington Drive, San Marino, California 91108 (Address of principal executive offices) (Zip Code) </TABLE> Registrant's telephone number, including area code: (626) 799-5700 ---------------- Securities registered pursuant to Section 12(b) of the Act: <TABLE> <CAPTION> Name of each exchange Title of each class on which registered ------------------- --------------------- <S> <C> 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 [_] Number of shares of common stock of the registrant outstanding as of July 31, 1999: 22,468,000 shares - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------
TABLE OF CONTENTS <TABLE> <S> <C> PART I--FINANCIAL INFORMATION................................................ 3 Item 1. Interim Consolidated Financial Statements.......................... 4-7 Notes to Interim Consolidated Financial Statements...................... 8-9 Item 2. Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations........................ 9-30 Item 3. Quantitative and Qualitative Disclosures of Market Risks........... 30 PART II--OTHER INFORMATION................................................... 31 Item 1. Legal Proceedings.................................................. 31 Item 2. Changes in Securities and Use of Proceeds.......................... 31 Item 3. Defaults upon Senior Securities.................................... 31 Item 4. Submission of Matters to a Vote of Security Holders................ 31 Item 5. Other Information.................................................. 31 Item 6. Exhibits and Reports on Form 8-K................................... 31 SIGNATURES................................................................... 32 </TABLE> 2
PART I--FINANCIAL INFORMATION ITEM 1. INTERIM CONSOLIDATED FINANCIAL STATEMENTS 3
EAST WEST BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands, except per share data) <TABLE> <CAPTION> June 30, December 31, 1999 1998 ----------- ------------ (unaudited) <S> <C> <C> ASSETS - ------ Cash and cash equivalents........................... $ 71,028 $ 161,131 Investment securities available for sale, at fair value (with amortized cost of $589,925 in 1999 and $683,335 in 1998).................................. 582,485 682,436 Loans receivable, net of allowance for loan losses of $20,019 in 1999 and $16,506 in 1998.................................... 1,324,504 1,100,579 Investment in Federal Home Loan Bank stock, at cost............................................... 27,330 32,874 Other real estate owned............................. 3,034 4,600 Investment in affordable housing partnerships....... 23,228 18,602 Premises and equipment, net......................... 23,029 23,406 Premiums on deposits acquired, net.................. 4,501 2,648 Excess of purchase price over fair value of net assets acquired, net............................... 7,006 3,590 Accrued interest receivable and other assets........ 28,982 28,294 Deferred tax asset.................................. 2,156 -- ---------- ---------- TOTAL........................................... $2,097,283 $2,058,160 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY - ------------------------------------ Customer deposit accounts........................... $1,433,882 $1,292,937 Securities sold under agreements to repurchase...... -- 33,000 Federal Home Loan Bank advances..................... 498,000 563,000 Notes payable....................................... 3,502 1,820 Accrued expenses and other liabilities.............. 13,775 12,871 Deferred income taxes............................... -- 1,259 ---------- ---------- Total liabilities................................. 1,949,159 1,904,887 ---------- ---------- FAIR VALUE OF NET ASSETS ACQUIRED IN EXCESS OF PURCHASE PRICE, NET................................ 2,236 2,443 STOCKHOLDER'S EQUITY Common stock (par value of $0.001 per share) Authorized -- 50,000,000 shares Issued and outstanding -- 22,468,000 shares and 23,775,000 shares in 1999 and 1998, respectively..................................... 22 24 Additional paid in capital.......................... 97,109 109,976 Accumulated other comprehensive loss: Unrealized losses on securities, net of tax....... (4,676) (888) Retained earnings................................... 53,433 41,718 ---------- ---------- Total stockholders' equity........................ 145,888 150,830 ---------- ---------- TOTAL........................................... $2,097,283 $2,058,160 ========== ========== </TABLE> See accompanying notes to interim consolidated financial statements. 4
EAST WEST BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (In thousands, except per share data) (unaudited) <TABLE> <CAPTION> Three Months Six Months Ended June 30, Ended June 30, --------------- ---------------- 1999 1998 1999 1998 ------- ------- ------- ------- <S> <C> <C> <C> <C> INTEREST AND DIVIDEND INCOME Loans receivable, including fees........... $25,759 $20,771 $49,017 $41,138 Investment securities available for sale... 9,266 5,500 19,044 10,193 Investment securities held for trading..... 14 -- 14 -- Short-term investments..................... 606 3,916 1,811 7,249 Federal Home Loan Bank stock............... 373 228 793 417 ------- ------- ------- ------- Total interest and dividend income........ 36,018 30,415 70,679 58,997 ------- ------- ------- ------- INTEREST EXPENSE Customer deposit accounts.................. 11,827 12,560 23,321 25,065 Short-term borrowings...................... 194 1,858 542 3,507 Federal Home Loan Bank advances............ 6,660 2,744 13,248 4,774 ------- ------- ------- ------- Total interest expense.................... 18,681 17,162 37,111 33,346 ------- ------- ------- ------- NET INTEREST INCOME BEFORE PROVISION FOR LOAN LOSSES................................ 17,337 13,253 33,568 25,651 PROVISION FOR LOAN LOSSES................... 1,486 1,583 2,686 3,325 ------- ------- ------- ------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES..................................... 15,851 11,670 30,882 22,326 ------- ------- ------- ------- NONINTEREST INCOME Loan fees.................................. 598 632 1,126 1,139 Branch fees................................ 883 669 1,611 1,246 Letters of credit fees and commissions..... 1,058 579 2,040 1,041 Net gain on sales of investment securities available for sale........................ 304 271 684 408 Net gain on sales of investment securities held for trading.......................... 407 -- 425 -- Net gain on sales of investment in affordable housing partnerships........... -- -- 402 -- Net gain on sale of branch................. 676 -- 676 -- Amortization of fair value of net assets acquired in excess of purchase price...... 105 104 208 208 Other operating income..................... 196 103 387 235 ------- ------- ------- ------- Total noninterest income.................. 4,227 2,358 7,559 4,277 ------- ------- ------- ------- NONINTEREST EXPENSE Compensation and employee benefits......... 4,463 4,210 9,137 8,613 Net occupancy.............................. 1,337 1,200 2,701 2,436 Data processing............................ 358 330 690 638 Amortization of premiums on deposits acquired and excess of purchase price over fair value of net assets acquired........................... 358 311 668 621 Amortization of investment in affordable housing partnerships...................... 777 281 1,187 507 Deposit insurance premiums and regulatory assessments............................... 208 213 416 423 Other real estate owned operations, net.... 23 (115) (261) (195) Other operating expenses................... 2,056 1,507 3,859 2,951 ------- ------- ------- ------- Total noninterest expense................. 9,580 7,937 18,397 15,994 ------- ------- ------- ------- INCOME BEFORE PROVISION FOR INCOME TAXES.... 10,498 6,091 20,044 10,609 PROVISION FOR INCOME TAXES.................. 3,398 2,262 6,932 3,764 ------- ------- ------- ------- NET INCOME.................................. $ 7,100 $ 3,829 $13,112 $ 6,845 ======= ======= ======= ======= BASIC AND DILUTED EARNINGS PER SHARE........ $ 0.31 $ 0.16 $ 0.57 $ 0.29 AVERAGE NUMBER OF SHARES OUTSTANDING........ 22,764 23,775 23,159 23,775 </TABLE> See accompanying notes to interim consolidated financial statements. 5
EAST WEST BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (unaudited) <TABLE> <CAPTION> Accumulated Additional Other Total Common Paid-In Comprehensive Retained Comprehensive Stockholders' Stock Capital Income (Losses) Earnings Income Equity ------ ---------- --------------- -------- ------------- ------------- (In thousands) <S> <C> <C> <C> <C> <C> <C> BALANCE, JANUARY 1, 1998 Comprehensive income... $24 $109,976 $(1,138) $23,690 $132,552 Net income for the year................. 18,028 $18,028 18,028 Other comprehensive income, net of tax... Net change in unrealized losses on securities, net of tax................. 250 250 250 --- -------- ------- ------- ------- -------- Comprehensive income... $18,278 ======= BALANCE, DECEMBER 31, 1998 24 109,976 (888) 41,718 150,830 Comprehensive income... Net income for the period............... 13,112 13,112 13,112 Other comprehensive income, net of tax... Net change in unrealized losses on securities, net of tax................. (3,788) (3,788) (3,788) ------- Comprehensive income... $ 9,324 ======= Repurchase of common stock................. (2) (12,867) (12,869) Dividends declared on common stock.......... (1,397) (1,397) --- -------- ------- ------- -------- BALANCE, JUNE 30, 1999.................. $22 $ 97,109 $(4,676) $53,433 $145,888 === ======== ======= ======= ======== </TABLE> <TABLE> <CAPTION> Six Months Year Ended Ended June 30, December 31, 1999 1998 ---------- ------------ (In thousands) <S> <C> <C> Disclosure of reclassification amounts: Unrealized holding (losses) gains arising during period, net of tax (benefit) expense of $(1,766) in 1999 and $595 in 1998................................ $(3,340) $1,109 Less: Reclassification adjustment for gains included in net income, net of tax expense of $237 in 1999 and $461 in 1998......................................... (448) (859) ------- ------ Net change in unrealized losses on securities, net of tax benefit (expense) of $2,002 in 1999 and $(134) in 1998................................................. $(3,788) $ 250 ======= ====== </TABLE> See accompanying notes to interim consolidated financial statements. 6
EAST WEST BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) <TABLE> <CAPTION> Six Months Ended June 30, ---------------------- 1999 1998 ----------- --------- (In thousands) <S> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES Net income............................................ $ 13,112 $ 6,845 Adjustments to reconcile net income to net cash provided by operating activities: Net amortization of premiums.......................... 799 895 Depreciation and amortization......................... 1,088 1,086 Net loan fees deferred................................ 1,246 1,040 Deferred tax benefit.................................. (1,525) (726) Provision for loan losses............................. 2,686 3,325 Provision for other real estate owned losses.......... 22 179 Net gain on sales of investment securities and other assets............................................... (2,673) (1,168) Federal Home Loan Bank stock dividends................ (847) (383) Proceeds from sale of loans held for sale............. 37,462 45,246 Originations of loans held for sale................... (29,047) (42,870) Increase in accrued interest receivable and other assets............................................... (688) (3,901) Increase (decrease) in accrued expenses and other liabilities.......................................... 904 (80) ----------- --------- Total adjustments.................................... 9,427 2,643 ----------- --------- Net cash provided by operating activities............ 22,539 9,488 ----------- --------- CASH FLOWS FROM INVESTING ACTIVITIES Net disbursements of loans............................ (78,166) (72,667) Purchases of: Investment securities available for sale.............. (331,760) (364,753) Loans receivable...................................... (156,768) (6,530) Federal Home Loan Bank stock.......................... (1,808) (3,820) Investment in affordable housing partnerships......... (5,647) (469) Premises and equipment................................ (751) (549) Proceeds from sale, maturity, redemption or repayment of: Investment securities available for sale.............. 426,478 268,230 Federal Home Loan Bank stock.......................... 8,200 -- Other real estate owned............................... 2,295 1,342 Investment in affordable housing partnerships......... 3,267 -- Premises and equipment................................ 2 -- Principal repayments on foreclosed property............ 100 -- Payment for purchase of First Central Bank, net of cash received.............................................. (5,413) -- ----------- --------- Net cash used in investing activities................ (139,971) (179,216) ----------- --------- CASH FLOWS FROM FINANCING ACTIVITIES Net change in deposits................................ $ 65,444 $ 4,209 Deposits acquired from First Central Bank............. 92,569 -- Deposits sold to People's Bank of California.......... (17,068) -- Proceeds from Federal Home Loan Bank advances......... 5,129,900 763,608 Repayment of Federal Home Loan Bank advances.......... (5,194,900) (717,608) Net (decrease) increase in federal funds purchased and securities sold under agreements to repurchase....... (33,000) 16,953 Repayments of notes payable on affordable housing investments.......................................... (1,350) -- Repurchase of common stock............................ (12,869) -- Dividends paid on common stock........................ (1,397) -- ----------- --------- Net cash provided by financing activities............ 27,329 67,162 ----------- --------- NET DECREASE IN CASH AND CASH EQUIVALENTS.............. (90,103) (102,566) CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD......... 161,131 347,601 ----------- --------- CASH AND CASH EQUIVALENTS, END OF PERIOD............... $ 71,028 $ 245,035 =========== ========= SUPPLEMENTAL CASH FLOW INFORMATION Interest paid......................................... $ 37,063 $ 32,397 Income tax payments, net.............................. 10,400 5,245 Noncash investing and financing activities: Other real estate acquired through foreclosure........ 1,130 4,039 Loans made to facilitate sales of other real estate owned................................................ 650 582 Investment in affordable housing partnerships acquired through notes payable................................ 3,033 -- Net change in unrealized losses on securities, net of tax.................................................. (3,788) 828 Mortgage loans held to maturity securitized to investment securities available for sale............. -- 35,875 </TABLE> See accompanying notes to interim consolidated financial statements. 7
EAST WEST BANCORP, INC. AND SUBSIDIARIES NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS For the Six Months Ended June 30, 1999 and 1998 (Unaudited) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The consolidated financial statements include the accounts of East West Bancorp, Inc. (the "Company") and its wholly-owned subsidiary bank, East West Bank and subsidiaries (the "Bank"). All material intercompany transactions and accounts have been eliminated. The interim consolidated financial statements are unaudited and reflect all adjustments which, in the opinion of management, are necessary for a fair statement of financial condition and results of operations for the interim periods. All adjustments are of a normal and recurring nature. Results for the period ended June 30, 1999 are not necessarily indicative of results which may be expected for any other interim period or for the year as a whole. Certain information and note disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. The unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes included in the Company's annual report for the year ended December 31, 1998. Certain reclassifications have been made to the prior period financial statements to conform to the current period presentation. 2. STOCKHOLDERS' EQUITY Earnings Per Share The actual number of shares outstanding at June 30, 1999, was 22,468,000. Basic earnings per share are calculated on the basis of the weighted number of shares outstanding during the period. Diluted earnings per share are calculated on the basis of the weighted average number of shares outstanding during the period plus shares issuable upon the assumed exercise of outstanding common stock options and warrants. All 1998 per share information in the financial statements and in Management's Discussion and Analysis has been restated to give retroactive effect to the 118,875 for 550,000 reverse stock split effective June 11, 1998. The basic earnings per share is equal to the diluted earnings per share due to the fact that the average market price of the options and warrants is less than their exercise price for the six months ended June 30, 1999. Quarterly Dividends An initial quarterly cash dividend of $0.03 per share was paid on or about February 16, 1999 to shareholders of record at February 2, 1999. A second quarterly cash dividend of $0.03 per share was paid on or about May 11, 1999 to shareholders of record at May 5, 1999. Stock Repurchase Program On January 25, 1999, the Company's Board of Directors authorized the Company to repurchase up to $7.0 million of its common stock. During the first quarter of 1999, the Company repurchased 725,000 shares of its common stock for a total of $7.0 million which completed the first stock repurchase program. On March 29, 1999, the Company's Board of Directors initiated a second stock repurchase program, authorizing the repurchase of up to an additional $7.0 million of its common stock. During the quarter ended June 30, 1999, in conjunction with its second stock repurchase program, the Company repurchased 582,000 shares of its common stock for approximately $5.9 million. The Company is holding the repurchased shares as treasury shares to be reissued in connection with the Company's incentive stock plan and its employee stock purchase plan. 8
3. FIRST CENTRAL BANK ACQUISITION On May 28, 1999, the Company completed its $13.5 million acquisition of First Central Bank, N.A. in an all-cash transaction. First Central Bank, with assets of $102 million, is a national bank with three branches in Southern California, specializing in serving the banking needs of the Chinese-American community. 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 has been reflected in deferred income taxes. The Company recorded total goodwill of approximately $3.5 million, which is being amortized using the straight-line method over 15 years. 4. BRANCH SALE On May 21, 1999, the Company completed the sale of its Irvine Branch to People's Bank of California. Total assets purchased and total liabilities assumed by People's Bank were $83 thousand and $17.1 million, respectively. The purchase price was 4.25% of outstanding deposits assumed as of May 21, 1999 or $725 thousand. The net gain on sale recorded by the Company on this transaction was $676 thousand. ITEM 2. 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 1998 annual report on Form 10-K for the year ended December 31, 1998, and the accompanying interim unaudited consolidated financial statements and notes thereto. 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 to differ materially from those discussed in such forward-looking statements. These factors include, but are not limited to, economic conditions and competition in the geographic and business areas in which the Company operates, demographic changes, inflation or deflation, fluctuations in interest rates, changes in business strategy or development plans, and changes in legislation and governmental regulation. Given these uncertainties, the reader is cautioned not to place undue reliance on such forward-looking statements. The Company disclaims any obligation to update any such factors or to publicly announce the results of any revisions to any of the forward- looking statements contained herein to reflect future events or developments. Quarterly Cash Dividend On April 19, 1999, the Company announced that the Board of Directors had declared a regular quarterly cash dividend of $0.03 per share. The dividend payment was made on or about May 11, 1999 to shareholders of record at May 5, 1999. Branch Sale On May 21, 1999, the Company announced the sale of its Irvine branch to People's Bank of California. The branch, located at 4860 Irvine Boulevard, with deposits of approximately $17 million, was sold at a net gain of $676 thousand. 9
Completion of First Central Bank Acquisition On May 28, 1999, the Company announced the completion of its $13.5 million acquisition of First Central Bank, N.A. in an all-cash transaction. Total goodwill recorded by the Company for this transaction was approximately $3.5 million. First Central Bank, with assets of $102 million, is a national bank with three branches in Southern California, specializing in serving the banking needs of the Chinese-American community. The Company intends to consolidate the First Central Bank branches into its branch network in September 1999. Specifically, the two branch locations of First Central Bank will be closed and combined with nearby East West Bank branches, while one branch of East West Bank will be closed and combined with a nearby First Central Bank branch. Stock Repurchase Programs As of July 31, 1999, the Company had repurchased $5.9 million or 582,000 shares of the total $7.0 million authorized by the Company's Board of Directors for the second stock repurchase program. Results of Operations East West Bancorp, Inc, parent company of East West Bank (the "Bank") reported second quarter 1999 net income of $7.1 million, or $0.31 per basic and diluted share, compared to $3.8 million, or $0.16 per basic and diluted share, reported during the second quarter of 1998. The Company's annualized return on average total assets increased to 1.38% for the quarter ended June 30, 1999, from 0.89% for the same period in 1998. The annualized return on average stockholders' equity increased to 19.26% for the second quarter of 1999, compared with 11.08% for the second quarter of 1998. Included in net income for the second quarter of 1999 is a one-time pretax gain of $676 thousand on the sale of the Company's Irvine branch. Excluding this gain, earnings for the second quarter of 1999 would have totaled approximately $6.7 million, or $0.29 per basic and diluted share. Net income for the six months ended June 30, 1999 increased to $13.1 million, or $0.57 per basic and diluted share, from $6.8 million, or $0.29 per basic and diluted share, for the first six months of 1998. The annualized return on average total assets increased to 1.29% for the first half of 1999, compared with 0.81% for the first half of 1998. The annualized return on average stockholders' equity increased to 17.61% for the first half of 1999, compared with 10.08% for the same period in 1998. Components of Net Income <TABLE> <CAPTION> Three Months Ended Six Months Ended June 30, June 30, -------------------- ------------------ 1999 1998 1999 1998 --------- --------- -------- -------- (In millions) (In millions) <S> <C> <C> <C> <C> Net interest income.............. $ 17.3 $ 13.3 $ 33.6 $ 25.7 Provision for loan losses........ (1.5) (1.6) (2.7) (3.3) Noninterest income............... 4.2 2.4 7.5 4.3 Noninterest expense.............. (9.6) (7.9) (18.4) (16.0) Provision for income taxes....... (3.3) (2.4) (6.9) (3.9) --------- --------- -------- -------- Net income..................... $ 7.1 $ 3.8 $ 13.1 $ 6.8 ========= ========= ======== ======== Annualized return on average total assets.................... 1.38% 0.89% 1.29% 0.81% ========= ========= ======== ======== </TABLE> Net income increased 85% and 92%, respectively, for the second quarter and the first six months of 1999 compared with corresponding periods in 1998. The increases in second quarter and year-to-date 1999 net income is largely attributable to the growth in the Company's loan and investment securities portfolios, and to the reduction in the Company's cost of funds. Further, sustained growth in noninterest-related revenues, as well as continuing efforts to manage operational expenses, have also contributed to the increase in net income. 10
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 for the second quarter of 1999 totaled $17.3 million, a 31% increase over net interest income of $13.3 million for the same period in 1998. For the first six months of 1999, net interest income increased to $33.6 million, also a 31% increase from $25.7 million for the first half of 1998. Total interest and dividend income during the quarter ended June 30, 1999 increased 18% to $36.0 million compared with $30.4 million during the same period in 1998. Similarly, year-to-date interest and dividend income increased 20% to $70.7 million, from $59.0 million during the first half of 1998. The increase in interest and dividend income is derived primarily from an increase in average interest-earning assets of 19% and 21%, respectively, during the second quarter and the first six months of 1999. Growth in the Company's average loan and investment portfolios, partially offset by a decrease in average short-term investments, propelled the net increase in average interest-earning assets. The net growth in average earning assets was funded largely by an increase in FHLB advances, which increased $325.9 million, or 161%, and $354.3 million, or 202%, respectively, during the second quarter and the first six months of 1999. Despite a 75 basis point decline in the average prime rate, when comparing the first half of 1999 to the first half of 1998, the overall yield on average earning assets during the first six months of 1999 only declined 8 basis points to 7.23%, from 7.31% for the same period a year ago, due primarily to higher interest income on investment securities. The impact of this prime rate reduction for the second quarter was even less perceptible, with the overall yield on average earning assets decreasing only 2 basis points to 7.31% for the 1999 second quarter, compared with 7.33% for the second quarter of 1998. Loan yields decreased 29 and 22 basis points, respectively, for the second quarter and the first six months of 1999, due to the decrease in the average prime rate. The decrease in loan yields was offset by an increase in yields on investment securities which increased 22 basis points to 5.77% for the second quarter of 1999, from 5.55% for the same quarter in 1998. For the first half of 1999, yields on investment securities increased 27 basis points to 5.72%, compared with 5.45% for the same period a year earlier. The increase in yields on investment securities was due, in part, to purchases of fixed-rate mortgage-backed securities during the second half of 1998. Total interest expense during the second quarter of 1999 increased 9% to $18.7 million compared with $17.2 million for the same period a year ago. For the first half of 1999, total interest expense increased 11% to $37.1 million, from $33.3 million for the first half of 1998. The increase in second quarter and year-to-date 1999 interest expense is primarily attributable to the increase in average FHLB advances, partially offset by a decrease in average short-term borrowings and a reduction in the cost of funds for all categories of interest-bearing liabilities. Net interest margin, defined as taxable equivalent net interest income divided by average earning assets, increased 33 basis points to 3.52% for the second quarter of 1999, compared with 3.19% for the second quarter of 1998. For the first six months of 1999, the net interest margin was 3.43%, a 25 basis point increase from the net interest margin of 3.18% for the same period a year ago. Despite a slight decline in the overall yield on average earning assets, the increase in the Company's net interest margin is primarily due to the decline in the cost of funds. The Company's overall cost of funds decreased 37 basis points to 4.20% for both the second quarter and the first half of 1999, from 4.57% for the same periods in 1998. 11
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 three months ended June 30, 1999 and 1998: <TABLE> <CAPTION> Three Months Ended June 30, --------------------------------------------------------- 1999 1998 ---------------------------- ---------------------------- Average Average Yield/ Yield/ Average Rate Average Rate Balance Interest (1) Balance Interest (1) ---------- -------- ------- ---------- -------- ------- (Dollars in thousands) <S> <C> <C> <C> <C> <C> <C> ASSETS - ------ Interest-earning assets: Short-term investments....................... $ 39,665 $ 606 6.11% $ 267,648 $ 3,916 5.85% Taxable investment securities (2)(3)......... 643,255 9,280 5.77 396,375 5,500 5.55 Loans receivable (2)(4)...................... 1,259,692 25,759 8.18 980,378 20,771 8.47 FHLB stock................................... 28,912 373 5.16 15,564 228 5.86 ---------- ------- ---------- ------- Total interest-earning assets............... 1,971,524 36,018 7.31 1,659,965 30,415 7.33 ------- ---- ------- ---- Noninterest-earning assets: Cash and due from banks...................... 29,766 21,545 Allowance for loan losses.................... (18,461) (13,661) Other assets................................. 79,388 58,723 ---------- ---------- Total assets................................ $2,062,217 $1,726,572 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY - ------------------------------------ Interest-bearing liabilities: Checking accounts............................ $ 84,034 $ 245 1.17 $ 77,734 $ 287 1.48 Money market accounts........................ 46,023 351 3.05 24,441 236 3.86 Savings deposits............................. 220,772 1,059 1.92 213,359 1,349 2.53 Time deposits................................ 886,165 10,172 4.59 851,087 10,688 5.02 Short-term borrowings........................ 15,035 194 5.16 132,347 1,858 5.62 FHLB advances................................ 528,530 6,660 5.04 202,582 2,744 5.42 ---------- ------- ---------- ------- Total interest-bearing liabilities.......... 1,780,559 18,681 4.20 1,501,550 17,162 4.57 ------- ---- ------- ---- Noninterest-bearing liabilities: Demand deposits.............................. 110,453 73,001 Other liabilities............................ 23,784 13,753 Stockholders' equity......................... 147,421 138,268 ---------- ---------- Total liabilities and stockholders' equity.. $2,062,217 $1,726,572 ========== ========== Interest rate spread.......................... 3.11% 2.76% ==== ==== Net interest income and net interest margin... $17,337 3.52% $13,253 3.19% ======= ==== ======= ==== </TABLE> - ------- (1) Annualized. (2) Includes amortization of premiums and accretion of discounts on loans receivable and investment securities. Also includes the amortization of deferred loan fees. (3) Average balances exclude unrealized gains or losses on available for sale securities. (4) Average balances include nonperforming loans. 12
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 six months ended June 30, 1999 and 1998: <TABLE> <CAPTION> Six Months Ended June 30, --------------------------------------------------------- 1999 1998 ---------------------------- ---------------------------- Average Average Yield/ Yield/ Average Rate Average Rate Balance Interest (1) Balance Interest (1) ---------- -------- ------- ---------- -------- ------- (Dollars in thousands) <S> <C> <C> <C> <C> <C> <C> ASSETS - ------ Interest-earning assets: Short-term investments........... $ 62,551 $ 1,811 5.79% $ 247,825 $ 7,249 5.85% Taxable investment securities (2)(3)..... 665,911 19,058 5.72 373,930 10,193 5.45 Loans receivable (2)(4)................ 1,196,045 49,017 8.20 977,753 41,138 8.42 FHLB stock............. 31,033 793 5.11 14,788 417 5.64 ---------- ------- ---------- ------- Total interest-earning assets............... 1,955,540 70,679 7.23 1,614,296 58,997 7.31 ------- ---- ------- ---- Noninterest-earning assets: Cash and due from banks................. 29,039 22,941 Allowance for loan losses................ (17,642) (12,966) Other assets........... 73,076 56,200 ---------- ---------- Total assets.......... $2,040,013 $1,680,471 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY - ------------------------------------ Interest-bearing liabilities: Checking accounts...... $ 81,883 $ 470 1.15 $ 77,148 $ 566 1.47 Money market accounts.. 42,057 625 2.97 23,339 446 3.82 Savings deposits....... 221,056 2,079 1.88 208,983 2,603 2.49 Time deposits.......... 872,077 20,147 4.62 852,428 21,450 5.03 Short-term borrowings.. 20,842 542 5.20 123,956 3,507 5.66 FHLB advances.......... 529,373 13,248 5.01 175,028 4,774 5.46 ---------- ------- ---------- ------- Total interest-bearing liabilities.......... 1,767,288 37,111 4.20 1,460,882 33,346 4.57 ------- ---- ------- ---- Noninterest-bearing liabilities: Demand deposits........ 104,676 70,023 Other liabilities...... 19,111 13,818 Stockholders' equity... 148,938 135,748 ---------- ---------- Total liabilities and stockholders' equity............... $2,040,013 $1,680,471 ========== ========== Interest rate spread.... 3.03% 2.74% ==== ==== Net interest income and net interest margin.... $33,568 3.43% $25,651 3.18% ======= ==== ======= ==== </TABLE> - ------- (1) Annualized. (2) Includes amortization of premiums and accretion of discounts on loans receivable and investment securities. Also includes the amortization of deferred loan fees. (3) Average balances exclude unrealized gains or losses on available for sale securities. (4) Average balances include nonperforming loans. 13
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> Three Months Ended June Six Months Ended June 30, 30, 1999 vs. 1998 1999 vs. 1998 --------------------------- --------------------------- Changes Due to Changes Due to Total Rates Total Rates Change Volume (1) (1) Change Volume (1) (1) ------- ---------- ------- ------- ---------- ------- (In thousands) (In thousands) <S> <C> <C> <C> <C> <C> <C> INTEREST-EARNING ASSETS: Short-term investments.. $(3,310) $(3,337) $ 27 $(5,437) $(5,419) $ (18) Taxable investment securities............. 3,780 3,426 354 8,865 7,959 906 Loans receivable, net... 4,988 5,917 (929) 7,878 9,185 (1,307) FHLB stock.............. 145 196 (51) 376 458 (82) ------- ------- ------- ------- ------- ------- Total interest income............... $ 5,603 $ 6,202 $ (599) $11,682 $12,183 $ (501) ======= ======= ======= ======= ======= ======= INTEREST-BEARING LIABILITIES: Checking accounts....... $ (42) $ 23 $ (65) $ (96) $ 35 $ (131) Money market accounts... 115 208 (93) 179 358 (179) Savings deposits........ (290) 47 (337) (524) 150 (674) Time deposits........... (516) 441 (957) (1,303) 494 (1,797) Short-term borrowings... (1,664) (1,647) (17) (2,965) (2,917) (48) FHLB advances........... 3,916 4,415 (499) 8,474 9,665 (1,191) ------- ------- ------- ------- ------- ------- Total interest expense.............. $ 1,519 $ 3,487 $(1,968) $ 3,765 $ 7,785 $(4,020) ======= ======= ======= ======= ======= ======= CHANGE IN NET INTEREST INCOME................. $ 4,084 $ 2,715 $ 1,369 $ 7,917 $ 4,398 $ 3,519 ======= ======= ======= ======= ======= ======= </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 of $1.5 million for the second quarter of 1999 approximates the $1.6 million provision recorded for the same period in 1998. For the first half of 1999, the provision for loan losses decreased 19% to $2.7 million, compared to $3.3 million for the first half of 1998. The decreased provision for loan losses recorded in the current year reflects continued stability in the Company's asset quality, as manifested by lower net chargeoffs and improvements in nonperforming asset ratios, when compared to 1998. For further information regarding net credit losses and the allowance for loan losses, see the "Allowance for Loan Losses" section of this report. 14
Noninterest Income Components of Noninterest Income <TABLE> <CAPTION> Six Three Months Ended Months Ended June 30, June 30, ------------------- ------------- 1999 1998 1999 1998 --------- --------- ------ ------ (In millions) (In millions) <S> <C> <C> <C> <C> Loan fees................................ $ 0.60 $ 0.63 $ 1.13 $ 1.14 Branch fees.............................. 0.88 0.67 1.61 1.25 Letters of credit fees and commissions... 1.06 0.58 2.04 1.04 Net gain on sales of securities available for sale................................ 0.30 0.27 0.68 0.41 Net gain on sales of securities held for trading................................. 0.41 -- 0.43 -- Gain on sale of affordable housing investments............................. -- -- 0.40 -- Gain on sale of branch................... 0.68 -- 0.68 -- Amortization of negative intangibles..... 0.10 0.10 0.21 0.21 Other.................................... 0.20 0.11 0.38 0.23 --------- --------- ------ ------ Total.................................. $ 4.23 $ 2.36 $ 7.56 $ 4.28 ========= ========= ====== ====== </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, and net gains on sales of trading securities, investment securities available for sale, and affordable housing investments. Noninterest income for the three months ended June 30, 1999 increased to $4.2 million, from $2.4 million for the three months ended June 30, 1998. Noninterest income for the second quarter of 1999 includes a one-time gain on sale of the Company's Irvine branch amounting to $676 thousand. Excluding this gain, noninterest income increased 51% to $3.6 million for the second quarter of 1999 when compared to the second quarter of 1998. Noninterest income for the first half of 1999 increased to $7.6 million, from $4.3 million for the first half of 1998. Excluding the gain on sale of the Irvine branch and the $402 thousand gain on sale of an investment in affordable housing partnerships recorded during the 1999 first quarter, noninterest income increased 52% to $6.5 million for the first six months of 1999 when compared to the same period in 1998. The increase in noninterest income for the quarter and year-to-date compared with the prior year is primarily due to growth in fee-based service income, including letters of credit fees and commissions and branch fees. Letters of credit fees and commissions amounted to $1.1 million for the second quarter of 1999 compared to $579 thousand for the second quarter of 1998. This increase of $479 thousand or 83% is attributed primarily to a $295 thousand increase in issuance and maintenance fees related to standby letters of credit. The remainder of the increase is attributed to trade finance activities which experienced growth of 59% and 48%, respectively, in the number of transactions processed for the three months and the six months ended June 30, 1999 in comparison to the same periods a year ago. For the six months ended June 30, 1999, letters of credit fees and commissions increased 96% to $2.0 million, compared with $1.0 million for the same period in 1998. Branch fees for the second quarter of 1999 amounted to $883 thousand, an increase of $214 thousand or 32% from the $669 thousand earned during the second quarter of 1998. This was primarily due to higher revenues derived from analysis charges on commercial deposit accounts, increased fees related to transaction accounts, and higher revenues from the sale of nonproprietary mutual funds. For the six months ended June 30, 1999, branch fees increased 29% to $1.6 million, compared with $1.2 million for the same period in 1998. Other contributions to noninterest income for the 1999 second quarter include $304 thousand in gains on sales of investment securities available for sale, compared with $271 thousand for the second quarter of 1998. For the six months ended June 30, 1999, gains on sales of investment securities available for sale increased to $684 thousand from $408 thousand for the same period in 1998. Net gains on investment securities held for 15
trading for the second quarter and the first six months of 1999 totaled $407 thousand and $425 thousand, respectively. There were no gains on sales of trading securities during the same periods in 1998. Noninterest Expense Components of Noninterest Expense <TABLE> <CAPTION> Three Months Ended Six Months Ended June 30, June 30, ------------------- ------------------ 1999 1998 1999 1998 --------- --------- -------- -------- (In millions) (In millions) <S> <C> <C> <C> <C> Compensation and other employee benefits......................... $ 4.46 $ 4.21 $ 9.14 $ 8.61 Net occupancy..................... 1.34 1.20 2.70 2.44 Data processing................... 0.36 0.33 0.69 0.64 Amortization of positive intangibles...................... 0.36 0.31 0.67 0.62 Amortization of affordable housing investments...................... 0.78 0.28 1.19 0.51 Deposit insurance premiums and regulatory assessments........... 0.21 0.21 0.42 0.42 Other real estate owned operations, net.................. 0.02 (0.11) (0.26) (0.20) Other............................. 2.05 1.51 3.85 2.95 -------- --------- -------- -------- Total........................... $ 9.58 $ 7.94 $ 18.40 $ 15.99 ======== ========= ======== ======== Efficiency ratio................ 43% 49% 43% 52% ======== ========= ======== ======== </TABLE> Noninterest expense increased 21% to $9.6 million for the first three months ended June 30, 1999, from $7.9 million for the three months ended June 30, 1998. Noninterest expense totaled $18.4 million for the six months ended June 30, 1999, compared with $16.0 million for the same period in 1998. Noninterest expense is comprised primarily of compensation and employee benefits, occupancy and other operating expenses. Compensation and employee benefits increased 6% to $4.5 million for the second quarter of 1999, compared with $4.2 million for the second quarter of 1998. This primarily reflects the Company's continuing growth which includes the opening of a new branch office in Milpitas, California in August 1998 and the acquisition of First Central Bank at the end of May 1999. For the six months ended June 30, 1999, compensation and employee benefits increased to $9.1 million from $8.6 million for the same period a year earlier. In addition to the Milpitas branch opening, the impact of annual salary and related cost increases for existing employees, as well as increases in incentive compensation tied to the Company's performance, further contributed to the year-to-date increase in compensation and employee benefits. Occupancy expenses increased to $1.3 million and $2.7 million, respectively, for the second quarter and the first half of 1999. The 11% increase in occupancy expenses for the second quarter and the first half of 1999 primarily reflects the operations of the new Milpitas branch and one month of operations for the branches and administrative offices of First Central Bank, overhead factors which were not present during the corresponding periods in 1998. Additionally, the impact of normal rent adjustments in existing leases, as well as increased expenses related to the outsourcing of computer hardware maintenance further contributed to the rise in occupancy expenses. The amortization of investments in affordable housing partnerships increased to $777 thousand for the second quarter of 1999, compared with $281 thousand for the second quarter of 1998. For the six months ended June 30, 1999, amortization of investments in affordable housing partnerships totaled $1.2 million, compared to $507 thousand for the same period in 1998. The increase in amortization reflects the impact of additional investment purchases made since the second quarter of 1998. Total investments in affordable housing partnerships amounted to $23.2 million as of June 30, 1999, compared with $14.4 million as of June 30, 1998. Net expenses related to OREO operations increased $138 thousand or 120% during the second quarter of 1999 when compared to the second quarter of 1998. This is primarily attributed to a $257 thousand reduction in 16
net rental income collected on OREO properties and a $36 thousand decline in net gains on sales of OREO properties, partially offset by a $155 thousand decrease in OREO writedowns. For the six months ended June 30, 1999, net income generated from OREO operations totaled $261 thousand compared to $195 thousand for the same period in 1998. This increase in year-to-date net OREO income is due primarily to higher net gains on sales of OREO properties and lower writedowns on OREO properties, offset partially by lower net rental income on such properties. 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 for the second quarter of 1999 increased $549 thousand or 36% to $2.1 million, compared with $1.5 million for the second quarter of 1998. For the six months ended June 30, 1999, other operating expenses increased $908 thousand or 31% to $3.9 million, compared with $3.0 million for the six months ended June 30, 1998. The increase in expenses for the second quarter and year-to-date is primarily due to the overall growth of the Company. Further, various expenses directly related to the Company's change in status from a privately held institution to a public company have also contributed to the increase in other operating expenses. These expenses include, but are not limited to, legal fees, investor relations expenses, Delaware corporation franchise fees, SEC and NASDAQ filing fees, and stock transfer agent fees. Continuing efforts to closely manage operational expenses have resulted in a significant improvement in the Company's efficiency ratio, which represents noninterest expense (excluding the amortization of intangibles) divided by the aggregate of net interest income before provision for loan losses and noninterest income (excluding the amortization of intangibles). For the second quarter of 1999, the Company's efficiency ratio improved to 43%, as compared to 49% for the second quarter of 1998. For the six months ended June 30, 1999, the efficiency ratio improved to 43%, compared with 52% for the same period in 1998. Provision for Income Taxes The provision for income taxes increased 50% to $3.4 million during the second quarter of 1999, compared with $2.3 million for the second quarter of 1998 primarily due to higher pretax income partially offset by tax credits from qualified affordable housing investments. Tax credits utilized in the second quarter of 1999 totaled $945 thousand, compared to $397 thousand for the second quarter of 1998. The second quarter 1999 provision reflects an effective tax rate of 32.4%, compared with an effective tax rate of 37.1% for the second quarter 1998. For the six months ended June 30, 1999, the provision for income taxes totaled $6.9 million, an 84% increase from the $3.8 million income tax expense recorded for the same period a year ago. The effective tax rate of 34.6% for the first half of 1999 reflects tax credits of $1.5 million, compared with an effective tax rate of 35.5% for the first half of 1998 reflecting tax credits of $837 thousand. Balance Sheet Analysis The Company's total assets at June 30, 1999 were $2.10 billion, an increase of $39.1 million or 2% when compared to December 31, 1998. The increase in total assets was comprised primarily of a $223.9 million growth in loans receivable, partially offset by decreases in short-term investments of $90.1 million and investment securities available for sale of $100.0 million. The increase in total assets was funded by an increase of $140.9 million in deposits, partially offset by decreases of $33.0 million in short-term borrowings and $65.0 million in FHLB advances. Investment Securities Available for Sale Investment securities available for sale of $582.5 million as of June 30, 1999 represents a decrease of $100.0 million, or 15%, compared to the December 31, 1998 balance of $682.4 million. Total repayments on mortgage-backed securities, including calls and redemptions, totaled $325.7 million for the first half of 1999. Proceeds from such repayments were utilized to purchase additional mortgage-backed securities and to fund loan originations and purchases. During the first six months of 1999, the Bank sold mortgage-backed securities with a 17
total carrying value of $177.1 million. The Bank recorded net gains on sale of $684 thousand from these transactions. Proceeds from the sale of these securities were used to repay $65.0 million of FHLB advances and $33.0 million of short-term borrowings. The remaining proceeds were used to fund a portion of the loan originations and loan purchases made during the first half of 1999. The following table sets forth the amortized cost and the estimated fair values of investment securities available for sale as of June 30, 1999 and December 31, 1998: <TABLE> <CAPTION> Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- ---------- ---------- --------- (In thousands) <S> <C> <C> <C> <C> As of June 30, 1999: U.S. Treasury securities............. $ 1,975 $ -- $ (18) $ 1,957 U.S. Government agency securities.... 75,599 -- (775) 74,824 Mortgage-backed securities........... 512,151 120 (6,771) 505,500 Obligations of states and political subdivisions........................ 200 4 -- 204 -------- ----- ------- -------- Total investment securities available for sale................ $589,925 $ 124 $(7,564) $582,485 ======== ===== ======= ======== As of December 31, 1998: U.S. Treasury securities............. $ -- $ -- $ -- $ -- U.S. Government agency securities.... -- -- -- -- Mortgage-backed securities........... 683,335 471 (1,370) 682,436 Obligations of states and political subdivisions........................ -- -- -- -- -------- ----- ------- -------- Total investment securities available for sale................ $683,335 $ 471 $(1,370) $682,436 ======== ===== ======= ======== </TABLE> Investment Securities Held for Trading Investment securities held for trading are investment grade securities which are generally held by the Company for a period of seven days or less. During the first six months of 1999, the Company sold investment securities held for trading with a total carrying amount of $20.7 million. Net gains realized on these transactions amounted to $425 thousand for the six months ended June 30, 1999. There were no purchases and sales of investment securities held for trading during 1998. There were no outstanding investment securities held for trading at June 30, 1999. Loans The Company continued to experience strong loan demand during the second quarter of 1999. Net loans receivable at June 30, 1999 totaled $1.32 billion, representing a $223.9 million or 20% increase from December 31, 1998. The increase in loans was funded, in large part, through repayments and sales of mortgage-backed securities and, to a lesser extent, through the liquidation of lower-yielding short-term investments. The Company continues to focus its lending efforts on originating multifamily and commercial loan products, as evidenced by the composition of the growth in loans during the first half of 1999. Excluding the $55.0 million in loans acquired from First Central Bank, gross loans receivable increased $171.3 million, or 15%, from December 31, 1998. This growth is comprised of increases in multifamily loans of $82.3 million or 49%, commercial real estate loans of $76.5 million or 21%, construction loans of $14.9 million or 19%, and commercial loans, including trade finance products, of $8.8 million or 4%. Management anticipates continued strong loan demand in these categories throughout the remainder of 1999. Partially offsetting the increases in the multifamily and commercial loan categories is a decline of $15.4 million, or 6%, in single family residential loans, which excludes the $4.8 million of single family loans acquired from First Central Bank. This decrease is consistent with the Bank's strategy of de-emphasizing the retention of single family mortgage loans for its portfolio. Under the Bank's current lending strategy, substantially all new fixed-rate single family residential loans are sold into the secondary market. 18
The following table sets forth the composition of the loan portfolio as of the dates indicated: <TABLE> <CAPTION> June 30, 1999 December 31, 1998 June 30, 1998 ------------------- ------------------- ----------------- Balance Percent Balance Percent Balance Percent ---------- ------- ---------- ------- -------- ------- (Dollars in thousands) <S> <C> <C> <C> <C> <C> <C> Real estate loans: Residential, one to four units............ $ 259,772 19.3% $ 270,444 24.2% $301,820 30.6% Residential, multifamily........... 258,902 19.3 167,545 15.0 150,108 15.2 Commercial and industrial real estate........... 469,218 34.9 358,850 32.0 330,660 33.6 Construction........... 96,089 7.1 78,922 7.0 38,502 3.9 ---------- ----- ---------- ----- -------- ----- Total real estate loans................ 1,083,981 80.6 875,761 78.2 821,090 83.3 ---------- ----- ---------- ----- -------- ----- Other loans: Business, commercial... 235,956 17.5 223,318 20.0 150,108 15.2 Automobile............. 4,981 0.4 4,972 0.4 5,089 0.5 Other consumer......... 20,107 1.5 15,156 1.4 9,768 1.0 ---------- ----- ---------- ----- -------- ----- Total other loans..... 261,044 19.4 243,446 21.8 164,965 16.7 ---------- ----- ---------- ----- -------- ----- Total gross loans.... 1,345,025 100.0% 1,119,207 100.0% 986,055 100.0% ========== ===== ========== ===== ======== ===== Unearned fees, premiums and discounts, net..... (502) (2,122) (2,448) Allowance for loan losses................. (20,019) (16,506) (14,213) ---------- ---------- -------- Loans receivable, net.................. $1,324,504 $1,100,579 $969,394 ========== ========== ======== </TABLE> Nonperforming Assets Nonaccrual loans, which include loans 90 days or more past due, totaled $5.5 million at June 30, 1999, compared with $9.8 million at December 31,1998, and $4.4 million at June 30, 1998. Nonaccrual loans as a percentage of total loans outstanding were 0.41% at June 30, 1999, 0.88% at December 31, 1998, and 0.44% at June 30, 1998. Loans totaling $4.3 million were placed on nonaccrual status during the three months ended June 30, 1999. The increase in nonaccrual loans was partially offset by $1.2 million in payoffs, $1.4 million in loans brought current and one loan for $116 thousand that was transferred to other real estate owned. The increase in nonaccrual loans during the second quarter of 1999 is comprised of $2.2 million in residential single family loans, $372 thousand in residential multifamily loans, $921 thousand in commercial real estate loans, and $895 thousand in commercial loans. For the six months ended June 30, 1999, nonaccrual loans decreased by $4.3 million due to payoffs totaling $5.4 million, loans brought current totaling $2.7 million, gross chargeoffs totaling $158 thousand and loans transferred to other real estate owned totaling $270 thousand. These were offset by $4.2 million of loans placed on nonaccrual status during the six months ended June 30, 1999. Restructured loans or loans that have had their original terms modified totaled $7.2 million at June 30, 1999, representing an increase of $1.3 million from the $5.9 million reported at December 31, 1998. The increase in restructured loans is primarily due to the addition of two commercial loans. Other real estate owned ("OREO") includes properties acquired through foreclosure or through full or partial satisfaction of loans. Other real estate owned totaled $3.0 million, $4.6 million and $5.4 million at June 30, 1999, December 31, 1998 and June 30, 1998, respectively. For the six months ended June 30, 1999, three properties with combined book value of $480 thousand were added to OREO and eleven properties with a total book value of $1.9 million were sold. Net gains amounting to $371 thousand were recognized on OREO sales during the first half of 1999. 19
The following table sets forth information regarding nonaccrual loans, restructured loans and other real estate owned as of the dates indicated: <TABLE> <CAPTION> June June 30, March 31, December 31, September 30, 30, 1999 1999 1998 1998 1998 ------- --------- ------------ ------------- ------- (Dollars in thousands) <S> <C> <C> <C> <C> <C> Nonaccrual loans........ $ 5,508 $ 3,983 $ 9,762 $ 9,415 $ 4,378 Loans past due 90 days or more but not on nonaccrual............. -- -- 129 -- -- ------- ------- ------- ------- ------- Total nonperforming loans................ 5,508 3,983 9,891 9,415 4,378 ------- ------- ------- ------- ------- Restructured loans...... 7,249 6,154 5,936 6,430 6,279 Other real estate owned, net.................... 3,034 3,585 4,600 5,088 5,386 ------- ------- ------- ------- ------- Total nonperforming assets............... $15,791 $13,722 $20,427 $20,933 $16,043 ======= ======= ======= ======= ======= Total nonperforming assets to total assets................. 0.75% 0.69% 0.99% 1.12% 0.89% Allowance for loan losses to nonperforming loans.................. 363.45 440.87 166.88 167.92 324.65 Nonperforming loans to total gross loans...... 0.41 0.34 0.88 0.90 0.44 </TABLE> Loans classified as impaired totaled $12.7 million at June 30, 1999, compared with $10.0 million at December 31, 1998. Specific reserves on impaired loans were $230 thousand and $350 thousand as of June 30, 1999 and December 31, 1998, respectively. Total chargeoffs associated with impaired loans as of June 30, 1999 amounted to $1.0 million. A significant portion of the impaired loans, 57% at June 30, 1999 and 67% at December 31, 1998, were secured by real estate. The Bank's average recorded investment in impaired loans for the six months ended June 30, 1999 was $13.2 million. During the six months ended June 30, 1999, gross interest income that would have been recorded on impaired loans, had they performed in accordance with their original terms, totaled $630 thousand. Of this amount, actual interest recognized on impaired loans, on a cash basis, was $468 thousand. Allowance for Loan Losses A certain degree of risk is inherent in the extension of credit. The allowance for loan losses is maintained at a level considered by management to be commensurate with the estimated known and inherent risks in the existing portfolio. Management performs an ongoing assessment of the risks inherent in the loan portfolio. 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. The Bank determines the level of the allowance for loan losses, and correspondingly, the provision for loan losses based upon various judgments and assumptions, including general economic conditions (especially in California), loan portfolio composition and concentrations, prior loan loss experience, collateral values, identification of problem and potential problem loans, and other relevant data. While management believes that the allowance for loan losses is adequate at June 30, 1999, future additions to the allowance will be subject to continuing evaluation of inherent risks in the loan portfolio. 20
At June 30, 1999, the allowance for loan losses amounted to $20.0 million, or 1.49% of total loans, compared with $16.5 million, or 1.47% of total loans, at December 31, 1998, and $14.2 million, or 1.44% of total loans, at June 30, 1998. The following table summarizes activity in the allowance for loan losses for the periods indicated: <TABLE> <CAPTION> Three Months Ended Six Months Ended June 30, June 30, -------------------- -------------------- 1999 1998 1999 1998 ---------- -------- ---------- -------- (Dollars in thousands) <S> <C> <C> <C> <C> Allowance balance at beginning of period........................... $ 17,560 $ 12,947 $ 16,506 $ 12,273 Allowance from acquisition........ 1,150 -- 1,150 -- Provision for loan losses......... 1,486 1,583 2,686 3,325 Actual chargeoffs: 1-4 family residential real estate......................... 18 29 21 97 Multifamily real estate......... 39 78 39 111 Commercial and industrial real estate......................... -- -- -- 60 Business, commercial............ 274 414 601 1,775 Automobile...................... -- 73 -- 116 Other........................... 1 -- 1 3 ---------- -------- ---------- -------- Total chargeoffs.............. 332 594 662 2,162 ---------- -------- ---------- -------- Recoveries: 1-4 family residential real estate......................... -- 30 -- 101 Multifamily real estate......... -- -- 70 -- Commercial and industrial real estate......................... (43) 201 27 476 Business, commercial............ 198 30 228 173 Automobile...................... -- 16 14 27 Other........................... -- -- -- -- ---------- -------- ---------- -------- Total recoveries.............. 155 277 339 777 ---------- -------- ---------- -------- Net chargeoffs.............. 177 317 323 1,385 ---------- -------- ---------- -------- Allowance balance at end of period........................... $ 20,019 $ 14,213 $ 20,019 $ 14,213 ========== ======== ========== ======== Average net loans outstanding..... $1,259,692 $980,378 $1,196,045 $977,753 ========== ======== ========== ======== Total gross loans outstanding at end of period.................... $1,345,025 $986,055 $1,345,025 $986,055 ========== ======== ========== ======== Net chargeoffs to average loans... 0.01% 0.03% 0.03% 0.14% Allowance for loan losses to total gross loans at end of period..... 1.49 1.44 1.49 1.44 </TABLE> The provision for loan losses totaled $2.7 million for the six months ended June 30, 1999, compared with $3.3 million for the same period in 1998. The decline reflects an improvement in the Company's chargeoff experience. Net chargeoffs totaled $177 thousand for the second quarter of 1999, a 44% decrease from second quarter 1998 net chargeoffs of $317 thousand. As a percentage of average loans outstanding, net chargeoffs were 0.01% and 0.03%, respectively, for the three months ended June 30, 1999 and 1998. For the six months ended June 30, 1999, net chargeoffs of $323 thousand represent a 77% decrease from net chargeoffs of $1.4 million for the same period in 1998. As a percentage of average loans outstanding, net chargeoffs were 0.03% and 0.14%, respectively, for the six months ended June 30, 1999 and 1998. The improvement in chargeoff experience was partly achieved through the Company's ongoing efforts to implement more stringent underwriting parameters and administration procedures, and aggressive collection efforts with troubled debtors. Another significant factor contributing to the improvement of the Company's chargeoff experience is the continuance of a prosperous economy. Management recognizes these factors and adjusts the loan loss provision accordingly. 21
The Company uses 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 Company also performs an analysis to quantify the potential impact on asset quality created by customer preparedness or lack thereof to "Year 2000" technology requirements. The classification migration model utilizes net losses incurred by the Company during the preceding five years in conjunction with current asset classifications to extrapolate loss factors for various loan categories in determining an estimated allowance requirement. The individual loan review analysis method provides a more contemporaneous assessment of the portfolio by incorporating individual asset evaluations prepared by the Company's credit administration department. Loans are reviewed at least annually and more frequently, if warranted by circumstances. Real estate loans and commercial business loans not subject to individual loan review, as well as out-of-cycle individually reviewed loans, are monitored based on problem loan indicators such as loan payment 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 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> December 31, June 30, 1999 1998 --------------- --------------- Amount Percent Amount Percent ------- ------- ------- ------- (Dollars in Thousands) <S> <C> <C> <C> <C> 1-4 family residential real estate.............. $ 497 19.3% $ 500 24.2% Multifamily real estate......................... 3,316 19.3 2,435 15.0 Commercial and industrial real estate........... 3,659 34.9 1,373 32.0 Construction.................................... 1,489 7.1 2,339 7.0 Business, commercial............................ 7,498 17.5 7,679 20.0 Automobile...................................... 26 0.4 45 0.4 Consumer and other.............................. 29 1.5 22 1.4 Year 2000 exposure.............................. 650 600 Unallocated..................................... 2,855 1,513 ------- ----- ------- ----- Total....................................... $20,019 100.0% $16,506 100.0% ======= ===== ======= ===== </TABLE> The allowance for loan losses of $20.0 million at June 30, 1999 exceeded the Company's estimated allowance requirement by $3.5 million. The estimated allowance requirement as of June 30, 1999 was $16.5 million as compared to $14.4 million as of December 31, 1998. Notwithstanding the unallocated allowance of $2.9 million at June 30, 1999, the Company continues to record loan loss provisions on a monthly basis to compensate for growth in the various loan portfolios. Moreover, it is management's opinion that the commercial loan portfolio has not fully seasoned, and therefore, current positive chargeoff experience may not necessarily be reflective of potential future losses, which is even more relevant in light of current favorable economic conditions. As of June 30, 1999, the Company has earmarked $650 thousand of the unallocated allowance to absorb any potential exposure to "Year 2000" issues. The remaining unallocated allowance at June 30, 1999 is $2.9 million compared to the $1.5 million unallocated allowance at December 31, 1998. These amounts represent 14% and 9% of the total allowance for loan losses at June 30, 1999 and December 31, 1998, respectively. The maintenance of the unallocated portion of the allowance is considered necessary for the reasons outlined in the preceding paragraph. Management believes that the maintenance of the unallocated portion of the allowance is considered prudent not only to mitigate the uncertainties associated with the Bank's relatively untested loan portfolios, but also to compensate for the attendant estimation risk associated with the classification migration and individual loan review analysis methodologies. 22
Deposits Deposits of $1.43 billion at June 30, 1999, represented an increase of $140.9 million or 11% over December 31, 1998. The increase in deposits reflects $92.6 million in deposits acquired through First Central Bank in May 1999, partially offset by $17.1 million of deposits sold to People's Bank of California in connection with the sale of the Company's Irvine branch during the same month. Excluding these transactions, deposits at June 30, 1999 grew $65.4 million or 5% over December 31, 1998. This growth in deposits is comprised primarily of increases in time deposits of $47.2 million or 6% and noninterest-bearing demand deposits of $13.9 million or 14%. The increase in time deposits during the first six months of 1999 is due to various promotions associated with the Chinese New Year holiday and the Year 2000. 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. The average balance of non- time deposit accounts, which include noninterest-bearing demand accounts, interest-bearing checking accounts, savings deposits and money market accounts, increased $70.2 million or 18% during the six months ended June 30, 1999, compared with the same period in 1998. This increase was comprised of a $34.7 million or 49% increase in noninterest-bearing demand accounts, an $18.7 million or 80% increase in money market accounts, a $12.1 million or 6% increase in savings deposits, and a $4.7 million or 6% increase in interest- bearing checking accounts. Borrowings The Company had no short-term borrowings at June 30, 1999. In comparison, short-term borrowings, which consist primarily of federal funds purchased and securities sold under agreements to repurchase, totaled $33.0 million as of December 31, 1998. FHLB advances totaled $498.0 million as of June 30, 1999, representing a $65.0 million or 12% decrease from the December 31, 1998 balance of $563.0 million. The decreases in short-term borrowings and FHLB advances resulted primarily from runoffs in short-term investments and mortgage-backed securities. Capital Resources The primary source of capital for the Company is the retention of net after tax earnings. At June 30, 1999, stockholders' equity totaled $145.9 million, a decrease of $4.9 million or 3% from $150.8 million as of December 31, 1998. The decrease is due primarily to: (i) repurchases of $12.9 million or 1,307,000 shares of common stock in connection with the first and second stock repurchase programs approved by the Board of Directors during the first quarter of 1999; (ii) payment of first and second quarter 1999 cash dividends totaling $1.4 million; and (iii) a net increase of $3.8 million in unrealized losses on available-for-sale securities. These transactions were offset, in part, by net income of $13.1 million for the six months ended June 30, 1999. 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 June 30, 1999, the Company's Tier 1 and total capital ratios were 9.23% and 10.48%, respectively, compared to 10.28% and 11.42%, respectively, at December 31, 1998, and 11.85% and 13.08%, respectively, at June 30, 1998. 23
The following table compares the Company's and the Bank's actual capital ratios at June 30, 1999, 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)............ 10.48% 10.46% 8.0% 10.0% Tier 1 Capital (to Risk- Weighted Assets)............ 9.23 9.21 4.0 6.0 Tier 1 Capital (to Average Assets)..................... 6.87 6.85 4.0 5.0 </TABLE> ASSET LIABILITY AND MARKET RISK MANAGEMENT Liquidity Liquidity management involves the Company'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 Company'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 Company, including adequate cash flow for off-balance sheet instruments. The Company's primary sources of liquidity are derived from financing activities which include the acceptance of customer 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. For the six months ended June 30, 1999, the Company experienced a net cash outflow of $140.0 million from its investing activities primarily due to the growth in the Company's loan portfolio. Partially offsetting the net cash outflow from investing activities is $22.5 million in net cash provided by operating activities and $27.3 million in net cash provided by financing activities. Increases in interest income on loans and investment securities and net proceeds from sales of loans held for sale accounted for the net cash inflow from operating activities, while the growth in the Company's deposit base can be attributed for the net cash inflow from financing activities. As a means of augmenting its liquidity, the Bank has established federal funds lines with two correspondent banks and several master repurchase agreements with major brokerage companies. At June 30, 1999, the Bank's available borrowing capacity includes approximately $11.5 million in repurchase arrangements, $40.0 million in federal funds line facilities, and $38.5 million in unused FHLB advances. Management believes its liquidity sources to be stable and adequate. At June 30, 1999, management was not aware of any information that would result in or that was reasonably likely to have a material effect on the Bank's liquidity position. 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. For the second quarter of 1999, East West Bank paid dividends amounting to $6.8 million to East West Bancorp, Inc. For the six months ended June 30, 1999, total dividends paid by the Bank to East West Bancorp, Inc. totaled $14.7 million. As of June 30, 1999, approximately $17.4 million of undivided profits of the Bank was available for dividends to the Company. 24
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 strategy 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. The table below shows the estimated impact of changes in interest rates on net interest income and market value of equity as of June 30, 1999, assuming a parallel shift of 100 to 200 basis points in both directions: <TABLE> <CAPTION> Change in Interest Rates Net Interest Income Net Portfolio Value (Basis Points) Volatility (1) Volatility (2) ------------------------ ------------------- ------------------- <S> <C> <C> +200 3.2% (9.8)% +100 2.9% (2.7)% -100 (4.3)% (3.0)% -200 (8.9)% (9.5)% </TABLE> - -------- (1) The percentage change represents net interest income for twelve months in a stable interest rate environment versus the net interest income in the various rate scenarios. (2) The percentage change represents net portfolio value of the Bank in a stable rate environment versus the net portfolio value in the various rate scenarios. All interest-earning assets, interest-bearing liabilities and derivative contracts are included in the interest rate sensitivity analysis at June 30, 1999. At June 30, 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 rates. The model also incorporates prepayment assumptions and market rates of interest provided by independent broker/dealer quotations, an independent pricing model and other available public sources. Adjustments are made to reflect the shift in the Treasury and other appropriate yield curves. The model 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. 25
The following table provides the outstanding principal balances and the weighted average interest rates of the Bank's non-derivative financial instruments as of June 30, 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 1999 2000 2001 2002 2003 2003 Total June 30, 1999 ---------- ------- ------- -------- ------- ------- ---------- ------------- (Dollars in thousands) <S> <C> <C> <C> <C> <C> <C> <C> <C> Assets: Short-term investments.. $ 39,500 $ -- $ -- $ -- $ -- $ -- $ 39,500 $ 39,500 Weighted average rate.. 5.83% -- % -- % -- % -- % -- % 5.83% Investment securities available- for-sale (fixed rate)........... $ 94,673 $65,596 $46,265 $ 32,927 $22,043 $46,148 $ 307,652 $ 302,509 Weighted average rate.. 6.15% 6.18% 6.17% 6.16% 6.17% 6.18% 6.17% Investment securities available- for-sale (variable rate)........ $ 282,273 $ -- $ -- $ -- $ -- $ -- $ 282,273 $ 279,976 Weighted average rate.. 5.62% -- % -- % -- % -- % -- % 5.62% Total gross loans....... $1,189,611 $55,685 $39,481 $ 28,304 $23,347 $ 8,597 $1,345,025 $1,353,280 Weighted average rate.. 7.98% 7.91% 8.08% 8.29% 8.20% 7.57% 7.98% Liabilities: Checking accounts....... $ 89,940 $ -- $ -- $ -- $ -- $ -- $ 89,940 $ 89,940 Weighted average rate.. 1.30% -- % -- % -- % -- % -- % 1.30% Money market accounts... $ 56,245 $ -- $ -- $ -- $ -- $ -- $ 56,245 $ 56,245 Weighted average rate.. 3.14% -- % -- % -- % -- % -- % 3.14% Savings deposits........ $ 217,277 $ -- $ -- $ -- $ -- $ -- $ 217,277 $ 217,277 Weighted average rate.. 1.91% -- % -- % -- % -- % -- % 1.91% Time deposits........... $ 905,435 $20,348 $ 1,127 $ 785 $ 2,286 $15,000 $ 944,981 $ 944,116 Weighted average rate.. 4.57% 4.69% 5.24% 5.43% 5.37% 7.00% 4.63% FHLB advances........... $ 288,000 $ 5,000 $ -- $195,000 $10,000 $ -- $ 498,000 $ 498,911 Weighted average rate.. 5.13% 5.16% -- % 5.11% 5.78% -- % 5.13% </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 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 26
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 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. Interest rate swaps were designated for purposes of converting fixed rate loans to floating rate assets while interest rate cap agreements were designated as hedges against certain securities in the available-for-sale portfolio. The total gross notional amount of the interest rate swaps on June 30, 1999 was $43.5 million. The net unrealized loss on the swap agreement portfolio was $884 thousand compared to a net unrealized loss of $1.5 million at December 31, 1998. Interest rate caps are used as hedges against market fluctuations in the Bank's available-for-sale securities portfolio. The total gross notional amount of interest rate cap agreements on June 30, 1999 was $36.0 million. The net unrealized loss on the cap agreement portfolio was $354 thousand compared to a net unrealized loss of $580 thousand at December 31, 1998. These cap agreements are primarily linked to the three-month LIBOR. 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 June 30, 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 1999 2000 2001 2002 2003 2003 Total Gain (Loss) Maturity ---- ---- ------- ------- ---- ------- ------- ----------- --------- (Dollars in thousands) <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> Interest rate swap agreements: Notional amount......... $ -- $ -- $10,000 $18,500 $ -- $15,000 $43,500 $(884) 5.4 Years Weighted average receive rate................... --% --% 5.23% 5.23% --% 5.29% 5.25% Weighted average pay rate................... --% --% 6.46% 6.45% --% 7.00% 6.64% Interest rate cap agreements: Notional amount......... $ -- $ -- $18,000 $18,000 $ -- $ -- $36,000 $(354) 2.6 Years LIBOR cap rate.......... --% --% 6.50% 7.00% --% -- % 6.75% </TABLE> Year 2000 Many computer programs were designed and developed using only two digits in date fields, resulting in the inability to recognize the year 2000 or years thereafter. This "Year 2000" issue creates risks for the Bank from unforseen or unanticipated problems in its internal computer systems as well as from computer systems of the Federal Reserve Bank, correspondent banks, customers, and vendors. Failures of these systems or untimely corrections could have a material adverse impact on the Bank's ability to conduct its business and results of operations. The Bank's computer systems and programs are designed and supported by companies specifically in the business of providing such products and services. The Bank has formed a Year 2000 committee comprised of certain of the Bank's officers to address the "Year 2000" issue. The committee's Year 2000 plan includes holding awareness seminars; evaluating existing hardware, software, ATMs, vaults, alarm systems, communication systems, and other electrical devices; testing critical application programs and systems, both internally and externally; establishing a contingency plan; and upgrading hardware and software as necessary. As of June 30, 1999, the Bank has successfully completed the awareness, assessment, remediation, and testing phases of the Year 2000 plan. The plan is on schedule and the Bank is in the last stage of the implementation phase of the plan. All of the Bank's critical systems are programmed, serviced or provided by outside system vendors. All of the systems that were identified in the assessment phase as critical to the Bank's operations have been tested and certified as compliant by the various "system owners" of the Bank. This meets 27
the Federal Financial Institutions Examination Council's ("FFIEC") time frame for year 2000 progress. The Bank has also been reviewing and coordinating relationships with "secondary" systems vendors, borrowers, and other third parties to ensure that their systems will be "Year 2000" compliant. These vendors have informed the Bank that their "Year 2000" projects are on schedule and progress is being monitored by Bank personnel. In addition, as discussed below, manual data processing of business functions is part of the Bank's contingency plan. In addition to these software applications, much of the Bank's hardware and network infrastructure is being replaced as part of the "Year 2000" plan. The Bank has developed a detailed project plan for the replacement. The principal elements are the replacement of the router network and the replacement or upgrading of personal computers. The router network has already been replaced and the replacement or upgrading of personal computers is in process and is now 75% complete. The hardware and network infrastructure replacement cost of $750 thousand represents the largest portion of the "Year 2000" plan total budget of $1.0 million. The Bank has incurred $885 thousand in "Year 2000" expenses to date, $587 thousand of which was incurred during 1999. Non-information technology systems are expected to function well in 2000 and beyond; none have been identified with "Year 2000" problems. The Bank's environmental systems have been reviewed by the Bank's administrative services personnel and vendor indications have been received in writing for all such systems. In addition, the Bank has obtained a written indication of "Year 2000" compliance from the local energy company. Indications of "Year 2000" readiness have also been received from the telecommunications companies on which the Bank depends. The contingency plan provides for changing outside vendors if current vendors cannot meet their schedules to be "Year 2000" compliant and for manual processing and other action by the Bank in the event a problem is not discovered in a critical system that has previously been tested and certified as compliant. An expected reasonable "worst case" scenario is that, notwithstanding the testing and certification of all the Bank's critical systems beforehand, a problem is discovered in the year 2000 that impacts the core accounting systems. In this event, the Bank would be required to perform many business functions manually until such time as the responsible vendor corrects the problem. Such manual processing of functions is provided for in the Bank's contingency plans, which have been reviewed, updated, and Board- approved as of June 16, 1999. In October 1998, the Bank tested the transition from computer-performed operations to "offline" manual operations at all branch locations. The test was conducted while an outside vendor shut down the Bank's system to perform the "Year 2000" upgrade. During the shut down, the transition to manual procedures worked as planned. Other elements of the Bank's contingency plan will be tested during 1999, as is the case with wire transfer operations which were successfully tested at the Bank's offsite contingency location during January 1999. The Bank's contingency plan will be independently validated by September 30, 1999 in accordance with the FFIEC's "Year 2000" progress time frame. Business Segments The Company has identified four principal operating segments for purposes of management reporting: retail banking, commercial lending, treasury, and residential lending. Information related to the Company's remaining centralized functions 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. 28
The following tables present the operating results and other key financial measures for the individual operating segments for the three months and the six months ended June 30, 1999 and 1998. 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. Any 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 will be restated for comparability in the event of future changes in management structure or reporting methodologies. <TABLE> <CAPTION> Three Months Ended June 30, 1999 (unaudited) Retail Commercial Residential Banking Lending Treasury Lending Other Total -------- ---------- -------- ----------- ------- ---------- (In thousands) <S> <C> <C> <C> <C> <C> <C> Interest income......... $ 6,770 $ 9,032 $ 10,133 $ 9,533 $ 550 $ 36,018 Charges for funds used.. (3,923) (5,152) (8,549) (6,396) -- (24,020) -------- -------- -------- -------- ------- ---------- Interest spread on funds used............ 2,847 3,880 1,584 3,137 550 11,998 -------- -------- -------- -------- ------- ---------- Interest expense........ (9,794) (691) (8,195) -- (1) (18,681) Credit on funds provided............... 13,715 1,225 9,080 -- -- 24,020 -------- -------- -------- -------- ------- ---------- Interest spread on funds provided........ 3,921 534 885 -- (1) 5,339 -------- -------- -------- -------- ------- ---------- Net interest income... $ 6,768 $ 4,414 $ 2,469 $ 3,137 $ 549 $ 17,337 ======== ======== ======== ======== ======= ========== Depreciation and amortization........... $ 346 $ 68 $ 1 $ -- $ 136 $ 551 Segment pretax profit... 1,639 3,556 2,599 2,704 -- 10,498 Segment assets as of June 30, 1999.......... 351,241 448,654 649,326 563,464 84,598 2,097,283 <CAPTION> Three Months Ended June 30, 1998 (unaudited) Retail Commercial Residential Banking Lending Treasury Lending Other Total -------- ---------- -------- ----------- ------- ---------- (In thousands) <S> <C> <C> <C> <C> <C> <C> Interest income......... $ 4,054 $ 6,783 $ 9,532 $ 9,559 $ 487 $ 30,415 Charges for funds used.. (2,534) (4,047) (8,901) (8,031) -- (23,513) -------- -------- -------- -------- ------- ---------- Interest spread on funds used............ 1,520 2,736 631 1,528 487 6,902 -------- -------- -------- -------- ------- ---------- Interest expense........ (10,583) (666) (5,913) -- -- (17,162) Credit on funds provided............... 14,903 984 7,626 -- -- 23,513 -------- -------- -------- -------- ------- ---------- Interest spread on funds provided........ 4,320 318 1,713 -- -- 6,351 -------- -------- -------- -------- ------- ---------- Net interest income... $ 5,840 $ 3,054 $ 2,344 $ 1,528 $ 487 $ 13,253 ======== ======== ======== ======== ======= ========== Depreciation and amortization........... $ 348 $ 82 $ 1 $ -- $ 116 $ 547 Segment pretax profit... 751 2,491 1,854 995 -- 6,091 Segment assets as of June 30, 1998.......... 180,756 326,631 749,899 504,360 47,067 1,808,713 </TABLE> 29
<TABLE> <CAPTION> Six Months Ended June 30, 1999 (unaudited) Retail Commercial Residential Banking Lending Treasury Lending Other Total -------- ---------- -------- ----------- ------- ---------- (In thousands) <S> <C> <C> <C> <C> <C> <C> Interest income......... $ 12,237 $ 17,342 $ 21,496 $ 18,363 $ 1,241 $ 70,679 Charges for funds used.. (7,141) (9,924) (18,274) (12,219) -- (47,558) -------- -------- -------- -------- ------- ---------- Interest spread on funds used............ 5,096 7,418 3,222 6,144 1,241 23,121 -------- -------- -------- -------- ------- ---------- Interest expense........ (19,364) (1,363) (16,384) -- -- (37,111) Credit on funds provided............... 27,037 2,335 18,186 -- -- 47,558 -------- -------- -------- -------- ------- ---------- Interest spread on funds provided........ 7,673 972 1,802 -- -- 10,447 -------- -------- -------- -------- ------- ---------- Net interest income... $ 12,769 $ 8,390 $ 5,024 $ 6,144 $ 1,241 $ 33,568 ======== ======== ======== ======== ======= ========== Depreciation and amortization........... $ 713 $ 129 $ 2 $ -- $ 244 $ 1,088 Segment pretax profit... 2,494 7,309 5,169 5,072 -- 20,044 Segment assets as of June 30, 1999.......... 351,241 448,654 649,326 563,464 84,598 2,097,283 <CAPTION> Six Months Ended June 30, 1998 (unaudited) Retail Commercial Residential Banking Lending Treasury Lending Other Total -------- ---------- -------- ----------- ------- ---------- (In thousands) <S> <C> <C> <C> <C> <C> <C> Interest income......... $ 7,537 $ 13,157 $ 17,856 $ 19,553 $ 894 $ 58,997 Charges for funds used.. (4,749) (7,819) (15,903) (16,408) -- (44,879) -------- -------- -------- -------- ------- ---------- Interest spread on funds used............ 2,788 5,338 1,953 3,145 894 14,118 -------- -------- -------- -------- ------- ---------- Interest expense........ (21,428) (1,302) (10,616) -- -- (33,346) Credit on funds provided............... 29,825 1,912 13,142 -- -- 44,879 -------- -------- -------- -------- ------- ---------- Interest spread on funds provided........ 8,397 610 2,526 -- -- 11,533 -------- -------- -------- -------- ------- ---------- Net interest income... $ 11,185 $ 5,948 $ 4,479 $ 3,145 $ 894 $ 25,651 ======== ======== ======== ======== ======= ========== Depreciation and amortization........... $ 741 $ 115 $ 2 $ -- $ 228 $ 1,086 Segment pretax profit... 918 4,916 3,296 1,479 -- 10,609 Segment assets as of June 30, 1998.......... 180,756 326,631 749,899 504,360 47,067 1,808,713 </TABLE> ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES OF MARKET RISKS For quantitative and qualitative disclosures regarding market risks in the Company's portfolio, see, "Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations--Asset Liability and Market Risk Management." 30
PART II--OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Neither the Bank nor the Company 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. In the opinion of management, based upon the advice of legal counsel, the resolution of any such issues would not have a material adverse impact on the financial position, results of operations, or liquidity of the Bank or the Company. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS No events have transpired which would make response to this item appropriate. ITEM 3. DEFAULTS UPON SENIOR SECURITIES No events have transpired which would make response to this item appropriate. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No events have transpired which would make response to this item appropriate. ITEM 5. OTHER INFORMATION No events have transpired which would make response to this item appropriate. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Index <TABLE> <CAPTION> Exhibit Number Description -------------- ----------- <C> <S> 27 Financial Data Schedule </TABLE> All other material referenced in this report which is required to be filed as an exhibit hereto has previously been submitted. (b) Reports on Form 8-K The Company filed no reports on Form 8-K during the second quarter of 1999. 31
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. Dated: August 9, 1999 EAST WEST BANCORP, INC. (Registrant) By /s/ Julia Gouw ----------------------------------- JULIA GOUW Executive Vice President and Chief Financial Officer 32