ITEM 1.
BUSINESS
GENERAL
Community West Bancshares, a California corporation, is a bank holding company registered under the Bank Holding Company Act of 1956, as amended, or “BHCA,” with corporate headquarters in Goleta, California. CWBC’s common stock is listed on Nasdaq under the trading symbol “CWBC”. CWBC’s principal business is to serve as the holding company for its wholly-owned subsidiary Community West Bank, N.A., a national banking association chartered by the Office of the Comptroller of the Currency (“OCC”). Through CWB, the Company provides a variety of financial products and services to customers through eight full-service branch offices in the cities of Goleta, Oxnard, San Luis Obispo, Santa Barbara, Santa Maria, Ventura, Paso Robles and Westlake Village, California.
PRODUCTS AND SERVICES
CWB is focused on relationship-based banking to small to medium-sized businesses and their owners, professional, high-net worth individuals, and non-profit organizations in the communities served by its branch offices. The products and services provided include deposit products such as checking accounts, savings accounts, money market accounts and fixed rate, fixed maturity certificates of deposits, cash management products, and lending products, including commercial, commercial real estate, agricultural and consumer loans.
Competition in our markets remains healthy. The Company continues to be competitive due to its focus on high quality customer service and our experienced relationship bankers who have strong relationships within the communities we serve.
Manufactured Housing
The Company has a financing program for manufactured housing to provide affordable home ownership. These loans are offered in approved mobile home parks throughout California primarily on or near the coast. The parks must meet specific criteria. The manufactured housing loans are secured by the manufactured home and are retained in the Company’s loan portfolio.
Agricultural Loans for Real Estate and Operating Lines
The Company has an agricultural lending program for agricultural land, agricultural operational lines, and agricultural term loans for crops, equipment and livestock. These loan products are partially guaranteed by the U.S. Department of Agriculture (“USDA”), the Farm Service Agency (“FSA”), and the USDA Business and Industry loan program. The FSA typically issues a 90% guarantee up to $1,776,000 (amount adjusted annually based on inflation) for up to 40 years.
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The Company also originates and sells loans to the secondary market through the Federal Agricultural Mortgage Corporation (“Farmer Mac”) program. Farmer Mac provides the Company with access to flexible, low-cost financing and effective risk management tools to help farm, ranch and rural utility customers.
Small Business Administration Lending
CWB has been a preferred lender/servicer of loans guaranteed by the Small Business Administration (“SBA”) since 1990. The Company originates SBA loans which can be sold into the secondary market. The Company continues to service these loans after sale and is required under the SBA programs to retain specified amounts. The primary SBA loan program that CWB offers is the Section 504 (“504”) program.
CWB also offers Business & Industry (“B & I”) loans. These loans are similar to the SBA product, except they are guaranteed by the U.S. Department of Agriculture. The maximum guaranteed amount is 80%. B&I loans are made to businesses in designated rural areas and are generally larger loans to larger businesses than the 7(a) loans. Similar to the SBA 7(a) product, they can be sold into the secondary market.
As a Preferred Lender, CWB has been delegated the loan approval, closing and most servicing and liquidation responsibility from the SBA.
Loans to One Borrower
Under federal law, the unsecured obligations of any one borrower to a national bank generally may not exceed 15% of the sum of the Bank’s unimpaired capital and unimpaired surplus, and the secured and unsecured obligations of any one borrower. CWB was approved to increase this lending limit under the OCC’s Special Lending Limits Program to 25%. This program ensures that national bank lending limits, such as CWB’s, would remain competitive with state-chartered banks. In addition, California state banking law generally limits the amount of funds that a state-chartered bank may lend to a single borrower to 15% of the bank’s capital for unsecured loans and 25% of the bank’s capital for secured loans, and considers real estate secured loans as “secured” for lending limits purposes.
Foreign Operations
The Company has no foreign operations. The Bank may provide loans, letters of credit and other trade-related services to commercial enterprises that conduct business outside the United States.
Customer Concentration
The Company does not have any customer relationships that individually account for 10% of consolidated or segment revenues, respectively.
COMPETITION
The financial services industry is highly competitive. Many of the Bank’s competitors are much larger in total assets and capitalization, have greater access to capital markets, have higher lending limits, and can offer a broader range of financial services than the Bank can offer and may have lower cost structures.
This increasingly competitive environment is primarily a result of long term changes in regulation that made mergers and geographic expansion easier; changes in technology and product delivery systems and web-based tools; the accelerating pace of consolidation among financial services providers; and the flight of deposit customers to perceived increased safety. We compete for customers related to loans and deposits and customers with other banks, credit unions, securities and brokerage companies, mortgage companies, insurance companies, finance companies, and other non-bank financial services providers. This strong competition for deposit and loan products directly affects the rates of those products and the terms on which they are offered to consumers.
Technological innovation continues to contribute to greater competition in domestic and international financial services markets.
Mergers between financial institutions have placed additional pressure on banks to consolidate their operations, reduce expenses and increase revenues to remain competitive. The competitive environment is also significantly impacted by federal and state legislation that makes it easier for non-bank financial institutions to compete with the Company.
EMPLOYEES
As of December 31, 2019, the Company had 133 full-time equivalent team members. The Company’s employees are not represented by a union or covered by a collective bargaining agreement. Management believes that its employee relations are good.
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GOVERNMENT POLICIES
The Company’s operations are affected by various state and federal legislative changes and by regulations and policies of various regulatory authorities, including those of the states in which it operates and the U.S. government. These laws, regulations and policies include, for example, statutory maximum legal lending rates, domestic monetary policies by the Board of Governors of the Federal Reserve System which impact interest rates, U.S. fiscal policy, anti-terrorism and money laundering legislation and capital adequacy and liquidity constraints imposed by bank regulatory agencies. Changes in these laws, regulations and policies may greatly affect our operations. See “Item 1A
ITEM 1A.
RISK FACTORS
Investing in our common stock involves various risks which are specific to the Company. Several of these risks and uncertainties, are discussed below and elsewhere in this Form 10-K. This listing should not be considered as all-inclusive. These factors represent risks and uncertainties that could have a material adverse effect on our business, results of operations and financial condition. Other risks that we do not know about now, or that we do not believe are significant, could negatively impact our business or the trading price of our securities. In addition to common business risks such as theft, loss of market share and disasters, the Company is subject to special types of risk due to the nature of its business. See additional discussions about credit, interest rate, market and litigation risks in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of this Form 10-K beginning on page 16 and additional information regarding legislative and regulatory risks in the “Supervision and Regulation” section beginning on page 38.
Risks Relating to the Bank and to the Business of Banking in General
Our business may be adversely affected by downturns in the national economy and in the economies in our market areas.
Substantially all of our loans are to businesses and individuals in the State of California. A decline in the economies of our local market areas of Santa Barbara, San Luis Obispo, and Ventura Counties in which we operate, and which we consider to be our primary market areas, could have a material adverse effect on our business, financial condition, results of operations and prospects.
While real estate values and unemployment rates remain stable, a deterioration in economic conditions in the market areas we serve could result in the following consequences, any of which could have a materially adverse impact on our business, financial condition and results of operations:
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loan delinquencies, problem assets and foreclosures may increase;
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the sale of foreclosed assets may slow;
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demand for our products and services may decline possibly resulting in a decrease in our total loans or assets;
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collateral for loans made could decline in value, exposing us to increased risk in our loans, reducing customers’ borrowing power, and reducing the value of assets and collateral associated with existing loans;
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the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to us; and
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the amount of our low-cost or non-interest bearing deposits may decrease and the composition of our deposits may be adversely affected.
A decline in local economic conditions may have a greater effect on our earnings and capital than on the earnings and capital of larger financial institutions whose real estate loans are geographically diverse. If we are required to liquidate a significant amount of collateral during a period of reduced real estate values, our financial condition and profitability could be adversely affected.
A return of recessionary conditions could result in increases in our level of non-performing loans and/or reduce demand for our products and services, which could have an adverse effect on our results of operations.
Economic conditions have remained stable since the end of the economic recession; and the current expansion has continued since June 2009. A return of recessionary conditions and/or negative developments in the domestic and international credit markets may significantly affect the markets in which we do business, the value of our loans and investments, and our ongoing operations, costs and profitability. Declines in real estate value and sales volumes and high unemployment levels may result in higher than expected loan delinquencies and a decline in demand for our products and services. These negative events may cause us to incur losses and may adversely affect our capital, liquidity and financial condition.
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Furthermore, the Board of Governors of the Federal Reserve System, in an attempt to help the overall economy, had among other things, kept interest rates low through its targeted federal funds rate and the purchase of U.S. Treasury and mortgage-backed securities. The Federal Reserve Board increased the federal funds rate by 25 basis points in December 2016, 75 basis points in 2017, and 100 basis points in 2018, and decreased the federal funds rate by 75 basis points in 2019 to help stimulate the economy. The potential for further changes in the federal funds rate exist in the near future. Market rates of interest tend to follow the federal funds rate, and decreasing rates tend to enhance borrowing and stimulate housing markets and the U.S. economic conditions.
Reserve for loan losses may not be adequate to cover actual loan losses.
The risk of nonpayment of loans is inherent in all lending activities, and nonpayment, if it occurs, may have an adverse effect on our financial condition and/or results of operations. The Company maintains a reserve for loan losses to absorb estimated probable losses inherent in the loan and commitment portfolios as of the balance sheet date. Provisions are taken from earnings and applied to the loan loss reserves as the risk of loss in the loan and commitment portfolios increases. Conversely, credits to earnings from the loan loss reserves are made when asset qualities improve resulting in a decrease in the risk of loss in the loan and commitment portfolios. As of December 31, 2019, the Company’s allowance for loan losses was $8.7 million, or 1.19% of loans held for investment. In addition, as of December 31, 2019, we had $2.7 million in loans on nonaccrual, $0.3 million of which are government guaranteed. In determining the level of the reserve for loan losses, Management makes various assumptions and judgments about the loan portfolio. Management relies on an analysis of the loan portfolio based on historical loss experience, volume and types of loans, trends in classifications, volume and trends in delinquencies and non-accruals, national and local economic conditions and other pertinent information known to Management at the time of the analysis. If Management’s assumptions are incorrect, the reserve for loan losses may not be sufficient to cover losses, which could have a material adverse effect on the Company’s financial condition and/or results of operations. While the allowance for loan losses was determined to be adequate at December 31, 2019, based on the information available to us at the time, there can be no assurance that the allowance will be adequate to cover actual losses in the loan portfolio in the future.
All of our lending involves underwriting risks.
Lending, even when secured by the assets of a business, involves considerable risk of loss in the event of failure of the business. To reduce such risk, the Company typically takes additional security interests in other collateral of the borrower, such as real property, certificates of deposit, life insurance, and/or obtains personal guarantees. Despite efforts to reduce risk of loss, additional measures may not prove sufficient as the value of the additional collateral or personal guarantees may be significantly reduced. There can be no assurances that collateral values will be sufficient to repay loans should borrowers become unable to repay loans in accordance with their original terms and, if not, the cumulative effect may have an adverse effect on our financial condition and/or results of operations.
The Company is dependent on real estate concentrated in the State of California.
As of December 31, 2019, approximately $479.6 million, or 62%, of our loan portfolio is secured by various forms of real estate, including residential and commercial real estate. A decline in current economic conditions or rising interest rates could have an adverse effect on the demand for new loans, the ability of borrowers to repay outstanding loans and the value of real estate and other collateral securing loans. The real estate securing our loan portfolio is concentrated in California. A decline in the real estate market could materially and adversely affect the business of CWB because a significant portion of its loans are secured by real estate. The ability to recover on defaulted loans by selling the real estate collateral would then be diminished and CWB would be more likely to suffer losses on loans. Substantially all of the real property collateral is located in California. If there is decline in real estate values, especially in California, the collateral for their loans would provide less security. Real estate values could be affected by, among other things, a decline of economic conditions, an increase in foreclosures, a decline in home sale volumes, an increase in interest rates, high levels of unemployment, drought, earthquakes, brush fires and other natural disasters particular to California.
We operate in a highly regulated industry and the laws and regulations that govern our operations, corporate governance, executive compensation and financial accounting or reporting, including changes in them, or our failure to comply with them, may adversely affect us.
The Company is subject to extensive regulation and supervision that govern almost all aspects of its operations. Intended to protect customers, depositors, consumers, deposit insurance funds and the stability of the U.S. financial system, these laws and regulations, among other matters, prescribe minimum capital requirements, impose limitations on our business activities, limit the dividend or distributions that the Company can pay, restrict the ability of institutions to guarantee the Company’s debt and impose certain specific accounting requirements that may be more restrictive and may result in greater or earlier charges to earnings or reductions in our capital than accounting principles generally accepted in the United States (“GAAP”). Compliance with laws and regulations can be difficult and costly and changes to laws and regulations often impose additional compliance costs. We are currently facing increased regulation and supervision of our industry. Such additional regulation and supervision may increase our costs and limit our ability to pursue business opportunities. Further, our failure to comply with these laws and regulations, even if the failure was inadvertent or reflects a difference in interpretation, could subject us to restrictions on our business activities, fines and other penalties, any of which could adversely affect our results of operations, capital base and the price of our securities. Further, any new laws, rules and regulations could make compliance more difficult or expensive or otherwise adversely affect our business and financial condition.
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We are periodically subject to examination and scrutiny by a number of banking agencies and, depending upon the findings and determinations of these agencies, we may be required to make adjustments to our business that could adversely affect us.
Federal banking agencies periodically conduct examinations of our business, including compliance with applicable laws and regulations. If, as a result of an examination, a federal banking agency were to determine that the financial condition, capital resources, asset quality, asset concentration, earnings prospects, management, liquidity sensitivity to market risk or other aspects of any of our operations has become unsatisfactory, or that we or our management is in violation of any law or regulation, it could take a number of different remedial actions as it deems appropriate. These actions include the power to enjoin “unsafe or unsound” practices, to require affirmative actions to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in our capital, to restrict our growth, to change the asset composition of our portfolio or balance sheet, to assess civil monetary penalties against our officers or directors, to remove officers and directors and, if it is concluded that such conditions cannot be corrected or there is an imminent risk of loss to depositors, to terminate our deposit insurance. If we become subject to such regulatory actions, our business, results of operations and reputation may be negatively impacted.
CWBC is subject to regulation and supervision by the FRB and CWB is subject to supervision and regulation by the OCC with applicable laws and regulations governing the types, amounts and terms of investments and loans we make, disclosures of products and services we offer to our customers, the levels of capital we must maintain, and the rates of interest we may pay. Those regulations continuously change and may increase our costs of doing business and reduce or limit our ability to pursue or affect our business. While legislation enacted in 2018 was designed to reduce some of the obligations imposed by the Dodd-Frank Act, no assurances can be given that such modifications will be implemented and that future changes in applicable laws and regulations would not impose regulatory restrictions resulting in a negative impact on CWBC. For further discussion, see “SUPERVISION AND REGULATION” herein.
The short-term and long-term impact of the regulatory capital standards and the capital rules is uncertain.
The federal banking agencies revised capital guidelines to reflect the requirements of the Dodd-Frank Act and to effect the implementation of the Basel III Accords. The quantitative measures, established by the regulators to ensure capital adequacy, require that a bank holding company maintain minimum ratios of capital to risk-weighted assets. Various provisions of the Dodd-Frank Act increase the capital requirements of bank holding companies, such as the Company, and non-bank financial companies that are supervised by the Federal Reserve. For a further discussion of the capital rules, see “SUPERVISION AND REGULATION” herein.
Curtailment of government guaranteed loan programs could affect a segment of the Company’s business.
A segment of our business consists of originating and periodically selling government guaranteed loans, in particular those guaranteed by the USDA and the SBA. From time to time, the government agencies that guarantee these loans reach their internal limits and cease to guarantee loans. In addition, these agencies may change their rules for loans or Congress may adopt legislation that would have the effect of discontinuing or changing the loan programs. Non-governmental programs could replace government programs for some borrowers, but the terms might not be equally acceptable. Therefore, if these changes occur, the volume of loans to small business, industrial and agricultural borrowers of the types that now qualify for government guaranteed loans could decline. Also, the profitability of these loans could decline.
Small business customers may lack the resources to weather a downturn in the economy.
One of the primary focal points of our business development and marketing strategy is serving the banking and financial services needs of small to medium-sized businesses and professional organizations. Small businesses generally have fewer financial resources in terms of capital or borrowing capacity than do larger entities. If economic conditions are generally unfavorable in the Company’s service areas, the businesses of the Company’s lending clients and their ability to repay outstanding loans may be negatively affected. As a consequence, the Company’s results of operations and financial condition may be adversely affected.
CWBC and CWB have liquidity risk.
Liquidity risk is the risk that CWBC and CWB will have insufficient cash or access to cash to satisfy current and future financial obligations, including demands for loans and deposit withdrawals, funding operating costs, and for other corporate purposes. An inability to raise funds through deposits, borrowings, the sale of loans and other sources could have a material adverse effect on liquidity. Access to funding sources in amounts adequate to finance business activities could be impaired by factors that affect either entity specifically or the financial services industry in general. Factors that could detrimentally impact access to liquidity sources include a decrease in the level of business activity due to a market downturn or adverse regulatory action against either entity. The ability of CWB to acquire deposits or borrow could also be impaired by factors that are not specific to CWB, such as a severe disruption of the financial markets or negative views and expectations about the prospects for the financial services industry as a whole. CWB mitigates liquidity risk by establishing and accessing lines of credit with various financial institutions and having back-up access to the brokered Certificate of Deposits “CD’s” markets. Results of operations could be adversely affected if either entity were unable to satisfy current or future financial obligations.
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As a legal entity, separate and distinct from the Bank, CWBC must rely on its own resources to pay its operating expenses and dividends to its shareholders. In addition to raising capital on its own behalf or borrowing from external sources, CWBC may also obtain funds from dividends paid by, and fees charged for services provided to, the Bank. However, statutory and regulatory constraints on the Bank may restrict or totally preclude the payment of dividends by the Bank to CWBC, thereby negatively impacting its separate liquidity.
From time to time, the Company has been dependent on borrowings from the FHLB and, infrequently, the FRB, and there can be no assurance these programs will be available as needed.
As of December 31, 2019, the Company has borrowings from the FHLB of San Francisco of $65.0 million and no borrowings from the FRB. The Company in the recent past has been reliant on such borrowings to satisfy its liquidity needs. The Company’s borrowing capacity is generally dependent on the value of the Company’s collateral pledged to these entities. These lenders could reduce the borrowing capacity of the Company or eliminate certain types of collateral and could otherwise modify or even terminate their loan programs. Any change or termination could have an adverse effect on the Company’s liquidity and profitability.
The Company is exposed to risk of environmental liabilities with respect to properties to which we obtain title.
Approximately 62% of the Company’s loan portfolio at December 31, 2019 was secured by real estate. In the course of our business, the Company may foreclose and take title to real estate, and could be subject to environmental liabilities with respect to these properties. The Company may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clean up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. In addition, if the Company is the owner or former owner of a contaminated site, it may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. These costs and claims could adversely affect the Company’s business and prospects.
Changes in interest rates could adversely affect the Company’s profitability, business and prospects.
Most of the Company’s assets and liabilities are monetary in nature, which subjects it to significant risks from changes in interest rates and can impact the Company’s net income and the valuation of its assets and liabilities. Increases or decreases in prevailing interest rates could have an adverse effect on the Company’s business, asset quality and prospects. The Company’s operating income and net income depend to a great extent on it’s net interest margin. Net interest margin is the difference between the interest yields received on loans, securities and other earning assets and the interest rates paid on interest-bearing deposits, borrowings and other liabilities. These rates are highly sensitive to many factors beyond the Company’s control, including competition, general economic conditions and monetary and fiscal policies of various governmental and regulatory authorities, including the Federal Reserve. If the rate of interest paid on interest-bearing deposits, borrowings and other liabilities increases more than the rate of interest received on loans, securities and other earning assets increases, the Company’s net interest income, and therefore earnings, would be adversely affected. The Company’s earnings also could be adversely affected if the rates on its loans and other investments fall more quickly than those on its deposits and other liabilities.
In addition, loan volumes are affected by market interest rates on loans. Rising interest rates generally are associated with a lower volume of loan originations while lower interest rates are usually associated with higher loan originations. Conversely, in rising interest rate environments, loan repayment rates will decline and in falling interest rate environments, loan repayment rates will increase. The Company cannot guarantee that it will be able to minimize interest rate risk. In addition, an increase in the general level of interest rates may adversely affect the ability of certain borrowers to pay the interest on and principal of their debt obligations.
Interest rates also affect how much money the Company can lend. When interest rates rise, the cost of borrowing increases. Accordingly, changes in market interest rates could materially and adversely affect the Company’s net interest spread, asset quality, loan origination volume, business, financial condition, results of operations and cash flows.
The Company’s future success will depend on our ability to compete effectively in a highly competitive market.
The Company faces substantial competition in all phases of its operations from a variety of different competitors. Its competitors, including commercial banks, community banks, savings and loan associations, mutual savings banks, credit unions, consumer finance companies, insurance companies, securities dealers, brokers, mortgage bankers, investment advisors, money market mutual funds, online banks, and other financial institutions, compete with lending and deposit-gathering services offered by the Company. Increased competition in the Company’s markets may result in reduced loans and deposits.
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There is very strong competition for financial services in the market areas in which we conduct our businesses from many local commercial banks as well as numerous national commercial banks and regionally based commercial banks. Many of these competing institutions have much greater financial and marketing resources than we have. Due to their size, many competitors can achieve larger economies of scale and may offer a broader range of products and services than us. If we are unable to offer competitive products and services, our business may be negatively affected.
In order to remain competitive in our industry and provide our customers with the latest products and services, we must be able to keep up with the changes in technology. Many of the financial institutions and the financial technology companies with which we compete have greater resources than we do to develop and implement the technology-driven products and our failure to keep pace with these changes could have an adverse effect on our customer relations and, in turn, our financial condition and results of operations.
Some of the financial services organizations with which we compete are not subject to the same degree of regulation as is imposed on bank holding companies and federally insured depository institutions. As a result, these non-bank competitors have certain advantages over us in accessing funding and in providing various services. The banking business in our primary market areas is very competitive, and the level of competition facing us may increase further, which may limit our asset growth and financial results.
If we fail to maintain proper and effective internal controls, our ability to produce accurate financial statements on a timely basis could be impaired, which could result in a loss of investor confidence in our financial reports and have an adverse effect on our stock price.
The Company is responsible for establishing and maintaining adequate internal control over financial reporting to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles, or GAAP. If we are unable to maintain adequate internal control over financial reporting, we might be unable to report our financial information on a timely basis and might suffer adverse regulatory consequences or violate Nasdaq listing standards. There could also be a negative reaction in the financial markets due to a loss of investor confidence in us and the reliability of our financial statements. We have in the past and may in the future discover areas of our internal financial and accounting controls and procedures that need improvement. Our internal control conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system will be met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company will be detected. If we are unable to maintain proper and effective internal controls, we may not be able to produce accurate financial statements on a timely basis, which could adversely affect our ability to operate our business, which could result in regulatory action and which could require us to restate our financial statements. Any such restatement could result in a loss of public confidence in the reliability of our financial statements and sanctions imposed on us by the SEC.
Changes in accounting standards or inaccurate estimates or assumptions in the application of accounting policies could adversely affect our financial condition and results of operations.
Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. Some of these policies require use of estimates and assumptions that may affect the reported value of our assets or liabilities and results of operations and are critical because they require management to make difficult, subjective and complex judgments about matters that are inherently uncertain. If those assumptions, estimates or judgments were incorrectly made, we could be required to correct and restate prior period financial statements. Accounting standard-setters and those who interpret the accounting standards (such as the Financial Accounting Standards Board, the SEC, banking regulators and our independent registered public accounting firm) may also amend or even reverse their previous interpretations or positions on how various standards should be applied. These changes can be difficult to predict and can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new revised standard retroactively, resulting in the need to revise and republish prior period financial statements.
One recent change is ASU 2016-13, which was released by the Financial Accounting Standards Board in 2016 and must be adopted by the Company by no later than January 1, 2023. Currently, the impairment model used by financial institutions to assess the adequacy of the reserve for loan losses is based on incurred losses, and loans are recognized as impaired when there is no longer an assumption that future cash flows will be collected in full under the originally contracted terms. This model will be replaced by the current expected credit loss (“CECL”) model, in which financial institutions will be required to use historical information, current conditions and reasonable forecasts to estimate the expected loss over the life of the loan. The transition to the CECL model will necessitate significantly greater data requirements and changes to methodologies to accurately account for expected losses over the life of a loan. There can be no assurance that we will not be required to increase reserves and the allowance for loan losses as a result of the implementation of CECL. Increased provisions for loan losses may adversely affect the results of operations and our financial condition.
Natural disasters, severe weather terrorist attacks and threats of war or actual war may impact all aspects of our operations, revenues, costs and stock price in unpredictable ways
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In the last few years, California has experienced extensive wildfires that have burned millions of acres, destroyed thousands of homes and commercial properties, and resulted in the loss of life not only in California generally but also directly in our market area. Such natural disasters sometimes were followed by significant rains resulting in further loss of property. Also in recent years, California has experienced a drought and while above average rainfall in early 2019 has improved those conditions, drought conditions could reappear which could negatively affect our customers. As of December 31, 2019, CWB had $69.8 million of agricultural loans. The occurrence of severe weather conditions and the resulting disasters cannot be predicted with any certainty and a substantial portion of our customers businesses and residences are located in areas susceptible to such events as earthquakes, floods, droughts and wildfires. The occurrence of such events could adversely impact our customers’ and their businesses and ability to repay their loans all of which could have a material adverse effect on CWBC.
The business may be adversely affected by internet fraud.
The Company is inherently exposed to many types of operational risk, including those caused by the use of computer, internet and telecommunications systems. These risks may manifest themselves in the form of fraud by employees, by customers, other outside entities targeting us and/or our customers that use our internet banking, electronic banking or some other form of our telecommunications systems. Given the growing level of use of electronic, internet-based, and networked systems to conduct business directly or indirectly with our clients, certain fraud losses may not be avoidable regardless of the preventative and detection systems in place, which losses could adversely affect the Company and its financial condition.
We may experience interruptions or breaches in our information system security.
We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in the security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan and other systems. While we have policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of these information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of these information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.
A failure in or breach of our operational or security systems or infrastructure, or those of our third party vendors and other service providers, including as a result of cyber attacks, could disrupt our businesses, result in the disclosure or misuse of confidential or proprietary information, damage our reputation, increase our costs and cause losses
As a financial institution, we are susceptible to fraudulent activity that may be committed against us or our clients, which may result in financial losses to us or our clients, privacy breaches against our clients, or damage to our reputation. Such fraudulent activity may take many forms, including check fraud, electronic fraud, wire fraud, phishing, and other dishonest acts. In recent periods, there has been a rise in electronic fraudulent activity within the financial services industry, especially in the commercial banking sector, due to cyber criminals targeting commercial bank accounts. Consistent with industry trends, we have also experienced an increase in attempted electronic fraudulent activity in recent periods.
In addition, our operations rely on the secure processing, storage and transmission of confidential and other information on our computer systems and networks. Although we take numerous protective measures to maintain the confidentiality, integrity and availability of the Company’s and our customers’ information across all geographic and product lines, and endeavor to modify these protective measures as circumstances warrant, the nature of the threats continues to evolve. As a result, our computer systems, software and networks and those of our customers may be vulnerable to unauthorized access, loss or destruction of data (including confidential client information), account takeovers, unavailability of service, computer viruses or other malicious code, cyber attacks and other events that could have an adverse security impact and result in significant losses by us and/or our customers. Despite the defensive measures we take to manage our internal technological and operational infrastructure, these threats may originate externally from third parties, such as foreign governments, organized crime and other hackers, and outsource or infrastructure-support providers and application developers, or the threats may originate from within our organization. Given the increasingly high volume of our transactions, certain errors may be repeated or compounded before they can be discovered and rectified.
We also face the risk of operational disruption, failure, termination or capacity constraints of any of the third parties that facilitate our business activities, including exchanges, clearing agents, clearing houses or other financial intermediaries. Such parties could also be the source of an attack on, or breach of, our operational systems, data or infrastructure. In addition, as interconnectivity with our clients grows, we increasingly face the risk of operational failure with respect to our clients’ systems.
Although to date we have not experienced any material losses relating to cyber attacks or other information security breaches, there can be no assurance that we will not suffer such losses in the future. Our risk and exposure to these matters remains heightened because of, among other things, the evolving nature of these threats, the outsourcing of some of our business operations, and the continued uncertain global economic environment. As cyber threats continue to evolve, we may be required to expend significant additional resources to continue to modify or enhance our protective measures or to investigate and remediate any information security vulnerabilities.
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We maintain an insurance policy which we believe provides sufficient coverage at a manageable expense for an institution of our size and scope with similar technological systems. However, we cannot assure that this policy will afford coverage for all possible losses or would be sufficient to cover all financial losses, damages, penalties, including lost revenues, should we experience any one or more of our or a third party’s systems failing or experiencing attack.
The success of the Company is dependent upon its ability to recruit and retain qualified employees, especially seasoned relationship bankers.
The Company’s business plan includes and is dependent upon hiring and retaining highly qualified and motivated executives and employees at every level. In particular, our relative success to date has been partly the result of our skills of our senior management and management’s ability to identify and retain highly qualified relationship bankers that have long-standing relationships in their communities. These professionals bring with them valuable customer relationships and have been integral in our ability to attract deposits and to expand our market share. From time to time, the Company recruits or utilizes the services of employees who are subject to limitations on their ability to use confidential information of a prior employer, to freely compete with that employer, or to solicit customers of that employer. If the Company is unable to hire or retain qualified employees it may not be able to successfully execute its business strategy. If the Company or its employee is found to have violated any nonsolicitation or other restrictions applicable to it or its employees, the Company or its employee could become subject to litigation or other proceedings.
We may be required to raise capital in the future, but that capital may not be available or may not be on acceptable terms when it is needed.
We are required by federal regulatory authorities to maintain adequate capital levels to support operations. We may need to raise additional capital in the future to achieve and maintain those adequate capital levels. Our ability to raise additional capital is dependent on capital market conditions at that time and on our financial performance and outlook. Regulatory changes, such as regulations to implement Basel III and the Dodd-Frank Act, may require us to have more capital than was previously required. If we cannot raise additional capital when needed, we may not be able to meet these requirements, and our ability to further expand our operations through organic growth or through acquisitions may be adversely affected.
We may face risks related to health epidemics that could impact our results of operations.
Our business could be adversely affected by the effects of a widespread outbreak of contagious disease, including the recent outbreak of respiratory illness caused by a novel coronavirus first identified in Wuhan, Hubei Province, China. Any outbreak of contagious diseases and other adverse public health developments could have a material and adverse effect on our business operations. Although we do not currently expect the coronavirus outbreak to impact our operating results, it is possible. In addition, a significant outbreak of contagious diseases in the human population could result in a widespread health crisis that could adversely affect the U.S. economy and financial markets, resulting in an economic downturn that could impact our business.
Risks Relating to our Common Stock
An investment in our common stock is not an insured deposit.
Our common stock is not a bank deposit and, therefore, is not insured against loss by the FDIC, any other deposit insurance fund or by any other public or private entity. Investment in our common stock is subject to the same market forces that affect the price of common stock in any company.
Our ability to pay dividends and continue with share repurchases is subject to restrictions.
As a holding company with no significant assets other than the Bank, CWBC is dependent on dividends from the Bank to fund operating expenses and estimated tax payments. The ability to continue to pay dividends and conduct share repurchases depends in large part upon the receipt of dividends or other capital distributions from the Bank. The ability of the Bank to pay dividends or make other capital distributions is subject to the restrictions of the National Bank Act. In addition, it is possible, depending upon the financial condition of the Bank and other factors, that the OCC could assert that payment of dividends or other payments is an unsafe or unsound practice. The amount that the Bank may pay in dividends is further restricted due to the fact that the Bank must maintain a certain minimum amount of capital to be considered a “well capitalized” institution as well as a separate capital conservation buffer, as further described under “Item 7 - Management’s Discussion and Analysis of Operations - Regulatory Matters- Dividends” in this Form 10-K.
In the event the Bank is unable to pay dividends to CWBC, it is likely that CWBC, in turn, would have to discontinue cash dividends and share repurchases and may have difficulty meeting its other financial obligations. The inability of the Bank to pay dividends to CWBC could have a material adverse effect on our business, including the market price of our common stock.
For the year ended December 31, 2019, CWBC paid approximately $2.5 million in dividends to the Bank. No assurances can be given that future performances will justify the payment of dividends in any particular year. Moreover, CWBC’s ability to pay dividends is also subject to the restrictions of the California Corporations Code.
Issuance of additional common stock or other equity securities in the future could dilute the ownership interest of existing shareholders.
In order to maintain capital at desired or regulatory-required levels, or to fund future growth, the board of directors may decide from time to time to issue additional shares of common stock, or securities convertible into, exchangeable for, or representing rights to acquire shares of the common stock. The sale of these shares may significantly dilute ownership interests of shareholders. New investors in the future may also have rights, preferences and privileges senior to current shareholders which may adversely impact current shareholders.
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ITEM 1B.
ITEM 1B.
UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2.
ITEM 2.
PROPERTIES
The Company is headquartered at 445 Pine Avenue in Goleta, California. This facility houses the Company’s corporate offices and the manufactured housing lending division. The Company operates eight domestic branch locations, two of which are owned. All other properties are leased by the Company, including the corporate headquarters.
The Company continually evaluates the suitability and adequacy of its offices. Management believes that the existing facilities are adequate for its present and anticipated future use.
ITEM 3.
ITEM 3.
LEGAL PROCEEDINGS
From time to time, the Company may be involved in various litigation matters of a routine nature in the ordinary course of the Company’s business. In the opinion of Management, based in part on consultation with legal counsel, the resolution of these litigation matters are not expected to have a material impact on the Company’s financial position or results of operations.
ITEM 4.
ITEM 4.
MINE SAFETY DISCLOSURES
Not applicable.
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PART II
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
The Company’s common stock is traded on the Nasdaq Global Market (“NASDAQ”) under the symbol CWBC. The following table sets forth the high and low sales prices on a per share basis for the Company’s common stock as reported by NASDAQ for the period indicated:
Holders
As of February 28, 2020 the closing price of our common stock on NASDAQ was $10.85 per share. As of that date the Company had approximately 204 holders of record of its common stock. The Company has a greater number of beneficial owners of our common stock who own their shares through brokerage firms and institutional accounts.
Common Stock Dividends
It is the Company’s intention to review its dividend policy on a quarterly basis. As a holding company with limited significant assets other than the capital stock of our subsidiary bank, CWBC’s ability to pay dividends depends primarily on the receipt of dividends from its subsidiary bank, CWB. CWB’s ability to pay dividends to the Company is limited by the National Bank Act. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Supervision and Regulation - CWBC - Limitations on Dividend Payments.”
Repurchases of Securities
Common
On August 24, 2017, the Board of Directors extended the common stock repurchase program of up to $3.0 million for two additional years. Under this program, as of December 31, 2019, the Company has repurchased 350,189 common stock shares for $3.1 million at an average price of $8.71 per share.
The following is a summary of the Company’s repurchases of its common stock during the twelve months ended December 31, 2019.
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Securities Authorized for Issuance under Equity Compensation Plans
The following table summarizes the securities authorized for issuance as of December 31, 2019:
For material features of the plans, see “Item 8. Financial Statements and Supplementary Data - Note 11. Stockholders’ Equity-Stock Option Plans.”
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ITEM 6.
ITEM 6.
SELECTED FINANCIAL DATA
The following summary presents selected financial data as of and for the periods indicated. You should read the selected financial data presented below in conjunction with “Item 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with “Item 8 - Financial Statements and Supplementary Data.” This discussion and analysis contains forward-looking statements that involve risk, uncertainties and assumptions. Certain risks, uncertainties and other factors, including but not limited to those set forth under “ Forward-Looking Statements,” on page 4 of this Form 10-K, may cause actual results to differ materially from those projected in the forward-looking statements.
Financial Overview and Highlights
Community West Bancshares is a financial services company headquartered in Goleta, California that provides full service banking and lending through its wholly-owned subsidiary Community West Bank (“CWB”), which has eight California branch banking offices located in Goleta, Oxnard, San Luis Obispo, Santa Barbara, Santa Maria, Ventura, Paso Robles and Westlake Village.
Financial Result Highlights of 2019
Net income available to common stockholders was $8.0 million, or $0.93 per diluted share for 2019, compared to $7.4 million, or $0.88 per diluted share for 2018 and $4.9 million or $0.57 per diluted share for 2017.
The significant factors impacting the Company during 2019 were:
•
Net income was $8.0 million, or $0.93 per diluted share for the year ended 2019, compared to $7.4 million, or $0.88 per diluted share in 2018.
•
Net interest margin of 4.06% at December 31, 2019 compared to 4.07% for the year ended 2018.
•
Total deposits were $750.9 million at December 31, 2019 and increased by 4.9% compared to $716.0 million at December 31, 2018.
•
Total demand deposits represented 56.6% of total deposits at December 31, 2019 compared to 52.9% at December 31, 2018.
•
Book value per common share increased to $9.68 at December 31, 2019, compared to $8.92 at December 31, 2018.
•
Provision (credit) for loan losses was ($165,000) for the year, compared to a provision for loan losses of $14,000 for 2018.
•
Net recoveries were $0.2 million for the year ended 2019 compared to $0.3 million for 2018.
•
Total risk based capital improved to 11.73% at December 31, 2019 from 11.26% at December 31, 2018.
•
Net nonaccrual loans improved to $2.4 million at December 31, 2019 compared to $3.4 million at December 31, 2018.
•
Other assets acquired through foreclosure, net was $2.5 million at December 31, 2019, compared to zero at December 31, 2018.
The impact to the Company from these items, and others of both a positive and negative nature, will be discussed in more detail as they pertain to the Company’s overall comparative performance for the year ended December 31, 2019 throughout the analysis sections of this Form 10-K.
A summary of our results of operations and financial condition and select metrics is included in the following table:
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Asset Quality
For all banks and bank holding companies, asset quality plays a significant role in the overall financial condition of the institution and its results of operations. The Company measures asset quality in terms of nonaccrual loans as a percentage of gross loans, and net charge-offs as a percentage of average loans. Net charge-offs are calculated as the difference between charged-off loans and recovery payments received on previously charged-off loans. The following table summarizes these asset quality metrics:
Asset and Deposit Growth
The Company’s assets and liabilities are comprised primarily of loans and deposits. The ability to originate new loans and attract new deposits is fundamental to the Company’s asset growth. Total assets increased to $913.9 million at December 31, 2019 from $877.3 million at December 31, 2018. Total loans including net deferred fees and unearned income increased by $7.3 million, or 1.0%, to $775.6 million as of December 31, 2019 compared to $768.2 million as of December 31, 2018. Total deposits increased by 4.9% to $750.9 million as of December 31, 2019 from $716.0 million as of December 31, 2018.
RESULTS OF OPERATIONS
The following table sets forth a summary financial overview for the comparable years:
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Interest Rates and Differentials
The following table illustrates average yields on interest-earning assets and average rates on interest-bearing liabilities for the periods indicated:
(1)
Includes nonaccrual loans.
(2)
Net interest margin is computed by dividing net interest income by total average earning assets.
(3)
Net interest spread represents average yield earned on interest-earning assets less the average rate paid on interest-bearing liabilities.
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(1)
Includes nonaccrual loans.
(2)
Net interest margin is computed by dividing net interest income by total average earning assets.
(3)
Net interest spread represents average yield earned on interest-earning assets less the average rate paid on interest-bearing liabilities.
The table below sets forth the relative impact on net interest income of changes in the volume of earning assets and interest-bearing liabilities and changes in rates earned and paid by the Company on such assets and liabilities. For purposes of this table, nonaccrual loans have been included in the average loan balances.
(1)
Changes due to both volume and rate have been allocated to volume changes.
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Comparison of interest income, interest expense and net interest margin
Commercial loans consist of term loans and revolving business lines of credit. Under the terms of the revolving lines of credit, the Company grants a maximum loan amount, which remains available to the business during the loan term. The collateral for these loans typically are by Uniform Commercial Code (“UCC-1”) lien filings, real estate and personal guarantees. The Company does not extend material loans of this type in excess of five years.
Interest expense for the year ended December 31, 2019 increased compared to 2018 by $2.4 million and increased compared to 2017 by $6.7 million, respectively, to $11.4 million. The increase for 2019 compared to 2018 was mostly the result of the increase of deposits and increased rates paid on interest-bearing demand deposits and time deposits. The average cost on interest-bearing deposits also increased to 165 basis points in 2019 compared to 128 basis points in 2018. Total cost of funds increased by 28 basis points for 2019 compared to 2018 and by 78 basis points compared to 2017.
The net impact of the changes in yields on interest-earning assets and the rates paid on interest-bearing liabilities was to decrease the margin for 2019 compared to 2018. The net interest margin was 4.06% for 2019 compared to 4.07% for 2018 and 4.34% in 2017.
Net interest income increased by $0.7 million for 2019 compared to 2018 and $1.7 million, compared to 2017.
Total interest income increased by $5.2 million to $42.6 million in 2018 compared to 2017. The interest income was impacted by increased yields on earning assets in 2018 which increased to 5.16% compared to 4.96% for 2017. The average yield on loans increased to 5.44% for 2018 compared to 5.24% for 2017. Total interest expense increased by $4.3 million in 2018 compared to 2017. This increase was primarily due to increased total cost of funds which include non-interest bearing deposits from 68 basis points for 2017 to 118 basis points for 2018. Net interest income increased by $1.0 million for 2018 compared to 2017.
Provision for loan losses
The provision for loan losses in each period is reflected as a charge against earnings in that period. The provision for loan losses is equal to the amount required to maintain the allowance for loan losses at a level that is adequate to absorb probable losses inherent in the loan portfolio. The provision (credit) for loan losses was $(165,000) in 2019 compared to $14,000 in 2018 and $411,000 in 2017. The provision (credit) for loan losses for 2019 resulted primarily from net recoveries and change in the loan portfolio mix. The provision for 2018 resulted primarily from loan growth and change in loan portfolio mix. As a result of improvements in credit quality, decreased historical loss rates, and net recoveries for the year, the ratio of the allowance for loan losses to loans held for investment decreased to 1.19% at December 31, 2019 from 1.21% at December 31, 2018. Additional information regarding improved credit quality can be found beginning on page 26.
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The following table summarizes the provision (credit), charge-offs (recoveries) by loan category for the year ended December 31, 2019, 2018 and 2017:
The percentage of net non-accrual loans (net of government guarantees) to the total loan portfolio has decreased to 0.31% as of December 31, 2019 from 0.44% at December 31, 2018 primarily due to commercial loan repayments.
The allowance for loan losses compared to net non-accrual loans has increased to 365% as of December 31, 2019 from 257% as of December 31, 2018. Total past due loans were $1.9 million as of December 31, 2019 compared to $3.7 million as of December 31, 2018.
Non-interest Income
The Company earned non-interest income primarily through fees related to services provided to loan and deposit customers.
The following tables present a summary of non-interest income for the periods presented:
Total non-interest income increased $1.0 million for 2019 compared to 2018. The increase was mostly from increased service charges and gains from loans sold. The increase was partially offset by a decrease in document processing fees.
Total non-interest income decreased $0.1 million for 2018 compared to 2017. The decrease was mostly from reduced document processing fees due to the competitive loan growth market. These decreases were partially offset by increased other loan fees.
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Non-Interest Expenses
The following tables present a summary of non-interest expenses for the periods presented:
Total non-interest expenses for the year ended December 31, 2019 compared to 2018 increased by $0.7 million primarily due to additional salaries and employee benefits, professional services, and advertising as a result of the Company’s expansions in the Northern and Southern regions, and addition of customer relationship and support positions. FDIC assessment decreased $0.3 million in 2019 compared to 2018 due to a small bank assessment credit in the third quarter of 2019.
Total non-interest expenses for the year ended December 31, 2018 compared to 2017 increased by $1.5 million primarily due to additional salaries and employee benefits, occupancy, and advertising as a result of the Company’s expansions in the Northern and Southern regions, and addition of customer relationship and support positions. Additionally, during the fourth quarter 2018, the Company opened a full-service branch in Paso Robles. FDIC assessment increased $0.1 million in 2018 compared to 2017 due to a higher asset base for assessment and increased assessment factor. Professional services for 2018 compared to 2017 increased by $0.3 million mostly due to increased consulting costs for operational training and project implementation.
Income Taxes
The income tax provision for 2019 was $3.4 million compared to $2.8 million in 2018 and $5.5 million in 2017. The effective income tax rate was 30.0%, 27.5%, and 53.0%, respectively for 2019, 2018 and 2017, reflecting the federal corporate tax rate reduction implemented in 2018.
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts and their respective tax basis including operating losses and tax credit carryforwards. Net deferred tax assets of $3.2 million at December 31, 2019 are reported in the consolidated balance sheet as a component of total assets.
On December 22, 2017, the President of the United States signed into law the Tax Cuts and Jobs Act tax reform legislation. This legislation makes significant change in U.S. tax law including a reduction in the corporate tax rates, changes to net operating loss carryforwards and carrybacks, and a repeal of the corporate alternative minimum tax. The legislation reduced the U.S. corporate tax rate from the current rate of 34% to 21%. As a result of the enacted law, the Company was required to revalue deferred tax assets and liabilities at the 21% rate. The revaluation resulted in $1.3 million income tax expense and a corresponding reduction in the net deferred tax asset. The other provisions of the Tax Cuts and Jobs Act did not have a material impact on the fiscal 2017 consolidated financial statements.
Accounting Standards Codification Topic 740, Income Taxes, requires that companies assess whether a valuation allowance should be established against their deferred tax assets based on the consideration of all available evidence using a “more likely than not” standard.
A valuation allowance is established for deferred tax assets if, based on weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets may not be realized. Management evaluates the Company’s deferred tax assets for recoverability using a consistent approach which considers the relative impact of negative and positive evidence, including the Company’s historical profitability and projections of future taxable income. The Company is required to establish a valuation allowance for deferred tax assets and record a charge to income if management determines, based on available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets may not be realized.
There was no valuation allowance on deferred tax assets at December 31, 2019 and 2018.
ASC 740 also prescribes a more likely than not threshold for the financial statement recognition of uncertain tax positions. ASC 740 clarifies the accounting for income taxes by prescribing a minimum recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. On a quarterly basis, the Company undergoes a process to evaluate whether income tax accruals are in accordance with ASC 740 guidance on uncertain tax positions. There were no uncertain tax positions at December 31, 2019 and 2018.
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Additional information regarding income taxes, including a reconciliation of the differences between the recorded income tax provision and the amount of tax computed by applying statutory federal and state income tax rates before income taxes, can be found in Note 7 “Income Taxes” to the consolidated financial statements of Form 10-K beginning on page 73.
BALANCE SHEET
Total assets increased $36.6 million to $913.9 million at December 31, 2019 compared to $877.3 million at December 31, 2018. The majority of the increase was $25.7 million in cash and interest bearing deposits in other financial institutions and increase of total loans of $7.3 million. Total commercial real estate loans increased by 5.4% to $385.6 million at December 31, 2019 compared to 2018, and comprised 49.7% of the total loan portfolio. Manufactured housing loans increased by 4.1% to $257.2 million at December 31, 2019 compared to 2018, and represented 33.2% of the total loan portfolio. Total commercial loans including commercial agriculture loans decreased 14.4% to $101.5 million at December 31, 2019 compared to 2018, and represented 13.1% of the total loan portfolio.
Total liabilities increased $30.8 million, or 3.8% to $831.9 million at December 31, 2019 from $801.1 million at December 31, 2018. The majority of this increase was due to deposit growth. Total deposits increased by $34.9 million, or 4.9% to $750.9 million at December 31, 2019 from $716.0 million at December 31, 2018. Non-interest bearing demand deposits increased by $2.7 million to $110.8 million at December 31, 2019 from $108.2 million at December 31, 2018. Certificates of deposit decreased by $12.6 million to $310.1 million at December 31, 2019 compared to $322.8 million at December 31, 2018. Interest-bearing demand deposits increased by $43.8 million to $314.3 million at December 31, 2019 compared to $270.4 million at 2018. Savings deposits increased slightly to $15.7 million at December 31, 2019 compared to $14.6 million at December 31, 2018. Other borrowings decreased by $10.0 million to $65.0 million at December 31, 2019 compared to $75.0 million at December 31, 2018 due to decreased FHLB advances.
Total stockholders’ equity increased to $82.0 million at December 31, 2019 from $76.2 million at December 31, 2018. This increase was primarily from 2019 net income of $8.0 million reduced by quarterly common stock dividends of $1.8 million.
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The following tables present the Company’s average balances as of the dates indicated:
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Loan Portfolio
Market Summary
Total loans increased by $7.3 million during 2019 to $775.6 million. The majority of this increase was driven by $19.8 million of growth in the commercial real estate portfolio. Total manufactured housing loans increased by $10.1 million and total commercial loans including commercial agriculture loans decreased by $17.0 million. SBA loans declined by $1.1 million as the Company no longer originates SBA 7(a) loans outside of California and did not focus on this product in 2019. Single family real estate loans increased by $0.6 million. With the recent decrease in interest rates the competition for quality loans has increased in our markets.
The table below summarizes the distribution of the Company’s loans (including loans held for sale) at the year-end:
Commercial Loans
Commercial loans consist of term loans and revolving business lines of credit. Under the terms of the revolving lines of credit, the Company grants a maximum loan amount, which remains available to the business during the loan term. The collateral for these loans typically are by Uniform Commercial Code (“UCC-1”) lien filings, real estate and personal guarantees. The Company does not extend material loans of this type in excess of five years.
Commercial Real Estate
Commercial real estate and construction loans are primarily made for the purpose of purchasing, improving or constructing, commercial and industrial properties. This loan category also includes SBA 504 loans and land loans.
Commercial and industrial real estate loans are primarily secured by nonresidential property. Office buildings or other commercial property primarily secure these types of loans. Loan to appraised value ratios on nonresidential real estate loans are generally restricted to 75% of appraised value of the underlying real property if occupied by the owner or owner’s business; otherwise, these loans are generally restricted to 70% of appraised value of the underlying real property.
The Company makes real estate construction loans on commercial properties and single family dwellings for speculative purposes. These loans are collateralized by first and second trust deeds on real property. Construction loans are generally written with terms of six to eighteen months and usually do not exceed a loan to appraised value of 75%.
SBA 504 loans are made in conjunction with Certified Development Companies. These loans are granted to purchase or construct real estate or acquire machinery and equipment. The loan is structured with a conventional first trust deed provided by a private lender and a second trust deed which is funded through the sale of debentures. The predominant structure is terms of 10% down payment, 50% conventional first loan and 40% debenture. Construction loans of this type must provide additional collateral to reduce the loan-to-value to approximately 75%. Conventional and investor loans are sometimes funded by our secondary-market partners and CWB receives a premium for these transactions.
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SBA Loans
SBA loans consist of SBA 7(a) and Business and Industry loans (“B&I”). The SBA 7(a) loan proceeds are used for working capital, machinery and equipment purchases, land and building purposes, leasehold improvements and debt refinancing. At present, the SBA guarantees as much as 85% on loans up to $150,000 and 75% on loans more than $150,000. The SBA’s maximum exposure amount is $3,750,000. The Company may sell a portion of the loans, however, under the SBA 7(a) loan program; the Company is required to retain a minimum of 5% of the principal balance of each loan it sells into the secondary market.
B&I loans are guaranteed by the U.S. Department of Agriculture. The maximum guaranteed amount is 60% to 80% depending on the size of the loan. B&I loans are similar to the SBA 7(a) loans but are made to businesses in designated rural areas. These loans can also be sold into the secondary market.
Agricultural Loans for real estate and operating lines
The Company has an agricultural lending program for agricultural land, agricultural operational lines, and agricultural term loans for crops, equipment and livestock. The primary product is supported by guarantees issued from the U.S. Department of Agriculture (“USDA”), Farm Service Agency (“FSA”), and the USDA B&I loan program. The FSA loans typically have a 90% guarantee up to $1,776,000 (amount adjusted annually based on inflation) for up to 40 years, but not always. The Company had $69.8 million of commercial agriculture loans at December 31, 2019, of these loans $31.6 million had FSA guarantees.
CWB is an approved Federal Agricultural Mortgage Corporation (“Farmer Mac”) lender under the Farmer Mac I and Farmer Mac II Programs. Under the Farmer Mac I program, loans are sourced by CWB, underwritten, funded and serviced by Farmer Mac. CWB receives an origination fee and an ongoing field servicing fee of 25 basis points to 115 basis points for maintaining the relationship with the borrower and performing certain loan compliance monitoring, and other duties as directed by the Central Servicer.
Manufactured Housing Loans
CWB originates loans secured by manufactured homes located in approved rental, co-operative ownership, condominium and planned unit development mobile home parks in Santa Barbara, Ventura and San Luis Obispo Counties as well as along the California coast from San Diego to San Francisco. The loans are made to borrowers for purchasing or refinancing new or existing manufactured homes. The loans are made under either fixed rate programs for terms of 10 to 20 years or adjustable rate programs with terms of 25 to 30 years. The adjustable rate loans have an initial fixed rate period of five years and then adjust annually subject to interest rate caps.
HELOC
Home equity lines of credit (“HELOC”) held at the Bank are lines of credit collateralized by residential real estate. Typically, HELOCs are collateralized by a second deed of trust. The combined loan-to-value, first trust deed and second trust deed, are not to exceed 75% on all HELOCs. The Bank is not actively originating new HELOCs.
Other Installment Loans
Installment loans consist of automobile and general-purpose loans made to individuals.
Single Family Real Estate Loans
Until the third quarter of 2015, the Company originated loans that consisted of first and second mortgage loans secured by trust deeds on one-to-four family homes. These loans were made to borrowers for purposes such as purchasing a home, refinancing an existing home, interest rate reduction or home improvement.
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Loan Maturities and Sensitivity to Interest Rates
The following table sets forth the amount of loans outstanding by type of loan as of December 31, 2019 that were contractually due in one year or less, more than one year and less than five years, and more than five years based on remaining scheduled repayments of principal. Lines of credit or other loans having no stated final maturity and no stated schedule of repayments are reported as due in one year or less. The tables also present an analysis of the rate structure for loans within the same maturity time periods. Actual cash flows from these loans may differ materially from contractual maturities due to prepayment, refinancing or other factors.
At December 31, 2019, total loans consisted of 78.8% with floating rates and 21.2% with fixed rates. Manufactured housing loans, which are generally fixed rate for the first five years are included in floating rate loans during the fixed period.
The following table presents total gross loans based on remaining scheduled contractual repayments of principal as of the periods indicated:
Concentrations of Lending Activities
The Company’s lending activities are primarily driven by the customers served in the market areas where the Company has branch offices in the Central Coast of California. The Company monitors concentrations within selected categories such as geography and product. The Company makes manufactured housing, commercial, SBA, construction, commercial real estate and consumer loans to customers through branch offices located in the Company’s primary markets. The Company’s business is concentrated in these areas and the loan portfolio includes significant credit exposure to the manufactured housing and commercial real estate markets of these areas. As of December 31, 2019 and 2018, manufactured housing loans comprised 33.2% and 32.2%, of total loans, respectively. As of December 31, 2019 and 2018, commercial real estate loans accounted for approximately 49.7% and 47.6% of total loans, respectively. Approximately 31.9% and 33.8% of these commercial real estate loans were owner occupied at December 31, 2019 and 2018, respectively. Substantially all of these loans are secured by first liens with an average loan to value ratios of 54.3% and 57.9% at December 31, 2019 and 2018, respectively. The Company was within established policy limits at December 31, 2019 and 2018.
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Interest Reserves
Interest reserves are generally established at the time of the loan origination as an expense item in the budget for a construction and land development loan. The Company’s practice is to monitor the construction, sales and/or leasing progress to determine the feasibility of ongoing construction and development projects. If, at any time during the life of the loan, the project is determined not to be viable, the Company discontinues the use of the interest reserve and may take appropriate action to protect its collateral position via renegotiation and/or legal action as deemed appropriate. At December 31, 2019, the Company had 11 loans with an outstanding balance of $24.0 million with available interest reserves of $2.8 million. Total construction and land loans are approximately 5% and 10% of the Company’s loan portfolio at December 31, 2019 and 2018, respectively.
Impaired loans
A loan is considered impaired when, based on current information, it is probable that the Company will be unable to collect the scheduled payments of principal and/or interest under the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and/or interest payments. Loans that experience insignificant payment delays or payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays or payment shortfalls on a case-by-case basis. When determining the possibility of impairment, management considers the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. For collateral-dependent loans, the Company uses the fair value of collateral method to measure impairment. All other loans are measured for impairment based on the present value of future cash flows. Impairment is measured on a loan-by-loan basis for all impaired loans in the portfolio.
A loan is considered a troubled debt restructured loan (“TDR”) when concessions have been made to the borrower and the borrower is in financial difficulty. These concessions include but are not limited to term extensions, rate reductions and principal reductions. Forgiveness of principal is rarely granted and modifications for all classes of loans are predominantly term extensions. TDR loans are also considered impaired.
The recorded investment in loans that are considered impaired is as follows:
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The following schedule summarizes impaired loans and specific reserves by loan class as of the periods indicated:
$0.6 million of the above impaired loans are government guaranteed.
$3.1 million of the above impaired loans are government guaranteed.
Total impaired loans decreased by $11.1 million at December 31, 2019 compared to December 31, 2018. The manufactured housing impaired loans decreased by $4.0 million and commercial impaired loans decreased by $6.0 million in 2019 compared to 2018. Both the SBA and single family real estate impaired loans decreased by $0.5 million each in 2019 compared to 2018. Impaired manufactured housing loans decreased mainly due to upgrades and payoffs of existing loans. Impaired commercial loans decreased in 2019 compared to 2018 primarily due to loan payoffs and payments paired with a couple of foreclosed properties transferred into other real estate owned.
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The following schedule reflects recorded investment in certain types of loans at the dates indicated:
The accrual of interest is discontinued when substantial doubt exists as to collectability of the loan; generally at the time the loan is 90 days delinquent. Any unpaid but accrued interest is reversed at that time. Thereafter, interest income is usually no longer recognized on the loan. Interest income may be recognized on impaired loans to the extent they are not past due by 90 days. Interest on nonaccrual loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all of the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
The following table summarizes the composition of nonaccrual loans:
Total nonaccrual balances decreased $3.5 million to $2.7 million at December 31, 2019, from $6.2 million at December 31, 2018. Nonaccrual balances include $0.3 million and $2.8 million of loans that are government guaranteed at December 31, 2019 and 2018, respectively. Nonaccrual loans net of government guarantees decreased $1.0 million or 29%, from $3.4 million at December 31, 2018 to $2.4 million at December 31, 2019. The percentage of nonaccrual loans to the total loan portfolio has decreased to 0.31% as of December 31, 2019 from 0.44% at December 31, 2018.
CWB or the SBA repurchases the guaranteed portion of SBA loans from investors when those loans become past due 120 days. After the foreclosure and collection process is complete, the SBA reimburses CWB for this principal balance. Therefore, although these balances do not earn interest during this period, they generally do not result in a loss of principal to CWB.
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Allowance for Loan Losses
The following table summarizes the activity in our allowance for loan losses for the periods indicated.
The following table summarizes the allocation of allowance for loan losses by loan type. However allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories:
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Total allowance for loan losses remained relatively flat at $8.7 million at December 31, 2019 compared to the prior year. In addition, the Company had net recoveries of $0.2 million in 2019 compared to net recoveries of $0.3 million in 2018.
Potential Problem Loans
The Company classifies loans consistent with federal banking regulations. These loan grades are described in further detail in “Item 8. Note 1, Summary of Significant Accounting Policies” of this Form 10-K. The following table presents information regarding potential problem loans consisting of loans graded Special Mention or worse, but still performing:
(1)
Loan balance includes $2.1 million guaranteed by government agencies.
(1)
Loan balance includes $1.5 million guaranteed by government agencies.
Investment Securities
Investment securities are classified at the time of acquisition as either held-to-maturity or available-for-sale based upon various factors, including asset/liability management strategies, liquidity and profitability objectives, and regulatory requirements. Held-to-maturity securities are carried at amortized cost, adjusted for amortization of premiums or accretion of discounts. Available-for-sale securities are securities that may be sold prior to maturity based upon asset/liability management decisions. Investment securities identified as available-for-sale are carried at fair value. Unrealized gains or losses on available-for-sale securities are recorded as accumulated other comprehensive income in stockholders’ equity. Amortization of premiums or accretion of discounts on mortgage-backed securities is periodically adjusted for estimated prepayments.
The investment securities portfolio of the Company is utilized as collateral for borrowings, required collateral for public deposits and to manage liquidity, capital, and interest rate risk.
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The carrying value of investment securities for the years indicated was as follows:
The weighted average yields of investment securities by maturity period were as follows at December 31, 2019:
Expected maturities may differ from contractual maturities because borrowers or issuers have the right to call or prepay certain investment securities. Changes in interest rates may also impact prepayment or call options.
The Company does not own any subprime mortgage backed securities (“MBS”) in its investment portfolio. Gross unrealized losses at December 31, 2019 are primarily caused by interest rate fluctuations, credit spread widening and reduced liquidity in applicable markets. The Company has reviewed all securities on which there was an unrealized loss in accordance with its accounting policy for other than temporary impaired (“OTTI”) described in “Item 8. Note 2 in this Form 10-K, “Investment Securities” and determined no impairment was required. At December 31, 2019, the Company had the intent and the ability to retain its investments for a period of time sufficient to allow for any anticipated recovery in fair value.
Other Assets Acquired Through Foreclosure
The following table represents the changes in other assets acquired through foreclosure:
Other assets acquired through foreclosure consist primarily of properties acquired as a result of, or in-lieu-of, foreclosure. Properties or other assets (primarily manufactured housing) are classified as other real estate owned and other repossessed assets and are reported at fair value at the time of foreclosure less estimated costs to sell. Costs relating to development or improvement of the assets are capitalized and costs related to holding the assets are charged to expense. At December 31, 2019, the Company had $0.2 million valuation allowance on foreclosed assets. At December 31, 2018 and 2017, the Company had no valuation allowance on foreclosed assets.
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Deposits
The average balances by deposit type as of the dates presented below:
Total deposits increased to $750.9 million at December 31, 2019 from $716.0 million at December 31, 2018, an increase of $34.9 million. This increase was primarily from interest-bearing demand deposits. Certificates of deposits decreased by $12.6 million to $310.1 million at December 31, 2019 compared to $322.8 million at December 31, 2018. Interest-bearing demand deposits increased by $43.8 million to $314.3 million at December 31, 2019 compared to $270.4 million at December 31, 2018. Deposits have been the primary source of funding the Company’s asset growth. In addition the bank is a member of Certificate of Deposit Account Registry Service (“CDARS”) and Insured Cash Sweep (“ICS”) services. Both CDARS and ICS provide a mechanism for obtaining FDIC insurance for large deposits. At December 31, 2019 and 2018, the Company had $28.7 million and $35.2 million, respectively of CDARS deposits. At December 31, 2019 and 2018, the Company had $54.5 million and $9.5 million, respectively of ICS deposits.
Time Certificates of Deposits
The following table presents TCD maturities:
The Company’s deposits may fluctuate as a result of local and national economic conditions. Management does not believe that deposit levels are influenced by seasonal factors.
The Company utilizes money desk and brokered deposits in accordance with strategic and liquidity planning.
Other Borrowings
The following table sets forth certain information regarding FHLB advances and other borrowings.
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FHLB and FRB Advances
The Company utilizes borrowed funds to support liquidity needs. The Company’s borrowing capacity at FHLB and FRB is determined based on collateral pledged, generally consisting of securities and loans. At December 31, 2019, no advances were outstanding from the FRB.
Other Borrowing
The Company has a revolving line of credit agreement for up to $10.0 million. The line of credit matures July 30, 2022. The Company must maintain a compensating deposit with the lender of 25% of the outstanding principal balance in a non-interest-bearing deposit account. In addition, the Company must maintain a minimum debt service coverage ratio of 1.65, a minimum Tier 1 leverage ratio of 7.0% and a minimum total risked based capital ratio of 10.0%. At December 31, 2019, the line of credit balance was zero.
Preferred Stock
There are no shares of the Company’s preferred stock outstanding as of December 31, 2019 and 2018.
Capital Resources
The federal banking agencies have adopted risk-based capital adequacy guidelines that are used to assess the adequacy of capital in supervising a bank holding companies and banks. In July 2013, the federal banking agencies approved the final rules (“Final Rules”) to establish a new comprehensive regulatory capital framework with a phase-in period beginning January 1, 2015 and ending January 1, 2019. The Final Rules implement the third installment of the Basel Accords (“Basel III”) regulatory capital reforms and changes required by the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) and substantially amended the regulatory risk-based capital rules applicable to the Company. Basel III redefined the regulatory capital elements and minimum capital ratios, introduced regulatory capital buffers above those minimums, revised rules for calculating risk-weighted assets and added a new component of Tier 1 capital called Common Equity Tier 1, which includes common equity and retained earnings and excludes preferred equity.
The following tables illustrates the Bank’s regulatory ratios and the current adequacy guidelines as of December 31, 2019 and 2018. The fully-phased in guidelines applicable on January 1, 2019 are also summarized.
Contractual Obligations and Off-Balance Sheet Arrangements
The Company enters into contracts for services in the ordinary course of business that may require payment for services to be provided in the future and may contain penalty clauses for early termination of the contracts. To meet the financing needs of customers, the Company has financial instruments with off-balance sheet risk, including commitments to extend credit and standby letters of credit. The Company does not believe that these off-balance sheet arrangements have or are reasonably likely to have a material effect on its financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources. However, there can be no assurance that such arrangements will not have a future effect.
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The following table sets forth our significant contractual obligations as of December 31, 2019.
Purchase obligations primarily related to contracts for software licensing and maintenance and outsourced service providers. Off-balance sheet commitments associated with outstanding letters of credit, commitments to extend credit, and overdraft lines as of December 31, 2019 are summarized below. Since commitments associated with letters of credit and commitments to extend credit may expire unused, the amounts shown do not necessarily reflect the actual future cash funding requirements.
Critical Accounting Policies
The Notes to Consolidated Financial Statements contain a discussion of our significant accounting policies, including information regarding recently issued accounting pronouncements, our adoption of such policies and the related impact of their adoption. We believe that certain of these policies, along with various estimates that we are required to make in recording our financial transactions, are important to have a complete understanding of our financial position. In addition, these estimates require us to make complex and subjective judgments, many of which include matters with a high degree of uncertainty. See “Item 8. Financial Statements and Supplementary Data - Note 1. Summary of Significant Accounting Policies for a discussion of these critical accounting policies and significant estimates.
Liquidity
Liquidity for a bank is the ongoing ability to fund asset growth and business operations, to accommodate liability maturities and deposit withdrawals and meet contractual obligations through unconstrained access to funding at reasonable market rates. Liquidity management involves forecasting funding requirements and maintaining sufficient capacity to meet the needs and accommodate fluctuations in asset and liability levels due to changes in our business operations or unanticipated events.
The ability to have readily available funds sufficient to repay fully maturing liabilities is of primary importance to depositors, creditors and regulators. CWB’s available liquidity, represented by cash and amounts due from banks, federal funds sold and non-pledged marketable securities. CWB manages its liquidity risk through operating, investing and financing activities. In order to ensure funds are available when necessary, on at least a quarterly basis, CWB projects the amount of funds that will be required, and strive to maintain relationships with a diversified customer base. Liquidity requirements can also be met through short-term borrowings or the disposition of short-term assets. The Company has federal funds borrowing lines at correspondent banks totaling $20.0 million. In addition, loans and securities are pledged to the FHLB providing $60.5 million in available borrowing capacity as of December 31, 2019. Loans pledged to the FRB discount window provided $108.6 million in borrowing capacity. As of December 31, 2019, there were no outstanding borrowings from the FRB.
The Bank has established policies as well as analytical tools to manage liquidity. Proper liquidity management ensures that sufficient funds are available to meet normal operating demands in addition to unexpected customer demand for funds, such as high levels of deposit withdrawals or increased loan demand, in a timely and cost effective manner. The most important factor in the preservation of liquidity is maintaining public confidence that facilitates the retention and growth of core deposits. Ultimately, public confidence is gained through profitable operations, sound credit quality and a strong capital position. CWB’s liquidity management is viewed from a long-term and short-term perspective, as well as from an asset and liability perspective. Management monitors liquidity through regular reviews of maturity profiles, funding sources and loan and deposit forecasts to minimize funding risk. The Bank has asset/liability committees (“ALCO”) at the Board and Bank management level to review asset/liability management and liquidity issues.
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The Company through CWB has a blanket lien credit line with the FHLB. FHLB advances are collateralized in the aggregate by the Company’s eligible loans and securities. Total FHLB advances were $65.0 million and $70.0 million at December 31, 2019 and 2018, respectively, borrowed at fixed rates. At December 31, 2019, CWB had pledged to FHLB, securities of $25.6 million at carrying value and loans of $324.2 million. At December 31, 2018, the Company had pledged to FHLB, securities of $32.2 million at carrying value and loans of $269.4 million, and had $35.9 million available for additional borrowing.
The Company has established a credit line with the FRB. Advances are collateralized in the aggregate by eligible loans. There were no advances outstanding as of December 31, 2019 and unused borrowing capacity was $108.6 million.
The Company also maintains federal funds purchased lines with a total borrowing capacity of $20.0 million. There was no amount outstanding as of December 31, 2019 and 2018.
The Company has not experienced disintermediation and does not believe this is a likely occurrence, although there is significant competition for core deposits. The liquidity ratio of the Bank was 14% and 15%, at December 31, 2019 and December 31, 2018, respectively. The Bank’s liquidity ratio fluctuates in conjunction with loan funding demands. The liquidity ratio consists of the sum of cash and due from banks, deposits in other financial institutions, available for sale investments, federal funds sold and loans held for sale, divided by total assets.
As a legal entity, separate and distinct from the Bank, CWCB must rely on its own resources for its liquidity. CWBC’s routine funding requirements primarily consisted of certain operating expenses, common stock dividends and interest payments on the other borrowings. CWBC obtains funding to meet its obligations from dividends collected from CWB and fees charged for services provided to CWB, and has the capability to issue equity and debt securities. Federal banking laws and regulatory requirements regulate the amount of dividends that may be paid by a banking subsidiary without prior approval.
Interest Rate Risk
The Company is exposed to different types of interest rate risks. These risks include: lag, repricing, basis and prepayment risk.
Lag risk results from the inherent timing difference between the repricing of the Company’s adjustable rate assets and liabilities. For instance, certain loans tied to the prime rate index may only reprice on a quarterly basis. This lag can produce some short-term volatility, particularly in times of numerous prime rate changes.
Repricing risk is caused by the mismatch in the maturities or repricing periods between interest-earning assets and interest-bearing liabilities. If CWB was perfectly matched, the net interest margin would expand during rising rate periods and contract during falling rate periods. This happens because loans tend to reprice more quickly than funding sources.
Basis risk is due to item pricing tied to different indices which tend to react differently. CWB’s variable products are mainly priced off the treasury and prime rates.
Prepayment risk results from borrowers paying down or paying off their loans prior to maturity. Prepayments on fixed-rate products increase in falling interest rate environments and decrease in rising interest rate environments. A majority of CWB’s loans have adjustable rates and are reset based on changes in the treasury and prime rates.
The Company’s ability to originate, purchase and sell loans is also significantly impacted by changes in interest rates. In addition, increases in interest rates may reduce the amount of loan and commitment fees received by CWB.
Management of Interest Rate Risk
To mitigate the impact of changes in market interest rates on the Company’s interest-earning assets and interest-bearing liabilities, the amounts and maturities are actively managed. Short-term, adjustable-rate assets are generally retained as they have similar repricing characteristics as funding sources. CWB can sell a portion of its FSA and SBA loan originations. While the Company has some interest rate exposure in excess of five years, it has internal policy limits designed to minimize risk should interest rates rise. The Company has not used derivative instruments to help manage risk, but will consider such instruments in the future if the perceived need should arise.
For further discussion regarding the impact to the Company of interest rate changes, see “Item 7A.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company’s primary market risk is interest rate risk (“IRR”). To minimize the volatility of net interest income at risk (“NII”) and the impact on economic value of equity (“EVE”), the Company manages its exposure to changes in interest rates through asset and liability management activities within guidelines established by the Board’s Asset Liability Committee (“ALCO”). ALCO has the responsibility for approving and ensuring compliance with asset/liability management policies, including IRR exposure.
To mitigate the impact of changes in interest rates on the Company’s interest-earning assets and interest-bearing liabilities, the Company actively manages the amounts and maturities. While the Company has some assets and liabilities in excess of five years, it has internal policy limits designed to minimize risk should interest rates rise. Currently, the Company does not use derivative instruments to help manage risk, but will consider such instruments in the future if the perceived need should arise.
The Company uses a simulation model, combined with downloaded detailed information from various application programs, and assumptions regarding interest rates, lending and deposit trends and other key factors to forecast/simulate the effects of both higher and lower interest rates. The results detailed below indicate the impact, in dollars and percentages, on NII and EVE of an increase and decrease in interest rates compared to a flat interest rate scenario. The model assumes that the rate change shock occurs immediately.
The following table presents the impact of that analysis in dollars and percentages at December 31, 2019.
At December 31, 2018, the following table presents the impact of that analysis in dollars and percentages:
As of December 31, 2019 the Fed Funds target rate was a range of 1.75% to 2.00% and the prime rate was 4.75%. As of December 31, 2018, the Fed Funds target rate was a range of 2.25% to 2.50% and the prime rate was 5.25%.
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Economic Value of Equity. We measure the impact of market interest rate changes on the net present value of estimated cash flows from our assets, liabilities and off-balance sheet items, defined as economic value of equity, using a simulation model. This simulation model assesses the changes in the market value of interest rate sensitive financial instruments that would occur in response to an instantaneous and sustained increase or decrease (shock) in market interest rates.
At December 31, 2019 and 2018, our economic value of equity exposure related to these hypothetical changes in market interest rates was within the current guidelines established by us. The following tables show projected change in economic value of equity for this set of rate shocks.
For further discussion of interest rate risk, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity Management - Interest Rate Risk.”
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ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our consolidated financial statements and supplementary data included in this Form 10-K begin on page 50 immediately following the index to consolidated financial statements page to this Form 10-K.
Report of Independent Registered Public Accounting Firm
To the Stockholders and the Board of Directors of Community West Bancshares
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Community West Bancshares (the Company) as of December 31, 2019 and 2018, the related consolidated income statements, comprehensive income, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2019, and the related notes to the consolidated financial statements (collectively, the financial statements). In our opinion, the 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 the each of the three years in the period ended December 31, 2019 in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with 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 financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the 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 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 financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ RSM US LLP
We have served as the Company’s auditor since 2015.
Las Vegas, Nevada
March 10, 2020
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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
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COMMUNITY WEST BANCSHARES
CONSOLIDATED BALANCE SHEETS
See the accompanying notes.
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COMMUNITY WEST BANCSHARES
CONSOLIDATED INCOME STATEMENTS
See the accompanying notes.
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COMMUNITY WEST BANCSHARES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
See the accompanying notes.
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COMMUNITY WEST BANCSHARES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
See the accompanying notes.
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COMMUNITY WEST BANCSHARES
CONSOLIDATED STATEMENTS OF CASH FLOWS
See the accompanying notes.
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COMMUNITY WEST BANCSHARES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations
Community West Bancshares (“CWBC”), incorporated under the laws of the state of California, is a bank holding company providing full service banking through its wholly-owned subsidiary Community West Bank, N.A. (“CWB” or the “Bank”). These entities are collectively referred to herein as the “Company”.
Basis of Presentation
The accounting and reporting policies of the Company are in accordance with accounting principles generally accepted in the United States (“GAAP”) and conform to practices within the financial services industry. The accounts of the Company and its consolidated subsidiary are included in these Consolidated Financial Statements. All significant intercompany balances and transactions have been eliminated.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant changes in the near term relate to the determination of the allowance for loan losses and fair value of investment securities available for sale. Although Management believes these estimates to be reasonably accurate, actual amounts may differ. In the opinion of Management, all adjustments considered necessary have been reflected in the financial statements during their preparation.
Reclassifications
Certain amounts in the consolidated financial statements as of and for the years ended December 31, 2018 and 2017 have been reclassified to conform to the current presentation. The reclassifications have no effect on net income or stockholders’ equity as previously reported.
Business Segments
Reportable business segments are determined using the “management approach” and are intended to present reportable segments consistent with how the chief operating decision maker organizes segments within the company for making operating decisions and assessing performance. As of December 31, 2019, 2018 and 2017, the Company had only one reportable business segment.
Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks (including cash items in process of clearing), and federal funds sold. Cash flows from loans originated by the Company and deposits are reported net.
The Company maintains amounts due from banks, which at times may exceed federally insured limits. The Company has not experienced any losses in such accounts.
Cash Reserve Requirement
Depository institutions are required by law to maintain reserves against their transaction deposits. The reserves must be held in cash or with the Federal Reserve Bank (“FRB”). The amount of the reserve varies by bank as the bank is permitted to meet this requirement by maintaining the specified amount as an average balance over a two-week period. The total reserve balance requirement was approximately $3.0 million and $2.9 million as of December 31, 2019 and 2018.
Investment Securities
Investment securities may be classified as held-to-maturity (“HTM”), available-for-sale (“AFS”) or trading. The appropriate classification is initially decided at the time of purchase. Securities classified as held-to-maturity are those debt securities the Company has both the intent and ability to hold to maturity regardless of changes in market conditions, liquidity needs or general economic conditions. These securities are carried at amortized cost. The sale of a security within three months of its maturity date or after the majority of the principal outstanding has been collected is considered a maturity for purposes of classification and disclosure.
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Securities classified as AFS or trading are reported as an asset on the Consolidated Balance Sheets at their estimated fair value. As the fair value of AFS securities changes, the changes are reported net of income tax as an element of other comprehensive income (“OCI”), except for impaired securities. When AFS securities are sold, the unrealized gain or loss is reclassified from OCI to non-interest income. The changes in the fair values of trading securities are reported in non-interest income. Securities classified as AFS are debt securities the Company intends to hold for an indefinite period of time, but not necessarily to maturity. Any decision to sell a security classified as AFS would be based on various factors, including significant movements in interest rates, changes in the maturity mix of the Company’s assets and liabilities, liquidity needs, decline in credit quality, and regulatory capital considerations. The Company has its AGM Stock securities classified as measured at fair value. The fair value changes are adjusted through non-interest income monthly.
Interest income is recognized based on the coupon rate and increased by accretion of discounts earned or decreased by the amortization of premiums paid over the contractual life of the security using the interest method. For mortgage-backed securities, estimates of prepayments are considered in the constant yield calculations.
In estimating whether there are any other than temporary impairment losses, management considers 1) the length of time and the extent to which the fair value has been less than amortized cost, 2) the financial condition and near term prospects of the issuer, 3) the impact of changes in market interest rates, and 4) the intent and ability of the Company to retain its investment for a period of time sufficient to allow for any anticipated recovery in fair value and it is not more likely than not the Company would be required to sell the security.
Declines in the fair value of individual debt securities available for sale that are deemed to be other than temporary are reflected in earnings when identified. The fair value of the debt security then becomes the new cost basis. For individual debt securities where the Company does not intend to sell the security and it is not more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis, the other than temporary decline in fair value of the debt security related to 1) credit loss is recognized in earnings, and 2) market or other factors is recognized in other comprehensive income or loss. Credit loss is recorded if the present value of cash flows is less than amortized cost.
For individual debt securities where the Company intends to sell the security or more likely than not will not recover all of its amortized cost, the other than temporary impairment is recognized in earnings equal to the entire difference between the securities cost basis and its fair value at the balance sheet date. For individual debt securities for which a credit loss has been recognized in earnings, interest accruals and amortization and accretion of premiums and discounts are suspended when the credit loss is recognized. Interest received after accruals have been suspended is recognized on a cash basis.
Federal Home Loan Bank (“FHLB”) and Federal Reserve Bank (“FRB”) Stock
The Company’s subsidiary bank is a member of the Federal Home Loan Bank (“FHLB”) system and maintains an investment in capital stock of the FHLB. The bank also maintains an investment in FRB stock. These investments are considered equity securities with no actively traded market. These investments are carried at cost, which is equal to the value at which they may be redeemed. The dividend income received from the stock is reported in interest income. We conduct a periodic review and evaluation of our FHLB stock to determine if any impairment exists. No impairment existed in the years ended December 31, 2019 or 2018.
Servicing Assets
The guaranteed portion of certain Small Business Administration (“SBA”) loans can be sold into the secondary market. Servicing assets are recognized as separate assets when loans are sold with servicing retained. Servicing assets are amortized in proportion to, and over the period of, estimated future net servicing income. The Company uses industry prepayment statistics and its own prepayment experience in estimating the expected life of the loans. Management evaluates its servicing assets for impairment quarterly. Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to amortized cost. Fair value is determined using discounted future cash flows calculated on a loan-by-loan basis and aggregated by predominate risk characteristics. The initial servicing asset and resulting gain on sale are calculated based on the difference between the best actual par and premium bids on an individual loan basis.
CWB is an approved Federal Agricultural Mortgage Corporation (“Farmer Mac”) seller/servicer. Servicing assets/liabilities are recognized as separate assets/liabilities as certain servicing requirements are retained. Servicing assets are amortized over the period of, estimated net servicing income. CWB uses Farmer Mac prepayment statistics in estimating the expected life of the loans. Management evaluates its servicing assets for impairment quarterly. Servicing assets are evaluated for impairment based on the fair value of the rights as compared to amortized cost. Fair value is determined using discounted future cash flows calculated on a loan-by-loan basis. The initial servicing asset and resulting gain or calculated based on the contractual net servicing fees.
Loans Held For Sale
Loans which are originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value determined on an aggregate basis. Valuation adjustments, if any are recognized through a valuation allowance by charges to lower of cost or fair value provision. Loans held for sale are mostly comprised of SBA and commercial agriculture. In 2015, the Company exited from originating single family residential loans for sale. The Company did not incur any lower of cost or fair value provision in the years ended December 31, 2019, 2018 and 2017.
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Loans Held for Investment and Interest and Fees from Loans
Loans are recognized at the principal amount outstanding, net of unearned income, loan participations and amounts charged off. Unearned income includes deferred loan origination fees reduced by loan origination costs. Unearned income on loans is amortized to interest income over the life of the related loan using the level yield method.
Interest income on loans is accrued daily using the effective interest method and recognized over the terms of the loans. Loan fees collected for the origination of loans less direct loan origination costs (net deferred loan fees) are amortized over the contractual life of the loan through interest income. If the loan has scheduled payments, the amortization of the net deferred loan fee is calculated using the interest method over the contractual life of the loan. If the loan does not have scheduled payments, such as a line of credit, the net deferred loan fee is recognized as interest income on a straight-line basis over the contractual life of the loan commitment. Commitment fees based on a percentage of a customer’s unused line of credit and fees related to standby letters of credit are recognized over the commitment period.
When loans are repaid, any remaining unamortized balances of unearned fees, deferred fees and costs and premiums and discounts paid on purchased loans are accounted for though interest income.
Nonaccrual loans: For all loan types, when a borrower discontinues making payments as contractually required by the note, the Company must determine whether it is appropriate to continue to accrue interest. Generally, the Company places loans in a nonaccrual status and ceases recognizing interest income when the loan has become delinquent by more than 90 days or when Management determines that the full repayment of principal and collection of interest is unlikely. The Company may decide to continue to accrue interest on certain loans more than 90 days delinquent if they are well secured by collateral and in the process of collection. Other personal loans are typically charged off no later than 120 days delinquent.
For all loan types, when a loan is placed on nonaccrual status, all interest accrued but uncollected is reversed against interest income in the period in which the status is changed. Subsequent payments received from the customer are applied to principal and no further interest income is recognized until the principal has been paid in full or until circumstances have changed such that payments are again consistently received as contractually required. The Company occasionally recognizes income on a cash basis for non-accrual loans in which the collection of the remaining principal balance is not in doubt.
Impaired loans: A loan is considered impaired when, based on current information; it is probable that the Company will be unable to collect the scheduled payments of principal and/or interest under the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and/or interest payments. Loans that experience insignificant payment delays or payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays or payment shortfalls on a case-by-case basis. When determining the possibility of impairment, management considers the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. For collateral-dependent loans, the Company uses the fair value of collateral method to measure impairment. The collateral-dependent loans that recognize impairment are charged down to the fair value less costs to sell. All other loans are measured for impairment either based on the present value of future cash flows or the loan’s observable market price.
Troubled debt restructured loan (“TDR”): A TDR is a loan on which the Company, for reasons related to the borrower’s financial difficulties, grants a concession to the borrower that the Company would not otherwise consider. These concessions included but are not limited to term extensions, rate reductions and principal reductions. Forgiveness of principal is rarely granted and modifications for all classes of loans are predominately term extensions. A TDR loan is also considered impaired. Generally, a loan that is modified at an effective market rate of interest may no longer be disclosed as a troubled debt restructuring in years subsequent to the restructuring if it is not impaired based on the terms specified by the restructuring agreement.
Allowance for Loan Losses and Provision for Loan Losses
The Company maintains a detailed, systematic analysis and procedural discipline to determine the amount of the allowance for loan losses (“ALL”). The ALL is based on estimates and is intended to be appropriate to provide for probable losses inherent in the loan portfolio. This process involves deriving probable loss estimates that are based on migration analysis and historical loss rates, in addition to qualitative factors that are based on management’s judgment. The migration analysis and historical loss rate calculations are based on the annualized loss rates and the Company extended its time horizon for the ALL methodology in 2019. Migration analysis is utilized for the Commercial Real Estate (“CRE”), Commercial, Commercial Agriculture, Small Business Administration (“SBA”), Home Equity Line of Credit (“HELOC”), Single Family Residential, and Consumer portfolios. The historical loss rate method is utilized primarily for the Manufactured Housing portfolio. The migration analysis takes into account the risk rating of loans that are charged off in each loan category. Loans that are considered Doubtful are typically charged off. The following is a description of the characteristics of loan ratings. Loan ratings are reviewed as part of our normal loan monitoring process, but, at a minimum, updated on an annual basis.
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Substantially Risk Free - These borrowers have virtually no probability of default or loss given default and present no identifiable or potential adverse risk to the Company. Documented repayment is either backed by the full faith and credit of the United States Government, or secured by cash collateral at a ratio of 115% of the principal borrowed. The collateral must be in the possession of the Company and free from potential claim. In addition, these credits will conform in all aspects to established loan policies and procedures, laws, rules, and regulations.
Nominal Risk - This rating is for the highest quality borrowers with nominal probability of default or loss given default from the transaction. Typically this is a borrower with a well-established record of financial performance, a strong equity position, abundant liquidity and excellent debt service ability. The Borrower’s financial outlook is stable due to a broad range of operations or products and is able to weather an economic downturn without significant impact to liquidity or net worth. Typically, this borrower will be publicly owned or have access to public debt or equity, all investment grade. In addition, these credits will conform in all aspects to established loan policies and procedures, laws, rules, and regulations. Transaction can include marketable securities as collateral, properly margined.
Pass/Management Attention Risk - The loans is the three remaining pass categories range from minimal risk to moderate risk to management attention risk. Loans rated in the first two categories are acceptable loans, appropriately underwritten, bearing an ordinary risk of loss to the Company. Loans in the minimal and moderate risk categories are loans to quality borrowers with financial statements presenting a good primary source as well as an adequate secondary source of repayment. In the case of individuals, borrowers with this rating are quality borrowers demonstrating a reasonable level of secure income, a net worth adequate to support the loan and presenting a good primary source as well as an adequate secondary source of repayment. An asset in the management attention risk category indicates that although the borrower meets the criteria for a rating of acceptable risk or better, the credit possesses an identified and elevated risk level that should be resolved in a short period of time. Technical risks include, but are not limited to, inadequate or improperly executed documentation, which may be material, serious delays in the submission of financial reporting or covenant violations that are not indicative of a protracted trend.
Special Mention - A Special Mention loan has potential weaknesses that require 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 assets are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.
Substandard - A Substandard loan is inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. These loans have a well-defined weakness or weaknesses that jeopardize full collection of amounts due. They are characterized by the distinct possibility that the Company will sustain some loss if the borrower’s deficiencies are not corrected.
Doubtful - A loan classified Doubtful has all the weaknesses inherent in one classified 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 and improbable. The possibility of loss is extremely high, but because of certain important and reasonably specific pending factors, which may work to the advantage and strengthening of the loan, its classification as an estimated loss is deferred until its more exact status may be determined. Pending factors include proposed merger, acquisition or liquidation procedures, capital injection, perfecting liens on additional collateral and refinancing plans.
Loss - Loans classified Loss are considered uncollectible and of such little value that their continuance as bankable loans is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this loan even though partial recovery may be realized in the future. Losses are taken in the period in which they are considered uncollectible.
The Company’s ALL is maintained at a level believed appropriate by management to absorb known and inherent probable losses on existing loans. The allowance is charged for losses when management believes that full recovery on the loan is unlikely. The following is the Company’s policy regarding charging off loans.
Commercial, CRE and SBA Loans
Charge-offs on these loan categories are taken as soon as all or a portion of any loan balance is deemed to be uncollectible. A loan is considered impaired when, based on current information, it is probable that the Company will be unable to collect the scheduled payments of principal and/or interest under the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and/or interest payments. Loans that experience insignificant payment delays or payment shortfalls generally are not classified as impaired. Generally, loan balances are charged-down to the fair value of the collateral, if, based on a current assessment of the value, an apparent deficiency exists. In the event there is no perceived equity, the loan is charged-off in full. Unsecured loans which are delinquent over 90 days are also charged-off in full.
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Single Family Real Estate, HELOC’s and Manufactured Housing Loans
Consumer loans and residential mortgages secured by one-to-four family residential properties, HELOC and manufactured housing loans in which principal or interest is due and unpaid for 90 days, are evaluated for impairment. Loan balances are charged-off to the fair value of the property, less estimated selling costs, if, based on a current appraisal, an apparent deficiency exists. In the event there is no perceived equity, the loan is generally fully charged-off.
Consumer Loans
All consumer loans (excluding real estate mortgages, HELOCs and savings secured loans) are charged-off or charged-down to net recoverable value before becoming 120 days or five payments delinquent.
The ALL calculation for the different loan portfolios is as follows:
•
Commercial Real Estate, Commercial, Commercial Agriculture, SBA, HELOC, Single Family Residential, and Consumer - Migration analysis combined with risk rating is used to determine the required ALL for all non-impaired loans. In addition, the migration results are adjusted based upon qualitative factors that affect the specific portfolio category. Reserves on impaired loans are determined based upon the individual characteristics of the loan.
•
Manufactured Housing - The ALL is calculated on the basis of loss history and risk rating, which is primarily a function of delinquency. In addition, the loss results are adjusted based upon qualitative factors that affect this specific portfolio.
The Company evaluates and individually assesses for impairment loans classified as substandard or doubtful in addition to loans either on nonaccrual, considered a TDR or when other conditions exist which lead management to review for possible impairment. Measurement of impairment on impaired loans is determined on a loan-by-loan basis and in total establishes a specific reserve for impaired loans. The amount of impairment is determined by comparing the recorded investment in each loan with its value measured by one of three methods:
•
The expected future cash flows are estimated and then discounted at the effective interest rate.
•
The value of the underlying collateral net of selling costs. Selling costs are estimated based on industry standards, the Company’s actual experience or actual costs incurred as appropriate. When evaluating real estate collateral, the Company typically uses appraisals or valuations, no more than twelve months old at time of evaluation. When evaluating non-real estate collateral securing the loan, the Company will use audited financial statements or appraisals no more than twelve months old at time of evaluation. Additionally, for both real estate and non-real estate collateral, the Company may use other sources to determine value as deemed appropriate.
•
The loan’s observable market price.
Interest income is not recognized on impaired loans except for limited circumstances in which a loan, although impaired, continues to perform in accordance with the loan contract and the borrower provides financial information to support maintaining the loan on accrual.
The Company determines the appropriate ALL on a monthly basis. Any differences between estimated and actual observed losses from the prior month are reflected in the current period in determining the appropriate ALL and adjusted as deemed necessary. The review of the appropriateness of the allowance takes into consideration such factors as concentrations of credit, changes in the growth, size and composition of the loan portfolio, overall and individual portfolio quality, review of specific problem loans, collateral, guarantees and economic and environmental conditions that may affect the borrowers’ ability to pay and/or the value of the underlying collateral. Additional factors considered include: geographic location of borrowers, changes in the Company’s product-specific credit policy and lending staff experience. These estimates depend on the outcome of future events and, therefore, contain inherent uncertainties.
Another component of the ALL considers qualitative factors related to non-impaired loans. The qualitative portion of the allowance on each of the loan pools is based on changes in any of the following factors:
•
Concentrations of credit
•
International risk
•
Trends in volume, maturity, and composition of loans
•
Volume and trend in delinquency, nonaccrual, and classified assets
•
Economic conditions
•
Geographic distance
•
Policy and procedures or underwriting standards
•
Staff experience and ability
•
Value of underlying collateral
•
Competition, legal, or regulatory environment
•
Quality of loan review and Board oversight
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Off Balance Sheet and Credit Exposure
In the ordinary course of business, the Company has entered into off-balance sheet financial instruments consisting of commitments to extend credit and standby letters of credit. Such financial instruments are recorded in the consolidated financial statements when they are funded. They involve, to varying degrees, elements of credit risk in excess of amounts recognized in the consolidated balance sheets. Losses would be experienced when the Company is contractually obligated to make a payment under these instruments and must seek repayment from the borrower, which may not be as financially sound in the current period as they were when the commitment was originally made. Commitments to extend credit are agreements to lend to a customer as long as 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. The Company enters into credit arrangements that generally provide for the termination of advances in the event of a covenant violation or other event of default. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the party. The commitments are collateralized by the same types of assets used as loan collateral.
As with outstanding loans, the Company applies qualitative factors and utilization rates to its off-balance sheet obligations in determining an estimate of losses inherent in these contractual obligations. The estimate for loan losses on off-balance sheet instruments is included within other liabilities and the charge to income that establishes this liability is included in non-interest expense.
Premises and Equipment
Premises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized over the terms of the leases or the estimated useful lives of the improvements, whichever is shorter. Generally, the estimated useful lives of other items of premises and equipment are as follows:
Leases
At inception, contracts are evaluated to determine whether the contract constitutes a lease agreement. For contracts that are determined to be an operating lease, a corresponding Right of Use (“ROU”) asset and operating lease liability are recorded in separate line items on the Consolidated Balance Sheet. ROU assets represent the Company’s right to use an underlying asset during the lease term and a lease liability represents the Company’s commitment to make contractually obligated lease payments. Operating lease ROU assets and liabilities are recognized at the commencement date of the lease and are based on the present value of lease payments over the lease term. The measurement of the operating lease ROU asset includes any lease payments made and is reduced by lease incentive that are paid or are payable to the Company. Variable lease payments that depend on an index are included in lease payments based on the rate in effect at the commencement date of the lease. Lease payments are recognized on a straight-line basis as part of occupancy expense over the lease term.
As the rate implicit in the lease is not readily determinable, the Company’s incremental borrowing rate is used to determine the present value of lease payments. This rate gives consideration to the applicable FHLB collateralized borrowing rates and is based on the information available at the commencement date. The Company has elected to apply the short-term lease measurement and recognition exemption to leases with an initial term of 12 months or less, therefore, these leases are not recorded on the Company’s Balance Sheet. Lease expense of these leases is recognized over the lease term on a straight-line basis. The Company’s lease agreements may include options to extend or terminate the lease. These options are included in the lease term when it is reasonably certain that the option will be exercised.
In addition to the package of practical expedients, the Company also elected the practical expedient that allows lessees to make an accounting policy election to not separate non-lease components from the associated lease component, and instead account for them all together as part of the applicable lease component. The majority of the Company’s non-lease components, such as common area maintenance and taxes, are variable and expensed as incurred. Variable payment amounts are determined in arrears by the landlord depending on actual costs incurred. See ‘‘Note 14. Leases” of these Notes to Consolidated Financial Statements for further disclosures required under the standard.
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Foreclosed Real Estate and Repossessed Assets
Foreclosed real estate and other repossessed assets are recorded at fair value at the time of foreclosure less estimated costs to sell. Any excess of loan balance over the fair value less estimated costs to sell of the other assets is charged-off against the allowance for loan losses. Any excess of the fair value less estimated costs to sell over the loan balance is recorded as a loan loss recovery to the extent of the loan loss previously charged-off against the allowance for loan losses; and, if greater, recorded as a gain on foreclosed assets. Subsequent to the legal ownership date, the Company periodically performs a new valuation and the asset is carried at the lower of carrying amount or fair value less estimated costs to sell. Operating expenses or income, and gains or losses on disposition of such properties, are recorded in current operations.
Income Taxes
The Company uses the asset and liability method, which recognizes an asset or liability representing the tax effects of future deductible or taxable amounts that have been recognized in the consolidated financial statements. Due to tax regulations, certain items of income and expense are recognized in different periods for tax return purposes than for financial statement reporting. These items represent “temporary differences.” Deferred income taxes are recognized for the tax effect of temporary differences between the tax basis of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. A valuation allowance is established for deferred tax assets if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets may not be realized. Any interest or penalties assessed by the taxing authorities is classified in the financial statements as income tax expense. Deferred tax assets are included in other assets on the consolidated balance sheets.
Management evaluates the Company’s deferred tax asset for recoverability using a consistent approach which considers the relative impact of negative and positive evidence, including the Company’s historical profitability and projections of future taxable income. The Company is required to establish a valuation allowance for deferred tax assets and record a charge to income if management determines, based on available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets may not be realized.
The Company is subject to the provisions of ASC 740, Income Taxes (“ASC 740”). ASC 740 prescribes a more likely than not threshold for the financial statement recognition of uncertain tax positions. ASC 740 clarifies the accounting for income taxes by prescribing a minimum recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. On a quarterly basis, the Company evaluates income tax accruals in accordance with ASC 740 guidance on uncertain tax positions.
Bank Owned Life Insurance
Bank owned life insurance is stated at its cash surrender value with changes recorded in other non-interest income in the consolidated income statements. The cash surrender value of the underlying policies was $6.9 million and $6.7 million as of December 31, 2019 and 2018, respectively. There are no loans offset against cash surrender values, and there are no restrictions as to the use of proceeds.
Fair Value of Financial Instruments
The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities. FASB ASC 820, Fair Value Measurements and Disclosures (“ASC 820”) established a framework for measuring fair value using a three-level valuation hierarchy for disclosure of fair value measurement. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset as of the measurement date. ASC 820 establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions about the factors market participants would consider in pricing the asset or liability developed based on the best information available in the circumstances. The hierarchy is broken down into three levels based on the reliability of inputs, as follows:
•
Level 1- Observable quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
•
Level 2- Observable quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, matrix pricing or model-based valuation techniques where all significant assumptions are observable, either directly or indirectly in the market.
•
Level 3- Model-based techniques where all significant assumptions are not observable, either directly or indirectly, in the market. These unobservable assumptions reflect management’s estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques may include use of discounted cash flow models and similar techniques.
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The availability of observable inputs varies based on the nature of the specific financial instrument. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, the degree of judgment exercised by the Company in determining fair value is greatest for instruments categorized in Level 3. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement in its entirety.
Fair value is a market-based measure considered from the perspective of a market participant who holds the asset or owes the liability rather than an entity-specific measure. When market assumptions are available, ASC 820 requires the Company to make assumptions regarding the assumptions that market participants would use to estimate the fair value of the financial instrument at the measurement date.
FASB ASC 825, Financial Instruments (“ASC 825”) requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value.
Management uses its best judgment in estimating the fair value of the Company’s financial instruments; however, there are inherent limitations in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates presented herein are not necessarily indicative of the amounts the Company could have realized in a sales transaction at December 31, 2019 or 2018. The estimated fair value amounts for December 31, 2019 and 2018 have been measured as of period-end, and have not been reevaluated or updated for purposes of these consolidated financial statements subsequent to those dates. As such, the estimated fair values of these financial instruments subsequent to the reporting date may be different than the amounts reported at the period-end.
The information presented in Note 16, “Fair Value Measurement,” should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only required for a limited portion of the Company’s assets and liabilities.
Due to the wide range of valuation techniques and the degree of subjectivity used in making the estimate, comparisons between the Company’s disclosures and those of other companies or banks may not be meaningful.
The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments:
Cash and cash equivalents
The carrying amounts reported in the consolidated balance sheets for cash and due from banks approximate their fair value.
Money market investments
The carrying amounts reported in the consolidated balance sheets for money market investments approximate their fair value.
Investment securities
The fair value of Farmer Mac class A stock is based on quoted market prices and are categorized as Level 1 of the fair value hierarchy.
The fair value of other investment securities were determined based on matrix pricing. Matrix pricing is a mathematical technique that utilizes observable market inputs including, for example, yield curves, credit ratings and prepayment speeds. Fair values determined using matrix pricing are generally categorized as Level 2 in the fair value hierarchy.
FRB and FHLB stock
CWB is a member of the FHLB system and maintains an investment in capital stock of the FHLB. CWB also maintain an investment in FRB stock. These investments are carried at cost since no ready market exists for them, and they have no quoted market value. The Company conducts a periodic review and evaluation of our FHLB stock to determine if any impairment exists. The fair values have been categorized as Level 2 in the fair value hierarchy.
Loans
Fair value for loans is estimated based on exit-pricing discounted cash flows using interest rates currently being offered for loans with similar terms to borrowers with similar credit quality with adjustments that the Company believes a market participant would consider in determining fair value based on a third party independent valuation. As a result, the fair value for loans is categorized as Level 2 in the fair value hierarchy. Fair values of impaired loans using a discounted cash flow method to measure impairment have been categorized as Level 3.
Deposit liabilities
The amount payable at demand at report date is used to estimate the fair value of demand and savings deposits. The estimated fair values of fixed-rate time deposits are determined by discounting the cash flows of segments of deposits that have similar maturities and rates, utilizing a discount rate that approximates the prevailing rates offered to depositors as of the measurement date. The fair value measurement of deposit liabilities is categorized as Level 2 in the fair value hierarchy.
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Federal Home Loan Bank advances and other borrowings
The fair values of the Company’s borrowings are estimated using discounted cash flow analyses, based on the market rates for similar types of borrowing arrangements. The other borrowings have been categorized as Level 3 in the fair value hierarchy. The FHLB advances have been categorized as Level 2 in the fair value hierarchy.
Off-balance sheet instruments
Fair values for the Company’s off-balance sheet instruments (lending commitments and standby letters of credit) are based on quoted fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing.
Earnings Per Share
Basic earnings per common share is computed using the weighted average number of common shares outstanding for the period divided into the net income (loss) available to common shareholders. Diluted earnings per share include the effect of all dilutive potential common shares for the period. Potentially dilutive common shares include stock options and warrants.
Recent Accounting Pronouncements
In May 2014, the FASB issued guidance codified within ASU 2014-09, “Revenue Recognition - Revenue from Contracts with Customers,” which amends the guidance in former Topic 605, Revenue Recognition. The new revenue recognition standard will supersede virtually all revenue guidance in U.S. GAAP, including industry specific guidance. The guidance in this Update affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets, unless those contracts are within the scope of other standards. ASU 2014-09 is effective for the Company for annual reporting periods beginning after December 15, 2016. In August 2015, this effective date was extended for the Company to December 15, 2017. The Company may elect to apply the amendments of this Update using one of the following two methods: 1) retrospectively to each prior reporting period presented or 2) retrospectively with the cumulative effect of initially applying this Update recognized at the date of initial application. Our revenue is comprised of net interest income on financial assets and liabilities, which is explicitly excluded from the scope of the new guidance, and noninterest income. The contracts that are in scope of the guidance are primarily related to service charges on deposit accounts, cardholder income, and other service charge fees. The Company adopted this guidance as of January 1, 2018 which did not have a material impact on the Company’s Consolidated Financial Statements.
In January 2016, the FASB issued guidance codified within ASU 2016-01, “Financial Instruments - Overall, Subtopic 825-10: Recognition and Measurement of Financial Assets and Financial Liabilities,” which amends certain guidance on classification and measurement of financial instruments. The update is intended to enhance the reporting model for financial instruments to provide users of financial instruments with more decision-useful information and addresses certain aspects of the recognition, measurement, presentation, and disclosure of financial instruments. ASU 2016-01 is effective for the Company for annual reporting periods beginning after December 15, 2017. The Company has evaluated the impact of the provisions in this standard on the Company’s Consolidated Financial Statements. The Company’s adoption of this guidance did not have a material impact on the Company’s Consolidated Financial Statements.
In February 2016, the FASB amended its standards with respect to the accounting for leases. The amended guidance serves to replace all current U.S. GAAP guidance on this topic and requires that an operating lease be recognized on the statement of financial condition as a “right-to-use” asset along with a corresponding liability representing the rent obligation. Key aspects of current lessor accounting remain unchanged from existing guidance. This standard is expected to result in an increase to assets and liabilities recognized and, therefore, increase risk-weighted assets for regulatory capital purposes. The guidance requires the use of the modified retrospective transition approach for existing leases that have not expired before the date of initial application and will become effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The standard is effective for the Company as of January 1, 2019. Upon adoption of the guidance on January 1, 2019, the Company recorded a ROU asset and lease liability of $8.4 million and $8.4 million respectively, on the consolidating balance. No cumulative effect adjustment to retained earnings resulted from the adoption of this guidance. The new standard did not have a material impact in the Company’s result of operations or cash flows.
In March 2016, the FASB issued update guidance codified within ASU-2016-09, “Compensation - Stock Compensation (Topic 718), Improvements to Employee Share-Based Payment Accounting,” which amends the guidance on certain aspects of share-based payments to employees. The new guidance will require entities to recognize all income tax effects of awards in the income statement when the awards vest or are settled. The guidance requires the use of the modified retrospective transition method by means of a cumulative-effect adjustment to equity as of the beginning of the period in which the guidance is adopted. The standard was effective for the Company as of January 1, 2017. The adoption of this standard did not have a material impact on the Company’s Consolidated Financial Statements.
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In June of 2016, the FASB issued update guidance codified within ASU-2016-13, “Financial Instruments - Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments,” which amends the guidance for recognizing credit losses from an “incurred loss” methodology that delays recognition of credit losses until it is probable a loss has been incurred to an expected credit loss methodology. The guidance requires the use of the modified retrospective transition method by means of a cumulative-effect adjustment to equity as of the beginning of the period in which the guidance is adopted. The standard is effective for the Company as of January 1, 2023. The Company is currently evaluating the impact of the amended guidance and has not yet determined the effect of the standard on its ongoing financial reporting.
In March 2017, the FASB issued updated guidance codified within ASU-2017-08, “Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20),” which is intended to enhance the accounting for the amortization of premiums for purchased callable debt securities. The standard is effective for the Company as of January 1, 2019. The adoption of this standard did not have a material impact on the Company’s financials.
In February 2018, the FASB issued guidance codified within ASU-2018-02, “Income Statement - Reporting Comprehensive Income (Topic 220), Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income,” to address the income tax accounting treatment of the standard tax effects within other comprehensive income due to the prohibition of backward tracing due to an income tax rate change that was initially recorded in other comprehensive income. This issue came about from the enactment of the Tax Cuts and Jobs Act on December 22, 2017 that changed the Company’s income tax rate from 34% to 21%. The ASU changed current accounting whereby an entity may elect to reclassify the stranded tax effect from accumulated other comprehensive income to retained earnings. The ASU is effective for periods beginning after December 15, 2018 although early adoption is permitted. The Company adopted ASU-2018-02 in the first quarter of 2018 and reclassified its stranded tax credit of $53,000 within accumulated other comprehensive income to retained earnings at January 1, 2018.
2.
INVESTMENT SECURITIES
The amortized cost and estimated fair value of investment securities are as follows:
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At December 31, 2019 and 2018, $25.6 million and $32.2 million of securities at carrying value, respectively, were pledged to the Federal Home Loan Bank (“FHLB”), as collateral for current and future advances.
The Company had no investment security sales in 2019 or 2018.
The maturity periods and weighted average yields of investment securities at December 31, 2019 and 2018 were as follows:
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The amortized cost and fair value of investment securities by contractual maturities as of the periods presented were as shown below:
Actual maturities may differ from contractual maturities as borrowers or issuers have the right to prepay or call the investment securities. Changes in interest rates may also impact prepayments.
The following tables show all securities that are in an unrealized loss position:
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As of December 31, 2019 and 2018, there were 20 and 21 securities, respectively, in an unrealized loss position. Declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In estimating other than temporary impairment losses, management considers, among other things (i) the length of time and the extent to which the fair value has been less than cost (ii) the financial condition and near-term prospects of the issuer and (iii) the Company’s intent to sell an impaired security and if it is not more likely than not it will be required to sell the security before the recovery of its amortized basis.
The unrealized losses are primarily due to increases in market interest rates over the yields available at the time the underlying securities were purchased. The fair value is expected to recover as the bonds approach their maturity date, repricing date or if market yields for such investments decline. Management does not believe any of the securities are impaired due to reasons of credit quality. Accordingly, as of December 31, 2019 and 2018, management believes the impairments detailed in the table above are temporary and no other than temporary impairment loss has been realized in the Company’s consolidated income statements.
3.
LOANS HELD FOR SALE
SBA and Agriculture Loans
As of December 31, 2019 and 2018, the Company had approximately $10.4 million and $13.6 million, respectively, of SBA loans included in loans held for sale. As of December 31, 2019 and 2018, the principal balance of SBA loans serviced for others was $5.2 million and $7.2 million, respectively.
The Company’s agricultural lending program includes loans for agricultural land, agricultural operational lines, and agricultural term loans for crops, equipment and livestock. The primary products are supported by guarantees issued from the USDA, FSA, and the USDA Business and Industry loan program.
As of December 31, 2019 and 2018, the Company had $31.6 million and $34.8 million of USDA loans included in loans held for sale, respectively. As of December 31, 2019 and 2018, the principal balance of USDA loans serviced for others was $1.9 million and $2.0 million, respectively.
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4.
LOANS HELD FOR INVESTMENT
The composition of the Company’s loans held for investment loan portfolio follows:
The following tables present the contractual aging of the recorded investment in past due held for investment loans by class of loans:
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Allowance for Loan Losses
The following table summarizes the changes in the allowance for loan losses:
As of December 31, 2019 and 2018, the Company had reserves for credit losses on undisbursed loans of $85,000 and $73,000 which were included in Other liabilities.
The following tables summarize the changes in the allowance for loan losses by portfolio type:
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The following tables present impairment method information related to loans and allowance for loan losses by loan portfolio segment:
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Included in impaired loans are $0.6 million and $3.1 million of loans guaranteed by government agencies at December 31, 2019 and 2018, respectively. A valuation allowance is established for an impaired loan when the fair value of the loan is less than the recorded investment. In certain cases, portions of impaired loans are charged-off to realizable value instead of establishing a valuation allowance and are included, when applicable in the table above as “Impaired loans without specific valuation allowance under ASC 310.” The valuation allowance disclosed above is included in the allowance for loan losses reported in the consolidated balance sheets as of December 31, 2019 and 2018.
The table below reflects recorded investment in loans classified as impaired:
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The following table presents impaired loans by class:
The following table summarizes the average investment in impaired loans by class and the related interest income recognized:
The Company is not committed to lend significant additional funds on these impaired loans.
The following table reflects the recorded investment in certain types of loans at the periods indicated:
The accrual of interest is discontinued when substantial doubt exists as to collectability of the loan; generally at the time the loan is 90 days delinquent. Any unpaid but accrued interest is reversed at that time. Thereafter, interest income is no longer recognized on the loan. Interest income may be recognized on impaired loans to the extent they are not past due by 90 days. Interest on nonaccrual loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all of the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
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The following table presents the composition of nonaccrual loans by class of loans:
Included in nonaccrual loans are $0.3 million and $2.8 million of loans guaranteed by government agencies at December 31, 2019 and 2018, respectively.
The guaranteed portion of each SBA loan is repurchased from investors when those loans become past due 120 days by either CWB or the SBA directly. After the foreclosure and collection process is complete, the principal balance of loans repurchased by CWB are reimbursed by the SBA. Although these balances do not earn interest during this period, they generally do not result in a loss of principal to CWB; therefore a repurchase reserve has not been established related to these loans.
The Company utilizes an internal asset classification system as a means of reporting problem and potential problem loans. Under the Company’s risk rating system, the Company classifies problem and potential problem loans as “Special Mention,” “Substandard,” “Doubtful” and “Loss”. For a detailed discussion on these risk classifications see “Note 1 Summary of Significant Accounting Policies - Allowance for Loan Losses and Provision for Loan Losses” of this Form 10-K. Loans that do not currently expose the Company to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses that deserve management’s close attention are deemed to be Special Mention. 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 assets are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification. Risk rates are updated as part of the normal loan monitoring process, at a minimum, annually.
The following tables present gross loans by risk rating:
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Troubled Debt Restructured Loan (TDR)
A TDR is a loan on which the bank, for reasons related to a borrower’s financial difficulties, grants a concession to the borrower that the bank would not otherwise consider. The loan terms that have been modified or restructured due to a borrower’s financial situation include, but are not limited to, a reduction in the stated interest rate, an extension of the maturity or renewal of the loan at an interest rate below current market, a reduction in the face amount of the debt, a reduction in the accrued interest, extensions, deferrals, renewals and rewrites. The majority of the bank’s modifications are extensions in terms or deferral of payments which result in no lost principal or interest followed by reductions in interest rates or accrued interest. A TDR is also considered impaired. Generally, a loan that is modified at an effective market rate of interest may no longer be disclosed as a troubled debt restructuring in years subsequent to the restructuring if it is not impaired based on the terms specified by the restructuring agreement.
The following tables summarize the financial effects of TDR loans by class for the periods presented:
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The average rate concession was 82 basis points and 73 basis points for the twelve months ended December 31, 2019 and 2018, respectively. The average term extension in months was 147 and 151 for the twelve months ended December 31, 2019 and 2018, respectively.
A TDR loan is deemed to have a payment default when the borrower fails to make two consecutive payments or the collateral is transferred to repossessed assets. The Company had no TDR’s with payment defaults for the twelve months ended December 31, 2019 or 2018.
At December 31, 2019, there were no material loan commitments outstanding on TDR loans.
Related Parties
Principal stockholders, directors, and executive officers of the Company, together with companies they control and family members, are considered to be related parties. In the ordinary course of business, the Company has extended credit to these related parties. Federal banking regulations require that any such extensions of credit not be offered on terms more favorable than would be offered to non-related party borrowers of similar creditworthiness.
The following table summarizes the aggregate activity in such loans:
None of these loans are past due, on nonaccrual status or have been restructured to provide a reduction or deferral of interest or principal because of deterioration in the financial position of the borrower. There were no loans to a related party that were considered classified loans at December 31, 2019 or 2018.
Unfunded loan commitments outstanding with related parties total approximately $0.3 million at December 31, 2019 and $1.0 million at December 31 2018.
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5.
PREMISES AND EQUIPMENT
Lease Obligations
The Company leases certain premises under non-cancelable operating leases expiring through 2028. The following is a schedule of future minimum rental payments under these leases at December 31, 2019:
The Company leases the majority of its office locations and many of these leases contain multiple renewal options and provisions for increased rents. Total rent expense of $1.3 million, $1.2 million and $1.2 million is included in occupancy expenses for the years ended December 31, 2019, 2018 and 2017, respectively. Total depreciation expense of $0.9 million, $0.8 million, and $0.7 million is included in occupancy expenses for the each of the years ended December 31, 2019, 2018 and 2017, respectively.
6.
OTHER ASSETS ACQUIRED THROUGH FORECLOSURE
The following table summarizes the changes in other assets acquired through foreclosure:
7.
INCOME TAXES
The provision for income taxes consisted of the following:
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The reconciliation between the statutory income tax rate and the Company’s effective tax rate follows:
The cumulative tax effects of the primary temporary differences are as shown in the following table:
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts and their respective tax basis including operating losses and tax credit carryforwards. Net deferred tax assets of $3.2 million at December 31, 2019 are reported in the consolidated balance sheet as a component of total assets.
On December 22, 2017, the President of the United States signed into law the Tax Cuts and Jobs Act tax reform legislation. This legislation makes significant change in U.S. tax law including a reduction in the corporate tax rates, changes to net operating loss carryforwards and carrybacks, and a repeal of the corporate alternative minimum tax. The legislation reduced the U.S. corporate tax rate from the current rate of 34% to 21%. As a result of the enacted law, the Company was required to revalue deferred tax assets and liabilities at the 21% rate. The revaluation resulted in $1.3 million income tax expense and a corresponding reduction in the net deferred tax asset. The other provisions of the Tax Cuts and Jobs Act did not have a material impact on the fiscal 2017 consolidated financial statements.
Accounting standards Codification Topic 740, Income Taxes, requires that companies assess whether a valuation allowance should be established against their deferred tax assets based on the consideration of all available evidence using a “more likely than not” standard. A valuation allowance is established for deferred tax assets if, based on weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets may not be realized. Management evaluates the Company’s deferred tax assets for recoverability using a consistent approach which considers the relative impact of negative and positive evidence, including the Company’s historical profitability and projections of future taxable income. The Company is required to establish a valuation allowance for deferred tax assets and record a charge to income if management determines, based on available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets may not be realized.
There was no valuation allowance on deferred tax assets at December 31, 2019 or December 31, 2018.
The Company is subject to the provisions of ASC 740, Income Taxes (ASC 740). ASC 740 prescribes a more likely than not threshold for the financial statement recognition of uncertain tax positions. ASC 740 clarifies the accounting for income taxes by prescribing a minimum recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. On a quarterly basis, the Company undergoes a process to evaluate whether income tax accruals are in accordance with ASC 740 guidance on uncertain tax positions. There were no uncertain tax positions at December 31, 2019.
The Company is subject to income taxation in the United States and certain state jurisdictions. The Company’s federal and state income tax returns are filed on a consolidated basis. The Company is generally open to examination by tax authorities for the years 2014 and later. Although the Company is unable to determine the outcome under examination, it has evaluated whether there are any uncertain tax positions in accordance with ASC 740-10 and concluded that there are no significant uncertain tax positions requiring recognition in the financial statements.
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When tax returns are filed, it is highly certain that most positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the Consolidated Financial Statements in the period in which, based on all available evidence, management believes it is more-likely-than-not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50% likely of being realized upon settlement with the applicable taxing authority. As of December 31, 2019, the Company does not have any uncertain tax positions.
8.
DEPOSITS
The table below summarizes deposits by type:
Of the total deposits at December 31, 2019 $440.8 million may be immediately withdrawn. Time certificates of deposit are the only deposits which have a specified maturity.
The summary of the contractual maturities for all time deposits is as follows:
The Company through the bank is a member of the Certificate of Deposit Account Registry Service (“CDARS”), which provides Federal Deposit Insurance Corporation (“FDIC”) insurance for large deposits. Federal banking law and regulation place restrictions on depository institutions regarding brokered deposits as they pose increased liquidity risk for institutions that gather significant amounts of brokered deposits. At December 31, 2019 and 2018, the Company had $28.7 million and $35.2 million, respectively, of reciprocal CDARS deposits.
The Company also accepts deposits from related parties which totaled $27.1 million at December 31, 2019 and $12.5 million at December 31, 2018.
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9.
OTHER BORROWINGS
The following table summarizes the Company’s FHLB advances by maturity date:
The Company through the bank has a blanket lien credit line with the FHLB. FHLB advances are collateralized in the aggregate by the Company’s eligible loans and securities. Total FHLB advances were $65.0 million and $70.0 million at December 31, 2019 and 2018, respectively, borrowed at fixed rates. The Company also had $114.3 million of letters of credit with FHLB at December 31, 2019 to secure public funds. At December 31, 2019, the Company had pledged to the FHLB, $25.6 million of securities and $324.2 million of loans. At December 31, 2019, the Company had $60.5 million available for additional borrowing. At December 31, 2018, the Company had pledged to the FHLB, $32.2 million of securities and $269.4 million of loans. At December 31, 2018, CWB had $35.9 million available for additional borrowing. Total FHLB interest expense for the years ended December 31, 2019, 2018 and 2017 was $1.2 million, $1.0 million and $0.3 million, respectively.
Other Borrowing - In July of 2019, the Company entered into a change in terms on its revolving line of credit agreement for reducing the maximum available to $10.0 million. The line of credit matures July 30, 2022. The Company must maintain a compensating deposit with the lender of 25% of the outstanding principal balance in a non-interest bearing deposit account. The required balance was $1.2 million at December 31, 2018. In addition, the Company must maintain a minimum debt service coverage ratio of 1.65, a minimum Tier 1 leverage ratio of 7.0% and a minimum total risked based capital ratio of 10.0%. At December 31, 2019 and 2018 , the line of credit balance was zero and $5.0 million, respectively.
Federal Reserve Bank -The Company has established a credit line with the FRB. Advances are collateralized in the aggregate by eligible loans for up to 28 days. There were no outstanding FRB advances as of December 31, 2019 and 2018. Available borrowing capacity was $108.6 million and $103.8 million as of December 31, 2019 and 2018, respectively.
Federal Funds Purchased Lines- The Company has federal funds borrowing lines at correspondent banks totaling $20.0 million. There was no amount outstanding as of December 31, 2019 and 2018.
10.
COMMITMENTS AND CONTINGENCIES
Unfunded Commitments and Letters of Credit
The Company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. They involve, to varying degrees, elements of credit risk in excess of amounts recognized in the consolidated balance sheets.
Lines of credit are obligations to lend money to a borrower. Credit risk arises when the borrowers’ current financial condition may indicate less ability to pay than when the commitment was originally made. In the case of standby letters of credit, the risk arises from the possibility of the failure of the customer to perform according to the terms of a contract. In such a situation, the third party might draw on the standby letter of credit to pay for completion of the contract and the Company would look to its customer to repay these funds with interest. To minimize the risk, the Company uses the same credit policies in making commitments and conditional obligations as it would for a loan to that customer.
Standby letters of credit are commitments issued by the Company to guarantee the performance of a customer to a third party in borrowing arrangements. Typically, letters of credit issued have expiration dates within one year.
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A summary of the contractual amounts for unfunded commitments and letters of credit are as follows:
Commitments to extend credit are agreements to lend to a customer as long as 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. The Company enters into credit arrangements that generally provide for the termination of advances in the event of a covenant violation or other event of default. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the party. The commitments are collateralized by the same types of assets used as loan collateral.
The Company has exposure to credit losses from unfunded commitments and letters of credit. As funds have not been disbursed on these commitments, they are not reported as loans outstanding. Credit losses related to these commitments are not included in the allowance for credit losses reported in Note 4, “Loans Held For Investment” of these Consolidated Financial Statements and are accounted for as a separate loss contingency as a liability. This loss contingency for unfunded loan commitments and letters of credit was $85,000 and $73,000 as of December 31, 2019 and 2018, respectively. Changes to this liability are adjusted through other non-interest expense.
Concentrations of Lending Activities
The Company’s lending activities are primarily driven by the customers served in the market areas where the Company has branch offices in the Central Coast of California. The Company monitors concentrations within selected categories such as geography and product. The Company makes manufactured housing, commercial, SBA, construction, commercial real estate and consumer loans to customers through branch offices located in the Company’s primary markets. The Company’s business is concentrated in these areas and the loan portfolio includes significant credit exposure to the manufactured housing and commercial real estate markets of these areas. As of December 31, 2019 and 2018, manufactured housing loans comprised 33.2% and 32.2%, respectively of total loans. As of December 31, 2019 and 2018, commercial real estate loans accounted for approximately 49.7% and 47.6% of total loans, respectively. Approximately 31.9% and 33.8% of these commercial real estate loans were owner occupied at December 31, 2019 and 2018, respectively. Substantially all of these loans are secured by first liens with an average loan to value ratios of 54.3% and 57.9% at December 31, 2019 and 2018, respectively. The Company was within established policy limits at December 31, 2019 and 2018.
Loan Sales and Servicing
The Company retains a certain level of risk relating to the servicing activities and retained interest in sold loans. In addition, during the period of time that the loans are held for sale, the Company is subject to various business risks associated with the lending business, including borrower default, foreclosure and the risk that a rapid increase in interest rates would result in a decline of the value of loans held for sale to potential purchasers.
In connection with certain loan sales, the Company enters agreements which generally require the company to repurchase or substitute loans in the event of a breach of a representation or warranty made by the Company to the loan purchaser, any misrepresentation during the loan origination process or, in some cases, upon any fraud or early default on such loans.
The Company has sold loans that are guaranteed or insured by government agencies for which the Company retained all servicing rights and responsibilities. The Company is required to perform certain monitoring functions in connection with these loans to preserve the guarantee by the government agency and prevent loss to the Company in the event of nonperformance by the borrower. Management believes that the Company is in compliance with these requirements. The outstanding balance of the loans serviced for others was approximately $76.3 million and $9.2 million at December 31, 2019 and 2018, respectively.
Salary Continuation
The Company has agreements with certain key officers, which provide for a monthly cash payment to the officers or beneficiaries in the event of death, disability or retirement, beginning in the month after the retirement date or death and extending for a period of fifteen years subject to vesting. The Company purchased life insurance policies of $5.0 million as an investment. The income from the policy investments will help fund this liability.
At December 31, 2019 and 2018, the Company had accrued salary continuation liability for these agreements of $0.8 million and $0.6 million, respectively. The cash surrender value of the life insurance policies was $6.9 million at December 31, 2019, and is included in other assets.
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Other
The Company is involved in various other litigation matters of a routine nature that are being handled and defended in the ordinary course of the Company’s business. In the opinion of Management, based in part on consultation with legal counsel, the resolution of these litigation matters will not have a material impact on the Company’s financial position or results of operations.
11.
STOCKHOLDERS’ EQUITY
Common Stock Warrant
The Warrant issued as part of the TARP provided for the purchase of up to 521,158 shares of the common stock, at an exercise price of $4.49 per share (“Warrant Shares”). The Warrants were exercised for 300,401 shares of common stock prior to expiration in the fourth quarter of 2018.
Common Stock
During the years ended December 31, 2019 and 2018, the Company recorded $1.8 million and $1.6 million, respectively of dividends on common stock.
On February 28, 2019, the Board of Directors extended the repurchase program and increased the common stock repurchases to $4.5 million until August 31, 2021. Under this program the Company has repurchased 350,189 common stock shares for $3.1 million at an average price of $8.75 per share.
Stock Option Plans
The Company has one stock option plan available for option grants. Stock options granted in 2019 generally have a vesting period of 5 years and a contractual life of 10 years. The Company recognizes compensation cost for options ratably over the requisite service period for all awards. As of December 31, 2019, 55,100 options were available for future grant.
The fair value of each option award is estimated on the date of grant using the Black-Scholes option valuation model that uses the assumptions noted in the following table. This model requires the input of highly subjective assumptions, changes to which can materially affect the fair value estimate. The expected volatility is based on the historical volatility of the stock of the Company over the expected life of the options. The risk-free rate for the periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of the grant. The dividend rate assumption was the dividend yield at grant date. A summary of the assumptions used in calculating the fair value of option awards during the years ended December 31, 2019, 2018 and 2017 are as follows:
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A summary of option activity under the plan is presented below:
As of December 31, 2019, 2018 and 2017, there was $0.6 million, $0.7 million and $0.7 million, respectively, of total unrecognized compensation cost related to unvested share-based compensation arrangements granted under the Company’s plan. That cost is expected to be recognized over a weighted average period of 3.0 years, 3.2 years, and 3.3 years, respectively. The total intrinsic value of options exercised during the years ended December 31, 2019, 2018 and 2017, was $0.1 million, $0.6 million, and $0.5 million, respectively.
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The following table summarizes the change in unvested stock option shares during the year ended December 31, 2019:
12.
CAPITAL REQUIREMENTS
The Federal Reserve has adopted capital adequacy guidelines that are used to assess the adequacy of capital in supervising a bank holding company. In July 2013, the federal banking agencies approved the final rules (“Final Rules”) to establish a new comprehensive regulatory capital framework with a phase-in period beginning January 1, 2015 and ending January 1, 2019. The Final Rules implement the third installment of the Basel Accords (“Basel III”) regulatory capital reforms and changes required by the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) and substantially amend the regulatory risk-based capital rules applicable to the Company. Basel III redefines the regulatory capital elements and minimum capital ratios, introduces regulatory capital buffers above those minimums, revises rules for calculating risk-weighted assets and adds a new component of Tier 1 capital called Common Equity Tier 1, which includes common equity and retained earnings and excludes preferred equity.
The following tables illustrates the Bank’s regulatory ratios and the Federal Reserve’s current adequacy guidelines as of December 31, 2019 and 2018. The Federal Reserve’s fully phased-in guidelines applicable in 2019 are also summarized.
13.
REVENUE RECOGNITION
The Company adopted ASU No, 2014-09 “Revenue from Contracts with Customers” (Topic 606) and all subsequent ASUs that modified Topic 606 on January 1, 2018. The implementation of the new standard did not have a material impact on the measurement or recognition of revenue; as such, a cumulative effect adjustment to opening retained earnings was not deemed necessary. Results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts were not adjusted and continue to be reported in accordance with our historic accounting under Topic 605.
Topic 606 does not apply to revenue associated with financial instruments, including revenue from loans and securities. In addition, certain non-interest income streams such as servicing rights, financial guarantees and certain credit card fees are also not in scope of the new guidance. Topic 606 is applicable to non-interest income streams such as deposit related fees, interchange fees and merchant income. However the recognition of these income streams did not change upon the adoption of Topic 606. Substantially all of the Company’s revenue is generated from contracts with customers. Non-interest revenue streams in-scope of Topic 606 are discussed below.
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Service Charges on Deposit Accounts
Service charges on deposit accounts consist of monthly service fees, check orders, account analysis fees, and other deposit account related fees. The Company’s performance obligation for monthly service fees and account analysis fees is generally satisfied, and the related income recognized, over the period in which the service is provided. Check orders and other deposit related fees are largely transactional based and, therefore, the Company’s performance obligation is satisfied and related income recognized, at a point in time. Payment for service charges on deposit accounts is primarily received immediately or in the following month through a direct charge to customers’ accounts.
Exchange Fees and Other Service Charges
Exchange fees and other service charges are primarily comprised of debit and credit card income, merchant services income, ATM fees and other service charges. Debit and credit card income is primarily comprised of interchange fees earned whenever the Company’s debit and credit cards are processed through card payment networks such as Visa or MasterCard. Merchant services income is primarily fees charged to merchants to process their debit and credit card transactions. ATM fees are primarily generated when a Company cardholder uses a non-Company ATM or a non-Company cardholder uses a Company ATM. Other service charges include fees from processing wire transfers, cashier’s checks and other services. The Company’s performance obligation for exchange and other service charges are largely satisfied, and related revenue recognized, when the services are rendered or upon completion. Payment is typically received immediately or in the following month.
The following table presents non-interest income, segregated by revenue streams in-scope and out-of-scope of Topic 606, for periods indicated.
Contract Balances
A contract asset balance occurs when an entity performs a service for a customer before the customer pays consideration (resulting in a contract receivable) or before payment is due (resulting in a contract asset). A contract liability balance is an entity’s obligation to transfer a service to a customer for which the entity has already received payment (or payment is due) from the customer. The Company’s non-interest income streams are largely based on transactional activity. Consideration is often received immediately or shortly after the Company satisfies its performance obligation and income is recognized. The Company does not typically enter into long-term revenue contracts with customers, and therefore, does not experience significant contract balances. As of December 31, 2019 and December 31, 2018, the Company did not have any signficant contract balances.
Contract Acquisition Costs
In connection with the adoption of Topic 606, an entity is required to capitalize, and subsequently amortize into expense, certain incremental costs of obtaining a contract with a customer if these costs are expected to be recovered. The incremental costs of obtaining a contract are those costs that an entity incurs to obtain a contract with a customer that it would not have incurred if the contract had not been obtained. The Company utilizes the practical expedient which allows entities to immediately expense contract acquisition costs when the asset that would have resulted from capitalizing these costs would have been amortized in one year or less. Upon adoption of Topic 606, the Company did not capitalize any contract acquisition cost.
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14.
LEASES
As described in Note 1 - Summary of Significant Accounting Policies - Recent Accounting Pronouncements, effective January 1, 2019, we adopted Topic 842. We have operating leases for office space. Our office leases are typically for terms of between 2 and 10 years. Rents usually increase annually in accordance with defined rent steps or based on current year consumer price index adjustments. When renewal options exist, we generally do not deem them to be reasonably certain to be exercised, and therefore the amounts are not recognized as part of our lease liability nor our right-of-use asset. As part of the adoption, we elected the package of practical expedients permitted under the transition guidance, but not the hindsight practical expedient. As of December 31, 2019, the balance of the right-of-use assets was $6.3 million and the lease liabilities were $6.3 million. The right-of-use assets are included in other assets and the lease liabilities are included in other liabilities in the accompanying Consolidated Balance Sheets.
Future minimum operating lease payments:
15.
EMPLOYEE BENEFIT PLANS
401(k) Plan:
The Company has a qualified 401(k) employee benefit plan for all eligible employees. Participants are able to defer up to a maximum of $19,000 (for those under 50 years of age in 2019) of their annual compensation. The Company may elect to match a discretionary amount each year, which was 3% of the participant’s eligible compensation. The Company’s total contribution was $0.3 million for the years ended December 31, 2019, 2018 and 2017, respectively.
Deferred Compensation Plans:
A deferred compensation plan covers the executive officers. Under the plan, the Company pays each participant a percentage of their base salary plus interest. Vesting occurs at age 65. A liability is accrued for the obligation under these plans. The expense incurred for the deferred compensation for each of the last three years was $0.1 million resulting in a deferred compensation liability of $1.3 million and $1.1 million as of the year-end 2019 and 2018.
The Company also provides an unfunded nonqualified deferred compensation arrangement to provide supplemental retirement benefits for the Participants which are a select group of management or highly compensated employees of the Company. The Participants may defer up to 30% of their base salary and bonus each plan year. The 36 month certificate of deposit rate is paid on the vested balance.
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16.
FAIR VALUE MEASUREMENT
The fair value of an asset or liability is the price that would be received to sell the asset or paid to transfer the liability in an orderly transaction occurring in the principal market for such asset or liability. ASC 820 establishes a fair value hierarchy that prioritizes the inputs and valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (“Level 1”) and the lowest priority to unobservable inputs (“Level 3”). The three levels of the fair value hierarchy under ASC 820 and the methods and assumptions used by the Company in estimating the fair value of its financial instruments are described in “Note 1. Summary of Significant Accounting Policies - Fair Value of Financial Instruments” of these Notes to the Consolidated Financial Statements.
The following tables summarize the fair value of assets measured on a recurring basis:
Market valuations of our investment securities which are classified as level 2 are provided by an independent third party. The fair values are determined by using several sources for valuing fixed income securities. Their techniques include pricing models that vary based on the type of asset being valued and incorporate available trade, bid and other market information. In accordance with the fair value hierarchy, the market valuation sources include observable market inputs and are therefore considered Level 2 inputs for purposes of determining the fair values.
On certain SBA loan sales, the Company retained interest only strips (“I/O strips”), which represent the present value of excess net cash flows generated by the difference between (a) interest at the stated rate paid by borrowers and (b) the sum of (i) pass-through interest paid to third-party investors and (ii) contractual servicing fees. I/O strips are classified as level 3 in the fair value hierarchy. The fair value is determined on a quarterly basis through a discounted cash flow analysis prepared by an independent third party using industry prepayment speeds. I/O strip valuation adjustments are recorded as additions or offsets to loan servicing income.
Historically, the Company has elected to use the amortizing method for the treatment of servicing assets and has measured for impairment on a quarterly basis through a discounted cash flow analysis prepared by an independent third party using industry prepayment speeds. In connection with the sale of certain SBA and USDA loans the Company recorded servicing assets and elected to measure those assets at fair value in accordance with ASC 825-10. Significant assumptions in the valuation of servicing assets include estimated loan repayment rates, the discount rate, and servicing costs, among others. Servicing assets are classified as Level 3 measurements due to the use of significant unobservable inputs, as well as significant management judgment and estimation.
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The Company also has assets that under certain conditions are subject to measurement at fair value on a non-recurring basis. These assets include loans held for sale, foreclosed real estate and repossessed assets and loans that are considered impaired per generally accepted accounting principles.
The following summarizes the fair value measurements of assets measured on a non-recurring basis:
The Company records certain loans at fair value on a non-recurring basis. When a loan is considered impaired an allowance for a loan loss is established. The fair value measurement and disclosure requirement applies to loans measured for impairment using the practical expedients method permitted by accounting guidance for impaired loans. Impaired loans are measured at an observable market price, if available or at the fair value of the loan’s collateral, if the loan is collateral dependent. The fair value of the loan’s collateral is determined by appraisals or independent valuation. When the fair value of the loan’s collateral is based on an observable market price or current appraised value, given the current real estate markets, the appraisals may contain a wide range of values and accordingly, the Company classifies the fair value of the impaired loans as a non-recurring valuation within Level 2 of the valuation hierarchy. For loans in which impairment is determined based on the net present value of cash flows, the Company classifies these as a non-recurring valuation within Level 3 of the valuation hierarchy.
Loans held for sale are carried at the lower of cost or fair value. The fair value of loans held for sale is based on what secondary markets are currently offering for portfolios with similar characteristics or based on the agreed-upon sale price. As such, the Company classifies the fair value of loans held for sale as a non-recurring valuation within Level 2 of the fair value hierarchy. At December 31, 2019 and 2018, the Company had loans held for sale with an aggregate carrying value of $42.0 million and $48.4 million respectively.
Foreclosed real estate and repossessed assets are carried at the lower of book value or fair value less estimated costs to sell. Fair value is based upon independent market prices obtained from certified appraisers or the current listing price, if lower. When the fair value of the collateral is based on a current appraised value, the Company reports the fair value of the foreclosed collateral as non-recurring Level 2. When a current appraised value is not available or if management determines the fair value of the collateral is further impaired, the Company reports the foreclosed collateral as non-recurring Level 3.
FAIR VALUES OF FINANCIAL INSTRUMENTS
The estimated fair values of financial instruments have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data to develop estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
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The estimated fair value of the Company’s financial instruments are as follows:
Interest rate risk
The Company assumes interest rate risk (the risk to the Company’s earnings and capital from changes in interest rate levels) as a result of its normal operations. As a result, the fair values of the Company’s financial instruments as well as its future net interest income will change when interest rate levels change and that change may be either favorable or unfavorable to the Company.
Interest rate risk exposure is measured using interest rate sensitivity analysis to determine the change in the net portfolio value and net interest income resulting from hypothetical changes in interest rates. If potential changes to net portfolio value and net interest income resulting from hypothetical interest rate changes are not within the limits established by the Board of Directors, the Board of Directors may direct management to adjust the asset and liability mix to bring interest rate risk within board-approved limits. As of December 31, 2019, the Company’s interest rate risk profile was within Board-approved limits.
The Company’s subsidiary bank has an Asset and Liability Management Committee charged with managing interest rate risk within Board approved limits. Such limits are structured to prohibit an interest rate risk profile that is significantly asset or liability sensitive.
Fair value of commitments
Loan commitments on which the committed interest rates were less than the current market rate are insignificant at December 31, 2019 and 2018. The estimated fair value of standby letters of credit outstanding at December 31, 2018 was also insignificant.
17.
ACCUMULATED OTHER COMPREHENSIVE INCOME
The following table summarizes the changes in other comprehensive income by component, net of tax for the period indicated:
There were no reclassifications out of accumulated other comprehensive income for the years ended December 31, 2019, 2018 and 2017.
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18.
PARENT COMPANY FINANCIAL INFORMATION
The condensed financial statements of the holding company are presented in the following tables:
COMMUNITY WEST BANCSHARES
Condensed Balance Sheets
COMMUNITY WEST BANCSHARES
Condensed Income Statements
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COMMUNITY WEST BANCSHARES
Condensed Statements of Cash Flows
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19.
QUARTERLY FINANCIAL DATA (UNAUDITED)
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ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
The Company’s management, under the supervision and with the participation of the Chief Executive Officer, and the Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of December 31, 2019. Based on that evaluation, the Company’s management concluded that the Company’s disclosure controls and procedures are effective as of December 31, 2019, in timely alerting them to material information relating to the Company (including its consolidated subsidiary) required to be included in the Company’s reports that it files with or submits to the SEC under the Exchange Act.
Report on Management’s Assessment of Internal Control over Financial Reporting
The Company’s management is responsible for establishing and maintaining an adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). 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 reporting purposes in accordance with accounting principles generally accepted in the United States of America. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Management has assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2019. In making its assessment, management has utilized the criteria set forth by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission in Internal Control - Integrated Framework (2013 framework). Management concluded that, based on its assessment, the Company’s internal control over financial reporting was effective as of December 31, 2019.
Changes in Internal Control Over Financial Reporting
The Company’s management has also evaluated, with the participation of the Company’s Chief Executive Officer and the Chief Financial Officer, whether there were any changes in the Company’s internal control over financial reporting that occurred during the fourth quarter ended December 31, 2019. Based upon this evaluation, the Company’s management has determined that there were no changes in the Company’s internal control over financial reporting that occurred during the Company’s fourth quarter ended December 31, 2019, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
This Form 10-K does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to rules of the Commission that permit the Company to provide only the management’s report in this Form 10-K.
ITEM 9B.
ITEM 9B.
OTHER INFORMATION
Not applicable.
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PART III
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Information required by this Item regarding the Company’s directors and executive officers, and corporate governance, including information with respect to beneficial ownership reporting compliance, will appear in the Proxy Statement we will deliver to our shareholders in connection with our 2020 Annual Meeting of Shareholders (the “Proxy Statement”) to be filed pursuant to Regulation 14A within 120 days after the end of the Company’s last fiscal year. Such information is incorporated herein by reference.
The Company has adopted a code of ethics that applies to its directors, principal executive officer, principal financial officer, principal accounting officer or controller and persons performing similar functions and employees. A copy of the code of ethics is available on the Company’s website at www.communitywest.com.
ITEM 11.
ITEM 11.
EXECUTIVE COMPENSATION
The information required by this Item will appear in the Proxy Statement we will deliver to our shareholders in connection with our 2020 Annual Meeting of Shareholders. Such information is incorporated herein by reference.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS
The information required by this Item regarding security ownership of certain beneficial owners and management will appear in the Proxy Statement we will deliver to our shareholders in connection with our 2020 Annual Meeting of Shareholders . Such information is incorporated herein by reference.
Information relating to securities authorized for issuance under the Company’s equity compensation plans is contained under “Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities - Securities Authorized for Issuance Under Equity Compensation Plans” herein.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
The information required by this Item will appear in the Proxy Statement we will deliver to our stockholders in connection with our 2020 Annual Meeting of Shareholders. Such information is incorporated herein by reference.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by this Item will appear in the Proxy Statement we will deliver to our stockholders in connection with our 2020 Annual Meeting of Shareholders. Such information is incorporated herein by reference.
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PART IV
ITEM 15.
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(1) The following financial statements are incorporated by reference from Item 8 hereto:
(2) Financial Statement Schedules
Financial statement schedules other than those listed above have been omitted because they are either not applicable or the information is otherwise included.
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EXHIBITS
(3) Exhibits. The following is a list of exhibits filed as a part of this Annual Report.
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(1)
Incorporated by reference from the Registrant’s Annual Report on Form 10-K filed with the Commission on March 26, 1998.
(2)
Incorporated by reference from the Registrant’s Form 8-K filed with the Commission on December 18, 2008.
(3)
Incorporated by reference from the Registrant’s Amendment to Registration Statement on Form 8-A filed with the Commission on March 12, 1998.
(4)
Incorporated by reference from the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2002 filed with the Commission on March 31, 2003.
(5)
Incorporated by reference from Registrant’s Annual Report on Form 10-K for the year ended December 31, 2006 filed with the Commission on March 26, 2007.
(6)
Incorporated by reference from the Registrant’s Form 8-K filed with the Commission on July 2, 2007.
(7)
Incorporated by reference from the Registrant’s Form 8-K filed with the Commission on November 3, 2011.
(8)
Incorporated by reference from the Registrant’s Form 8-K filed with the Commission on January 29, 2014.
(9)
Incorporated by reference from Registrant’s Statement on Form S-8 (File No 333-201281) filed with the Commission on December 29, 2014.
(10)
Incorporated by reference from the Registrant’s Form 10-Q for the quarter and nine months ended September 30, 2015 filed with the Commission on November 6, 2015.
(11)
Incorporated by reference from the Registrant’s Form 10-Q for the quarter and six months ended June 30, 2017 filed with the Commission on August 4, 2017.
(12)
Incorporated by reference from the Registrant’s Statement on Form S-8 (File No 323-218994) filed with the Commission on June 27, 2017.
(13)
Incorporated by reference from the Registrant’s Form 10-Q for the quarter and nine months ended September 30, 2018 filed with the Commission on November 2, 2018.
*
Indicates a management contract or compensatory plan or arrangement.
**
Filed herewith.
***
Furnished herewith.
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SIGNATURES
Pursuant to the requirements of Section 13 of 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.
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.
Signature
Title
Date
/s/ William R. Peeples
Director and Chairman of the Board
March 10, 2020
William R. Peeples
/s/ Martin E. Plourd
President and Chief Executive Officer and Director
March 10, 2020
Martin E. Plourd
(Principal Executive Officer)
/s/ Susan C. Thompson
Executive Vice President and Chief Financial Officer
March 10, 2020
Susan C. Thompson
(Principal Financial and Accounting Officer)
/s/ Robert H. Bartlein
Director
March 10, 2020
Robert H. Bartlein
/s/ Jean W. Blois
Director
March 10, 2020
Jean W. Blois
/s/ Dana L. Boutain
Director
March 10, 2020
Dana L. Boutain
/s/ Tom L. Dobyns
Director
March 10, 2020
Tom L. Dobyns
/s/ John D. Illgen
Director and Secretary of the Board
March 10, 2020
John D. Illgen
/s/ James W. Lokey
Director
March 10, 2020
James W. Lokey
/s/ Shereef Moharram
Director
March 10, 2020
Shereef Moharram
/s/ Kirk B. Stovesand
Director
March 10, 2020
Kirk B. Stovesand