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.
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.
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 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:
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:
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:
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.
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.
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.
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.
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.
The following tables present the Company’s average balances as of the dates indicated:
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.
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.
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.
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:
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.
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.
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:
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:
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.
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.
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.
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.
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.
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. Quantitative and Qualitative Disclosure about Market Risk.”
Litigation
See “Part 1. Item 3: Legal Proceedings” beginning on page 13 of this Form 10-K.
SUPERVISION AND REGULATION
Introduction
CWBC is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended, and is registered with, regulated and examined by the Board of Governors of the Federal Reserve
System (the “FRB”). In addition to the regulation of the Company by the FRB, CWB is subject to extensive regulation and periodic examination, principally by the Office of the Comptroller of the Currency (“OCC”). The Federal Deposit Insurance
Corporation (“FDIC”) insures the Bank’s deposits up to certain prescribed limits. The Company is also subject to jurisdiction of the Securities and Exchange Commission (“SEC”) and to the disclosure and regulatory requirements of the Securities Act of
1933 (the “Securities Act”) and the Securities Exchange Act of 1934 (the “Exchange Act”), and through the listing of the common stock on the NASDAQ Capital Select Market, the Company is subject to the rules of NASDAQ.
Banking is a complex, highly regulated industry. The primary goals of the rules and regulations are to maintain a safe and sound banking system, protect depositors and the FDIC’s insurance fund, and
facilitate the conduct of sound monetary policy. In furtherance of these goals, Congress and the states have created several largely autonomous regulatory agencies and enacted numerous laws that govern banks, bank holding companies and the financial
services industry. Consequently, the growth and earnings performance of the Company can be affected not only by Management decisions and general economic conditions, but also by the requirements of applicable state and federal statues, regulations
and the policies of various governmental regulatory authorities.
From time to time laws or regulations are enacted which have the effect of increasing the cost of doing business, limiting or expanding the scope of permissible activities, or changing the competitive
balance between banks and other financial and non-financial institutions. Proposals to change the laws and regulations governing the operations of banks and bank holding companies are frequently made in Congress and by various bank and other
regulatory agencies. Future changes in the laws, regulations or polices that impact CWBC and CWB cannot necessarily be predicted, but they may have a material effect on the business and earnings of the Company.
Securities Registration and Listing
CWBC’s common stock is registered with the SEC under the Exchange Act and, therefore, is subject to the information, proxy solicitation, insider trading, corporate governance, and other disclosure
requirements and restrictions of the Exchange Act, as well as the Securities Act both administered by the SEC. CWBC is required to file annual, quarterly and other current reports with the SEC. The SEC maintains an Internet site, http://www.sec.gov,
at which CWBC’s filings with the SEC may be accessed. CWBC’s SEC filings are also available on its website at www.communitywest.com.
CWBC’s common stock is listed on the NASDAQ Capital Market and trade under the symbol “CWBC.” As a company listed on the NASDAQ Capital Market, CWBC is subject to NASDAQ standards for listed companies.
CWBC is also subject to certain provisions of the Sarbanes-Oxley Act of 2002 (“SOX”), the Federal Deposit Insurance Corporation Improvement Act (“FDICIA”), provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”),
and other federal and state laws and regulations that govern financial presentations, corporate governance requirements for board audit and compensation committees and their members, and disclosure of controls and procedures and internal control over
financial reporting, auditing and accounting, executive compensation, and enhanced and timely disclosure of corporate information. NASDAQ has also adopted corporate governance rules, which are intended to allow shareholders and investors to more
easily and efficiently monitor the performance of companies and their directors.
Dodd-Frank Wall Street Reform and Consumer Protection Act
The Dodd-Frank Act was signed into law in 2010 to effect a fundamental restructuring of federal banking regulation. Among other things, the Dodd-Frank Act created the Financial Stability Oversight
Council to identify systemic risks in the financial system and oversee and coordinate the actions of the U.S. financial regulatory agencies.
The Dodd-Frank Act and the regulations promulgated thereunder require, among other things, that: (i) the consolidated capital requirements of depository holding companies must be not less stringent than
those applied to depository institutions; (ii) the reserve ratio of the Deposit Insurance Fund must increase from 1.15% to 1.35%; (iii) publicly traded companies, such as CWBC, must provide their stockholders with a non-binding vote on executive
compensation at least every three years and on “golden parachute” payments in connection with approvals of mergers and acquisitions unless previously voted on by shareholders; (iv) the deposit insurance amounts for banks, savings institutions and
credit unions be permanently increased to $250,000 per qualified depositor; (v) authority is given to the federal banking regulators to prohibit extensive compensation to executives of depository institutions and their holding companies with assets
in excess of $1.0 billion; (vi) Section 23A of the Federal Reserve Act is broadened and prohibits a depository institution from purchasing an asset from or selling an asset to an insider unless the transaction is on market terms and if representing
more than 10% of capital, is approved by the disinterested directors; (vii) interstate branching rights are expanded; and (viii) bank entities, under the (“Volker Rule”), are prohibited from conducting certain investment activities that are
considered proprietary trading with their own accounts.
2018 Regulatory Reform - The EGRRCPA
In May 2018, the Economic Growth, Regulatory Relief and Consumer Protection Act (the “EGRRCPA”), was enacted to modify or remove certain financial reform rules and regulations, including some of those
implemented under the Dodd-Frank Act. While the EGRRCPA maintains most of the regulatory structure established by the Dodd-Frank Act, it amends certain aspects of the regulatory framework for small depository institutions with assets of less than
$10 billion, such as CWB, and for large banks with assets of more than $50 billion. Many of these changes could result in meaningful regulatory relief for community banks such as CWB.
The EGRRCPA, among other matters, expands the definition of qualified mortgages which may be held by a financial institution and simplifies the regulatory capital rules for financial institutions and
their holding companies with total consolidated assets of less than $10 billion by instructing the federal banking regulators to establish a single “Community Bank Leverage Ratio” of between 8-10%. Any qualifying depository institution or its holding
company that exceeds the “Community Bank Leverage Ratio” will be considered to have met generally applicable leverage and risk-based regulatory capital requirements and any qualifying depository institution that exceeds the new ratio will be
considered to be “well capitalized” under the prompt corrective action rules. The EGRRCPA also expands the category of holding companies that may rely on the “Small Bank Holding Company and Savings and Loan Holding Company Policy Statement” by
raising the maximum amount of assets a qualifying holding company may have from $1 billion to $3 billion. This expansion also excludes such holding companies from the minimum capital requirements of the Dodd-Frank Act. In addition, the EGRRCPA
includes regulatory relief for community banks regarding regulatory examination cycles, call reports, the Volcker Rule, mortgage disclosures and risk weights for certain high-risk commercial real estate loans.
The EGRRCPA requires the enactment of a number of implementing regulations, the details of which may have a material effect on the ultimate impact of the law. It is difficult at this time to predict
when or how any new standards under the EGRRCPA will ultimately be applied to us or what specific impact the EGRRCPA, and the yet-to-be-written implementing rules and regulations, will have on community banks.
Financial Institutions Capital Rules
In addition to the Dodd-Frank Act, the international oversight body of the Basel Committee on Banking Supervision, or Basel III, reached agreements that introduced a minimum common equity tier 1 capital requirement of
4.50 percent, along with a capital conservation buffer of 2.50 percent to bring total common equity capital requirements to 7.00 percent. The federal banking agencies issued final rules that implemented Basel III and certain other revisions to the
Basel capital framework, as well as the minimum leverage and risk-based capital requirements of Dodd Frank Act. Federal regulators periodically propose amendments to the risk-based capital guidelines and the related regulatory framework and consider
changes to the capital standards that could significantly increase the amount of capital needed to meet applicable standards. The timing of adoption, ultimate form and effect of any such proposed amendments cannot be determined at this time.
Basel III, among other things: (i) implemented increased capital levels for CWBC and CWB; (ii) introduced a new capital measure of common equity Tier 1 capital known as “ CET1” and related regulatory capital ratio of
CET1 to risk-weighted assets; (iii) specified that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments meeting certain revised requirements; (iv) mandated that most deductions/adjustments to regulatory capital measures be made
to CET1 and not to the other components of capital; and (v) expanded the scope of the deductions from and adjustments to capital. Under Basel III, for most banking organizations the most common form of Additional Tier 1 capital is non-cumulative
perpetual preferred stock and the most common form of Tier 2 capital is subordinated notes and a portion of the allowance for loan and lease losses, in each case, subject to Basel III specific requirements.
Under Basel III, the minimum capital ratios are as follows: (i) 4.5% CET1 to risk-weighted assets; (ii) 6.0% Tier 1 capital (that is, CET1 plus Additional Tier 1 capital) to risk-weighted assets; (iii) 8.0% Total
capital (that is, Tier 1 capital plus Tier 2 capital) to risk-weighted assets; and (iv) 4% Tier 1 capital to average consolidated assets as reported on regulatory financial statements (known as the “leverage ratio”). The Basel III new capital
conservation buffer is designed to absorb losses and protect the financial institution during periods of economic difficulties. Banking institutions with a ratio of CET1 to risk-weighted assets, Tier 1 to risk-weighted assets or total capital to
risk-weighted assets above the minimum but below the capital conservation buffer will face limitations on their ability to pay dividends, repurchase shares or pay discretionary bonuses based on the amount of the shortfall and the institution’s
“eligible retained income. As of January 1, 2019, the capital conservation buffer is fully phased-in and CWBC and CWB are required to maintain an additional capital conservation buffer of 2.5% of CET1, effectively resulting in minimum ratios of (i)
CET1 to risk-weighted assets of at least 7%, (ii) Tier 1 capital to risk-weighted assets of at least 8.5%, and (iii) total capital to risk-weighted assets of at least 10.5%.
Basel III provides for a number of deductions from and adjustments to CET1. These include the requirement that deferred tax assets arising from temporary differences that could not be realized through net operating
loss carrybacks and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such items, in the aggregate, exceed 15% of CET1.
Basel III provides a standardized approach for risk weightings that expands the risk-weighting categories from the previous four Basel I-derived categories (0%, 20%, 50% and 100%) to a larger and more risk-sensitive
number of categories, depending on the nature of the assets, generally ranging from 0% for U.S. government and agency securities, to 600% for certain equity exposures, resulting in higher risk weights for a variety of asset classes.
CWBC
General. As a bank holding company, CWBC is registered under the Bank Holding Company Act of 1956, as
amended (“BHCA”), and is subject to regulation by the FRB. According to FRB Policy, CWBC is expected to act as a source of financial strength for CWB, to commit resources to support it in circumstances where CWBC might not otherwise do so. Under the
BHCA, CWBC is subject to periodic examination by the FRB. CWBC is also required to file periodic reports of its operations and any additional information regarding its activities and those of its subsidiaries as may be required by the FRB.
Bank Holding Company Liquidity. CWBC is a legal entity, separate and distinct from CWB. CWBC has the
ability to raise capital on its own behalf or borrow from external sources, CWBC may also obtain additional funds from dividends paid by, and fees charged for services provided to, CWB. However, regulatory constraints on CWB may restrict or totally
preclude the payment of dividends by CWB to CWBC.
Transactions with Affiliates and Insiders. CWBC and any subsidiaries it may purchase or organize are
deemed to be affiliates of CWB within the meaning of Sections 23A and 23B of the Federal Reserve Act, and the FRB’s Regulation W. Under Sections 23A and 23B and Regulation W, loans by CWB to affiliates, investments by them in affiliates’ stock, and
taking affiliates’ stock as collateral for loans to any borrower is limited to 10% of CWB’s capital, in the case of any one affiliate, and is limited to 20% of CWB’s capital, in the case of all affiliates. In addition, transactions between CWB and
other affiliates must be on terms and conditions that are consistent with safe and sound banking practices. In particular, a bank and its subsidiaries generally may not purchase from an affiliate a low-quality asset, as defined in the Federal Reserve
Act. These restrictions also prevent a bank holding company and its other affiliates from borrowing from a banking subsidiary of the bank holding company unless the loans are secured by marketable collateral of designated amounts. CWBC and CWB are
also subject to certain restrictions with respect to engaging in the underwriting, public sale and distribution of securities.
The Federal Reserve Act and FRB Regulation O place limitations and conditions on loans or extensions of credit to a bank or bank holding company’s executive officers, directors and principal
shareholders; any company controlled by any such executive officer, director or shareholder; or any political or campaign committee controlled by such executive officer, director or principal shareholder. Additionally, such loans or extensions of
credit must comply with loan-to-one-borrower limits; require prior full board approval when aggregate extensions of credit to the person exceed specified amounts; must be made on substantially the same and follow credit-underwriting procedures no
less stringent than those prevailing at the time for comparable transactions with non-insiders; must not involve more than the normal risk of repayment or present other unfavorable features; and must not exceed the bank’s unimpaired capital and
unimpaired surplus in the aggregate.
Limitations on Business and Investment Activities. Under the BHCA, a bank holding company must obtain
the FRB’s approval before: (i) directly or indirectly acquiring more than 5% ownership or control of any voting shares of another bank or bank holding company; (ii) acquiring all or substantially all of the assets of another bank; or (iii) merging or
consolidating with another bank holding company.
The FRB may allow a bank holding company to acquire banks located in any state of the United States without regard to whether the acquisition is prohibited by the law of the state in which the target
bank is located. In approving interstate acquisitions, however, the FRB must give effect to applicable state laws limiting the aggregate amount of deposits that may be held by the acquiring bank holding company and its insured depository institutions
in the state in which the target bank is located, provided that those limits do not discriminate against out-of-state depository institutions or their holding companies, and state laws which require that the target bank have been in existence for a
minimum period of time, not to exceed five years, before being acquired by an out-of-state bank holding company.
In addition to owning or managing banks, bank holding companies may own subsidiaries engaged in certain businesses that the FRB has determined to be “so closely related to banking as to be a proper
incident thereto.” CWBC, therefore, is permitted to engage in a variety of banking-related businesses.
Additionally, qualifying bank holding companies making an appropriate election to the FRB may engage in a full range of financial activities, including insurance, securities and merchant banking. CWBC
has not elected to qualify for these financial services.
Federal law prohibits a bank holding company and any subsidiary banks from engaging in certain tie-in arrangements in connection with the extension of credit. Thus, for example, CWB may not extend
credit, lease or sell property, or furnish any services, or fix or vary the consideration for any of the foregoing on the condition that:
Capital Adequacy. Bank holding companies must maintain minimum levels of capital under the FRB’s
risk-based capital adequacy guidelines. If capital falls below minimum guideline levels, a bank holding company, among other things, may be denied approval to acquire or establish additional banks or non-bank businesses.
The FRB’s risk-based capital adequacy guidelines, discussed in more detail below in the section entitled “Supervision and Regulation – CWB – Regulatory Capital Guidelines,” assign various risk
percentages to different categories of assets and capital is measured as a percentage of risk assets. Under the terms of the guidelines, bank holding companies are expected to meet capital adequacy guidelines based both on total risk assets and on
total assets, without regard to risk weights.
The risk-based guidelines are minimum requirements. Higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual organizations. For example, the
FRB’s capital guidelines contemplate that additional capital may be required to take adequate account of, among other things, interest rate risk, or the risks posed by concentrations of credit, nontraditional activities or securities trading
activities. Moreover, any banking organization experiencing or anticipating significant growth or expansion into new activities, particularly under the expanded powers under the Gramm-Leach-Bliley Act, would be expected to maintain capital ratios,
including tangible capital positions, well above the minimum levels.
Limitations on Dividend Payments. California Corporations Code Section 500 allows CWBC to pay a
dividend to its shareholders only to the extent that CWBC has retained earnings and, after the dividend, CWBC’s:
Additionally, the FRB’s policy regarding dividends provides that a bank holding company should not pay cash dividends exceeding its net income or which can only be funded in ways that weaken the bank
holding company’s financial health, such as by borrowing. The FRB also possesses enforcement powers over bank holding companies and their non-bank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices or violations of
applicable statutes and regulations.
The Sarbanes-Oxley Act of 2002 (“SOX”). SOX provides a permanent framework that improves the quality
of independent audits and accounting services, improves the quality of financial reporting, strengthens the independence of accounting firms and increases the responsibility of management for corporate disclosures and financial statements.
SOX provisions are significant to all companies that have a class of securities registered under Section 12 of the Exchange Act, or are otherwise reporting to the SEC (or the appropriate federal banking
agency) pursuant to Section 15(d) of the Exchange Act, including CWBC. In addition to SEC rulemaking to implement SOX, NASDAQ has adopted corporate governance rules intended to allow shareholders to more easily and effectively monitor the performance
of companies and directors.
As a result of SOX, and its regulations, CWBC has incurred substantial cost to interpret and ensure compliance with the law and its regulations including, without limitation, increased expenditures by
CWBC in auditors’ fees, attorneys’ fees, outside advisors fees, and increased errors and omissions insurance premium costs. Future changes in the laws, regulation, or policies that impact CWBC cannot necessarily be predicted and may have a material
effect on the business and earnings of CWBC.
CWB
General. CWB, as a national banking association which is a member of the Federal Reserve System, is
subject to regulation, supervision and regular examination by the OCC and FDIC. CWB’s deposits are insured by the FDIC up to the maximum extent provided by law. The regulations of these agencies govern most aspects of CWB’s business and establish a
comprehensive framework governing its operations.
Regulatory Capital Guidelines. The federal banking agencies have established minimum capital
standards known as risk-based capital guidelines. These guidelines are intended to provide a measure of capital that reflects the degree of risk associated with a bank’s operations. The risk-based capital guidelines include both a definition of
capital and a framework for calculating the amount of capital that must be maintained against a bank’s assets and off-balance sheet items. The amount of capital required to be maintained is based upon the credit risks associated with the various
types of a bank’s assets and off-balance sheet items. A bank’s assets and off-balance sheet items are classified under several risk categories, with each category assigned a particular risk weighting from 0% to 150%.
The following table sets forth the regulatory capital for CWB and CWBC (on a consolidated basis) at December 31, 2019.
Prompt Corrective Action Authority. The federal banking agencies possess broad powers to take prompt
corrective action to resolve the problems of insured banks. Each federal banking agency has issued regulations defining five capital categories: “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and
“critically undercapitalized.” Under the regulations, a bank shall be deemed to be:
While these benchmarks have not changed, due to market turbulence, the regulators have strongly encouraged and, in many instances, required, banks and bank holding companies to achieve and maintain
higher ratios as a matter of safety and soundness.
Banks are prohibited from paying dividends or management fees to controlling persons or entities if, after making the payment, the bank would be “undercapitalized,” that is, the bank fails to meet the
required minimum level for any relevant capital measure. Asset growth and branching restrictions apply to “undercapitalized” banks. Banks classified as “undercapitalized” are required to submit acceptable capital plans guaranteed by its holding
company, if any. Broad regulatory authority was granted with respect to “significantly undercapitalized” banks, including forced mergers, growth restrictions, ordering new elections for directors, forcing divestiture by its holding company, if any,
requiring management changes and prohibiting the payment of bonuses to senior management. Even more severe restrictions are applicable to “critically undercapitalized” banks. Restrictions for these banks include the appointment of a receiver or
conservator. All of the federal banking agencies have promulgated substantially similar regulations to implement this system of prompt corrective action.
A bank, based upon its capital levels, that is classified as “well capitalized,” “adequately capitalized” or “undercapitalized” may be treated as though it were in the next lower capital category if the
appropriate federal banking agency, after notice and opportunity for a hearing, determines that an unsafe or unsound condition, or an unsafe or unsound practice, warrants such treatment. Further, a bank that otherwise meets the capital levels to be
categorized as “well capitalized,” will be deemed to be “adequately capitalized,” if the bank is subject to a written agreement requiring that the bank maintain specific capital levels. At each successive lower capital category, an insured bank is
subject to more restrictions. The federal banking agencies, however, may not treat an institution as “critically undercapitalized” unless its capital ratios actually warrant such treatment.
In addition to measures taken under the prompt corrective action provisions, insured banks may be subject to potential enforcement actions by the federal banking agencies for unsafe or unsound practices
in conducting their businesses or for violations of any law, rule, regulation or any condition imposed in writing by the agency or any written agreement with the agency. Enforcement actions may include the imposition of a conservator or receiver, the
issuance of a cease-and-desist order that can be judicially enforced, the termination of insurance of deposits (in the case of a depository institution), the imposition of civil money penalties, the issuance of directives to increase capital, the
issuance of formal and informal agreements, the issuance of removal and prohibition orders against institution-affiliated parties. The enforcement of such actions through injunctions or restraining orders may be based upon a judicial determination
that the agency would be harmed if such equitable relief was not granted.
The OCC, as the primary regulator for national banks, also has a broad range of enforcement measures, from cease and desist powers and the imposition of monetary penalties to the ability to take
possession of a bank, including causing its liquidation.
Limitations on Dividend Payments. CWB is a national bank, governed by the National Bank Act and the rules and regulations of the OCC.
National banks generally may not declare a dividend in excess of the bank’s undivided profits and, absent the approval of the OCC, if the total amount of dividends declared by the national bank in any calendar year exceeds the total of the national
bank’s retained net income of that year to date combined with its retained net income for the preceding two years. A dividend in excess of that amount constitutes a reduction in permanent capital and requires the prior approval of the OCC and the
approval of two-thirds of the bank’s shareholders.
Brokered Deposit Restrictions. Well-capitalized banks are not subject to limitations on brokered
deposits, while an adequately capitalized bank is able to accept, renew or roll over brokered deposits only with a waiver from the FDIC and subject to certain restrictions on the yield paid on such deposits. Undercapitalized banks are generally not
permitted to accept, renew, or roll over brokered deposits. As of December 31, 2019, CWB is deemed to be “well capitalized” and, therefore, is eligible to accept brokered deposits.
FDIC Insurance and Insurance Assessments. The FDIC utilizes a risk-based assessment system to set
quarterly insurance premium assessments which categorizes banks into four risk categories based on capital levels and supervisory “CAMELS” ratings and names them Risk Categories I, II, III and IV. The CAMELS rating system is based upon an evaluation
of the six critical elements of an institution’s operations: Capital adequacy, Asset quality, Management, Earnings, Liquidity, and Sensitivity to risk. This rating system is designed to take into account and reflect all significant financial and
operational factors financial institution examiners assess in their evaluation of an institution’s performance.
As previously noted, the Dodd-Frank Act requires the FDIC to take such steps as necessary to increase the reserve ratio of the Deposit Insurance Fund from 1.15% to 1.35% of insured deposits by September
30, 2020. In setting the assessments, the FDIC is required to offset the effect of the higher reserve ratio against insured depository institutions with total consolidated assets of less than $10 billion. The Dodd-Frank Act also broadened the base
for FDIC insurance assessments so that assessments are based on the average consolidated total assets less average tangible equity capital of a financial institution rather than on its insured deposits. The Deposit Insurance Fund reserve ratio
actually reached 1.36% on September 30, 2018, ahead of the September 30, 2020 deadline. As a result small banks received assessment credits for the portion of their assessment that contributed to the growth in the reserve ratio between 1.15% and
1.35%.
The FDIC may terminate its insurance of deposits if it finds that a bank has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any
applicable law, regulation, rule, order or condition imposed by the FDIC.
Anti-Money Laundering and OFAC Regulation.
A major focus of governmental policy on financial institutions in recent years has been aimed at combating money laundering and terrorist financing. The Bank Secrecy Act of 1970 (“BSA”) and subsequent
laws and regulations requires CWB to take steps to prevent the use of it or its systems from facilitating the flow of illegal or illicit money and to file suspicious activity reports. Those requirements include ensuring effective Board and management
oversight, establishing policies and procedures, developing effective monitoring and reporting capabilities, ensuring adequate training and establishing a comprehensive internal audit of BSA compliance activities. The USA Patriot Act of 2001
(“Patriot Act”) significantly expanded the anti-money laundering (“AML”) and financial transparency laws and regulations by imposing significant new compliance and due diligence obligations, creating new crimes and penalties and expanding the
extra-territorial jurisdiction of the United States. Regulations promulgated under the Patriot Act impose various requirements on financial institutions, such as standards for verifying client identification at account opening and maintaining
expanded records (including “Know Your Customer” and “Enhanced Due Diligence” practices) and other obligations to maintain appropriate policies, procedures and controls to aid the process of preventing, detecting, and reporting money laundering and
terrorist financing.
CWB must provide BSA/AML training to employees, designate a BSA compliance officer and annually audit the BSA/AML program to assess its effectiveness. The federal regulatory agencies continue to issue
regulations and new guidance with respect to the application and requirements of BSA and AML. The United States has imposed economic sanctions that affect transactions with designated foreign countries, nationals and others. Based on their
administration by Treasury’s Office of Foreign Assets Control (“OFAC”), these are typically known as the “OFAC” rules. The OFAC-administered sanctions targeting countries take many different forms. Generally, however, they contain one or more of the
following elements: (i) restrictions on trade with or investment in a sanctioned country, including prohibitions against direct or indirect imports from and exports to a sanctioned country and prohibitions on “U.S. persons” engaging in financial
transactions relating to making investments in, or providing investment-related advice or assistance to, a sanctioned country; and (ii) a blocking of assets in which the government or specially designated nationals of the sanctioned country have an
interest, by prohibiting transfers of property subject to U.S. jurisdiction (including property in the possession or control of U.S. persons). Blocked assets (e. g., property and bank deposits) cannot be paid out, withdrawn, set off or transferred in
any manner without a license from OFAC.
Failure of CWB to maintain and implement adequate BSA, AML and OFAC programs, or to comply with all of the relevant laws or regulations, could have serious legal and reputational consequences for the
institution. CWB has augmented its systems and procedures to accomplish this. CWB believes that the ongoing cost of compliance with the BSA, AML and OFAC programs is not likely to be material to CWB
Community Reinvestment Act. The Community Reinvestment Act (“CRA”) is intended to encourage insured depository institutions, while operating
safely and soundly, to help meet the credit needs of their communities. CRA specifically directs the federal bank regulatory agencies, in examining insured depository institutions, to assess their record of helping to meet the credit needs of their
entire community, including low- and moderate-income neighborhoods, consistent with safe and sound banking practices. CRA further requires the agencies to take a financial institution’s record of meeting its community credit needs into account when
evaluating applications for, among other things, domestic branches, consummating mergers or acquisitions or holding company formations.
The federal banking agencies have adopted regulations which measure a bank’s compliance with its CRA obligations on a performance-based evaluation system. This system bases CRA ratings on an
institution’s actual lending service and investment performance rather than the extent to which the institution conducts needs assessments, documents community outreach or complies with other procedural requirements. The ratings range from
“outstanding” to a low of “substantial noncompliance.”
CWB had a CRA rating of “Satisfactory” as of its most recent regulatory examination.
Safeguarding of Customer Information and Privacy. The bank regulatory agencies have adopted guidelines for safeguarding confidential,
personal customer information. These guidelines require financial institutions to create, implement and maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information, protect
against any anticipated threats or hazard to the security or integrity of such information and protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer. CWB has adopted a
customer information security program to comply with such requirements.
Financial institutions are also required to implement policies and procedures regarding the disclosure of nonpublic personal information about consumers to non-affiliated third parties. In general,
financial institutions must provide explanations to consumers on policies and procedures regarding the disclosure of such nonpublic personal information, and, except as otherwise required by law, are prohibited from disclosing such information. CWB
has implemented privacy policies addressing these restrictions which are distributed regularly to all existing and new customers of CWB.
Consumer Compliance and Fair Lending Laws. CWB is subject to a number of federal and state laws designed to protect borrowers and promote
lending to various sectors of the economy and population. These laws include the Patriot Act, BSA, the Foreign Account Tax Compliance Act, CRA, the Fair Credit Reporting Act, as amended by the Fair and Accurate Credit Transactions Act, the Equal
Credit Opportunity Act, the Truth in Lending Act, the Fair Housing Act, the Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act, the National Flood Insurance Act, various state law counterparts, and the Consumer Financial
Protection Act of 2010, which constitutes part of the Dodd-Frank Act. The enforcement of Fair Lending laws has been an increasing area of focus for regulators, including the FDIC and the Consumer Financial Protection Bureau, which was created by the
Dodd-Frank Act.
In addition, federal law and certain state laws (including California) currently contain client privacy protection provisions. These provisions limit the ability of banks and other financial
institutions to disclose non-public information about consumers to affiliated companies and non-affiliated third parties. These rules require disclosure of privacy policies to clients and, in some circumstance, allow consumers to prevent disclosure
of certain personal information to affiliates or non-affiliated third parties by means of “opt out” or “opt in” authorizations. Pursuant to the Gramm-Leach-Bliley Act and certain state laws (including California) companies are required to notify
clients of security breaches resulting in unauthorized access to their personal information.
Safety and Soundness Standards. The federal banking agencies have adopted guidelines designed to assist the federal
banking agencies in identifying and addressing potential safety and soundness concerns before capital becomes impaired. The guidelines set forth operational and managerial standards relating to: (i) internal controls, information systems and internal
audit systems; (ii) loan documentation; (iii) credit underwriting; (iv) asset growth; (v) earnings; and (vi) compensation, fees and benefits. In addition, the federal banking agencies have also adopted safety and soundness guidelines with respect to
asset quality and earnings standards. These guidelines provide nine standards for establishing and maintaining a system to identify problem assets and prevent those assets from deteriorating.
Other Aspects of Banking Law. CWB is also subject to federal statutory and regulatory provisions
covering, among other things, security procedures, insider and affiliated party transactions, management interlocks, electronic funds transfers, funds availability, and truth-in-savings. There are also a variety of federal statutes which
regulate acquisitions of control and the formation of bank holding companies.
Moreover, additional initiatives may be proposed or introduced before Congress, the California Legislature, and other government bodies in the future which, if enacted, may further alter the
structure, regulation, and competitive relationship among financial institutions and may subject bank holding companies and banks to increased supervision and disclosure, compliance costs and reporting requirements. In addition, the various bank
regulatory agencies often adopt new rules and regulations and policies to implement and enforce existing legislation. Bank regulatory agencies have been very aggressive in responding to concerns and trends identified in examinations, and this has
resulted in the increased issuance of enforcement actions to financial institutions requiring action to address credit quality, liquidity and risk management, capital adequacy, BSA compliance, as well as other safety and soundness concerns.
It cannot be predicted whether, or in what form, any such legislation or regulatory changes in policy may be enacted or the extent to which CWB’s businesses would be affected thereby. In addition, the outcome of examinations, any litigation, or
any investigations initiated by state or federal authorities may result in necessary changes in CWB’s operations and increased compliance costs.