Item 1.
Business
Overview
The Parent is a financial holding company that conducts its business operations primarily through its commercial banking subsidiary, BBVA USA, which is an Alabama banking corporation headquartered in Birmingham, Alabama. The Parent was organized in 2007 as a Texas corporation. In April, BBVA announced that it was moving to unify its brand globally. As part of this re-branding, the Bank will transition away from the use of the BBVA Compass name and be re-branded as BBVA. As part of this re-branding, effective June 10, 2019, the Parent amended its Certificate of Formation to change its legal name from BBVA Compass Bancshares, Inc. to BBVA USA Bancshares, Inc.
The Parent is a wholly owned subsidiary of BBVA (NYSE: BBVA). BBVA is a global financial services group founded in 1857. It has a significant market position in Spain, owns the largest financial institution in Mexico, has franchises in South America, has a banking position in Turkey and operates an extensive global branch network. BBVA acquired the Company in 2007.
The Bank performs banking services customary for full service banks of similar size and character. Such services include receiving demand and time deposits, making personal and commercial loans and furnishing personal and commercial checking accounts. The Bank offers, either directly or through its subsidiaries or affiliates, a variety of services, including: portfolio management and administration and investment services to estates and trusts; term life insurance, variable annuities, property and casualty insurance and other insurance products; investment advisory services; a variety of investment services and products to institutional and individual investors; discount brokerage services, and investment company securities and fixed-rate annuities.
The Parent also owns BSI, a registered broker-dealer that engages in investment banking and institutional sales of fixed income securities.
Through BBVA Transfer Holdings, Inc., the Company engages in money transfer services and related activities, including money transmission and foreign exchange services.
As part of its operations, the Company regularly evaluates acquisition and investment opportunities of a type permissible for a financial holding company. The Company may also from time to time consider the potential disposition of certain of its assets, branches, subsidiaries, or lines of business.
On August 1, 2017, BBVA received notification that the Federal Reserve Board determined that the election by BBVA to become an FHC was effective as of August 1, 2017. This election allows the Company to engage in a broader range of activities that are (i) financial in nature or incidental to financial activities or (ii) complementary to a financial activity and do not pose a substantial risk to the safety and soundness of depository institutions or the financial system in general. These expanded services include securities underwriting and dealing, insurance underwriting, merchant banking, and insurance company portfolio investment.
Banking Operations
At December 31, 2019, the Company, through the Bank, operated 641 banking offices in Alabama, Arizona, California, Colorado, Florida, New Mexico, and Texas. The following chart reflects the distribution of branch locations in each of the states in which the Company conducts its banking operations:
The banking centers in Alabama are located throughout the state. In Arizona, the banking centers are concentrated in the Tucson and Phoenix metropolitan markets. The banking centers in California are concentrated in the Inland Empire and Central Valley regions. The Colorado banking centers are concentrated in the Denver metropolitan area and the New Mexico banking centers are concentrated in the Albuquerque metropolitan area. In Florida, the banking centers are concentrated in Jacksonville, Gainesville, and the Florida panhandle. The Texas banking centers are primarily located in the state’s four largest metropolitan areas of Houston, Dallas/Ft. Worth, San Antonio, and Austin, as well as cities in south Texas, such as McAllen and Laredo.
The Company also operates loan production offices in Atlanta, Georgia; Miami, Orlando, West Palm Beach, Sarasota, and Tampa, Florida; Chicago, Illinois; New York, New York; Baltimore, Maryland; Fresno, Irvine, Los Angeles, Oakland, Ontario, Sacramento, San Diego and San Jose, California; and Charlotte and Raleigh, North Carolina.
Economic Conditions
The Company's operations and customers are primarily concentrated in the Sunbelt region of the United States, particularly in Alabama, Arizona, California, Colorado, Florida, New Mexico and Texas. In terms of geographic distribution, approximately 53% of the Company’s total deposits and 51% of its branches are located in Texas, while Alabama represents approximately 22% of the Company’s total deposits. While the Company's ability to conduct business and the demand for the Company's products is impacted by the overall health of the United States economy, local economic conditions in the Sunbelt region, and specifically in the states in which the Company conducts business, also significantly affect demand for the Company's products, the ability of borrowers to repay loans and the value of collateral securing loans.
One key indicator of economic health is the unemployment rate. During 2019, the U.S. unemployment rate improved slightly from 3.9% for December 2018 to 3.5% in December 2019. The following table provides a comparison of unemployment rates as of December 2019 and 2018 for the states in which the Company has a retail branch presence.
* Source: United States Department of Labor, Bureau of Labor Statistics as of December 2019
A key driver of the improvement in the unemployment rate has been continued strength in nonfarm payroll growth. The following table provides a comparison of nonfarm payroll at December 2019 to December 2018.
* Source: United States Department of Labor, Bureau of Labor Statistics as of December 2019
Combined, the seven-state Sunbelt region in which the Company operates accounted for approximately 50% of the total increase in nonfarm payroll in the U.S. in 2019. The largest year-over-year increases nationally occurred in California, Florida and Texas, with Texas accounting for 16% of the total increase in total nonfarm payroll in 2019.
Another economic indicator of health is the real estate market, and in particular changes in residential home prices. After 2008, the national real estate market experienced a significant decline in value, and the value of real estate in certain Southeastern and Southwestern states in particular declined significantly more than real estate values in the United States as a whole. Recent data suggests that the housing market throughout the United States continues to strengthen and home prices have recaptured most of the value lost during the economic downturn. The following table presents changes in home prices since the end of 2007 and changes in home prices during 2019 for the states in which the Company operates. During 2019 home prices increased equal to or higher than the national average in all of the states in which the Company operates a retail branch network except California and Colorado. Additionally, home prices were above 2007 levels in all states.
* Source: Home price data from FHFA House price index through the third quarter of 2019
Segment Information
The Company is organized along lines of business. Each line of business is a strategic unit that serves a particular group of customers with certain common characteristics by offering various products and services. The lines of business results include certain overhead allocations and intercompany transactions. At December 31, 2019, the Company’s operating segments consisted of Commercial Banking and Wealth, Retail Banking, Corporate and Investment Banking, and Treasury.
The Commercial Banking and Wealth segment serves the Company’s commercial customers through its wide array of banking and investment services to businesses in the Company’s markets. The segment also provides private banking and wealth management services to high net worth individuals, including specialized investment portfolio management, traditional credit products, traditional trust and estate services, investment advisory services, financial counseling and customized services to companies and their employees. The Commercial Banking and Wealth segment also supports its commercial customers with capabilities in treasury management, accounts receivable purchasing, asset-based lending, international services, as well as insurance and interest rate protection and investment products. The Commercial Banking and Wealth segment is also responsible for the Company's small business customers and indirect automobile portfolio.
The Retail Banking segment serves the Company’s consumer customers through its full-service banking centers, private client offices throughout the U.S., and alternative delivery channels such as internet, mobile, ATMs and telephone banking. The Retail Banking segment provides individuals with comprehensive products and services including home mortgages, consumer loans, credit and debit cards, and deposit accounts.
The Corporate and Investment Banking segment is responsible for providing a wide array of banking and investment services to corporate and institutional clients. In addition to traditional credit and deposit products, the Corporate and Investment Banking segment also supports its customers with capabilities in treasury management, accounts receivable purchasing, asset-based lending, foreign-exchange and international services, and interest rate protection and investment products.
The Treasury segment’s primary function is to manage the liquidity and funding position of the Company, the interest rate sensitivity of the Company's balance sheet and the investment securities portfolio.
For financial information regarding the Company’s segments, which are presented by line of business, as of and for the years ended December 31, 2019, 2018 and 2017, see Note 21, Segment Information, in the Notes to the Consolidated Financial Statements.
Competition
In most of the markets served by the Company, it encounters intense competition from national, regional and local financial service providers, including banks, thrifts, securities dealers, mortgage bankers and finance companies. Competition is based on a number of factors, including customer service and convenience, the quality and range of products and services offered, innovation, price, reputation and interest rates on loans and deposits. The Company’s ability to compete effectively also depends on its ability to attract, retain and motivate employees while managing employee-related costs.
Many of the Company’s nonfinancial institution competitors have fewer regulatory constraints, broader geographic service areas and, in some cases, lower cost structures. In addition, competition for quality customers has intensified as a result of changes in regulation, advances in technology and product delivery channels, consolidation among financial service providers, bank failures and the conversion of certain former investment banks to bank holding companies. For a discussion of risks related to the competition the Company faces, see Item 1A.
Item 1A.
Risk Factors
This section highlights the material risks that the Company currently faces. Any of the risks described below could materially adversely affect the Company's business, financial condition, or results of operations.
Any deterioration in national, regional and local economic conditions, particularly unemployment levels and home prices, could materially affect the Company's business, financial condition or results of operations.
The Company's business is subject to periodic fluctuations based on national, regional and local economic conditions. These fluctuations are not predictable, cannot be controlled, and may have a material adverse impact on its financial condition and operations even if other favorable events occur. The Company's banking operations are locally-oriented and community-based. Accordingly, the Company expects to continue to be dependent upon local business conditions as well as conditions in the local residential and commercial real estate markets it serves, including Alabama, Arizona, California, Colorado, Florida, New Mexico and Texas. These economic conditions could require the Company to charge-off a higher percentage of loans or increase provisions for credit losses, which would reduce its net income.
The Company is part of the financial system and a systemic lack of available credit, a lack of confidence in the financial sector, continued volatility in the financial markets and/or reduced business activity could materially adversely affect its business, financial condition or results of operations.
A return of the volatile economic conditions experienced in the U.S. during 2008-2009, including the adverse conditions in the fixed income debt markets, for an extended period of time, particularly if left unmitigated by policy measures, may materially and adversely affect the Company.
Weakness in the real estate market has adversely affected the Company in the past and may do so in the future.
At December 31, 2019, residential real estate loans totaled $13.5 billion, or 21.2% of the Company’s loan portfolio and commercial real estate loans totaled $13.9 billion, or 21.7% of the Company’s loan portfolio. Declining residential real estate prices have historically caused cyclically higher delinquencies and losses on residential mortgage loans and home equity lines of credit. These conditions have resulted in losses, write-downs and impairment charges in the Company's mortgage and other business units.
Future declines in residential real estate values, low sales volumes, the fluctuating valuation of collateral, financial stress on borrowers as a result of unemployment, interest rate resets on ARMs or other factors could have adverse effects on borrowers that could result in higher delinquencies and greater charge-offs in future periods. Similar trends may be observed in the commercial real estate loan portfolio in times of general or localized economic downturns. Further, decreases in real estate values generally might adversely affect the creditworthiness of state and local governments, and this might result in decreased profitability or credit losses from loans made to such governments. In markets dependent on energy production, falling energy prices may adversely affect real estate values.
A decline in real estate values or overall economic weakness could also have an adverse impact upon the value of real estate or other assets which the Company owns as a result of foreclosing a loan and its ability to realize value on such assets. Any of these conditions, should they occur, could adversely affect the Company's financial condition or results of operations.
Ineffective liquidity management could adversely affect the Company’s financial results and condition.
Effective liquidity management is essential for the operation of the Company’s business. The Company requires sufficient liquidity to meet customer loan requests, customer deposit maturities/withdrawals, payments on debt obligations as they come due and other cash commitments under both normal operating conditions and unpredictable circumstances causing industry or general financial market stress. The Company’s access to funding sources in amounts adequate to finance activities on terms that are acceptable to the Company could be impaired by factors that affect the Company specifically or the financial services industry or economy in general. Factors that could detrimentally impact the Company’s access to liquidity sources include a downturn in the geographic markets in which our loans and operations are concentrated or difficult credit markets. The Company’s access to deposits may also be affected by the liquidity needs of the Company’s depositors. In particular, a majority of the Company’s liabilities during 2019 were checking accounts and other liquid deposits, which are payable on demand or upon several days’ notice, while by comparison, a substantial majority of the Company’s assets were loans, which cannot be called or sold in the same time
frame. Although the Company has historically been able to replace maturing deposits and advances as necessary, the Company might not be able to replace such funds in the future, especially if a large number of the Company’s depositors seek to withdraw their accounts, regardless of the reason. A failure to maintain adequate liquidity could materially and adversely affect our business, results of operations or financial condition.
The Company is subject to credit risk.
When the Company loans money, commits to loan money or enters into a letter of credit or other contract with a counterparty, it incurs credit risk, which is the risk of losses if its borrowers do not repay their loans or its counterparties fail to perform according to the terms of their contracts. Many of the Company's products expose it to credit risk, including loans, leases and lending commitments.
The Company may suffer increased losses in its loan portfolio despite enhancement of its underwriting policies and practices, and the Company's allowances for credit losses may not be adequate to cover such eventual losses.
The Company seeks to mitigate risks inherent in its loan portfolio by adhering to specific underwriting policies and practices, which often include analysis of (1) a borrower's credit history, financial statements, tax returns and cash flow projections; (2) valuation of collateral based on reports of independent appraisers; and (3) verification of liquid assets. The Company's underwriting policies, practices and standards are periodically reviewed and, if appropriate, enhanced in response to changing market conditions and/or corporate strategies.
Like other financial institutions, the Company maintains allowances for credit losses to provide for loan defaults and nonperformance. The Company's allowances for credit losses may not be adequate to cover eventual loan losses, and future provisions for credit losses could materially and adversely affect the Company's financial condition and results of operations. In addition, beginning in 2020, the FASB's Accounting Standards Update No. 2016-13, Financial Instruments-Credit Losses (Topic 326), will substantially change the accounting for credit losses under current U.S. GAAP standards. Under current U.S. GAAP standards, credit losses are not reflected in financial statements until it is probable that the credit loss has been incurred. Under this ASU, an entity will be required to reflect in its financial statements its current estimate of credit losses on financial assets over the expected life of each financial asset. This ASU may have a negative impact on the Company's reported earnings, capital, regulatory capital ratios, as well as on regulatory limits which are based on capital (e.g., loans to affiliates) since it would accelerate the recognition of estimated credit losses. In December 2018, the U.S. federal banking agencies finalized rules that permit bank holding companies and banks to phase-in, for regulatory capital purposes, the day-one impact of the new current expected credit loss accounting rule on retained earnings over a period of three years.
Changes in interest rates could affect the Company's income and cash flows.
The Company's earnings and financial condition are largely dependent on net interest income, which is the difference between interest earned from loans and investments and interest paid on deposits and borrowings. The narrowing of interest rate spreads, meaning the difference between interest rates earned on loans and investments and the interest rates paid on deposits and borrowings, could adversely affect the Company's earnings and financial condition. In addition, changes in interest rates may impact the fair value of our fixed-rate securities and the extent to which customers prepay mortgages and other loans. The Company cannot control or predict with certainty changes in interest rates.
Regional and local economic conditions, competitive pressures and the policies of regulatory authorities, including monetary policies of the Federal Reserve Board, affect interest income and interest expense. Following a prolonged period in which the federal funds rate was stable or decreasing, the Federal Reserve Board has begun to increase this benchmark rate. In addition, the Federal Reserve Board has stated its intention to end its quantitative easing program and has begun to reduce the size of its balance sheet by selling securities, which might also affect interest rates. The Company has policies and procedures designed to manage the risks associated with changes in market interest rates. Changes in interest rates, however, may still have an adverse effect on the Company's profitability. While the Company actively manages against these risks, if its assumptions regarding borrower behavior are wrong or overall economic conditions are significantly different than planned for, then its risk mitigation techniques may be insufficient to protect against the risk.
The Company is subject to certain risks related to originating and selling mortgages. It may be required to repurchase mortgage loans or indemnify mortgage loan purchasers as a result of breaches of representations and warranties, borrower fraud or certain breaches of its servicing agreements, and this could harm the Company's liquidity, results of operations and financial condition.
The Company originates and often sells mortgage loans. When it sells mortgage loans, whether as whole loans or pursuant to a securitization, the Company is required to make customary representations and warranties to the purchaser about the mortgage loans and the manner in which they were originated. The Company's whole loan sale agreements require it to repurchase or substitute mortgage loans in the event that it breaches certain of these representations or warranties. In addition, the Company may be required to repurchase mortgage loans as a result of borrower fraud or in the event of early payment default of the borrower on a mortgage loan. Likewise, the Company is required to repurchase or substitute mortgage loans if it breaches a representation or warranty in connection with its securitizations, whether or not it was the originator of the loan. While in many cases it may have a remedy available against certain parties, often these may not be as broad as the remedies available to a purchaser of mortgage loans against it, and the Company faces the further risk that such parties may not have the financial capacity to satisfy remedies that may be available to it. Therefore, if a purchaser enforces its remedies against it, the Company may not be able to recover its losses from third parties. The Company has received repurchase and indemnity demands from purchasers. These have resulted in an increase in the amount of losses for repurchases. While the Company has taken steps to enhance its underwriting policies and procedures, these steps will not reduce risk associated with loans sold in the past. If repurchase and indemnity demands increase materially, the Company's results of operations may be adversely affected.
The Company is at risk of increased losses from fraud.
Criminals committing fraud increasingly are using more sophisticated techniques and in some cases are part of larger criminal rings, which allow them to be more effective. Fraudulent activity has taken many forms and escalates as more tools for accessing financial services emerge, such as real-time payments. Fraud schemes are broad and continuously evolving and include such things as debit card/credit card fraud, check fraud, mechanical devices attached to ATM machines, social engineering and phishing attacks to obtain personal information, or impersonation of our clients through the use of falsified or stolen credentials. Additionally, an individual or business entity may properly identify themselves, yet seek to establish a business relationship for the purpose of perpetrating fraud. An emerging type of fraud involves the creation of synthetic identification in which fraudsters “create” individuals for the purpose of perpetrating fraud. Further, in addition to fraud committed against us, we may suffer losses as a result of fraudulent activity committed against third parties. Increased deployment of technologies, such as chip card technology, defray and reduce aspects of fraud; however, criminals are turning to other sources to steal personally identifiable information, such as unaffiliated healthcare providers and government entities, in order to impersonate the consumer to commit fraud. Many of these data compromises have been widely reported in the media. Further, as a result of the increased sophistication of fraud activity, we have increased our spending on systems and controls to detect and prevent fraud. This will result in continued ongoing investments in the future.
The Company’s operational or security systems or infrastructure, or those of third parties, could fail or be breached, which could disrupt its business and adversely impact its results of operations, liquidity and financial condition, as well as cause legal or reputational harm.
The potential for operational risk exposure exists throughout the Company’s business and, as a result of its interactions with, and reliance on, third parties, is not limited to the Company’s own internal operational functions. The Company’s operational and security systems and infrastructure, including its computer systems, data management, and internal processes, as well as those of third parties, are integral to its performance. The Company relies on employees and third parties in its day-to-day and ongoing operations, who may, as a result of human error, misconduct, malfeasance or failure, or breach of the Company’s or of third-party systems or infrastructure, expose the Company to risk. For example, the Company’s ability to conduct business may be adversely affected by any significant disruptions to the Company or to third parties with whom it interacts or upon whom it relies. In addition, the Company’s ability to implement backup systems and other safeguards with respect to third-party systems is more limited than with respect to its own systems. The Company’s financial, accounting, data processing, backup or other operating or security systems and infrastructure may fail to operate properly or become disabled or damaged as a result of a number of factors, including events that are wholly or partially beyond its control, which could adversely affect its ability to process transactions or provide services. Such events may include sudden increases in customer transaction volume; electrical, telecommunications or other major physical infrastructure outages; natural disasters such as earthquakes, tornadoes, hurricanes and floods;
disease pandemics; and events arising from local or larger scale political or social matters, including wars and terrorist acts. In addition, the Company may need to take its systems offline if they become infected with malware or a computer virus or as a result of another form of cyber-attack. The Company's business may be susceptible to infrastructure outages because its data centers are located outside the U.S. In the event that backup systems are utilized, they may not process data as quickly as the Company’s primary systems and some data might not have been saved to backup systems, potentially resulting in a temporary or permanent loss of such data. The Company frequently updates its systems to support its operations and growth and to remain compliant with all applicable laws, rules and regulations. This updating entails significant costs and creates risks associated with implementing new systems and integrating them with existing ones, including business interruptions. Implementation and testing of controls related to the Company’s computer systems, security monitoring and retaining and training personnel required to operate its systems also entail significant costs. Operational risk exposures could adversely impact the Company’s results of operations, liquidity and financial condition, as well as cause reputational harm. In addition, the Company may not have adequate insurance coverage to compensate for losses from a major interruption.
The Company faces security risks, including denial of service attacks, hacking, social engineering attacks targeting its colleagues and customers, malware intrusion or data corruption attempts, and identity theft that could result in the disclosure of confidential information, adversely affect its business or reputation, and create significant legal and financial exposure.
The Company’s computer systems and network infrastructure and those of third parties, on which it is highly dependent, are subject to security risks and could be susceptible to cyber-attacks, such as denial of service attacks, hacking, terrorist activities or identity theft. The Company’s business relies on the secure processing, transmission, storage and retrieval of confidential, proprietary and other information in its computer and data management systems and networks, and in the computer and data management systems and networks of third parties. In addition, to access the Company’s network, products and services, its customers and other third parties may use personal mobile devices or computing devices that are outside of its network environment and are subject to their own cybersecurity risks.
The Company, its customers, regulators and other third parties, including other financial services institutions and companies engaged in data processing, have been subject to, and are likely to continue to be the target of, cyber-attacks. These cyber-attacks include computer viruses, malicious or destructive code, phishing attacks, denial of service or information, ransomware, improper access by employees or vendors, attacks on personal email of employees, ransom demands to not expose security vulnerabilities in the Company’s systems or the systems of third parties or other security breaches that could result in the unauthorized release, gathering, monitoring, misuse, loss or destruction of confidential, proprietary and other information of the Company, its employees, its customers or of third parties, damage its systems or otherwise materially disrupt the Company’s or its customers’ or other third parties’ network access or business operations. As cyber threats continue to evolve, the Company may be required to expend significant additional resources to continue to modify or enhance its protective measures or to investigate and remediate any information security vulnerabilities or incidents. Despite efforts to ensure the integrity of the Company’s systems and implement controls, processes, policies and other protective measures, the Company may not be able to anticipate all security breaches, nor may it be able to implement guaranteed preventive measures against such security breaches. Cyber threats are rapidly evolving and the Company may not be able to anticipate or prevent all such attacks and could be held liable for any security breach or loss.
Cybersecurity risks for banking organizations have significantly increased in recent years in part because of the proliferation of new technologies, and the use of the internet and telecommunications technologies to conduct financial transactions. For example, cybersecurity risks may increase in the future as the Company continues to increase its mobile-payment and other internet-based product offerings and expand its internal usage of web-based products and applications. In addition, cybersecurity risks have significantly increased in recent years in part due to the increased sophistication and activities of organized crime affiliates, terrorist organizations, hostile foreign governments, disgruntled employees or vendors, activists and other external parties, including those involved in corporate espionage. Even the most advanced internal control environment may be vulnerable to compromise. Targeted social engineering attacks and "spear phishing" attacks are becoming more sophisticated and are extremely difficult to prevent. In such an attack, an attacker will attempt to fraudulently induce colleagues, customers or other users of the Company’s systems to disclose sensitive information in order to gain access to its data or that of its clients. Persistent attackers may succeed in penetrating defenses given enough resources, time, and motive. The techniques used by cyber criminals change frequently, may not be recognized until launched and may not be recognized until well after a breach has occurred. The
risk of a security breach caused by a cyber-attack at a vendor or by unauthorized vendor access has also increased in recent years. Additionally, the existence of cyber-attacks or security breaches at third-party vendors with access to the Company’s data may not be disclosed to it in a timely manner.
The Company also faces indirect technology, cybersecurity and operational risks relating to the customers, clients and other third parties with whom it does business or upon whom it relies to facilitate or enable its business activities, including, for example, financial counterparties, regulators and providers of critical infrastructure such as internet access and electrical power. As a result of increasing consolidation, interdependence and complexity of financial entities and technology systems, a technology failure, cyber-attack or other information or security breach that significantly degrades, deletes or compromises the systems or data of one or more financial entities could have a material impact on counterparties or other market participants, including the Company. This consolidation, interconnectivity and complexity increases the risk of operational failure, on both individual and industry-wide bases, as disparate systems need to be integrated, often on an accelerated basis. Any third-party technology failure, cyber-attack or other information or security breach, termination or constraint could, among other things, adversely affect the Company’s ability to effect transactions, service its clients, manage its exposure to risk or expand its business.
Cyber-attacks or other information or security breaches, whether directed at the Company or third parties, may result in a material loss or have material consequences. Furthermore, the public perception that a cyber-attack on its systems has been successful, whether or not this perception is correct, may damage the Company’s reputation with customers and third parties with whom it does business. Hacking of personal information and identity theft risks, in particular, could cause serious reputational harm. A successful penetration or circumvention of system security could cause the Company serious negative consequences, including loss of customers and business opportunities, significant business disruption to its operations and business, misappropriation or destruction of its confidential information and/or that of its customers, or damage to the Company’s or its customers’ and/or third parties’ computers or systems, and could result in a violation of applicable privacy laws and other laws, litigation exposure, regulatory fines, penalties or intervention, loss of confidence in the Company’s security measures, reputational damage, reimbursement or other compensatory costs, additional compliance costs, and could adversely impact its results of operations, liquidity and financial condition.
The Company relies on other companies to provide key components of our business infrastructure.
Third parties provide key components of the Company’s business operations such as data processing, recording and monitoring transactions, online banking interfaces and services, Internet connections and network access. While the Company has selected these third-party vendors carefully, performing upfront due diligence and ongoing monitoring activities, even with a strong oversight in place, the Company does not entirely control their actions. Any problems caused by these third parties, including those resulting from disruptions in services provided by a vendor (including as a result of a cyber-attack, other information security event or a natural disaster), financial or operational difficulties for the vendor, or resulting from issues at third-party vendors to the vendors, failure of a vendor to handle current or higher volumes, failure of a vendor to provide services for any reason, poor performance of services, failure to comply with applicable laws and regulations, or fraud or misconduct on the part of employees of any of our vendors, could adversely affect the Company’s ability to deliver products and services to the Company’s customers, the Company’s reputation and the Company’s ability to conduct its business. In certain situation, replacing these third-party vendors could also create significant delay and expense. Accordingly, use of such third parties creates an unavoidable, inherent risk to the Company’s business operations.
Cybersecurity and data privacy are areas of heightened legislative and regulatory focus.
As cybersecurity and data privacy risks for banking organizations and the broader financial system have significantly increased in recent years, cybersecurity and data privacy issues have become the subject of increasing legislative and regulatory focus. The federal bank regulatory agencies have proposed enhanced cyber risk management standards, which would apply to a wide range of large financial institutions and their third-party service providers, including the Company and the Bank, and would focus on cyber risk governance and management, management of internal and external dependencies, and incident response, cyber resilience and situational awareness. Several states have also proposed or adopted cybersecurity and data privacy legislation and regulations, which require, among other things, notification to affected individuals when there has been a security breach of their personal data.
The Company receives, maintains and stores non-public personal information of its customers and counterparties, including, but not limited to, personally identifiable information and personal financial information. The sharing, use, disclosure and protection of this information are governed by federal and state law. Both personally identifiable information and personal financial information is increasingly subject to legislation and regulation, the intent of which is to protect the privacy of personal information that is collected and handled.
The Company may become subject to new legislation or regulation concerning cybersecurity or the privacy of personally identifiable information and personal financial information or of any other information it may store or maintain. The Company could be adversely affected if new legislation or regulations are adopted or if existing legislation or regulations are modified such that it is required to alter its systems or require changes to its business practices or privacy policies. If cybersecurity, data privacy, data protection, data transfer or data retention laws are implemented, interpreted or applied in a manner inconsistent with the Company’s current practices, the Company may be subject to fines, litigation or regulatory enforcement actions or ordered to change its business practices, policies or systems in a manner that adversely impacts its operating results.
The Company is subject to legislation and regulation, and future legislation or regulation or changes to existing legislation or regulation could affect its business.
Government regulation and legislation subject the Company and other financial institutions to restrictions, oversight and/or costs that may have an impact on the Company’s business, financial condition or results of operations.
The Company is subject to extensive state and federal regulation, supervision and legislation that govern almost all aspects of its operations and limit the businesses in which the Company may engage. These laws and regulations may change from time to time and are primarily intended for the protection of consumers and depositors and are not designed to protect security-holders. The impact of any changes to laws and regulations or other actions by regulatory agencies may negatively impact the Company or its ability to increase the value of its business. In addition, actions by regulatory agencies or significant litigation against the Company could cause it to devote significant time and resources to defending itself and may lead to penalties that materially affect the Company and its shareholders. Future changes in the laws or regulations or their interpretations or enforcement may also be materially adverse to the Company and it's shareholder or may require the Company to expend significant time and resources to comply with such requirements.
The Company cannot predict whether any pending or future legislation will be adopted or the substance and impact of any such new legislation on the Company. Changes in regulation could affect the Company in a substantial way and could have an adverse effect on its business, financial condition and results of operations. In addition, legislation or regulatory reform could affect the behaviors of third parties that the Company deals with in the course of business, such as rating agencies, insurance companies and investors. The extent to which the Company can adjust its strategies to offset such adverse impacts also is not known at this time.
In addition, as a result of the Tailoring Rules, the Company and the Bank are now subject to less restrictive capital and liquidity requirements and enhanced prudential standards than in past years. If, however, the Company becomes a Category IV U.S. IHC under the Tailoring Rules, it will again be subject to certain additional capital and liquidity requirements and enhanced prudential standards that applied to the Company in past years.
The Company and the Bank are also regulated and supervised by the CFPB. The CFPB has promulgated many mortgage-related rules since it was established under the Dodd-Frank Act, including rules related to the ability to repay and qualified mortgage standards, mortgage servicing standards, loan originator compensation standards, high-cost mortgage requirements, Home Mortgage Disclosure Act requirements and appraisal and escrow standards for higher-priced mortgages. The mortgage-related rules issued by the CFPB have materially restructured the origination, servicing and securitization of residential mortgages in the United States. These rules have impacted, and will continue to impact, the business practices of mortgage lenders, including the Company and the Bank.
Please refer to Item 1. Business - Supervision, Regulation and Other Factors for more information.
Compliance with anti-money laundering and anti-terrorism financing rules involves significant cost and effort.
The Company is subject to rules and regulations regarding money laundering and the financing of terrorism. Monitoring compliance with anti-money laundering and anti-terrorism financing rules and regulations can put a significant financial burden on banks and other financial institutions and poses significant technical problems. Although
the Company has internal policies and procedures designed to ensure compliance with applicable anti-money laundering and anti-terrorism financing rules and regulations, it cannot guarantee that its policies and procedures completely prevent violations of such rules and regulations. Any such violations may have severe consequences, including sanctions, fines and reputational consequences, which could have a material adverse effect on the Company's business, financial condition or results of operations.
The costs and effects of litigation, regulatory investigations, examinations or similar matters, or adverse facts and developments relating thereto, could materially affect the Company's business, operating results and financial condition.
The Company faces legal risks in its business, and the volume of claims and amount of damages and penalties claimed in litigation and regulatory proceedings against financial institutions remain high and are escalating. Substantial legal liability or significant regulatory action against the Company may have material adverse financial effects or cause significant reputational harm, which in turn could seriously harm its business prospects.
The Company and its operations are subject to increased regulatory oversight and scrutiny, which may lead to additional regulatory investigations or enforcement actions, thereby increasing the Company’s costs associated with responding to or defending such actions. In particular, inquiries could develop into administrative, civil or criminal proceedings or enforcement actions and may increase the Company's compliance costs, require changes in the Company's business practices, affect the Company's competitiveness, impair the Company's profitability, harm the Company's reputation or otherwise adversely affect the Company's business.
In February 2015, the Federal Reserve Board announced the results of its regularly scheduled examination covering 2011 and 2012 to determine the Bank’s compliance with the CRA. The CRA requires the Federal Reserve Board to evaluate the record of the Bank in meeting the credit needs of its local community, including low and moderate income neighborhoods. The Bank received a rating of “needs to improve." The Bank’s rating in this CRA examination resulted in restrictions on certain activities, including certain mergers and acquisitions and applications to open branches or certain other facilities. These restrictions were removed when the Bank received a “Satisfactory” CRA rating in its subsequent exam. The Bank received an "Outstanding" rating in its most recent CRA examination. The Bank must maintain a CRA rating of at least "Satisfactory" for the Company to engage in the full range of activities permissible for financial holding companies.
The Company's insurance may not cover all claims that may be asserted against it and indemnification rights to which it is entitled may not be honored. Any claims asserted against the Company, regardless of merit or eventual outcome, may harm its reputation. Should the ultimate judgments or settlements in any litigation or investigation significantly exceed the Company's insurance coverage, they could have a material adverse effect on its business, financial condition and results of operations. In addition, premiums for insurance covering the financial and banking sectors are rising. The Company may not be able to obtain appropriate types or levels of insurance in the future, nor may it be able to obtain adequate replacement policies with acceptable terms or at historic rates, if at all.
The Company is exposed to risks in relation to compliance with anti-corruption laws and regulations and economic sanctions programs.
The Company is required to comply with various anti-corruption laws, including the U.S. Foreign Corrupt Practices Act of 1977, and economic sanctions programs, including those administered by the United Nations Security Council and the United States, including OFAC. The anti-corruption laws generally prohibit providing anything of value to government officials for the purposes of obtaining or retaining business or securing any improper business advantage. As part of its business, the Company may deal with entities, the employees of which are considered government officials. In addition, as noted above in Part I, Item 1 (“Anti-Money Laundering; USA PATRIOT Act; Office of Foreign Assets Control”), economic sanctions programs restrict the Company from conducting certain transactions or dealings involving certain sanctioned countries or persons.
Although the Company has internal policies and procedures designed to ensure compliance with applicable anti-corruption laws and sanctions regulations, there can be no assurance that such policies and procedures will be sufficient or that the Company’s employees, directors, officers, partners, agents and service providers will not take actions in violation of the Company’s policies and procedures (or otherwise in violation of the relevant anti-corruption laws and sanctions regulations) for which they or the Company may ultimately be held responsible. Violations of anti-corruption
laws and sanctions regulations could lead to financial penalties being imposed on the Company, limits being placed on the Company’s activities, authorizations or licenses being revoked, damage to the Company’s reputation and other consequences that could have a material adverse effect on the Company’s business, results of operations and financial condition. Further, litigation or investigations relating to alleged or suspected violations of anti-corruption laws or sanctions regulations could be costly.
Expected Replacement of LIBOR may adversely affect the Company’s business.
On July 27, 2017, the Chief Executive of the United Kingdom Financial Conduct Authority, which regulates LIBOR, announced that it intends to stop persuading or compelling banks to submit rates for the calculation of LIBOR to the administrator of LIBOR after 2021. The announcement indicates that the continuation of LIBOR on the current basis cannot and will not be guaranteed after 2021. It is impossible to predict whether and to what extent banks will continue to provide LIBOR submissions to the administrator of LIBOR or whether any additional regulatory or other actions or reforms with respect to LIBOR may be enacted in the United Kingdom or elsewhere.
On April 3, 2018, the Federal Reserve Bank of New York commenced publication of three reference rates based on overnight U.S. Treasury repurchase agreement transactions, including SOFR, which has been recommended as an alternative to U.S. dollar LIBOR by the Alternative Reference Rates Committee. The Alternative Reference Rates Committee is a group of private-market participants convened by the Federal Reserve and the Federal Reserve Bank of New York, with the objective of helping to ensure a transition from USD LIBOR to SOFR. Further, the Bank of England is publishing a reformed Sterling Overnight Index Average, comprised of a broader set of overnight Sterling money market transactions, which has been selected by the Working Group on Sterling Risk-Free Reference Rates as the alternative rate to Sterling LIBOR. Central bank-sponsored committees in other jurisdictions, including Europe, Japan and Switzerland, have selected alternative reference rates denominated in other currencies and have plans to replace or reform existing benchmarks with those alternative reference rates.
In particular, any such transition, action or reform could:
•
Adversely impact the pricing, liquidity, value of, return on and trading for a broad array of financial products and transactions, including any LIBOR-linked securities such as the Company’s Series A Preferred Stock, Capital Securities, loans and derivatives that are included in our financial assets and liabilities;
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Require extensive changes to documentation that governs or references LIBOR or LIBOR-based products and transactions, including, for example, pursuant to time-consuming renegotiations of existing documentation to modify the terms of outstanding securities, related hedging transactions, loans and derivatives;
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Result in inquiries or other actions from regulators in respect of our preparation and readiness for the replacement of LIBOR with one or more alternative reference rates;
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Result in disputes, litigation or other actions with counterparties regarding the interpretation and enforceability of provisions in LIBOR based products and transactions such as fallback language or other related provisions, including in the case of fallbacks to the alternative reference rates, regarding any economic, legal, operational or other impact resulting from the fundamental differences between U.S. dollar LIBOR, or other LIBORs or other benchmarks that are being replaced or reformed, on the one hand, and the various alternative reference rates, on the other;
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Require the transition and/or development of appropriate systems and analytics to effectively transition our risk management processes from LIBOR-based products and transactions to those based on one or more alternative reference rates in a timely manner, including by quantifying value and risk for various alternative reference rates, which may prove challenging given the limited history of the proposed alternative reference rates; and
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Cause us to incur additional costs in relation to any of the above factors.
Depending on several factors including those set forth above, our business, financial condition and results of operations could be materially adversely impacted by the market transition or reform of certain benchmarks, including
U.S. dollar LIBOR. Other factors include the pace of the transition to replacement or reformed rates, the specific terms and parameters for and market acceptance of any alternative reference rate, prices of and the liquidity of trading markets for products based on alternative reference rates, and our ability to transition and develop appropriate systems and analytics for one or more alternative reference rates.
Downgrades to the U.S. government's credit rating, or the credit rating of its securities, by one or more of the credit ratings agencies could have a material adverse effect on general economic conditions, as well as the Company's operations, earnings and financial condition.
It is foreseeable that the ratings and perceived creditworthiness of instruments issued, insured or guaranteed by institutions, agencies or instrumentalities directly linked to the U.S. government could be correspondingly affected by any downgrade to the U.S. government's sovereign credit rating, including the rating of U.S. Treasury securities. Instruments of this nature are key assets on the balance sheets of financial institutions, including the Company, and are widely used as collateral by financial institutions to meet their day-to-day cash flows in the short-term debt market.
A downgrade of the U.S. government's sovereign credit rating, and the perceived creditworthiness of U.S. government-related obligations, could impact the Company's ability to obtain funding that is collateralized by affected instruments, as well as affecting the pricing of that funding when it is available. A downgrade may also adversely affect the market value of such instruments. The Company cannot predict if, when or how any changes to the credit ratings or perceived creditworthiness of these organizations will affect economic conditions. Such ratings actions could result in a significant adverse impact on the Company. A downgrade of the sovereign credit ratings of the U.S. government or the credit ratings of related institutions, agencies or instrumentalities would significantly exacerbate the other risks to which the Company is subject and any related adverse effects on its business, financial condition and results of operations.
A reduction in the Company's own credit rating could have a material adverse effect on the Company's liquidity and increase the cost of its capital markets funding.
Adequate liquidity is essential to the Company's businesses. A reduction to the Company's credit rating could have a material adverse effect on the Company's business, financial condition and results of operations.
The rating agencies regularly evaluate the Company and their ratings are based on a number of factors, including the Company's financial strength as well as factors not entirely within its control, such as conditions affecting the financial services industry generally. Adverse changes in the credit ratings of the Kingdom of Spain, which subsequently could impact BBVA, could also adversely impact the Company's credit rating. There can be no assurance that the Company will maintain its current ratings. The Company's failure to maintain those ratings could increase its borrowing costs, require the Company to replace funding lost due to the downgrade, which may include the loss of customer deposits, and may also limit the Company's access to capital and money markets and trigger additional collateral requirements in derivatives contracts and other secured funding arrangements.
The Company's ability to access the capital markets is important to its overall funding profile. This access is affected by its credit rating. The interest rates that the Company pays on its securities are also influenced by, among other things, the credit ratings that it receives from recognized rating agencies. A downgrade to the Company's credit rating could affect its ability to access the capital markets, increase its borrowing costs and negatively impact its profitability. A ratings downgrade to the Company's credit rating could also create obligations or liabilities for it under the terms of its outstanding securities that could increase its costs or otherwise have a negative effect on the Company's results of operations or financial condition. Additionally, a downgrade of the credit rating of any particular security issued by the Company could negatively affect the ability of the holders of that security to sell the securities and the prices at which any such securities may be sold.
The financial services market is undergoing rapid technological changes, and the Company may be unable to effectively compete or may experience heightened cyber-security and/or fraud risks as a result of these changes.
The financial services market, including banking services, is undergoing rapid changes with frequent introductions of new technology-driven products and services. In addition to better serving customers, the effective use of technology increases efficiency and may enable the Company to reduce costs. The Company's future success may depend, in part, on its ability to use technology to provide products and services that provide convenience to customers and to create additional efficiencies in its operations. Some of the Company's competitors have substantially greater resources to
invest in technological improvements. The Company may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to its customers. As a result, the Company's ability to effectively compete to retain or acquire new business may be impaired, and its business, financial condition or results of operations may be adversely affected.
The Company is under continuous threat of loss due to cyber-attacks, especially as it continues to expand customer capabilities to utilize internet and other remote channels to transact business. Two of the most significant cyber-attack risks that it faces are e-fraud and breach of sensitive customer data. Loss from e-fraud occurs when cybercriminals breach and extract funds directly from customers' or the Company's accounts. A breach of sensitive customer data, such as account numbers and social security numbers could present significant reputational, legal and/or regulatory costs to the Company.
Over the past few years, there have been a series of distributed denial of service attacks on financial services companies. Distributed denial of service attacks are designed to saturate the targeted online network with excessive amounts of network traffic, resulting in slow response times, or in some cases, causing the site to be temporarily unavailable. Generally, these attacks have not been conducted to steal financial data, but meant to interrupt or suspend a company's internet service. While these events may not result in a breach of client data and account information, the attacks can adversely affect the performance of a company’s website and in some instances have prevented customers from accessing a company’s website. Distributed denial of service attacks, hacking and identity theft risks could cause serious reputational harm. Cyber threats are rapidly evolving and the Company may not be able to anticipate or prevent all such attacks. The Company's risk and exposure to these matters remains heightened because of the evolving nature and complexity of these threats from cybercriminals and hackers, its plans to continue to provide internet banking and mobile banking channels, and its plans to develop additional remote connectivity solutions to serve its customers. The Company may incur increasing costs in an effort to minimize these risks and could be held liable for any security breach or loss.
Additionally, fraud risk may increase as the Company offers more products online or through mobile channels.
The Company is subject to intense competition in the financial services industry, particularly in its market area, which could result in losing business or margin declines.
The Company operates in a highly competitive industry that could become even more competitive as a result of legislative, regulatory and technological changes, as well as continued consolidation. The Company faces aggressive competition from other domestic and foreign lending institutions and from numerous other providers of financial services. The ability of non-banking financial institutions to provide services previously limited to commercial banks has intensified competition. Because non-banking financial institutions are not subject to the same regulatory restrictions as banks and bank holding companies, they can often operate with greater flexibility and lower cost structures. Securities firms and insurance companies that elect to become financial holding companies can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking, and may acquire banks and other financial institutions. This may significantly change the competitive environment in which the Company conducts business. Some of the Company's competitors have greater financial resources and/or face fewer regulatory constraints. As a result of these various sources of competition, the Company could lose business to competitors or be forced to price products and services on less advantageous terms to retain or attract clients, either of which would adversely affect its profitability.
Some of the Company's larger competitors, including certain national banks that have a significant presence in its market area, may have greater capital and resources than the Company, may have higher lending limits and may offer products and services not offered by the Company. Although the Company remains strong, stable and well capitalized, management cannot predict the reaction of customers and other third parties with which it conducts business with respect to the strength of the Company relative to its competitors, including its larger competitors. Any potential adverse reactions to the Company's financial condition or status in the marketplace, as compared to its competitors, could limit its ability to attract and retain customers and to compete for new business opportunities. The inability to attract and retain customers or to effectively compete for new business may have a material and adverse effect on the Company's financial condition and results of operations.
The Company also experiences competition from a variety of institutions outside of its market area. Some of these institutions conduct business primarily over the internet and may thus be able to realize certain cost savings and offer
products and services at more favorable rates and with greater convenience to the customer who can obtain loans, pay bills and transfer funds directly without going through a bank. This “disintermediation” could result in the loss of fee income, as well as the loss of customer deposits and income generated from those deposits. In addition, changes in consumer spending and saving habits could adversely affect the Company's operations, and the Company may be unable to timely develop competitive new products and services in response to these changes.
Customers could pursue alternatives to bank deposits, causing the Company to lose a relatively inexpensive source of funding.
Checking and savings account balances and other forms of client deposits could decrease if customers perceive alternative investments, such as the stock market, provide superior expected returns. When clients move money out of bank deposits in favor of alternative investments, the Company can lose a relatively inexpensive source of funds, thus increasing its funding costs.
The Company depends on the accuracy and completeness of information about clients and counterparties.
In deciding whether to extend credit or enter into other transactions with clients and counterparties, the Company may rely on information furnished by or on behalf of clients and counterparties, including financial statements and other financial information. The Company also may rely on representations of clients and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors.
Negative public opinion could damage the Company's reputation and adversely impact business and revenues.
As a financial institution, the Company's earnings and capital are subject to risks associated with negative public opinion. The reputation of the financial services industry in general has been damaged as a result of the financial crisis and other matters affecting the financial services industry, including mortgage foreclosure issues. Negative public opinion regarding the Company could result from its actual or alleged conduct in any number of activities, including lending practices, the failure of any product or service sold by it to meet its clients' expectations or applicable regulatory requirements, breach of sensitive customer information, a cybersecurity incident, corporate governance and acquisitions, or from actions taken by government regulators and community organizations in response to those activities. The Company could also be adversely affected by negative public opinion involving BBVA. Negative public opinion can adversely affect the Company's ability to keep, attract and/or retain clients and personnel, and can expose it to litigation and regulatory action. Actual or alleged conduct by one of the Company's businesses can result in negative public opinion about its other businesses. Negative public opinion could also affect the Company's credit ratings, which are important to accessing unsecured wholesale borrowings. Significant changes in these ratings could change the cost and availability of these sources of funding.
The Company’s ability to attract and retain customers, clients, investors, and highly-skilled management and employees is affected by its reputation. Public perception of the financial services industry in general was damaged as a result of the credit crisis that started in 2008. Significant harm to its reputation can also arise from other sources, including employee misconduct, actual or perceived unethical behavior, conflicts of interest, litigation, GSE or regulatory actions, failing to deliver minimum or required standards of service and quality, failing to address customer and agency complaints, compliance failures, unauthorized release of confidential information due to cyber-attacks or otherwise, and the activities of the Company’s clients, customers and counterparties, including vendors. Actions by the financial service industry generally or by institutions or individuals in the industry can adversely affect the Company’s reputation, indirectly by association. All of these could adversely affect its growth, results of operation and financial condition.
The Company's rebranding strategy may not produce the benefits expected, may involve substantial costs and may not be favorably received by Customers.
Since 2008, the Company has marketed the Company's products and services using the “BBVA Compass” brand name and logo. Effective June 10, 2019, the Parent amended its Certificate of Formation to change its legal name from BBVA Compass Bancshares, Inc. to BBVA USA Bancshares, Inc. During 2019, the Bank began the process of transitioning away from the use of the “BBVA Compass” name and rebranding as “BBVA.”
Developing and maintaining awareness and integrity of the Company and the Company's brand are important to achieving widespread acceptance of our existing and future offerings and are important elements in attracting new customers. The importance of brand recognition will increase as competition in the Company's market further intensifies. Successful promotion of the Company's brand will depend on the effectiveness of the Company's marketing efforts and on the Company's ability to provide reliable and useful banking solutions. The Company plans to continue investing substantial resources to promote the Company's brand, but there is no guarantee that the Company will be able to achieve or maintain brand name recognition or status under the new brand, “BBVA,” that is comparable to the recognition and status previously enjoyed by the “BBVA Compass” brand. Even if the Company's brand recognition and loyalty increases, this may not result in increased use of the Company's products and services or higher revenue.
For these reasons, the Company's rebranding initiative may not produce the benefits expected, could adversely affect the Company's ability to retain and attract customers, and may have a negative impact on the Company's operations, business, financial results and financial condition.
The Company is a subsidiary of BBVA Group, and activities across BBVA Group could adversely affect the Company’s business and results of operations.
The Company is a part of a highly diversified international financial group which offers a wide variety of financial and related products and services including retail banking, asset management, private banking and wholesale banking. The BBVA Group strives to foster a culture in which its employees act with integrity and feel comfortable reporting instances of misconduct. The BBVA Group employees are essential to this culture, and acts of misconduct by any employee, and particularly by senior management, could erode trust and confidence and damage the BBVA Group and the Company’s reputation among existing and potential clients and other stakeholders. Negative public opinion could result from actual or alleged conduct by the BBVA Group entities in any number of activities or circumstances, including operations, employment-related offenses such as sexual harassment and discrimination, regulatory compliance, the use and protection of data and systems, and the satisfaction of client expectations, and from actions taken by regulators or others in response to such conduct.
Spanish judicial authorities are investigating the activities of Centro Exclusivo de Negocios y Transacciones, S.L. (Cenyt). Such investigation includes the provision of services by Cenyt to BBVA. On July 29, 2019, BBVA was named as an investigated party (investigado) in a criminal judicial investigation (Preliminary Proceeding No. 96/2017 - Piece No. 9, Central Investigating Court No. 6 of the National High Court) for alleged facts which could represent the crimes of bribery, revelation of secrets and corruption. As of the date of this Annual Report on Form 10-K, no formal accusation against BBVA has been made. Certain current and former officers and employees of the BBVA Group, as well as former directors of BBVA, have also been named as investigated parties in connection with this investigation. BBVA has been and continues to be proactively collaborating with the Spanish judicial authorities, including sharing with the courts information from its on-going forensic investigation regarding its relationship with Cenyt. BBVA has also testified before the judge and prosecutors at the request of the Central Investigating Court No. 6 of the National High Court. On February 3, 2020, BBVA was notified by the Central Investigating Court No. 6 of the National High Court of the order lifting the secrecy of the proceedings. This criminal judicial proceeding is at a preliminary stage. Therefore, it is not possible at this time to predict the scope or duration of such proceeding or any related proceeding or its or their possible outcomes or implications for the Group, including any fines, damages or harm to the Group’s reputation caused thereby.
This matter or any similar matters arising across the BBVA Group could damage the Company’s reputation and adversely affect the confidence of the Company’s clients, rating agencies, regulators, bondholders and other parties and could have an adverse effect on the Company’s business, financial condition and operating results.
The Company's framework for managing risks may not be effective in mitigating risk and loss to the Company.
The Company's risk management framework is made up of various processes and strategies to manage its risk exposure. The framework to manage risk, including the framework's underlying assumptions, may not be effective under all conditions and circumstances. If the risk management framework proves ineffective, the Company could suffer unexpected losses and could be materially adversely affected.
The Company's financial reporting controls and procedures may not prevent or detect all errors or fraud.
Financial reporting disclosure controls and procedures are designed to reasonably assure that information required to be disclosed by the Company in reports filed or submitted under the Exchange Act is accumulated and communicated to management, and recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. Any disclosure controls and procedures over financial reporting or internal controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.
These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by an unauthorized override of the controls. Accordingly, because of the inherent limitations in the control system, misstatements due to error or fraud may occur and not be detected.
Volatile or declining oil prices could adversely affect the Company's performance.
As of December 31, 2019, energy-related loan balances represented approximately 4.5 percent of the Bank’s total loan portfolio. This amount is comprised of loans directly related to energy, such as exploration and production, pipeline transportation of natural gas, crude oil and other refined petroleum products, oil field services, and refining and support. In late 2014, oil prices began to decline and continued to decline through the first half of 2016, which has had an adverse effect on some of the Bank’s borrowers in this portfolio and on the value of the collateral securing some of these loans. If oil prices decline in a material way, the cash flows of the Bank’s customers in this industry could be adversely impacted which could impair their ability to service any loans outstanding to them and/or reduce demand for loans. These factors could result in higher delinquencies and greater charge-offs in future periods, which could adversely affect the Company's business, financial condition or results of operations.
Furthermore, energy production and related industries represent a significant part of the economies in some of the Bank’s primary markets. A prolonged period of low or volatile oil prices could have a negative impact on the economies and real estate markets of states such as Texas, which could adversely affect the Company's business, financial condition or results of operations.
The failure of the European Union to stabilize the fiscal condition of member countries, especially in Spain, could have an adverse impact on global financial markets, the current U.S. economic recovery and the Company.
Certain European Union member countries have fiscal obligations greater than their fiscal revenue, which has caused investor concern over such countries' ability to continue to service their debt and foster economic growth. Fiscal austerity measures such as raising taxes and reducing entitlements have improved the ability of some member countries to service their debt, but have challenged economic growth and efforts to lower unemployment rates in the region. Although the fiscal health and economic outlook of Spain and the European Union, more generally, have improved, there is no guarantee that these trends will continue.
The Company is a wholly owned subsidiary of BBVA, which is based in Spain and serves as a source of strength and capital to the Company. Accordingly, European Union weakness, particularly in Spain, could directly impact BBVA and could have an adverse impact on the Company's business or financial condition.
A weaker European economy may transcend Europe, cause investors to lose confidence in the safety and soundness of European financial institutions and the stability of European member economies, and likewise affect U.S.-based financial institutions, the stability of the global financial markets and the economic recovery underway in the U.S. Should the U.S. economic recovery be adversely impacted by these factors, loan and asset growth at U.S. financial institutions, like the Company, could be affected.
The Company is subject to capital adequacy and liquidity standards, and if it fails to meet these standards its financial condition and operations would be adversely affected.
The U.S. Basel III final rule and provisions in the Dodd-Frank Act increased capital requirements for banking organizations such as the Company and the Bank. Consistent with the Basel Committee's Basel III capital framework, the U.S. Basel III final rule includes a minimum ratio of CET1 capital to risk weighted assets of 4.5 percent and a CET1 capital conservation buffer of greater than 2.5 percent of risk-weighted assets that applies to all U.S. banking
organizations, including the Bank and the Company. Failure to maintain the capital conservation buffer would result in increasingly stringent restrictions on a banking organization's ability to make dividend payments and other capital distributions and pay discretionary bonuses to executive officers.
The Company has also been required to submit a periodic capital plan to the Federal Reserve Board under the CCAR process, subject to Dodd-Frank Act stress testing requirements and additional liquidity requirements. As a result of the Tailoring Rules, however, the Company and the Bank are no longer subject to CCAR, Dodd-Frank Act stress testing and the LCR. If, however, the Company becomes a Category IV U.S. IHC under the Tailoring Rules, it will again be subject to certain modified forms of these requirements that applied to the Company in past years.
In addition, BBVA designated the Parent as its IHC to comply with the Federal Reserve Board's final rule to enhance its supervision and regulation of the U.S. operations of Large FBOs. The Company is subject to U.S. risk-based and leverage capital, liquidity, risk management, and other enhanced prudential standards on a consolidated basis under this rule, as amended by the Tailoring Rules. BBVA's combined U.S. operations (including its U.S. branches, agencies and subsidiaries) are also subject to certain enhanced prudential standards. These enhanced prudential standards could affect the Company’s operations.
Please refer to Item 1. Business - Supervision, Regulation and Other Factors for more information.
The Parent is a holding company and depends on its subsidiaries for liquidity in the form of dividends, distributions and other payments.
The Parent is a legal entity separate and distinct from its subsidiaries, including the Bank. The principal source of cash flow for the Parent is dividends from the Bank. There are statutory and regulatory limitations on the payment of dividends by the Bank. Regulations of both the Federal Reserve Board and the State of Alabama affect the ability of the Bank to pay dividends and other distributions to the Company and to make loans to the Company. Also, the Company’s right to participate in a distribution of assets upon a subsidiary's liquidation or reorganization is subject to the prior claims of the subsidiary's creditors. Limitations on the Parent’s ability to receive dividends and distributions from its subsidiaries could have a material adverse effect on the Company’s liquidity and on its ability to pay dividends on common stock. For additional information regarding these limitations see Item 1. Business - Supervision, Regulation and Other Factors - Dividends.
Disruptions in the Company's ability to access capital markets may adversely affect its capital resources and liquidity.
The Company may access capital markets to provide it with sufficient capital resources and liquidity to meet its commitments and business needs, and to accommodate the transaction and cash management needs of its clients. Other sources of contingent funding available to the Company include inter-bank borrowings, brokered deposits, repurchase agreements, FHLB capacity and borrowings from the Federal Reserve discount window. Any occurrence that may limit the Company's access to the capital markets, such as a decline in the confidence of debt investors, its depositors or counterparties participating in the capital markets, or a downgrade of its debt rating, may adversely affect the Company's capital costs and its ability to raise capital and, in turn, its liquidity.
Disruptions in the liquidity of financial markets may directly impact the Company to the extent it needs to access capital markets to raise funds to support its business and overall liquidity position. This situation could adversely affect the cost of such funds or the Company's ability to raise such funds. If the Company were unable to access any of these funding sources when needed, it might be unable to meet customers' needs, which could adversely impact its financial condition, results of operations, cash flows and level of regulatory-qualifying capital.
The value of the Company’s goodwill may decline in the future.
A significant decline in the Company’s expected future cash flows, a significant adverse change in the business climate, or slower growth rates, any or all of which could be materially impacted by many of the risk factors discussed herein, may require that the Company take charges in the future related to the impairment of goodwill. Future regulatory actions could also have a material impact on assessments of goodwill for impairment. If the Company were to conclude that a future write-down of its goodwill and other intangible assets is necessary, the Company would record the appropriate charge which could have a material adverse effect on its results of operations.
The Company depends on the expertise of key personnel, and its operations may suffer if it fails to attract and retain skilled personnel.
The Company's success depends, in large part, on its ability to attract and retain key individuals. Competition for qualified candidates in the activities and markets that the Company serves is great and it may not be able to hire these candidates and retain them. If the Company is not able to hire or retain these key individuals, it may be unable to execute its business strategies and may suffer adverse consequences to its business, operations and financial condition.
In June 2010, the federal banking regulators issued joint guidance on executive compensation designed to help ensure that a banking organization's incentive compensation policies do not encourage imprudent risk taking and are consistent with the safety and soundness of the organization. In addition, the Dodd-Frank Act requires those agencies, along with the SEC, to adopt rules affecting the structure and reporting of incentive compensation. The federal banking regulators and SEC proposed such rules in 2011 and issued revised proposed rules in 2016.
As a wholly owned subsidiary of BBVA, the Company is also required to comply with the European Union’s CRD-IV, which, among other things, impacts the variable compensation of certain risk-takers and highly compensated individuals in the Company or its subsidiaries. In accordance with CRD-IV, the Bank pays variable compensation of certain employees half in stock and half in cash. Additionally, in accordance with CRD-IV, from 40% to 50% (depending on the classification of the employee), of such payment is deferred for three years. The deferred amounts are subject to performance indicators and a malus clause, which could result in the reduction or forfeiture of the deferred amounts. The equity awards are subject to an additional one-year holding period after delivery. Most of the Company’s competitors are not subject to CRD-IV.
If the Company is unable to attract and retain qualified employees, or do so at rates necessary to maintain its competitive position, or if compensation costs required to attract and retain employees become more expensive, the Company's performance, including its competitive position, could be materially adversely affected.
Unpredictable catastrophic events could have a material adverse effect on the Company.
The occurrence of catastrophic events such as hurricanes, tropical storms, tornadoes, terrorist attacks, disease pandemics and other large scale catastrophes could adversely affect the Company's consolidated financial condition or results of operations. The Company has operations and customers in the southern United States, which could be adversely impacted by hurricanes and other severe weather in those regions. Unpredictable natural and other disasters could have an adverse effect on the Company in that such events could materially disrupt its operations or the ability or willingness of its customers to access the financial services it offers. The incidence and severity of catastrophes are inherently unpredictable. Although the Company carries insurance to mitigate its exposure to certain catastrophic events, these events could nevertheless reduce its earnings and cause volatility in its financial results for any fiscal quarter or year and have a material adverse effect on its financial condition and/or results of operations.
Changes in accounting standards could impact reported earnings.
The entities that set accounting standards and other regulatory bodies periodically change the financial accounting and reporting standards that govern the preparation of the Company’s consolidated financial statements. These changes can materially impact how management records and reports the Company’s financial condition and results of operations. In some cases, the Company could be required to apply a new or revised accounting standard retroactively, resulting in a possible restatement of prior period financial statements.
Item 1B.
Item 1B.
Unresolved Staff Comments
Not Applicable.
Item 2.
Item 2.
Properties
The Company occupies various facilities principally located in Alabama, Arizona, California, Colorado, Florida, New Mexico and Texas and in states where it operates loan production offices that are used in the normal course of the financial services business. The properties consist of both owned and leased properties and include land for future banking center sites. The leased properties include both land and buildings that are generally under long-term leases. The Company leases office space used as the Company's principal executive offices in Houston, Texas. The Bank has significant operations in Birmingham, Alabama. The Company owns the land and building where the Bank is headquartered. See Note 5, Premises and Equipment, in the Notes to the Consolidated Financial Statements, for additional disclosures related to the Company’s properties.
Item 3.
Item 3.
Legal Proceedings
See under “Legal and Regulatory Proceedings” in Note 15, Commitments, Contingencies and Guarantees, in the Notes to the Consolidated Financial Statements.
Item 4.
Item 4.
Mine Safety Disclosures
Not Applicable.
Part II
Item 5.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
The Parent's common stock is not traded on any exchange or other interdealer electronic trading facility and there is no established public trading market for the Parent's common stock.
Holders
As of the date of this filing, BBVA was the sole holder of the Parent's common stock.
Dividends
The payment of dividends on the Parent's common stock is subject to determination and declaration by the Board of Directors of the Parent and regulatory limitations on the payment of dividends. There is no assurance that dividends will be declared or, if declared, what the amount of dividends will be, or whether such dividends will continue. The following table sets forth the common dividends the Parent paid to its sole shareholder, BBVA, for each of the last eight quarters.
A discussion of dividend restrictions is provided in Item 1. Business - Overview - Supervision, Regulation, and Other Factors - Dividends and in Note 16, Regulatory Capital Requirements and Dividends from Subsidiaries, in the Notes to the Consolidated Financial Statements.
Recent Sales of Unregistered Securities
Not Applicable.
Item 6.
Item 6.
Selected Financial Data
The following table sets forth summarized historical consolidated financial information for each of the periods indicated. This information should be read together with Management's Discussion and Analysis of Financial Condition and Results of Operations below and with the accompanying Consolidated Financial Statements included in this Annual Report on Form 10-K. The historical information indicated as of and for the years ended December 31, 2019 through 2015, has been derived from the Company's audited Consolidated Financial Statements for the years ended December 31, 2019 through 2015. Historical results set forth below and elsewhere in this Annual Report on Form 10-K are not necessarily indicative of future performance.
(1)
Noninterest expense for the years ended December 31, 2019, 2016 and 2015 includes goodwill impairment of $470.0 million, $59.9 million, $17.0 million, respectively.
Item 7.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The purpose of this discussion is to focus on significant changes in the financial condition and results of operations of the Company during the years ended December 31, 2019, 2018 and 2017. The Executive Overview summarizes information management believes is important for an understanding of the financial condition and results of operations of the Company. Topics presented in the Executive Overview are discussed in more detail within, and should be read in conjunction with, this Management’s Discussion and Analysis of Financial Condition and Results of Operations and the accompanying Consolidated Financial Statements included in this Annual Report on Form 10-K. The discussion of the critical accounting policies and analysis set forth below is intended to supplement and highlight information contained in the accompanying Consolidated Financial Statements and the selected financial data presented elsewhere in this Annual Report on Form 10-K.
Executive Overview
Financial Performance
Consolidated net income attributable to the Company for 2019 was $151.1 million compared to $761.4 million earned during 2018. The Company's 2019 results reflected higher noninterest expense as a result of a $470 million goodwill impairment charge and higher provision for loan losses.
Net interest income was $2.6 billion in both 2019 and 2018. The net interest margin for 2019 was 3.17% compared to 3.30% for 2018. Net interest margin in 2019 was primarily impacted by higher funding costs.
The provision for loan losses was $597.4 million for 2019 compared to $365.4 million for 2018. The increase in provision for loan losses for 2019 was primarily driven by higher losses in the consumer direct loan portfolio as well as an increase in losses in the commercial, financial and agricultural loan portfolio. Net charge-offs for 2019 totaled $561.7 million compared to $322.9 million for 2018. The primary driver of the increase in net charge-offs was a $110.6 million increase in consumer direct net charge-offs as well as an $86.7 million increase in commercial, financial, and agricultural net charge-offs, $22.7 million increase in credit card net charge-offs, and a $14.5 million increase in consumer indirect net charge-offs.
Noninterest income was $1.1 billion for both 2019 and 2018, a slight increase of $79.0 million. The increase in noninterest income was driven by a $22.6 million increase in card and merchant processing fees, a $13.7 million increase in service charges on deposit accounts, a $7.5 million increase in money transfer income, a $6.0 million increase in investment banking and advisory fees and a $30.0 million increase in investment securities gains which were partially offset by $13.1 million decrease in corporate and correspondent investment sales.
Noninterest expense increased $516.1 million to $2.9 billion for 2019 compared to 2018. The increase in noninterest expense was primarily attributable to a $470.0 million goodwill impairment related to the Corporate and Investment Banking reporting unit. Also, contributing to the increase was a $27.1 million increase in salaries, benefits and commissions, a $15.8 million increase in professional services, a $6.1 million increase in money transfer expense, a $6.3 million increase in marketing, and a $45.9 million increase in other noninterest expense. Partially offsetting the increase was a $39.8 million decrease in FDIC insurance and an $8.8 million decrease in communications expense.
Income tax expense was $126.0 million for 2019 compared to $184.7 million for 2018. This resulted in an effective tax rate of 45.1% for 2019 and a 19.5% effective tax rate for 2018. The increase in the effective tax rate was primarily driven by lower net income combined with an unfavorable permanent difference related to goodwill impairment.
The Company's total assets at December 31, 2019 were $93.6 billion, an increase of $2.7 billion from December 31, 2018 levels. Total loans excluding loans held for sale were $63.9 billion at December 31, 2019, a decrease of $1.2 billion or 1.9% from December 31, 2018 levels. The decrease in loans was primarily due to the sale of approximately $1.1 billion in commercial loans to BBVA, S.A. New York Branch and loan production volumes.
Deposits increased $2.8 billion or 3.9% compared to December 31, 2018, driven by an increase in transaction accounts which increased 11.5%.
Total shareholder's equity at December 31, 2019 was $13.4 billion, a decrease of $126 million compared to December 31, 2018.
Capital
The Company's Tier 1 and CET1 ratios were 12.83% and 12.49%, respectively at December 31, 2019, compared to 12.33% and 12.00%, respectively at December 31, 2018, under the U.S. Basel III final rule.
For more information, see “Capital” in this Management’s Discussion and Analysis of Financial Condition and Results of Operations, Item 1. Business - Supervision, Regulation and Other Factors - Capital, and Note 16, Regulatory Capital Requirements and Dividends from Subsidiaries, in the Notes to the Consolidated Financial Statements in this Annual Report on Form 10-K.
Liquidity
The Company’s sources of liquidity include customers’ interest-bearing and noninterest-bearing deposit accounts, loan principal and interest payments, investment securities, and borrowings. As a holding company, the Parent’s primary source of liquidity is the Bank. Due to the net earnings restrictions on dividend distributions, the Bank was not permitted to pay any dividends at December 31, 2019 and 2018 without regulatory approval.
The Parent paid common dividends totaling $482.0 million to its sole shareholder, BBVA, during 2019.
As noted in Item 1. Business - Supervision, Regulation and Other Factors, the Company is no longer subject to the LCR as a result of the Tailoring Rules, but may become subject to the LCR again in the future if the Company becomes a Category IV U.S. IHC under the Tailoring Rules. At December 31, 2019, the Company's LCR was 145% and was fully compliant with the LCR requirements.
Management believes that the current sources of liquidity are adequate to meet the Company’s requirements and plans for continued growth. For more information, see below under “Liquidity Management” in this Management’s Discussion and Analysis of Financial Condition and Results of Operations, and Note 10, FHLB and Other Borrowings, Note 11, Shareholder's Equity, and Note 15, Commitments, Contingencies and Guarantees, in the Notes to the Consolidated Financial Statements.
Critical Accounting Policies
The accounting principles followed by the Company and the methods of applying these principles conform with accounting principles generally accepted in the United States of America and with general practices within the banking industry. The Company’s critical accounting policies relate to the allowance for loan losses and goodwill impairment. These critical accounting policies require the use of estimates, assumptions and judgments which are based on information available as of the date of the financial statements. Accordingly, as this information changes, future financial statements could reflect the use of different estimates, assumptions and judgments. Certain determinations inherently have a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported.
Allowance for Loan Losses: Management’s policy is to maintain the allowance for loan losses at a level sufficient to absorb estimated probable incurred losses in the loan portfolio. Management performs periodic and systematic detailed reviews of its loan portfolio to identify trends and to assess the overall collectability of the loan portfolio. Accounting standards require that loan losses be recorded when management determines it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated.
Estimates for the allowance for loan losses are determined by analyzing historical losses, historical migration to charge-off experience, current trends in delinquencies and charge-offs, the results of regulatory examinations and changes in the size, composition and risk assessment of the loan portfolio. Also included in management’s estimate for the allowance for loan losses are considerations with respect to the impact of current economic events. These events may include, but are not limited to, fluctuations in overall interest rates, political conditions, legislation that may directly or indirectly affect the banking industry and economic conditions affecting specific geographical areas and industries in which the Company conducts business.
While management uses the best information available to establish the allowance for loan losses, future adjustments to the allowance for loan losses and methodology may be necessary if economic or other conditions differ substantially
from the assumptions used in making the estimates. Such adjustments to original estimates, as necessary, are made in the period in which these factors and other relevant considerations indicate that loss levels vary from previous estimates.
A detailed discussion of the methodology used in determining the allowance for loan losses is included in Note 1, Summary of Significant Accounting Policies, in the Notes to the Consolidated Financial Statements.
Goodwill Impairment: It is the Company’s policy to assess goodwill for impairment at the reporting unit level on an annual basis or between annual assessments if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Impairment is the condition that exists when the carrying amount of goodwill exceeds its implied fair value.
Accounting standards require management to estimate the fair value of each reporting unit in assessing impairment at least annually. As such, the Company engages an independent valuation expert to assist in the computation of the fair value estimates of each reporting unit as part of its annual assessment. This assessment utilizes a blend of income and market based valuation methodologies.
The impairment testing process conducted by the Company begins by assigning net assets and goodwill to each reporting unit. The Company then completes the impairment test by comparing the fair value of each reporting unit with the recorded book value of its net assets, with goodwill included in the computation of the carrying amount. If the fair value of a reporting unit exceeds its carrying amount, goodwill of that reporting unit is not considered impaired. If the carrying amount of a reporting unit exceeds its fair value, an impairment loss is recognized in an amount equal to that excess.
The computation of the fair value estimate is based upon management’s estimates and assumptions. Although management has used the estimates and assumptions it believes to be most appropriate in the circumstances, it should be noted that even relatively minor changes in certain valuation assumptions used in management’s calculation could result in differences in the results of the impairment test. See “Goodwill” in this Management’s Discussion and Analysis of Financial Condition and Results of Operations and see Note 7, Goodwill, in the Notes to the Consolidated Financial Statements for a detailed discussion of the impairment testing process.
Recently Issued Accounting Standards Not Yet Adopted
Credit Losses
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses, which introduces new guidance for the accounting for credit losses on instruments within its scope. The new approach changes the impairment model for most financial assets, and will require the use of an “expected credit loss” model for financial instruments measured at amortized cost and certain other instruments. This model applies to receivables, loans, debt securities, and off-balance sheet credit exposures. This model requires entities to estimate the lifetime expected credit loss on such instruments and record an allowance that represents the portion of the amortized cost basis that the entity does not expect to collect. This allowance is deducted from the financial asset’s amortized cost basis to present the net amount expected to be collected. The new expected credit loss model will also apply to purchased financial assets with credit deterioration, superseding current accounting guidance for such assets.
The amended guidance also amends the impairment model for available-for-sale debt securities, requiring entities to determine whether all or a portion of the unrealized loss on such securities is a credit loss, and also eliminating the option for management to consider the length of time a security has been in an unrealized loss position as a factor in concluding whether or not a credit loss exists. The amended model states that an entity will recognize an allowance for credit losses on available-for-sale debt securities, instead of a direct reduction of the amortized cost basis of the investment, as required under current guidance. As a result, entities will recognize improvements to estimated credit losses on available-for-sale debt securities immediately in earnings as opposed to in interest income over time. There are also additional disclosure requirements included in this guidance.
In November 2018, the FASB issued ASU 2018-19 and in April, May and November 2019, the FASB issued ASU 2019-04, ASU 2019-05, and ASU 2019-11 respectively, which made minor clarifications to the guidance in ASU 2016-13. The FASB has also established a Transition Resource Group for Credit Losses to evaluate implementation issues arising from the amended guidance and make recommendations to the FASB on which issues may warrant the issuance of additional clarifying guidance.
The amendments in this ASU are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2019. Early application of this ASU is permitted. The Company will adopt this standard on January 1, 2020. Adoption will be applied on a modified retrospective basis with the cumulative effect of initially applying the amendments recognized in retained earnings at the date of initial application. However, certain provisions of the guidance are only required to be applied on a prospective basis.
The Company’s implementation process includes data sourcing and validation, loss model development, development of governance processes, development of a qualitative framework, documentation and governance surrounding economic forecast for credit loss purposes, evaluation of technical accounting topics, updates to allowance policies and methodology documentation, development of reporting processes and related internal controls, and overall operational readiness for adoption of the amended guidance, including parallel runs alongside the Company’s current allowance process.
The Company provides updates to senior management and the Audit Committee. These communications provide an update on the status of the implementation project plan and any identified risks.
The Company currently expects the allowance for credit losses to increase by 15-25% upon adoption given that the allowance will be required to cover the expected life of the loan portfolio upon adoption. The expected increase in the allowance for loan losses is largely attributable to the consumer portfolio, given the longer asset duration associated with many of these products. The expected impact is based on loan exposure balances and the Company’s internally developed macroeconomic forecast which projects a relatively stable macroeconomic environment over a four-year reasonable and supportable forecast period. After the forecast period, the Company reverts to longer historical loss experience, adjusted for prepayments, to estimate losses over the remaining life. The extent of this impact is still being evaluated and is subject to change based on continuing review of models and assumptions, refinement of the qualitative framework, resulting analytics, assumptions, methodologies and judgments that are continuing through the first quarter of 2020.
The amended guidance in this ASU eliminates the current accounting model for purchased-credit-impaired loans, but requires an allowance to be recognized for purchased-credit-deteriorated assets (those that have experienced more-than-insignificant deterioration in credit quality since origination). The Company will have no impact from purchased-credit-deteriorated assets upon adoption. Upon adoption, the Company does not expect to record a material allowance with respect to HTM and AFS securities as the portfolios consist primarily of agency-backed securities that inherently have minimal nonpayment risk.
The impact of adoption of this ASU will be reflected as an adjustment to beginning retained earnings, net of income taxes. Federal banking regulatory agencies have provided relief for initial regulatory capital decreases at adoption by allowing the impact to be phased-in over a a three-year period with the impact of adoption completely recognized by the beginning of the fourth year.
Fair Value Measurements
In August 2018, the FASB issued ASU 2018-13, Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurements. The amendments in this ASU modify the disclosure requirements for fair value measurements in Topic 820, Fair Value Measurements. This ASU is effective for fiscal years beginning after December 15, 2019, and for interim periods within those fiscal years. Early adoption is permitted. The Company does not expect the adoption of this standard to have a significant impact on its fair value disclosures.
Internal-Use Software
In August 2018, the FASB issued ASU 2018-15, Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That is a Service Contract. The amendments in this ASU align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software and hosting arrangements that include an internal-use software license. This ASU is effective for fiscal years beginning after December 15, 2019, and for interim periods within those fiscal years. Early adoption is permitted. The adoption of this standard will not have a material impact on the financial condition or results of operation of the Company.
Income Taxes
In December 2019, the FASB issued ASU 2019-12, Simplifying the Accounting for Income Taxes. The amendments in this ASU simplify the accounting for income taxes. This ASU is effective for fiscal years beginning after December 15, 2020, and for interim periods within those fiscal years. Early adoption is permitted. The Company is currently assessing the impact that the adoption of this standard will have on the financial condition and results of operations of the Company.
Analysis of Results of Operations
Consolidated net income attributable to the Company totaled $151.1 million, $761.4 million, and $458.8 million for 2019, 2018 and 2017, respectively. The Company's 2019 results reflected higher noninterest expense as a result of a $470 million goodwill impairment charge and higher provision for loan losses.
Net Interest Income and Net Interest Margin
Net interest income is the principal component of the Company’s income stream and represents the difference, or spread, between interest and fee income generated from earning assets and the interest expense paid on deposits and borrowed funds. Fluctuations in interest rates as well as changes in the volume and mix of earning assets and interest bearing liabilities can impact net interest income. The following discussion of net interest income is presented on a fully taxable equivalent basis, unless otherwise noted, to facilitate performance comparisons among various taxable and tax-exempt assets.
2019 compared to 2018
Net interest income totaled $2.6 billion in both 2019 and 2018. Net interest income on a fully taxable equivalent basis totaled $2.7 billion in both 2019 and 2018.
Net interest margin was 3.17% in 2019 compared to 3.30% in 2018. The 13 basis point decrease in net interest margin was primarily driven by higher funding costs.
The fully taxable equivalent yield for 2019 for the loan portfolio was 4.89% compared to 4.64% for the prior year. The 25 basis point increase was primarily driven by the impact of higher interest rates during the first half of 2019 as the Federal Reserve Board did not begin lowering benchmark rates until July 2019.
The fully taxable equivalent yield on the total investment securities portfolio was 2.30% for 2019, compared to 2.12% for the prior year. The 18 basis point increase was a result of higher interest rates partially offset by higher levels of premium amortization as actual and expected prepayments have increased.
The average rate paid on interest bearing deposits was 1.49% for 2019 compared to 1.06% for 2018 and reflects the impact of higher funding costs on interest bearing deposit offerings including savings and money market products.
The average rate on FHLB and other borrowings during 2019 was 3.43% compared to 3.18% for the prior year. The 25 basis point increase was primarily driven by the impact of the $600 million issuance of unsecured senior notes in August 2019 as well as the impact of the $1.2 billion issuance of unsecured senior notes in June 2018 .
2018 compared to 2017
Net interest income totaled $2.6 billion and $2.3 billion in 2018 and 2017, respectively. Net interest income on a fully taxable equivalent basis totaled $2.7 billion and $2.4 billion in 2018 and 2017, respectively. The increase in net interest income was primarily the result of an increase in interest income on loans and investment securities partially offset by an increase in interest expense on interest bearing deposits.
Net interest margin was 3.30% in 2018 compared to 3.10% in 2017. The 20 basis point increase in net interest margin was primarily driven by the impact of higher interest rates.
The fully taxable equivalent yield for 2018 for the loan portfolio was 4.64% compared to 4.17% for the prior year. The 47 basis point increase was primarily driven by the impact of higher interest rates.
The fully taxable equivalent yield on the total investment securities portfolio was 2.12% for 2018, compared to 1.95% for the prior year. The 17 basis point increase was a result of increases in interest rates. Additionally, as interest rates have increased the amount of premium amortization required has decreased as actual and expected prepayments have decreased.
The yield on other earning assets for 2018 was 2.16% compared to 1.85% for the prior year. The 31 basis point increase between years was primarily due to the impact of higher interest rates.
The average rate paid on interest bearing deposits was 1.06% for 2018 compared to 0.66% for 2017 and reflects the impact of higher interest rates offered on savings and money market products.
The average rate on FHLB and other borrowings during 2018 was 3.18% compared to 2.36% for the prior year. The 82 basis point increase was primarily driven by the impact of higher rate FHLB advances as well as the impact of the $750 million issuance of unsecured senior notes in June 2017 and the $1.2 billion issuance of unsecured senior notes in June 2018.
The following tables set forth the major components of net interest income and the related annualized yields and rates, as well as the variances between the periods caused by changes in interest rates versus changes in volumes.
(1)
Loans include loans held for sale and nonaccrual loans.
(2)
Interest income includes loan fees for rate calculation purposes.
(3)
Yields are stated on a fully taxable equivalent basis assuming the tax rate in effect for each period presented.
(4)
Includes federal funds sold, securities purchased under agreements to resell, interest bearing deposits, interest bearing deposits with the Federal Reserve and other earning assets.
(5)
Yield/rate reflects impact of balance sheet offsetting. See Note 14, Securities Financing Activities.
(1)
The change in interest not solely due to volume or yield/rate is allocated to the volume column and yield/rate column in proportion to their relationship of the absolute dollar amounts of the change in each.
(2)
Includes federal funds sold, securities purchased under agreement to resell, interest bearing deposits, interest bearing deposits with the Federal Reserve and other earning assets.
Provision for Loan Losses
The provision for loan losses is the charge to earnings that management determines to be necessary to maintain the allowance for loan losses at a sufficient level reflecting management's estimate of probable incurred losses in the loan portfolio.
2019 compared to 2018
Provision for loan losses was $597.4 million for 2019 compared to $365.4 million for 2018. The increase in provision for loan losses in 2019 was primarily attributable to higher losses within the consumer direct loan portfolio as well as an increase in the allowance on individually evaluated nonperforming loans in the commercial, financial and agricultural loan portfolio.
The Company recorded net charge-offs of $561.7 million during 2019 compared to $322.9 million during 2018. The increase was due to an $86.7 million increase in commercial, financial, and agricultural net charge-offs as well as a $110.6 million increase in consumer direct net charge-offs, a $22.7 million increase in credit card net charge-offs, and a $14.5 million increase in consumer indirect net charge-offs.
Net charge-offs were 0.88% of average loans for 2019 compared to 0.51% of average loans for 2018.
2018 compared to 2017
Provision for loan losses was $365.4 million for 2018 compared to $287.7 million of provision for loan losses for 2017. The increase in provision for loan losses for 2018 was primarily impacted by growth in the consumer direct loan portfolio, as well as higher losses in the consumer direct loan portfolio. Partially offsetting these was a decrease in the allowance for loan losses related to the estimated impact of Hurricanes Harvey and Irma on the loan portfolio.
At December 31, 2018, there was no remaining allowance for loan losses related to the Hurricanes Harvey and Irma impacted loan portfolio compared to $45 million at December 31, 2017 based upon management's best estimate of the probable incurred losses resulting from these hurricanes.
The Company recorded net charge-offs of $322.9 million during 2018 compared to $283.2 million during 2017. The increase in net charge-offs was due to a $51.0 million increase in consumer direct net charge-offs and a $14.2 million increase in consumer indirect net charge-offs primarily related to the growth in those portfolios as well as the further seasoning of newly established consumer direct portfolio product offerings. Partially offsetting these increases was a $15.8 million decrease in commercial, financial, and agricultural net charge-offs primarily due to a decrease in charge-offs related to energy loans and an $8.9 million decrease in commercial real estate - mortgage net charge-offs.
Net charge-offs were 0.51% of average loans for 2018 compared to 0.47% of average loans for 2017. Consumer direct and indirect net charge-offs were 5.73% and 2.41% of average consumer direct and indirect loans, respectively, for 2018 compared to 4.90% and 2.28% of average consumer direct and indirect loans, respectively, for 2017.
For further discussion and analysis of the allowance for loan losses, refer to the discussion of lending activities found later in this section. Also, refer to Note 3, Loans and Allowance for Loan Losses, in the Notes to the Consolidated Financial Statements for additional disclosures.
Noninterest Income
The following table presents the components of noninterest income.
2019 compared to 2018
Noninterest income was $1.1 billion for both 2019 and 2018, a slight increase of $79.0 million. The increase in total noninterest income was driven by increases in service charges on deposit accounts, card and merchant processing fees, money transfer income, investment banking and advisory fees, investment securities gains, and other noninterest income which were partially offset by a decrease in corporate and correspondent investment sales.
Service charges on deposit accounts represent the Company's largest category of noninterest revenue. Service charges on deposit accounts were $250.4 million in 2019, compared to $236.7 million in 2018 due to continued customer account growth in 2019 when compared to 2018.
Card and merchant processing fees represent income related to customers’ utilization of their debit and credit cards, as well as interchange income and merchants’ discounts. Card and merchant processing fees were $197.5 million in 2019, an increase of $22.6 million compared to 2018. Growth in the number of accounts as well as an increase in current customers' spending volumes contributed to the increase in interchange income.
Investment services sales fees is comprised of mutual fund and annuity sales income and insurance sales fees. Income from investment services sales fees was $115.4 million in 2019, compared to $112.7 million in 2018.
Money transfer income represents income from the Parent's wholly owned subsidiary, BBVA Transfer Holdings, Inc., which engages in money transfer services, including money transmission and foreign exchange services. Income from money transfer services increased to $99.1 million in 2019 compared to $91.7 million in 2018, driven by an increase in transaction volumes during the year.
Investment banking and advisory fees primarily represent income from BSI. Income from investment banking and advisory fees increased to $83.7 million in 2019 compared to $77.7 million in 2018 primarily driven by an increase in the volume of underwriting activity.
Asset management fees are generated from money management transactions executed with the Company through trusts, higher net worth customers and other long-term clients. Asset management fees increased to $45.6 million in 2019, compared to $43.8 million in 2018.
Corporate and correspondent investment sales represents income generated through the sales of interest rate protection contracts to corporate customers and the sale of bonds and other services to the Company's correspondent banking clients. Income from corporate and correspondent investment sales decreased to $38.6 million in 2019 from $51.7 million in 2018. The primary drivers of the decrease were a decrease in interest rate contract sales driven by less demand as interest rates have declined in 2019 as well as valuation adjustments on interest rate contracts.
Mortgage banking income for 2019 was $28.1 million compared to $26.8 million in 2018. Mortgage banking income is comprised of servicing income, guarantee fees and gains on sales of mortgage loans as well as fair value adjustments on mortgage loans held for sale, mortgage related derivatives and MSRs.
BOLI represents income generated by the underlying investments maintained within each of the Company’s life insurance policies on certain key executives and employees. BOLI was $17.5 million in 2019 compared to $17.8 million in 2018.
Investment securities gains, net increased to $30.0 million in 2019 compared to none in 2018. See “-Investment Securities” for more information related to the investment securities sales.
Other income is comprised of income recognized that does not typically fit into one of the other noninterest income categories and includes primarily various fees associated with letters of credit, syndication, ATMs, and foreign exchange fees. The gain (loss) associated with the sale of fixed assets is also included in other income. For 2019, other income increased by $7.0 million due in part to a $17.9 million increase in the value of the SBIC investments, and a $7.9 million increase in syndication fees partially offset by a $21.0 million decrease in service and referral income with BBVA and its affiliates.
2018 compared to 2017
Noninterest income was $1.1 billion for 2018, a slight increase of $10.9 million compared to $1.0 billion reported in 2017. The increase in total noninterest income was driven by increases in service charges on deposit accounts, card and merchant processing fees, corporate and correspondent investment sales and mortgage banking income which were partially offset by decreases in money transfer income, investment banking and advisory fees, and investment securities gains.
Service charges on deposit accounts were $236.7 million in 2018, compared to $222.1 million in 2017, driven by an increase in demand deposit accounts during 2018.
Card and merchant processing fees were $174.9 million in 2018, an increase of $46.8 million compared to 2017. Growth in the number of accounts accounted for $14.6 million of the increase in interchange income. Additionally, effective January 1, 2018, the Company began recording certain interchange income, previously recorded within other income, in card and merchant processing fees. This change resulted in a $28.1 million increase for 2018.
Income from investment services sales fees was $112.7 million in 2018, compared to $109.2 million in 2017.
Income from money transfer services decreased to $91.7 million in 2018 compared to $101.5 million in 2017 driven by a decrease in transaction volumes during the year.
Income from investment banking and advisory fees decreased to $77.7 million in 2018 compared to $103.7 million in 2017 primarily driven by a decrease in the volume of underwriting.
Income from corporate and correspondent investment sales increased to $51.7 million in 2018 from $38.1 million in 2017. The primary drivers of the increase include approximately $6.5 million increase in interest rate contract income, a $5.8 million increase in foreign exchange income and a $1.4 million increase in bond trading.
Asset management fees increased to $43.8 million in 2018, compared to $40.5 million in 2017.
Mortgage banking income for the year ended December 31, 2018 was $26.8 million compared to $14.4 million in 2017. Mortgage banking income in 2018 included $33.7 million of origination fees and gains on sales of mortgage loans partially offset by losses of $6.7 million related to fair value adjustments on mortgage loans held for sale, mortgage related derivatives and MSRs. Mortgage banking income in 2017 included $25.0 million of origination fees and gains on sales of mortgage loans and losses of $10.2 million related to fair value adjustments on mortgage loans held for sale, mortgage related derivatives and MSRs. The increase in mortgage banking income in 2018 compared to 2017 was driven in part by an increase in the valuation related to the MSRs due to rising interest rates. Additionally, effective January 1, 2018, the Company began recording servicing income and guarantee fees in this caption which were previously recorded in other noninterest income. This change increased mortgage banking income by $11.2 million for 2018.
BOLI was $17.8 million in 2018 compared to $17.1 million in 2017.
There were no investment securities gains in 2018 compared to $3.0 million in 2017. See “-Investment Securities” for more information related to the investment securities sales.
For 2018, other income decreased by $45.1 million due in part to a $25.5 million decrease in servicing fees, that effective January 1, 2018, are recorded in mortgage banking income. Interchange fees also decreased by $22.0 million as certain interchange fees are now recorded in card and merchant processing fees beginning January 1, 2018.
Noninterest Expense
The following table presents the components of noninterest expense.
2019 compared to 2018
Noninterest expense was $2.9 billion for 2019, an increase of $516.1 million compared to $2.3 billion reported in 2018. The increase in noninterest expense was primarily attributable to increases in salaries, benefits and commissions, professional services, money transfer expense, marketing, goodwill impairment, and other noninterest expense which were partially offset by decreases in FDIC insurance and communications.
Salaries, benefits and commissions expense is comprised of salaries and wages in addition to other employee benefit costs and represents the largest components of noninterest expense. Salaries, benefits and commissions expense was $1.2 billion in 2019, an increase of $27.1 million when compared to 2018. The increase was largely attributable to increases in full time salaries due to annual merit increases as well as an increase in incentive expenses.
Professional services expense represents fees incurred for the various support functions, which includes legal, consulting, outsourcing and other professional related fees. Professional services expense increased by $15.8 million in 2019 to $292.9 million compared to 2018 due to an $8.0 million increase in outsourcing and professional services paid to BBVA, a $3.4 million increase in bankcard fees, and a $3.3 million increase in services related to credit reporting.
Money transfer expense represents expense from the Parent's wholly owned subsidiary, BBVA Transfer Holdings, Inc., which engages in money transfer services, including money transmission and foreign exchange services. Money transfer expense increased to $68.2 million in 2019 compared to $62.1 million in 2018 driven by an increase in transaction volumes during the year.
Marketing increased $6.3 million to $55.2 million in 2019 compared to $48.9 million in 2018. Approximately $2.1 million of the increase was related to rebranding costs incurred as a result of the global rebranding strategy. The increase was also driven by higher costs associated with digital sales initiatives and performance media channels.
Communications decreased to $21.8 million in 2019 compared to $30.6 million in 2018. The primary driver of the decrease was due to a change in telecommunication services providers.
FDIC insurance was $27.7 million in 2019 compared to $67.6 million in 2018. The primary driver of the decrease was the elimination of the Large Bank FDIC surcharge which resulted in approximately $31.3 million less expense in 2019.
Goodwill impairment related to the Corporate and Investment Banking reporting unit was $470.0 million in 2019 compared to no goodwill impairment in 2018. Refer to "-Goodwill" and Note 7, Goodwill in the Notes to the Consolidated Financial Statements for further details.
Other noninterest expense represents postage, supplies, subscriptions, provision for unfunded commitments and gains and losses on the sales and write-downs of OREO as well as other OREO associated expenses. Other noninterest expense increased in 2019 to $324.8 million compared to $278.9 million in 2018. The increase was primarily attributable to an $18.6 million increase in provision for unfunded commitments as well as a $16.3 million increase in fraud related charges.
2018 compared to 2017
Noninterest expense was $2.3 billion for both 2018 and 2017, an increase of $38.4 million compared to 2017. The increase in noninterest expense was primarily attributable to increases in salaries, benefits and commissions, professional services and communications expense which were partially offset by decreases in amortization of intangibles and other noninterest expense.
Salaries, benefits and commissions expense was $1.2 billion in 2018, an increase of $22.8 million when compared to 2017. The increase was largely attributable to increases in full time salaries due to annual merit increases.
Professional services expense increased by $13.7 million in 2018 to $277.2 million compared to 2017 due primarily to an increase of approximately $13.3 million of contractor services.
FDIC insurance was $67.6 million in 2018 compared to $64.9 million in 2017.
Money transfer expense decreased to $62.1 million in 2018 compared to $65.8 million in 2017 driven by a decrease in transaction volumes during the year.
Amortization of intangibles decreased by $5.0 million to $5.1 million in 2018 due to the intangible assets being fully amortized in 2018 compared to 2017.
Other noninterest expense decreased in 2018 to $278.9 million compared to $287.7 million in 2017. The decrease was due in part to a $27.1 million decrease in legal reserves and a $23.9 million decrease in provision for unfunded commitments and letters of credit. Partially offsetting the decrease was an increase of $31.3 million in business development expense, a $9.3 million increase related to item processing and a $2.3 million increase in other pension expense due to the adoption of ASU 2017-07 beginning in January 2018.
Income Tax Expense
The Company’s income tax expense totaled $126.0 million, $184.7 million and $316.1 million for 2019, 2018, and 2017, respectively. The effective tax rate was 45.1%, 19.5%, and 40.7% for 2019, 2018 and 2017, respectively.
The increase in the effective tax rate for 2019 compared to 2018 was primarily driven by lower net income combined with an unfavorable permanent difference related to goodwill impairment.
The decrease in the effective tax rate in 2018 compared to 2017 was primarily driven by the enactment of the Tax Cuts and Jobs Act which reduced the corporate tax rate from 35% to 21% effective January 1, 2018. The tax rate for 2018 was also impacted by $11.4 million of additional income tax expense related to the correction of an error in prior periods that resulted from an incorrect calculation of the proportional amortization of the Company's Low Income Housing Tax Credit investments.
Refer to Note 18, Income Taxes, in the Notes to the Consolidated Financial Statements for a reconciliation of the effective tax rate to the statutory tax rate and a discussion of uncertain tax positions and other tax matters.
Analysis of Financial Condition
A review of the Company’s major balance sheet categories is presented below.
Federal Funds Sold, Securities Purchased Under Agreements to Resell and Interest Bearing Deposits
Federal funds sold, securities purchased under agreements to resell and interest bearing deposits totaled $5.8 billion at December 31, 2019, compared to $2.1 billion December 31, 2018. The increase was primarily driven by a $3.5 billion increase in interest bearing deposits with the Federal Reserve.
Trading Account Assets
The following table details the composition of the Company’s trading account assets.
Trading account assets increased $236 million to $474 million at December 31, 2019. The increase in trading account assets primarily related to increases in interest rate derivative contracts and in U.S. Treasury securities.
Debt Securities
The composition of the Company’s debt securities portfolio reflects the Company’s investment strategy of maximizing portfolio yields commensurate with risk and liquidity considerations. The primary objectives of the Company’s investment strategy are to maintain an appropriate level of liquidity and provide a tool to assist in controlling the Company’s interest rate sensitivity position while at the same time producing adequate levels of interest income. The Company’s debt securities are classified into one of three categories based upon management’s intent to hold the debt securities: (i) debt securities available for sale, (ii) debt securities held to maturity or (iii) trading account assets and liabilities.
For additional financial information regarding the Company’s debt securities, see Note 2, Debt Securities Available for Sale and Debt Securities Held to Maturity, in the Notes to the Consolidated Financial Statements.
The following table reflects the carrying amount of the debt securities portfolio at the end of each of the last three years.
(1)
Represents private placement transactions underwritten as loans but meeting the definition of a security within ASC Topic 320, Investments - Debt Securities, at origination.
As of December 31, 2019, the securities portfolio included $7.2 billion in available for sale debt securities and $6.8 billion in held to maturity debt securities. Approximately 96% of the total debt securities portfolio was backed by government agencies or government-sponsored entities.
During 2019 and 2017, the Company received proceeds of $2.4 billion and $210.9 million, respectively, related to the sale of U.S. Treasury securities and agency mortgage-backed securities classified as available for sale which resulted in net gains of $30.0 million and $3.0 million, respectively. There were no sales of debt securities during 2018.
The Company also purchased approximately $4.4 billion, $1.2 billion and $6.2 million of U.S. Treasury securities, agency collateralized mortgage obligations and states and political subdivision securities classified as held to maturity during 2019, 2018 and 2017, respectively.
The Company recognized $215 thousand in OTTI charges in 2019 compared to $592 thousand and $242 thousand in 2018 and 2017, respectively. While all securities are reviewed by the Company for OTTI, the debt securities primarily impacted by credit impairment are held to maturity non-agency collateralized mortgage obligations. Refer to Note 2,
Debt Securities Available for Sale and Debt Securities Held to Maturity, in the Notes to the Consolidated Financial Statements for further details.
The maturities and weighted average yields of the debt securities available for sale and the debt securities held to maturity portfolios at December 31, 2019 are presented in the following table. Maturity data is calculated based on the next re-pricing date for debt securities with variable rates and remaining contractual maturity for securities with fixed rates. For other mortgage-backed securities excluding pass-through securities, the maturity was calculated using weighted average life. Taxable equivalent adjustments, using a 21 percent tax rate, have been made in calculating yields on tax-exempt obligations.
Lending Activities
The Company groups its loans into portfolio segments based on internal classifications reflecting the manner in which the allowance for loan losses is established and how credit risk is measured, monitored and reported. Commercial loans are comprised of commercial, financial and agricultural, real estate-construction, and commercial real estate-mortgage loans. Consumer loans are comprised of residential real-estate mortgage, equity lines of credit, equity loans, credit cards, consumer direct and consumer indirect loans.
The Company also had a portfolio of covered loans that were acquired in the 2009 FDIC-assisted acquisition of certain assets and liabilities of Guaranty Bank. Covered loans represent loans acquired from the FDIC subject to loss sharing agreements. The loss sharing agreements provide for FDIC loss sharing for five years for commercial loans and 10 years for single family residential loans. The loss sharing agreement for commercial loans expired in the fourth quarter of 2014. In July 2017, the Company terminated the single family residential loss share agreement with the FDIC ahead of the contractual maturity.
The Loan Portfolio table presents the classifications by major category at December 31, 2019, and for each of the preceding four years.
Loans and loans held for sale, net of unearned income, totaled $64.1 billion at December 31, 2019, a decrease of $1.2 billion from December 31, 2018. During 2019, the Company sold to BBVA, S.A. New York Branch approximately $1.1 billion of commercial loans.
See Note 3, Loans and Allowance for Loan Losses, and Note 4, Loan Sales and Servicing, in the Notes to the Consolidated Financial Statements for additional discussion.
The Selected Loan Maturity and Interest Rate Sensitivity table presents maturities of certain loan classifications at December 31, 2019, and an analysis of the rate structure for such loans with maturities greater than one year.
Scheduled repayments in the preceding table are reported in the maturity category in which the payment is due. Determinations of maturities are based upon contract terms.
Asset Quality
Nonperforming assets, which includes nonaccrual loans and loans held for sale, accruing loans 90 days past due, accruing TDRs 90 days past due, foreclosed real estate and other repossessed assets totaled $710 million at December 31, 2019 compared to $840 million at December 31, 2018. The decrease in nonperforming assets was primarily due to a $145 million decrease in nonaccrual loans driven by a $132 million decrease in commercial, financial and agricultural nonaccrual loans. As a percentage of total loans and loans held for sale and foreclosed real estate, nonperforming assets were 1.11% at December 31, 2019 compared with 1.29% at December 31, 2018.
The Company defines potential problem loans as commercial loans rated substandard or doubtful that do not meet the definition of nonaccrual, TDR or 90 days past due and still accruing. See Note 3, Loans and Allowance for Loan Losses, in the Notes to the Consolidated Financial Statements for further information on the Company’s credit grade categories, which are derived from standard regulatory rating definitions. The following table provides a summary of potential problem loans.
The following table summarizes asset quality information for the past five years.
(1)
TDR totals include accruing loans 90 days past due classified as TDR.
Nonperforming assets, which include loans held for sale, are detailed in the following table.
(1)
Excludes loans classified as TDRs
(1)
Nonperforming loans include nonaccrual loans and loans held for sale (including nonaccrual loans classified as TDR), accruing loans 90 days past due and accruing TDRs 90 days past due.
(2)
Nonperforming assets include nonperforming loans, foreclosed real estate and other repossessed assets.
(3)
Nonperforming loans include nonaccrual loans (including nonaccrual loans classified as TDR), accruing loans 90 days past due and accruing TDRs 90 days past due.
The following table provides a rollforward of nonaccrual loans and loans held for sale, excluding covered loans.
Generally, when a loan is placed on nonaccrual status, the Company applies the entire amount of any subsequent payments (including interest) to the outstanding principal balance. Consequently, a substantial portion of the interest received related to nonaccrual loans has been applied to principal. At December 31, 2019, nonaccrual loans and loans held for sale totaled $607 million. During the year ended December 31, 2019, $12.1 million of interest income was recognized on loans and loans held for sale classified as nonaccrual as of December 31, 2019. Under the original terms of the loans, interest income would have been approximately $43.4 million for loans and loans held for sale classified as nonaccrual as of December 31, 2019.
When borrowers are experiencing financial difficulties, the Company may, in order to assist the borrowers in repaying the principal and interest owed to the Company, make certain modifications to the loan agreement. To facilitate this process, a concessionary modification that would not otherwise be considered may be granted resulting in a classification of the loan as a TDR. Within each of the Company’s loan classes, TDRs typically involve modification of the loan interest rate to a below market rate or an extension or deferment of the loan. The financial effects of TDRs are reflected in the components that comprise the allowance for loan losses in either the amount of charge-offs or loan loss provision and period-end allowance levels. All TDRs are considered to be impaired loans. Refer to Note 1, Summary of Significant Accounting Policies, and Note 3, Loans and Allowance for Loan Losses, in the Notes to the Consolidated Financial Statements for additional information.
The following table provides a rollforward of TDR activity, excluding covered loans and loans held for sale.
The Company’s aggregate recorded investment in impaired loans modified through TDRs decreased to $215 million at December 31, 2019 from $311 million at December 31, 2018. Included in these amounts are $98 million at December 31, 2019 and $110 million at December 31, 2018 of accruing TDRs. Accruing TDRs are not considered nonperforming because they are performing in accordance with the restructured terms.
Allowance for Loan Losses
Management’s policy is to maintain the allowance for loan losses at a level sufficient to absorb estimated probable incurred losses in the loan portfolio. Refer to Note 1, Summary of Significant Accounting Policies, and Note 3, Loans and Allowance for Loan Losses, in the Notes to the Consolidated Financial Statements for additional disclosures regarding the allowance for loan losses. The total allowance for loan losses increased to $921 million at December 31, 2019, from $885 million at December 31, 2018. The ratio of the allowance for loan losses to total loans was 1.44% at December 31, 2019 compared 1.36% at December 31, 2018. Nonperforming loans decreased to $678 million at December 31, 2019 from $811 million at December 31, 2018. The allowance attributable to individually impaired loans was $127 million at December 31, 2019 compared to $107 million at December 31, 2018. Loans individually evaluated for impairment may have no allowance recorded if the fair value of the collateral less costs to sell or the present value of the loan's expected future cash flows exceeds the recorded investment of the loans.
Net charge-offs were 0.88% of average loans for 2019 compared to 0.51% of average loans for 2018. The increase in net charge-offs was due to an $86.7 million increase in commercial, financial, and agricultural net charge-offs as well as a $110.6 million increase in consumer direct net charge-offs, a $22.7 million increase in credit card net charge-offs, and a $14.5 million increase in consumer indirect net charge-offs.
When determining the adequacy of the allowance for loan losses, management considers changes in the size and character of the loan portfolio, changes in nonperforming and past due loans, historical loan loss experience, the existing risk of individual loans, concentrations of loans to specific borrowers or industries and current economic conditions. The portion of the allowance that has not been identified by the Company as related to specific loan categories has been allocated to the individual loan categories on a pro rata basis for purposes of the table below.
The following table presents an estimated allocation of the allowance for loan losses. This allocation of the allowance for loan losses is calculated on an approximate basis and is not necessarily indicative of future losses or allocations. The entire amount of the allowance is available to absorb losses occurring in any category of loans.
The following table sets forth information with respect to the Company’s loans, excluding loans held for sale, and the allowance for loan losses.
Concentrations
The following tables provide further details regarding the Company’s commercial, financial and agricultural, commercial real estate, residential real estate and consumer segments as of December 31, 2019 and 2018.
Commercial, Financial and Agricultural
In accordance with the Company's lending policy, each commercial loan undergoes a detailed underwriting process, which incorporates the Company's risk tolerance, credit policy and procedures. In addition, the Company has a graduated approval process which accounts for the quality, loan type and total exposure of the borrower. The Company has also adopted an internal exposure based limit which is based on a variety of risk factors, including but not limited to the borrower's industry.
The commercial, financial and agricultural portfolio segment totaled $24.4 billion at December 31, 2019, compared to $26.6 billion at December 31, 2018. This segment consists primarily of large national and international companies
and small to mid-sized companies. This segment also contains owner occupied commercial real estate loans. Loans in this portfolio are generally underwritten individually and are secured with the assets of the company, and/or the personal guarantees of the business owners. The Company minimizes the risk associated with this segment by various means, including maintaining prudent advance rates, financial covenants, and obtaining personal guarantees from the principals of the company.
The following table provides details related to the commercial, financial, and agricultural segment.
Commercial Real Estate
The commercial real estate portfolio segment includes the commercial real estate and real estate - construction loan portfolios. Commercial real estate loans totaled $13.9 billion at December 31, 2019, compared to $13.0 billion at December 31, 2018, and real estate - construction loans totaled $2.0 billion at both December 31, 2019 and 2018.
This segment consists primarily of extensions of credit to real estate developers and investors for the financing of land and buildings, whereby the repayment is generated from the sale of the real estate or the income generated by the real estate property. The Company attempts to minimize risk on commercial real estate properties by various means
including requiring collateral values that exceed the loan amount, adequate cash flow to service the debt, and the personal guarantees of principals of the borrowers. In order to minimize risk on the construction portfolio, the Company has established an operations group outside of the lending staff which is responsible for loan disbursements during the construction process.
The following tables present the geographic distribution for the commercial real estate and real estate - construction portfolios.
Residential Real Estate
The residential real estate portfolio includes residential real estate - mortgage loans, equity lines of credit and equity loans. The residential real estate portfolio primarily contains loans to individuals, which are secured by single-family residences. Loans of this type are generally smaller in size than commercial real estate loans and are geographically
dispersed throughout the Company's market areas, with some guaranteed by government agencies or private mortgage insurers. Losses on residential real estate loans depend, to a large degree, on the level of interest rates, the unemployment rate, economic conditions and collateral values.
Residential real estate - mortgage loans totaled $13.5 billion at December 31, 2019 and $13.4 billion at December 31, 2018. Risks associated with residential real estate - mortgage loans are mitigated through rigorous underwriting procedures, collateral values established by independent appraisers and mortgage insurance. In addition, the collateral for this segment is concentrated in the Company's footprint as indicated in the table below.
The following table provides information related to refreshed FICO scores for the Company's residential real estate portfolio.
Equity lines of credit and equity loans totaled $2.8 billion at December 31, 2019 and $3.0 billion at December 31, 2018. Losses in these portfolios generally track overall economic conditions. These loans are underwritten in accordance with the underwriting standards set forth in the Company's policy and procedures. The collateral for this segment is concentrated within the Company's footprint as indicated in the table below.
The following table provides information related to refreshed FICO scores for the Company's equity loans and lines.
Other Consumer
The Company centrally underwrites and sources from the Company's branches or online, credit card loans and other consumer direct loans. Total consumer direct loans at December 31, 2019 were $2.3 billion and $2.6 billion at December 31, 2018. Total credit cards at December 31, 2019 were $1.0 billion and at December 31, 2018 were $818 million.
The Company also operates a consumer finance unit which purchases loan contracts for indirect automobile and other consumer financing. These loans are centrally underwritten using underwriting guidelines and industry accepted tools. Total consumer indirect loans were $3.9 billion at December 31, 2019 and $3.8 billion at December 31, 2018.
The following tables provide information related to refreshed FICO scores for the Company's consumer direct and consumer indirect loans.
Foreign Exposure
As of December 31, 2019, foreign exposure risk did not represent a significant concentration of the Company's total portfolio of loans and was substantially represented by borrowers domiciled in Mexico and foreign borrowers currently residing in the United States.
Goodwill
Goodwill totaled $4.5 billion and $5.0 billion at December 31, 2019 and 2018 and is allocated to each of the Company’s reporting units, the level at which goodwill is tested for impairment on an annual basis or more often if events and circumstances indicate impairment may exist. At December 31, 2019 the goodwill, net of accumulated impairment losses, attributable to each of the Company’s three identified reporting units is as follows: Commercial Banking and Wealth - $2.7 billion, Retail Banking - $1.4 billion, and Corporate and Investment Banking - $426 million.
The Company early adopted ASU 2017-04, Simplifying the Test for Goodwill Impairment, which eliminated step 2 from the two step goodwill impairment test. Accordingly, for the 2019 test, the Company compared the carrying amounts of the reporting units to their respective fair values and recognized an impairment loss in an amount equal to the excess carrying value over fair value by reporting unit, limited to the total amount of goodwill allocated to that reporting unit.
A test of goodwill for impairment consists of comparing the fair value of each reporting unit with its carrying amount, including goodwill. The carrying value of equity for each reporting unit is determined from an allocation based upon risk weighted assets. If the carrying amount of a reporting unit exceeds its fair value, an impairment loss is recognized in an amount equal to that excess.
The estimated fair value of the reporting unit is determined using a blend of both income and market approaches. For the income approach, estimated future cash flows and terminal values are discounted. The Company utilizes a CAPM in order to derive the base discount rate. The inputs to the CAPM include the 20-year risk free rate, 5-year beta for a select peer set, and a market risk premium based on published data. Once the output of the CAPM is determined, a size premium is added (also based on a published source) for each reporting unit.
In estimating future cash flows, a balance sheet as of the test date and a statement of income for the last 12 months of activity for each reporting unit is compiled. From that point, future balance sheets and statements of income are projected based on the inputs. Cash flows are based on future capitalization requirements due to balance sheet growth and anticipated changes in regulatory capital requirements.
The Company uses the guideline public company method and the guideline transaction method as the market approaches. The public company method applies valuation multiples derived from each reporting unit's peer group to tangible book value or earnings and an implied control premium to the respective reporting unit. The control premium is evaluated and compared to similar financial services transactions considering the absolute and relative potential revenue synergies and cost savings. The guideline transaction method applies valuation multiples to a financial metric of the reporting unit based on comparable observed purchase transactions in the financial services industry for the reporting unit, where available.
The Company tested its three identified reporting units with goodwill for impairment as of October 31, 2019. The results of this test indicated $470 million of goodwill impairment related to the Corporate and Investment Banking reporting unit. For the Company's two remaining reporting units, the most recent goodwill impairment test indicated that no goodwill impairment existed at that time. The primary causes of the goodwill impairment in the Corporate and Investment Banking reporting unit were the volatility in the market capitalization of U.S. banks along with revised management projections based on the current economic and industry conditions. These factors resulted in the fair value of the reporting unit being less than the reporting unit's carrying value.
The goodwill impairment charge is a non-cash item which does not have an adverse impact on regulatory capital or liquidity. Refer to "Critical Accounting Policies" in this Management’s Discussion and Analysis of Financial Condition and Results of Operations for further details.
The following table includes the carrying value and fair value of each reporting unit as of October 31, 2019, the date of the most recent annual goodwill impairment test.
The fair values of the reporting units are based upon management’s estimates and assumptions. Although management has used the estimates and assumptions it believes to be most appropriate in the circumstances, it should
be noted that even relatively minor changes in certain valuation assumptions used in management’s calculations would result in significant differences in the results of the impairment tests.
For sensitivity analysis, if the discount rates used in the October 31, 2019 test were increased by 50 basis points the estimated fair values of equity for Commercial Banking and Wealth, Corporate and Investment Banking, and Retail Banking would be $8.7 billion, $1.3 billion, and $4.5 billion, respectively. Commercial Banking and Wealth and Retail Banking's fair values would continue to exceed the book values by approximately $658 million and $187 million, respectively, while Corporate and Investment Banking would indicate an additional impairment of $40 million. If the discount rates used in the test were increased by 100 basis points the estimated fair values of equity for Commercial Banking and Wealth, Corporate and Investment Banking, and Retail Banking would be $8.4 billion, $1.3 billion, and $4.3 billion, respectively. Commercial Banking and Wealth and Retail Banking's fair values would continue to exceed the book values by approximately $348 million and $47 million, respectively while Corporate and Investment Banking would indicate an additional impairment of $80 million. This assumes all other assumptions would remain unchanged in the 2019 calculation.
The sensitivity analysis above is hypothetical and should not be considered to be predictive of future performance. Changes in implied fair value based on adverse changes in assumptions generally cannot be extrapolated because of the relationship of the change in assumption to the change in fair value may not be linear. Also, the effect of an adverse variation in a particular assumption on the implied fair value of goodwill is calculated without changing any other assumption, while in reality changes in one factor may result in changes in another which may magnify or counteract the effect of the change.
Specific factors as of the date of filing of the financial statements that could negatively impact the assumptions used in assessing goodwill for impairment include: disparities in the level of fair value changes in net assets; increases in book values of equity of a reporting unit in excess of the increase in fair value of equity; adverse business trends resulting from litigation and/or regulatory actions; higher loan losses; future increased minimum regulatory capital requirements above current thresholds; and future federal rules and actions of regulators.
Funding Activities
Deposits are the primary source of funds for lending and investing activities and their cost is the largest category of interest expense. The Company also utilizes brokered deposits as a funding source in addition to customer deposits. Scheduled payments, as well as prepayments, and maturities from portfolios of loans and investment securities also provide a stable source of funds. FHLB advances, other secured borrowings, federal funds purchased, securities sold under agreements to repurchase and other short-term borrowed funds, as well as longer-term debt issued through the capital markets, all provide supplemental liquidity sources. The Company’s funding activities are monitored and governed through the Company’s asset/liability management process, which is further discussed in the Market Risk Management section in Management’s Discussion and Analysis of Financial Condition and Results of Operations herein.
At December 31, 2019, the Company's and the Bank's credit ratings were as follows:
(1)
S&P does not provide a rating; therefore, the rating is N/A.
The cost and availability of financing to the Company and the Bank are impacted by its credit ratings. A downgrade to the Company’s or Bank’s credit ratings could affect its ability to access the credit markets and increase its borrowing costs, thereby adversely impacting the Company’s financial condition and liquidity. Key factors in maintaining high credit ratings include a stable and diverse earnings stream, strong credit quality, strong capital ratios and diverse funding sources, in addition to disciplined liquidity monitoring procedures.
A credit rating is not a recommendation to buy, sell or hold securities, and the ratings are subject to revision or withdrawal by the assigning rating agency. Each rating should be evaluated independently of any other rating.
Following is a brief description of the various sources of funds used by the Company.
Deposits
Total deposits increased by $2.8 billion from $72.2 billion at December 31, 2018 to $75.0 billion at December 31, 2019 due primarily to growth in money market accounts, as well as growth in noninterest and interest bearing demand deposits. Marketing efforts were the primary driver of this growth. At December 31, 2019 and 2018, total deposits included $4.7 billion and $9.0 billion, respectively, of brokered deposits.
The following table presents the Company’s average deposits segregated by major category:
For additional information about deposits, see Note 8, Deposits, in the Notes to the Consolidated Financial Statements.
The following table summarizes the remaining maturities of time deposits of $100,000 or more outstanding at December 31, 2019.
Borrowed Funds
In addition to internal deposit generation, the Company also relies on borrowed funds as a supplemental source of funding. Borrowed funds consist of short-term borrowings, FHLB advances, subordinated debentures and other long-term borrowings.
Short-term borrowings are primarily in the form of federal funds purchased, securities sold under agreements to repurchase and other short-term borrowings. The short-term borrowings table presents the distribution of the Company’s short-term borrowed funds and the corresponding weighted average interest rates for each of the last three years. Also provided are the maximum outstanding amounts of borrowings, the average amounts of borrowings and the average interest rates at year-end for the last three years. For additional information regarding the Company’s short-term borrowings, see Note 9, Short-Term Borrowings, in the Notes to the Consolidated Financial Statements.
(1)
Average interest rate does not reflect the impact of balance sheet offsetting. See Note 14 Securities Financing Activities, in the Notes to the Consolidated Financial Statements.
At December 31, 2019, total short-term borrowings totaled $173 million, an increase of $71 million, compared to the ending balance at December 31, 2018. The increase in total short-term borrowings was driven by a $71 million increase in securities sold under agreements to repurchase relating to BSI.
At December 31, 2019 FHLB and other borrowings were $3.7 billion, a decrease of $298 million compared to the ending balance at December 31, 2018.
In August 2019, the Bank issued under its Global Bank Note Program $600 million aggregate principal amount of its 2.50% unsecured senior notes due 2024.
For the year ended December 31, 2019, proceeds received from the FHLB and other borrowings were approximately $4.4 billion and repayments were approximately $4.8 billion.
For a discussion of interest rates and maturities of FHLB and other borrowings, refer to Note 10, FHLB and Other Borrowings, in the Notes to the Consolidated Financial Statements.
Shareholder’s Equity
Total shareholder's equity at December 31, 2019 was $13.4 billion compared to $13.5 billion at December 31, 2018. Shareholder's equity decreased $125.9 million due primarily to the payment of preferred and common dividends totaling $500 million to its sole shareholder, BBVA, offsetting the decrease was $153 million of earnings attributable to shareholder during the period.
Risk Management
In the normal course of business, the Company encounters inherent risk in its business activities. The Company’s risk management approach includes processes for identifying, assessing, managing, monitoring and reporting risks. Management has grouped the risks facing its operations into the following categories: credit risk, structural interest rate, market and liquidity risk, operational risk, strategic and business risk, and reputational risk. Each of these risks is managed through the Company’s ERM program. The ERM program provides the structure and framework to identify, measure, control and manage risk across the organization. ERM is the cornerstone for defining risk tolerance, identifying key risk indicators, managing capital and integrating the Company’s capital planning process with on-going risk assessments and related stress testing for major risks.
The ERM program follows fundamental principles in establishing, executing and maintaining a program to manage overall risks. The Company's Board of Directors is responsible for overseeing the strategic and business plans, the ERM program and framework and the risk tolerance of the Company, approving key risk management policies, overseeing their implementation, and holding executive management accountable for the execution of the ERM program. Under the oversight of the Company's Board of Directors, management is charged with implementing an effective, integrated risk management structure. This incorporates a defined organizational structure, with defined roles and responsibilities for all aspects of risk management and appropriate tools that support the identification, assessment, control and reporting of key risks. Management is also responsible for defining categories of risk pertaining to the operations of the Company and is responsible for defining that the risk management framework adequately covers both measurable as well as non-measurable risk. Management prepares risk policies and procedures that delineate the approach to all aspects of risk management through proper documentation and communication through appropriate channels. These risk management policies and procedures are aligned with the Company’s overall business strategies and support the ongoing improvement of its risk management. Management and employees within each line of business and support units are the first line of defense in the identification, assessment, mitigation, monitoring and reporting of risks taken by the lines of business, consistent with the Company’s risk tolerance, the current regulatory model for these risks and any material failures that may occur. The lines of business and support units also will have additional infrastructure for certain types of risk embedded in the lines. The risk management organization and other control units serve as the second line of defense and the credit quality review and internal audit functions provide the third line of defense.
Some of the more significant processes used to manage and control these and other risks are described in the remainder of this Annual Report on Form 10-K.
Credit Risk
Credit risk is the most significant risk affecting the organization. Credit risk refers to the potential that one party to a financial instrument will cause a financial loss for the other party by failing to discharge an obligation. It can arise from items carried on the balance sheet or in off-balance sheet instruments, customers in the Company’s normal lending
activities, and other counterparties. The general definition of credit risk also includes transfer risk. That is, the risk that a particular counterparty cannot honor an obligation because it cannot obtain the currency in which the debt is denominated.
The Company has established the following general practices to manage credit risk:
•
limiting the amount of credit that may be extended to individual borrowers, or on an aggregate basis to certain industries, products or collateral types;
•
providing tools and policies to promote prudent lending practices;
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developing credit risk underwriting standards, metrics and the continuous monitoring of portfolio performance;
•
assessing, monitoring, and reporting credit risks; and
•
periodically reevaluating the Company’s strategy and overall exposure as economic, market and other relevant conditions change.
The following discussion presents the principal types of lending conducted by the Company and describes the underwriting procedures and overall risk management of the Company’s lending function.
Management Process
The Company assesses and manages credit risk through a series of policies, processes, measurement systems and controls. The lines of business are responsible for credit risk at the operational day-to-day level. Oversight of the lines of business is provided by the Credit Risk Management department and the appropriate credit committees established within the Company.
Credit Risk Management evaluates all loan requests and approves those that meet the Company’s risk tolerance and are in compliance with Company policies and regulatory guidance. Credit Risk Management also provides policy, portfolio, and approval data to management so that there is a common understanding of loan portfolio risk. This is accomplished by developing credit risk underwriting standards, metrics and the ongoing monitoring of portfolio performance and assessing whether risk management practices have been carried out in accordance with the Company’s credit risk strategy and policies. Key metrics, trends and issues related to credit risk are presented to the Risk Committee of the Board of Directors.
The CQR function provides an independent review of the Company’s credit quality. The CQR function reports to the Risk Committee of the Board of Directors. The CQR function is charged with providing the Company's Board of Directors and executive management with independent, objective, and timely assessments of the Company’s portfolio quality, credit policies, and credit risk management process.
Underwriting Approach
The Company’s underwriting approach is designed to define acceptable combinations of specific risk-mitigating features so that the credit relationships are expected to conform to the Company’s risk tolerances. Provided below is a summary of the most significant underwriting criteria used to evaluate new loans and loan renewals.
•
Cashflow and debt service coverage - cash flow adequacy is a condition of creditworthiness, meaning that loans not clearly supported by a borrower’s cash flow should be justified by secondary repayment sources.
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Secondary sources of repayment - alternative repayment sources are a significant risk-mitigating factor as long as they are liquid, can be easily accessed, and provide adequate resources to supplement the primary cash flow source.
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Value of any underlying collateral - loans are often secured by the asset being financed. Because an analysis of the primary and secondary sources of repayment is the most important factor, collateral, unless it is liquid, generally does not justify loans that cannot be serviced by the borrower’s normal cash flows.
•
Overall creditworthiness of the customer, taking into account the customer’s relationships, both past and current, with other lenders - the Company’s success depends on building lasting and mutually beneficial relationships with clients, which involves assessing their financial position and background. Consumer underwriting relies heavily on credit bureau scores and other bureau attributes, as well as on other factors such as ability to pay, guarantors or collateral in the case of secured lending.
•
Level of equity invested in the transactions - in general, borrowers are required to contribute or invest a portion of their own funds prior to any loan advances.
Structural Interest Rate, Market, and Liquidity Risks
Structural interest rate risk arises from the impact on the Company’s banking assets and liabilities due to changes in the interest rate curves in the market, impacting both economic value and net interest income generation. Market risk arises from the movement of market variables that impact the trading book. These variables can include interest rates, foreign exchange rates, and commodity prices, among others. Liquidity risk refers to the risk that an institution's financial condition or overall safety and soundness is adversely affected by an inability to meet its obligations. See the Market Risk Management and Liquidity sections of Management’s Discussion and Analysis of Financial Condition and Results of Operations herein.
Operational Risk
Operational risk refers to the potential loss resulting from inadequate or failed internal processes, people or systems, or from external events. It includes the current and prospective risk to earnings and capital arising from fraud, error, and the inability to deliver products or services, maintain a competitive position or manage information. Included in operational risk are compliance and legal risk. This refers to the possibility of legal or regulatory sanctions and liabilities, financial loss or damage to reputation the Company may suffer as a result of its failure to comply with all applicable laws, regulations, codes of conduct and good practice standards.
Operational risk is managed by the lines of business and supporting units with oversight by the Operational Risk Committees at the line of business and supporting unit level. The Operational Risk Committees are the key element to monitor operational risk events and the implementation of action plans and controls. Summary reports of these committees’ activities and decisions are provided to executive management.
Strategic and Business Risk
Strategic and business risk refers to the potential of lower earnings generation due to reduced operating income that cannot be offset quickly through expense management. The origin can be either company specific or systemic. Management of these risks is a shared responsibility throughout the organization using the following management processes. An annual business planning process occurs where market, competitive and economic factors that could have a negative impact on earnings are addressed with action plans developed to deal with these factors. Additionally, monthly reporting and analysis at a line of business and support unit level is performed and reviewed.
Reputational Risk
Reputational risk normally results as a consequence of events related to other risks previously discussed. Therefore, an adequate management of all the different financial and non-financial risk is critical to mitigate and control reputational risk. Management of this risk also involves brand management, community involvement and internal and external communication.
Market Risk Management
The effective management of market risk is essential to achieving the Company’s strategic financial objectives. As a financial institution, the Company’s most significant market risk exposure is interest rate risk in its balance sheet; however, market risk also includes product liquidity risk, price risk and volatility risk in the Company’s lines of business. The primary objectives of market risk management are to minimize any adverse effect that changes in market risk factors may have on net interest income, and to offset the risk of price changes for certain assets recorded at fair value.
Interest Rate Market Risk
The Company’s net interest income and the fair value of its financial instruments are influenced by changes in the level of interest rates. The Company manages its exposure to fluctuations in interest rates through policies established by its Asset/Liability Committee. The Asset/Liability Committee meets regularly and has responsibility for approving asset/liability management policies, formulating strategies to improve balance sheet positioning and/or earnings and reviewing the interest rate sensitivity of the Company.
Management utilizes an interest rate simulation model to estimate the sensitivity of the Company’s net interest income to changes in interest rates. Such estimates are based upon a number of assumptions for each scenario, including the level of balance sheet growth, deposit repricing characteristics and the rate of prepayments.
The estimated impact on the Company’s net interest income sensitivity over a one-year time horizon at December 31, 2019, is shown in the table below. Such analysis assumes a gradual and sustained parallel shift in interest rates, expectations of balance sheet growth and composition and the Company’s estimate of how interest-bearing transaction accounts would reprice in each scenario using current yield curves at December 31, 2019.
The following table shows the effect that the indicated changes in interest rates would have on EVE. Inherent in this calculation are many assumptions used to project lifetime cash flows for every item on the balance sheet that may or may not be realized, such as deposit decay rates, prepayment speeds and spread assumptions. This measurement only values existing business without consideration for new business or potential management actions.
The Company is also subject to trading risk. The Company utilizes various tools to measure and manage price risk in its trading portfolios. In addition, the Board of Directors of the Company has established certain limits relative to positions and activities. The level of price risk exposure at any given point in time depends on the market environment and expectation of future price and market movements, and will vary from period to period.
Derivatives
The Company uses derivatives primarily to manage economic risks related to commercial loans, mortgage banking operations, long-term debt and other funding sources. The Company also uses derivatives to facilitate transactions on behalf of its clients. As of December 31, 2019, the Company had derivative financial instruments outstanding with notional amounts of $53.8 billion, including $36.5 billion related to derivatives to facilitate transactions on behalf of its clients. The estimated net fair value of open contracts was in a net asset position of $219 million at December 31, 2019. For additional information about derivatives, refer to Note 13, Derivatives and Hedging, in the Notes to the Consolidated Financial Statements.
Liquidity Management
Liquidity is the ability of the Company to convert assets into cash or cash equivalents without significant loss and to raise additional funds by increasing liabilities. Liquidity management involves maintaining the Company’s ability to meet the day-to-day cash flow requirements of its customers, whether they are depositors wishing to withdraw funds or borrowers requiring funds to meet their credit needs. Without proper liquidity management, the Company would not be able to perform the primary function of a financial intermediary and would, therefore, not be able to meet the needs of the customers it serves.
The Company regularly assesses liquidity needs under various scenarios of market conditions, asset growth and changes in credit ratings. The assessment includes liquidity stress testing which measures various sources and uses of funds under the different scenarios. The assessment provides regular monitoring of unused borrowing capacity and available sources of contingent liquidity to prepare for unexpected liquidity needs and to cover unanticipated events that could affect liquidity.
The asset portion of the balance sheet provides liquidity primarily through unencumbered securities available for sale, loan principal and interest payments, maturities and prepayments of investment securities held to maturity and, to a lesser extent, sales of investment securities available for sale and trading account assets. Other short-term investments such as federal funds sold, securities purchased under agreements to resell are additional sources of liquidity due to their short-term maturities.
The liability portion of the balance sheet provides liquidity through various customers’ interest-bearing and noninterest-bearing deposit accounts and through FHLB and other borrowings. Brokered deposits, federal funds purchased, securities sold under agreements to repurchase and other short-term borrowings as well as excess borrowing capacity with the FHLB and access to debt capital markets are additional sources of liquidity and, basically, represent the Company’s incremental borrowing capacity. These sources of liquidity are used as necessary to fund asset growth and meet short-term liquidity needs.
The Company's financing arrangement with the FHLB adds additional flexibility in managing the Company's liquidity position. At December 31, 2019, the Company had unused FHLB borrowing capacity of $5.9 billion.
In addition to the Company’s financial performance and condition, liquidity may be impacted by the Parent’s structure as a holding company that is a separate legal entity from the Bank. The Parent requires cash for various operating needs including payment of dividends to its shareholder, the servicing of debt, and the payment of general corporate expenses. The primary source of liquidity for the Parent is dividends paid by the Bank. Applicable federal and state statutes and regulations impose restrictions on the amount of dividends that may be paid by the Bank. In addition to the formal statutes and regulations, regulatory authorities also consider the adequacy of the Bank’s total capital in relation to its assets, deposits and other such items. Due to the net earnings restrictions on dividend distributions, the Bank was not permitted to pay dividends at December 31, 2019 or December 31, 2018 without regulatory approval. Appropriate limits and guidelines are in place so that the Parent has sufficient cash to meet operating expenses and other commitments without relying on subsidiaries or capital markets for funding.
During 2019, the Parent paid common dividends of $482 million to its sole shareholder, BBVA.
In August 2019, the Bank issued under its Global Bank Note Program $600 million aggregate principal amount of its 2.50% unsecured senior notes due 2024.
At December 31, 2019, the Company's LCR was 145% and was fully compliant with the LCR requirements. However, the Company is no longer subject to the LCR going forward as a result of the Tailoring Rules. It may become subject to the LCR again in the future if the Company becomes a Category IV U.S. IHC under the Tailoring Rules. Please refer to Item 1. Business - Supervision, Regulation and Other Factors - U.S. Liquidity Standards for more information concerning the LCR requirements applicable to the Company.
Management believes that the current sources of liquidity are adequate to meet the Company’s requirements and plans for continued growth. See Note 10, FHLB and Other Borrowings, Note 11, Shareholder's Equity, and Note 15, Commitments, Contingencies and Guarantees, in the Notes to the Consolidated Financial Statements for additional information regarding outstanding balances of sources of liquidity and contractual commitments and obligations.
The following table presents information about the Company’s contractual obligations.
(1)
Amounts do not include associated interest payments.
(2)
For more information, see Note 9, Short-Term Borrowings, in the Notes to the Consolidated Financial Statements.
(3)
Deposits with indeterminable maturity include noninterest bearing demand, savings, interest-bearing demand accounts and money market accounts.
Off Balance Sheet Arrangements
The Company's off balance sheet credit risk includes obligations for loans sold with recourse, unfunded commitments, and letters of credit. Additionally, the Company periodically invests in various limited partnerships that sponsor affordable housing projects. See Note 15, Commitments, Contingencies and Guarantees, in the Notes to the Consolidated Financial Statements for further discussion.
Capital
The Company and the Bank are subject to various regulatory capital requirements administered by federal and state banking regulators. Failure to meet minimum risk-based and leverage capital requirements can subject the Company and the Bank to a series of increasingly restrictive regulatory actions.
The following table sets forth the Company's U.S. Basel III regulatory capital ratios subject to transitional provisions at December 31, 2019 and 2018.
At December 31, 2019, the regulatory capital ratios of the Bank also remain well above current regulatory requirements for banks based on applicable U.S. regulatory capital requirements. The Company continually monitors these ratios to ensure that the Bank exceeds this standard.
Please refer to Item 1. Business - Supervision, Regulation and Other Factors - Capital Requirements and Item 1A. - Risk Factors for more information regarding regulatory capital requirements. Also, see Note 16, Regulatory Capital Requirements and Dividends from Subsidiaries, in the Notes to the Consolidated Financial Statements for further details.
Effects of Inflation
The majority of assets and liabilities of a financial institution are monetary in nature; therefore, a financial institution differs greatly from most commercial and industrial companies, which have significant investments in fixed assets or inventories that are greatly impacted by inflation. However, inflation does have an important impact on the growth of total assets in the banking industry and the resulting need to increase equity capital at higher than normal rates in order to maintain an appropriate equity-to-assets ratio. Inflation also affects other expenses that tend to rise during periods of general inflation.
Management believes the most significant potential impact of inflation on financial results is a direct result of the Company’s ability to manage the impact of changes in interest rates. Management attempts to minimize the impact of interest rate fluctuations on net interest income. However, this goal can be difficult to completely achieve in times of rapidly changing interest rates and is one of many factors considered in determining the Company’s interest rate positioning. The Company is asset sensitive as of December 31, 2019. Refer to Table 34, Net Interest Income Sensitivity, for additional details on the Company’s interest rate sensitivity.
Effects of Deflation
A period of deflation would affect all industries, including financial institutions. Potentially, deflation could lead to lower profits, higher unemployment, lower production and deterioration in overall economic conditions. In addition, deflation could depress economic activity and impair earnings through increasing the value of debt while decreasing the value of collateral for loans. If the economy experienced a severe period of deflation, then it could depress loan demand, impair the ability of borrowers to repay loans and sharply reduce earnings.
Management believes the most significant potential impact of deflation on financial results relates to the Company’s ability to maintain a high amount of capital to cushion against future losses. In addition, the Company can utilize
certain risk management tools to help it maintain its balance sheet strength even if a deflationary scenario were to develop.
Quarterly Financial Results
The accompanying table presents condensed information relating to quarterly periods.
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures about Market Risk
See “Market Risk Management” in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, which is incorporated herein by reference.
Item 8.
Item 8.
Financial Statements and Supplementary Data
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholder and Board of Directors
BBVA USA Bancshares, Inc.:
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of BBVA USA Bancshares, Inc. and subsidiaries (the Company) as of December 31, 2019 and 2018, the related consolidated statements of income, comprehensive income, shareholder’s equity, and cash flows for each of the years in the three-year period ended December 31, 2019, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2019, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 28, 2020 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ KPMG LLP
We have served as the Company’s auditor since 2016.
Birmingham, Alabama
February 28, 2020
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholder and Board of Directors
BBVA USA Bancshares, Inc.:
Opinion on Internal Control Over Financial Reporting
We have audited BBVA USA Bancshares, Inc. and subsidiaries’ (the Company) internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2019 and 2018, the related consolidated statements of income, comprehensive income, shareholder’s equity, and cash flows for each of the years in the three-year period ended December 31, 2019, and the related notes (collectively, the consolidated financial statements), and our report dated February 28, 2020 expressed an unqualified opinion on those consolidated financial statements.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ KPMG LLP
Birmingham, Alabama
February 28, 2020
See accompanying Notes to Consolidated Financial Statements.
See accompanying Notes to Consolidated Financial Statements.
See accompanying Notes to Consolidated Financial Statements.
(1)
Related to the Company's adoption of ASU 2016-02, ASU 2017-12 and ASU 2018-02 on January 1, 2019. See Note 1, Summary of Significant Accounting Policies, for additional information.
See accompanying Notes to Consolidated Financial Statements.
See accompanying Notes to Consolidated Financial Statements.
BBVA USA BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies
Nature of Operations
BBVA USA Bancshares, Inc., headquartered in Houston, Texas, is a wholly owned subsidiary of BBVA.
The Bank, the Company's largest subsidiary, headquartered in Birmingham, Alabama, operates banking centers in Alabama, Arizona, California, Colorado, Florida, New Mexico and Texas. The Bank operates under the brand name BBVA USA, which is a trade name and trademark of BBVA USA Bancshares, Inc.
The Bank performs banking services customary for full service banks of similar size and character. Such services include receiving demand and time deposits, making personal and commercial loans and furnishing personal and commercial checking accounts. The Bank offers, either directly or through its subsidiaries and affiliates, a variety of services, including portfolio management and administration and investment services to estates and trusts; term life insurance, variable annuities, property and casualty insurance and other insurance products; investment advisory services; a variety of investment services and products to institutional and individual investors; discount brokerage services, mutual funds and fixed-rate annuities; and lease financing services.
Basis of Presentation
The accompanying Consolidated Financial Statements include the accounts of the Company and its subsidiaries for the years ended December 31, 2019, 2018 and 2017. All intercompany accounts and transactions and balances have been eliminated in consolidation.
The Company has evaluated subsequent events through the filing date of this Annual Report on Form 10-K, to determine if either recognition or disclosure of significant events or transactions is required.
The accounting policies followed by the Company and its subsidiaries and the methods of applying these policies conform with U.S. GAAP and with practices generally accepted within the banking industry. Certain policies that significantly affect the determination of financial position, results of operations and cash flows are summarized below.
Use of Estimates
The preparation of the Consolidated Financial Statements in conformity with generally accepted accounting principles in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period, the most significant of which relate to the allowance for loan losses and goodwill impairment. Actual results could differ from those estimates.
Correction of Accounting Error
During the year ended December 31, 2018, income tax expense included $11.4 million of income tax expense related to the correction of an error in prior periods that resulted from an incorrect calculation of the proportional amortization of the Company's Low Income Housing Tax Credit investments. This error primarily related to 2017 and was corrected in the second quarter of 2018.
The Company has evaluated the effect of this correction on prior interim and annual periods' consolidated financial statements in accordance with the guidance provided by SEC Staff Accounting Bulletin No. 108, codified as SAB Topic 1.N, Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements, and concluded that no prior annual period is materially misstated. In addition, the Company has considered the effect of this correction on the Company's December 31, 2018 financial results, and concluded that the impact on these periods was not material.
Cash and cash equivalents
The Company classifies cash on hand, amounts due from banks, federal funds sold, securities purchased under agreements to resell and interest bearing deposits as cash and cash equivalents. These instruments have original maturities of three months or less.
Securities Purchased Under Agreements to Resell and Securities Sold Under Agreements to Repurchase
Securities purchased under agreements to resell and securities sold under agreements to repurchase are generally accounted for as collateralized financing transactions and are recorded at the amounts at which the securities were acquired or sold plus accrued interest. The securities pledged or received as collateral are generally U.S. government and federal agency securities. The Company's policy is to take possession of securities purchased under agreements to resell. The fair value of collateral either received from or provided to a third party is continually monitored and adjusted as deemed appropriate.
Securities
The Company classifies its debt securities into one of three categories based upon management’s intent and ability to hold the debt securities: (i) trading account assets and liabilities, (ii) debt securities held to maturity or (iii) debt securities available for sale. Debt securities held in a trading account are required to be reported at fair value, with unrealized gains and losses included in earnings. The Company classifies purchases, sales, and maturities of trading securities held for investment purposes as cash flows from investing activities. Cash flows related to trading securities held for trading purposes are reported as cash flows from operating activities. Debt securities held to maturity are stated at cost adjusted for amortization of premiums and accretion of discounts. The related amortization and accretion is determined by the interest method and is included as a noncash adjustment in the net cash provided by operating activities in the Company’s Consolidated Statements of Cash Flows. The Company has the ability, and it is management’s intention, to hold such securities to maturity. Debt securities available for sale are recorded at fair value. Increases and decreases in the net unrealized gain or loss on the portfolio of debt securities available for sale are reflected as adjustments to the carrying value of the portfolio and as an adjustment, net of tax, to accumulated other comprehensive income. See Note 19, Fair Value Measurements, for information on the determination of fair value.
Interest earned on trading account assets, debt securities available for sale and debt securities held to maturity is included in interest income in the Company’s Consolidated Statements of Income. Net realized gains and losses on the sale of debt securities available for sale, computed principally on the specific identification method, are shown separately in noninterest income in the Company’s Consolidated Statements of Income. Net gains and losses on the sale of trading account assets and liabilities are recognized as a component of other noninterest income in the Company’s Consolidated Statements of Income.
The Company regularly evaluates each held to maturity and available for sale security in an unrealized loss position for OTTI. The Company evaluates for OTTI on a specific identification basis. In its evaluation, the Company considers such factors as the length of time and the extent to which the fair value has been below cost, the financial condition of the issuer, the Company’s intent to hold the security to an expected recovery in fair value and whether it is more likely than not that the Company will have to sell the security before its fair value recovers. The credit loss component of the OTTI on debt and equity securities is recognized in earnings. For debt securities, the portion of OTTI related to all other factors is recognized in other comprehensive income. See Note 2, Debt Securities Available for Sale and Debt Securities Held to Maturity, for details of OTTI.
Loans Held for Sale
Loans held for sale are recorded at either estimated fair value, if the fair value option is elected, or the lower of cost or estimated fair value. The Company applies the fair value option accounting guidance codified under the FASB's ASC Topic 825, Financial Instruments, for single family real estate mortgage loans originated for sale in the secondary market. Under the fair value option, all changes in the applicable loans’ fair value are recorded in earnings. Loans classified as held for sale that were not originated for resale in the secondary market are accounted for under the lower of cost or fair value method and are evaluated on an individual basis.
Loans
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are considered held for investment. Loans are stated at principal outstanding adjusted for charge-offs, deferred loan fees and direct costs on originated loans and unamortized premiums or discounts on purchased loans. Interest income on loans is recognized on the interest method. Loan fees, net of direct costs, and unamortized premiums and discounts are deferred and amortized as an adjustment to the yield of the related loan over the term of the loan and are included as a noncash adjustment in the net cash provided by operating activities in the Company’s Consolidated Statements of Cash Flows. For additional information related to the Company’s loan portfolio by type, refer to Note 3, Loans and Allowance for Loan Losses.
It is the general policy of the Company to stop accruing interest income and apply subsequent interest payments as principal reductions when any commercial, industrial, commercial real estate or construction loan is 90 days or more past due as to principal or interest and/or the ultimate collection of either is in doubt, unless collection of both principal and interest is assured by way of collateralization, guarantees or other security, or the loan is accounted for under ASC Subtopic 310-30. Accrual of interest income on consumer loans, including residential real estate loans, is generally suspended when any payment of principal or interest is more than 90 days delinquent or when foreclosure proceedings have been initiated or repossession of the underlying collateral has occurred. When a loan is placed on a nonaccrual status, any interest previously accrued but not collected is reversed against current interest income unless the fair value of the collateral for the loan is sufficient to cover the accrued interest.
In general, a loan is returned to accrual status when none of its principal and interest is due and unpaid and the Company expects repayments of the remaining contractual principal and interest or when it is determined to be well secured and in the process of collection. Charge-offs on commercial loans are recognized when available information confirms that some or all of the balance is uncollectible. Consumer loans are subject to mandatory charge-off at a specified delinquency date consistent with regulatory guidelines. In general, charge-offs on consumer loans are recognized at the earlier of the month of liquidation or the month the loan becomes 120 days past due; residential loan deficiencies are charged off in the month the loan becomes 180 days past due; and credit card loans are charged off before the end of the month when the loan becomes 180 days past due with the related interest accrued but not collected reversed against current income. The Company determines past due or delinquency status of a loan based on contractual payment terms.
All nonaccrual loans and loans modified in a troubled debt restructuring are considered impaired. The Company’s policy for recognizing interest income on impaired loans classified as nonaccrual is consistent with its nonaccrual policy. The Company’s policy for recognizing interest income on accruing impaired loans is consistent with its interest recognition policy for accruing loans.
Troubled Debt Restructurings
A loan is accounted for as a TDR if the Company, for economic or legal reasons related to the borrower’s financial difficulties, grants a concession to the borrower that it would not otherwise consider. A TDR typically involves a modification of terms such as establishment of a below market interest rate, a reduction in the principal amount of the loan, a reduction of accrued interest or an extension of the maturity date at a stated interest rate lower than the current market rate for a new loan with similar risk. The Company’s policy for measuring impairment on TDRs, including TDRs that have defaulted, is consistent with its impairment measurement process for all impaired loans. The Company’s policy for returning nonaccrual TDRs to accrual status is consistent with its return to accrual policy for all other loans.
Allowance for Loan Losses
The amount of the provision for loan losses charged to income is determined on the basis of numerous factors including actual loss experience, identified loan impairment, current economic conditions and periodic examinations and appraisals of the loan portfolio. Such provisions, less net loan charge-offs, comprise the allowance for loan losses which is deducted from loans and is maintained at a level management considers to be adequate to absorb losses inherent in the portfolio.
The Company monitors the entire loan portfolio in an effort to identify problem loans so that risks in the portfolio can be identified on a timely basis and an appropriate allowance maintained. Loan review procedures, including loan grading, periodic credit rescoring and trend analysis of portfolio performance, are utilized by the Company in order to
ensure that potential problem loans are identified. Management’s involvement continues throughout the process and includes participation in the work-out process and recovery activity. These formalized procedures are monitored internally and by regulatory agencies.
The allowance for loan losses is established as follows:
•
Loans with outstanding balances greater than $1 million that are nonaccrual and all TDRs are evaluated individually with specific reserves allocated based on the present value of the loan’s expected future cash flows, discounted at the loan’s original effective interest rate, except where foreclosure or liquidation is probable or when the primary source of repayment is provided by real estate collateral. In these circumstances, impairment is measured based upon the fair value less cost to sell of the collateral. In addition, in certain rare circumstances, impairment may be based on the loan’s observable fair value.
•
Loans in the remainder of the portfolio, including nonaccrual loans with balances of less than $1 million, are collectively evaluated for impairment.
For commercial loans, the estimate of loss based on pools of loans with similar characteristics is made by applying a PD factor and a LGD factor to each individual loan based on loan grade, using a standardized loan grading system. The PD factor and LGD factor are determined for each loan grade using statistical models based on historical performance data. The PD factor considers on-going reviews of the financial performance of the specific borrower, including cash flow, debt-service coverage ratio, earnings power, debt level and equity position, in conjunction with an assessment of the borrower’s industry and future prospects. The PD factor considers current loan grade unless the account is delinquent over 60 days, in which case a higher PD factor is used. The LGD factor considers analysis of the type of collateral and the relative LTV ratio. These reserve factors are developed based on credit migration models that track historical movements of loans between loan grades over time and long-term average loss experience. The historical time frame currently used for both PDs and LGDs is 10 years.
For consumer loans, except for credit cards, the estimate of loss based on pools of loans with similar characteristics is also made by applying a PD and a LGD factor. The PD factor considers current credit scores unless the account is delinquent over 60 days, in which case a higher PD factor is used. The credit score provides a basis for understanding the borrower’s past and current payment performance. The LGD factor considers analysis of the type of collateral and the relative LTV ratio. Credit scores, models, analyses, and other factors used to determine both the PD and LGD factors are updated frequently to capture the recent behavioral characteristics of the subject portfolios, as well as any changes in loss mitigation or credit origination strategies, and adjustments to the reserve factors are made as required. The historical time frame currently used for both PDs and LGDs is 10 years. The allowance for loan losses for credit cards is estimated based on historical loss experience which uses historical average net charge-off rates.
The Company adjusts the loss estimates described above when it is determined that probable incurred losses may not have been captured in the loss estimates. To adjust the loss estimates, the Company considers qualitative factors such as changes in underwriting practices, the nature and volume of the loan portfolio, collateral values, credit concentrations, and the general economic environment in the Company’s markets.
In order to estimate a reserve for unfunded commitments, the Company uses a process consistent with that used in developing the allowance for loan losses. The Company estimates the future funding of current unfunded commitments based on historical funding experience of these commitments before default. Allowance for loan loss factors, which are based on product and loan grade and are consistent with the factors used for portfolio loans, are applied to these funding estimates to arrive at the reserve balance. This reserve for unfunded commitments is recognized in accrued expenses and other liabilities on the Company’s Consolidated Balance Sheets with changes recognized in other noninterest expense in the Company’s Consolidated Statements of Income.
Premises and Equipment
Premises, furniture, fixtures, equipment, assets under capital leases and leasehold improvements are stated at cost less accumulated depreciation or amortization. Land is stated at cost. In addition, purchased software and costs of computer software developed for internal use are capitalized provided certain criteria are met. Depreciation is computed principally using the straight-line method over the estimated useful lives of the related assets, which ranges between
1 and 40 years. Leasehold improvements are amortized on a straight-line basis over the lesser of the lease terms or the estimated useful lives of the improvements.
Leases
The Company leases certain land, office space, and branches. These leases are generally for periods of 10 to 20 years with various renewal options. The Company, by policy, does not include renewal options for facility leases as part of its right-of-use assets and lease liabilities unless they are deemed reasonably certain to be exercised. Variable lease payments that are dependent on an index or a rate are initially measured using the index or rate at the commencement date and are included in the measurement of lease liability. Variable lease payments that are not dependent on an index or a rate or changes in variable payments based on an index or rate after the commencement date are excluded from the measurement of the lease liability and recognized in profit and loss in accordance with Topic 842. Variable lease payments are defined as payments made for the right to use an asset that vary because of changes in facts or circumstances occurring after the commencement date, other than the passage of time.
The Company has made a policy election to not apply the recognition requirements of ASC 842 to all short-term leases. Instead, the short-term lease payments will be recognized in the income statement on a straight-line basis over the lease term and variable lease payments in the period in which the obligation for those payments is incurred. As a practical expedient, the Company has also made a policy election to not separate nonlease components from lease components and instead account for each separate lease component and the nonlease components associated with that lease component as a single lease component.
The Company determines whether a contract contains a lease based on whether a contract, or a part of a contract, that conveys the right to control the use of an identified asset for a period of time in exchange for consideration. The discount rate is determined as the rate implicit in the lease or when a rate cannot be readily determined, the Company’s incremental borrowing rate. The incremental borrowing rate is the rate of interest that the Company would have to pay to borrow on a collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment.
Bank Owned Life Insurance
The Company maintains life insurance policies on certain of its executives and employees and is the owner and beneficiary of the policies. The Company invests in these policies, known as BOLI, to provide an efficient form of funding for long-term retirement and other employee benefits costs. The Company records these BOLI policies within bank owned life insurance on the Company’s Consolidated Balance Sheets at each policy’s respective cash surrender value, with changes recorded in noninterest income in the Company’s Consolidated Statements of Income.
Goodwill
Goodwill represents the excess of the purchase price over the estimated fair value of identifiable net assets associated with acquisition transactions. Goodwill is assigned to each of the Company’s reporting units and tested for impairment annually as of October 31 or on an interim basis if events or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying value.
If, after considering all relevant events and circumstances, the Company determines it is not more-likely-than-not that the fair value of a reporting unit is less than its carrying amount, then performing an impairment test is not necessary. If the Company elects to bypass the qualitative analysis, or concludes via qualitative analysis that it is more-likely-than-not that the fair value of a reporting unit is less than its carrying value, a goodwill impairment test is performed. If the carrying amount of a reporting unit exceeds its fair value, an impairment loss is recognized in an amount equal to that excess.
The Company has defined its reporting unit structure to include: Commercial Banking and Wealth, Retail Banking, and Corporate and Investment Banking. Each of the defined reporting units was tested for impairment as of October 31, 2019. See Note 7, Goodwill, for a further discussion.
Other Real Estate Owned
Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at the lower of recorded balance of the loan or fair value less costs to sell of the collateral assets at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, OREO is carried at the lower of carrying amount or fair value less costs to sell and is included in other assets on the Consolidated Balance Sheets. Gains and losses on the sales and write-downs on such properties and operating expenses from these OREO properties are included in other noninterest expense in the Company’s Consolidated Statements of Income.
Accounting for Transfers and Servicing of Financial Assets
The Company accounts for transfers of financial assets as sales when control over the transferred assets is surrendered. Control is generally considered to have been surrendered when (1) the transferred assets are legally isolated from the Company, even in bankruptcy or other receivership, (2) the transferee has the right to pledge or exchange the assets with no conditions that constrain the transferee and provide more than a trivial benefit to the Company, and (3) the Company does not maintain the obligation or unilateral ability to reclaim or repurchase the assets. If these sale criteria are met, the transferred assets are removed from the Company's balance sheet and a gain or loss on sale is recognized. If not met, the transfer is recorded as a secured borrowing, and the assets remain on the Company's balance sheet, the proceeds from the transaction are recognized as a liability, and gain or loss on sale is deferred until the sale criterion are achieved.
The Company has one primary class of MSR related to residential real estate mortgages. These mortgage servicing rights are recorded in other assets on the Consolidated Balance Sheets at fair value with changes in fair value recorded as a component of mortgage banking income in the Company’s Consolidated Statements of Income. See Note 4, Loan Sales and Servicing, for a further discussion.
Revenue from Contracts with Customers
The following is a discussion of key revenues within the scope of ASC 606, Revenue from Contracts with Customers:
•
Service charges on deposit accounts - Revenue from service charges on deposit accounts is earned through cash management, wire transfer, and other deposit-related services; as well as overdraft, non-sufficient funds, account management and other deposit-related fees. Revenue is recognized for these services either over time, corresponding with deposit accounts’ monthly cycle, or at a point in time for transactional related services and fees.
•
Card and merchant processing fees - Card and merchant processing fees consists of interchange fees from consumer credit and debit cards processed by card association networks, merchant services, and other card related services. Interchange rates are generally set by the credit card associations and based on purchase volumes and other factors. Interchange fees are recognized as transactions occur. Merchant services income represents account management fees and transaction fees charged to merchants for the processing of card association transactions. Merchant services revenue is recognized as transactions occur, or as services are performed.
•
Investment banking and advisory fees - Investment banking and advisory fees primarily represent revenues earned by the Company for various corporate services including advisory, debt placement and underwriting. Revenues for these services are recorded at a point in time or upon completion of a contractually identified transaction. Underwriting costs are presented gross against underwriting revenues.
•
Money transfer income - Money transfer income represents income from the Parent’s wholly owned subsidiary, BBVA Transfer Holdings, Inc., which engages in money transfer services, including money transmission and foreign exchange services. Money transfer income is recognized as transactions occur.
•
Asset management, retail investment, and commissions fees - Asset management, retail investment, and commissions fees consists of fees generated from money management transactions and treasury management services, along with mutual fund and annuity sales fee income. Revenue from trade execution and brokerage services is earned through commissions from trade execution on behalf of clients. Revenue from these transactions is recognized at the trade date. Any ongoing service fees are recognized on a monthly basis as
services are performed. Trust and asset management services include asset custody and investment management services provided to individual and institutional customers. Revenue is recognized monthly based on a minimum annual fee, and the market value of assets in custody. Additional fees are recognized for transactional activity. Insurance revenue is earned through commissions on insurance sales and earned at a point in time. These revenues are recorded in asset management fees and investment services sales fees within non-interest income in the Company's Consolidated Statements of Income.
Advertising Costs
Advertising costs are generally expensed as incurred and recorded as marketing expense, a component of noninterest expense in the Company’s Consolidated Statements of Income.
Income Taxes
The Company and its eligible subsidiaries file a consolidated federal income tax return. The Company files separate tax returns for subsidiaries that are not eligible to be included in the consolidated federal income tax return. Based on the laws of the respective states where it conducts business operations, the Company either files consolidated, combined or separate tax returns.
Deferred tax assets and liabilities are determined based on temporary differences between financial reporting and tax bases of assets and liabilities and are measured using the tax rates and laws that are expected to be in effect when the differences are anticipated to reverse. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as income or expense in the period the change is incurred. In evaluating the Company's ability to recover its deferred tax assets within the jurisdiction from which they arise, the Company must consider all available evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies, and the results of recent operations. A valuation allowance is recognized for a deferred tax asset, if based on the available evidence, it is more likely than not that some portion or all of a deferred tax asset will not be realized.
On December 22, 2017, the Tax Cuts and Jobs Act was enacted into law. The new legislation included a decrease in the corporate federal income tax rate from 35% to 21% effective January 1, 2018. Under ASC Topic 740, Income Taxes, the effects of the changes in tax rates and laws are recognized in the period in which the new legislation is enacted. In December 2017, the SEC issued SAB 118, which allowed companies to record provisional amounts during a measurement period not to extend beyond one year of the enactment date. The Company completed its analysis within the measurement period in accordance with SAB 118 and adjusted the provisional amounts in 2018 when it filed its federal tax return for the tax year 2017.
The Company recognizes income tax benefits associated with uncertain tax positions, when, in its judgment, it is more likely than not of being sustained on the basis of the technical merits. For a tax position that meets the more-likely-than-not recognition threshold, the Company initially and subsequently measures the tax benefit as the largest amount that the Company judges to have a greater than 50% likelihood of being realized upon ultimate settlement with the taxing authority.
The Company recognizes interest and penalties related to unrecognized tax benefits as a component of other noninterest expense in the Company’s Consolidated Statements of Income. Accrued interest and penalties are included within accrued expenses and other liabilities on the Company’s Consolidated Balance Sheets.
The Company applies the proportional amortization method in accounting for its qualified Low Income Housing Tax Credit investments. This method recognizes the amortization of the investment as a component of income tax expense. At December 31, 2019 and 2018, net Low Income Housing Tax Credit investments were $542 million and $516 million, respectively, and are included in other assets on the Company's Consolidated Balance Sheets.
Noncontrolling Interests
The Company applies the accounting guidance codified in ASC Topic 810, Consolidation, related to the treatment of noncontrolling interests. This guidance requires the amount of consolidated net income attributable to the parent and to the noncontrolling interests be clearly identified and presented on the face of the consolidated financial statements.
The noncontrolling interests attributable to the Company's REIT preferred securities and mezzanine investment fund (see Note 11, Shareholder's Equity, for a discussion of the preferred securities) are reported within shareholder’s equity, separately from the equity attributable to the Company’s shareholder. The dividends paid to the REIT preferred shareholders and other mezzanine investment fund investors are reported as reductions in shareholder’s equity in the Consolidated Statements of Shareholder’s Equity, separately from changes in the equity attributable to the Company’s shareholder.
Accounting for Derivatives and Hedging Activities
A derivative is a financial instrument that derives its cash flows, and therefore its value, by reference to an underlying instrument, index or referenced interest rate. These instruments include interest rate swaps, caps, floors, financial forwards and futures contracts, foreign exchange contracts, options written and purchased. The Company mainly uses derivatives to manage economic risk related to commercial loans, long-term debt and other funding sources. The Company also uses derivatives to facilitate transactions on behalf of its customers.
All derivative instruments are recognized on the Company’s Consolidated Balance Sheets at their fair value. The Company does not offset fair value amounts under master netting agreements. Fair values are estimated using pricing models and current market data. On the date the derivative instrument contract is entered into, the Company designates the derivative as (1) a fair value hedge, (2) a cash flow hedge, or (3) a free-standing derivative. Changes in the fair value of a derivative instrument that is highly effective and that is designated and qualifies as a fair value hedge, along with the loss or gain on the hedged asset or liability that is attributable to the hedged risk (including losses or gains on firm commitments), are recorded in earnings. Changes in the fair value of a derivative instrument that is highly effective and that is designated and qualifies as a cash flow hedge are recorded in accumulated other comprehensive income, until earnings are affected by the variability of cash flows (e.g., when periodic settlements on a variable-rate asset or liability are recorded in earnings). Changes in the fair value of a free-standing derivative and settlements on the instruments are reported in earnings.
The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking various hedge transactions. This process includes linking all derivative instruments that are designated as fair value or cash flow hedges to specific assets and liabilities on the Company’s Consolidated Balance Sheets or to specific firm commitments or forecasted transactions. The Company also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivative instruments that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items.
The Company discontinues hedge accounting prospectively when: (1) it is determined that the derivative instrument is no longer highly effective in offsetting changes in the fair value or cash flows of a hedged item (including firm commitments or forecasted transactions); (2) the derivative instrument expires or is sold, terminated or exercised; (3) the derivative instrument is de-designated as a hedge instrument because it is unlikely that a forecasted transaction will occur; (4) a hedged firm commitment no longer meets the definition of a firm commitment; or (5) management determines that designation of the derivative instrument as a hedge instrument is no longer appropriate.
When hedge accounting is discontinued because it is determined that the derivative instrument no longer qualifies as an effective fair value or cash flow hedge, the derivative instrument continues to be carried on the Company’s Consolidated Balance Sheets at its fair value, with changes in the fair value included in earnings. Additionally, for fair value hedges, the hedged asset or liability is no longer adjusted for changes in fair value and the existing basis adjustment is amortized or accreted as an adjustment to the yield over the remaining life of the asset or liability. For cash flow hedges, when hedge accounting is discontinued, but the hedged cash flows or forecasted transaction are still expected to occur, the unrealized gains and losses that were accumulated in other comprehensive income are recognized in earnings in the same period when the earnings are affected by the hedged cash flows or forecasted transaction. When a cash flow hedge is discontinued, because the hedged cash flows or forecasted transactions are not expected to occur, unrealized gains and losses that were accumulated in other comprehensive income are recognized in earnings immediately.
Recently Adopted Accounting Standards
Leases
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) which supersedes ASC Topic 840, Leases. Subsequently, the FASB issued ASU 2018-01 in January 2018 which provides a practical expedient for land easements and issued ASU 2018-11 in July 2018 which includes an option to recognize a cumulative effect adjustment to retained earnings in the period of adoption instead of applying the guidance to prior comparative periods. This ASU, as amended, requires lessees to recognize right-of-use assets and associated liabilities that arise from leases, with the exception of short-term leases. Subsequent accounting for leases varies depending on whether the lease is classified as an operating lease or a finance lease. This ASU, as amended, does not make significant changes to lessor accounting. There are several new qualitative and quantitative disclosures required. Upon transition, lessees and lessors have the option to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective transition approach or to apply the modified retrospective approach with an additional, optional transition method that initially applies this ASU as of the adoption date and recognizes a cumulative effect adjustment to the opening balance of retained earnings in the period of adoption.
The Company adopted this ASU, as amended, on January 1, 2019 using the optional transition method, which allowed for a modified retrospective method of adoption with a cumulative effect adjustment to retained earnings without restating comparable periods. The Company also elected the transition relief package of practical expedients for which there is no requirement to reassess existence of leases, their classification, and initial direct costs as well as an exemption for short term leases with a term of less than one year. The Company did not elect the practical expedient to use hindsight in determining the lease term and in assessing impairment of right-of-use assets.
At January 1, 2019, the Company recognized right-of-use assets of $290 million and lease liabilities of $332 million. The right-of-use assets and corresponding lease liabilities, recorded upon adoption, were primarily based on the present value of unpaid future minimum lease payments as of January 1, 2019. Those amounts were impacted by assumptions related to renewals and/or extensions of existing lease contracts and the interest rate used to discount those future lease obligations. Additionally, the Company recognized a cumulative effect adjustment of approximately $3.5 million at adoption to increase the beginning balance of retained earnings as of January 1, 2019 for the remaining deferred gains on sale-leaseback transactions which occurred prior to adoption. This ASU will not have a material impact on the timing of expense recognition on the Company's results of operations.
See Note 6, Leases, for the required disclosures in accordance with this ASU.
Premium Amortization on Purchased Callable Debt Securities
In March 2017, the FASB issued ASU 2017-08, Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20), Premium Amortization on Purchased Callable Debt Securities. The amendments in this ASU reduce the amortization period for certain callable debt securities carried at a premium and require the premium to be amortized over a period not to exceed the earliest call date. These amendments do not apply to securities carried at a discount. The Company adopted this ASU on January 1, 2019. The adoption of this standard had no impact on the financial condition or results of operations of the Company.
Derivatives and Hedging
In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815), Targeted Improvements to Accounting for Hedging Activities. The amendments in this ASU better align an entity's risk management activities and financial reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results.
In October 2018, the FASB issued ASU 2018-16, Inclusion of the SOFR OIS Rate as a Benchmark Interest Rate for Hedge Accounting Purposes. The amendments in this ASU permit the OIS rate based on SOFR as a US benchmark interest rate for hedge accounting purposes under Topic 815.
The Company adopted these ASUs on January 1, 2019. The adoption of these standards did not have a material impact on the financial condition or results of operations of the Company. The adoption resulted in an immaterial
cumulative effect adjustment to the opening balance of retained earnings. For additional information on the Company’s derivative and hedging activities, see Note 13, Derivatives and Hedging.
Comprehensive Income
In February 2018, the FASB issued ASU 2018-02, Income Statement - Reporting Comprehensive Income, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. The amendments in this ASU allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act. The Company adopted this ASU on January 1, 2019 and reclassified approximately $35.4 million from accumulated other comprehensive income to retained earnings.
Goodwill
In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, which simplifies the manner in which an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. Under the amendments in this ASU, an entity should (1) perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount, and (2) recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value, with the understanding that the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. Additionally, ASU No. 2017-04 removes the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails such qualitative test, to perform Step 2 of the goodwill impairment test. This ASU is effective for fiscal years beginning after December 15, 2019, and for interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. The ASU should be applied using a prospective method. The Company elected to early adopt this standard in connection with the annual goodwill assessment performed as of October 31, 2019. As such, the Company recorded a $470 million goodwill impairment within the Corporate and Investment Banking reporting unit which represented the amount by which the carrying amount exceeded the Corporate and Investment Banking reporting unit’s fair value. For additional information on the Company’s goodwill impairment test, see Note 7, Goodwill.
(2) Debt Securities Available for Sale and Debt Securities Held to Maturity
The following table presents the adjusted cost and approximate fair value of debt securities available for sale and debt securities held to maturity.
At December 31, 2019, approximately $2.7 billion of debt securities were pledged to secure public deposits, securities sold under agreements to repurchase and FHLB advances and for other purposes as required or permitted by law.
The investments held within the states and political subdivision caption of debt securities held to maturity relate to private placement transactions underwritten as loans by the Company but meet the definition of a debt security within ASC Topic 320, Investments - Debt Securities.
At December 31, 2019, approximately 99.99% of the debt securities classified within available for sale are rated “AAA,” the highest possible rating by nationally recognized rating agencies.
The following table discloses the fair value and the gross unrealized losses of the Company’s available for sale securities and held to maturity securities that were in a loss position at December 31, 2019 and 2018. This information is aggregated by investment category and the length of time the individual securities have been in an unrealized loss position.
As indicated in the previous table, at December 31, 2019, the Company held certain debt securities in unrealized loss positions. The Company does not have the intent to sell these securities and believes it is not more likely than not that it will be required to sell these securities before their anticipated recovery.
Management does not believe that any individual unrealized loss in the Company’s debt securities available for sale or held to maturity portfolios, presented in the preceding tables, represents an OTTI at either December 31, 2019 or 2018, other than those noted below.
The following table discloses activity related to credit losses for debt securities where a portion of the OTTI was recognized in other comprehensive income.
During the years ended December 31, 2019, 2018 and 2017, OTTI recognized on held to maturity debt securities totaled $215 thousand, $592 thousand and $242 thousand, respectively. The debt securities impacted by credit impairment consist of held to maturity non-agency collateralized mortgage obligations.
The contractual maturities of the securities portfolios are presented in the following table.
The gross realized gains and losses recognized on sales of debt securities available for sale are shown in the table below.
At December 31, 2019 and 2018 there were $28 million and $33 million, respectively, of unrealized losses, net of tax related to debt securities transferred from available for sale to held to maturity in accumulated other comprehensive income, which are being amortized over the remaining life of those securities.
(3) Loans and Allowance for Loan Losses
The following table presents the composition of the loan portfolio.
Total loans includes unearned income totaling $224.9 million and $258.6 million at December 31, 2019 and 2018, respectively; and unamortized deferred costs totaling $376.6 million and $380.2 million at December 31, 2019 and 2018, respectively.
The loan portfolio is diversified geographically, by product type and by industry exposure. Geographically, the portfolio is predominantly in the Sunbelt states, including Alabama, Arizona, Colorado, Florida, New Mexico and Texas, as well as growing but modest exposure in northern and southern California. The loan portfolio’s most significant geographic presence is within Texas. The Company monitors its exposure to various industries and adjusts loan production based on current and anticipated changes in the macro-economic environment as well as specific structural, legal and business conditions affecting each broad industry category.
At December 31, 2019, approximately $13.7 billion of loans were pledged to secure deposits and FHLB advances and for other purposes as required or permitted by law.
Allowance for Loan Losses and Credit Quality
The following table, which excludes loans held for sale, presents a summary of the activity in the allowance for loan losses. The portion of the allowance that has not been identified by the Company as related to specific loan categories has been allocated to the individual loan categories on a pro rata basis for purposes of the table below:
(1)
Includes commercial real estate - mortgage and real estate - construction loans.
(2)
Includes residential real estate - mortgage, equity lines of credit and equity loans.
(3)
Includes credit card, consumer direct and consumer indirect loans.
The table below provides a summary of the allowance for loan losses and related loan balances by portfolio.
(1)
Includes commercial real estate - mortgage and real estate - construction loans.
(2)
Includes residential real estate - mortgage, equity lines of credit and equity loans.
(3)
Includes credit card, consumer direct and consumer indirect loans.
The following table presents information on individually evaluated impaired loans, by loan class.
The following table presents information on individually evaluated impaired loans, by loan class.
The Company monitors the credit quality of its commercial portfolio using an internal dual risk rating, which considers both the obligor and the facility. The obligor risk ratings are defined by ranges of default probabilities of the borrowers, through internally assigned letter grades (AAA through D2), and the facility risk ratings are defined by ranges of the loss given default. The combination of those two approaches results in the assessment of the likelihood of loss and it is mapped to the regulatory classifications. The Company assigns internal risk ratings at loan origination and at regular intervals subsequent to origination. Loan review intervals are dependent on the size and risk grade of the loan, and are generally conducted at least annually. Additional reviews are conducted when information affecting the loan’s risk grade becomes available. The general characteristics of the risk grades are as follows:
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The Company’s internally assigned letter grades “AAA” through “B-” correspond to the regulatory classification “Pass.” These loans do not have any identified potential or well-defined weaknesses and have a high likelihood of orderly repayment. Exceptions exist when either the facility is fully secured by a CD and held at the Company or the facility is secured by properly margined and controlled marketable securities.
•
Internally assigned letter grades “CCC+” through “CCC” correspond to the regulatory classification “Special Mention.” Loans within this classification have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or in the institution’s credit position at some future date. Special mention loans are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.
•
Internally assigned letter grades “CCC-” through “D1” correspond to the regulatory classification “Substandard.” A loan classified as substandard is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Substandard loans have a well-defined weakness, or weaknesses, that jeopardize the liquidation of the loan. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.
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The internally assigned letter grade “D2” corresponds to the regulatory classification “Doubtful.” Loans classified as doubtful have all the weaknesses inherent in a loan classified as substandard 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 or improbable.
The Company considers payment history as the best indicator of credit quality for the consumer portfolio. Nonperforming loans in the tables below include loans classified as nonaccrual, loans 90 days or more past due and loans modified in a TDR 90 days or more past due.
The following tables, which exclude loans held for sale, illustrate the credit quality indicators associated with the Company’s loans, by loan class.
The following tables present an aging analysis of the Company’s past due loans, excluding loans classified as held for sale.
It is the Company’s policy to classify TDRs that are not accruing interest as nonaccrual loans. It is also the Company’s policy to classify TDR past due loans that are accruing interest as TDRs and not according to their past due status. The tables above reflect this policy.
Within each of the Company’s loan classes, TDRs typically involve modification of the loan interest rate to a below market rate or an extension or deferment of the loan. During the year ended December 31, 2019, $25 million of TDR modifications included an interest rate concession and $73 million of TDR modifications resulted from modifications to the loan’s structure. During the year ended December 31, 2018, $28 million of TDR modifications included an interest rate concession and $119 million of TDR modifications resulted from modifications to the loan’s structure. During the year ended December 31, 2017, $7 million of TDR modifications included an interest rate concession and $246 million of TDR modifications resulted from modifications to the loan’s structure.
The following table presents an analysis of the types of loans that were restructured and classified as TDRs, excluding loans classified as held for sale.
The impact to the allowance for loan losses related to modifications classified as TDRs was approximately $21.0 million, $11.2 million and $27.1 million for the years ended December 31, 2019, 2018 and 2017, respectively.
The Company considers TDRs aged 90 days or more past due, charged off or classified as nonaccrual subsequent to modification, where the loan was not classified as a nonperforming loan at the time of modification, as subsequently defaulted.
The following tables provide a summary of initial subsequent defaults that occurred within one year of the restructure date. The table excludes loans classified as held for sale as of period-end and includes loans no longer in default as of year-end.
All commercial and consumer loans modified in a TDR are considered to be impaired, even if they maintain their accrual status.
At December 31, 2019 and 2018, there were $43.8 million and $54.2 million, respectively, of commitments to lend additional funds to borrowers whose terms have been modified in a TDR.
Foreclosure Proceedings
Other real estate owned, a component of other assets in the Company's Consolidated Balance Sheets, totaled $22 million and $17 million at December 31, 2019 and 2018, respectively. Other real estate owned included $14 million of foreclosed residential real estate properties at both December 31, 2019 and 2018. As of December 31, 2019 and 2018, there were $57 million and $62 million, respectively, of loans secured by residential real estate properties for which formal foreclosure proceedings were in process.
(4) Loan Sales and Servicing
Loans held for sale were $112 million and $69 million at December 31, 2019 and 2018, respectively. Loans held for sale at December 31, 2019 and 2018 were comprised entirely of residential real estate - mortgage loans.
The following table summarizes the Company's activity in the loans held for sale portfolio and loan sales, excluding activity related to loans originated for sale in the secondary market.
The following table summarizes the Company's sales of loans originated for sale in the secondary market.
(1)
The Company has retained servicing responsibilities for all loans sold that were originated for sale in the secondary market.
(2)
Net gains were recorded in mortgage banking income in the Company's Consolidated Statements of Income.
(3)
Beginning in 2018, recorded as a component of mortgage banking in the Company's Consolidated Statements of Income. 2017 servicing fees are recorded as a component of other noninterest income in the Company's Consolidated Statements of Income.
The following table provides the recorded balance of loans sold with retained servicing and the related MSRs.
(1)
These loans are not included in loans on the Company's Consolidated Balance Sheets.
(2)
Recorded under the fair value method and included in other assets on the Company's Consolidated Balance Sheets.
The fair value of MSRs is significantly affected by mortgage interest rates available in the marketplace, which influence mortgage loan prepayment speeds. In general, during periods of declining rates, the fair value of MSRs declines due to increasing prepayments attributable to increased mortgage-refinance activity. During periods of rising interest rates, the fair value of MSRs generally increases due to reduced refinance activity. The Company maintains a non-qualifying hedging strategy to manage a portion of the risk associated with changes in the fair value of the MSR portfolio. This strategy includes the purchase of various trading securities. The interest income, mark-to-market adjustments and gain or loss from sale activities associated with these securities are expected to economically hedge a portion of the change in the fair value of the MSR portfolio.
The following table is an analysis of the activity in the Company’s MSRs.
(1)
Represents the realization of expected net servicing cash flows, expected borrower repayments and the passage of time.
See Note 19, Fair Value Measurements, for additional disclosures related to the assumptions and estimates used in determining fair value of residential MSRs.
At December 31, 2019 and 2018, the sensitivity of the current fair value of the residential MSRs to immediate 10% and 20% adverse changes in key economic assumptions are included in the following table:
The sensitivity calculations above are hypothetical and should not be considered to be predictive of future performance. As indicated, changes in fair value based on adverse changes in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be and should not be considered to be linear. Also, in this table, the effect of an adverse variation in a particular assumption on the fair value of the MSRs is calculated without changing any other assumption; while in reality, changes in one factor may result in changes in another, which may magnify or counteract the effect of the change.
(5) Premises and Equipment
A summary of the Company’s premises and equipment is presented below.
The Company recognized $189.0 million, $198.4 million and $194.3 million of depreciation expense related to the above premises and equipment for the years ended December 31, 2019, 2018 and 2017, respectively.
(6) Leases
The following table summarizes the Company’s lease portfolio classification and respective right-of-use asset balances and lease liability balances which are included in other assets and accrued expenses and other liabilities, respectively, on the Company’s Consolidated Balance Sheets.
The table below presents information about the Company's total lease costs which include amounts recognized on the Company’s Consolidated Statements of Income during the period.
The Company incurred lease expense of $86.8 million and $84.3 million for the years ended December 31, 2018 and 2017, respectively. The Company received lease income of $7.7 million and $6.8 million for the years ended December 31, 2018 and 2017, respectively, related to space leased to third parties.
The table below presents supplemental cash flow information arising from lease transactions and noncash information on lease liabilities arising from obtaining right-of-use assets.
The weighted-average remaining lease term and discount rates at December 31, 2019 were as follows:
The following table provides the annual undiscounted future minimum payments under finance and noncanceable operating leases at December 31, 2019:
At December 31, 2019 the Company had no additional operating or finance leases that had not yet commenced that would create significant rights and obligations for the Company as a lessee.
The table below presents a reconciliation of the undiscounted cash flows to the finance lease liabilities and operating lease liabilities.
(7) Goodwill
A summary of the activity related to the Company’s goodwill follows.
Goodwill is allocated to each of the Company's segments (each a reporting unit: Commercial Banking and Wealth, Retail Banking, and Corporate and Investment Banking).
At December 31, 2019 and 2018, the goodwill, net of accumulated impairment losses, attributable to each of the Company’s three identified reporting units is as follows:
Through December 31, 2019, the Company had recognized accumulated goodwill impairment losses of $2.5 billion, $1.4 billion, and $719 million within the Commercial Banking and Wealth, Retail Banking, and Corporate and Investment Banking reporting units, respectively. In addition, the Company has previously recognized $784 million of accumulated goodwill impairment losses from reporting units that no longer have a goodwill balance.
In accordance with the applicable accounting guidance, the Company performs annual tests to identify potential impairment of goodwill. The tests are required to be performed annually and more frequently if events or circumstances indicate a potential impairment may exist. The Company compares the fair value of each reporting unit with its carrying amount, including goodwill. If the carrying amount of a reporting unit exceeds its fair value, an impairment loss is recognized in an amount equal to that excess.
The estimated fair value of the reporting unit is determined using a blend of both income and market approaches.
The Company completed its annual goodwill impairment test as of October 31, 2019. The 2019 annual test indicated a goodwill impairment of $470 million within the Corporate and Investment Banking reporting unit resulting in the Company recording a goodwill impairment charge of the same amount in 2019. The primary causes of the goodwill impairment in the Corporate and Investment Banking reporting unit were economic and industry conditions, volatility in the market capitalization of U.S. banks, and management's downward revisions to projections that resulted in the fair value of the reporting unit being less than the reporting unit's carrying value. During the years ended December 31, 2018 and 2017, the Company recognized no goodwill impairment charges.
The fair values of the reporting units are based upon management’s estimates and assumptions. Although management has used the estimates and assumptions it believes to be most appropriate in the circumstances, it should be noted that even relatively minor changes in certain valuation assumptions used in management’s calculations could result in significant differences in the results of the impairment tests.
(8) Deposits
Time deposits of $250,000 or less totaled $8.0 billion at December 31, 2019, while time deposits of more than $250,000 totaled $4.0 billion. At December 31, 2019, the scheduled maturities of time deposits were as follows.
At December 31, 2019 and 2018, demand deposit overdrafts reclassified to loans totaled $17 million and $16 million, respectively. In addition to the securities and loans the Company has pledged as collateral to secure public deposits and FHLB advances at December 31, 2019, the Company also had $7.7 billion of standby letters of credit issued by the FHLB to secure public deposits.
(9) Short-Term Borrowings
The short-term borrowings table below shows the distribution of the Company’s short-term borrowed funds.
(10) FHLB and Other Borrowings
The following table details the Company’s FHLB advances and other borrowings including maturities and interest rates as of December 31, 2019.
In August 2019, the Bank issued $600 million aggregate principal amount of its 2.50% unsecured senior notes due 2024.
During 2018, the Bank issued $700 million aggregate principal amount of its 3.50% unsecured senior notes due 2021, and $450 million aggregate principal amount of its floating rate unsecured senior notes due 2021.
The following table presents maturity information for the Company’s FHLB and other borrowings, including the fair value of hedged senior notes and subordinated debentures as well as unamortized discounts and premiums, as of December 31, 2019.
(11) Shareholder's Equity
Series A Preferred Stock
In December 2015, the Company completed the sale of 1,150 shares of its Floating Non-Cumulative Perpetual
Preferred Stock, Series A at a per share price of $200,000 to BBVA. As the sole holder of the Series A Preferred Stock, BBVA will be entitled to receive dividend payments only when, and if declared by the Company’s Board of Directors or a duly authorized committee thereof. Any such dividends will be payable from the date of original issue at a floating rate per annum equal to the three-month U.S. dollar LIBOR as determined on the relevant dividend determination date plus 5.24%. Any such dividends will be payable on a non-cumulative basis, quarterly in arrears on March 1, June 1, September 1 and December 1, commencing March 1, 2016. Payment of dividends on the Series A Preferred Stock is subject to certain legal, regulatory and other restrictions. Redemption is solely at the Company's option. The Company may, at its option, redeem the Series A Preferred Stock (i) in whole or in part, from time to time, on any dividend payment date on or after December 1, 2022 or (ii) in whole but not in part at any time within 90 days of certain changes to regulatory capital requirements.
At both December 31, 2019 and 2018, the carrying amount of the Series A Preferred Stock, including related surplus, net of issuance costs was approximately $229 million.
Class B Preferred Stock
In December 2000, a subsidiary of the Bank issued $21 million of Class B Preferred Stock. The Preferred Stock outstanding was approximately $22 million at both December 31, 2019 and 2018, and is classified as noncontrolling interests on the Company’s Consolidated Balance Sheets. The Preferred Stock qualifies as Tier 1 capital under Federal Reserve guidelines. The Preferred Stock dividends are preferential, non-cumulative and payable semi-annually in arrears on June 15 and December 15 of each year, commencing June 15, 2001, at a rate per annum equal to 9.875% of the liquidation preference of $1,000 per share when and if declared by the board of directors of the subsidiary, in its sole discretion, out of funds legally available for such payment.
The Preferred Stock is redeemable for cash, at the option of the subsidiary, in whole or in part, at any time on or after June 15, 2021. Prior to June 15, 2021, the Preferred Stock is not redeemable, except that prior to such date, the Preferred Stock may be redeemed for cash, at the option of the subsidiary, in whole but not in part, only upon the occurrence of certain tax or regulatory events. Any such redemption is subject to the prior approval of the Federal Reserve. The Preferred Stock is not redeemable at the option of the holders thereof at any time.
(12) Comprehensive Income
Comprehensive income is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances arising from nonowner sources. The following summarizes the change in the components of other comprehensive income (loss).
Activity in accumulated other comprehensive income (loss), net of tax, was as follows:
(1)
Related to the Company's adoption of ASU 2017-12 and ASU 2018-02 on January 1, 2019. See Note 1, Summary of Significant Accounting Policies, for additional information.
The following table presents information on reclassifications out of accumulated other comprehensive income.
(1)
Amounts in parentheses indicate debits to the Consolidated Statements of Income.
(2)
These accumulated other comprehensive income components are included in the computation of net periodic pension cost (see Note 17, Benefit Plans, for additional details).
(13) Derivatives and Hedging
The Company is a party to derivative instruments in the normal course of business to meet financing needs of its customers and reduce its own exposure to fluctuations in interest rates and foreign currency exchange rates. The Company has made an accounting policy decision to not offset derivative fair value amounts under master netting agreements. See Note 1, Summary of Significant Accounting Policies, for additional information on the Company’s accounting policies related to derivative instruments and hedging activities. For derivatives cleared through central clearing houses the variation margin payments made are legally characterized as settlements of the derivatives. As a result, these variation margin payments are netted against the fair value of the respective derivative contracts in the balance sheet and related disclosures and there is no fair value presented for these contracts. The following table reflects the notional amount and fair value of derivative instruments included on the Company’s Consolidated Balance Sheets on a gross basis.
(1)
Derivative assets, except for trading account assets that are recorded as a component of trading account assets on the Consolidated Balance Sheets, are recorded in other assets on the Company’s Consolidated Balance Sheets.
(2)
Derivative liabilities are recorded in accrued expenses and other liabilities on the Company’s Consolidated Balance Sheets.
(3)
Changes in fair value are cash settled daily; therefore, there is no ending balance at any given reporting period.
Hedging Derivatives
The Company uses derivative instruments to manage the risk of earnings fluctuations caused by interest rate volatility. For those financial instruments that qualify and are designated as a hedging relationship, either a fair value hedge or cash flow hedge, the effect of interest rate movements on the hedged assets or liabilities will generally be offset by the change in fair value of the derivative instrument. See Note 1, Summary of Significant Accounting Policies, for additional information on the Company’s accounting policies related to derivative instruments and hedging activities.
Fair Value Hedges
The Company enters into fair value hedging relationships using interest rate swaps to mitigate the Company’s exposure to losses in value as interest rates change. Derivative instruments that are used as part of the Company’s interest rate risk management strategy include interest rate swaps that relate to the pricing of specific balance sheet assets and liabilities. Interest rate swaps generally involve the exchange of fixed and variable rate interest payments between two parties, based on a common notional principal amount and maturity date.
Interest rate swaps are used to convert the Company’s fixed rate long-term debt to a variable rate. The critical terms of the interest rate swaps match the terms of the corresponding hedged items. All components of each derivative instrument’s gain or loss are included in the assessment of hedge effectiveness.
The Company recognized no gains or losses for the years ended December 31, 2019, 2018 and 2017 related to hedged firm commitments no longer qualifying as a fair value hedge. At December 31, 2019, the fair value hedges had a weighted average expected remaining term of 3.3 years.
Cash Flow Hedges
The Company enters into cash flow hedging relationships using interest rate swaps and options, such as caps and floors, to mitigate exposure to the variability in future cash flows or other forecasted transactions associated with its floating rate assets and liabilities. The Company uses interest rate swaps and options to hedge the repricing characteristics of its floating rate commercial loans and FHLB advances. The Company also uses foreign currency forward contracts to hedge its exposure to fluctuations in foreign currency exchange rates due to a portion of the money transfer expense being denominated in foreign currency. All components of each derivative instrument’s gain or loss are included in the assessment of hedge effectiveness. The initial assessment of expected hedge effectiveness is based on regression analysis. The ongoing periodic measures of hedge ineffectiveness are based on the expected change in cash flows of the hedged item caused by changes in the benchmark interest rate. There were no gains or losses reclassified from other comprehensive income (loss) because of the discontinuance of cash flow hedges related to certain forecasted transactions that are probable of not occurring for the years ended December 31, 2019, 2018 and 2017.
At December 31, 2019, cash flow hedges not terminated had a net fair value of $(3) million and a weighted average life of 3.2 years. Net gains of $23.5 million are expected to be reclassified to income over the next 12 months as net settlements occur. The maximum length of time over which the entity is hedging its exposure to the variability in future cash flows for forecasted transactions is 4.1 years.
The following table presents the effect of hedging derivative instruments on the Company’s Consolidated Statements of Income.
(1)
See Note 12, Comprehensive Income, for gain or loss recognized for cash flow hedges in accumulated other comprehensive income.
(2)
Pre-tax
The following table presents the carrying amount and associated cumulative basis adjustment related to the application of hedge accounting that is included in the carrying amount of hedged assets and liabilities on the Company's Consolidated Balance Sheets in fair value hedging relationships.
Derivatives Not Designated As Hedges
Derivatives not designated as hedges include those that are entered into as either economic hedges as part of the Company’s overall risk management strategy or to facilitate client needs. Economic hedges are those that are not designated as a fair value hedge, cash flow hedge or foreign currency hedge for accounting purposes, but are necessary to economically manage the risk exposure associated with the assets and liabilities of the Company.
The Company also enters into a variety of interest rate contracts and foreign exchange contracts in its trading activities. The primary purpose for using these derivative instruments in the trading account is to facilitate customer transactions. The trading interest rate contract portfolio is actively managed and hedged with similar products to limit market value risk of the portfolio. Changes in the estimated fair value of contracts in the trading account along with the related interest settlements on the contracts are recorded in noninterest income as corporate and correspondent investment sales in the Company’s Consolidated Statements of Income.
The Company enters into forward and option contracts to economically hedge the change in fair value of certain residential mortgage loans held for sale due to changes in interest rates. Revaluation gains and losses from free-standing derivatives related to mortgage banking activity are recorded as a component of mortgage banking income in the Company’s Consolidated Statements of Income.
Interest rate lock commitments issued on residential mortgage loan commitments that will be held for resale are also considered free-standing derivative instruments, and the interest rate exposure on these commitments is economically hedged primarily with forward contracts. Revaluation gains and losses from free-standing derivatives related to mortgage banking activity are recorded as a component of mortgage banking income in the Company’s Consolidated Statements of Income.
In conjunction with the sale of its Visa, Inc. Class B shares in 2009, the Company entered into a total return swap in which the Company will make or receive payments based on subsequent changes in the conversion rate of the Class B shares into Class A shares. This total return swap is accounted for as a free-standing derivative.
The Company offers its customers equity-linked CDs that have a return linked to individual equities and equity indices. Under appropriate accounting guidance, a CD that pays interest based on changes in an equity index is a hybrid instrument that requires separation into a host contract (the CD) and an embedded derivative contract (written equity call option). The Company has entered into an offsetting derivative contract in order to economically hedge the exposure related to the issuance of equity-linked CDs. Both the embedded derivative and derivative contract entered into by the Company are classified as free-standing derivative instruments.
The Company also enters into foreign currency contracts to hedge its exposure to fluctuations in foreign currency exchange rates due to its funding of commercial loans in foreign currencies.
The net gains and losses recorded in the Company’s Consolidated Statements of Income from free-standing derivative instruments not designated as hedging instruments are summarized in the following table.
Derivatives Credit and Market Risks
By using derivative instruments, the Company is exposed to credit and market risk. If the counterparty fails to perform, credit risk is equal to the extent of the Company’s fair value gain in a derivative. When the fair value of a derivative instrument contract is positive, this generally indicates that the counterparty owes the Company and, therefore, creates a credit risk for the Company. When the fair value of a derivative instrument contract is negative, the Company owes the counterparty and, therefore, it has no credit risk. The Company minimizes the credit risk in derivative instruments by entering into transactions with high-quality counterparties that are reviewed periodically. Credit losses are also mitigated through collateral agreements and other contract provisions with derivative counterparties.
Market risk is the adverse effect that a change in interest rates or implied volatility rates has on the value of a financial instrument. The Company manages the market risk associated with interest rate and foreign currency contracts by establishing and monitoring limits as to the types and degree of risk that may be undertaken.
The Company’s derivatives activities are monitored by its Asset/Liability Committee as part of its risk-management oversight. The Company’s Asset/Liability Committee is responsible for mandating various hedging strategies that are developed through its analysis of data from financial simulation models and other internal and industry sources. The resulting hedging strategies are then incorporated into the Company’s overall interest rate risk management and trading strategies.
Entering into interest rate swap agreements and options involves not only the risk of dealing with counterparties and their ability to meet the terms of the contracts but also interest rate risk associated with unmatched positions. At December 31, 2019, interest rate swap agreements and options classified as trading were substantially matched. The Company had credit risk of $336 million related to derivative instruments in the trading account portfolio, which does not take into consideration master netting arrangements or the value of the collateral. There were no material net credit
losses associated with derivative instruments classified as trading for the years ended December 31, 2019, 2018 and 2017. At December 31, 2019 and 2018, there were no material nonperforming derivative positions classified as trading.
The Company’s derivative positions designated as hedging instruments are primarily executed in the over-the-counter market. These positions have credit risk of $11 million, which does not take into consideration master netting arrangements or the value of the collateral.
There were no credit losses associated with derivative instruments classified as nontrading for the years ended December 31, 2019, 2018 and 2017. At December 31, 2019 and 2018, there were no nonperforming derivative positions classified as nontrading.
As of December 31, 2019 and 2018, the Company had recorded the right to reclaim cash collateral of $150 million and $97 million, respectively, within other assets on the Company’s Consolidated Balance Sheets and had recorded the obligation to return cash collateral of $12 million and $22 million, respectively, within deposits on the Company’s Consolidated Balance Sheets.
Contingent Features
Certain of the Company’s derivative instruments contain provisions that require the Company’s debt to maintain a certain credit rating from each of the major credit rating agencies. If the Company’s debt were to fall below this rating, it would be in violation of these provisions, and the counterparties to the derivative instruments could demand immediate and ongoing full overnight collateralization on derivative instruments in net liability positions. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that were in a liability position on December 31, 2019 was $47 million for which the Company has collateral requirements of $45 million in the normal course of business. If the credit-risk-related contingent features underlying these agreements had been triggered on December 31, 2019, the Company’s collateral requirements to its counterparties would increase by $2 million. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that were in a liability position on December 31, 2018 was $24 million for which the Company had collateral requirements of $23 million in the normal course of business. If the credit-risk-related contingent features underlying these agreements had been triggered on December 31, 2018, the Company’s collateral requirements to its counterparties would have increased by $1 million.
Netting of Derivative Instruments
The Company is party to master netting arrangements with its financial institution counterparties for some of its derivative and hedging activities. The Company does not offset assets and liabilities under these master netting arrangements for financial statement presentation purposes. The master netting arrangements provide for single net settlement of all derivative instrument arrangements, as well as collateral, in the event of default with respect to, or termination of, any one contract with the respective counterparties. Cash collateral is usually posted by the counterparty with a net liability position in accordance with contract thresholds.
The following represents the Company’s total gross derivative instrument assets and liabilities subject to an enforceable master netting arrangement. The derivative instruments the Company has with its customers are not subject to an enforceable master netting arrangement.
(1)
The actual amount of collateral received/pledged is limited to the asset/liability balance and does not include excess collateral received/pledged. When excess collateral exists, the collateral shown in the table above has been allocated based on the percentage of the actual amount of collateral posted.
(14) Securities Financing Activities
Netting of Securities Purchased Under Agreements to Resell and Securities Sold Under Agreements to Repurchase
The Company has various financial asset and liabilities that are subject to enforceable master netting agreements or similar agreements. The Company's derivatives that are subject to enforceable master netting agreements or similar transactions are discussed in Note 13, Derivatives and Hedging. The Company enters into agreements under which it purchases or sells securities subject to an obligation to resell or repurchase the same or similar securities. Securities purchased under agreements to resell and securities sold under agreements to repurchase are generally accounted for as collateralized financing transactions and recorded at the amounts at which the securities were purchased or sold plus accrued interest. The securities pledged as collateral are generally U.S. Treasury securities and other U.S. government agency securities and mortgage-backed securities.
Securities purchased under agreements to resell and securities sold under agreements to repurchase are governed by an MRA. Under the terms of the MRA, all transactions between the Company and the counterparty constitute a single business relationship such that in the event of default, the nondefaulting party is entitled to set off claims and apply property held by that party in respect of any transaction against obligations owed. Any payments, deliveries, or other transfers may be applied against each other and netted. These amounts are limited to the contract asset/liability balance, and accordingly, do not include excess collateral received or pledged. The Company offsets the assets and liabilities under netting arrangements for the balance sheet presentation of securities purchased under agreements to resell and securities sold under agreements to repurchase provided certain criteria are met that permit balance sheet netting.
(1)
The actual amount of collateral received/pledged is limited to the asset/liability balance and does not include excess collateral received/pledged. When excess collateral exists the collateral shown in the table above has been allocated based on the percentage of the actual amount of collateral posted.
Collateral Associated with Securities Financing Activities
Securities sold under agreements to repurchase are accounted for as secured borrowings. The following table presents the Company's related activity, by collateral type and remaining contractual maturity.
In the event of a significant decline in fair value of the collateral pledged for the securities sold under agreements to repurchase, the Company would be required to provide additional collateral. The Company mitigates the risk by monitoring the liquidity and credit quality of the collateral, as well as the maturity profile of the transactions.
At December 31, 2019, the fair value of collateral received related to securities purchased under agreements to resell was $648 million and the fair value of collateral pledged for securities sold under agreements to repurchase was $644 million. At December 31, 2018, the fair value of collateral received related to securities purchased under agreements to resell was $251 million and the fair value of collateral pledged for securities sold under agreements to repurchase was $247 million.
(15) Commitments, Contingencies and Guarantees
Commitments to Extend Credit & Standby and Commercial Letters of Credit
The following represents the Company’s commitments to extend credit, standby letters of credit and commercial letters of credit.
Commitments to extend credit are agreements to lend to customers on certain terms and conditions as long as all conditions are satisfied and there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
Standby and commercial letters of credit are commitments issued by the Company to guarantee the performance of a customer to a third party. These guarantees are primarily issued to support public and private borrowing
arrangements, including commercial paper, bond financing and similar transactions, and expire in decreasing amounts with terms ranging from one to four years.
The credit risk involved in issuing letters of credit and commitments is essentially the same as that involved in extending loan facilities to customers. The fair value of the letters of credit and commitments typically approximates the fee received from the customer for issuing such commitments. These fees are deferred and are recognized over the commitment period. At December 31, 2019 and 2018, the recorded amount of these deferred fees was $7 million and $8 million, respectively. The Company holds various assets as collateral supporting those commitments for which collateral is deemed necessary. At December 31, 2019, the maximum potential amount of future undiscounted payments the Company could be required to make under outstanding standby letters of credit was $997 million. At December 31, 2019 and 2018, the Company had reserves related to letters of credit and unfunded commitments recorded in accrued expenses and other liabilities on the Company’s Consolidated Balance Sheet of $67 million and $66 million, respectively.
Loan Sale Recourse
The Company has potential recourse related to FNMA securitizations. At December 31, 2019 and 2018, the amount of potential recourse was $18 million and $19 million, respectively, of which the Company had reserved $693 thousand and $793 thousand, respectively, which is recorded in accrued expenses and other liabilities on its Consolidated Balance Sheets for the respective years.
The Company also issues standard representations and warranties related to mortgage loan sales to government-sponsored agencies. Although these agreements often do not specify limitations, the Company does not believe that any payments related to these warranties would materially change the financial condition or results of operations of the Company. At both December 31, 2019 and 2018, the Company recorded $1.2 million of reserves in accrued expenses and other liabilities on the Company’s Consolidated Balance Sheets related to potential losses from loans sold.
Low Income Housing Tax Credit Partnerships
The Company has committed to make certain equity investments in various limited partnerships that sponsor affordable housing projects utilizing the Low Income Housing Tax Credit pursuant to Section 42 of the Internal Revenue Code. The purpose of these investments will be to facilitate the sale of additional affordable housing product offerings and to assist in achieving goals associated with the Community Reinvestment Act, and to achieve a satisfactory return on capital. The total unfunded commitment associated with these investments at December 31, 2019 and 2018 were $171 million and $175 million, respectively, and were recorded in accrued expenses and other liabilities on the Company’s Consolidated Balance Sheets.
Forward Starting Reverse Repurchase Agreements and Forward Starting Repurchase Agreements.
The Company enters into securities purchased under agreements to resell and securities sold under agreements to repurchase that settle at a future date, generally within three business days. At December 31, 2019 the Company had no forward starting reverse repurchase agreements and forward starting repurchase agreements of $450 million. The Company had no forward starting reverse repurchase agreements or forwarding starting repurchase agreements at December 31, 2018.
Legal and Regulatory Proceedings
In the ordinary course of business, the Company is subject to legal proceedings, including claims, litigation, investigations and administrative proceedings, all of which are considered incidental to the normal conduct of business. The Company believes it has substantial defenses to the claims asserted against it in its currently outstanding legal proceedings and, with respect to such legal proceedings, intends to defend itself vigorously. Set forth below are descriptions of certain of the Company’s legal proceedings.
In January 2014, the Bank was named as a defendant in a lawsuit filed in the District Court of Dallas County, Texas, David Bagwell, individually and as Trustee of the David S. Bagwell Trust, et al. v. BBVA USA, et al., wherein the plaintiffs (who are the borrowers and guarantors of the underlying loans) allege that BBVA USA wrongfully sold their loans to a third party after representing that it would not do so. The plaintiffs seek unspecified monetary relief. Following trial in December 2017, the jury rendered a verdict in favor of the plaintiffs totaling $98 million. On June 27, 2018, the court entered a judgment in favor of the plaintiffs in the
amount of $96 million, which includes prejudgment interest. The Bank has appealed and will vigorously contest the judgment on appeal. The Company believes there are substantial defenses to these claims and intends to defend them vigorously.
In October 2016, BSI was named as a defendant in a putative class action lawsuit filed in the District Court of Harris County, Texas, St. Lucie County Fire District Firefighters' Pension Trust, individually and on behalf of all others similarly situated v. Southwestern Energy Company, et al., wherein the plaintiffs allege that Southwestern Energy Company, its officers and directors, and the underwriting defendants (including BSI) made inaccurate and misleading statements in the registration statement and prospectus related to a securities offering. The plaintiffs seek unspecified monetary relief. The Company believes there are substantial defenses to these claims and intends to defend them vigorously.
The Company and the Bank have been named in two proceedings involving David L. Powell: one that was filed in January 2017 with the Federal Conciliation and Arbitration Labor Board of Mexico City, Mexico, David Lannon Powell Finneran v. BBVA USA Bancshares, Inc., et al., and one that was filed in April 2018 in the United States District Court for the Northern District of Texas, David L. Powell, et al. v. BBVA USA. Powell alleges discrimination and wrongful termination in both proceedings, and seeks unspecified monetary relief. The Company believes there are substantial defenses to these claims and intends to defend them vigorously.
In March 2019, the Company and its subsidiary, Simple Finance Technology Corp., were named as defendants in a putative class action lawsuit filed in the United States District Court for the Northern District of California, Amitahbo Chattopadhyay v. BBVA USA Bancshares, Inc., et al. Plaintiff claims that Simple and the Company only permit United States citizens to open Simple accounts (which are exclusively originated through online channels). Plaintiff alleges that this constitutes alienage discrimination and violations of California's Unruh Act. The Company believes that there are substantial defenses to these claims and intends to defend them vigorously.
In July 2019, the Company was named as a defendant in a putative class action lawsuit filed in the United States District Court for the Northern District of Alabama, Ferguson v. BBVA USA Bancshares, Inc., wherein the plaintiffs allege certain investment options within the Company’s employee retirement plan violate provisions of ERISA. The plaintiffs seek unspecified monetary relief. The Company believes there are substantial defenses to these claims and intends to defend them vigorously.
The Company is or may become involved from time to time in information-gathering requests, reviews, investigations and proceedings (both formal and informal) by various governmental regulatory agencies, law enforcement authorities and self-regulatory bodies regarding the Company’s business. Such matters may result in material adverse consequences, including without limitation adverse judgments, settlements, fines, penalties, orders, injunctions, alterations in the Company’s business practices or other actions, and could result in additional expenses and collateral costs, including reputational damage, which could have a material adverse impact on the Company’s business, consolidated financial position, results of operations or cash flows.
The Company assesses its liabilities and contingencies in connection with outstanding legal proceedings utilizing the latest information available. Where it is probable that the Company will incur a loss and the amount of the loss can be reasonably estimated, the Company records a liability in its consolidated financial statements. These legal reserves may be increased or decreased to reflect any relevant developments. Where a loss is not probable or the amount of a probable loss is not reasonably estimable, the Company does not accrue legal reserves. At December 31, 2019, the Company had accrued legal reserves in the amount of $23 million. Additionally, for those matters where a loss is reasonably possible and the amount of loss is reasonably estimable, the Company estimates the amount of losses that it could incur beyond the accrued legal reserves. Under U.S. GAAP, an event is “reasonably possible” if “the chance of the future event or events occurring is more than remote but less than likely” and an event is “remote" if “the chance of the future event or events occurring is slight.” For a limited number of legal matters in which the Company is involved, the Company is able to estimate a range of reasonably possible losses in excess of related reserves, if any. Management currently estimates these losses to range from $0 to approximately $76 million. This estimated range of reasonably possible losses is based on information available at December 31, 2019. The matters underlying the estimated range will change from time to time, and the actual results may vary significantly from this estimate. Those matters for which an estimate is not possible are not included within this estimated range; therefore, this estimated range does not represent the Company’s maximum loss exposure.
While the outcome of legal proceedings and the timing of the ultimate resolution are inherently difficult to predict, based on information currently available, advice of counsel and available insurance coverage, the Company believes that it has established adequate legal reserves. Further, based upon available information, the Company is of the opinion that these legal proceedings, individually or in the aggregate, will not have a material adverse effect on the Company’s financial condition or results of operations. However, in the event of unexpected future developments, it is possible that the ultimate resolution of those matters, if unfavorable, may be material to the Company’s results of operations for any particular period, depending, in part, upon the size of the loss or liability imposed and the operating results for the applicable period.
Income Tax Review
The Company is subject to review and examination from various tax authorities. The Company is currently under examination by a number of states, and has received notices of proposed adjustments related to state income taxes due for prior years. Management believes that adequate provisions for income taxes have been recorded. Refer to Note 18, Income Taxes, for additional information on various tax audits.
(16) Regulatory Capital Requirements and Dividends from Subsidiaries
The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s Consolidated Financial Statements. Under capital adequacy guidelines, the regulatory framework for prompt corrective action and the Gramm-Leach-Bliley Act, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of each entity's assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification of the Company and the Bank are also subject to qualitative judgments by the regulators about capital components, risk weightings and other factors.
At December 31, 2019, the Company and the Bank, remain above the applicable U.S. regulatory capital requirements. Under the U.S. Basel III capital rule, the current minimum required regulatory capital ratios under Transition Requirements to which the Company and the Bank were subject are as follows:
(1)
At December 31, 2019, under transition requirements, the CET1, tier 1 and total capital minimum ratio requirements include a capital conservation buffer of 2.500%.
(2)
At December 31, 2018, under transition requirements, the CET1, tier 1 and total capital minimum ratio requirements include a capital conservation buffer of 1.875%.
The following table presents the Transitional Basel III regulatory capital ratios at December 31, 2019 and 2018 for the Company and the Bank.
Dividends paid by the Bank are the primary source of funds available to the Parent for payment of dividends to its shareholder and other needs. Applicable federal and state statutes and regulations impose restrictions on the amount of dividends that may be declared by the Bank. In addition to the formal statutes and regulations, regulatory authorities also consider the adequacy of each bank’s total capital in relation to its assets, deposits and other such items. Capital adequacy considerations could further limit the availability of dividends from the Bank. The Bank could have paid additional dividends to the Parent in the amount of $2.0 billion while continuing to meet the capital requirements for “well-capitalized” banks at December 31, 2019; however, due to the net earnings restrictions on dividend distributions, the Bank did not have the ability to pay any dividends at December 31, 2019 without regulatory approval.
The Bank is required to maintain cash balances with the Federal Reserve. The average amount of these balances approximated $4.5 billion and $2.2 billion for the years ended December 31, 2019 and 2018, respectively.
(17) Benefit Plans
Defined Benefit Plan
The Company sponsors a defined benefit pension plan that is intended to qualify under the Internal Revenue Code. At the beginning of 2003, the pension plan was closed to new participants, with existing participants being offered the option to remain in the pension plan or move to an employer funded defined contribution plan. Benefits under the pension plan are based on years of service and the employee's highest consecutive five years of compensation during employment.
During 2014, the Company announced to all active participants the sunsetting of the pension plan on December 31, 2017. Beginning on this date, active participants will no longer be credited with future service but rather will be transitioned into the employer funded portion of the Company's defined contribution plan.
The following tables summarize the Company’s defined benefit pension plan.
Obligations and Funded Status
Amounts recognized on the Company’s Consolidated Balance Sheets consist of:
The accumulated benefit obligation for the Company’s defined benefit pension plan was $379 million and $334 million at December 31, 2019 and 2018, respectively. The Company anticipates amortizing $226 thousand of the actuarial loss from accumulated other comprehensive income over the next twelve months.
The components of net periodic benefit cost recognized in the Company’s Consolidated Statements of Income are as follows.
The following table provides additional information related to the Company’s defined benefit pension plan.
To establish the discount rate utilized, the Company performs an analysis of matching anticipated cash flows for the duration of the plan liabilities to third party forward discount curves. To develop the expected return on plan assets, the Company considers the current level of expected returns on risk free investments (primarily government bonds), the historical level of risk premium associated with other asset classes in which plan assets are invested, and the expectations for future returns of each asset class. The expected return for each asset class is then weighted based on the target asset allocation, and a range of expected return on plan assets is developed. Based on this information, the plan’s Retirement Committee sets the discount rate and expected rate of return assumption.
Future Benefit Payments
The following table summarizes the estimated benefits to be paid in the following periods.
The expected benefits above were estimated based on the same assumptions used to measure the Company’s benefit obligation at December 31, 2019 and include benefits attributable to estimated future employee service.
Plan Assets
The Company’s Retirement Committee sets the investment policy for the defined benefit pension plan and reviews investment performance and asset allocation on a quarterly basis. The current asset allocation for the plan is entirely allocated to fixed income securities, including U.S. Treasury and other U.S. government securities, corporate debt securities and municipal debt securities, as well as cash and cash equivalent securities.
The following table presents the fair value of the Company’s defined benefit pension plan assets.
In general, the fair value applied to the Company’s defined benefit pension plan assets is based upon quoted market prices or Level 1 measurements, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use observable market based parameters as inputs, or Level 2 measurements. Level 3 measurements include discounted cash flow analyses based on assumptions that are not readily observable in the market place, such as projections of future cash flows, loss assumptions and discount rates. See Note 19, Fair Value Measurements, for a further discussion of the fair value hierarchy.
Supplemental Retirement Plans
The Company maintains unfunded defined benefit plans for certain key executives that are intended to meet the requirements of Section 409A of the Internal Revenue Code and provide additional retirement benefits not otherwise provided through the Company’s basic retirement benefit plans. These plans had unfunded projected benefit obligations and net plan liabilities of $33 million and $30 million at December 31, 2019 and 2018, respectively, which are reflected on the Company’s Consolidated Balance Sheets as accrued expenses and other liabilities. Net periodic expenses of these plans was $1.8 million for both the years ended December 31, 2019 and 2018, and $1.5 million for the year ended December 31, 2017. At December 31, 2019 and 2018, the Company had $12.2 million and $9.5 million, respectively, recognized in accumulated other comprehensive income, net of tax, related to these plans.
Defined Contribution Plan
The Company sponsors a defined contribution plan comprised of a traditional employee defined contribution component with matching employer contributions and an employer funded defined contribution component. Under the
traditional employee portion of the defined contribution plan, employees may contribute up to 75% of their compensation on a pretax basis subject to statutory limits. The Company makes matching contributions equal to 100% of the first 3% of compensation deferred plus 50% of the next 2% of compensation deferred. The Company may also make voluntary non-matching contributions to the plan.
Under the employer funded portion of the defined contribution plan, the Company makes contributions on behalf of certain employees based on pay and years of service. The Company's contributions range from 2% to 4% of the employee's base pay based on the employee's years of service. Participation in this portion of the defined contribution plan was limited to employees hired after January 1, 2002 and those participants in the defined benefit pension plan who, in 2002, chose to forgo future accumulation of benefit service.
In aggregate, the Company recognized $43.0 million, $41.3 million, and $38.1 million of expense recorded in salaries, benefits and commissions in the Company's Consolidated Statements of Income related to this defined contribution plan for the years ended December 31, 2019, 2018, and 2017, respectively.
(18) Income Taxes
Income tax expense consisted of the following:
Income tax expense differed from the amount computed by applying the federal statutory income tax rate to pretax earnings for the following reasons:
(1)
Includes $(5.0) million and $40 million of (benefit) expense related to items in accumulated other comprehensive income in which the related tax effects were originally recognized in other comprehensive income for December 31, 2018 and 2017, respectively.
(2)
Includes $11.4 million of expense for December 31, 2018 related to the correction of an error in prior periods that resulted from an incorrect calculation of the proportional amortization of the Company's Low Income Housing Tax Credit investments. See Note 1, Summary of Significant Accounting Policies, for additional details.
On December 22, 2017, President Trump signed the Tax Cuts and Jobs Act into legislation, which reduced the corporate tax rate from 35% to 21% effective January 1, 2018. ASC Topic 740, Income Taxes, requires the effect of a change in tax laws or rates to be recognized as of the date of enactment. The Company has recorded tax expense of $121.2 million, primarily due to the remeasurement of deferred tax assets and liabilities at the federal tax rate of 21% for the year ended December 31, 2017. The Company adjusted the provisional amounts in 2018 when it filed its federal tax return for the tax year 2017.
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are presented below.
As of December 31, 2019 and 2018, the Company has approximately zero and $49 thousand, respectively, of federal net operating loss carryforwards for future utilization.
A real estate investment subsidiary of the Company has net operating loss carryforwards of approximately $18.8 million at both December 31, 2019 and 2018. These losses begin to expire in 2030. The Company has determined that it is more likely than not the benefit from this deferred tax asset will not be realized in the carryforward period and has recorded a full valuation allowance of approximately $4.0 million against the assets at both December 31, 2019 and 2018.
Additionally, the Company has state net operating loss carryforwards of approximately $182.0 million and $215.0 million at December 31, 2019 and 2018, respectively. These state net operating losses expire in years 2020 through 2038. The Company believes it is more likely than not the benefit from certain state net operating loss carryforwards will not be realized, and, accordingly, has established a valuation allowance associated with these net operating loss carryforwards. The Company had recorded a valuation allowance of approximately $4.9 million and $8.0 million at December 31, 2019 and 2018, respectively, related to these state net operating loss carryforwards.
The following is a tabular reconciliation of the total amounts of the gross unrecognized tax benefits.
During the years ended December 31, 2019, 2018 and 2017, the Company recognized benefits of $19 thousand, $772 thousand and $872 thousand, respectively, for interest and penalties related to the unrecognized tax benefits noted above. At December 31, 2019 and 2018, the Company had approximately $507 thousand and $527 thousand, respectively, of accrued interest and penalties recognized related to unrecognized tax benefits within accrued expenses and other liabilities. Included in the balance of unrecognized tax benefits at December 31, 2019, 2018 and 2017 were $7.3 million, $7.2 million and $14.9 million, respectively, of tax benefits that, if recognized after the balance sheet date, would affect the effective tax rate.
The Company and its subsidiaries are routinely examined by various taxing authorities. The following table summarizes the tax years that are either currently under examination or remain open under the statute of limitations and subject to examination by the major tax jurisdictions in which the Company operates:
(1)Major state tax jurisdictions include Alabama, California, Texas and New York.
The Company believes that it has adequately reserved on federal and state issues and any variance on final resolution, whether over or under the reserve amount, would be immaterial to the financial statements.
It is reasonably possible that the above unrecognized tax benefits could be reduced by approximately $1 million in 2020 due to statute expiration and audit settlement.
(19) Fair Value Measurements
The Company applies the fair value accounting guidance required under ASC Topic 820 which establishes a framework for measuring fair value. This guidance defines fair value as the exchange price that would be received for an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. This guidance also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. A financial instrument’s categorization within this fair value hierarchy is based upon the lowest level of input that is significant to the instrument’s fair value measurement. The three levels within the fair value hierarchy are described as follows.
•
Level 1 - Fair value is based on quoted prices in an active market for identical assets or liabilities.
•
Level 2 - Fair value is based on quoted market prices for similar instruments traded in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuation techniques for which all significant assumptions are observable in the market.
•
Level 3 - Fair value is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities would include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar pricing techniques based on the Company’s own assumptions about what market participants would use to price the asset or liability.
A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments under the fair value hierarchy, is set forth below. These valuation methodologies were applied to the Company’s financial assets and financial liabilities carried at fair value. In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use observable market based parameters as inputs. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality and the Company’s creditworthiness, among other things, as well as other unobservable parameters. Any such valuation adjustments are applied consistently over time. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. The Company’s valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, the reported fair value amounts have not been comprehensively revalued since the presentation dates, and, therefore, estimates of fair value after the balance sheet date may differ significantly from the amounts presented herein.
Financial Instruments Measured at Fair Value on a Recurring Basis
Trading account assets and liabilities, securities available for sale, certain mortgage loans held for sale, derivative assets and liabilities, and mortgage servicing rights are recorded at fair value on a recurring basis. The following is a description of the valuation methodologies for these assets and liabilities.
Trading account assets and liabilities and debt securities available for sale - Trading account assets and liabilities and debt securities available for sale consist of U.S. Treasury securities and other U.S. government agency securities, mortgage-backed securities, collateralized mortgage obligations, debt obligations of state and political subdivisions, other debt securities, and derivative contracts.
•
U.S. Treasury securities and other U.S. government agency securities are valued based on quoted market prices of identical assets on active exchanges (Level 1 measurements) or are valued based on a market approach using observable inputs such as benchmark yields, reported trades, broker/dealer quotes, benchmark securities, and bids/offers of government-sponsored enterprise securities (Level 2 measurements).
•
Mortgage-backed securities are primarily valued using market-based pricing matrices that are based on observable inputs including benchmark To Be Announced security prices, U.S. Treasury yields, U.S. dollar swap yields, and benchmark floating-rate indices. Mortgage-backed securities pricing may also give consideration to pool-specific data such as prepayment history and collateral characteristics. Valuations for mortgage-backed securities are therefore classified as Level 2 measurements.
•
Collateralized mortgage obligations are valued using market-based pricing matrices that are based on observable inputs including reported trades, bids, offers, dealer quotes, U.S. Treasury yields, U.S. dollar swap yields, market convention prepayment speeds, tranche-specific characteristics, prepayment history, and collateral characteristics. Fair value measurements for collateralized mortgage obligations are classified as Level 2 measurements.
•
Debt obligations of states and political subdivisions are primarily valued using market-based pricing matrices that are based on observable inputs including Municipal Securities Rulemaking Board reported trades, issuer spreads, material event notices, and benchmark yield curves. These valuations are Level 2 measurements.
•
Other debt securities consist of foreign and corporate debt. Foreign and corporate debt valuations are based on information and assumptions that are observable in the market place. The valuations for these securities are therefore classified as Level 2 measurements.
•
Other derivative assets and liabilities consist primarily of interest rate contracts. The Company’s interest rate contracts are valued utilizing Level 2 observable inputs (yield curves and volatilities) to determine a current market price for each interest rate contract. These valuations are classified as Level 2 measurements.
Loans held for sale - The Company has elected to apply the fair value option for single family real estate mortgage loans originated for resale in the secondary market. The election allows for a more effective offset of the changes in fair values of the loans and the derivative instruments used to economically hedge them without the burden of complying with the requirements for hedge accounting. The Company has not elected the fair value option for other loans held for sale primarily because they are not economically hedged using derivative instruments.
The fair value of loans held for sale is based on what secondary markets are currently offering for portfolios with similar characteristics. The changes in fair value of these assets are largely driven by changes in interest rates subsequent to loan funding and changes in the fair value of servicing associated with the mortgage loan held for sale. Both the mortgage loans held for sale and the related forward contracts are classified as Level 2 measurements.
At both December 31, 2019 and 2018, no loans held for sale for which the fair value option was elected were 90 days or more past due or were in nonaccrual. Interest income on mortgage loans held for sale is recognized based on contractual rates and is reflected in interest and fees on loans in the Consolidated Statements of Income. Net gains (losses) of $999 thousand, $596 thousand and $748 thousand resulting from changes in fair value of these loans were recorded in noninterest income during the years ended December 31, 2019, 2018, and 2017, respectively.
The Company also had fair value changes on forward contracts related to residential mortgage loans held for sale of approximately $469 thousand, $(790) thousand and $(2.0) million for the years ended December 31, 2019, 2018, and 2017, respectively. An immaterial portion of these amounts was attributable to changes in instrument-specific credit risk.
The following tables summarize the difference between the aggregate fair value and the aggregate unpaid principal balance for residential mortgage loans measured at fair value.
Derivative assets and liabilities - Derivative assets and liabilities are measured using models that primarily use market observable inputs, such as quoted security prices, and are accordingly classified as Level 2. The derivative assets and liabilities classified within Level 3 of the fair value hierarchy were comprised of interest rate lock commitments that are valued using third-party software that calculates fair market value considering current quoted TBA and other market based prices and then applies closing ratio assumptions based on software-produced pull through ratios that are generated using the Company’s historical fallout activity. Based upon this process, the fair value measurement obtained for these financial instruments is deemed a Level 3 classification. The Company's Secondary Marketing Committee is responsible for the appropriate application of the valuation policies and procedures surrounding the Company’s interest rate lock commitments. Policies established to govern mortgage pipeline risk management activities must be approved by the Company’s Asset Liability Committee on an annual basis.
Other assets - equity securities - A component of other assets measured at fair value on a recurring basis are mutual funds and U.S. government agency equity securities. Mutual funds are valued based on quoted market prices of identical assets trading on active exchanges. These valuations are Level 1 measurements. U.S. government agency equity securities are valued based on quoted market prices of identical assets trading on active exchanges. These valuations thus qualify as Level 1 measurements.
Other assets - MSR - A component of other assets measured at fair value on a recurring basis and classified within Level 3 of the fair value hierarchy are MSRs that are valued through a discounted cash flow analysis using a third-party commercial valuation system. The MSR valuation takes into consideration the objective characteristics of the MSR portfolio, such as loan amount, note rate, service fee, loan term, and common industry assumptions, such as servicing costs, ancillary income, prepayment estimates, earning rates, cost of fund rates, option-adjusted spreads, etc. The Company’s portfolio-specific factors are also considered in calculating the fair value of MSRs to the extent one can reasonably assume a buyer would also incorporate these factors. Examples of such factors are geographical concentrations of the portfolio, liquidity consideration, or additional views of risk not inherently accounted for in prepayment assumptions. Product liquidity and these other risks are generally incorporated through adjustment of discount factors applied to forecasted cash flows. Based on this method of pricing MSRs, the fair value measurement obtained for these financial instruments is deemed a Level 3 classification.
The value of the MSR is calculated by a third-party firm that specializes in the MSR market and valuation services. Additionally, the Company obtains a valuation from an independent party to compare for reasonableness. The Company’s Secondary Marketing Committee is responsible for ensuring the appropriate application of valuation, capitalization, and fair value decay policies for the MSR portfolio. The Committee meets at least monthly to review the MSR portfolio.
Other assets - SBIC - A component of other assets measured at fair value on a recurring basis and classified within Level 3 of the fair value hierarchy are SBIC investments. The SBIC investments are valued initially based upon transaction price. Valuation factors such as recent or proposed purchase or sale of debt or equity of the issuer, pricing by other dealers in similar securities, size of position held, liquidity of the market, and changes in economic conditions affecting the issuer, are used in the determination of estimated fair value.
The following tables summarize the financial assets and liabilities measured at fair value on a recurring basis.
There were no transfers between Levels 1 or 2 of the fair value hierarchy for the years ended December 31, 2019 and 2018. It is the Company’s policy to value any transfers between levels of the fair value hierarchy based on end of period fair values.
The following table reconciles the assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3).
(1)
Included in noninterest income in the Consolidated Statements of Income.
Assets Measured at Fair Value on a Nonrecurring Basis
Periodically, certain assets may be recorded at fair value on a non-recurring basis. These adjustments to fair value usually result from the application of lower of cost or fair value accounting or write-downs of individual assets due to impairment. The following table represents those assets that were subject to fair value adjustments during the years ended December 31, 2019 and 2018 and still held as of the end of the year, and the related losses from fair value adjustments on assets sold during the year as well as assets still held as of the end of the year.
(1)
Total gains (losses) represent charge-offs on impaired loans for which adjustments are based on the appraised value of the collateral.
The following is a description of the methodologies applied for valuing these assets:
Debt securities held to maturity - Nonrecurring fair value adjustments on debt securities held to maturity reflect impairment write-downs which the Company believes are other than temporary. For analyzing these securities, the Company has retained a third-party valuation firm. Impairment is determined through the use of cash flow models that estimate cash flows on the underlying mortgages using security-specific collateral and the transaction structure. The cash flow models incorporate the remaining cash flows which are adjusted for future expected credit losses. Future expected credit losses are determined by using various assumptions such as current default rates, prepayment rates, and loss severities. The Company develops these assumptions through the use of market data published by third-party sources in addition to historical analysis which includes actual delinquency and default information through the current period. The expected cash flows are then discounted at the interest rate used to recognize interest income on the security to arrive at a present value amount. As the fair value assessments are derived using a discounted cash flow modeling approach, the nonrecurring fair value adjustments are classified as Level 3 measurements.
Impaired Loans - Impaired loans measured at fair value on a non-recurring basis represent the carrying value of impaired loans for which adjustments are based on the appraised value of the collateral. Nonrecurring fair value adjustments to impaired loans reflect full or partial write-downs that are generally based on the fair value of the underlying collateral supporting the loan. Loans subjected to nonrecurring fair value adjustments based on the current estimated fair value of the collateral are classified as Level 3 measurements.
OREO - OREO is recorded at the lower of recorded balance or fair value, which is based on appraisals and third-party price opinions, less estimated costs to sell. The fair value is classified as Level 3 measurements.
The tables below present quantitative information about the significant unobservable inputs for material assets and liabilities measured at fair value using significant unobservable inputs (Level 3) on a recurring and nonrecurring basis.
(1)
Represents discounts to appraised value for estimated costs to sell.
(1)
Represents discounts to appraised value for estimated costs to sell.
The following provides a description of the sensitivity of the valuation technique to changes in unobservable inputs for recurring fair value measurements.
Recurring Fair Value Measurements Using Significant Unobservable Inputs
Interest Rate Contracts - Interest Rate Lock Commitments
Significant unobservable inputs used in the valuation of interest rate contracts are pull-through and cap grids. Increases or decreases in the pull-through or cap grids will have a corresponding impact in the value of interest rate contracts.
Other Assets - MSRs
The significant unobservable inputs used in the fair value measurement of MSRs are option-adjusted spreads, constant prepayment rate or life speed, and cost to service assumptions. The impact of prepayments and changes in the option-adjusted spread are based on a variety of underlying inputs. Increases or decreases to the underlying cash flow inputs will have a corresponding impact on the value of the MSR asset. The impact of the costs to service assumption will have a directionally opposite change in the fair value of the MSR asset.
Other Assets - SBIC Investments
The significant unobservable inputs used in the fair value measurement of SBIC Investments are initially based upon transaction price. Increases or decreases in valuation factors such as recent or proposed purchase or sale of debt or equity of the issuer, pricing by other dealers in similar securities, size of position held, liquidity of the market will have a corresponding impact in the value of SBIC investments.
Fair Value of Financial Instruments
The carrying amounts and estimated fair values, as well as the level within the fair value hierarchy, of the Company’s financial instruments are as follows:
(20) Supplemental Disclosure for Statement of Cash Flows
The following table presents the Company’s noncash investing and financing activities.
The following table provides a reconciliation of cash, cash equivalents and restricted cash reported within the Company’s Consolidated Balance Sheets that sum to the total of the same such amounts shown in the Company's Consolidated Statements of Cash Flows.
Restricted cash primarily represents cash collateral related to the Company's derivatives as well as amounts restricted for regulatory purposes related to BSI and BBVA Transfer Holdings, Inc. Restricted cash is included in other assets on the Company’s Consolidated Balance Sheets.
(21) Segment Information
The Company's operating segments are based on the Company's lines of business. Each line of business is a strategic unit that serves a particular group of customers with certain common characteristics by offering various products and services. The segment results include certain overhead allocations and intercompany transactions. All intercompany transactions have been eliminated to determine the consolidated balances. The Company operates primarily in the United States, and, accordingly, the geographic distribution of revenue and assets is not significant. There are no individual customers whose revenues exceeded 10% of consolidated revenue.
At December 31, 2019, the Company’s operating segments consisted of Commercial Banking and Wealth, Retail Banking, Corporate and Investment Banking, and Treasury.
The Commercial Banking and Wealth segment serves the Company’s commercial customers through its wide array of banking and investment services to businesses in the Company’s markets. The segment also provides private banking and wealth management services to high net worth individuals, including specialized investment portfolio management, traditional credit products, traditional trust and estate services, investment advisory services, financial counseling and customized services to companies and their employees. The Commercial Banking and Wealth segment also supports its commercial customers with capabilities in treasury management, accounts receivable purchasing, asset-based lending, international services, as well as insurance and interest rate protection and investment products. The Commercial Banking and Wealth segment is also responsible for the Company's small business customers and indirect automobile portfolio.
The Retail Banking segment serves the Company’s consumer customers through its full-service banking centers, private client offices throughout the U.S., and alternative delivery channels such as internet, mobile, ATMs and telephone banking. The Retail Banking segment provides individuals with comprehensive products and services including home mortgages, consumer loans, credit and debit cards, and deposit accounts.
The Corporate and Investment Banking segment is responsible for providing a wide array of banking and investment services to corporate and institutional clients. In addition to traditional credit and deposit products, the Corporate and Investment Banking segment also supports its customers with capabilities in treasury management, accounts receivable purchasing, asset-based lending, foreign-exchange and international services, and interest rate protection and investment products.
The Treasury segment's primary function is to manage the liquidity and funding positions of the Company, the interest rate sensitivity of the Company's balance sheet and the investment securities portfolio.
Corporate Support and Other includes activities that are not directly attributable to the operating segments, such as, the activities of the Parent and corporate support functions that are not directly attributable to a strategic business segment, as well as the elimination of intercompany transactions. Goodwill impairment is also presented within Corporate Support and Other as the Company does not allocate goodwill impairment to the related segments in the Company's internal profitability reporting system. Corporate Support and Other also includes the activities associated with Simple.
The following table presents the segment information for the Company’s segments.
Results of the Company’s business segments are based on the Company’s lines of business and internal management accounting policies that have been developed to reflect the underlying economics of the business.
The financial information presented was derived from the internal profitability reporting system used by management to monitor and manage the financial performance of the Company. This information is based on internal management accounting policies that have been developed to reflect the underlying economics of the businesses. These policies address the methodologies applied and include policies related to funds transfer pricing, cost allocations and capital allocations.
Funds transfer pricing was used in the determination of net interest income earned primarily on loans and deposits. The method employed for funds transfer pricing is a matched funding concept whereby lines of business which are fund providers are credited and those that are fund users are charged based on maturity, prepayment and/or repricing characteristics applied on an instrument level. Provision for loan losses is allocated to each segment based on internal management accounting policies for the allowance for loan losses and the related provision which differs from the policies for consolidated purposes. The difference between the consolidated provision for loan losses and the segments'
provision for loan losses is reflected in Corporate Support and Other. Costs for centrally managed operations are generally allocated to the lines of business based on the utilization of services provided or other appropriate indicators. Revenue is recorded in the business segment responsible for the related product or service. Fee sharing is recorded to allocate portions of such revenue to other business segments involved in selling to, or providing services to, customers. Results of operations for the business segments reflect these fee sharing allocations. Capital is allocated to the lines of business based upon the underlying risks in each business considering economic and regulatory capital standards.
The development and application of these methodologies is a dynamic process. Accordingly, prior period financial results have been revised to reflect management accounting enhancements and changes in the Company's organizational structure. Unless noted otherwise, the 2018 and 2017 segment information has been revised to conform to the 2019 presentation. In addition, unlike financial accounting, there is no authoritative literature for management accounting similar to U.S. GAAP. Consequently, reported results are not necessarily comparable with those presented by other financial institutions.
(22) Revenue from Contracts with Customers
The following tables depict the disaggregation of revenue according to revenue type and segment.
(1) Other revenues primarily relate to revenues not derived from contracts with customers.
(1) Other revenues primarily relate to revenues not derived from contracts with customers.
(1) Other revenues primarily relate to revenues not derived from contracts with customers.
(23) Parent Company Financial Statements
The condensed financial information for BBVA USA Bancshares, Inc. (Parent company only) is presented as follows:
(1)
See Consolidated Statement of Comprehensive Income detail.
(24) Related Party Transactions
The Company enters into various contracts with BBVA that affect the Company’s business and operations. The following discloses the significant transactions between the Company and BBVA during 2019, 2018 and 2017.
The Company believes all of the transactions entered into between the Company and BBVA were transacted on terms that were no more or less beneficial to the Company than similar transactions entered into with unrelated market participants, including interest rates and transaction costs. The Company foresees executing similar transactions with BBVA in the future.
Derivatives
The Company has entered into various derivative contracts as noted below with BBVA as the upstream counterparty. The total notional amount of outstanding derivative contracts between the Company and BBVA are $3.4 billion and $4.1 billion as of December 31, 2019 and 2018, respectively. The net fair value of outstanding derivative contracts between the Company and BBVA are detailed below.
Securities Purchased Under Agreements to Resell/Securities Sold Under Agreements to Repurchase
The Company enters into agreements with BBVA as the counterparty under which it purchases/sells securities subject to an obligation to resell/repurchase the same or similar securities. The following represents the amount of securities purchased under agreements to resell and securities sold under agreements to repurchase where BBVA is the counterparty.
Borrowings
BSI, a wholly owned subsidiary of the Company, had a $420 million revolving note and cash subordination agreement with BBVA that was executed on March 16, 2012 with an original maturity date of March 16, 2018. On March 16, 2017, the agreement was amended to increase the available amount to $450 million and the maturity date was extended to March 16, 2023. BSI also had a $150 million line of credit with BBVA that was initiated on August 1, 2014. This agreement was terminated on July 13, 2017. On March 16, 2017, BSI entered into an uncommitted demand facility agreement with BBVA for a revolving loan facility up to $1 billion to be used for trade settlement purposes. BSI has not drawn against this facility in 2019. At both December 31, 2019 and December 31, 2018 there was no amount outstanding under the revolving note and cash subordination agreement. Interest expense related to these agreements was $50 thousand, $309 thousand, and $931 thousand for the years ended December 31, 2019, 2018 and 2017, respectively, and are included in interest on other short term borrowings within the Company's Consolidated Statements of Income.
Service and Referral Agreements
The Company and its affiliates entered into or were subject to various service and referral agreements with BBVA and its affiliates. Each of the agreements was done in the ordinary course of business and on market terms. Income associated with these agreements was $30.1 million, $49.7 million, and $45.0 million for the years ended December 31, 2019, 2018 and 2017, respectively, and is recorded as a component of noninterest income within the Company's Consolidated Statements of Income. Expenses associated with these agreements were $38.6 million, $31.5 million, and $28.5 million for the years ended December 31, 2019, 2018 and 2017, respectively, and are recorded as a component of noninterest expense within the Company's Consolidated Statements of Income.
Series A Preferred Stock
BBVA is the sole holder of the Series A Preferred Stock that the Company issued in December 2015. At both December 31, 2019 and 2018, the carrying amount of the Series A Preferred Stock was approximately $229 million. During the years ended December 31, 2019 and 2018, the Company paid $18.0 million and $17.0 million, respectively, of preferred stock dividends to BBVA.
Loan Sales to Related Parties
During the year ended December 31, 2019 the Company transferred to loans held for sale and subsequently sold $1.2 billion of commercial loans to BBVA, S.A. New York Branch. The Company recognized a gain on the sale of these loans of $778 thousand.
During the year ended December 31, 2018, the Company sold, without recourse, loans of approximately $165 million to BBVA, S.A. New York Branch. The sale resulted in no gain or loss.
Item 9.
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not Applicable.
Item 9A.
Item 9A. Controls and Procedures
Disclosure Controls and Procedures.
The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company’s reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
Management of the Company, with the participation of its Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures. Based on their evaluation, as of the end of the period covered by this Annual Report on Form 10-K, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) were effective.
Management’s Report on Internal Control Over Financial Reporting.
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Exchange Act Rule 13a-15(f).
The Company’s internal control over financial reporting is a process affected by those charged with governance, management, and other personnel designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. The Company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.
Because of inherent limitations in any internal control, no matter how well designed, misstatements due to error or fraud may occur and not be detected, including the possibility of the circumvention or overriding of controls. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2019 based on the framework set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework (2013). Based on that assessment, management concluded that, as of December 31, 2019, the Company’s internal control over financial reporting is effective based on the criteria established in Internal Control - Integrated Framework (2013).
KPMG LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K and has issued a report on the effectiveness of our internal control over financial reporting, which report is included in "Part II - Item 8. Financial Statements and Supplementary Data" of this Report.
Changes In Internal Control Over Financial Reporting.
There have been no changes in the Company’s internal controls over financial reporting during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Item 9B.
Item 9B. Other Information
Not Applicable.
Part III
Item 10.
Item 10.
Directors, Executive Officers and Corporate Governance
Information for this item is not required as the Company is filing this Annual Report on Form 10-K with a reduced disclosure format. See "Explanatory Note."
Item 11.
Item 11.
Executive Compensation
Information for this item is not required as the Company is filing this Annual Report on Form 10-K with a reduced disclosure format. See "Explanatory Note."
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information for this item is not required as the Company is filing this Annual Report on Form 10-K with a reduced disclosure format. See "Explanatory Note."
Item 13.
Item 13.
Certain Relationships and Related Transactions, and Director Independence
Information for this item is not required as the Company is filing this Annual Report on Form 10-K with a reduced disclosure format. See "Explanatory Note."
Item 14.
Item 14.
Principal Accounting Fees and Services
For the years ended December 31, 2019 and 2018, professional services were performed by KPMG, LLP. The following table sets forth the aggregate fees paid to KPMG LLP by the Company.
(1)
Audit fees are fees for professional services rendered for audits of the Company's financial statements, SEC regulatory filings, and services that are normally provided by KPMG LLP in connection with statutory and regulatory filings or engagements.
(2)
Audit related fees generally include fees associated with reports pursuant to service organization examinations, employee benefit plan audits, and other compliance reports.
(3)
Tax fees include fees associated with tax compliance services, tax advice and tax planning.
Pre-approval of Services by the Independent Registered Public Accounting Firm
Under the terms of its charter, the Audit and Compliance Committee of the Board of Directors (the “Audit Committee”) must approve all audit services and permitted non-audit services to be provided by the independent registered public accounting firm for the Company, either before the firm is engaged to render such services or pursuant to pre-approval policies and procedures established by the Audit Committee, subject to a de minimis exception for non-audit services that are approved by the Audit Committee prior to the completion of the audit and otherwise in accordance with the terms of applicable SEC rules. The de minimis exception waives the pre-approval requirements for non-audit services provided that such services: (1) do not aggregate to more than five percent of total revenues paid by the Corporation to its independent registered public accountant in the fiscal year when services are provided, (2) were not recognized as non-audit services at the time of the engagement, and (3) are promptly brought to the attention of the Audit Committee and approved prior to the completion of the audit by the Audit Committee or one or more designated representatives. Between meetings of the Audit Committee, the authority to pre-approve such services is delegated to the Chairperson of the Audit Committee. The Audit Committee may also delegate to one or more of its members the authority to grant pre-approvals of such services. The decisions of the Chairperson or any designee to pre-approve any audit or permitted non-audit service must be presented to the Audit Committee at its next scheduled meeting.
Part IV
Item 15.
Item 15.
Exhibits, Financial Statement Schedules
(1)
Financial Statements
See Item 8.
(2)
Financial Statement Schedules
None
(3)
Exhibits
See the Exhibit Index below.
Certain instruments defining rights of holders of long-term debt of the Company and its subsidiaries constituting less than 10% of the Company’s total assets are not filed herewith pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K. At the SEC’s request, the Company agrees to furnish the SEC a copy of any such agreement.
Item 16.
10-K Summary
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: February 28, 2020
BBVA USA Bancshares, Inc.
By:
/s/ Kirk P. Pressley
Name:
Kirk P. Pressley
Title:
Senior Executive Vice President, Chief Financial Officer and Duly Authorized Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.