10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

 

 

x Quarterly report pursuant Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended March 31, 2014

 

¨ Transition report pursuant Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from                      to                     .

001-35542

(Commission File number)

 

 

 

LOGO

(Exact name of registrant as specified in its charter)

 

 

 

Pennsylvania   27-2290659

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

Identification No.)

1015 Penn Avenue

Suite 103

Wyomissing PA 19610

(Address of principal executive offices)

(610) 933-2000

(Registrant’s telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

 

 

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

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

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

 

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

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

On May 1, 2014, 23,274,409 shares of Voting Common Stock and 1,019,755 shares of Class B Non-Voting Common Stock were issued and outstanding.

 

 

 


Table of Contents

CUSTOMERS BANCORP, INC. AND SUBSIDIARIES

Customers Bancorp, Inc.

Table of Contents

 

Part I

    

Item 1.

 

Customers Bancorp, Inc. Consolidated Financial Statements as of March 31, 2014 and for the three month period ended March 31, 2014 (unaudited)

     3   

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      39   

Item 3.

  Quantitative and Qualitative Disclosures about Market Risk      54   

Item 4.

  Controls and Procedures      54   

PART II

    

Item 1.

  Legal Proceedings      54   

Item 1A.

  Risk Factors      55   

Item 2.

  Unregistered Sales of Equity Securities and Use of Proceeds      55   

Item 3.

  Defaults Upon Senior Securities      55   

Item 4.

  Mine Safety Disclosures      55   

Item 5.

  Other Information      55   

Item 6.

  Exhibits      56   

SIGNATURES

     57   

Ex-31.1

    

Ex-31.2

    

Ex-32.1

    

Ex-32.2

    

Ex-101

    

 

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Table of Contents

CUSTOMERS BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEET — UNAUDITED

(dollars in thousands, except share data)

 

     March 31,
2014
    December 31,
2013
 
ASSETS     

Cash and due from banks

   $ 73,544      $ 59,339   

Interest-earning deposits

     216,923        173,729   
  

 

 

   

 

 

 

Cash and cash equivalents

     290,467        233,068   

Investment securities available for sale, at fair value

     458,302        497,573   

Loans held for sale, at fair value

     697,532        747,593   

Loans receivable not covered under Loss Sharing Agreements with the FDIC

     3,294,908        2,398,353   

Loans receivable covered under Loss Sharing Agreements with the FDIC

     61,639        66,725   

Allowance for loan losses

     (26,704     (23,998
  

 

 

   

 

 

 

Total loans receivable, net of allowance for loan losses

     3,329,843        2,441,080   

FHLB, Federal Reserve Bank, and other restricted stock

     50,430        42,424   

Accrued interest receivable

     9,629        8,362   

FDIC loss sharing receivable

     8,272        10,046   

Bank premises and equipment, net

     11,234        11,625   

Bank-owned life insurance

     105,303        104,433   

Other real estate owned (includes $9,329 and $6,953, respectively, covered under Loss Sharing Agreements with the FDIC)

     15,670        12,265   

Goodwill and other intangibles

     3,673        3,676   

Other assets

     33,876        41,028   
  

 

 

   

 

 

 

Total assets

   $ 5,014,231      $ 4,153,173   
  

 

 

   

 

 

 
LIABILITIES AND SHAREHOLDERS’ EQUITY     

Liabilities:

    

Deposits:

    

Demand, non-interest bearing

   $ 634,578      $ 478,103   

Interest bearing

     2,971,754        2,481,819   
  

 

 

   

 

 

 

Total deposits

     3,606,332        2,959,922   

Federal funds purchased

     0        13,000   

FHLB advances

     905,000        706,500   

Other borrowings

     65,250        65,250   

Accrued interest payable and other liabilities

     36,711        21,878   
  

 

 

   

 

 

 

Total liabilities

     4,613,293        3,766,550   

Shareholders’ equity:

    

Preferred stock, no par value or as set by the board; 100,000,000 shares authorized, none issued

     0        0   

Common stock, par value $1.00 per share; 200,000,000 shares authorized; 24,826,424 and 24,756,411 shares issued as of March 31, 2014 and December 31, 2013; 24,294,164 and 24,224,151 shares outstanding as of March 31, 2014 and December 31, 2013

     24,826        24,756   

Additional paid in capital

     308,820        307,231   

Retained earnings

     79,144        71,008   

Accumulated other comprehensive loss, net

     (3,598     (8,118

Treasury stock, at cost (532,260 shares, respectively)

     (8,254     (8,254
  

 

 

   

 

 

 

Total shareholders’ equity

     400,938        386,623   
  

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 5,014,231      $ 4,153,173   
  

 

 

   

 

 

 

See accompanying notes to the unaudited consolidated financial statements.

 

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CUSTOMERS BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME — UNAUDITED

(dollars in thousands, except share data)

 

     Three Months Ended
March 31,
 
     2014      2013  

Interest income:

     

Loans receivable

   $ 28,355       $ 16,099   

Loans held for sale

     5,083         10,884   

Investment securities

     3,040         829   

Other

     116         108   
  

 

 

    

 

 

 

Total interest income

     36,594         27,920   
  

 

 

    

 

 

 

Interest expense:

     

Deposits

     5,415         5,136   

Other borrowings

     1,171         21   

FHLB advances

     496         238   
  

 

 

    

 

 

 

Total interest expense

     7,082         5,395   
  

 

 

    

 

 

 

Net interest income

     29,512         22,525   

Provision for loan losses

     4,368         (117
  

 

 

    

 

 

 

Net interest income after provision for loan losses

     25,144         22,642   

Non-interest income:

     

Gain on sale of investment securities

     2,832         0   

Mortgage warehouse transactional fees

     1,759         3,668   

Bank-owned life insurance

     835         476   

Mortgage banking income

     409         0   

Deposit fees

     214         130   

Other

     1,541         624   
  

 

 

    

 

 

 

Total non-interest income

     7,590         4,898   
  

 

 

    

 

 

 

Non-interest expense:

     

Salaries and employee benefits

     9,351         7,397   

Occupancy

     2,637         1,910   

Professional services

     2,282         706   

FDIC assessments, taxes, and regulatory fees

     2,131         1,347   

Technology, communications and bank operations

     1,560         841   

Loan workout

     441         674   

Advertising and promotion

     414         115   

Other real estate owned

     351         36   

Loss contingency

     0         2,000   

Other

     2,002         1,454   
  

 

 

    

 

 

 

Total non-interest expense

     21,169         16,480   
  

 

 

    

 

 

 

Income before income tax expense

     11,565         11,060   

Income tax expense

     3,429         3,871   
  

 

 

    

 

 

 

Net income

   $ 8,136       $ 7,189   
  

 

 

    

 

 

 

Basic earnings per share

   $ 0.34       $ 0.39   

Diluted earnings per share

     0.32         0.38   

See accompanying notes to the unaudited consolidated financial statements.

 

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CUSTOMERS BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME — UNAUDITED

(in thousands)

 

     Three Months Ended
March 31,
 
     2014     2013  

Net income

   $ 8,136      $ 7,189   
  

 

 

   

 

 

 

Unrealized gains (losses) on securities:

    

Unrealized holding gain (loss) on securities arising during the period (1)

     9,121        (1,093

Income tax effect (1)

     (3,193     383   

Less: reclassification adjustment for gains on securities included in net income

     (2,832     0   

Income tax effect

     992        0   
  

 

 

   

 

 

 

Net unrealized gains/ (losses)

     4,088        (710

Unrealized gains on cash flow hedges:

    

Unrealized gain on cash flow hedges arising during the period

     664        0   

Income tax effect

     (232     0   
  

 

 

   

 

 

 

Net unrealized gains

     432        0   

Other comprehensive income (loss), net of tax

     4,520        (710
  

 

 

   

 

 

 

Comprehensive income

   $ 12,656      $ 6,479   
  

 

 

   

 

 

 

 

(1) Includes immaterial gains on foreign currency items for the first quarter 2014.

See accompanying notes to the unaudited consolidated financial statements.

 

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CUSTOMERS BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY — UNAUDITED

(dollars in thousands, except share data)

 

     For the Three Months Ended March 31, 2014  
     Shares of
Common
Stock
     Common
Stock
     Additional
Paid in
Capital
     Retained
Earnings
     Accumulated
Other
Comprehensive
Loss
    Treasury
Stock
    Total  

Balance, January 1, 2014

     24,224,151       $ 24,756       $ 307,231       $ 71,008       $ (8,118   $ (8,254   $  386,623   

Net income

              8,136             8,136   

Other comprehensive income

                 4,520          4,520   

Share-based compensation expense

           955                955   

Issuance of common stock under share-based compensation arrangements

     70,013         70         634                704   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance, March 31, 2014

     24,294,164       $ 24,826       $ 308,820       $ 79,144       $ (3,598   $ (8,254   $ 400,938   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 
     For the Three Months Ended March 31, 2013  
     Shares of
Common
Stock
     Common
Stock
     Additional
Paid in
Capital
     Retained
Earnings
     Accumulated
Other
Comprehensive
Income
    Treasury
Stock
    Total  

Balance, January 1, 2013

     18,459,502       $ 18,507       $ 212,090       $ 38,314       $ 1,064      $ (500   $ 269,475   

Net income

              7,189             7,189   

Other comprehensive loss

                 (710       (710

Share-based compensation expense

           704                704   

Issuance of common stock under share-based compensation arrangements

     23,411         24         228                252   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance, March 31, 2013

     18,482,913       $ 18,531       $ 213,022       $ 45,503       $ 354      $ (500   $ 276,910   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

See accompanying notes to the unaudited consolidated financial statements.

 

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CUSTOMERS BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS — UNAUDITED

(in thousands)

 

     Three Months Ended
March 31,
 
     2014     2013  

Cash Flows from Operating Activities

    

Net income

   $ 8,136      $ 7,189   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Provision for loan losses, net of change to FDIC receivable

     4,368        (117

Loss contingency

     0        2,000   

Provision for depreciation and amortization

     890        628   

Share-based compensation

     955        704   

Deferred taxes

     2,215        1   

Net amortization of investment securities premiums and discounts

     177        108   

Gain on sale of investment securities

     (2,832     0   

Gain on sale of loans

     (498     (50

Origination of loans held for sale

     (2,819,236     (6,035,469

Proceeds from the sale of loans held for sale

     2,869,796        6,113,541   

Increase in FDIC loss sharing receivable

     (990     (723

Amortization (accretion) of fair value discounts

     (129     41   

Net loss (gain) on sales of other real estate owned

     47        (29

Valuation and other adjustments to other real estate owned

     127        89   

Earnings on investment in bank-owned life insurance

     (835     (476

Decrease (increase) in accrued interest receivable and other assets

     1,552        (176

Increase in accrued interest payable and other liabilities

     15,562        778   
  

 

 

   

 

 

 

Net Cash Provided by Operating Activities

     79,305        88,039   

Cash Flows from Investing Activities

    

Proceeds from maturities, calls and principal repayments of investment securities available for sale

     10,264        4,902   

Proceeds from sales of investment securities available for sale

     187,891        0   

Purchases of investment securities available for sale

     (149,940     (35,620

Net increase in loans

     (608,672     (141,965

Purchase of loan portfolios

     (288,253     (155,306

Proceeds from sales of SBA loans

     424        436   

Purchases of bank-owned life insurance

     0        (10,000

Net purchases of FHLB, Federal Reserve Bank, and other restricted stock

     (8,006     (3,918

Reimbursements from the FDIC on loss sharing agreements

     1,297        2,370   

Purchases of bank premises and equipment

     (207     (290

Proceeds from sales of other real estate owned

     1,376        445   
  

 

 

   

 

 

 

Net Cash Used In Investing Activities

     (853,826     (338,946

Cash Flows from Financing Activities

    

Net increase in deposits

     646,420        95,031   

Net increase in short-term borrowed funds

     185,500        101,000   

Proceeds from long-term FHLB borrowings

     0        50,000   
  

 

 

   

 

 

 

Net Cash Provided by Financing Activities

     831,920        246,031   
  

 

 

   

 

 

 

Net Increase (Decrease) in Cash and Cash Equivalents

     57,399        (4,876

Cash and Cash Equivalents – Beginning

     233,068        186,016   
  

 

 

   

 

 

 

Cash and Cash Equivalents – Ending

   $ 290,467      $ 181,140   
  

 

 

   

 

 

 

Supplementary Cash Flows Information

    

Interest paid

   $ 7,017      $ 5,383   

Income taxes paid

     2,082        337   

Non-cash items:

    

Transfer of loans to other real estate owned

   $ 4,955      $ 1,935   

Issuance of common stock under share-based compensation arrangements

     704        252   

Securities purchased not settled

     0        3,421   

See accompanying notes to the unaudited consolidated financial statements.

 

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CUSTOMERS BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS

NOTE 1 — DESCRIPTION OF THE BUSINESS

Customers Bancorp, Inc. (the “Bancorp”, “Customers Bancorp”, or the “Company”) is a bank holding company engaged in banking activities through its wholly owned subsidiary, Customers Bank (the “Bank”). Customers Bancorp also has made certain equity investments through its wholly owned subsidiaries CB Green Ventures Pte Ltd. and CUBI India Ventures Pte Ltd.

Customers Bancorp, Inc. and its wholly owned subsidiary, Customers Bank, serve residents and businesses in Southeastern Pennsylvania (Bucks, Berks, Chester, Philadelphia and Delaware Counties), Rye, New York (Westchester County); Hamilton, New Jersey (Mercer County); Boston, Massachusetts; and Providence, Rhode Island. The Bank has 14 branches and provides commercial and consumer banking products, primarily loans and deposits. The Bank also provides liquidity to residential mortgage originators nationwide through commercial loans to mortgage companies. Customers Bank is subject to regulation of the Pennsylvania Department of Banking and Securities and the Federal Reserve Bank and is periodically examined by those regulatory authorities.

NOTE 2 — ACQUISITION ACTIVITY

Acquisition Activity

New England Lending Acquisitions

On January 15, 2014, Customers Bank purchased $277.9 million of residential adjustable-rate jumbo mortgage loans (indexed to one-year LIBOR) from Michigan-based Flagstar Bank. The purchase price was 100.75% of loans outstanding.

On March 28, 2013, Customers Bank completed the purchase of certain commercial loans from Flagstar Bank. Under the terms of the agreement, Customers Bank acquired $182.3 million in commercial loan and related commitments, of which $155.1 million was drawn at the date of acquisition. Also, as part of the agreement, Customers Bank assumed the leases for two of Flagstar’s commercial lending offices in New England. The purchase price was 98.7% of loans outstanding.

NOTE 3 — SIGNIFICANT ACCOUNTING POLICIES AND BASIS OF PRESENTATION

Basis of Presentation

The interim unaudited consolidated financial statements of Customers Bancorp, Inc. and subsidiaries have been prepared pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (the “SEC”). These interim unaudited consolidated financial statements reflect all normal and recurring adjustments that are, in the opinion of management, necessary to present a fair statement of the financial position and the results of operations and cash flows of Customers Bancorp and subsidiaries for the interim periods presented. Certain information and footnote disclosures normally included in the annual consolidated financial statements have been omitted from these interim unaudited consolidated financial statements as permitted by SEC rules and regulations. The December 31, 2013 consolidated balance sheet presented in this report has been derived from Customers Bancorp’s audited 2013 consolidated financial statements. Management believes that the disclosures are adequate to present fairly the consolidated financial statements as of the dates and for the periods presented. These interim unaudited consolidated financial statements should be read in conjunction with the 2013 consolidated financial statements of Customers Bancorp and subsidiaries included in Customers’ Annual Report on Form 10-K for the year ended December 31, 2013 filed with the SEC on March 12, 2014. That Form 10-K describes Customers Bancorp’s significant accounting policies, which include its policies on Principles of Consolidation; Cash and Cash Equivalents; Restrictions on Cash and Amounts due from Banks; Investment Securities, Loan Accounting Framework; Allowance for Loan Losses; Goodwill; FHLB, Federal Reserve Bank, and other restricted stock; Other Real Estate Owned; FDIC Loss Sharing Receivable; Bank Owned Life Insurance; Bank Premises and Equipment; Treasury Stock; Income Taxes; Share-Based Compensation; Comprehensive Income; Earnings per Share; Segment Information; and Accounting Changes. Certain prior period amounts have been reclassified to conform to current period presentation. Results for interim periods are not necessarily indicative of those that may be expected for the fiscal year. Presented below are Customers Bancorp’s significant accounting policies that were updated during the three months ended March 31, 2014 to address new or evolving activities and recently issued accounting standards and updates that were issued or effective during first quarter 2014.

 

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Derivative Instruments and Hedging Activities

The Financial Accounting Standards Board (“FASB”) ASC 815, Derivatives and Hedging (“ASC 815”), provides the disclosure requirements for derivatives and hedging activities with the intent to provide users of financial statements with an enhanced understanding of: (a) how and why an entity uses derivative instruments, (b) how the entity accounts for derivative instruments and related hedged items, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. Further, qualitative disclosures are required that explain the Bancorp’s objectives and strategies for using derivatives, as well as quantitative disclosures about the fair value of and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative instruments.

As required by ASC 815, the Customers Bancorp records all derivatives on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether Customers has elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Derivatives may also be designated as hedges of the foreign currency exposure of a net investment in a foreign operation. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge. The Bancorp may enter into derivative contracts that are intended to economically hedge certain of its risk, even though hedge accounting does not apply or the Company elects not to apply hedge accounting.

Prior to first quarter 2014, none of Customer Bancorp’s financial derivatives were designated in qualifying hedge relationships in accordance with the applicable accounting guidance. As such, all changes in fair value of the financial derivatives were recognized directly in earnings. In March 2014, Customers Bancorp entered into a $150.0 million notional balance forward starting pay fixed interest rate swap to hedge the variable cash flows associated with the forecasted issuance of debt. The Bancorp documented and designated this swap as a cash flow hedge. The effective portion of changes in the fair value of financial derivatives designated and qualifying as cash flow hedges is recorded in Accumulated Other Comprehensive Income and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. The ineffective portion of the change in fair value of the financial derivatives is recognized directly in earnings. Amounts reported in accumulated other comprehensive income related to financial derivatives will be reclassified to interest expense as interest payments are made on the Company’s variable-rate debt.

Customers Bancorp purchased credit derivatives with a notional balance of $13.4 million to hedge the performance risk of one of its counterparties during first quarter 2014. These derivatives were not designated in hedge relationships for accounting purposes and are being recorded at their fair value, with fair value changes recorded directly in earnings.

In accordance with the FASB’s fair value measurement guidance, Customers Bancorp made an accounting policy election to measure the credit risk of its derivative financial instruments that are subject to master netting agreements on a net basis by counterparty portfolio.

Recently Issued Accounting Standards

In January 2014, the FASB issued Accounting Standard Update (“ASU”) 2014-06, Technical Corrections and Improvements Related to Glossary Terms. This ASU is limited to amendments related to the Master Glossary, including technical corrections related to glossary links, glossary term deletions, and glossary term name changes. The amendments in this ASU apply to all reporting entities within the scope of the affected accounting guidance and were effective upon issuance. This ASU has not had a significant impact on the Bancorp’s financial condition or results of operation.

In January 2014, the FASB issued ASU 2014-04, Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure, a consensus of the FASB Emerging Issues Task Force. The ASU clarifies that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. The ASU also requires additional related interim and annual disclosures. The guidance in this ASU is effective for annual and interim periods beginning after December 15, 2014. The Bancorp does not expect this ASU to have a significant impact on its financial condition or results of operation.

 

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In January 2014, the FASB issued ASU 2014-01, Accounting for Investments in Qualified Affordable Housing Projects, a consensus of the FASB Emerging Issues Task Force. The ASU provides guidance on accounting for investments by a reporting entity in flow-through limited liability entities that manage or invest in affordable housing projects that qualify for the low-income housing tax credit. The guidance in this ASU is effective for annual periods and interim reporting periods within those annual periods, beginning after December 15, 2014. The Bancorp does not expect this ASU to have a significant impact on its financial condition or results of operation.

In February 2013, the FASB issued ASU 2013-04, Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation Is Fixed at the Reporting Date, a consensus of the FASB Emerging Issues Task Force. The guidance in this USU requires an entity to measure obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of this guidance is fixed at the reporting date, as the sum of the following: (a) the amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors, and (b) any additional amount the reporting entity expects to pay on behalf of its co-obligors. The guidance in this ASU was effective in first quarter 2014. This ASU has not had a significant impact on the Bancorp’s financial condition or results of operation.

NOTE 4 — CHANGES IN ACCUMULATED OTHER COMPREHENSIVE INCOME BY COMPONENT (1)

The following table presents the changes in accumulated other comprehensive income by component for the three months ended March 31, 2014 and 2013.

 

     Unrealized Gains               
     and Losses on     Unrealized Gains         
     Available-for-sale     on         
(amounts in thousands)    Securities     Cash Flow Hedges      Total  

Beginning balance - January 1, 2014

   $ (8,118   $ 0       $ (8,118
  

 

 

   

 

 

    

 

 

 

Other comprehensive income before reclassifications

     5,929        432         6,361   

Amounts reclassified from accumulated other comprehensive loss to net income (2)

     (1,841     0         (1,841
  

 

 

   

 

 

    

 

 

 

Net current-period other comprehensive (loss) income

     4,088        432         4,520   
  

 

 

   

 

 

    

 

 

 

Ending balance - March 31, 2014

   $ (4,030   $ 432       $ (3,598
  

 

 

   

 

 

    

 

 

 

 

     Unrealized Gains  
     and Losses on  
     Available-for-sale  
(amounts in thousands)    Securities (3)  

Beginning balance - January 1, 2013

   $ 1,064   
  

 

 

 

Other comprehensive loss before reclassifications

     (710

Amounts reclassified from accumulated other comprehensive loss to net income

     0   
  

 

 

 

Net current-period other comprehensive (loss) income

     (710
  

 

 

 

Ending balance - March 31, 2013

   $ 354   
  

 

 

 

 

(1) All amounts are net of tax. Amounts in parentheses indicate debits.
(2) Reclassification amount reported as gain on sale of investment securities on the Consolidated Statements of Income.
(3) Prior to first quarter 2014, all amounts deferred in accumulated other comprehensive income were related to available-for-sale securities.

 

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NOTE 5 — EARNINGS PER SHARE

The following are the components and results of the Bancorp’s earnings per share calculation for the periods presented:

 

     Three Months Ended
March 31,
 
     2014      2013  
(dollars in thousands, except per share data)              

Net income available to common shareholders

   $ 8,136       $ 7,189   
  

 

 

    

 

 

 

Weighted-average number of common shares outstanding - basic

     24,260,518         18,471,207   

Share-based compensation plans

     769,001         283,580   

Warrants

     220,509         155,152   
  

 

 

    

 

 

 

Weighted-average number of common shares - diluted

     25,250,028         18,909,939   
  

 

 

    

 

 

 

Basic earnings per share

   $ 0.34       $ 0.39   

Diluted earnings per share

   $ 0.32       $ 0.38   

The following is a summary of securities that could potentially dilute basic earnings per share in future periods that were not included in the computation of diluted earnings per share because to do so would have been anti-dilutive for the periods presented:

 

     Three Months Ended
March 31,
 
     2014      2013  

Anti-dilutive securities:

     

Share-based compensation awards

     122,438         102,684   

Warrants

     118,745         129,946   
  

 

 

    

 

 

 

Total anti-dilutive securities

     241,183         232,630   
  

 

 

    

 

 

 

NOTE 6 — INVESTMENT SECURITIES

The amortized cost and approximate fair value of investment securities as of March 31, 2014 and December 31, 2013 are summarized in the tables below:

 

     March 31, 2014  
     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair Value  
     (dollars in thousands)  

Available for Sale:

          

Mortgage-backed securities (1)

   $ 416,428       $ 1,314       $ (6,661   $ 411,081   

Corporate notes

     25,000         278         (2     25,276   

Equity securities (2)

     23,074         0         (1,129     21,945   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 464,502       $ 1,592       $ (7,792   $ 458,302   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

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     December 31, 2013  
     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair Value  
     (dollars in thousands)  

Available for Sale:

          

Mortgage-backed securities (1)

   $ 461,988       $ 207       $ (10,659   $ 451,536   

Corporate notes

     25,000         344         (21     25,323   

Equity securities(2)

     23,074         0         (2,360     20,714   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 510,062       $ 551       $ (13,040   $ 497,573   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

(1) Comprised primarily of mortgage-backed securities issued by government-sponsored agencies, including FHLMC, FNMA, and GNMA.
(2) Comprised primarily of equity securities in a foreign entity.

The following table presents proceeds from the sale of available-for-sale investment securities and gross gains and gross losses realized on those sales for the three months ended March 31, 2014 and 2013:

 

     Three months ended March 31,  
     2014      2013  
     (dollars in thousands)  

Proceeds from sale of available-for-sale securities

   $ 187,891       $           0   
  

 

 

    

 

 

 

Gross gains

   $ 2,832       $ 0   

Gross losses

     0         0   
  

 

 

    

 

 

 

Net gains

   $ 2,832       $ 0   
  

 

 

    

 

 

 

These gains and losses were determined using the specific identification method and were included in non-interest income.

The following table presents available-for-sale debt securities by stated maturity. Debt securities backed by mortgages have expected maturities that differ from contractual maturities because borrowers have the right to call or prepay and are, therefore, classified separately with no specific maturity date:

 

     March 31, 2014  
     Amortized
Cost
     Fair
Value
 
     (dollars in thousands)  

Due in one year or less

   $ 0       $ 0   

Due after one year through five years

     25,000         25,276   

Due after five years through ten years

     0         0   

Due after ten years

     0         0   

Mortgage-backed securities

     416,428         411,081   
  

 

 

    

 

 

 

Total debt securities

   $ 441,428       $ 436,357   
  

 

 

    

 

 

 

The Bancorp’s investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at March 31, 2014 and December 31, 2013 were as follows:

 

     March 31, 2014  
     Less Than 12 Months     12 Months or More     Total  
     Fair Value      Unrealized
Losses
    Fair Value      Unrealized
Losses
    Fair Value      Unrealized
Losses
 
     (dollars in thousands)  

Available for Sale:

               

Mortgage-backed securities (1)

   $ 234,566       $ (4,990   $ 21,429       $ (1,671   $ 255,995       $ (6,661

Corporate notes

     0         0        4,998         (2     4,998         (2

Equity securities (2)

     21,945         (1,129     0         0        21,945         (1,129
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 256,511       $ (6,119   $ 26,427       $ (1,673   $ 282,938       $ (7,792
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

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Table of Contents
     December 31, 2013  
     Less Than 12 Months     12 Months or More     Total  
     Fair Value      Unrealized
Losses
    Fair Value      Unrealized
Losses
    Fair Value      Unrealized
Losses
 
     (dollars in thousands)  

Available for Sale:

               

Mortgage-backed securities (1)

   $ 425,623       $ (10,061   $ 5,274       $ (598     430,897       $ (10,659

Corporate notes

     4,982         (18     4,997         (3     9,979         (21

Equity securities (2)

     20,714         (2,360     0         0        20,714         (2,360
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 451,319       $ (12,439   $ 10,271       $ (601   $ 461,590       $ (13,040
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) Comprised primarily of mortgage-backed securities issued by government-sponsored agencies, including FHLMC, FNMA, and GNMA
(2) Comprised primarily of equity securities in a foreign entity.

At March 31, 2014, there were twenty-two available-for-sale investment securities in the less-than-twelve-month category and ten available-for-sale investment securities in the twelve-month-or-more category. At December 31, 2013, there were thirty-six available for sale investment securities in the less-than-twelve-month category and eight available-for-sale investment securities in the twelve-month-or-more category. Customers has analyzed these investments for other than temporary impairment. The unrealized losses on the mortgage backed securities are guaranteed by government-sponsored entities and primarily relate to changes in market interest rates. All amounts are expected to be recovered when market prices recover or at maturity. The unrealized losses on the equity securities reflect decreases in market price or foreign currency exchange rates. Customers evaluated the financial condition and capital strength of the issuer of these securities and concluded that the decline in fair value was temporary and would recover by way of changes in market prices or foreign currency exchange rates. The Company intends to hold these securities for the foreseeable future, and does not intend to sell the securities before the price recovers. Customers considers it more likely than not that it will not be required to sell the securities. Accordingly, Customers has concluded that the securities are not other-than-temporarily impaired.

At March 31, 2014 and December 31, 2013, Customers Bank had pledged investment securities aggregating $410.6 million and $451.1 million fair value, respectively, as collateral that the counterparties do not have the ability to sell or repledge.

NOTE 7 – LOANS HELD FOR SALE

The composition of loans held for sale was as follows:

 

     March 31,
2014
     December 31,
2013
 
     (in thousands)  

Mortgage warehouse loans at fair value

   $ 693,405       $ 740,694   

Residential mortgage loans at fair value

     4,127         6,899   
  

 

 

    

 

 

 

Loans held for sale

   $ 697,532       $ 747,593   
  

 

 

    

 

 

 

 

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NOTE 8 — LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES

The following table presents loans receivable as of March 31, 2014 and December 31, 2013:

 

     March 31,
2014
    December 31,
2013
 
     (in thousands)  

Construction

   $ 12,775      $ 14,627   

Commercial real estate

     23,176        24,258   

Commercial and industrial

     6,131        5,814   

Residential real estate

     16,324        18,733   

Manufactured housing

     3,233        3,293   
  

 

 

   

 

 

 

Total loans receivable covered under FDIC loss sharing agreements (1)

     61,639        66,725   

Construction

     36,132        36,901   

Commercial real estate

     2,470,589        1,835,186   

Commercial and industrial

     240,099        239,509   

Mortgage warehouse

     655        866   

Manufactured housing

     136,952        139,471   

Residential real estate

     408,417        145,188   

Consumer

     1,822        2,144   
  

 

 

   

 

 

 

Total loans receivable not covered under FDIC loss sharing agreements

     3,294,666        2,399,265   
  

 

 

   

 

 

 

Total loans receivable

     3,356,305        2,465,990   

Deferred (fees) costs, net

     242        (912

Allowance for loan losses

     (26,704     (23,998
  

 

 

   

 

 

 

Loans receivable, net

   $ 3,329,843      $ 2,441,080   
  

 

 

   

 

 

 

 

(1) Loans that were acquired in two FDIC-assisted transactions and are covered under loss sharing agreements with the FDIC are referred to as covered loans throughout these financial statements.

 

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Table of Contents

Non-Covered Loans

The following tables summarize non-covered loans by class and performance status as of March 31, 2014 and December 31, 2013:

 

     March 31, 2014  
     30-89 Days
Past Due (1)
     90 Days
Or More
Past Due(1)
     Total Past
Due (1)
     Non-
Accrual
     Current (2)      Purchased-
Credit-
Impaired
Loans (3)
     Total
Loans (4)
 
     (in thousands)  

Commercial and industrial

   $ 1,607       $ 0       $ 1,607       $ 1,697       $ 235,031       $ 1,764       $ 240,099   

Commercial real estate

     717         0         717         9,448         2,425,015         35,409         2,470,589   

Construction

     0         0         0         451         34,991         690         36,132   

Residential real estate

     853         0         853         454         397,054         10,056         408,417   

Consumer

     0         0         0         0         1,433         389         1,822   

Mortgage warehouse

     0         0         0         0         655         0         655   

Manufactured housing (5)

     7,091         3,938         11,029         562         120,697         4,664         136,952   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 10,268       $ 3,938       $ 14,206       $ 12,612       $ 3,214,876       $ 52,972       $ 3,294,666   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 2013  
     30-89 Days
Past Due (1)
     90 Days
Or More
Past Due(1)
     Total Past
Due (1)
     Non-
Accrual
     Current (2)      Purchased-
Credit-
Impaired
Loans (3)
     Total
Loans (4)
 
     (in thousands)  

Commercial and industrial

   $ 10       $ 0       $ 10       $ 123       $ 237,453       $ 1,923       $ 239,509   

Commercial real estate

     0         0         0         9,924         1,788,144         37,118         1,835,186   

Construction

     0         0         0         2,049         33,922         930         36,901   

Residential real estate

     555         0         555         969         133,158         10,506         145,188   

Consumer

     0         0         0         0         1,728         416         2,144   

Mortgage warehouse

     0         0         0         0         866         0         866   

Manufactured housing (5)

     7,921         3,772         11,693         448         122,416         4,914         139,471   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 8,486       $ 3,772       $ 12,258       $ 13,513       $ 2,317,687       $ 55,807       $ 2,399,265   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Includes past due loans that are accruing interest because collection is considered probable.
(2) Loans where next payment due is less than 30 days from the report date.
(3) Purchased-credit-impaired loans aggregated into a pool are accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flows, and the past due status of the pools, or that of the individual loans within the pools, is not meaningful. Because of the credit impaired nature of the loans, the loans are recorded at a discount reflecting estimated future cash flows and the Bank recognizes interest income on each pool of loans reflecting the estimated yield and passage of time. Such loans are considered to be performing. Purchased-credit-impaired loans that are not in pools accrete interest when the timing and amount of their expected cash flows are reasonably estimable, and are reported as performing loans.
(4) Amounts exclude deferred costs and fees and the allowance for loan losses.
(5) Manufactured housing loans purchased in 2010 are subject to cash reserves held at the Bank that are used to fund past-due payments when the loan becomes 90 days or more delinquent. Subsequent purchases are subject to varying provisions in the event of borrowers’ delinquencies.

 

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Table of Contents

Covered Loans

The following tables summarize covered loans by class and performance status as of March 31, 2014 and December 31, 2013:

 

     March 31, 2014  
     30-89 Days
Past Due (1)
     90 Days
Or More
Past Due (1)
     Total Past
Due (1)
     Non-
Accrual
     Current (2)      Purchased
- Credit
Impaired
Loans (3)
     Total
Loans (4)
 
     (in thousands)  

Commercial and industrial

   $ 39       $ 0       $ 39       $ 219       $ 3,461       $ 2,412       $ 6,131   

Commercial real estate

     243         0         243         1,279         13,130         8,524         23,176   

Construction

     0         0         0         3,382         530         8,863         12,775   

Residential real estate

     750         0         750         561         13,231         1,782         16,324   

Manufactured housing

     71         0         71         16         3,018         128         3,233   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,103       $ 0       $ 1,103       $ 5,457       $ 33,370       $ 21,709       $ 61,639   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 2013  
     30-89 Days
Past Due (1)
     90 Days
Or More
Past Due (1)
     Total Past
Due (1)
     Non-
Accrual
     Current (2)      Purchased-
Credit
Impaired
Loans (3)
     Total
Loans (4)
 
     (in thousands)  

Commercial and industrial

   $ 295       $ 0       $ 295       $ 2       $ 3,172       $ 2,345       $ 5,814   

Commercial real estate

     245         0         245         1,691         13,586         8,736         24,258   

Construction

     0         0         0         3,382         1,967         9,278         14,627   

Residential real estate

     90         0         90         564         14,108         3,971         18,733   

Manufactured housing

     56         0         56         11         3,081         145         3,293   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 686       $ 0       $ 686       $ 5,650       $ 35,914       $ 24,475       $ 66,725   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Includes past due loans that are accruing interest because collection is considered probable.
(2) Purchased loans in FDIC assisted transactions with no evidence of credit deterioration since origination.
(3) Purchased-credit-impaired loans aggregated into a pool are accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flows, and the past due status of the pools, or that of the individual loans within the pools, is not meaningful. Because of the credit impaired nature of the loans, the loans are recorded at a discount reflecting estimated future cash flows and the Bank recognizes interest income on each pool of loans reflecting the estimated yield and passage of time. Such loans are considered to be performing. Purchased-credit-impaired loans that are not in pools accrete interest when the timing and amount of their expected cash flows are reasonably estimable, and are reported as performing loans.
(4) Amounts exclude deferred costs and fees and allowance for loan losses.

 

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Table of Contents

Allowance for Loan Losses and FDIC Loss Sharing Receivable

Prospective losses incurred on covered loans are eligible for partial reimbursement by the FDIC. Subsequent to the purchase date, the expected cash flows on the covered loans are subject to evaluation. Decreases in the present value of expected cash flows are recognized by increasing the allowance for loan losses with a related charge to the provision for loan losses. At the same time the FDIC indemnification asset is increased reflecting an estimated future collection from the FDIC with a related credit to the provision for loan losses. If the expected cash flows on the covered loans increase such that a previously recorded impairment can be reversed, the Bancorp records a reduction in the allowance for loan losses with a related credit to the provision for loan losses accompanied by a reduction in the FDIC receivable and a charge to the provision for loan losses. Increases in expected cash flows of purchased loans and decreases in expected cash flows of the FDIC loss sharing receivable, when there are no previously recorded impairments, are considered together and recognized over the remaining life of the loans as interest income.

The following table presents changes in the allowance for loan losses and the FDIC loss sharing receivable for the three months ended March 31, 2014 and 2013.

 

     Allowance for Loan Losses  
     For the Three Months Ended March 31,  
(amounts in thousands)    2014     2013  

Beginning balance

   $ 23,998      $ 25,837   

Provision for loan losses (1)

     2,901        1,100   

Charge-offs

     (536     (563

Recoveries

     341        65   
  

 

 

   

 

 

 

Ending balance

   $ 26,704      $ 26,439   
  

 

 

   

 

 

 

 

     FDIC Loss Sharing Receivable  
     For the Three Months Ended March 31,  
(amounts in thousands)    2014     2013  

Beginning balance

   $ 10,046      $ 12,343   

(Decreased)/Increased estimated cash flows (2)

     (1,467     1,217   

Other activity, net (3)

     990        853   

Cash receipts from FDIC

     (1,297     (2,370
  

 

 

   

 

 

 

Ending balance

   $ 8,272      $ 12,043   
  

 

 

   

 

 

 

(1) Provision for loan losses

   $ 2,901      $ 1,100   

(2) Effect attributable to FDIC loss share arrangements

     1,467        (1,217
  

 

 

   

 

 

 

Net amount reported as provision for loan losses

   $ 4,368      $ (117
  

 

 

   

 

 

 

 

(3) Includes external costs, such as legal fees, real estate taxes, and appraisal expenses, that qualify for reimbursement under loss sharing arrangements.

 

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Table of Contents

Impaired Loans — Covered and Non-Covered

The following tables present a summary of impaired loans as of March 31, 2014 and December 31, 2013 and the average recorded investment and interest income recognized for the three months ended March 31, 2014 and 2013. Purchased-credit-impaired loans are considered to be performing and are not included in the tables below.

 

     March 31, 2014      For the Three Months Ended
March 31, 2014
 
     Recorded
Investment
Net of
Charge Offs
     Unpaid
Principal
Balance
     Related
Allowance
     Average
Recorded
Investment
     Interest
Income
Recognized
 
     (in thousands)  

With no related allowance recorded:

              

Commercial and industrial

   $ 10,909       $ 12,241          $ 12,003       $ 99   

Commercial real estate

     19,881         20,733            17,139         274   

Construction

     2,325         3,594            2,551         0   

Consumer

     5         5            3         0   

Residential real estate

     1,951         1,951            2,391         13   

With an allowance recorded:

              

Commercial and industrial

     836         734       $ 588         1,653         8   

Commercial real estate

     2,438         3,328         1,093         2,350         1   

Construction

     1,568         1,568         347         1,350         15   

Consumer

     64         5         14         64         1   

Residential real estate

     250         250         197         251         1   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 40,227       $ 44,409       $ 2,239       $ 39,755       $ 412   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 2013      For the Three Months EndedMarch
31, 2013
 
     Recorded
Investment
Net of
Charge Offs
     Unpaid
Principal
Balance
     Related
Allowance
     Average
Recorded
Investment
     Interest Income
Recognized
 
     (in thousands)  

With no related allowance recorded:

              

Commercial and industrial

   $ 13,097       $ 13,159          $ 4,796       $ 56   

Commercial real estate

     14,397         15,249            23,627         198   

Construction

     2,777         4,046            7,320         2   

Consumer

     0         0            103         0   

Residential real estate

     2,831         2,831            2,463         8   

With an allowance recorded:

              

Commercial and industrial

     2,469         3,739       $ 829         671         7   

Commercial real estate

     2,261         3,167         946         8,585         11   

Construction

     1,132         1,132         351         6,307         49   

Consumer

     64         64         17         53         1   

Residential real estate

     252         252         199         1,103         2   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 39,280       $ 43,639       $ 2,342       $ 55,028       $ 334   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Troubled Debt Restructurings

At March 31, 2014 and 2013, there were $5.1 million and $6.4 million, respectively, in loans reported as troubled debt restructurings (“TDRs”). TDRs are reported as impaired loans in the calendar year of their restructuring and are evaluated to determine whether they should be placed on non-accrual status. In subsequent years, a TDR may be returned to accrual status if it satisfies a minimum six-month performance requirement; however, it will remain classified as impaired. Generally, the Bancorp requires sustained performance for nine months before returning a TDR to accrual status.

Modification of purchased-credit-impaired loans that are accounted for within loan pools in accordance with the accounting standards for purchased-credit-impaired loans do not result in the removal of these loans from the pool even if modifications would otherwise be considered a TDR. Accordingly, as each pool is accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flows, modifications of loans within such pools are not TDRs.

 

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Table of Contents

The following is an analysis of loans modified in a troubled debt restructuring by type of concession for the three months ended March 31, 2014 and 2013. There were no modifications that involved forgiveness of debt.

 

     TDRs in
Compliance
with Their
Modified
Terms and
Accruing
Interest
     TDRs in
Compliance
with Their
Modified
Terms and
Not

Accruing
Interest
     Total  
     (in thousands)  

Three months ended March 31, 2014

        

Extended under forbearance

   $ 0       $ 0       $ 0   

Multiple extensions resulting from financial difficulty

     0         0         0   

Interest-rate reductions

     247         127         374   
  

 

 

    

 

 

    

 

 

 

Total

   $ 247       $ 127       $ 374   
  

 

 

    

 

 

    

 

 

 

Three months ended March 31, 2013

        

Extended under forbearance

   $ 0       $ 0       $ 0   

Multiple extensions resulting from financial difficulty

     0         0         0   

Interest-rate reductions

     0         257         257   
  

 

 

    

 

 

    

 

 

 

Total

   $ 0       $ 257       $ 257   
  

 

 

    

 

 

    

 

 

 

 

19


Table of Contents

The following table provides, by class, the number of loans modified in troubled debt restructurings and the recorded investments and unpaid principal balances during the three months ended March 31, 2014 and 2013.

 

     TDRs in Compliance with Their
Modified Terms and Accruing
Interest
     TDRs in
Compliance
with Their
Modified
Terms and Not
Accruing Interest
 
     Number
of Loans
     Recorded
Investment
     Number
of Loans
     Recorded
Investment
 
     (dollars in thousands)  

Three months ended March 31, 2014

           

Commercial and industrial

     0       $ 0         0       $ 0   

Commercial real estate

     0         0         0         0   

Construction

     0         0         0         0   

Manufactured housing

     1         47         2         127   

Residential real estate

     3         200         0         0   

Consumer

     0         0         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     4       $ 247         2       $ 127   
  

 

 

    

 

 

    

 

 

    

 

 

 

Three months ended March 31, 2013

           

Commercial and industrial

     0       $ 0         0       $ 0   

Commercial real estate

     0         0         0         0   

Construction

     0         0         0         0   

Manufactured housing

     0         0         3         257   

Residential real estate

     0         0         0         0   

Consumer

     0         0         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     0       $ 0         3       $ 257   
  

 

 

    

 

 

    

 

 

    

 

 

 

At March 31, 2014 and 2013, there were no commitments to lend additional funds to debtors whose terms have been modified in troubled debt restructuring.

For the three months ended March 31, 2014 and 2013, the recorded investment of loan determined to be TDRs was $0.4 million and $0.3 million, respectively, both before and after restructuring. During the three month period ended March 31, 2014, two TDR loans defaulted with a recorded investment of $0.1 million. During the three month period ended March 31, 2013, three TDR loans defaulted with a recorded investment of $0.3 million.

Loans modified in troubled debt restructurings are evaluated for impairment. The nature and extent of impairment of TDRs, including those which have experienced a subsequent default, is considered in the determination of an appropriate level of allowance for credit losses. There were no specific allowances resulting from TDR modifications during the three months ended March 31, 2014 and 2013.

Credit Quality Indicators

Commercial and industrial, commercial real estate, residential real estate and construction loans are rated based on an internally assigned risk rating system which is assigned at the loan origination and reviewed on a periodic or on an “as needed” basis. Consumer, mortgage warehouse and manufactured housing loans are evaluated based on the payment activity of the loan.

To facilitate the monitoring of credit quality within the commercial and industrial, commercial real estate, construction, and residential real estate classes, and for purposes of analyzing historical loss rates used in the determination of the allowance for loan losses for the respective portfolio class, the Bank utilizes the following categories of risk ratings: pass/satisfactory (includes risk rating 1 through 6), special mention, substandard, doubtful, and loss. The risk rating categories, which are derived from standard regulatory rating definitions, are assigned upon initial approval of credit to borrowers and updated periodically thereafter. Pass/satisfactory ratings, which are assigned to those borrowers who do not have identified potential or well-defined weaknesses and for whom there is a high likelihood of orderly repayment, are updated periodically based on the size and credit characteristics of the borrower. All other categories are updated on a quarterly basis during the month preceding the end of the calendar quarter. Consumer loans are not assigned a risk rating. While assigning risk ratings involves judgment, the risk-rating process allows management to identify riskier credits in a timely manner and allocate the appropriate resources to managing the loans.

 

20


Table of Contents

The risk rating grades are defined as follows:

“1” – Pass/Excellent

Loans rated 1 represent a credit extension of the highest quality. The borrower’s historic (at least five years) cash flows manifest extremely large and stable margins of coverage. Balance sheets are conservative, well capitalized, and liquid. After considering debt service for proposed and existing debt, projected cash flows continue to be strong and provide ample coverage. The borrower typically reflects broad geographic and product diversification and has access to alternative financial markets.

“2” – Pass/Superior

Loans rated 2 are those for which the borrower has a strong financial condition, balance sheet, operations, cash flow, debt capacity and coverage with ratios better than industry norms. The borrowers of these loans exhibit a limited leverage position, borrowers are virtually immune to local economies in stable growing industries, and where management is well respected and the company has ready access to public markets.

“3” – Pass/Strong

Loans rated 3 are those loans for which the borrower has above average financial condition and flexibility; more than satisfactory debt service coverage, balance sheet and operating ratios are consistent with or better than industry peers, have little industry risk, move in diversified markets and are experienced and competent in their industry. These borrowers’ access to capital markets is limited mostly to private sources, often secured, but the borrower typically has access to a wide range of refinancing alternatives.

“4” – Pass/Good

Loans rated 4 have a sound primary and secondary source of repayment. The borrower may have access to alternative sources of financing, but sources are not as widely available as they are to a higher grade borrower. These loans carry a normal level of risk, with very low loss exposure. The borrower has the ability to perform according to the terms of the credit facility. The margins of cash flow coverage are satisfactory but vulnerable to more rapid deterioration than the higher quality loans.

5” – Satisfactory

Loans rated 5 are extended to borrowers who are determined to be a reasonable credit risk and demonstrate the ability to repay the debt from normal business operations. Risk factors may include reliability of margins and cash flows, liquidity, dependence on a single product or industry, cyclical trends, depth of management, or limited access to alternative financing sources. The borrower’s historical financial information may indicate erratic performance, but current trends are positive and the quality of financial information is adequate, but is not as detailed and sophisticated as information found on higher grade loans. If adverse circumstances arise, the impact on the borrower may be significant.

“6” – Satisfactory/Bankable with Care

Loans rated 6 are those for which the borrower has higher than normal credit risk; however, cash flow and asset values are generally intact. These borrowers may exhibit declining financial characteristics, with increasing leverage and decreasing liquidity and may have limited resources and access to financial alternatives. Signs of weakness in these borrowers may include delinquent taxes, trade slowness and eroding profit margins.

“7” – Special Mention

Loans rated Special Mention are credit facilities that may have potential developing weaknesses and deserve extra attention from the account manager and other management personnel. In the event that potential weaknesses are not corrected or mitigated, deterioration in the ability of the borrower to repay the debt in the future may occur. This grade is not assigned to loans that bear certain peculiar risks normally associated with the type of financing involved, unless circumstances have caused the risk to increase to a level higher than would have been acceptable when the credit was originally approved. Loans where significant actual, not potential, weaknesses or problems are clearly evident are graded in the category below.

“8” – Substandard

Loans are classified Substandard when the loans are inadequately protected by the current sound worth and payment capacity of the obligor or of the collateral pledged, if any. Loans so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt and are characterized by the distinct possibility that the Company will sustain some loss if the weaknesses are not corrected.

 

21


Table of Contents

“9” – Doubtful

The Bank assigns a doubtful rating to loans that have all the attributes of a substandard rating with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The possibility of loss is extremely high, but because of certain important and reasonable specific pending factors that may work to the advantage of and strengthen the credit quality of the loan, its classification as an estimated loss is deferred until its more exact status may be determined. Pending factors may include a proposed merger or acquisition, liquidation proceeding, capital injection, perfecting liens on additional collateral or refinancing plans.

“10” – Loss

The Bank assigns a loss rating to loans considered uncollectible and of such little value that their continuance as an active asset is not warranted. Amounts classified as loss are immediately charged off.

Risk ratings are not established for home equity loans, consumer loans, and installment loans, mainly because these portfolios consist of a larger number of homogenous loans with smaller balances. Instead, these portfolios are evaluated for risk mainly based upon aggregate payment history through the monitoring of delinquency levels and trends and are classified as performing and nonperforming.

The following table presents the credit ratings of the non-covered loan portfolio as of March 31, 2014 and December 31, 2013:

 

     March 31, 2014  
     Commercial
and
Industrial
     Commercial
Real Estate
     Construction      Residential
Real Estate
 
     (in thousands)  

Pass/Satisfactory

   $ 229,557       $ 2,442,494       $ 35,652       $ 406,515   

Special Mention

     8,487         15,173         29         864   

Substandard

     2,055         12,922         451         1,038   

Doubtful

     0         0         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total loans receivable, non-covered

   $ 240,099       $ 2,470,589       $ 36,132       $ 408,417   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     Consumer      Mortgage
Warehouse
     Manufactured
Housing
 
     (in thousands)  

Performing

   $ 1,822       $ 655       $ 125,361   

Nonperforming (1)

     0         0         11,591   
  

 

 

    

 

 

    

 

 

 

Total loans receivable, non-covered

   $ 1,822       $ 655       $ 136,952   
  

 

 

    

 

 

    

 

 

 

 

(1) Includes loans that are on nonaccrual status at March 31, 2014.

 

22


Table of Contents
     December 31, 2013  
     Commercial
and
Industrial
     Commercial
Real Estate
     Construction      Residential
Real Estate
 
     (in thousands)  

Pass/Satisfactory

   $ 228,748       $ 1,808,804       $ 34,822       $ 142,588   

Special Mention

     10,314         12,760         29         940   

Substandard

     447         13,622         2,050         1,660   

Doubtful

     0         0         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total loans receivable, non-covered

   $ 239,509       $ 1,835,186       $ 36,901       $ 145,188   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     Consumer      Mortgage
Warehouse
     Manufactured
Housing
 
     (in thousands)  

Performing

   $ 2,144       $ 866       $ 127,330   

Nonperforming (1)

     0         0         12,141   
  

 

 

    

 

 

    

 

 

 

Total loans receivable, non-covered

   $ 2,144       $ 866       $ 139,471   
  

 

 

    

 

 

    

 

 

 

 

(1) Includes loans that are on nonaccrual status at December 31, 2013.

The following table presents the credit ratings of the covered loan portfolio as of March 31, 2014 and December 31, 2013:

 

     March 31, 2014  
     Commercial
and
Industrial
     Commercial
Real Estate
     Construction      Residential
Real Estate
 
     (in thousands)  

Pass/Satisfactory

   $ 4,027       $ 13,630       $ 531       $ 13,914   

Special Mention

     0         3,205         0         455   

Substandard

     2,104         6,341         12,244         1,955   

Doubtful

     0         0         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total loans receivable, covered

   $ 6,131       $ 23,176       $ 12,775       $ 16,324   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     Manufactured
Housing
 
     (in thousands)  

Performing

   $ 3,146   

Nonperforming (1)

     87   
  

 

 

 

Total loans receivable, covered

   $ 3,233   
  

 

 

 

 

(1) Includes loans that are on nonaccrual status at March 31, 2014.

 

23


Table of Contents
     December 31, 2013  
     Commercial
and
Industrial
     Commercial
Real Estate
     Construction      Residential
Real Estate
 
     (in thousands)  

Pass/Satisfactory

   $ 3,688       $ 14,330       $ 1,967       $ 14,137   

Special Mention

     223         2,989         0         455   

Substandard

     1,903         6,939         12,660         4,141   

Doubtful

     0         0         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total loans receivable, covered

   $ 5,814       $ 24,258       $ 14,627       $ 18,733   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     Manufactured
Housing
 
     (in thousands)  

Performing

   $ 3,226   

Nonperforming (1)

     67   
  

 

 

 

Total loans receivable, covered

   $ 3,293   
  

 

 

 

 

(1) Includes loans that are on nonaccrual status at December 31, 2013.

 

24


Table of Contents

Allowance for loan losses

The changes in the allowance for loan losses for the three months ended March 31, 2014 and 2013 and the loans and allowance for loan losses by loan class based on impairment evaluation method are as follows. The amounts presented for the provision for loan losses below do not include the effect of changes to estimated benefits resulting from the FDIC loss share arrangements for the covered loans.

 

    Commercial
and
Industrial
    Commercial
Real Estate
    Construction     Residential
Real Estate
    Manufactured
Housing
    Consumer     Mortgage
Warehouse
    Residual
Reserve
    Total  
    (in thousands)  

Three months ended March 31, 2014

                 

Beginning Balance, January 1, 2014

  $ 2,638      $ 15,705      $ 2,385      $ 2,490      $ 614      $ 130      $ 36      $ 0      $ 23,998   

Charge-offs

    0        (248     0        (288     0        0        0        0        (536

Recoveries

    90        25        0        224        0        2        0        0        341   

Provision for loan losses

    (285     3,370        (43     (119     (21     (5     4        0        2,901   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance, March 31, 2014

  $ 2,443      $ 18,852      $ 2,342      $ 2,307      $ 593      $ 127      $ 40      $ 0      $ 26,704   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

At March 31, 2014

                 

Loans:

                 

Individually evaluated for impairment

  $ 11,745      $ 22,319      $ 3,893      $ 2,201      $ 0      $ 69      $ 0      $ 0      $ 40,227   

Collectively evaluated for impairment

    230,309        2,427,513        35,461        410,702        135,393        1,364        655        0        3,241,397   

Loans acquired with credit deterioration

    4,176        43,933        9,553        11,838        4,792        389        0        0        74,681   
                 

 

 

 
                  $ 3,356,305   
                 

 

 

 

Allowance for loan losses:

                 

Individually evaluated for impairment

  $ 588      $ 1,093      $ 347      $ 197      $ 0      $ 14      $ 0      $ 0      $ 2,239   

Collectively evaluated for impairment

    1,670        12,532        241        791        86        35        40        0        15,395   

Loans acquired with credit deterioration

    185        5,227        1,754        1,319        507        78        0        0        9,070   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
  $ 2,443      $ 18,852      $ 2,342      $ 2,307      $ 593      $ 127      $ 40      $ 0      $ 26,704   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

25


Table of Contents
    Commercial
and
Industrial
    Commercial
Real Estate
    Construction     Residential
Real Estate
    Manufactured
Housing
    Consumer     Mortgage
Warehouse
    Residual
Reserve
    Total  
    (in thousands)  

Three months ended March 31, 2013

                 

Beginning Balance, January 1, 2013

  $ 1,477      $ 15,439      $ 3,991      $ 3,233      $ 750      $ 154      $ 71      $ 722      $ 25,837   

Charge-offs

    (20     (410     0        (133     0        0        0        0        (563

Recoveries

    11        52        0        (3     0        5        0        0        65   

Provision for loan losses

    522        142        288        151        96        (18     (17     (64     1,100   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance, March 31, 2013

  $ 1,990      $ 15,223      $ 4,279      $ 3,248      $ 846      $ 141      $ 54      $ 658      $ 26,439   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

At March 31, 2013

                 

Loans:

                 

Individually evaluated for impairment

  $ 4,828      $ 32,835      $ 11,935      $ 3,480      $ 0      $ 201      $ 0      $ 0      $ 53,279   

Collectively evaluated for impairment

    180,530        975,651        34,086        110,588        148,016        1,145        7,220        0        1,457,236   

Loans acquired with credit deterioration

    5,710        62,783        17,187        15,875        5,693        478        0        0        107,726   
                 

 

 

 
                  $ 1,618,241   
                 

 

 

 

Allowance for loan losses:

                 

Individually evaluated for impairment

  $ 420      $ 2,207      $ 1,490      $ 364      $ 0      $ 14      $ 0      $ 0      $ 4,495   

Collectively evaluated for impairment

    1,322        8,459        374        955        72        50        54        658        11,944   

Loans acquired with credit deterioration

    248        4,557        2,415        1,929        774        77        0        0        10,000   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
  $ 1,990      $ 15,223      $ 4,279      $ 3,248      $ 846      $ 141      $ 54      $ 658      $ 26,439   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

26


Table of Contents

The non-covered manufactured housing portfolio was purchased in August 2010. A portion of the purchase price may be used to reimburse the Bank under the specified terms in the Purchase Agreement for defaults of the underlying borrower and other specified items. At March 31, 2014 and 2013, funds available for reimbursement, if necessary, were $3.2 million and $3.1 million, respectively. Each quarter, these funds are evaluated to determine if they would be sufficient to absorb probable losses within the manufactured housing portfolio.

The changes in accretable yield related to purchased-credit-impaired loans for the three months ended March 31, 2014 and 2013 were as follows:

 

For the Three Months Ended March 31,

   2014     2013  
     (in thousands)  

Accretable yield balance, beginning of period

   $ 22,557      $ 32,174   

Accretion to interest income

     (1,080     (2,071

Reclassification from nonaccretable difference and disposals, net

     (858     (438
  

 

 

   

 

 

 

Accretable yield balance, end of period

   $ 20,619      $ 29,665   
  

 

 

   

 

 

 

NOTE 9 — SHARE-BASED COMPENSATION

Stock Options

In February 2014, options to purchase an aggregate of 88,000 shares of voting common stock were granted to certain officers and team members. The options are subject to five-year cliff vesting. The fair values of the options were estimated using the Black-Scholes option pricing model. The following table presents the weighted-average assumptions used and the resulting weighted-average fair value of the options granted.

 

     March 31, 2014  

Weighted-average risk-free interest rate

     2.20

Expected dividend yield

     0.00

Weighted-average expected volatility

     17.61

Weighted-average expected life (in years)

     7.00   

Weighted-average fair value of each option granted

   $ 4.88   

The following table summarizes stock option activity for the three months ended March 31, 2014.

 

     Number
  of Options  
      Weighted-
   average
Exercise
Price
     Weighted-
average
Remaining
Contractual
  Term in Years  
       Aggregate
   Intrinsic
Value
 
     (dollars in thousands, except Weighted-average exercise price)  

Outstanding at January 1, 2014

     2,779,486      $ 13.66         

Granted

     88,000        19.42         

Forfeited

     (5,000     14.94         
  

 

 

         

Outstanding at March 31, 2014

     2,862,486      $ 13.84         7.93       $ 20,183   
  

 

 

         

 

 

 

Exercisable at March 31, 2014

     14,438      $ 20.06         3.07       $ 59   
  

 

 

         

 

 

 

 

 

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Also in February 2014, 142,395 restricted stock units were granted to certain officers and team members. Of the aggregate restricted stock units, 47,760 were granted under the Bonus Recognition and Retention Program and are subject to five-year cliff vesting. The remainders are subject to three-year cliff vesting. The following table summarizes restricted stock activity for the three months ended March 31, 2014.

 

     Restricted
Stock Units
    Weighted-
average grant-
date fair value
 

Outstanding and unvested at January 1, 2014

     613,464      $ 13.00   

Granted

     142,395        19.42   

Vested

     (34,414     12.00   
  

 

 

   

Outstanding and unvested at March 31, 2014

     721,445      $ 14.30   
  

 

 

   

Total share-based compensation expense for the three months ended March 31, 2014 and 2013 was $1.0 million and $0.7 million, respectively.

Customers Bancorp has a policy that permits its directors to elect to receive shares of voting common stock in lieu of their cash retainers. In January 2014, Customers Bancorp issued 25,541 shares of voting common stock with a fair value of $0.5 million to the directors as compensation for their services during 2013. In March 2014, Customers Bancorp issued 10,058 shares of voting common stock with a fair value of $0.2 million to directors as compensation for their services during first quarter 2014. The fair values were determined based on the opening price of the common stock on the day the shares were issued.

NOTE 10 — REGULATORY MATTERS

The Bank and the Bancorp are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet the minimum capital requirements can result in certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Bancorp’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank and Bancorp must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items, as calculated under the regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Prompt corrective action provisions are not applicable to bank holding companies.

Quantitative measures established by regulation to ensure capital adequacy require the Bank and Bancorp to maintain minimum amounts and ratios (set forth in the following table) of total and Tier 1 capital to risk-weighted assets and of Tier 1 capital to average assets (as defined in the regulations). At March 31, 2014 and December 31, 2013, the Bank and Bancorp met all capital adequacy requirements to which they were subject.

 

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To be categorized as well capitalized, an institution must maintain minimum total risk based, Tier 1 risk based and Tier 1 leveraged ratios as set forth in the following table:

 

     Actual     For Capital Adequacy
Purposes
    To Be Well Capitalized
Under
Prompt Corrective Action
Provisions
 
(dollars in thousands)    Amount      Ratio     Amount      Ratio     Amount      Ratio  

As of March 31, 2014:

               

Total capital (to risk weighted assets)

               

Customers Bancorp, Inc.

   $ 424,941         11.62   $ 292,570         8.0     N/A         N/A   

Customers Bank

   $ 448,604         12.36   $ 290,307         8.0   $ 362,884         10.0

Tier 1 capital (to risk weighted assets)

               

Customers Bancorp, Inc.

   $ 398,237         10.89   $ 146,285         4.0     N/A         N/A   

Customers Bank

   $ 421,900         11.63   $ 145,154         4.0   $ 217,731         6.0

Tier 1 capital (to average assets)

               

Customers Bancorp, Inc.

   $ 398,237         9.10   $ 174,957         4.0     N/A         N/A   

Customers Bank

   $ 421,900         9.71   $ 173,813         4.0   $ 217,266         5.0

As of December 31, 2013:

               

Total capital (to risk weighted assets)

               

Customers Bancorp, Inc.

   $ 411,527         13.21   $ 249,196         8.0     N/A         N/A   

Customers Bank

   $ 435,432         14.11   $ 246,936         8.0   $ 308,670         10.0

Tier 1 capital (to risk weighted assets)

               

Customers Bancorp, Inc.

   $ 387,529         12.44   $ 124,598         4.0     N/A         N/A   

Customers Bank

   $ 411,434         13.33   $ 123,468         4.0   $ 185,202         6.0

Tier 1 capital (to average assets)

               

Customers Bancorp, Inc.

   $ 387,529         10.11   $ 153,310         4.0     N/A         N/A   

Customers Bank

   $ 411,434         10.81   $ 152,191         4.0   $ 190,239         5.0

NOTE 11 — DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS

The Bancorp uses fair value measurements to record fair value adjustments to certain assets and liabilities to disclose the fair value of its financial instruments. FASB ASC 825, Financial Instruments, requires disclosure of the estimated fair value of an entity’s assets and liabilities considered to be financial instruments. For the Bancorp, as for most financial institutions, the majority of its assets and liabilities are considered to be financial instruments. However, many of these instruments lack an available trading market as characterized by a willing buyer and willing seller engaging in an exchange transaction. For fair value disclosure purposes, the Bancorp utilized certain fair value measurement criteria under the FASB ASC 820, Fair Value Measurements and Disclosures, as explained below.

Cash and cash equivalents:

The carrying amounts reported in the balance sheet for cash and short-term instruments approximate those assets’ fair values. These assets are included as Level 1 fair values, based upon the lowest level of input that is significant to the fair value measurements.

Investment securities:

The fair value of investment securities available for sale are determined by obtaining quoted market prices on nationally recognized and foreign securities exchanges (Level 1), matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted prices, or externally developed models that use unobservable inputs due to limited or no market activity of the instrument (Level 3). These assets are included as Level 1, 2, or 3 fair values, based upon the lowest level of input that is significant to the fair value measurements.

The carrying amount of FHLB and Federal Reserve stock approximates fair value, and considers the limited marketability of such securities. These assets are included as Level 2 fair values, based upon the lowest level of input that is significant to the fair value measurements.

 

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Loans held for sale - Residential mortgage loans:

The Bancorp generally estimates the fair values of loans held for sale based on commitments on hand from investors within the secondary market for loans with similar characteristics. These assets are included as Level 2 fair values, based upon the lowest level of input that is significant to the fair value measurements.

Loans held for sale - Mortgage warehouse loans:

The fair value of mortgage warehouse loans is the amount of cash initially advanced to fund the mortgage, plus accrued interest and fees, as specified in the respective agreements. The loan is used by mortgage companies as short-term bridge financing between the funding of mortgage loans and the finalization of the sale of the loans to an investor. Changes in fair value are not expected to be recognized since at inception of the transaction the underlying loans have already been sold to an approved investor or they have been hedged by the mortgage company. Additionally, the interest rate is variable, and the transaction is short-term, with an average life of 17 days from purchase to sale. These assets are included as Level 2 fair values, based upon the lowest level of input that is significant to the fair value measurements.

Loans receivable, net:

The fair values of loans held for investment are estimated using discounted cash flow analyses, using market rates at the balance sheet date that reflect the credit and interest rate-risk inherent in the loans. Projected future cash flows are calculated based upon contractual maturity or call dates, projected repayments and prepayments of principal. Generally, for variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. These assets are included as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements.

Impaired loans:

Impaired loans are those that are accounted for under ASC 450, Contingencies, in which the Bancorp has measured impairment generally based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third-party appraisals of the properties that collateralize the loans, or discounted cash flows based upon the expected proceeds. These assets are included as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements.

FDIC loss sharing receivable:

The FDIC loss sharing receivable is measured separately from the related covered assets, as it is not contractually embedded in the assets and is not transferable with the assets should the assets be sold. Fair value is estimated using projected cash flows related to the loss sharing agreements based on the estimated losses to be incurred on the loans and the expected reimbursements for losses using the applicable loss share percentages. These cash flows are discounted to reflect the estimated timing of the receipt of the loss share reimbursement from the FDIC. This asset is included as Level 3 fair value, based upon the lowest level of input that is significant to the fair value measurements.

Other real estate owned:

The fair value of OREO is determined using appraisals, which may be discounted based on management’s review and changes in market conditions (Level 3 Inputs). All appraisals must be performed in accordance with the Uniform Standards of Professional Appraisal Practice (“USPAP”). Appraisals are certified to the Bancorp and performed by appraisers on the Bancorp’s approved list of appraisers. Evaluations are completed by a person independent of management. The content of the appraisal depends on the complexity of the property. Appraisals are completed on a “retail value” and an “as is value”. These assets are included as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements.

Accrued interest receivable and payable:

The carrying amount of accrued interest receivable and accrued interest payable approximates its fair value. These assets are included as Level 2 fair values, based upon the lowest level of input that is significant to the fair value measurements.

Deposit liabilities:

The fair values disclosed for deposits (e.g., interest and noninterest checking, passbook savings and money market deposit accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered in the market on certificates to a schedule of aggregated expected monthly maturities on time deposits. These assets are included as Level 2 fair values, based upon the lowest level of input that is significant to the fair value measurements.

 

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Federal funds purchased:

For these short-term instruments, the carrying amount is considered a reasonable estimate of fair value. These assets are included as Level 2 fair values, based upon the lowest level of input that is significant to the fair value measurements.

Borrowings:

Borrowings consist of long-term and short-term FHLB advances, five-year senior unsecured notes, and subordinated debt. For the short-term borrowings, the carrying amount is considered a reasonable estimate of fair value. Fair values of long-term FHLB advances are estimated using discounted cash flow analysis, based on quoted prices for new FHLB advances with similar credit risk characteristics, terms and remaining maturity. The prices obtained from this active market represent a market value that is deemed to represent the transfer price if the liability were assumed by a third party. The five-year senior unsecured notes are traded on The NASDAQ Stock Market, and their price can be obtained daily. Fair values of subordinated debt are estimated using discounted cash flow analysis, based on market rates currently offered on such debt with similar credit risk characteristics, terms and remaining maturity. These liabilities are included as Level 2 fair values, based upon the lowest level of input that is significant to the fair value measurements.

Derivatives (Assets and Liabilities):

The fair values of interest rate swaps and credit derivatives are determined using models that incorporate readily observable market data into a market standard methodology. This methodology nets the discounted future fixed cash receipts and the discounted expected variable cash payments. The discounted variable cash payments are based on expectations of future interest rates derived from observable market interest rate curves. In addition, fair value is adjusted for the effect of nonperformance risk by incorporating credit valuation adjustments for the Bancorp and its counterparties. These assets and liabilities are included as Level 2 fair values, based upon the lowest level of input that is significant to the fair value measurements.

The fair values of the residential mortgage loan commitments are derived from the estimated fair values that can be generated when the underlying mortgage loan is sold in the secondary market. The Bancorp uses commitments on hand from third party investors to estimate an exit price, and adjusts for the probability of the commitment being exercised based on the Bancorp’s internal experience (i.e., pull-through rate). These assets and liabilities are included as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements.

Off-balance-sheet financial instruments:

Fair values for the Bancorp’s off-balance-sheet financial instruments (lending commitments and letters of credit) are based on fees currently charged in the market to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. These financial instruments are included as Level 2 fair values, based upon the lowest level of input that is significant to the fair value measurements. At March 31, 2014 and December 31, 2013, there were no off-balance-sheet financial instruments in excess of their contract value.

The following information should not be interpreted as an estimate of the fair value of the entire Bancorp since a fair value calculation is only provided for a limited portion of the Bancorp’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making these estimates, comparisons between the Bancorp’s disclosures and those of other companies may not be meaningful.

 

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The estimated fair values of the Bancorp’s financial instruments were as follows at March 31, 2014 and December 31, 2013.

 

                   Fair Value Measurements at March 31, 2014  
     Carrying
Amount
     Estimated
Fair Value
     Quoted
Prices in
Active
Markets for
Identical
Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 
     (in thousands)  

Assets:

              

Cash and cash equivalents

   $ 290,467       $ 290,467       $ 290,467       $ 0       $ 0   

Investment securities, available for sale

     458,302         458,302         21,945         436,357         0   

Loans held for sale

     697,532         697,532         0         697,532         0   

Loans receivable, net

     3,329,843         3,374,676         0         0         3,374,676   

FHLB, Federal Reserve Bank and other stock

     50,430         50,430         0         50,430         0   

Accrued interest receivable

     9,629         9,629         0         9,629         0   

FDIC loss sharing receivable

     8,272         8,272         0         0         8,272   

Derivatives

     5,160         5,160         0         5,057         103   

Liabilities:

              

Deposits

   $ 3,606,332       $ 3,569,597       $ 634,578       $ 2,935,019       $ 0   

Borrowings

     970,250         974,599         0         974,599         0   

Derivatives

     4,346         4,346         0         4,346         0   

Accrued interest payable

     1,740         1,740         0         1,740         0   

 

                   Fair Value Measurements at December 31, 2013  
     Carrying
Amount
     Estimated
Fair Value
     Quoted
Prices in
Active
Markets for
Identical
Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 
     (in thousands)  

Assets:

              

Cash and cash equivalents

   $ 233,068       $ 233,068       $ 233,068       $ 0       $ 0   

Investment securities, available for sale

     497,573         497,573         20,714         476,859         0   

Loans held for sale

     747,593         747,593         0         747,593         0   

Loans receivable, net

     2,441,080         2,444,900         0         0         2,444,900   

FHLB, Federal Reserve Bank and other stock

     42,424         42,424         0         42,424         0   

Accrued interest receivable

     8,362         8,362         0         8,362         0   

FDIC loss sharing receivable

     10,046         10,046         0         0         10,046   

Derivatives

     3,763         3,763         0         3,523         240   

Liabilities:

              

Deposits

   $ 2,959,922       $ 2,919,935       $ 478,103       $ 2,441,832       $ 0   

Federal funds purchased

     13,000         13,000         13,000         0         0   

Borrowings

     771,750         774,793         0         774,793         0   

Derivatives

     3,537         3,537         0         3,537         0   

Accrued interest payable

     1,675         1,675         0         1,675         0   

In accordance with FASB ASC 820, Fair Value Measurements and Disclosures, the fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Bancorp’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

 

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The fair value guidance provides a consistent definition of fair value, focusing on an exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.

 

Level 1:   Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
Level 2:   Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability.
Level 3:   Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported with little or no market activity).

A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

For financial assets and liabilities measured at fair value on a recurring and nonrecurring basis, the fair value measurements by level within the fair value hierarchy used at March 31, 2014 and December 31, 2013 were as follows:

 

    March 31, 2014  
    Fair Value Measurements at the End of the Reporting Period Using  
    Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
    Significant Other
Observable Inputs
(Level 2)
    Significant
Unobservable
Inputs
(Level 3)
    Total  
    (in thousands)  

Measured at Fair Value on a Recurring Basis:

       

Assets

       

Available-for-sale securities:

       

Mortgage-backed securities

  $ 0      $ 411,081      $ 0      $ 411,081   

Corporate notes

    0        25,276        0        25,276   

Equity securities

    21,945        0        0        21,945   

Derivatives (1)

    0        5,057        103        5,160   

Loans held for sale – fair value option

    0        697,532        0        697,532   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total assets - recurring fair value measurements

  $ 21,945      $ 1,138,946      $ 103      $ 1,160,994   
 

 

 

   

 

 

   

 

 

   

 

 

 

Liabilities

       

Derivatives (2)

  $ 0      $ 4,346      $ 0      $ 4,346   
 

 

 

   

 

 

   

 

 

   

 

 

 

Measured at Fair Value on a Nonrecurring Basis:

       

Assets

       

Impaired loans, net of specific reserves of $2,239

  $ 0      $ 0      $ 2,917      $ 2,917   

Other real estate owned

    0        0        504        504   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total assets - nonrecurring fair value measurements

  $ 0      $ 0      $ 3,421      $ 3,421   
 

 

 

   

 

 

   

 

 

   

 

 

 

 

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     December 31, 2013  
     Fair Value Measurements at the End of the Reporting Period Using  
     Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
     Significant Other
Observable Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
     Total  
     (in thousands)  

Measured at Fair Value on a Recurring Basis:

           

Assets

           

Available-for-sale securities:

           

Mortgage-backed securities

   $ 0       $ 451,536       $ 0       $ 451,536   

Corporate notes

     0         25,323         0         25,323   

Equity securities

     20,714         0         0         20,714   

Derivatives (1)

     0       $ 3,523         240       $ 3,736   

Loans held for sale – fair value option

     0         747,593         0         747,593   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets - recurring fair value measurements

   $ 20,714       $ 1,227,975       $ 240       $ 1,248,929   
  

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities

           

Derivatives (2)

     0       $ 3,537         0       $ 3,537   
  

 

 

    

 

 

    

 

 

    

 

 

 

Measured at Fair Value on a Nonrecurring Basis:

           

Assets

           

Impaired loans, net of specific reserves of $2,342

   $ 0       $ 0       $ 3,836       $ 3,836   

Other real estate owned

     0         0         335         335   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets - nonrecurring fair value measurements

   $ 0       $ 0       $ 4,171       $ 4,171   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Included in Other Assets
(2) Included in Other Liabilities

The changes in Level 3 assets measured at fair value on a recurring basis for the three months ended March 31, 2014 and 2013 are summarized as follows.

 

     Residential
Mortgage
Loan
Commitments
 
     (in thousands)  

Balance at January 1, 2014

   $ 240   

Issuances

     103   

Settlements

     (240
  

 

 

 

Balance at March 31, 2014

   $ 103   
  

 

 

 

 

     Loans
Held for
Sale (1)
 
     (in thousands)  

Balance at January 1, 2013

   $ 0   

Transfer from Level 2 to Level 3 (1)

     3,173   
  

 

 

 

Balance at March 31, 2013

   $ 3,173   
  

 

 

 

 

(1)

The Bancorp’s policy is to recognize transfers between levels when events or circumstances warrant transfers. During first quarter 2013, a suspected fraud was discovered in the Bank’s loans held-for-sale portfolio. Total loans involved in this fraud initially appeared to be $5.2 million, and management believed the range of possible loss to have been between $1.5 million and $3.2 million. Accordingly, management provided a loss contingency of $2.0 million at March 31, 2013. Due to the uncertainty surrounding the amount of loss, management transferred these loans and the related loss contingency from Level

 

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  2 to Level 3. During second quarter 2013, the Bank determined that an aggregate of $1.0 million of the loans were not involved in the fraud, and these loans were subsequently sold. In addition, the Bank recovered $1.5 million in cash from the alleged perpetrator. Since it was determined that these assets no longer met the definition of a loan, and since the Bank is pursuing restitution through the involved parties, the Bank determined this to be a receivable. As a result, the remaining aggregate $2.7 million of loans and the related $2.0 million reserve were transferred to other assets.

The following table summarizes financial assets and financial liabilities measured at fair value as of March 31, 2014 and December 31, 2013 on a recurring and nonrecurring basis for which the Bancorp utilized Level 3 inputs to measure fair value.

 

    Quantitative Information about Level 3 Fair Value Measurements

March 31, 2014

  Fair Value
Estimate
   

Valuation Technique

 

Unobservable Input

 

Range (Weighted
Average) (3)

    (dollars in thousands)

Impaired loans

  $ 2,917      Collateral appraisal (1)   Liquidation expenses (2)   -3% to -8% (-5.5%)

Other real estate owned

  $ 504      Collateral appraisal (1)   Liquidation expenses (2)   -3% to -8% (-5.5%)

Residential mortgage loan commitments

  $ 103      Adjusted market bid   Pull-through rate   80%
    Quantitative Information about Level 3 Fair Value Measurements

December 31, 2013

  Fair Value
Estimate
   

Valuation Technique

 

Unobservable Input

 

Range (Weighted
Average) (3)

    (dollars in thousands)

Impaired loans

  $ 3,836      Collateral appraisal (1)   Liquidation expenses (2)   -3% to -8% (-5.5%)

Other real estate owned

  $ 335      Collateral appraisal (1)   Liquidation expenses (2)   -3% to -8% (-5.5%)

Residential mortgage loan commitments

  $ 240      Adjusted market bid   Pull-through rate   80%

 

(1) Obtained from approved independent appraisers. Appraisals are current and in compliance with credit policy. The Bancorp does not discount appraisals.
(2) Fair value is adjusted for costs to sell.
(3) Presented as a percentage of the value determined by appraisal.

NOTE 12 — DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

Risk Management Objectives of Using Derivatives

The Bancorp is exposed to certain risks arising from both its business operations and economic conditions. The Bancorp manages economic risks, including interest rate, liquidity, and credit risk, primarily by managing the amount, sources, and durations of its assets and liabilities. Specifically, the Bancorp enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. The Bancorp’s derivative financial instruments are used to manage differences in the amount, timing, and duration of the Bancorp’s known or expected cash receipts and its known or expected cash payments principally related to certain fixed-rate borrowings. The Bancorp also has interest-rate derivatives resulting from a service provided to certain qualifying customers, and therefore, they are not used to manage interest-rate risk in assets or liabilities. The Bank manages a matched book with respect to its derivative instruments in order to minimize its net risk exposure resulting from such transactions.

Cash Flow Hedges of Interest Rate Risk

The Bancorp’s objectives in using interest-rate derivatives are to add stability to interest expense and to manage exposure to interest rate movements. To accomplish this objective, the Bancorp primarily uses interest rate swaps as part of its interest-rate-risk management strategy. Interest-rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for the Bancorp making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.

The effective portion of changes in the fair value of derivatives designated and qualifying as cash flow hedges is recorded in accumulated other comprehensive income and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. During the three months ended March 31, 2014, such derivatives were used to hedge the variable cash flows associated with a forecasted issuance of debt. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings. During the three months ended March 31, 2014, the Bancorp did not record any hedge ineffectiveness.

 

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Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are made on the Bancorp’s variable-rate debt. The Bancorp does not expect to reclassify any amounts from accumulated other comprehensive income to interest expense during the next 12 months as the Bancorp’s derivatives are effective after April 2016.

The Bancorp is hedging its exposure to the variability in future cash flows for forecasted transactions over a maximum period of 24 months (excluding forecasted transactions related to the payment of variable interest on existing financial instruments).

At March 31, 2014, the Bancorp had one outstanding interest rate derivative with a notional amount of $150.0 million that was designated as a cash flow hedge of interest rate risk.

Derivatives Not Designated as Hedging Instruments

The Bank executes interest rate swaps with commercial banking customers to facilitate their respective risk management strategies (typically the loan customers will swap a floating rate loan to a fixed rate loan). The customer interest rate swaps are simultaneously offset by interest rate swaps that the Bank executes with a third party in order to minimize risk exposure resulting from such transactions. Since the interest rate swaps associated with this program do not meet the hedge accounting requirements, changes in the fair value of both the customer swaps and the offsetting third-party market swaps are recognized directly in earnings. At March 31, 2014, the Bancorp had 32 interest rate swaps with an aggregate notional amount of $201.0 million related to this program. At December 31, 2013, the Bancorp had 28 interest rate swaps with an aggregate notional amount of $150.3 million related to this program.

The Bank enters into residential mortgage loan commitments in connection with its mortgage banking activities to fund mortgage loans at specified rates and times in the future. These commitments are short-term in nature and generally expire in 30 to 60 days. The residential mortgage loan commitments that relate to the origination of mortgage loans that will be held for sale are considered derivative instruments under applicable accounting guidance and are reported at fair value, with changes in fair value recorded directly to earnings. At March 31, 2014, the Bank had an outstanding notional balance of residential mortgage loan commitments of $5.9 million. At December 31, 2013, the Bank had an outstanding notional balance of residential mortgage loan commitments of $7.1 million.

During first quarter 2014, the Bank purchased credit derivatives to hedge the performance risk associated with one of its counterparties. These derivatives are not designated as hedging instruments and are reported at fair value, with changes in fair value reported directly in earnings. At March 31, 2014, the Bank had an outstanding notional balance of credit derivatives of $13.4 million.

Fair Value of Derivative Instruments on the Balance Sheet

The following table presents the fair value of the Bancorp’s derivative financial instruments as well as the classification on the balance sheet as of March 31, 2014 and December 31, 2013.

 

     March 31, 2014  
     Derivative Assets      Derivative Liabilities  
     Balance Sheet
Location
   Fair Value      Balance Sheet
Location
   Fair Value  
     (in thousands)  

Derivatives designated as cash flow hedges:

           

Interest rate swaps

   Other assets    $ 664       Other liabilities    $ 0   
     

 

 

       

 

 

 

Total

      $ 664          $ 0   
     

 

 

       

 

 

 

Derivatives not designated as hedging instruments:

           

Interest rate swaps

   Other assets    $ 4,274       Other liabilities    $ 4,346   

Credit contracts

   Other assets      119       Other liabilities      0   

Residential mortgage loan commitments

   Other assets      103       Other liabilities      0   
     

 

 

       

 

 

 

Total

      $ 4,496          $ 4,346   
     

 

 

       

 

 

 

 

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     December 31, 2013  
     Derivative Assets      Derivative Liabilities  
     Balance Sheet
Location
   Fair Value      Balance Sheet
Location
   Fair Value  
     (in thousands)  

Derivatives not designated as hedging instruments:

           

Interest rate swaps

   Other assets    $ 3,523       Other liabilities    $ 3,537   

Residential mortgage loan commitments

   Other assets      240       Other liabilities      0   
     

 

 

       

 

 

 

Total

      $ 3,763          $ 3,537   
     

 

 

       

 

 

 

Effect of Derivative Instruments on Comprehensive Income

The following table presents the effect of the Bancorp’s derivative financial instruments on comprehensive income for the three months ended March 31, 2014 and 2013.

 

     Three Months Ended March 31, 2014  
     Income Statement Location    Amount of income (loss)
recognized in earnings
 
     (in thousands)  

Derivatives not designated as hedging instruments:

     

Interest rate swaps

   Other non-interest income    $ (59

Credit contracts

   Other non-interest income      (149

Residential mortgage loan commitments

   Mortgage banking income      (137
     

 

 

 

Total

      $ (345
     

 

 

 

 

     Three Months Ended March 31, 2013  
     Income Statement Location    Amount of income (loss)
recognized in earnings
 
     (in thousands)  

Derivatives not designated as hedging instruments:

     

Interest rate swaps

   Other non-interest income    $ 43   
     

 

 

 

 

     Three Months Ended March 31, 2014  
            Location of Gain    Amount of Gain  
     Amount of Gain      Reclassified from    Reclassified from  
     Recognized in OCI on      Accumulated OCI into    Accumulated OCI into  
     Derivatives (Effective Portion) (1)      Income (Effective Portion)    Income (Effective Portion)  
     (in thousands)  

Derivative in cash flow hedging relationships:

        

Interest rate swaps

   $ 432       Interest expense    $ 0   
  

 

 

       

 

 

 

 

(1) Net of taxes

Credit-risk-related Contingent Features

By entering into derivative contracts, the Bank is exposed to credit risk. The credit risk associated with derivatives executed with Bank customers is the same as that involved in extending the related loans and is subject to the same standard credit policies. To mitigate the credit-risk exposure to major derivative dealer counterparties, the Bancorp only enters into agreements with those that maintain credit ratings of high quality.

Agreements with major derivative dealer counterparties contain provisions whereby default on any of the Bancorp’s indebtedness would be considered a default on its derivative obligations. The Bancorp also has entered into agreements that contain provisions under which the counterparty could require the Bancorp to settle its obligations if the Bancorp fails to maintain its status as a well/adequately-capitalized institution. As of March 31, 2014, the fair value of derivatives in a net liability position (which includes accrued interest but excludes any adjustment for nonperformance-risk) related to these agreements was $4.1 million. In addition, the Bancorp has minimum collateral posting thresholds with certain of these counterparties, and at March 31, 2014 had posted $4.8 million as collateral. The Bancorp records cash posted as collateral as a reduction in the outstanding balance of cash and cash equivalents and an increase in the balance of other assets.

 

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Disclosures about Offsetting Assets and Liabilities

The following tables present derivative instruments that are subject to enforceable master netting arrangements. The Bancorp’s interest rate swaps with institutional counterparties are subject to master netting arrangements and are included in the table below. Interest rate swaps with commercial banking customers and residential mortgage loan commitments are not subject to master netting arrangements and are excluded from the table below. The Bancorp has not made a policy election to offset its derivative positions.

Offsetting of Financial Assets and Derivative Assets

At March 31, 2014

 

            Gross Amounts      Net Amounts of      Gross Amounts not Offset in the         
            Offset in the      Assets Presented      Consolidated Balance Sheet         
     Gross Amount of      Consolidated      in the Consolidated      Financial      Cash Collateral         
     Recognized Assets      Balance Sheet      Balance Sheet      Instruments      Received      Net Amount  
     (in thousands)  

Description

                 

Interest rate swap derivatives with institutional counterparties

   $ 229       $ 0       $ 229       $ 229       $ 0       $ 0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Offsetting of Financial Liabilities and Derivative Liabilities

At March 31, 2014

  

  

            Gross Amounts      Net Amounts of      Gross Amounts not Offset in the         
            Offset in the      Liabilities Presented      Consolidated Balance Sheet         
     Gross Amount of      Consolidated      in the Consolidated      Financial      Cash Collateral         
     Recognized Liabilities      Balance Sheet      Balance Sheet      Instruments      Pledged      Net Amount  
     (in thousands)  

Description

                 

Interest rate swap derivatives with institutional counterparties

   $ 4,144       $ 0       $ 4,144       $ 229       $ 4,772       $ 0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Offsetting of Financial Assets and Derivative Assets

At December 31, 2013

  

  

            Gross Amounts      Net Amounts of      Gross Amounts not Offset in the         
            Offset in the      Assets Presented      Consolidated Balance Sheet         
     Gross Amount of      Consolidated      in the Consolidated      Financial      Cash Collateral         
     Recognized Assets      Balance Sheet      Balance Sheet      Instruments      Received      Net Amount  
     (in thousands)  

Description

                 

Interest rate swap derivatives with institutional counterparties

   $ 392       $ 0       $ 392       $ 392       $ 0       $ 0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Offsetting of Financial Liabilities and Derivative Liabilities

At December 31, 2013

  

  

            Gross Amounts      Net Amounts of      Gross Amounts not Offset in the         
            Offset in the      Liabilities Presented      Consolidated Balance Sheet         
     Gross Amount of      Consolidated      in the Consolidated      Financial      Cash Collateral         
     Recognized Liabilities      Balance Sheet      Balance Sheet      Instruments      Pledged      Net Amount  
     (in thousands)  

Description

                 

Interest rate swap derivatives with institutional counterparties

   $ 3,191       $ 0       $ 3,191       $ 392       $ 2,799       $ 0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Cautionary Note Regarding Forward-Looking Statements

This report and all attachments hereto as well as other written or oral communications made from time to time by Customers Bancorp may contain certain forward-looking information within the meaning of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended. These statements relate to future events or future predictions, including events or predictions relating to future financial performance, and are generally identifiable by the use of forward-looking terminology such as “believes,” “expects,” “may,” “will,” “should,” “plan,” “intend,” “anticipates,” “strategies” or the negative thereof or comparable terminology, or by discussion of strategy that involve risks and uncertainties. These forward-looking statements are only predictions and estimates regarding future events and circumstances and involve known and unknown risks, uncertainties and other factors, including the risks described under “Risk Factors” that may cause actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. This information is based on various assumptions that may not prove to be correct. These forward-looking statements are subject to significant uncertainties and contingencies, many of which are beyond the control of the Bancorp and the Bank. Although the expectations reflected in the forward-looking statements are currently believed to be reasonable, future results, levels of activity, performance or achievements cannot be guaranteed. Accordingly, there can be no assurance that actual results will meet expectations or will not be materially lower than the results contemplated in this report and attachments hereto. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this report or, in the case of documents referred to, the dates of those documents. Neither the Bancorp nor the Bank undertakes any obligation to release publicly or otherwise provide any revisions to these forward-looking statements to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events, except as may be required under applicable law.

Management’s discussion and analysis represents an overview of the financial condition and results of operations, and highlights the significant changes in the financial condition and results of operations, as presented in the accompanying consolidated financial statements for Customers Bancorp, a financial holding company, and its wholly owned subsidiaries, including Customers Bank. This information is intended to facilitate your understanding and assessment of significant changes and trends related to Customers Bancorp’s financial condition and results of operations as of and for the three months ended March 31, 2014. All quarterly information in this Management’s Discussion and Analysis is unaudited. You should read this section in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operation” included in Customers Bancorp’s filing on Form 10-K for the fiscal year ended December 31, 2013.

Critical Accounting Policies

We have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States of America and that are consistent with general practices within the banking industry in the preparation of our financial statements. Our significant accounting policies are described in “NOTE 3 — SIGNIFICANT ACCOUNTING POLICIES AND BASIS OF PRESENTATION” to our audited financial statements included in our 2013 Form 10-K and updated in this quarterly report on Form 10-Q for the three months ended March 31, 2014.

Certain accounting policies involve significant judgments and assumptions by Customers Bancorp that have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies to be critical accounting policies. The judgment and assumptions used are based on historical experience and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgments and assumptions management makes, actual results could differ from these judgments and estimates, which could have a material impact on the carrying values of our assets and liabilities and our results of operations. There have been no material changes in our critical accounting policies, judgments and estimates, including assumptions or estimation techniques utilized, as compared to those disclosed in our 2013 Form 10-K.

First Quarter Events of Note

Following a successful 2013, Customers Bancorp continued its strong performance in first quarter 2014. Most notably, total assets were $5.0 billion as of March 31, 2014, an increase of 21% from December 31, 2013 and a record high. During first quarter 2014, the Bancorp achieved significant organic loan growth in its multi-family loans (up $495 million) and commercial real estate and commercial and industrial loans (up $135 million). Additionally, the Company acquired $278 million of residential adjustable-rate jumbo mortgage loans from Michigan-based Flagstar Bank. Asset quality remained high and capital ratios exceeded levels established for “well capitalized” banks. First quarter financial results for 2014 included strong earnings of $8.1 million, or $0.32 per diluted share.

 

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Results of Operations

First Quarter 2014 Compared to First Quarter 2013

Net income available to common shareholders increased $0.9 million (13.2%) to $8.1 million for the three months ended March 31, 2014, compared to $7.2 million for the three months ended March 31, 2013. The increased net income resulted from increased net interest income of $7.0 million, increased non-interest income of $2.7 million, and reduced income tax expense of $0.4 million, partially offset by increased non-interest expense of $4.7 million and increased provision for loan losses of $4.5 million.

Net interest income increased $7.0 million (31.0%) for the three months ended Month 31, 2014 to $29.5 million, compared to $22.5 million for the three months ended March 31, 2013. This increase resulted principally from an increase in average loan balances (loans held for sale and loans receivable) of $894.4 million to $3.4 billion, offset in part by a 37 basis point decrease in average yields on loans to 3.92% net of a 3 basis point decrease in the cost of funding. The reduced yields are primarily driven by a decrease in market interest rates on loans, payoffs on maturing higher yielding loans and growth of multi-family loans, which have high credit quality but yield below the current loan portfolio average yield.

The provision for loan losses increased by $4.5 million to $4.4 million for the three months ended March 31, 2014, compared to $(0.1) million for the same period in 2013. The increase in the provision for loan losses during first quarter 2014 is primarily related to first quarter loan growth and reduced estimated benefits from the FDIC loss sharing receivable.

Non-interest income increased $2.7 million during the three months ended March 31, 2014 to $7.6 million, compared to $4.9 million for the three months ended March 31, 2013. The increase in 2014 is attributable to gains realized from sales of investment securities ($2.8 million), management advisory fees earned in conjunction with an equity investment in a foreign entity ($0.5 million), mortgage banking income ($0.4 million), increased fees earned by executing interest rate swaps with commercial banking customers (up $0.4 million), increased income from bank owned life insurance (up $0.4 million), offset in part by decreased mortgage warehouse transactional fees (down $1.9 million).

Non-interest expense increased $4.7 million during the three months ended March 31, 2014 to $21.2 million, compared to $16.5 million during the three months ended March 31, 2013. Expenses increased in 2014 compared to 2013 principally for salaries and employee benefits as staffing levels grew to support the growing business (up $2.0 million), professional services for loan workout, litigation, and development of materials to respond to increased regulatory inquiries triggered by increasing levels of growth and complexity (up $1.6 million), assessment for FDIC insurance and other regulatory fees as the bank grew and other costs were incurred (up $0.8 million), technology, communication and bank operation to further support and build infrastructure (up $0.7 million) and occupancy as the business expansion into new markets and increased activity in existing markets required additional facilities (up $0.7 million). These increases were offset in part by a provision for loss contingency recorded during first quarter 2013 as a result of a fraud perpetrated on a loan to fund a residential mortgage warehouse line of credit (down $2.0 million).

Income tax expense decreased $0.4 million in the three months ended March 31, 2014 to $3.4 million compared to $3.9 million in the same period of 2013. The decrease in the income tax expense is primarily due to an out of period adjustment of $0.6 million recorded in first quarter 2014 that related to the period ended December 31, 2013.

 

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Net Interest Income

Net interest income (the difference between the interest earned on loans, investments and interest-earning deposits with banks, and interest paid on deposits, borrowed funds and subordinated debt) is the primary source of Customers Bancorp’s earnings. The following table summarizes the Bancorp’s net interest income and related spread and margin for the periods indicated.

 

     Three Months Ended March 31,  
     2014     2013  
     Average
Balance
    Interest
Income or
Expense
     Average
Yield or
Cost
    Average
Balance
    Interest
Income or
Expense
     Average
Yield or
Cost
 
     (dollars in thousands)  
Assets               

Interest-earning deposits

   $ 187,085      $ 116         0.25   $ 174,637      $ 108         0.25

Investment securities, taxable (A)

     516,902        3,040         2.35     143,028        829         2.32

Loans held for sale

     566,535        5,083         3.64     1,123,420        10,884         3.93

Loans, taxable (B)

     2,818,023        28,188         4.05     1,379,228        16,027         4.71

Loans, non-taxable (B)

     24,027        167         2.83     11,491        72         2.53

Less: Allowance for loan losses

     (24,524          (26,299     
  

 

 

   

 

 

      

 

 

   

 

 

    

Total interest-earning assets

     4,088,048        36,594         3.62     2,805,505        27,920         4.03
    

 

 

        

 

 

    

Non-interest-earning assets

     282,192             156,969        
  

 

 

        

 

 

      

Total assets

   $ 4,370,240           $ 2,962,474        
  

 

 

        

 

 

      
Liabilities               

Interest checking

   $ 57,067        115         0.81   $ 35,892        39         0.43

Money market deposit accounts

     1,397,299        2,155         0.63     999,525        1,704         0.69

Other savings

     38,312        40         0.43     21,638        26         0.49

Certificates of deposit

     1,252,871        3,105         1.01     1,192,330        3,367         1.15
  

 

 

   

 

 

      

 

 

   

 

 

    

Total interest bearing deposits

     2,745,549        5,415         0.80     2,249,385        5,136         0.93

Borrowings

     551,339        1,667         1.22     171,333        259         0.61
  

 

 

   

 

 

      

 

 

   

 

 

    

Total interest-bearing liabilities

     3,296,888        7,082         0.87     2,420,718        5,395         0.90
    

 

 

        

 

 

    

Non-interest-bearing deposits

     666,775             254,859        
  

 

 

        

 

 

      

Total deposits & borrowings

     3,963,663           0.72     2,675,577           0.82

Other non-interest-bearing liabilities

     11,619             12,550        
  

 

 

        

 

 

      

Total liabilities

     3,975,282             2,688,127        

Shareholders’ Equity

     394,958             274,347        
  

 

 

        

 

 

      

Total liabilities and shareholders’ equity

   $ 4,370,240           $ 2,962,474        
  

 

 

        

 

 

      

Net interest earnings

       29,512             22,525      

Tax-equivalent adjustment (C)

       90             39      
    

 

 

        

 

 

    

Net interest earnings

     $ 29,602           $ 22,564      
    

 

 

        

 

 

    

Interest spread

          2.90          3.21
       

 

 

        

 

 

 

Net interest margin

          2.92          3.25
       

 

 

        

 

 

 

Net interest margin tax equivalent (C)

          2.93          3.26
       

 

 

        

 

 

 

 

(A) For presentation in this table, average balances and the corresponding average rates for investment securities are based upon historical cost, adjusted for amortization of premiums and accretion of discounts.
(B) Includes non-accrual loans, the effect of which is to reduce the yield earned on loans, and deferred loan fees.
(C) Full tax-equivalent basis, using a 35% statutory tax rate to approximate interest income as a taxable asset.

 

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The following table presents the dollar amount of changes in interest income and interest expense for the major categories of interest-earning assets and interest-bearing liabilities. Information is provided for each category of interest-earning assets and interest-bearing liabilities with respect to (i) changes attributable to volume (i.e., changes in average balances multiplied by the prior-period average rate) and (ii) changes attributable to rate (i.e., changes in average rate multiplied by prior-period average balances). For purposes of this table, changes attributable to both rate and volume which cannot be segregated have been allocated proportionately to the change due to volume and the change due to rate.

 

     Three Months Ended March 31,  
     2014 vs. 2013  
     Increase (decrease) due
to change in
       
     Rate     Volume     Total  
     (in thousands)  

Interest income:

      

Interest earning deposits

   $ (1   $ 9      $ 8   

Investment securities

     48        2,163        2,211   

Loans held for sale

     (3,267     (2,534     (5,801

Loans, taxable

     (9,085     21,246        12,161   

Loans, non-taxable

     34        61        95   
  

 

 

   

 

 

   

 

 

 

Total interest income

     (12,271     20,945        8,674   
  

 

 

   

 

 

   

 

 

 

Interest expense:

      

Interest checking

     135        (60     75   

Money market deposit accounts

     (662     1,122        460   

Savings

     (19     25        6   

Certificates of deposit

     (1,668     1,406        (262
  

 

 

   

 

 

   

 

 

 

Total interest bearing deposits

     (2,214     2,493        279   

Borrowings

     (2,835     4,243        1,408   
  

 

 

   

 

 

   

 

 

 

Total interest expense

     (5,049     6,736        1,687   
  

 

 

   

 

 

   

 

 

 

Net interest income

   $ (7,222   $ 14,209      $ 6,987   
  

 

 

   

 

 

   

 

 

 

Net interest income was $29.5 million for the three months ended March 31, 2014, compared to $22.5 million for the three months ended March 31, 2013, an increase of $7.0 million or 31.0%. This net increase was attributable to an increase of $1.3 billion in the average balance of interest-earning assets, offset in part by an increase of $0.9 billion in the average balance of interest-bearing liabilities. The primary driver of the increase in net interest income was higher loan volume from the following:

 

    $756.8 million increase in the average balance of multi-family loans due to growth of the multi-family lending business; and

 

    $439.3 million increase in the average balance of commercial loans primarily due to growth of the commercial and industrial loan portfolio including owner occupied commercial real estate loans.

The key measure of our net interest income is net interest margin. Our net interest margin decreased to 2.92% for the three months ended March 31, 2014 from 3.25% for the same period in 2013. The decrease was driven by a decrease in the average yield on loans from 4.29% to 3.92%, primarily due to the maturity of higher yielding loans, and the growth of multi-family loan products with higher credit quality but yields below the portfolio average yield. The effect of this decrease was marginally offset by the decrease in the cost of deposits and borrowings from 0.90% to 0.87%.

In addition to an increase in interest income from investment securities of $2.2 million, interest income from multi-family loans, and commercial and industrial loans increased by $7.1 million and $3.3 million, respectively, partially offset by a decrease of $5.9 million of interest income from warehouse lending. Driving the rise in interest income was higher average loan volume for multi-family loans of $756.8 million, and commercial loan volume of $439.3 million. The higher loan volume was a result of our strategy to grow our multi-family and commercial real estate businesses. The purchase of approximately $321.0 million of investment securities in the third quarter of 2013 led to their higher average volume in the first quarter of 2014 compared to the same quarter in 2013. In the three months ended March 31, 2014 interest expense for borrowings increased by $1.4 million. The average balance of borrowings increased by $380.0 million which was primarily driven by the increase in average FHLB advances of $322.1 million in the first quarter of 2014 compared to the same quarter in 2013, and the addition of the five year senior unsecured notes (“Senior Notes”) in the amount of $63.3 million during the third quarter of 2013. The Senior Notes carry a stated interest rate of 6.375% which contributed to the overall increase in borrowings costs of 0.60% when comparing the cost of 1.22% for the quarter ended March 31, 2014 versus 0.61% for the period ended March 31, 2013.

 

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Provision for Loan Losses

We have established an allowance for loan losses through a provision for loan losses charged as an expense on the consolidated statements of income. The loan portfolio is reviewed quarterly to evaluate the outstanding loans and to measure both the performance of the portfolio and the adequacy of the allowance for loan losses. At March 31, 2014, approximately 1.52% of the loan portfolio was covered under loss sharing agreements with the FDIC. Charge-offs incurred above the original estimated value are taken as additional provisions, and a corresponding receivable due from the FDIC is recorded as a reduction to the provision for loan losses for the portion anticipated to be recovered under the loss sharing agreements. Conversely, if the estimated cash flows on the covered loans increase, all or a portion of the previously recorded provision for loan losses will be reversed, and the corresponding receivable due from the FDIC will be written down as an increase to the provision for loan losses.

The provision for loan losses increased by $4.5 million to $4.4 million for the three months ended March 31, 2014, compared to $(0.1) million for the same period in 2013. The increase in the 2014 provision compared to the same period in 2013 was principally a result of a provision of $2.9 million recorded mainly to reflect first quarter 2014 loan growth and $1.5 million for reduced estimated benefits to be derived from the FDIC loss sharing receivable.

For more information about our provision and allowance for loan losses and our loss experience, see “Credit Risk” and “Asset Quality” herein.

Non-Interest Income

The chart below shows our results in the various components of non-interest income for the three months ended March 31, 2014 and 2013.

 

     Three Months Ended March 31,  
     2014      2013  
     (in thousands)  

Gain on sale of investment securities, net

   $ 2,832       $ 0   

Mortgage warehouse transactional fees

     1,759         3,668   

Bank-owned life insurance

     835         476   

Mortgage banking income

     409         0   

Deposit fees

     214         130   

Other

     1,541         624   
  

 

 

    

 

 

 

Total non-interest income

   $ 7,590       $ 4,898   
  

 

 

    

 

 

 

Non-interest income was $7.6 million for the three months ended March 31, 2014, an increase of $2.7 million from non-interest income of $4.9 million for the three months ended March 31, 2013. The increase was primarily the result of $2.8 million of gains realized from sales of available-for-sale investment securities (executed to shorten the duration of the asset portfolio), $0.5 million of management advisory fees earned in conjunction with an equity investment in a foreign entity that was made during third quarter 2013 and mortgage banking income of $0.4 million as Customers launched its mortgage banking activities in the latter half of 2013. There were also increased fees earned by executing interest rate swaps with commercial banking customers of $0.4 million and increased bank owned life insurance income of $0.4 million due to additional policies purchased during 2013. Partially offsetting these items was a decrease in mortgage warehouse transactional fees of $1.9 million as lending to mortgage companies to finance their inventories prior to sale of the loans has significantly decreased since this same period last year.

Non-Interest Expense

The table below presents the components of non-interest expense for the three months ended March 31, 2014 and 2013.

 

     Three Months Ended March 31,  
     2014      2013  
     (in thousands)  

Salaries and employee benefits

   $ 9,351       $ 7,397   

Occupancy

     2,637         1,910   

Professional services

     2,282         706   

FDIC assessments, taxes and regulatory fees

     2,131         1,347   

Technology, communications and bank operations

     1,560         841   

Loan workout

     441         674   

Advertising and promotion

     414         115   

Other real estate owned

     351         36   

Loss contingency

     0         2,000   

Other

     2,002         1,454   
  

 

 

    

 

 

 

Total non-interest expense

   $ 21,169       $ 16,480   
  

 

 

    

 

 

 

 

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Non-interest expense was $21.2 million for the three months ended March 31, 2014, an increase of $4.7 million from non-interest expense of $16.5 million for the three months ended March 31, 2013.

Salaries and employee benefits, which represent the largest component of non-interest expense, increased $2.0 million (26.4%) to $9.4 million for the three months ended March 31, 2014 from $7.4 million for the three months ended March 31, 2013. The primary reason for this increase was an increase in the number of employees from 283 full-time equivalents at March 31, 2013 to 387 full-time equivalents at March 31, 2014. This was directly related to the need for additional employees to support our organic growth and expansion into new markets. More specifically, the increased headcount is needed to support the growing multi-family, commercial real estate and commercial and industrial loan portfolios.

Professional services expense increased by 223.2%, or $1.6 million, to $2.3 million for the three months ended March 31, 2014 from $0.7 million for the three months ended March 31, 2013. This increase was primarily attributable to higher legal and consulting expenses in 2014 related to loan workout, litigation and other general regulatory matters.

Occupancy expense increased by 38.1%, or $0.7 million, rising to $2.6 million for the three months ended March 31, 2014 from $1.9 million for the three months ended March 31, 2013. The increase was related to building the infrastructure to support growth and expansion into new markets.

FDIC assessments, taxes and regulatory fees increased by 58.2%, or $0.8 million to $2.1 million for the three months ended March 31, 2014 from $1.3 million for the three months ended March 31, 2013. The primary reasons for this increase were related to higher Pennsylvania bank shares tax expense that resulted from legislative changes to the tax calculation, increased deposit premiums and other regulatory and filing fees.

Technology, communication and bank operations increased by 85.5%, or $0.7 million, rising to $1.6 million for the three months ended March 31, 2014 from $0.8 million for the three months ended March 31, 2013. The primary reason for this increase was related to building the infrastructure to support growth through increased technology improvements and upgrades as well as the costs related to expanding technological platforms into new markets. This corresponds with our philosophy of “high touch, high tech”, whereby we provide an exceptional level of customer service supported by state-of-the-art technology.

In March 2013, a suspected fraud was discovered in the Bank’s loans held-for-sale portfolio. Total loans involved in this fraud initially appeared to be $5.2 million. The Bank determined that an aggregate of $1.0 million of the loans were not involved in the fraud, and these loans were subsequently sold during 2013. In addition, the Bank recovered $1.5 million in cash from the alleged perpetrator in 2013. During 2013, a loss contingency expense of $2.0 million was provided, resulting in a net amount of $0.7 million classified in other assets as of March 31, 2014.

Other expenses increased by 37.7%, or $0.5 million, to $2.0 million for the three months ended March 31, 2014, compared to $1.5 million for the three months ended March 31, 2013 reflecting increased general expenses to support a rapidly growing business.

Income Taxes

Income tax expense was $3.4 million and $3.9 million, respectively, for the three months ended March 31, 2014 and 2013. The decrease in the income tax expense was primarily due to an out of period adjustment of $0.6 million recorded in first quarter 2014 that related to 2013.

The effective tax rate for the three months ended March 31, 2014 and 2013 was approximately 30 percent and 35 percent, respectively. The decrease in the effective tax rate for first quarter 2014 was primarily due to the out of period adjustment noted above.

Financial Condition

General

Total assets were $5.0 billion at March 31, 2014. This represented an $861.1 million, or 20.7% increase from $4.2 billion at December 31, 2013. The major change in our financial position occurred as the result of the growth in loans receivable not covered by loss sharing agreements with the FDIC, which increased by 37.4% or $0.9 billion to $3.3 billion at March 31, 2013, from $2.4 billion at December 31, 2013.

 

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The main driver of the increase in assets was primarily from the expansion of multi-family loans, which increased by $495.3 million (46.7%) to $1.6 billion at March 31, 2014 from $1.1 billion at December 31, 2013. Adjustable rate 1-4 family residential mortgage loans increased $260.3 million (83.3%) to $572.8 million at March 31, 2014 from $312.5 million at December 31, 2013; this increase was due to the purchased loan portfolio on January 15, 2014. Additionally, commercial real estate and commercial and industrial loans increased by $134.6 million (12.6%) to $1.2 billion at March 31, 2014 from $1.1 billion at December 31, 2013.

Total liabilities were $4.6 billion at March 31, 2014. This represented a $0.8 billion, or 22.5%, increase from $3.8 billion at December 31, 2013. The increase in total liabilities was due to a higher level of deposits at March 31, 2014 compared to December 31, 2013. Total deposits grew by $0.6 billion (21.8%) to $3.6 billion at March 31, 2014 from $3.0 billion at December 31, 2013. Deposits are obtained primarily from within the Bank’s geographic service area and through wholesale and broker networks. These networks provide low-cost funding alternatives to retail deposits and diversity to the Bank’s sources of funds. The increase in bank deposits was primarily due to the seasonal inflow of student deposits and the growth in brokered money market deposit accounts.

The following table sets forth certain key condensed balance sheet data:

 

     March 31,
2014
     December 31,
2013
 
     (in thousands)  

Cash and cash equivalents

   $ 290,467       $ 233,068   

Investment securities, available for sale

     458,302         497,573   

Loans held for sale

     697,532         747,593   

Loans receivable not covered under FDIC Loss Sharing Agreements

     3,294,908         2,398,353   

Loans receivable covered under FDIC Loss Sharing Agreements

     61,639         66,725   

Total loans receivable, net of the allowance for loan losses

     3,329,843         2,441,080   

Total assets

     5,014,231         4,153,173   

Total deposits

     3,606,332         2,959,922   

Federal funds purchased

     0         13,000   

FHLB advances

     905,000         706,500   

Other borrowings

     65,250         65,250   

Total liabilities

     4,613,293         3,766,550   

Total shareholders’ equity

     400,938         386,623   

Total liabilities and shareholders’ equity

     5,014,231         4,153,173   

Cash and Cash Equivalents

Cash and due from banks consists mainly of vault cash and cash items in the process of collection. These balances totaled $73.5 million at March 31, 2014. This represents a $14.2 million increase from $59.3 million at December 31, 2013. These balances vary from day to day, primarily due to variations in customers’ deposits with the Bank.

Investment Securities

Our investment securities portfolio is an important source of interest income and liquidity. It consists of mortgage-backed securities (principally guaranteed by an agency of the United States government), domestic corporate debt and marketable equity securities. In addition to generating revenue, the investment portfolio is maintained to manage interest-rate risk, provide liquidity, provide collateral for other borrowings, and diversify the credit risk of earning assets. The portfolio is structured to maximize net interest income, given changes in the economic environment, liquidity position, and balance sheet mix.

At March 31, 2014, our investment securities were $458.3 million compared to $497.6 million in December 31, 2013. The decrease is primarily the result of our sale of securities to strategically reduce interest rate risk in the investment portfolio, shortening the duration of the investment securities term.

Unrealized gains and losses on available-for-sale securities are included in other comprehensive income and reported as a separate component of shareholders’ equity, net of the related tax effect.

Loans

Existing lending relationships are primarily with small businesses and individual consumers primarily in Bucks, Berks, Chester, Montgomery, Delaware, and Philadelphia Counties, Pennsylvania; Camden and Mercer Counties, New Jersey; and Westchester County and New York City, New York; and the New England area. The loan portfolio is primarily comprised of loans to support mortgage banking companies’ funding needs, multi-family/commercial real estate, construction, and commercial and industrial loans.

 

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Mortgage warehouse loans and certain residential loans expected to be sold are classified as loans held for sale. Loans held for sale totaled $0.7 billion at March 31, 2014 and December 31, 2013. Loans held for sale are not included in the loan receivable amounts. The mortgage warehouse product line provides financing to mortgage companies nationwide from the time of the home purchase or refinancing of a mortgage loan through the sale of the loan by the mortgage originator into the secondary market, either through a repurchase facility or the purchase of the underlying mortgages. As a mortgage warehouse lender, we provide a form of financing to mortgage bankers by purchasing for resale the underlying residential mortgages on a short-term basis under a master repurchase agreement. We are subject to the risks associated with such lending, including, but not limited to, the risks of fraud, bankruptcy and default of the mortgage banker or of the underlying residential borrower, any of which could result in credit losses. The mortgage warehouse lending employees monitor these mortgage originators by obtaining financial and other relevant information to reduce these risks during the lending period.

Loans receivable, net, increased by $0.9 billion to $3.3 billion at March 31, 2014 from $2.4 billion at December 31, 2013. The multi-family/commercial real estate loan balance is increasing due to the focus on this element of Customers’ organic growth strategy. Offsetting these increases in part was the loan runoff for purchased-credit-impaired and covered loans. The composition of loan receivable as of March 31, 2014 and December 31, 2013 was as follows:

 

     March 31,
2014
    December 31,
2013
 
     (in thousands)  

Construction

   $ 12,775      $ 14,627   

Commercial real estate

     23,176        24,258   

Commercial and industrial

     6,131        5,814   

Residential real estate

     16,324        18,733   

Manufactured housing

     3,233        3,293   
  

 

 

   

 

 

 

Total loans receivable covered under FDIC loss sharing agreements (1)

     61,639        66,725   

Construction

     36,132        36,901   

Commercial real estate

     2,470,589        1,835,186   

Commercial and industrial

     240,099        239,509   

Mortgage warehouse

     655        866   

Manufactured housing

     136,952        139,471   

Residential real estate

     408,417        145,188   

Consumer

     1,822        2,144   
  

 

 

   

 

 

 

Total loans receivable not covered under FDIC loss sharing agreements

     3,294,666        2,399,265   
  

 

 

   

 

 

 

Total loans receivable

     3,356,305        2,465,990   

Deferred (fees) costs, net

     242        (912

Allowance for loan losses

     (26,704     (23,998
  

 

 

   

 

 

 

Loans receivable, net

   $ 3,329,843      $ 2,441,080   
  

 

 

   

 

 

 

 

(1) Loans that were acquired in two FDIC assisted transactions and are covered under loss sharing arrangements with the FDIC are referred to as “covered loans” throughout this Management’s Discussion and Analysis.

Credit Risk

Customers Bancorp manages credit risk by maintaining diversification in its loan portfolio, by establishing and enforcing prudent underwriting standards, by collection efforts and by continuous and periodic loan classification reviews. Management also considers the effect of credit risk on financial performance by maintaining an adequate allowance for loan losses. Credit losses are charged when they are identified, and provisions are added, to the allowance for loan losses when and as appropriate, but at least quarterly. The allowance for loan losses is evaluated at least quarterly.

The provision for loan losses was $4.4 million and $(0.1) million for the three months ended March 31, 2014 and 2013, respectively. The allowance for loan losses maintained for loans receivable (excludes loans held for sale as estimable credit losses are embedded in the fair values at which the loans are reported) was $26.7 million, or 0.8% of total non-covered loans, at March 31, 2014, and $26.4 million, or 1.7% of total non-covered loans, at March 31, 2013. The coverage ratio declined largely due to the decrease in non-performing loans as a result of net-charge-offs ($6.6 million for the twelve months ended March 31, 2014), transfers to other real estate owned, sustained performance improvements that led to lower reserve factors for commercial, multi-family and residential mortgage loans, and the growth of the multi-family loan portfolio which draws only a 40 basis point reserve level due to its historical

 

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payment experience. Net charge-offs were $0.2 million for the three months ended March 31, 2014, a decrease of $0.3 million compared to the same period in 2013. The Bank had approximately $61.6 million in loans that were covered under loss share arrangements with the FDIC as of March 31, 2014 compared to $66.7 million as of December 31, 2013. The Bank considers the covered loans in estimating the allowance for loan losses and considers recovery of estimated credit losses from the FDIC in the FDIC indemnification asset.

The chart below depicts changes in Customers Bancorp’s allowance for loan losses for the periods indicated.

Analysis of the Allowance for Loan Losses

 

     Three Months Ended
March 31,
 
     2014      2013  
     (dollars in thousands)  

Balance at the beginning of the period

   $ 23,998       $ 25,837   

Loan charge-offs

     

Construction

     0         0   

Commercial real estate

     248         410   

Commercial and industrial

     0         20   

Residential real estate

     288         133   

Consumer and other

     0         0   
  

 

 

    

 

 

 

Total Charge-offs

     536         563   
  

 

 

    

 

 

 

Loan recoveries

     

Construction

     0         0   

Commercial real estate

     25         52   

Commercial and industrial

     90         11   

Residential real estate

     224         (3

Consumer and other

     2         5   
  

 

 

    

 

 

 

Total Recoveries

     341         65   
  

 

 

    

 

 

 

Total net charge-offs

     195         498   

Provision for loan losses

     2,901         1,100   
  

 

 

    

 

 

 

Balance at the end of the period

   $ 26,704       $ 26,439   
  

 

 

    

 

 

 

The allowance for loan losses is based on a periodic evaluation of the loan portfolio and is maintained at a level that management considers adequate to absorb potential losses. All commercial loans are assigned credit risk ratings, based upon an assessment of the borrower, the structure of the transaction and the available collateral and/or guarantees. All loans are monitored regularly by the responsible officer, and the risk ratings are adjusted when considered appropriate. The risk assessment allows management to identify problem loans timely. Management considers a variety of factors, and recognizes the inherent risk of loss that always exists in the lending process. Management uses a disciplined methodology to estimate the appropriate level of allowance for loan losses. See “Asset Quality” for further discussion of the allowance for loan losses.

Customers’ methodology includes an evaluation of loss potential from individual problem credits, as well as a general reserve for the portfolio considering anticipated specific and general economic factors that may positively or adversely affect collectability. This assessment includes a review of changes in the composition and volume of the loan portfolio, overall portfolio quality and past loss experience, review of specific problem loans, current economic conditions that may affect borrowers’ ability to repay, and other factors that may warrant consideration in estimating the reserve. In addition, the Bancorp’s internal auditors, loan review, and various regulatory agencies periodically review the adequacy of the allowance as an integral part of their work responsibilities or examination process. Customers Bancorp may be asked to recognize additions or reductions to the allowance for loan losses based on their judgments of information available at the time of their examination.

Nearly 90% of the Bank’s commercial real estate, commercial and residential construction, consumer residential and commercial and industrial loan types have real estate as collateral (collectively, “the real estate portfolio”). The Bank’s lien position on the real estate collateral will vary on a loan-by-loan basis and will change as a result of changes in the value of the collateral. Current appraisals providing current value estimates of the property are received when the Bank’s credit group determines that the facts and circumstances have significantly changed since the date of the last appraisal, including that real estate values have deteriorated. The

 

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credit committee and loan officers review loans that are fifteen or more days delinquent and all non-accrual loans on a periodic basis. In addition, loans where the loan officers have identified a “borrower of interest” are discussed to determine if additional analysis is necessary to apply the risk rating criteria properly. The risk ratings for the real estate loan portfolio are determined based upon the current information available, including but not limited to discussions with the borrower, updated financial information, economic conditions within the geographic area and other factors that may affect the cash flow of the loan. On a quarterly basis, if necessary, the collateral values or discounted cash flow models are used to determine the estimated fair value of the underlying collateral for the quantification of a specific reserve for impaired loans. Appraisals used within this evaluation process do not typically age more than two years before a new appraisal is obtained. For loans where real estate is not the primary source of collateral, updated financial information is obtained, including accounts receivable and inventory aging reports and relevant supplemental financial data to determine the fair value of the underlying collateral.

These evaluations, however, are inherently subjective as they require material estimates, including, among other estimates, the amounts and timing of expected future cash flows on impaired loans, estimated losses in the loan portfolio, and general amounts for historical loss experience, economic conditions, uncertainties in estimating losses and inherent risks in the various credit portfolios, all of which may be susceptible to significant change. Pursuant to ASC 450 Contingencies and ASC 310-40 Troubled Debt Restructurings by Creditors, impaired loans, consisting of non-accrual and restructured loans, are considered in the methodology for determining the allowance for credit losses. Impaired loans are generally evaluated based on the expected future cash flows or the fair value of the underlying collateral (less estimated costs to sell) if principal repayment is expected to come from the sale or operation of such collateral.

Asset Quality

Customers divides its loan portfolio into two categories to analyze and understand loan activity and performance: loans that were originated and loans that were acquired. Customers further divides originated loans into two categories: those originated prior to the current underwriting standards in 2009 and those originated subject to those standards post 2009, and purchased loans into two categories: those purchased credit impaired, and those not acquired credit impaired. Management believes that this additional information provides for a better understanding of the risk in the portfolio and the various types of reserves that are available to absorb loan losses that may arise in future periods. Credit losses from originated loans are absorbed by the allowance for loan loss reserves. Credit losses from acquired loans are absorbed by the allowance for loan losses and cash reserves, as described below. This schedule includes both loans held for sale and loans held for investment.

 

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<
Asset Quality at March 31, 2014  

Loan Type

   Total
Loans
    PCI
Loans
(1)
     Current     30-90
Days
     Greater
than 90
Days
and
Accruing
     Non-
accrual/
NPL (a)
     OREO
(b)
     NPA
(a)+(b)
     NPL
to
Loan
Type
(%)
     NPA
to
Loans +
OREO
(%)
 
     (dollars in thousands)         

New Century Orig. Loans

                           

Legacy

   $ 67,244      $ 0       $ 56,729      $ 1,569       $ 0       $ 8,946       $ 5,197       $ 14,143         13.30         19.52   

TDRs

     1,738        0         1,080        0         0         658         0         658         37.86         37.86   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

       

Total Originated Loans

     68,982        0         57,809        1,569         0         9,604         5,197         14,801         13.92         19.95   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

       

Originated Loans

                           

Warehouse –Repo

     5,386        0         5,386        0         0         0         0         0         0.00         0.00   

Manufactured

     4,303        0         4,281        22         0         0         0         0         0.00         0.00   

Commercial

     958,709        0         956,609        1,607         0         493         0         493         0.05         0.05   

Multi-family

     1,553,426        0         1,553,426        0         0         0         0         0         0.00         0.00   

Consumer/Mortgage

     112,687        0         112,687        0         0         0         0         0         0.00         0.00   

CRA

     15,872        0         15,872        0         0         0         0         0         0.00         0.00   

TDRs

     320        0         320        0         0         0         0         0         0.00         0.00   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

       

Total Originated Loans

     2,650,703        0         2,648,581        1,629         0         493         0         493         0.02         0.02   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

       

Acquired Loans

                           

Berkshire

     11,054        0         9,091        0         0         1,963         813         2,776         17.76         23.39   

FDIC –Covered

     39,386        0         32,826        1,103         0         5,457         9,329         14,786         13.86         30.35   

FDIC – Non-covered

     15        0         15        0         0         0         0         0         0.00         0.00   

Manufactured Housing 2010

     73,428        0         68,971        4,457         0         0         0         0         0.00         0.00   

Manufactured Housing 2011

     0        0         0        0         0         0         331         331         0.00         100.0   

Manufactured Housing 2012

     52,184        0         45,694        2,552         3,938         0         0         0         0.00         0.00   

Flagstar (Commercial)

     128,883        0         128,883        0         0         0         0         0         0.00         0.00   

Flagstar (Residential)

     254,447        0         254,447        0         0         0         0         0         0.00         0.00   

TDRs

     3,074        0         2,461        61         0         552         0         552         17.96         17.96   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

       

Total Acquired Loans

     562,471        0         542,388        8,173         3,938         7,972         10,473         18,445         1.42         3.22   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

       

Acquired PCI Loans

                           

Berkshire

     47,797        47,797         43,322        239         4,236         0         0         0         

FDIC –Covered

     21,709        21,709         4,426        0         17,283         0         0         0         

Manufactured Housing 2011

     5,175        5,175         2,389        575         2,211         0         0         0         
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

       

Total Acquired PCI Loans

     74,681        74,681         50,137        814         23,730         0