UCBH Holdings 10-K 2009
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Commission File Number: 000-24947
UCBH Holdings, Inc.
(Exact name of registrant as specified in its charter)
Registrants telephone number, including area code: (415) 315-2800
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, Par Value $0.01 Per Share
Name of each exchange on which registered:
The NASDAQ Global Select Market
Securities registered pursuant to Section 12(g) of the Act:
Preferred Stock Purchase Rights
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
The aggregate market value of the common stock held by non-affiliates of the registrant is $245,025,266 and is based upon the last sales price as quoted on the NASDAQ Global Select Market as of June 30, 2008.
As of January 31, 2009, the Registrant had 120,436,096 shares of common stock, par value $0.01 per share, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
Proxy Statement for the May 21, 2009, Annual Meeting of Stockholders is incorporated by reference into Part III.
UCBH HOLDINGS, INC. AND SUBSIDIARIES
This document, including information included or incorporated by reference in this document, contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements provide current expectations or forecasts of future events and include, among other things:
These forward-looking statements are based upon managements current beliefs and expectations and are not guarantees of future performance, nor should they be relied upon as representing managements views as of any subsequent date. These forward-looking statements are also inherently subject to significant business, economic and competitive uncertainties, risks and contingencies, many of which are difficult to predict and generally beyond managements control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change and actual results, performance or achievements may be materially different from the anticipated results, performance or achievements discussed, expressed or implied by these forward-looking statements. Factors that might cause such differences include, but are not limited to the following:
You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this document or the date of any document incorporated by reference in this document. All subsequent written and oral forward-looking statements concerning matters addressed in this document and attributable to the Company or any person acting on the Companys behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this section. Except to the extent required by applicable law or regulation, the Company undertakes no obligation to update these forward-looking statements to reflect events, developments or circumstances after the date of this document or to reflect the occurrence of future events.
UCBH Holdings, Inc. (UCBH) is a Delaware corporation incorporated in 1998, and registered with the Board of Governors of the Federal Reserve System as a bank holding company. UCBH conducts its principal business through its wholly owned banking subsidiary, United Commercial Bank (UCB; UCBH, UCB and UCBs wholly owned subsidiaries are collectively referred to as the Company, we, us or our), which makes up substantially all of our consolidated assets and revenues. UCB is a California state-chartered commercial bank.
UCB was founded as United Federal Savings and Loan Association in 1974 to serve the financial needs of the San Francisco Chinese community. As the Chinese population grew significantly and expanded into new communities throughout California, we became United Savings Bank, F.S.B. to provide statewide banking services. In 1998, reflecting a rapidly growing focus on our commercial banking capabilities, we converted our charter to become UCB, a commercial bank. The Company went public on November 5, 1998, and currently trades on the NASDAQ Global Select Market (NASDAQ) under the symbol UCBH.
During 2006, the Company completed its acquisition of Summit Bank Corporation (Summit), headquartered in Atlanta, Georgia. As of the acquisition date, Summits total assets were $887.9 million and total deposits were $547.6 million. The acquisition included five branches/offices in Atlanta, Georgia, one branch in Houston, Texas, two branches/offices in California and a representative office in Shanghai, China. Additionally during 2006, UCB established a wholly owned subsidiary, UCB Asset Management, Inc. (UCBAM), which was created to provide professional investment management services to high-net-worth clients.
In 2007, the Company completed two acquisitions; CAB Holding, LLC (CAB), the holding company of The Chinese American Bank, a New York state-chartered bank, and Business Development Bank Ltd. (BDB), now United Commercial Bank (China) Limited (UCB China Ltd), a wholly foreign owned enterprise established and existing under the laws of the Peoples Republic of China. As of the acquisition date, CABs total assets were $357.2 million and total deposits were $312.4 million. The acquisition included three branches in the New York area. As of the acquisition date, UCB China Ltds total assets were $338.7 million and total deposits were $30.5 million. The acquisition included branches in Shanghai and Shantou, China and representative offices in Beijing and Guangzhou, China. UCB infused $65 million in capital into UCB China Ltd at the closing of the acquisition.
We intend to continue to expand within our existing markets and move into new markets by developing new product offerings, opening new branches and/or acquiring financial institutions in existing markets, and entering into and/or acquiring financial institutions in other markets with high concentrations of Asians in keeping with our capital requirements and management abilities.
We have been expanding to develop a nationwide presence to provide services to companies doing business in China and to enhance our local presence in Asian communities. These areas include the San Francisco Bay Area and the Sacramento/Stockton, Los Angeles, Atlanta, Boston, Houston, New York and Seattle metropolitan areas. We currently have fifty-one branches/offices in the State of California, five in the Atlanta metropolitan area, three in the Boston metropolitan area, a branch in Houston, nine in the New York metropolitan area, two in the Seattle metropolitan area and branches in Hong Kong, Shanghai and Shantou, China. We also have representative offices in
Shenzhen, Beijing, and Guangzhou, China and Taipei, Taiwan. Our Northern and Southern California locations encompass twenty-nine and twenty-two branches/offices, respectively.
We have tailored our products and services to meet the financial needs of the growing Asian communities in our market areas. We believe that this approach, together with the relationships of our management and the Companys Board of Directors with the Asian communities, provides us with an advantage in competing for customers in these areas.
Through our branch network, we provide a wide range of personal and commercial banking services to small- and medium-sized businesses, business executives, professionals and other individuals. We offer multilingual services to all of our customers in English, Cantonese and Mandarin.
We offer the following deposit products:
We offer a full complement of loan products, including the following types of loans:
We also provide a wide range of specialized services, including merchant bankcard services, cash management services, private client services, brokerage investment products and services, business credit card services, foreign exchange services, and online banking services. In addition, we provide trade finance facilities for customers involved in the import and/or export of goods principally between Asia and the United States.
UCB maintains an Internet banking website at www.ibankUNITED.com. This website, which is available in both English and Chinese character versions, provides information about UCB as well as easy access to business and personal online banking services, a web-based trade finance management system and an online information services for home loans. We believe our website serves as a strong platform to promote UCB, to cross-sell the products and services that UCB offers and to deliver advanced online banking services.
UCBH has eleven wholly owned subsidiaries, including UCB. Other than UCB, the subsidiaries are special purpose trusts that were either formed by UCBH to issue guaranteed preferred beneficial interests in UCBHs junior subordinated debentures or acquired by UCBH in the Summit acquisition.
UCB has ten wholly owned subsidiaries. United Commercial Bank (China) Limited was acquired during the fourth quarter of 2007. United Commercial Bank (China) Limited is a foreign owned bank incorporated in China whose primary business efforts are on the small and medium size enterprise corporate sector in China, which include private companies and businesses with annual revenues in the $7 million to $70 million revenue range. California Canton International Bank (Cayman) Ltd. which was acquired as part of the BCC transaction in 2002 provides banking services and has deposits and assets consisting of cash and investment securities. UCBIS is a registered broker-dealer with the United States Securities and Exchange Commission and is a member of the National
Association of Securities Dealers, Inc. UCBAM provides professional investment management services to high-net-worth clients. Newston Investments, Inc. owns the office building that houses UCBs branch in Houston, Texas. Of the remaining four subsidiaries of UCB, two are inactive, a third, U.F. Service Corporation acts as a trustee under deeds of trust securing promissory notes held by UCB and a fourth, United Commercial Mortgage Securities, LLC is a Delaware limited liability company organized for the purpose of serving as a private secondary mortgage market conduit.
The disclosure regarding the Companys segments are included in Note 32 to the Consolidated Financial Statements as set forth herein under Item 8.
The banking and financial services industry in California, and particularly in our market areas, is highly competitive. This is due in part to changes in regulation, changes in technology and product delivery systems, and the consolidation of the industry. We compete for loans, deposits and customers with the following types of institutions:
Many of our competitors are much larger in terms of total assets and capitalization, have greater access to capital markets and may offer a broader array of financial services. To compete with these financial service providers, we rely on local promotional activities, personal relationships established by our officers, bilingual employees to effectively interact with customers and specialized services tailored to meet our customers needs.
We also have several major competitors targeting Asian customers in California and other markets in which we compete. These competitors have branch locations in many of the same neighborhoods, provide similar services and market their services in similar Asian publications and media in California. Additionally, we compete with numerous financial institutions that do not target the Asian markets in California.
Supervision and Regulation
Both the Company and UCB are extensively regulated under both federal and state laws. The following is a summary of selected laws and regulations that govern the activities of the Company and UCB. These laws and regulations are intended to protect depositors, the Federal Deposit Insurance Corporation (the FDIC) Bank Insurance Fund and the banking system as a whole, and are not intended to protect security holders.
UCBH is a bank holding company registered with the Board of Governors of the Federal Reserve System and is subject to the Bank Holding Company Act of 1956, as amended (the Bank Holding Company Act), and the regulations of the Board of Governors of the Federal Reserve System (Federal Reserve Board). UCBH files quarterly and annual reports with the Federal Reserve Bank of San Francisco, Banking Supervision & Regulation Division (Federal Reserve), as well as any other information that the Federal Reserve may require under the Bank Holding Company Act. The Federal Reserve examines UCBH and its non-bank
subsidiaries. UCBH is also a bank holding company under Delaware law and, together with UCB, is subject to examination by the California Department of Financial Institutions (the DFI).
The Federal Reserve has the authority to require that UCBH stop an activity, whether conducted directly or through a subsidiary or affiliate, if the Federal Reserve believes that the activity poses a significant risk to the financial safety, soundness or stability of UCB. The Federal Reserve can also regulate provisions of certain debt instruments issued by bank holding companies, including imposing ceilings on interest rates and requiring reserves on such debt. In certain cases, UCBH will be required to file written notice and obtain approval from the Federal Reserve before repurchasing or redeeming its equity securities. Additionally, the Federal Reserve imposes capital requirements on UCBH as a bank holding company.
As a registered bank holding company, UCBH is required to obtain the approval of the Federal Reserve before it may acquire all or substantially all of the assets of any bank, or ownership or control of the voting shares of any bank if, after giving effect to such acquisition of shares, UCBH would own or control more than 5% of the voting shares of such bank. The Bank Holding Company Act allows UCBH to acquire voting shares of, or interest in, all or substantially all of the assets of a bank located outside the State of California, subject to the provisions of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994.
UCBH and any subsidiaries which it may acquire or organize are deemed affiliates of UCB within the meaning of that term as defined in the Federal Reserve Act and Federal Reserve Regulation W. This means, for example, that there are limitations on loans by UCB to affiliates and on investments by UCB in affiliates stock.
UCBH and any subsidiaries are also subject to certain restrictions with respect to engaging in non-banking activities, including the underwriting, public sale and distribution of securities and many insurance activities. Under the Gramm-Leach-Bliley Financial Modernization Act of 1999, qualifying bank holding companies may make an appropriate election to the Federal Reserve to become a financial holding company and may then engage in a full range of financial activities, including insurance, securities and merchant banking. See Gramm-Leach-Bliley Financial Modernization Act of 1999 following this discussion. Although the Company currently qualifies to make the election, UCBH has not elected to become a financial holding company. UCBH continues to review its business plan to determine whether it would benefit from the expanded powers of a financial holding company status.
As a company with securities registered under the Securities Exchange Act of 1934, as amended (the Exchange Act), and listed on NASDAQ, UCBH is also subject to the Sarbanes-Oxley Act of 2002 and regulation by the SEC and NASDAQ. See the Sarbanes-Oxley Act of 2002 section, which follows this discussion.
Bank Regulators. UCB is a California state-chartered commercial bank and its deposits are insured by the FDIC up to the applicable legal limits. UCB is supervised, examined and regulated by the DFI, as well as by the FDIC. In addition, our wholly owned subsidiary, UCB China Ltd, is subject to the regulatory oversight of the China Banking Regulatory Commission in China (CBRC) and by the Hong Kong Monetary Authority for our Hong Kong branch. Our broker dealer, UCB Investment Services, is subject to the regulatory oversight of the Financial Industry Regulatory Authority. Any of these regulatory agencies may take formal enforcement action if they determine that the financial condition, capital resources, asset quality, earnings prospects, management or liquidity aspects of UCBs operations are unsatisfactory. These agencies may also take action if UCB or its management is violating or has violated any law or regulation. No regulator has ever taken any such action against UCB in the past.
Safety and Soundness Standards. The FDIC has adopted guidelines that establish standards for safety and soundness of banks. The Federal Reserve Board has established safety and soundness guidelines for bank holding companies. These guidelines are designed to identify potential safety and soundness problems and ensure that banks address those concerns before they pose a risk to the deposit insurance fund. If the FDIC determines that an institution fails to meet any of these standards, the agency can require the institution to prepare and submit a plan to come into compliance. If the agency determines that the plan is unacceptable or not implemented, the agency must, by order, require the institution to correct the deficiency.
The FDIC also has safety and soundness regulations and accompanying guidelines on asset quality and earnings standards. The guidelines provide standards for establishing and maintaining a system to identify problem assets and prevent those assets from deteriorating. The guidelines also provide standards for evaluating and monitoring earnings and for ensuring that earnings are sufficient to maintain adequate capital and reserves. If an institution fails to comply with a safety and soundness standard, the agency may require the institution to submit and implement an acceptable compliance plan or face enforcement action.
Other Regulations. The activities of UCB as a consumer lender are also subject to regulations under various federal laws, including the Truth in Lending Act, the Equal Credit Opportunity Act, the Fair Credit Reporting Act as well as the Electronic Fund Transfer Act, the Fair Debt Collection Practices Act, the Community Reinvestment Act, etc., in addition to various state laws. These statutes impose requirements for providing timely disclosures to customers primarily in connection with the making, enforcement and collection of loans.
On February 8, 2006, President Bush signed into law the Federal Deposit Reform Act of 2005, which reformed the deposit insurance system. The law merged the Bank Insurance Fund with the Savings Association Insurance Fund into a new fund, the Deposit Insurance Fund (DIF). The law also granted the FDIC Board broad authority in managing the adequacy of the DIF, including the discretion to price deposit insurance according to risk for all insured institutions regardless of the level of reserve ratio.
Prior to the enactment of the law, the FDIC charged annual assessments to insure a banks deposits that ranged from zero to $0.27 per $100 of domestic deposits, depending on the risk that a particular institution poses to the Deposit Insurance Fund. The final rule, effective January 1, 2007, consolidates the existing nine risk categories into four and names them Risk Categories I, II, III, and IV. Within Risk Category I, the final rule combines supervisory ratings with other risk measures to differentiate risk. For most institutions, the final rule combines capital, asset quality, management, earnings, liquidity, and sensitivity (CAMELS) components with financial ratios to determine an institutions assessment rate. For large institutions that have long-term debt issuer ratings, the final rule differentiates risk by combining CAMELS component ratings with these ratings. The final rule defines a large institution as an institution that has $10 billion or more in assets. The final rule set actual rates beginning January 1, 2007, as follows: $0.05 to $0.07 per $100 of domestic deposits for Risk I Category (most favorable category); $0.10 per $100 for Risk II Category, $0.28 per $100 for Risk III Category; and $0.43 per $100 for Risk IV Category. Currently, UCB is in the Risk I Category.
During 2008, the economic downturn and continuing troubles in the housing and construction sectors, financial markets, and commercial real estate have caused failures of FDIC-insured institutions. These recent failures have caused the reserve ratio of the DIF to fall below the required minimum threshold. Because the fund reserve fell below the required minimum and that the FDIC expects the reserve ratio to remain below the required minimum for the foreseeable future, the Reform Act required the FDIC to establish and implement a Restoration Plan to restore the reserve ratio to at least the required minimum within five years.
On October 7, 2008, the FDIC established a Restoration Plan for the DIF. In the FDICs view, restoring the reserve ratio to at least the required minimum requires an increase in the deposit insurance assessment rates. Since the current rates are already three basis points above the existing base rate schedule, a new rulemaking was required. The rulemaking proposed that effective January 1, 2009, current assessment rates would increase uniformly 7 basis points for the first quarter 2009 assessment period. Effective April 1, 2009, the rulemaking proposed to alter the way in which the FDICs risk-based assessment system differentiates for risk and set new deposit insurance assessment rates. The final rule on the assessment rate schedule for the first quarter of 2009 raises the current rates by 7 basis points for the quarterly assessment period beginning January 1, 2009.
On February 27, 2009, the FDIC approved an interim rule to institute a one-time special assessment of 20 cents per $100 in domestic deposits to restore the DIF reserves depleted by recent bank failures. The interim rule additionally reserves the right of the FDIC to charge an additional up-to-10 basis point special premium at a later point if the DIF reserves continue to fall. The FDIC also approved an increase in regular premium rates for the second quarter of
2009. For most banks this will be between 12 to 16 basis points per $100 in domestic deposits. Premiums for the rest of 2009 have not yet been set.
UCB (on a consolidated basis) is subject to the capital requirements of Part 325 of the FDICs Rules and Regulations Capital Maintenance. Part 325 includes a framework that is sensitive to differences in risk between banking institutions. The amount of regulatory capital that a financial institution is required to have is dependent on its overall risk profile. The ratio of its regulatory capital to its risk-weighted assets is called the risk-based capital ratio. Assets and certain off-balance-sheet items are allocated into four categories based on the risk inherent of the asset and are weighted from 0% to 100%. The higher the risk-weighted asset category, the more risk UCB is subject to and thus more capital that is required. As of December 31, 2008, UCBs total risk-based capital ratio was 14.24% compared to 10.80% at December 31, 2007.
The guidelines divide a banks capital into two tiers. Tier 1 core capital is the sum of its common stockholders equity, non-cumulative perpetual preferred stock (including any related surplus), and minority interests in consolidated subsidiaries, minus all intangible assets (except for mortgage and nonmortgage servicing assets and eligible purchased credit card relationships) and minus certain other items specifically defined by Part 325. Tier 2 capital includes, among other items, cumulative perpetual and long-term, limited-life preferred stock, mandatory convertible securities, certain hybrid capital instruments, term subordinated debt and the allowance for loan losses (subject to certain limitations). In addition, certain items are required to be deducted from Tier 2 capital as specified in Part 325.
Banks must maintain a total risk-based capital ratio of 8%, of which at least 4% must be Tier 1 capital, to maintain a status as adequately capitalized as set forth by the prompt corrective action rules adopted by the FDIC. The well capitalized levels established by the FDIC are 10% and 6% for total risk-based capital ratio and Tier 1 risk-based capital ratio, respectively.
In addition, the FDIC has regulations prescribing a minimum Tier 1 leverage ratio (Tier 1 capital to total adjusted assets, as specified in the regulations). The required minimum Tier 1 leverage ratio is 3% if the FDIC determines that the institution is not anticipating or experiencing significant growth and has well diversified risk, including no undue interest rate risk exposure, excellent asset quality, high liquidity, good earnings and in general is considered a strong banking organization. Banks that do not meet the conditions for a 3% minimum must have a minimum Tier 1 leverage ratio of 4%. The FDIC may impose higher limits on individual institutions when particular circumstances exist, including if a bank is experiencing or anticipating significant growth. At December 31, 2008, UCBs Tier 1 leverage ratio was 9.06% compared to 7.42% at December 31, 2007.
UCB was in compliance with the FDICs capital maintenance rules as of December 31, 2008 and 2007. For further discussion of UCBs capital, refer to the Capital Management section under Managements Discussion and Analysis incorporated in Part II, Item 7 and Note 22 to the Consolidated Financial Statements in this Annual Report on Form 10-K.
The Federal Deposit Insurance Corporation Improvement Act of 1991 requires the federal banking regulators to take prompt corrective action against undercapitalized institutions. The FDIC and the other bank regulatory agencies have established a framework of supervisory actions for insured depository institutions that are not adequately capitalized. The following capital categories have been created to define capital adequacy:
Federal banking regulators are required to take prompt corrective action to resolve the problems of those institutions that fail to satisfy their minimum capital requirements. As an institutions capital level falls, the level of restrictions that can be imposed by the FDIC becomes increasingly severe and the institution is allowed less flexibility in its activities.
As of December 31, 2008 and 2007, UCB was well capitalized under the regulatory framework for prompt corrective action.
Under the Community Reinvestment Act (the CRA), as implemented by Part 345 of the FDICs regulations, a bank has an obligation, consistent with safe and sound operation, to help meet the credit needs of its entire community in which an institution is chartered, including low- and moderate-income neighborhoods. The CRA does not establish specific lending requirements or programs, nor does it limit a banks discretion to develop the types of products and services that it believes are best suited to its community. It does require that federal banking regulators, when examining an institution, assess the institutions record of meeting the credit needs of its community and to take such record into account in evaluating certain applications. As a state-chartered non-member bank, UCB is subject to the fair lending requirements and reporting obligations involving home mortgage and small business lending operations of the CRA. Federal banking regulators are required to provide a written examination report of an institutions CRA performance using a four-tiered descriptive rating system and these ratings are available to the public. UCB has received an outstanding rating for the past four CRA examinations.
The Gramm-Leach-Bliley Financial Modernization Act of 1999 (the Gramm-Leach-Bliley Act) eliminated most of the depression-era firewalls between banks, securities firms and insurance companies, which were established by The Banking Act of 1933, also known as the Glass-Steagall Act. The Glass-Steagall Act sought to insulate banks as depository institutions from the perceived risks of securities dealing and underwriting, and related activities.
Bank holding companies, which qualify as financial holding companies, can now, among other things, acquire securities firms or create them as subsidiaries, and securities firms can now acquire banks or start banking activities through a financial holding company. This liberalization of United States banking and financial services regulation applies both to domestic and foreign institutions conducting business in the United States. Consequently, the common ownership of banks, securities firms and insurance firms is now possible, as is the conduct of commercial banking, merchant banking, investment management, securities underwriting and insurance within a single financial institution using a financial holding company structure authorized by the Act. As noted earlier, the Company has not elected to become a financial holding company.
The Gramm-Leach-Bliley Act also requires that federal financial institutions and securities regulatory agencies respect the privacy of their customers and protect the security and confidentiality of customers non-public personal information. These regulations generally require that financial institutions:
Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001
Under Title III of the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act (the USA PATRIOT Act) adopted by the United States Congress on October 26, 2001, which strengthened the then existing anti-money laundering provisions of the Bank Secrecy Act, FDIC insured banks are required to increase their due diligence efforts for correspondent deposit accounts and private banking customers. The USA PATRIOT Act requires banks to perform additional record keeping and reporting, require identification of owners of deposit accounts and the customers of foreign banks with correspondent deposit accounts, and restrict or prohibit certain correspondent deposit accounts. The Financial Crimes Enforcement Network, a bureau of the Department of Treasury, has also issued regulations to implement the provisions of the USA PATRIOT Act. UCBs regulatory compliance in this important area has been found satisfactory.
The Sarbanes-Oxley Act of 2002 (the Sarbanes-Oxley Act) represents a comprehensive revision of laws affecting corporate governance, accounting obligations and corporate reporting. The Sarbanes-Oxley Act is applicable to all companies with equity or debt securities registered under Section 12 of the Exchange Act. Among other things, the Sarbanes-Oxley Act establishes:
In addition, the Sarbanes-Oxley Act generally prohibits loans by the Company to its executive officers and directors. However, the Sarbanes-Oxley Act contains a specific exception from such prohibitions for loans by a bank to its executive officers and directors in compliance with federal banking regulatory restrictions on such loans. UCBs authority to extend credit to affiliates is also governed by federal law. Such loans are required to be made on terms substantially the same as those offered to unaffiliated individuals and that do not involve more than the normal risk of repayment. An exception exists for loans made pursuant to a benefit or compensation program that is widely available to all employees of the institution and does not give preference to affiliates over other employees. The law limits both the individual and aggregate amount of loans that UCB may make to affiliates based, in part, on UCBs capital position and requires certain board approval procedures to be followed. For the years presented in this Annual Report on Form 10-K, UCBs policy was to make no loans to the Companys and UCBs executive officers or directors.
Although we have incurred additional accounting and other expense in complying with the requirements under the Sarbanes-Oxley Act and the regulations promulgated thereunder, such compliance has not had a material impact on our results of operations or financial condition.
The United States federal bank regulatory agencies risk-based capital guidelines are based upon the 1988 Capital Accord of the Basel Committee on Banking Supervision (the Basel Committee). The Basel Committee is a committee of central banks and bank supervisors/regulators from the major industrialized countries that develops broad policy guidelines that each countrys supervisors can use to set the supervisory policies they apply. In January 2001, the Basel Committee released a proposal to replace the 1988 Capital Accord with a new capital framework (the Basel II Framework) that would set capital requirements for operational risk and would also materially change the existing capital requirements for credit risk and market risk exposures. Operational risk is defined by the proposal to mean the risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems or from external events. The 1988 Capital Accord does not include separate capital requirements for operational risk. The Basel II Framework standard is intended to strengthen the regulation of large, complex
banking companies by making their capital requirements more sensitive to changes in risk. In June 2004, the Basel Committee issued a new capital accord (the Basel II Accord) to replace the 1988 Capital Accord. Institutions can elect not to use the Basel II Framework; however, the prospect of reductions in risk-based capital requirements under the Basel II Accord has given rise to competitive equity concerns among smaller banks and thrifts.
On December 26, 2006, the United States banking regulators issued proposed rulemaking that revises the existing risk-based capital framework for those institutions that elect not to use the Basel II Framework. This new framework is sometimes referred to as Basel 1-A as it is anticipated to apply to banks that do not adopt the international Basel II Accord. The proposed rule would allow an institution that elected not to adopt the Basel II Accord to continue using the existing risk-based capital rules or adopt the new Basel 1-A rules. The new rules would:
On December 7, 2007 the final rule implementing the advanced approaches of the Basel II Capital Accord was published jointly by the United States federal banking agencies. The final rule establishes regulatory capital requirements and supervisory expectations for credit and operational risks for banks that choose or are required to adopt the advanced approaches of the Basel II Capital Accord. The final rule retains the three groups of banks identified in the proposed rule: (i) large or internationally active banks that are required to adopt advanced capital approaches under Basel II (core banks); (ii) banks that voluntarily decide to adopt the advance approaches (opt-in banks); and (iii) banks that do not adopt the advanced approaches (general banks), and for which the provisions of the final rule are inapplicable. The final rule also retains the proposed rule definition of the core bank as a bank that meets either of two criteria: (i) consolidated assets of $250 billion or more, or (ii) consolidated total on-balance sheet foreign exposure of $10 billion or more. Also, a bank is a core bank if it is a subsidiary of a bank or bank holding company that uses advanced approaches. The final rule contains relevant implementation timeframes for core banks and qualification requirements that each core and opt-in bank must meet before using the advanced approaches for risk-based capital purposes.
The final rule is effective April 1, 2008. The agencies expect to publish in the near future a proposed rule that would provide all non-core banks with the option to adopt a standardized approach under the Basel II Capital Accord.
As of the date of this document, the agencies have not published the final rule governing the adoption of a standardized approach under the Basel II Capital Accord for all non-core banks.
On February 17, 2009, the American Recovery and Reinvestment Act of 2009 (ARRA) was signed into law by President Obama. The ARRA includes a wide variety of programs intended to stimulate the economy and provide for extensive infrastructure, energy, health, and education needs. In addition, the ARRA imposes certain new executive compensation and corporate expenditure limits on all current and future TARP recipients, including the Company, until the institution has repaid the U.S. Treasury, which is now permitted under the ARRA without penalty and without the need to raise new capital, subject to the U.S. Treasurys consultation with the recipients appropriate regulatory agency.
The executive compensation standards are more stringent than those currently in effect under the TARP Capital Purchase Program or those previously proposed by the U.S. Treasury. The new standards include (but are not limited to) (i) prohibitions on bonuses, retention awards and other incentive compensation, other than restricted stock grants which do not fully vest during the TARP period up to one-third of an employees total annual compensation, (ii) prohibitions on golden parachute payments for departure from a company, (iii) an expanded clawback of bonuses, retention awards, and incentive compensation if payment is based on materially inaccurate statements of
earnings, revenues, gains or other criteria, (iv) prohibitions on compensation plans that encourage manipulation of reported earnings, (v) retroactive review of bonuses, retention awards and other compensation previously provided by TARP recipients if found by the U.S. Treasury to be inconsistent with the purposes of TARP or otherwise contrary to public interest, (vi) required establishment of a company-wide policy regarding excessive or luxury expenditures, and (vii) inclusion in a participants proxy statements for annual shareholder meetings of a nonbinding Say on Pay shareholder vote on the compensation of executives.
At December 31, 2008, we had 1,542 employees. None of the employees are covered by a collective bargaining agreement. The Company believes that the relationship with its employees are good.
Our corporate Internet address is www.ucbh.com. We make available free of charge through our Internet website our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) of the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.
The public may read and copy any materials that the Company files with the SEC at the SECs Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. The Internet address of the SEC website is www.sec.gov.
The following table sets forth the names, ages and positions of the executive officers of UCBH and UCB as of December 31, 2008. There are no family relationships between any director or executive officer and any other director or executive officer of UCBH or UCB.
The Chief Executive Officer updates UCBHs and UCBs Management Succession Plan on an annual basis for review by the Compensation Committee and the Board of Directors.
Mr. Thomas S. Wu has been Chairman, President, and Chief Executive Officer of UCBH and UCB since October 10, 2001. Prior to this appointment, Mr. Wu served as President and Chief Executive Officer of UCB effective January 1, 1998. Prior to that appointment, Mr. Wu was an Executive Vice President and Director of UCB as of September 25, 1997. Mr. Wu was elected President and Chief Executive Officer of UCBH effective March 26, 1998, and as a director of UCBH on April 17, 1998. Previously, Mr. Wu was the Director of Customer Care for Pacific Link Communications Limited in Hong Kong where he was responsible for formulating and implementing customer care, customer retention and customer communications strategies. Mr. Wu served as a director of UCB from 1995 to 1996 and was a Senior Vice President, Head of Retail Banking of UCB from 1992 to 1996, when in addition to heading up the retail banking division, he directed marketing, public relations, loan originations, branch administration and operations control functions. Mr. Wu also served as Vice President and Regional Manager of UCBs Southern California Retail Banking Division from 1991 to 1992. Prior to joining UCBH, Mr. Wu held various banking positions with First Pacific Bank in Hong Kong, Chase Manhattan Bank, Banque Nationale De Paris and Standard Chartered Bank.
Mr. Craig S. On was appointed Executive Vice President and Chief Financial Officer of UCBH and UCB effective October 23, 2008. Mr. On has been serving as Senior Vice President and Interim Chief Financial Officer of the Company since May 2008. Prior to that, he had served as the Companys Deputy Chief Financial Officer since March 2008, and Senior Vice President and Corporate Controller since June 2005. Mr. On joined UCB after a twenty-one year career with the public accounting firm of Deloitte & Touche LLP, where he served in the capacity of Audit Director and oversaw the audits of commercial and community banks, investment management and hedge fund companies, as well as multi-lateral development banks and mortgage banking organizations.
Mr. Daniel M. Gautsch was appointed Executive Vice President and Chief Risk and Compliance Officer of UCBH and UCB effective August 23, 2006. Prior to this appointment, Mr. Gautsch was Executive Vice President and Director of Enterprise Risk Management of UCBH and UCB since February 7, 2005. Prior to joining UCB, Mr. Gautsch was the Assistant Regional Director, San Francisco Region of the FDIC responsible for overseeing over 270 insured institutions in Alaska, Hawaii, Northern California, Oregon, Washington and the Pacific Rim. His career at the FDIC spanned more than 30 years during which he served in various management and other positions.
Mr. William J. Laraia was appointed Executive Vice President and Director of the New York Region of UCBH and UCB effective January 1, 2007. Prior to this appointment, Mr. Laraia was formerly the Chairman, President and Chief Executive Officer of Great Eastern Bank (GEB). Prior to serving at GEB, Mr. Laraia served as Chairman and Chief Executive Officer of Apple Bank for Savings in New York City from 1991 to 1996 and as Executive Vice President and Group Head of National Westminster Bancorps Community Banking Group, where he managed the activities of the retail bank, from 1984 to 1991. Prior to joining National Westminster Bancorp, Mr. Laraia ran the Long Island Commercial Lending Division for Chemical Bank.
Ms. Sylvia Loh was appointed Executive Vice President and Chairman of UCB/China Minsheng Banking Corporation Strategic Alliance Task Force effective January 2008. Prior to this appointment, she was Executive Vice President and Chief Lending Officer of UCBH and UCB since August 1, 2005. Prior to this appointment, Ms. Loh served as Executive Vice President and Director of Commercial Banking of UCBH and UCB from July 1, 2002 to August 1, 2005, and joined UCB as Vice President and Head of Commercial Banking in January 1996. From 1992 to 1996, Ms. Loh held the position of Vice President, Relationship Manager at Bank of America, International Trade Division.
Mr. Ebrahim Shabudin has been Executive Vice President and Chief Operating Officer of UCBH and UCB since August 1, 2005. Prior to this appointment, Mr. Shabudin served as Executive Vice President and Chief Credit Officer of UCBH and UCB since January 1, 2004. Prior to joining UCBH, Mr. Shabudin was the Managing Director of Credit Risk Management with Deloitte & Touche LLP. Prior to that, Mr. Shabudin worked for Bank of America in various management positions for over 25 years with the most recent experience as a Senior Vice President and Credit Policy Executive.
Mr. Ka Wah Tsui has been Executive Vice President and General Manager, Greater China Region of UCBH and UCB since January 1, 2005. Prior to this appointment, he served as Senior Vice President and General Manager of our Hong Kong Branch since September 2003. Previously, Mr. Tsui held various management positions at Citibank, First Pacific Bank and International Bank of Asia in Hong Kong.
Mr. David Yu was appointed Executive Vice President and Director of the Southeast Region of UCBH and UCB effective December 30, 2006. Prior to joining UCB, Mr. Yu was the President of Summit Bank Corporation and Chairman of The Summit National Bank. Mr. Yu served as President and CEO of the Company until December 1989, at which time he was elected Chairman of the Board of Directors of The Summit National Bank. Mr. Wu was the founder and organizer of the Summit Bank Corporation and The Summit National Bank. Before organizing the Summit Bank Corporation and The Summit National Bank, Mr. Yu worked for The Citizens and Southern National Bank and First National Bank of Atlanta. From 1976 to 1980, Mr. Yu was employed as an Assistant National Bank Examiner by the Office of the Comptroller of the Currency in Atlanta.
Mr. John M. Cinderey was appointed Executive Vice President and Director of Commercial Banking of UCBH and UCB effective January 2008. Prior to this appointment, he served as Senior Vice President and Director of Real Estate Lending since November 2006 and Senior Vice President and Senior Credit Approval Officer of the Commercial Banking Division of UCB from May 2004 to November 2006. Prior to joining UCB, Mr. Cinderey spent over 20 years with Bank of America and over 10 years at other financial institutions, including Mount Diablo National Bank, GMAC Commercial Finance and Union Bank of California in various management functions.
Mr. John M. Kerr was Executive Vice President and Director of Portfolio Management and Credit Compliance of UCBH and UCB as of December 31, 2008. Prior to this appointment, he served as Senior Vice President and Chief Credit Officer since October 13, 2005. Prior to joining UCB, Mr. Kerr served as Senior Portfolio Manager for Primus Financial Products, an AAA-rated credit insurer in New York and a company in which he played a key role in building the business from a start-up in 2002 to its going public in 2004. Prior to that, Mr. Kerr was with Bank of America for 18 years, where he held senior positions in credit approval, corporate and commercial banking, private banking, and international banking. He also spent 11 years with Royal Bank of Canada in business development and credit in corporate and commercial banking, in strategic planning, and in international banking.
Mr. Dennis A. Lee has been Senior Vice President and Corporate Counsel of UCBH and UCB since January 1, 2001. Prior to that appointment, he served as Vice President and Corporate Counsel of UCBH and UCB since 1993.
Mr. Jonas B. Miller was appointed Senior Vice President and Treasurer of UCBH and UCB effective July 27, 2006. Prior to this appointment, he served as Senior Vice President and Treasurer of UCB from July 27, 2004 to July 27, 2006 and First Vice President and Treasurer of UCB from January 1, 2003 to July 27, 2004.
Mr. Douglas J. Mitchell was appointed Senior Vice President and Director of Corporate Development and Investor Relations of UCBH and UCB effective March 3, 2008. Mr. Mitchell joined UCB in 2004 and has been a major contributor in improving the Banks operations since that time. Over the past three years, he has helped the Bank implement many risk management solutions, including the Allowance for Loan Loss Methodology and Country Risk Management. He created and led the Business Technology Implementation group, which is responsible for new technology projects bank-wide, until it was transferred to IT at the end of 2006. Prior to joining UCB, Mr. Mitchell first spent seven years with ABN AMRO Bank in Chicago focusing initially on lending & retail banking and then on trading risk management, treasury, and bank ALM. Most recently, he spent seven years helping large and small banks and financial services companies implement solutions to risk management, operations, and technical accounting issues while working for Deloitte & Touche and Arthur Andersen in their Capital Markets consulting practices.
Mr. Robert C. Nagel was appointed as Senior Vice President and Chief Audit Executive of UCBH and UCB effective July 14, 2008. With 29 years of experience in banking with major financial institutions, including Wells Fargo, First Interstate, Union Bank of California and Charles Schwab, Mr. Nagel was most recently the Head of Internal Audit for the Charles Schwab Bank in San Francisco. Prior to internal audit, he held numerous positions including Relationship Manager, Regional Manager, Senior Credit Administrator and Director of Credit Review.
Ms. Martha F. Perry was appointed Senior Vice President and Director of Financial Planning & Analysis effective January 2008. Prior to this appointment she served as First Vice President and Director of Financial Planning & Analysis since November 2005. With over 35 years of financial services experience, prior to joining UCB Ms. Perry served as Vice President Finance for the Charles Schwab Corporation. Prior to that she served as the Chief Financial Officer for Civic Bank of Commerce, and also held various positions with the Federal Reserve Bank of San Francisco and Union Bank of California.
Mr. Burton D. Thompson has been Senior Vice President and Corporate Controller of UCBH and UCB effective August 1, 2008. Prior to this appointment, he served as Senior Vice President and Tax Director for the past two years. Prior to joining UCB, Mr. Thompson was Controller at Cosentino Wineries for 1 year, supporting their IPO on the London AIM exchange. Prior to that he was Controller/CFO at Charles Krug Winery for three years. That followed 15 years in public accounting, mainly with Deloitte & Touches tax practice and with MKF as their director of assurance services.
Item 1A. Risk Factors
The following describes some of the risk factors associated with UCBH Holdings, Inc. and subsidiaries (collectively referred to as the Company, we, us and our):
Fluctuations in interest rates may negatively affect our consolidated financial condition and results of operations.
Banking companies earnings depend largely on the relationship between the cost of funds, primarily deposits and borrowings, and the yield on earning assets, primarily loans and investments. This relationship, known as the interest rate margin, is subject to fluctuation and is affected by economic and competitive factors, which influence interest rates, the volume and mix of interest-earning assets and interest-bearing liabilities, and the level of nonperforming assets. Fluctuations in interest rates will also affect the customers demand for the products and services that we offer.
The Companys operations are subject to fluctuations in interest rates, to the degree that its interest-bearing liabilities may reprice or mature more slowly or more rapidly or on a different basis than their interest-earning assets. Given our current volume and mix of interest-bearing liabilities and interest-earning assets, the Companys net interest margin would be expected to increase during times of rising interest rates and, conversely, to decline during times of falling interest rates. As a result, significant fluctuations in interest rates may have an adverse effect on the Companys consolidated financial condition and results of operations.
In addition, in a falling interest rate environment, we are subject to the risk of higher loan prepayments from our loan portfolio, which in turn may have a negative impact on our net interest margin.
Given the significance of our business in the United States, we are particularly exposed to downturns in the U.S. economy. The dramatic declines in the housing market over the past year, with falling home prices, increasing foreclosures, and unemployment, have negatively impacted the credit performance of mortgage loans and resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities and major commercial and investment banks. These write-downs, initially of mortgage-backed securities but spreading to credit default swaps and other derivative and investment securities, in turn, have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail. Due to the concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have reduced or ceased providing funding to borrowers, including to other financial institutions. This market turmoil and tightening of credit have led to an increased level of commercial and consumer delinquencies, lack of consumer confidence, increased market volatility and widespread reduction of business activity in general. The resulting economic pressure on consumers and lack of confidence in the financial markets have adversely affected our business, financial position and results of operations. We do not expect that the difficult conditions in the financial markets are likely to improve in the near future. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on us and others in the financial institutions industry. In particular, we may face the following risks in connection with the aforementioned events:
The capital and credit markets have been experiencing volatility and disruption since the latter part of 2007. During 2008, such volatility and disruption reached unprecedented levels. In some cases, the market disruptions have created downward pressure on stock prices and credit availability from certain issuers without regard to those issuers underlying financial strength. If the current levels of market disruption and volatility continue or worsen, there can be no assurance that we will not experience an adverse effect, which may be material, on our ability to access capital on our domestic and international businesses, financial position and results of operations.
Management makes various estimates that affect reported amounts and disclosures in our financial statements. These estimates are used in measuring the fair value of certain financial instruments, accounting for goodwill and identifiable intangibles, establishing our provision for loan losses, valuing equity-based compensation awards and assessing the realizability of deferred income taxes. Such estimates are based on available information and on judgments by management of the Company. As such, actual results could differ from these estimates and the differences could have a material effect on our financial statements.
Where available, fair value is based on observable market prices or parameters or derived from such prices or parameters. Where observable prices or inputs are not available, valuations from outsourced service providers are generally obtained to assist the company. The valuations performed by the service providers involve some level of estimation and judgment, the degree of which is dependent on the price transparency of the financial instrument being valued and the financial instruments complexity. In particular, the residual tranche on our collateralized mortgage backed securities arising from our commercial real estate loan securitization, certain collateralized debt obligations and mortgage related asset backed securities, and certain other investments have no direct observable prices, and as a result, the related valuations require significant estimation and judgment and are therefore subject to significant subjectivity. Reliance on the estimation and judgment process increases in adverse market conditions with decreased liquidity, such as those experienced during 2008 and expected to continue for 2009.
Our business is subject to the success of the state, national and international economies in which we operate.
Because the majority of our borrowers and depositors are individuals and businesses located and doing business in the states of California, Georgia, Massachusetts, New York, Texas and Washington, our success depends on the strength of these economies. In addition, as we expand into other areas in the United States and into China, we will become increasingly dependent on the local economies in those markets, as well. Adverse economic conditions in these markets could reduce our growth rate, affect the ability of our customers to repay their loans and generally affect our financial condition and results of operations. Conditions, such as inflation, recession, unemployment, high interest rates, short money supply, scarce natural resources, international disorders, terrorism and other factors beyond our control, may adversely affect our profitability. In addition, any sustained period of increased payment
delinquencies, foreclosures or losses caused by adverse market or economic conditions in our markets could adversely affect the value of our assets, revenues, results of operations and financial condition.
Our business strategy includes the execution of growth plans, and our financial condition and results of operations could be negatively affected if we fail to grow or fail to manage our growth effectively.
We expect to experience growth in both loans and deposits as well as in our level of operations. Achieving our growth targets will require us to attract customers that currently do business at other financial institutions in our existing and future markets. Our ability to successfully grow will depend on a variety of factors, including our ability to attract and retain experienced management staff, the continued availability of desirable business opportunities, the competitive responses from other financial institutions in our markets and our ability to effectively manage our growth. While we believe we have the management resources and internal systems in place to successfully manage our future growth, there can be no assurance that we will be able to achieve our growth goals.
Our continued pace of growth may require us to raise additional capital in the future, but that capital may not be available when it is needed.
We are required by federal regulatory authorities to maintain adequate levels of capital to support our operations. We believe that our capital resources will satisfy these capital requirements for the foreseeable future. However, we may at some point need to raise additional capital to support our continued growth. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control. Accordingly, we cannot be assured of our ability to raise additional capital, if needed, on terms acceptable to us. If we cannot raise additional capital when needed, our ability to further expand our operations through internal growth and acquisitions could be materially impaired.
We plan to increase the level of our assets, including our loan portfolio. Our ability to increase our assets depends in large part on our ability to attract additional deposits at competitive rates. We intend to seek additional deposits by continuing to establish and strengthening our personal relationships with our existing customers and by offering deposit products that are competitive with those offered by other financial institutions in our markets. We cannot provide assurance that these efforts will be successful. Our inability to attract additional deposits at competitive rates could have a material effect on our business, consolidated financial position, results of operations and cash flows.
Our wholesale funding sources may prove insufficient to replace deposits at their maturity and support our future growth.
We must maintain sufficient funds to respond to the needs of our depositors and borrowers. As a part of our liquidity management, we use a number of funding sources in addition to core deposits. As we continue to grow, we are likely to become more dependent on these sources, which include Federal Home Loan Bank advances, proceeds from the sale of loans, brokered certificates of deposit, federal funds, repurchase lines, and a line of credit from another financial institution. Our financial flexibility could be severely constrained if we are unable to maintain our access to funding or if adequate financing is not available to accommodate future growth at acceptable interest rates. Finally, if we are required to rely more heavily on more expensive funding sources to support future growth, our revenues may not increase proportionately to cover our costs. In this case, our operating margins and profitability would be adversely affected.
We may experience further writedowns on our financial instruments related to volatile and illiquid market conditions.
The Company recorded a $43.1 million writedown on its investment and mortgage-backed securities available for sale during 2008. We continue to have exposure in our investment securities portfolio and as market conditions continue to evolve, the fair value of these financial instruments could further deteriorate. In addition, recent market
volatility has made it difficult to determine the fair value of certain of our investment securities and mortgage servicing rights. Further, cashflow shortfalls arising from actual prepayments and credit defaults exceeding our original estimates could in turn trigger other-than-temporary impairment in certain of our investment securities. Subsequent valuations, in light of factors then prevailing, may result in significant changes in the value of these investment securities and mortgage servicing rights in future periods. Any of these factors could require us to take further writedowns in our investment securities portfolio, which could adversely affect our results of operations and regulatory capital in the future.
The banking and financial services business is highly competitive. Competitive pressure is increasing as a result of changes in regulation, changes in technology and product delivery systems, and the accelerating pace of consolidation among financial service providers. The Company must compete for loans, deposits and customers with other commercial banks, savings and loan associations, securities and brokerage companies, mortgage companies, insurance companies, finance companies, money market funds, credit unions and other nonbank financial service providers. Many of these competitors are much larger in total assets and capitalization, have greater access to capital markets and offer a broader array of financial services than we do. There can be no assurance that the Company will be able to compete effectively in its markets and the Companys consolidated financial condition and results of operations could be adversely affected if circumstances affecting the nature or level of competition change.
The Companys performance and prospects will depend to a significant extent on the performance of its loan portfolio. There are a number of factors that could negatively impact the performance of the loan portfolio including, among others, the general political and economic conditions in the Companys markets, significant changes in the mix of our loan products, significant changes in the interest rate environment, pressures from products and services from competitors and any negative changes in the financial condition of the individual borrowers. In addition, to the extent that the Company does not retain the customers that it acquires in its acquisitions or incurs additional expenses in retaining them, there could be adverse effects on the Companys future consolidated financial condition and results of operations.
Like all financial institutions, we maintain an allowance for loan losses to provide for loans in our portfolio that may not be repaid in their entirety. We believe that our allowance for loan losses is maintained at a level that is adequate to absorb probable losses inherent in our loan portfolio as of the respective balance sheet date. However, our allowance for loan losses may not be sufficient to cover actual loan losses, and future provisions for loan losses could materially adversely affect our operating results.
If the value of real estate in our primary market areas were to decline materially, a significant portion of our loan portfolio could become under-collateralized, which could have a material adverse effect on us.
In the past three years, we have been growing our commercial business and construction loan portfolios. In addition, with a significant portion of our loans continuing to be in the state of California, a decline in local economic conditions could continue to adversely affect the value of the real estate collateral securing our loans. A further decline in property values would diminish our ability to recover on defaulted loans by selling the real estate collateral, making it more likely that we would suffer losses on defaulted loans. Additionally, a further decrease in asset quality could require additions to our allowance for loan losses through increased provisions for loan losses, which would reduce our future profits and regulatory capital. Real estate values are affected by various factors in addition to local economic conditions, including, among other things, changes in general or regional economic conditions, governmental rules or policies and natural disasters.
The Companys business is highly dependent on our ability to process, on a daily basis, a large number of transactions across geographic boundaries, both domestically and internationally. The Company performs the functions required to operate in different geographies either on our own or through agreements with third party service providers. The Company relies on the ability of its employees and its internal systems and information systems to process a high volume of transactions. In the event of a failure or improper operation of the Company or a third party service providers systems, or improper action by employees or third parties, the Company could suffer financial loss, business disruption, regulatory intervention or reputational damage, which in turn could adversely impact our financial condition.
If we are unable to successfully integrate the operations of future acquisitions or branch expansions, the Companys consolidated financial condition and results of operations could be negatively affected.
We have announced that our future growth strategy could include acquiring other financial service companies. In addition, we intend to establish additional overseas offices and branches in the Asia Pacific region. We could encounter unplanned difficulties associated with integration of the operations with new acquisitions or branch expansions. These difficulties could include retaining customers, successful conversion of systems and processes, combining different corporate cultures, and retaining key employees. Any problems with integration would negatively impact the Companys day-to-day operations and increase the costs associated with the acquisition/branch expansion, which, in turn, could negatively affect the Companys consolidated financial condition and results of operations.
Unanticipated costs relating to the Companys acquisitions could reduce its future earnings per share.
To the extent we make acquisitions, we face numerous risks and uncertainties with respect to combining operational, accounting and data processing systems and management controls, and in integrating relationships with business partners and customers. Unexpected transition costs or future operating expenses, as well as other types of unanticipated issues or developments, could have an adverse effect on the Companys future results of operations and financial condition. There is no assurance that any business we acquire in the future will be successfully integrated and result in all of the positive benefits anticipated. If we are not able to integrate successfully such acquisitions, there is a risk that our results of operations and financial condition may be materially and adversely impacted. In addition, there is a risk that the goodwill arising from any acquisitions could be subject to potential impairment.
The Company may engage in further expansion through new branch openings or acquisitions, which could adversely affect net income.
The Company has disclosed its intention to take advantage of future expansion opportunities. There are risks associated with such expansion and, in particular, expansion through acquisitions. These risks include, among others, incorrectly assessing the asset quality of a bank acquired in a particular acquisition, encountering greater than anticipated costs of opening new branches or integrating acquired businesses, facing resistance from customers or employees, and being unable to profitably deploy assets acquired through expansion or in acquisitions. Additional country- and region-specific risks are associated with any expansion and acquisitions that take place outside the United States, including in China. To the extent UCBH issues capital stock in connection with additional acquisitions, these acquisitions and related stock issuances may have a dilutive effect on earnings per share and share ownership.
To fund internal growth and future acquisitions, UCBH may offer shares of its common stock to the public and future acquirees including to China Minsheng Banking Corp., Ltd. Any such offerings would have a dilutive effect on earnings per share and share ownership. In addition, there is no assurance that UCBH would be able to effectively utilize any additional capital in the manner that it has done so in the past. UCBH does not currently have any definitive understandings or plans to raise additional capital.
On October 7, 2007, UCBH and China Minsheng Banking Corp., Ltd., a Chinese joint stock commercial bank (Minsheng), entered into an Investment Agreement, which was amended by a letter agreement dated as of September 22, 2008 (as so amended the Investment Agreement). Under the Investment Agreement, upon mutual consent and regulatory approvals, Minsheng may increase its ownership to 20.0% (calculated on a post-closing basis). The issuance of shares to Minsheng may have a dilutive effect on UCBHs earnings per share as well as change the ownership control balance of UCBH which may have an impact on the management of UCBHs operations and future growth.
The banking industry is subject to extensive federal and state supervision and regulation. Such regulations limit the manner in which the Company conducts its business, undertakes new investments and activities, and obtains financing. These regulations have been designed primarily for the protection of the deposit insurance funds and consumers, and not to benefit holders of the Companys common stock. Financial institution regulation has also been the subject of considerable legislation in recent years, and may be the subject of further significant legislation in the future, none of which is within our control. New legislation or changes in, or repeal of, existing laws may cause the Companys consolidated results to differ materially from its historical performance. Further, federal monetary policy, particularly as implemented through the Federal Reserve System, significantly affects credit conditions for financial institutions, primarily through open market operations in United States government securities, the discount rate for bank borrowings, and bank reserve requirements. Any material change in these conditions would likely have a material impact on the Companys consolidated financial condition and results of operations.
On October 3, 2008, the Troubled Asset Relief Program (TARP) was signed into law. TARP gave the Treasury authority to deploy up to $750 billion into the financial system with the goal of improving liquidity in the financial markets. On October 14, 2008, the Treasury announced a voluntary TARP Capital Purchase Program (the CP Program), pursuant to which the Treasury may purchase equity securities of eligible U.S. financial institutions, to enable such financial institutions to build capital and increase the flow of financing to U.S. businesses and consumers and thereby support the U.S. economy.
On November 14, 2008, UCBH issued to the Treasury, in exchange for aggregate consideration of $298.7 million, (i) 298,737 shares of UCBHs Fixed Rate Cumulative Perpetual Preferred Stock, Series C, having a par value of $0.01 per share and a liquidation preference of $1,000 per share (the Series C Preferred Stock), and (ii) a warrant (the Warrant) to purchase up to 7,847,732 shares of UCBHs common stock, par value $0.01 per share, at an exercise price of $5.71 per share, subject to certain anti-dilution and other adjustments.
By participating in the CP Program, the Company is subject to certain terms and conditions as well as on-going monthly reporting requirements to the FDIC that could have an impact on the Companys business. Certain terms and conditions of the CP Program include restriction of dividend payments to the Companys shareholders and adopting the Treasury Departments standards for executive compensation and corporate governance. The Companys participation in the program must adopt the Treasury Departments standards for executive compensation and corporate governance, for the period during which Treasury holds equity issued under the CP Program. These standards generally apply to the chief executive officer, chief financial officer, plus the next three most highly compensated executive officers.
On February 10, 2009, the U.S. Treasury and the federal bank regulatory agencies announced in a Joint Statement a new Financial Stability Plan which would include additional capital support for banks under a Capital Assistance Program, a public-private investment fund to address existing bank loan portfolios and expanded funding for the Federal Reserve Boards pending Term Asset-Backed Securities Loan Facility to restart lending and the securitization markets.
On February 17, 2009, the American Recovery and Reinvestment Act of 2009 (ARRA) was signed into law by President Obama. The ARRA includes a wide variety of programs intended to stimulate the economy and provide for extensive infrastructure, energy, health, and education needs. In addition, the ARRA imposes certain new executive compensation and corporate expenditure limits on all current and future TARP recipients, including the
Company, until the institution has repaid the U.S. Treasury, which is now permitted under the ARRA without penalty and without the need to raise new capital, subject to the U.S. Treasurys consultation with the recipients appropriate regulatory agency.
The executive compensation standards are more stringent than those currently in effect under the TARP Capital Purchase Program or those previously proposed by the U.S. Treasury. The new standards include (but are not limited to) (i) prohibitions on bonuses, retention awards and other incentive compensation, other than restricted stock grants which do not fully vest during the TARP period up to one-third of an employees total annual compensation, (ii) prohibitions on golden parachute payments for departure from a company, (iii) an expanded clawback of bonuses, retention awards, and incentive compensation if payment is based on materially inaccurate statements of earnings, revenues, gains or other criteria, (iv) prohibitions on compensation plans that encourage manipulation of reported earnings, (v) retroactive review of bonuses, retention awards and other compensation previously provided by TARP recipients if found by the U.S. Treasury to be inconsistent with the purposes of TARP or otherwise contrary to public interest, (vi) required establishment of a company-wide policy regarding excessive or luxury expenditures, and (vii) inclusion in a participants proxy statements for annual shareholder meetings of a nonbinding Say on Pay shareholder vote on the compensation of executives.
On February 23, 2008, the U.S. Treasury and the federal bank regulatory agencies issued a Joint Statement providing further guidance with respect to the Capital Assistance Program (CAP) announced February 10, 2009, including: (i) that the CAP will be initiated on February 25, 2009 and will include stress test assessments of major banks and that should the stress test indicate that an additional capital buffer is warranted, institutions will have an opportunity to turn first to private sources of capital; otherwise the temporary capital buffer will be made available from the government; (ii) such additional government capital will be in the form of mandatory convertible preferred shares, which would be converted into common equity shares only as needed over time to keep banks in a well-capitalized position and can be retired under improved financial conditions before the conversion becomes mandatory; and (iii) previous capital injections under the TARP Capital Purchase Program will also be eligible to be exchanged for the mandatory convertible preferred shares. The conversion of preferred shares to common equity shares would enable institutions to maintain or enhance the quality of their capital by increasing their tangible common equity capital ratios; however, such conversions would necessarily dilute the interests of existing shareholders.
On February 25, 2009, the first day the CAP program was initiated, the U.S. Treasury released the actual terms of the program, stating that the purpose of the CAP is to restore confidence throughout the financial system that the nations largest banking institutions have a sufficient capital cushion against larger than expected future losses, should they occur due to a more severe economic environment, and to support lending to creditworthy borrowers. Under the CAP terms, eligible U.S. banking institutions with assets in excess of $100 billion on a consolidated basis are required to participate in coordinated supervisory assessments, which are forward-looking stress test assessments to evaluate the capital needs of the institution under a more challenging economic environment. Should this assessment indicate the need for the bank to establish an additional capital buffer to withstand more stressful conditions, these larger institutions may access the CAP immediately as a means to establish any necessary additional buffer or they may delay the CAP funding for six months to raise the capital privately. Eligible U.S. banking institutions with assets below $100 billion may also obtain capital from the CAP. The CAP program does not replace the TARP Capital Purchase Program, but is an additional program to the TARP Capital Purchase Program, and is open to eligible institutions regardless of whether they participated in the TARP Capital Purchase Program. The deadline to apply to the CAP is May 25, 2009. Recipients of capital under the CAP will be subject to the same executive compensation requirements as if they had received TARP Capital Purchase Program.
Pursuant to the American Recovery and Reinvestment Act of 2009, further compensation restrictions, including significant limitations on incentive compensation and golden parachute payments, have been imposed on the Companys most highly compensated employees, which may make it more difficult for the Company to retain and recruit qualified personnel. Also, the restriction of dividend payments may result in constraining the Companys future capital management practices.
Our outstanding preferred stock impacts net income available to our common stockholders and earnings per common share, and the TARP Warrant as well may be dilutive to holders of our common stock.
The dividends declared and the accretion on discount on our outstanding preferred stock will reduce the net income available to common stockholders and our earnings per common share. Our outstanding preferred stock will also receive preferential treatment in the event of liquidation, dissolution or winding up of the Company. Additionally, the ownership interest of the existing holders of our common stock will be diluted to the extent the TARP Warrant is exercised. Although the U.S. Treasury has agreed not to vote any of the shares of common stock it receives upon exercise of the TARP Warrant, a transferee of any portion of the TARP Warrant or of any shares of common stock acquired upon exercise of the TARP Warrant is not bound by this restriction.
In addition to the regulatory oversight in the United States of America, we are subject to regulation in China. As such, we are subject to intervention by regulatory authorities, such as the CBRC in China and by the Hong Kong Monetary Authority for our Hong Kong branch. Among other things, we could be fined, prohibited from engaging in some of our business activities or subject to limitations or conditions on our business activities. Significant regulatory action against the Company could result in an adverse financial impact, cause significant reputational harm, or harm the Companys business prospects. New laws or regulations or changes in the enforcement of existing laws or regulations applicable to our clients may also adversely impact the Companys business.
The commercial soundness of many financial institutions may be closely interrelated as a result of credit, trading, clearing and other relationships between such institutions. As a result, concerns about, or a default or threatened default by one institution could lead to significant market-wide liquidity problems, losses or defaults by other institutions. This is sometimes referred to as systemic risk and may adversely affect financial intermediaries, such as clearing agencies, clearing houses, banks, securities firms and exchanges, with which we interact on a daily basis, and therefore could adversely affect the Company.
There can be no assurance that recently enacted legislation authorizing the United States government to take direct actions within the financial services industry will help strengthen the financial system.
During 2008, the economic downturn and continuing turmoil in the housing and construction sectors, financial markets, and commercial real estate have caused failures of FDIC-insured institutions. These recent failures have caused the reserve ratio of the DIF to fall below the required minimum threshold. Because the fund reserve fell below the required minimum and that the FDIC expects the reserve ratio to remain below the required minimum for the foreseeable future, the Reform Act required the FDIC to establish and implement a Restoration Plan to restore the reserve ratio to at least the required minimum within five years.
On October 7, 2008, the FDIC established a Restoration Plan for the DIF. In the FDICs view, restoring the reserve ratio to at least the required minimum requires an increase in the deposit insurance assessment rates. Since the current rates are already three basis points above the existing base rate schedule, a new rulemaking was required. The rulemaking proposed that effective January 1, 2009, current assessment rates would increase uniformly 7 basis points for the first quarter 2009 assessment period. Effective April 1, 2009, the rulemaking proposed to alter the way in which the FDICs risk-based assessment system differentiates for risk and set new deposit insurance assessment rates. The final rule on the assessment rate schedule for the first quarter of 2009 raises the current rates by 7 basis points for the quarterly assessment period beginning January 1, 2009.
On October 3, 2008, the Emergency Economic Stabilization Act of 2008 (EESA) was signed into law. The legislation was the result of a proposal by the U.S. Treasury Department to the United States Congress in September 2008, in response to the financial crises affecting the banking system and financial markets, as well as the going concern threats to certain investment banks and other financial institutions. Pursuant to EESA, the Treasury will have the authority to, among other things, invest in financial institutions and deploy up to $750 billion into the financial system with the goal of improving liquidity in the financial markets. On October 14, 2008, the Treasury announced the voluntary TARP Capital Purchase Program (the CP Program), whereby the Treasury may purchase
equity securities of eligible U.S. financial institutions, to enable such financial institutions to build capital and increase the flow of financing to U.S. businesses and consumers and thereby support the U.S. economy. In addition, in November 2008, the Temporary Liquidity Guarantee Program was enacted, which enables the Federal Deposit Insurance Corporation to temporarily guarantee newly-issued senior debt of FDIC insured institutions and their holding companies, as well as noninterest-bearing deposit transaction accounts. The behavior of depositors in regard to the new level of FDIC insurance could cause new customers to open deposit accounts at UCB. The level of composition of UCBs deposit portfolio directly impacts UCBs funding cost and net interest margin. There can be no assurance, however, as to the actual impact that EESA and these related actions will have on the financial markets, including the extreme levels of volatility and limited credit availability currently being experienced. The failure of EESA and these related actions to help stabilize the financial markets, coupled with a continuation or worsening of the current financial markets, could materially and adversely affect our business, financial position, results of operations, access to credit, or the trading price of our investment securities.
Our liquidity is critical to our ability to operate our business, as well as to allow us to grow and maintain profitability. The primary sources of funding for our banking subsidiary include customer deposits and wholesale market-based funding. A compromise on liquidity can have a significant negative effect on the Company. Some potential conditions that could negatively affect the Companys liquidity may be beyond our control and may be a result of general market disruption, negative views about the financial services industry generally, or operational problems that affect third parties, which in turn affects ourselves. Our ability to raise funding in the debt or capital markets has been and could continue to be adversely affected by economic conditions in the United States and international markets including China. As a result, we may experience diminished access to capital markets, and unforeseen outflows of cash, including customer deposits.
As a holding company, UCBH Holdings, Inc. relies on the earnings of its wholly owned subsidiary, United Commercial Bank, for its cash flow and consequent ability to pay dividends and satisfy obligations. The payments by United Commercial Bank typically take the form of dividends. United Commercial Bank is, in turn, subject to regulatory capital requirements or other regulatory or contractual restrictions on its ability to provide such dividends. Limitations in the dividends that UCBH Holdings, Inc. receives from United Commercial Bank could negatively affect UCBH Holdings, Inc.s liquidity position.
The Companys credit ratings are important to our liquidity. Rating agencies regularly evaluate us and our investment securities. Their ratings are based on a number of factors, including our financial strength, as well as factors not entirely within our control, including conditions affecting the financial services industry generally. In light of the difficulties currently being experienced in the financial services industry and the financial markets, there can be no assurance that we will maintain our current ratings. Our inability to maintain those ratings could adversely affect our liquidity and competitive position, increase our borrowing costs or limit our access to funding in the capital markets.
Item 1B. Unresolved Staff Comments
UCBH Holdings, Inc.s and United Commercial Banks principal office and headquarters is located at 555 Montgomery Street in San Francisco, California. UCB also owns an office building located at 711 Van Ness Avenue in San Francisco, California. With the acquisition of Summit Bank Corporation, UCB acquired two buildings. One building in Atlanta, Georgia, serves as an administrative facility for the Atlanta banking operations. The other serves as a branch and administrative facility for the Houston operations, which UCB owns through its subsidiary, Newston Investments, Inc. With the acquisition of CAB, UCB acquired two buildings. One building serves a full-service branch office in Manhattans Chinatown and the second building serves as a branch in Flushing, Queens. UCB also owns two buildings in the Boston, Massachusetts area, which serve as branch and administrative facilities for the Boston banking operations. In addition, UCB owns five branch facilities and leases all of its remaining branch and office facilities under noncancelable operating leases. Some of these branch leases contain renewal options and some include rent escalation clauses.
United Commercial Bank has been a party to litigation incidental to various aspects of its operations, in the ordinary course of business. Management is not currently aware of any litigation that in managements opinion will have a material adverse impact on UCBH Holdings, Inc.s consolidated financial condition or the results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders or otherwise for the three months ended December 31, 2008.
UCBH Holdings, Inc.s (UCBH) common stock is traded on the NASDAQ Global Select Market (NASDAQ) under the symbol UCBH. At December 31, 2008, there were approximately 17,141 stockholders of UCBHs common stock. The last reported sale price of the common stock on NASDAQ on January 30, 2009, was $2.33 per share.
The high and low sales prices of UCBHs common stock, as quoted on NASDAQ, during the years ended December 31, 2008 and 2007, were as follows:
ZACKS TOTAL RETURN ANNUAL COMPARISON
NOTE: Data complete through last fiscal year.
NOTE: Corporate Performance Graph with peer group uses peer group only performance (excludes only company).
NOTE: Peer group indices use beginning of period market capitalization weighting.
The frequency and amount of dividends paid per common share during the years ended December 31, 2008 and 2007, were as follows:
On January 22, 2009, UCBHs Board of Directors declared a dividend on UCBHs preferred stock. A cash dividend of $21.25 per share on its 8.50% Non-Cumulative Perpetual Convertible Series B Preferred Stock was declared payable on March 16, 2009, to stockholders of record as of the close of business on February 27, 2009. A cash dividend of $12.63 per share on Fixed Rate Cumulative Perpetual Preferred Stock, Series C was declared payable on February 15, 2009, to stockholders of record as of the close of business on February 5, 2009.
On February 17, 2009, UCBHs Board of Directors declared a dividend on UCBHs common stock. A cash dividend of $0.01 per share on the outstanding shares of Common Stock was declared payable April 13, 2009, to stockholders of record as of the close of business on March 31, 2009.
Unregistered Sales of Equity Securities
Item 6. Selected Financial Data
The following selected financial data should be read in conjunction with the UCBH Holdings, Inc. and subsidiaries consolidated financial statements and the accompanying notes presented elsewhere in this Annual Report on Form 10-K (dollars in thousands, except per share amounts):
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UCBH Holdings, Inc. (UCBH) and its consolidated subsidiaries (collectively referred to as the Company, we, us or our) is a $13.50 billion bank holding company with headquarters in San Francisco, California. The Companys operations are conducted primarily through its banking subsidiary, United Commercial Bank (UCB). UCB operates through seventy-eight offices and branches in the United States and Asia and is a leader in providing financial services to Asians in the United States. At December 31, 2008, we had seventy-one domestic branches and offices; twenty-nine in Northern California, twenty-two in Southern California, five in the Atlanta metropolitan area, three in the Boston metropolitan area, nine in the New York metropolitan area, two in the Seattle metropolitan area and one branch in Houston. UCB also has offices and branches in Hong Kong, Shanghai and Shantou, China and representative offices in Beijing, Guangzhou and Shenzhen, China and Taipei, Taiwan.
In providing its services, UCB has two primary goals:
UCB has established and intends to continue establishing branches in areas of high Asian population concentration to attract retail deposits through new branch openings as well as through acquisitions.
Currently, UCB has offices and branches in Hong Kong, Shanghai and Shantou, China and representative offices in Beijing, Guangzhou and Shenzhen, China and Taipei, Taiwan. Our fully operational Hong Kong, Shanghai and Shantou branches are authorized to conduct a complete range of banking operations, including offering deposit, foreign exchange and remittance services, issuing cashier orders, and providing trade finance, commercial banking and lending services. Our representative offices on the other hand, cannot conduct any profit generating banking business and are restricted to the specific activities that have been approved by the local banking authorities of their respective country, such as providing market research and acting in the capacity of a liaison to existing bank customers. As of December 31, 2008, UCBs Hong Kong branch had total loans of $659.3 million and total deposits of $828.6 million. This office has expanded its trade finance services since its opening and the fees associated with those services have also increased over last year. As of December 31, 2008, UCB China Ltd had total loans of $355.0 million, total deposits of $110.2 million and interbank borrowings of $148.0 million.
UCB intends to establish additional overseas offices and branches to facilitate international trade across the Asia Pacific region. In this regard, UCB has focused much of its growth strategies toward the expanding opportunities that have been emerging from China. Trade between China and the United States has increased steadily over the past several years and the trade finance business has followed. We anticipate that the opportunities for growth presented by the expansion of the Chinese economy will continue for some time.
Success in attaining our goals will be dependent on our adherence to the fundamentals that we believe are vital to our ongoing successful growth. These fundamentals include:
In addition, we believe that we have a unique set of capabilities that provide us with an in-depth understanding of the Asian population, our targeted market. These capabilities help to differentiate us and enable us to enhance the service that we provide. These capabilities include:
We are providing you with an overview of what we believe are the most significant factors and developments that impacted the Companys results for 2008 and that could impact future results. We encourage you to carefully read this full document for more detailed information with regard to the trends, events and uncertainties that have or may affect us in the future.
The Companys primary or core business consists of providing commercial and retail banking services to both individuals and companies in markets with high concentration of Asians both in the United States and the greater China regions.
2008 was a year in which our economy moved into an economic recession. This recession worsened significantly during the second half of 2008. The deepening financial crisis was the result of housing activity and price declines occurring throughout the year, the spike in energy prices, softening of consumer spending, worsening trends in employment, and loss of household wealth resulting from declines in home prices and stock market valuations. Businesses cut production and employment, as well as postponed capital spending plans. As a result of the economic slowdown and financial crisis, the United States Department of the Treasury and the Federal Reserve initiated several actions which changed the landscape of the United States financial services industry.
The deteriorating economy continued to impact the credit quality of our residential construction loan portfolio, with significantly more rapid deterioration occurring in the fourth quarter of 2008. In addition, the market dislocations occurring throughout 2008, including the severe volatility, illiquidity and credit dislocations that were experienced in the debt and equity markets, adversely impacted our collateralized debt obligations and CMBS residual investment securities. Further, we incurred losses associated with Fannie Mae and Freddie Mac equity securities.
The Company reported a net loss for 2008 of $67.7 million or diluted earnings per share of $(0.70). This compares with a net income of $102.3 million or diluted earnings per share of $0.97 for 2007 and a net income of $100.9 million or diluted earnings per share of $1.03 for 2006. Return on average equity (ROE) was (5.96)% and return on average assets (ROA) was (0.53)% in 2008, compared with 11.55% and 0.97% in 2007 and 15.59% and 1.23% in 2006, respectively.
Net interest income before loan loss provision in 2008 grew $13.5 million to $336.1 million, a 4.18% increase from $322.6 in 2007 despite the Federal Reserve interest rate cuts throughout 2008. However, the Company recorded provision for loan losses of $262.9 million for 2008 compared to $20.2 million for 2007. The significant increase in loan loss provision was primarily due to the deterioration in certain residential construction markets, loan growth and changes in the mix of the loan portfolio. In addition, the Company recorded other-than-temporary charges of $43.1 million for the full year of 2008. The other-than-temporary charges included a $5.2 million write-down in two non-bank Real Estate Investment Trust (REIT) collateralized debt obligations (CDOs) backed by trust preferred securities (TPS), a $22.3 million write-down on U.S. government sponsored enterprises (GSE)
investment securities, a $5.0 million write-down on the retained residual tranche from UCBs commercial real estate loan securitization and a $10.6 million write-down on three CDOs backed by pooled bank trust preferred securities.
When we evaluate the Companys performance, we focus on five primary areas: (1) loan and deposit growth, (2) credit quality, (3) net interest margin, (4) expense control and (5) capital adequacy.
Since 2004, UCB has experienced steady and strong growth in loans and deposits. This was accomplished in spite of a challenging economic and competitive environment that was present during a large portion of this time period. The net loans held in portfolio and total deposits at December 31, 2008, 2007, 2006, 2005 and 2004, were as follows (dollars in thousands):
The growth that was experienced in net loans held in portfolio and in deposits was achieved both organically and from acquisitions. Over the past six years, the Company has acquired seven banking companies, which added an aggregate of $1.83 billion in net loans held in portfolio and $2.71 billion in deposits as of the respective acquisition dates.
We expect modest growth in deposits and certain loans held in portfolio such as commercial business and international trade finance loans. However, a continued economic downturn may affect the Companys loan portfolio growth. In addition, as part of its balance sheet management UCB enters into loan sales, which are discussed in later sections of this document.
The housing downturn and financial market disruptions that began in the second half of 2007 have continued to affect the economy and the financial services industry in 2008. The housing market downturn and broader economic slowdown accelerated significantly during the second half of 2008, particularly in the fourth quarter of 2008, and negatively impacted our residential construction loan portfolio. The depth and breadth of the economic downturn remain unclear. However, the Company expects continued market turbulence and economic uncertainty to continue well into 2009. This could result in relatively high levels of loan loss provisioning in future periods.
Credit risk is evaluated and managed with a goal that concentrations of credit exposure do not result in undesirable levels of risk. We review, measure, and manage concentrations of credit exposure by industry, product, geography and customer relationship. We have not offered certain mortgage products such as negative amortizing mortgages or option ARMs. We continually monitor, evaluate and modify our credit underwriting criteria to address unacceptable levels of risk as they are identified. For example, during the latter part of 2007 and for the 2008 year, we tightened credit underwriting standards as we believed appropriate. We shifted our loan origination production mix to significantly more commercial business loans than in prior years, where production included a higher level of construction loans. Even with these credit management processes, we expect the related allowance for loan losses to increase corresponding to the growth in UCBs loan portfolio. In addition, loan losses may increase due to the effects of the unprecedented economic downturn on credit quality.
The average loans held in portfolio, total loan charge-offs and the ratios of nonperforming loans to loans held in portfolio, allowance for loan losses to loans held in portfolio and net charge-offs to average loans held in portfolio as of and for the years ended December 31, 2008, 2007, 2006, 2005 and 2004, were as follows (dollars in thousands):
The increase in the nonperforming loans to loans held in portfolio ratio and the allowance for loan losses to loans held in portfolio ratio is primarily the result of the downturn in the economy in 2008 and the resultant impact on the construction loan portfolio.
The economic downturn and continuing troubles in the housing and construction sector, financial markets, commercial real estate and challenging interest rate environment that has been affecting financial institutions over the past several years, continued to impact our net interest margin. In addition, our net interest margin reflects the effects of the Federal Reserve interest rate cut of 425 basis points during the year. However, we expect to continue our efforts to improve the net interest margin in the future through prudent balance sheet management and emphasis on growth in core deposits. See Interest Rate and Market Risk Management later in this document. The Companys net interest margin on a nontax equivalent basis and average federal funds rate for the years ended December 31, 2008, 2007, 2006, 2005 and 2004, were as follows:
We are continuously monitoring our costs and expenses and seeking new ways to maintain them at acceptable levels. For 2008, we experienced an increase in our noninterest expense. Much of this increase was a result of increased personnel and occupancy expenses due to additional cost of supporting the Companys commercial business, the expansion of the Companys infrastructure, full year expenses associated with the May 2007 acquisition of CAB and the December 2007 acquisition of BDB, increase in deposit insurance premium and other real estate owned expenses.
As regulated financial institutions, the Company and UCB (on a consolidated basis) are required to maintain adequate levels of capital as measured by several regulatory capital ratios. One of our goals is to maintain a well capitalized level of regulatory capital as defined by the banking regulators for both the Company and UCB. The Companys and UCBs risk-based capital ratios at December 31, 2008, 2007, 2006, 2005 and 2004, were as follows:
The notes to the consolidated financial statements contain a summary of the Companys significant accounting policies that are presented elsewhere in this Annual Report on Form 10-K. We believe that an understanding of certain policies, along with the related estimates that we are required to make in recording the financial transactions of the Company, is important to have a complete picture of the Companys financial condition. In addition, in arriving at these estimates, we are required to make complex and subjective judgments, many of which include a high degree of uncertainty. The following is a discussion of these critical accounting policies and significant estimates related to these policies. We have discussed each of these accounting policies and the related estimates with the Audit Committee of the Companys Board of Directors.
Valuation of Financial Instruments
Effective January 1, 2008, the Company determines the fair values of its financial instruments based on the fair value hierarchy delineated in Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements (SFAS 157), which requires the Company to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. SFAS 157 describes three levels of inputs that may be used to measure fair value:
Level 1: Quoted prices for identical financial assets or liabilities in active markets.
Level 2: Quoted prices for similar financial assets or liabilities in active markets; quoted prices for identical or similar financial assets or liabilities in markets that are not active; and valuations derived by models in which the significant inputs and significant value drivers are observable in active markets.
Level 3: Valuations derived by models in which one or more significant inputs or significant value drivers are unobservable. These unobservable assumptions reflect our own estimates of assumptions that market participants would use in pricing the financial asset or liability.
When determining the fair value measurements for financial assets and liabilities required to be recorded and reflected at and/or marked to fair value, the Company considers the principal or most advantageous market in which it would transact, and considers assumptions that market participants would take into account when pricing the asset or liability. When possible, the Company uses quoted market prices from active and observable markets to determine fair value for identical assets and liabilities. When identical assets and liabilities are not traded in active markets, the Company looks to market observable information for similar assets and liabilities. However, certain of the Companys assets and liabilities are not actively traded in observable markets and as such, the Company must use alternative valuation techniques to derive a fair value measurement. The information obtained from third parties is typically derived from models that take into account market-based or independently sourced market parameters, such as interest rates, currency rates, credit default, and prepayment rates.
It should be noted that the resulting fair value measurements derived from alternative valuation techniques oftentimes result in a fair value that cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the underlying financial asset or liability. Additionally, there may be inherent weaknesses in any calculation technique, and changes in the underlying key assumptions used, such as discount rates and estimates of future credit defaults, prepayments rates and future cash flows, that could significantly affect the results of current or future fair values.
Additionally, for these investments in which direct observable prices or inputs are used in the valuation process but in cases where the observable prices or inputs are either not current or are based on transactions in inactive or illiquid market conditions, such observable prices or inputs might not be relevant and could require significant adjustment. In these cases, the Company may use an internal cash flow model, which utilizes Level 3 inputs, including assumptions about future cash flows and risk-adjusted discount rates, in order to determine fair value of a particular investment security.
The Company holds fixed income mortgage and asset-backed securities, exchange traded equity securities, retained interests in securitizations, investments in private equity, venture capital and other nonpublic investments, over-the-counter foreign exchange derivative contracts and other financial instruments.
Financial instruments measured at fair value at December 31, 2008, on a recurring basis are investment and mortgage-backed securities available for sale, and derivative contracts that consist primarily of foreign currency forward, option contracts, and swaps. Investment and mortgage-backed securities comprise almost all of the financial instruments that are measured at fair value on a recurring basis at December 31, 2008.
Investment and mortgage-backed securities available for sale that are carried at fair value on a recurring basis at December 31, 2008 total $2.96 billion or 21.9% of the total assets of the Company. Investments and mortgage-backed securities are made up of U.S. Treasury Bill, Agency Preferred Stock, U.S Government sponsored enterprises notes (Agency Note), U.S. Government sponsored enterprises discount notes (Agency Discount Notes), Agency Mortgage-Backed Securities (Agency MBS), Agency Collateralized Mortgage Obligations (Agency CMOs), Private Collateralized Mortgage Obligations (Private CMOs), Municipals, Commercial Debt Obligations (CDOs), Collateralized Loan Obligation (CLO), Collateralized Mortgage-Backed Securities (CMBS), SBA I/O Strips and SBA Pool.
The table below provides the FAS 157 valuation hierarchy and fair value amount of the Companys investment and mortgage-backed securities available for sale. The principal market for these securities is the Fixed Income market (dollars in thousands).
Level I securities, which include Agency Preferred Stock and Treasury Bill, represents 1.70% of the total fair value of the investment securities and mortgage-backed securities available for sale. These securities are categorized as Level 1 due to quoted prices being accessible for identical securities in active markets.
Level II securities represent 87.0% of the investment and mortgage-backed securities available for sale. These securities are categorized as Level II due to no identical securities being traded in active markets however, observable market inputs are accessible. For example, quoted price on similar securities are accessible in active markets and market prices are readily available from different sources. The Company uses the pricing source from a third party pricing service (pricing service) to determine the fair value of the Level II securities. The pricing service provides evaluations that represent as to what a buyer in the marketplace would pay for a given security in a current sale. The sources used by the pricing service as inputs to its evaluated pricing vary according to the type of security being evaluated. The main source of information the pricing service uses include research materials prepared by others, corporate rating services, annual reports, prospectus, filings with the Securities and Exchange Commission and company press releases. Other sources include market maker, broker and dealer quotes, pricing service generated yield scales, factors, prepayment rates, currency rates, indices, and other data received from third parties. The pricing services evaluations are based on objectively verifiable information derived from or clearly relevant to the market for such securities. The pricing service bases its evaluation on interpretations of accepted Wall Street conventions. Information that is typically considered includes the securitys terms and conditions, including any features specific to that issue, which may influence risk, and thus marketability, and market activity with particular emphasis on events affecting market sectors and individual issuer credit worthiness.
Level III securities represent 11.3% of investment and mortgage-backed securities available for sale. These securities are categorized as Level III due to no identical securities in active markets and observable market inputs not readily available. The Companys internal model is used to derive the fair value of the CDOs, CLO and SBA I/O Strips. A third party is used to value the Companys CMBS.
The fair value of the CDOs and one CLO was derived using the Companys internal pricing model. In making the determination on the use of its internal pricing model, the Company obtained price indications from various brokers for the December 2008 month end pricing. Based on the broker quotes obtained, corresponding implied yields were estimated based on the Companys projected cash flow. By interpreting the implied yield against the credit rating of each CDO and CLO, the Company deemed that the implied yields were relatively high when compared to the respective cash flows. To access the market conditions and market participant assumptions to determine the valuation of the CDOs and CLO, various brokers were consulted. Based on the consultation with the brokers, the Company concluded that the CDO and CLO markets are inactive due to substantial risk aversion initiated by the credit crisis started in mid-2007 and fueled by continued negative market developments afterward. Since trading activity remained thin, observable transactions on these securities are scarce. Based on current market conditions, broker price indication and consultation with brokers, the Company concluded that the CDO and CLO markets are inactive. Brokers informed the Company that most trades in the market are related to liquidation sale, distress sale and bankruptcy sale. These trades reflect exit prices of transactions that are indicative of distressed or forced sales. Observable inputs are not available as transactions on CDO and CLO are scarce and not current.
The Company used its internal pricing model to generate projected cash flows for its CDOs and CLO based on the most recent trustee reports for these securities and using the Companys prepayment, default and recovery assumptions. The general assumptions on these factors were obtained from brokers. Since market participants deemed the defaults will be front loaded, different scenarios (with assigned probabilities) were derived for each CDO and CLO according to different severities of front-loaded default rates for the first twelve months. Since observable transactions on similar CDO and CLO are rare, the Company decided to determine the risk-adjusted discount margin (DM) on pricing the CDOs and CLO by using the DM implied by the corporate bond market. While the corporate bond market has displayed widening spreads and lower volumes at the end of September and throughout the fourth quarter of 2008, the instrument variety and number of data points in the corporate bond market enabled the Company to determine the appropriate risk-adjusted DM for each CDO and CLO. The final model pricing was determined by the sum of the probability weighted price derived from the discounted cash flows in each scenario that the Company stress tested with the appropriate risk-adjusted DM. The probability to each scenario is determined under a conservative view of the expected status of the economy.
The fair value of the SBA I/O Strips was derived using the Companys internal pricing model. In making the determination on the use of its internal model, the Company obtained price indications from various brokers for the December 2008 month end pricing. To access the market conditions and market participant assumptions to determine the valuation of the SBA I/O Strips, various brokers were consulted. Based on the consultation with the brokers, the Company concluded that the SBA I/O Strips markets are inactive as no secondary market activity is observed in the market. Observable transactions on these securities are scarce. After performing due diligence on both observable and unobservable inputs for the price indication provided by the broker, the Company determined that the pricing indication of brokers are largely based on scarce and non-current data and unobservable inputs for their pricing. The Company concluded that it was appropriate to place less reliance on pricing indications from brokers to value the SBA I/O Strips.
The Company used its internal pricing model to determine the pricing of its SBA I/O Strips. Since the cash flows of the SBA I/O Strips are guaranteed by the United States Government, there is virtually no risk involved in the cash flows. Therefore, the only assumption built into the pricing model to generate the projected cash flows used to compute the market values of the SBA I/O Strips is the discount yield and prepayment speed. The discount rate is based on the discount rate for the fair market value assumption of the SBA Loan Mortgage Servicing Rights estimated by a third party servicer. The Company used the prepayment rate that it determined as the most reasonable based on the underlying collateral of the SBA I/O Strips.
The Company used a third party service to determine the pricing of its CMBS available for sale investments. The third party performs pricing and scenario analysis for a variety of institutions engaged in the issuance and management of Commercial Mortgage-Backed Securities, Residential Mortgage-Backed Securities, and
Collateralized Debt Obligations. The third party service maintains a database of credit spread information on each CMBS transaction issued publicly as well as polling its client list for information related to each clients current CMBS credit spread assumptions. For prepayment and default scenario assumptions, the third party service uses a combination of internal credit default models and the published dealer research that estimate prepayment rates and default rates for each publicly available CMBS transaction.
The CMBS investments were the result of UCBs securitization of commercial real estate loans during the fourth quarter of 2007. The loans were exchanged for collateralized mortgage backed securities, issued through a newly established trust, United Commercial Mortgage Securities, LLC. There are four certificates representing the trust: Class A Certificates, Class M Certificates, Class C Certificates and Class R Certificates. The Class R Certificates have no economic value. In the pricing of the CMBS investments, Class A was priced at a credit spread to the interpolated U.S. Swap curve, Class M was priced at a credit spread to the interpolated U.S. Treasury curve and Class C was priced at the fixed rate credit spread. These rates were obtained based on market observations. Also, in deriving the price of the CMBS, the third party used different prepayment and credit default rate scenarios in their pricing model supplied by UCB since UCB is the Subservicer of the loans and has visibility to the borrowers loan information. As a Subservicer, UCB receives a fee based on an agreed upon rate applied to the principal balance of the securitized loans as of the first day of the related due period. UCB is also entitled to any amounts earned on funds in the related subservicing account.
Any declines in a specific investment securitys fair value that are determined to be other-than-temporary, result in a write-down of the investment security and a corresponding charge to noninterest income. During the twelve months ended December 31, 2008, as a result of continued deteriorating market conditions, the Company recognized other-than-temporary impairments totaling $43.1 million.
The allowance for loan losses represents our estimate of the losses that are inherent in the loans held in portfolio. UCB continuously monitors the quality of its loans held in portfolio and maintains an allowance for loan losses sufficient to absorb losses inherent in the loans held in portfolio. At December 31, 2008, UCBs total allowance for loan losses was $230.4 million, which represented 2.66% of loans held in portfolio.
UCBs methodology for assessing the adequacy of the allowance for loan losses includes the evaluation of two distinct components: a general allowance applied to loans held in portfolio categories as a whole and a specific reserve for loans deemed impaired. Loans that are determined to be impaired are excluded from the general allowance analysis of the loans held in portfolio and are assessed individually.
In determining the general allowance, UCB applies loss factors, differentiated by an internal credit risk rating system, to its major loan portfolio categories (based primarily on loan type). UCBs risk rating system is applied at the individual loan level within each of the major loan portfolio categories. The credit quality of the loan portfolio is regularly assessed through ongoing review.
The loss factors are developed from actual historic losses, and reflect comparative analysis with peer group loss rates and expected losses, which are in turn based on estimated probabilities of default and loss given default. This quantitative portion of the analysis also resulted in establishing a minimum loss factor for each of the major loan portfolio categories to better reflect minimum inherent loss in all portfolios including those with limited historic loss experience. Additionally, loss factors incorporate qualitative adjustments that reflect an assessment of internal and external influences on credit quality that have not yet been reflected in the historical loss or risk-rating data. These influences may include elements such as portfolio credit quality trends and changes in concentrations, growth, or credit underwriting. UCBs qualitative adjustments also include an economic surcharge factor to adjust loss factors in recognition of the impact various macro-economic factors have on portfolio performance.
UCB assesses the loss factors that are applied to loan portfolio categories on a quarterly basis, and as part of the assessment concluded during the year ended December 31, 2008, UCB effected further refinements in the determination of certain loss factors during the first quarter of 2008 as a result of UCBs annual methodology review. The annual methodology review primarily addresses the approaches, assumptions, and data inputs used in the quantitative support for the loss factors, and focused primarily on the continued development of the loss factors.
During the third quarter of 2008, the only changes in our loss factors were applicable to the construction portfolio due to the further softening in the residential construction markets in California and to the reserve for unfunded commitments related to criticized loans. During the fourth quarter of 2008, changes were made to the historic loss factor of criticized loans for all portfolios. Changes were also made to the qualitative loss and economic surcharge factors for construction and commercial business loan portfolios. These changes were necessitated by the continuing deterioration in the economy and the housing and construction sectors.
The second component of the allowance for loan losses, the specific reserve, applies to loans that are considered impaired. A loan is considered impaired when it is probable that UCB will not be able to collect all amounts due, including interest payments, in accordance with the loans contractual terms. Unless the loan is collateral-dependent, loan impairment is measured based on the present value of expected future cash flows that have been discounted at the loans effective interest rate. If the loan is collateral-dependent, either the observable market price or the current fair value of the collateral, reduced by estimated disposition costs, is used in place of the discounted cash flow analysis.
Additions to the allowance for loan losses are made by charges to the provision for loan losses. Credit exposures deemed to be uncollectible are charged against the allowance for loan losses. Recoveries of previously charged off amounts are credited to the allowance for loan losses.
While management uses its best judgment based on the information available, the adequacy of the allowance for loan losses depends on a number of important factors. Such factors include credit quality of the loan portfolio, changes in the Companys lending policies and procedures, changes in the interest rate, changes in economic and business conditions, changes in the severity and volume of past due and impaired loans, changes in the value of the underlying collateral-dependent loans, the effects of any changes in the concentration of credits, changes in legal and regulatory requirements, and other external factors. A weakening of the economy or change in any of the factors described above that has an adverse affect on loan quality could result in an increase in the loan loss provision in future periods due to higher delinquencies, a higher level of impaired loans and net charge-offs.
See Credit Risk Management for more information on how the Company determines the level for the allowances for loan losses and unfunded lending commitments.
UCB also estimates a reserve related to unfunded commitments and other off-balance sheet credit exposure. In assessing the adequacy of this reserve, UCB uses an approach similar to the approach used in the development of the allowance for loan losses. The reserve for unfunded commitments is included in other liabilities on the Consolidated Balance Sheets.
The reserve for unfunded commitments decreased $145,000 from December 31, 2007, to December 31, 2008, as a result primarily of the discontinuance of unfunded commitments related to criticized loans.
There are numerous components that enter into the evaluation of the allowance for loan losses. Some are quantitative while others require UCB to make qualitative judgments. Although UCB believes that its processes for determining an appropriate level for the allowance for loan losses adequately address all of the components to estimate inherent credit losses, the processes and their elements include features that may be susceptible to significant change. Any unfavorable differences between the actual outcome of credit-related events and UCBs estimates and projections could require an additional allowance for loan losses, which would negatively impact the Companys results of operations in future periods. UCB continually monitors and evaluates its allowance for loan loss methodology, seeking to refine and enhance the processes used to estimate incurred losses in our loan portfolios as appropriate.
UCB periodically enters into transactions that transfer loans from UCB to third-party purchasers. In most instances, UCB continues to provide the servicing on these loans as a condition of the transfer. In addition, as part of these transactions, UCB may retain a cash reserve account, overcollateralization, or an interest-only strip, all of which are considered to be retained interests in the sold loans.
Whenever UCB initiates a loan transfer, the first determination that it must make in connection with the transaction is whether the transfer constitutes a sale under accounting principles generally accepted in the United States of America. If it does, the assets are removed from UCBs consolidated statement of financial condition with a gain or loss recognized. Otherwise, the transfer is considered to be a financing arrangement, resulting in no gain or loss being recognized on the transfer, which is recorded as a liability on UCBs consolidated statement of financial condition. Generally, UCBs loan transfers have been structured to meet the existing criteria for sale treatment.
UCB must also make assumptions to determine the amount of gain or loss resulting from a sale transaction as well as the subsequent carrying amount for the above-discussed servicing rights and retained interests. Initially, the total carrying value of the loans being sold is allocated among the loans themselves, the servicing rights and any retained interests based on their relative fair values. The purchase price is then compared to the amount assigned to the loans, and any difference is recorded as either a gain or a loss on the sale. In determining the fair values of the components of the transaction, UCB uses estimates and assumptions that are based on the facts surrounding each sale. Using different assumptions could affect the amount of gain or loss recognized on the transaction and, in turn, UCBs results of operations.
In 2008, UCB securitized $254.5 million of multifamily and residential mortgage loans with servicing rights retained through the Federal National Mortgage Association (FNMA).
We have historically not sold any of the resulting securities or retained interests to outside parties. The Company has a substantive guarantee from the monoline insurer resulting in the recharacterization of the loans. We have reflected the resulting securities in our available for sale investment securities portfolio. Initially, the total carrying value of the resulting security is allocated to the various tranches and retained interests based on their relative fair values. The fair value of the securities is then compared to the net carrying value of the underlying loans that have been securitized, along with the related issuance costs. Any excess of carrying value over fair value of the loan principal is charged off against our allowance for loan losses. Subsequently, any changes in fair value are measured and reflected in other comprehensive income. UCB uses estimates and assumptions that take into account prepayment speeds, credit defaults and discount rates, based on the facts surrounding each securitization. In the event that actual prepayments and credit defaults exceed our original assumptions, the resulting cash flows related to the residual tranche could be adversely affected, which would reduce the value and potentially trigger an other-than-temporary impairment on such residual tranche.
UCB uses a third-party service to assist in the determination of the ongoing fair values of the servicing rights and retained interests subsequent to the transaction date. In valuing the servicing rights and retained interests, UCB stratifies its mortgage servicing rights based on the risk characteristics of the underlying loan pools. The fair value of mortgage servicing rights is determined by calculating the present value of estimated future net servicing cash flows, using assumptions of prepayments, defaults, ancillary income, adequate compensation and discount rates that UCB believes market participants would use for similar assets. These value estimations require a number of assumptions, including: annualized prepayment speed of the loans, expected annual net credit loss rate, and discount rate for the residual cash flows. We generally determine fair value of retained interests based on valuation models obtained from outsourced service providers. Such valuation models take into account observable inputs if such inputs are available. Observable inputs, however, may not be available, in which case the valuation model estimates fair value using the present value of expected future cash flows using estimates of key assumptions, including forecasted credit default rates, prepayment rates and discount rates commensurate with the rates used by unrelated third parties. If the carrying amounts of the servicing assets are greater than their fair values, impairment is recognized through a valuation allowance. If there has been an adverse cash flow change on residual interests, impairment is recognized. Since the valuations are based upon estimates and assumptions, any unfavorable differences between the actual outcome of the future performance of the sold loans and our estimates and assumptions could result in future impairment in excess of that currently recorded.
A loan is considered to be impaired when it is probable that all of the principal and interest due under the terms of the original loan agreement may not be collected. Impairment is measured using the practical expedient allowed by SFAS No. 114, Accounting by Creditors for Impairment of a Loan, whereby the amount of a loans impairment is
measured based on either the present value of expected cash flows, the observable market price of the loan, or the fair value of the collateral securing the loan if the loan is collateral dependent. Fair value is measured based on an appraisal prepared by an independent appraiser. Impaired loans are initially categorized as nonrecurring Level 2 but may move to Level 3 if the value set forth by the independent appraisals is significantly adjusted as a result of the quarterly review processes. As of December 31, 2008, impaired loans were categorized as Level 3 due to the continued weakness in real estate market conditions resulting in inactive market data which in turn required primarily the use of unobservable inputs and assumptions in our fair value measurements.
Business acquisitions often result in the recognition of goodwill, which represents the value attributable to the unidentifiable intangible elements in our acquired businesses. Goodwill is initially recorded at fair value and is subsequently evaluated at least annually for impairment in accordance with Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets. In accordance with the Companys annual review policy, the Company performs this annual test as of September 30 of each year. Evaluations are also performed on a more frequent basis if events or circumstances indicate that an impairment could have taken place. Such events could include, among others, a significant adverse change in the business climate, an adverse action by a regulator, an unanticipated change in the competitive environment, and a decision to change the operations or dispose of a reporting unit.
The first step in this evaluation process is to determine if a potential impairment exists in any of the Companys reporting units, and, if required from the results of this step, a second step measures the amount of any impairment loss. The computations required by both steps one and two call for us to make a number of estimates and assumptions.
In completing step one, we determine the fair value of the reporting unit that is being evaluated. There are a number of methods that we can use in completing this step, including market capitalization and the discounted present value of managements estimates of future cash or income flows.
If step one indicates a potential impairment of a reporting unit, step two requires us to estimate the implied fair value of goodwill for that unit. This process estimates the fair value of the units individual assets and liabilities in the same manner as if a purchase of the reporting unit were taking place. To do this, we must determine the fair value of the assets, liabilities and identifiable intangible assets of the reporting unit based upon the best available information. If the value of implied goodwill calculated in step two is less than the carrying amount of goodwill for the reporting unit, an impairment is indicated and the carrying value of goodwill is written down to the calculated value.
During the quarter ended March 31, 2008, and continuing throughout 2008, our stock price declined significantly to a level indicating a market capitalization well below book value. In analyzing the decline in the stock price, we considered the decline to be primarily attributed to general market declines and overall concerns with regard to the financial services industry. While this decline was considered in our analysis of potential impairment, we concluded that the unusual and severe conditions in the stock market meant that an entirely market capitalization based approach was not the most reliable indicator of fair value as we did in 2007. In 2008, we performed goodwill impairment testing at each quarter end utilizing both a market approach and income approach. The income approach was based on a discounted cash flow model to estimate the fair value of our reporting units, which we considered to be most reflective of a market participants view of fair value given the current market conditions.
The Company performed the goodwill impairment testing as of December 31, 2008, because its market capitalization had been less than its book value of equity for three consecutive quarters. The Company used a third party valuation firm to determine the goodwill valuation for its two reporting units, Domestic Reporting Unit and International Reporting Units. The estimated fair values of the two reporting units, Domestic Reporting Unit and International Reporting Units were calculated under the step one process. For the step one procedures, the Market and Income Approaches were used to derive the valuation of the Domestic Reporting Unit and International Reporting Units. Based on the results of the step one procedures, it was determined there is no goodwill impairment with the International Reporting Units because the fair value was greater than the carrying value. However, it was determined that the goodwill in the Companys Domestic Reporting Unit needed to be subjected to the step two
implied fair value methodology. Based on the step two evaluations, management has determined that there is no goodwill impairment charge associated with the Domestic Reporting Unit.
The discounted cash flow (DCF) method was used as an income approach to establish the fair value of the equity of the Domestic Unit and International Reporting Units. In determining the value, the cash flow projections through 2013 were utilized. Following 2013, the business was considered to have reached a steady state. The projected earnings were adjusted for earnings retained for capital growth and also adjusted to remove the effects of depreciation and amortization, if significant, in order to determine the projected cash flow of the reporting units. An appropriate discount rate, calculated using the Capital Asset Pricing Model and market participant based assumptions, was then applied.
The after-tax net cash flows were then calculated and discounted to their present value over the projection period. The terminal cash flow was then established using the terminal years projected cash flow to which a Gordon Growth multiple was applied. The terminal value was discounted to present value and added to the projected cash flows, resulting in a value of the Domestic Reporting Unit and International Reporting Units common equity. For the Domestic Reporting Unit, the market value of the Domestic Reporting Units preferred equity was then added to the concluded value of its common equity. In addition, the market value of the TARP preferred equity and warrant was added to the concluded value, leading to a total value of the Domestic Reporting Unit under the DCF approach.
For the step two procedures on the Domestic Reporting Unit, the implied fair value methodology was used. Step two of SFAS 142 measures the impairment of goodwill by comparing its carrying value to its implied fair value. SFAS 142 states that the implied fair value of goodwill should be determined in the same manner as goodwill is determined in a business combination. The fair value of the reporting unit should be allocated to the fair value of its assets and liabilities as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the purchase price. The remainder of the excess of the fair value of the reporting unit over the fair value of its tangible and intangible assets and liabilities is the implied fair value of goodwill. SFAS No. 141, Business Combinations, provides guidance for allocating the purchase price in business combinations, which includes identifying and qualifying intangible assets as well as valuing such items. SFAS 142 does not lead to either a write-up or write-down of tangible or intangible assets or liabilities as a result of the impairment testing process. In performing the step two analysis of the Domestic Reporting Unit the major balance sheet accounts were reviewed in addition to identifying all unrecognized intangible assets. The analysis of the major balance sheet accounts primarily involved the use of the DCF approach and the use of key assumptions in determining the fair value of the respective assets and liabilities. On the basis of the analysis performed and the resulting fair values of the major assets and liabilities, the determination was made that the implied fair value of goodwill determined in the step two analysis exceeded the carrying value. Therefore, it was determined that there was no goodwill impairment and no impairment charge was warranted as of December 31, 2008.
While management has a plan to return the Companys business fundamentals to levels that support the book value per common share, there is no assurance that the plan will be successful, or that the market price of the common stock will increase to such levels in the foreseeable future. Accordingly, the Company will continue to monitor goodwill for potential impairment until such time whereby the market capitalization exceeds the book value of equity.
The current market volatility and lack of confidence in the financial markets continue to adversely affect the stock prices of financial institutions, in the United States as well as globally. As one of these financial institutions, the Company has seen its stock price decline from its December 31, 2008 level. In the event the Companys stock price remains at its current level, the Company may be subjected to potential goodwill impairment.
The Company follows SFAS No. 123(R), Share-Based Payment. Under SFAS No. 123(R), the total fair value of the stock options awards is expensed ratably over the service period of the employees receiving the awards. The
Company used the modified prospective method of adoption effective January 1, 2006. Under this adoption method, compensation expense recognized includes: (a) compensation costs for all share-based payments granted prior to but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, Accounting for Stock-Based Compensation, and (b) compensation costs for all share-based payments granted subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123(R).
In estimating the fair value of each stock option award on their respective grant dates, we use the Black-Scholes pricing model. The following are the average assumptions that were incorporated in the model for the years ended December 31, 2008, 2007 and 2006:
The expected life of the options is based on the historical life of options that have been exercised and cancelled after vesting date and a forecasted assumption of unexercised options that will be exercised at expiration. The expected stock price volatility is estimated using the historical volatility of UCBHs common stock. The historical volatility covers a period that corresponds to the expected life of the options. The expected dividend yield is based on the estimated annual dividends that UCBH expects to pay over the expected life of the options as a percentage of the market value of UCBHs stock as of the grant date. The risk-free interest rate for the expected life of the options granted is based on the U.S. Treasury yield curve in effect as of the grant date. The increase in average volatility rate is a result of UCBHs stock price being less stable during the year ended December 31, 2008, as compared to the same period in 2007. The decrease in the risk free interest rate reflects the lower U.S. Treasury yields for the year ended December 31, 2008, as compared to the same period in 2007.
In addition to the above assumptions, UCBH uses a forfeiture rate based on historical data of UCBHs actual experience to total grants awarded.
The fair values assigned to UCBHs stock options are based upon estimates and assumptions. In accordance with SFAS No. 123(R), once established, the fair value does not change unless the option grant is modified subsequent to its issuance. However, we believe that given the procedures that we have followed in determining the assumptions used in the estimation process, the fair values of the options are appropriate.
Core deposit intangibles are created as a result of the Companys acquisition of another financial institution. They represent the value that the acquired deposits have as a source of funding when compared to alternative funding sources, such as borrowings. When acquired, core deposit intangibles are valued by an outside service by computing the present value of the expected cost savings attributable to the core deposit funding relative to an alternative source of funding. Subsequent to the initial recording, core deposit intangibles are amortized based upon the expected runoff rate of the related deposits. In addition, the value of core deposit intangibles is reviewed each quarter for possible impairment by comparing actual deposit runoff to estimated runoff. Should the actual runoff exceed the estimate, the core deposit intangible is written down to the adjusted amount through a charge to noninterest expense. At that point, the runoff estimates are adjusted to reflect the actual runoff and the new estimates are used for subsequent amortization.
The provision for income taxes is based on income reported for financial statement purposes and differs from the amount of taxes currently payable, because certain income and expense items are reported for financial statement purposes in different periods than those for tax reporting purposes.
The Company accounts for income taxes using the asset and liability approach, the objective of which is to establish deferred tax assets and liabilities for the temporary differences between the financial reporting basis and the tax
basis of the Companys assets and liabilities at enacted tax rates expected to be in effect when such amounts are realized or settled. 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 will not be realized. A valuation allowance is established, when necessary, to reduce the deferred tax assets to the amount that is more likely than not to be realized.
As part of the computation of the income tax provision, estimates and assumptions must be made regarding the deductibility of certain expenses and the treatment of tax contingencies. There is a possibility that these estimates and assumptions may be disallowed as part of an audit by the various taxing authorities that the Company is subject to. Any differences between items taken as deductions in our tax provision computations and those allowed by the taxing authorities could result in additional income tax expense (benefit) in future periods.
Disclosures by Public Entities (Enterprises) about Transfers of Financial Assets and Interests in Variable Interest Entities
FASB Staff Position (FSP) FAS 140-4 and FIN 46(R)-8, Disclosures by Public Entities (Enterprises) about Transfers of Financial Assets and Interests in Variable Interest Entities, amends SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, to require public entities to provide additional disclosures about transfers of financial assets. It also amends FASB Interpretation (FIN) No. 46 (revised December 31, 2003), Consolidation of Variable Interest Entities, to require public enterprises, including sponsors that have a variable interest in a variable interest entity, to provide additional disclosures about their involvement with variable interest entities. Additionally, this FSP requires certain disclosures to be provided by a public enterprise that is (a) a sponsor of a qualifying special purpose entity (SPE) that holds a variable interest in the qualifying SPE but was not the transferor (nontransferor) of financial assets to the qualifying SPE and (b) a servicer of a qualifying SPE that holds a significant variable interest in the qualifying SPE but was not the transferor (nontransferor) of financial assets to the qualifying SPE. The disclosures required by this FSP are intended to provide greater transparency to financial statement users about a transferors continuing involvement with transferred financial assets and an enterprises involvement with variable interest entities and qualifying SPEs. FSP FAS 140-4 and FIN 46(R)-8 is effective for the first reporting period (interim or annual) ending after December 15, 2008, with earlier application encouraged. Because FSP FAS 140-4 and FIN 46(R)-8 impacts the Companys disclosure but not its accounting treatment for transfers of financial assets and interests in variable interest entities, the Companys adoption of FSP FAS 140-4 and FIN 46(R)-8 will not impact its financial position or results of operations.
FSP FAS 142-3, Determination of the Useful Life of Intangible Assets, amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, Goodwill and Other Intangible Assets. The intent of this FSP is to improve the consistency between the useful life of a recognized intangible asset under SFAS No. 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS No. 141 (revised 2007), Business Combinations, and other U.S. generally accepted accounting principles (GAAP). FSP FAS 142-3 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years; early adoption is prohibited. The Company does not expect the adoption of FSP FAS 142-3 to have a material impact on the Companys financial position or results of operations.
Statement of Financial Accounting Standards No. 162, The Hierarchy of Generally Accepted Accounting Principles, was issued in May 2008. SFAS No. 162 identifies the sources of generally accepted accounting principles and provides a framework, or hierarchy, for selecting the principal used in preparing U.S. GAAP financial statements for nongovernmental entities. SFAS No. 162 makes the GAAP hierarchy explicitly and directly applicable to preparers of financial statements, a step that recognizes preparers responsibilities for selecting the
accounting principles for their financial statements. SFAS No. 162 is effective November 15, 2008. The Company does not expect the adoption of SFAS No. 162 to have a material impact on the Companys financial position or results of operations.
SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities - an amendment of FASB No. 133 (SFAS 161), was issued in March 2008. SFAS 161 requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative agreements. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. Because SFAS 161 impacts the Companys disclosure but not its accounting treatment for derivative instruments, the Companys adoption of SFAS 161 will not impact its financial position or results of operations.
SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements - an amendment of ARB No. 51, was issued in December 2007 and establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. SFAS 160 changes the way the consolidated income statement is presented. It requires consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the noncontrolling interest. It also requires disclosure, on the face of the consolidated statement of income, of the amounts of consolidated net income attributable to the parent and to the noncontrolling interest. SFAS 160 establishes a single method of accounting for changes in a parents ownership interest in a subsidiary that do not result in deconsolidation. SFAS 160 requires that a parent recognize a gain or loss in net income when a subsidiary is deconsolidated. SFAS 160 requires expanded disclosures in the consolidated financial statements that clearly identify and distinguish between the interests of the parents owners and the interests of the noncontrolling owners of a subsidiary. SFAS 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008 (that is, January 1, 2009, for entities with calendar year-ends). Earlier adoption is prohibited. The Company does not expect the adoption of SFAS 160 to have a material impact on the Companys financial position or results of operations.
Statement of Financial Accounting Standards No. 141(R), Business Combinations (SFAS 141R), was issued in December 2007. SFAS 141R replaces SFAS No. 141, Business Combinations (SFAS 141). SFAS 141R retains the fundamental requirements in SFAS 141 that the acquisition method of accounting (which SFAS 141 called the purchase method) be used for all business combinations and for an acquirer to be identified for each business combination. SFAS 141R requires an acquirer to recognize the assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions. This replaces SFAS 141s cost-allocation process, which required the cost of an acquisition to be allocated to the individual assets acquired and liabilities assumed based on their estimated fair values. SFAS 141R also requires the acquirer in a business combination achieved in stages (sometimes referred to as a step acquisition) to recognize the identifiable assets and liabilities, as well as the noncontrolling interest in the acquiree, at the full amounts of their fair values (or other amounts determined in accordance with SFAS 141R). SFAS 141R applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. An entity may not apply it before that date. The Company will apply SFAS 141R for any business combinations consummated on or after January 1, 2009.
RESULTS OF OPERATIONS
Financial Highlights (Dollars in Thousands, Except Per Share Data)
Year Ended December 31, 2008, Compared to Year Ended December 31, 2007
The consolidated net income for the year ended December 31, 2008 decreased by $170.0 million or 166.2%, to a net loss of $67.7 million, compared to $102.3 million net income for the same period in 2007. Income before income tax for the year ended December 2008 decreased by $289.5 million or 186.5% to a loss before income taxes of $134.3 million as compared to an income before income taxes of $155.2 million for 2007. The decrease of $289.5 million in income before income taxes during 2008 was primarily the result of an increase in provision for loan losses of $242.7 million, a decrease in noninterest income of $23.1 million and an increase of $37.1 million of noninterest expense as compared to 2007. Provision for loan losses was $262.9 million for 2008 as compared to $20.2 million for 2007. Noninterest income was $2.5 million for 2008 as compared to $25.6 million for 2007, a 90.4% decrease. Noninterest expense was $209.8 million for 2008 as compared to $172.8 million for 2007, a 21.5% increase. Income tax for 2008 was a tax benefit of $66.5 million as compared to a tax provision of $52.9 million for 2007. Further variance explanation of the major income and expense categories for 2008 as compared to 2007 are outlined below. Diluted earnings per share were $(0.70) and $0.97 for the years ended December 31, 2008 and 2007, respectively.
Net Interest Income and Net Interest Margin. Net interest income in 2008 grew $13.5 million to $336.1 million, a 4.2% increase from $322.6 in 2007 despite the Federal Reserve interest rate cuts throughout 2008. This was driven by organic balance sheet growth in loans, increased purchases of higher-yielding taxable investment securities combined with a decrease in funding costs. Average loans outstanding for 2008 was $8.59 billion compared to $7.36 billion for 2007, an increase of 16.7%. Average taxable securities investment for 2008 was $2.36 billion compared to $1.73 billion for 2007, an increase of 36.6%. Interest and dividend income from loans and investments for 2008 was $697.4 million compared to $706.3 million for 2007, a decrease of $9.0 million or 1.3%. At the same time funding costs for 2008 decreased $22.5 million or 5.8% to $361.3 million from $383.8 million for 2007.
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The following table reflects the distribution of average assets, liabilities and stockholders equity, as well as the amounts of interest income and resultant yields earned from average interest-earning assets, and the amounts of interest expense and resultant rates paid on average interest-bearing liabilities for the years ended December 31, 2008 and 2007 (dollars in thousands):
Net interest margin declined 46 basis points to 2.82% for the year ended December 31, 2008 compared to 3.28% for the same period in 2007. The decline reflects the effect of the Federal Reserve interest rate cuts of 425 basis points during the year and the reversal of accrued interest of $21.8 million on loans that have been placed on nonaccrual, primarily in construction loans that have been downgraded during the year ended December 31, 2008.
For the year ended December 31, 2008, net interest margin, calculated on a tax equivalent basis was 2.92% compared to 3.36% for 2007, a decline of 44 basis points. Certain interest-earning assets of the Company qualify for federal tax exemptions or credits. The net interest margin, calculated on a tax equivalent basis, considers the tax benefit derived from these assets.
Average interest-earning assets for the year ended December 31, 2008, increased $2.08 billion or 21.1% over the same period last year. The increase was primarily in the loans and investment and mortgage backed securities portfolio. Average outstanding loans for the year ended December 31, 2008 increased $1.23 billion or 16.7% compared to the year ended December 31, 2007, primarily as a result of organic commercial business loan growth in both the domestic and China market areas. UCBs continued focus on commercial lending activities, expansion of its Hong Kong branch and loan growth generated from its BDB acquisition reflects the increase in the average commercial loan balances of $1.18 billion or 17.2% compared to the corresponding period of 2007. Average commercial business loan balances for the year ended December 31, 2008, increased $724.8 million or 45.4% compared to the corresponding period of 2007. Average construction loan balances for the year ended December 31, 2008 increased $592.5 million or 46.0% compared to the same period in 2007. However, due to the continuing challenging current economic environment, the growth rate for commercial lending activities, especially in the construction lending market has slowed noticeably during the second half of 2008. Total new loan commitments for the second half of 2008 was $1.02 billion compared to $1.85 billion for the first half of 2008, a decrease of 44.9%. As of December 31, 2008, total loans represented 64.1% of total assets.
Average investment and mortgage-backed securities for the year ended December 31, 2008 was $2.82 billion, an increase of $792.2 million, or 39.0%, from the year ended December 31, 2007. Increase in investment and mortgage-backed securities resulting primarily from the purchases of U.S. Government sponsored enterprise notes. The balance of U.S. Government sponsored enterprise notes at December 31, 2008 was $1.01 billion compared to $447.2 million at December 31, 2007.
Total interest-bearing liabilities, which comprise of deposits and borrowings, increased $1.93 billion, or 22.0%, for the year ended December 31, 2008, from the year ended December 31, 2007.
Average total deposits increased $867.9 million, or 11.72%, for the year ended December 31, 2008, from the year ended December 31, 2007, reflecting UCBs ongoing focus on the generation of commercial and consumer deposits, both domestically and in the China market areas. Average interest-bearing deposits increased to $7.47 billion, up 12.6% from the year ended December 31, 2007, and average noninterest-bearing deposits increased to $799.2 million, up 4.1% for the year ended December 31, 2008, compared to the year ended December 31, 2007. At December 31, 2008, total deposits represented 74.3% of total liabilities.
Average total borrowings increased $1.09 billion, or 50.8%, for the year ended December 31, 2008, from the year ended December 31, 2007. At December 31, 2008, total borrowings were $2.99 billion and represented 24.7% of total liabilities. FHLB advances made up $1.72 billion of total borrowings at December 31, 2008.
The changes in interest income and interest expense for the major categories of interest-earning assets and interest-bearing liabilities, and the amount of change that is attributable to volume and rate changes by comparing the years ended December 31, 2008 to 2007, are as follows (dollars in thousands):
Provision for Loan Losses. The provision for loan losses was $262.9 million for 2008, as compared to $20.2 million for 2007. The economic and credit turmoil that began in the latter part of 2007 continued to worsen throughout 2008. The increased provision for loan losses during the first quarter of 2008 was the result of increases in classified residential construction loans and specific reserves on residential construction loans geographically located in distressed areas that included Riverside County, San Bernardino County, the Greater Sacramento area, Imperial County, the High Desert and the Central Valley, all of which are in California and Nevada. The provision for loan losses during the second quarter of 2008 reflects an increased assessment of loss severity, primarily on certain residential construction problem loans previously identified during the first quarter. In addition, provision for loan losses during the second quarter was necessitated by the high level of charge-offs. The provision for loan losses during the third quarter of 2008 was primarily due to further softening in the residential construction markets in California. The construction loan provision was impacted by increases in both specific reserves and by increases in loss factors applied. Also, $4.1 million of the third quarters provision was associated with increased commercial lending reserves for one commercial loan. Provision for loan losses during the fourth quarter was greater than the loan loss provision for the three quarters of 2008 combined. The significant loan loss provision of $152.1 million during the fourth quarter was primarily due to the further rapid deterioration in residential construction markets in certain areas of California. We experienced additional specific loss provisioning associated with a certain number of commercial real estate and commercial business loans, as a result of lender specific events that occurred during the latter half of 2008. The deterioration in the economy and the housing and construction sectors accelerated during the later stages of the fourth quarter of 2008. As such, the loan loss provision for the fourth quarter reflects a significant increase in non-performing loans, substantial increase in charge-offs, delinquencies and receipt of updated appraisals, especially in the residential construction loan portfolio as compared to the prior quarters of 2008.
For the year ended December 31, 2008, net charge-offs were $113.2 million, an increase of $104.0 million from the $9.3 million of net charge-offs for the year ended December 31, 2007. Construction net charge-offs was $90.4 million, representing 79.9% of the net charge-offs for 2008. Net charge-offs as a percentage of average loans held in portfolio was 1.33% for the year ended December 31, 2008, as compared to 0.13% for the year ended December 31, 2007, an increase of 120 basis points as compared to 2007. The provision for loan loss was $109.7 million greater
than net charge-offs for the year ended December 31, 2008, which resulted in a corresponding increase in the Companys allowance for loan losses.
See Credit Risk Management for more information on how the Company determines the level for the allowances for loan losses and unfunded lending commitments.
Noninterest Income. Noninterest income decreased by $23.1 million, or 90.4%, for the year ended December 31, 2008, compared to the year ended December 31, 2007. The net decrease was primarily the result of other-than-temporary impairment on investments of $43.1 million recognized for the full year of 2008. The other-than-temporary charges included a $5.2 million write-down in two non-bank REIT TPS CDOs, a $22.3 million write-down on GSE investment securities, a $5.0 million write-down on the retained residual tranche from UCBs commercial real estate loan securitization and a $10.6 million write-down on three CDOs backed by pooled bank trust preferred securities.
In addition, a $1.4 million charge was recorded during the first quarter of 2008 for a lower of cost or market adjustment on commercial real estate loans held for sale. Gain on sale on loans decreased to $2.0 million for the year ended December 31, 2008, from $8.2 million for the same period in 2007 due to decreased sales volume resulting from the current economic and market conditions. The decrease in noninterest income was partially offset by $9.8 million in foreign exchange gain for the year ended December 31, 2008, an increase of $9.6 million over the same period in 2007. For the year ended December 31, 2008, gain on available for sale investment securities increased $5.5 million, or 103.8%.
Noninterest Expense. Noninterest expense increased $37.1 million, or 21.5%, for the year ended December 31, 2008 as compared to the same period in 2007. For the year ended December 31, 2008, personnel and occupancy expenses increased by $19.6 million, or 16.4% as a result of additional cost of supporting the Companys commercial business, the expansion of the Companys infrastructure and includes a full year of salary and occupancy costs associated with the May, 2007 acquisition of The Chinese American Bank and the December, 2007 acquisition of UCB China.
Included in noninterest expense for the year ended December 31, 2008, was a $6.0 million of deposit insurance premium, an increase of $4.2 million over the same period in 2007 and $7.1 million in other real estate owned expenses, and increase of $6.5 million over the same period in 2007. The increase in deposit insurance premium reflects a 22.1% growth in domestic deposits and the inclusion of a one time credit of $3.6 million in the 2007 deposit insurance premium expense. In addition, other real estate owned expense increased by $6.5 million in 2008 due to increased foreclosures.
Income Tax Benefit. The Company recognized a $66.5 million income tax benefit for the year ended December 31, 2008 compared to a $52.9 million income tax expense for the year ended December 31, 2007. The income tax benefit for 2008 was primarily caused by a significant pretax loss for 2008 and tax exempt interest income and low-income housing credits. The effective tax rate for the year ended December 31, 2008, was 49.5% compared with 34.1% for the year ended December 31, 2007.
Year Ended December 31, 2007, Compared to Year Ended December 31, 2006
The consolidated net income of the Company for the year ended December 31, 2007, increased modestly by $1.4 million, or 1.4%, to $102.3 million, compared to $100.9 million for the same period in 2006. The modest increase in net income was the result of increase in loan loss provision and realized losses on certain collateralized debt obligations that were deemed impaired in the fourth quarter of 2007 as a result of credit downgrades. The ROE and ROA ratios for the year ended December 31, 2007, were 11.55% and 0.97%, respectively. These amounts compare with the ROE ratio of 15.59% and the ROA ratio of 1.23% for the year ended December 31, 2006. During the fourth quarter of 2007, the Company recorded an $11.6 million other-than-temporary impairment charge on two of its collateralized debt obligations. In addition, as a result of credit deterioration in certain of its construction loans, the Company recorded a $14.0 million provision for loan losses in the fourth quarter of 2007. The declines in the ratios are reflective of the growth rates of assets and equity that exceeded the growth in net income, primarily as a result of the Companys expansion and acquisitions that were consummated in the latter part of 2007 as well as a result of the CDO writedown and increase loan loss provisions recorded in the fourth quarter of 2007. The efficiency
ratio was 49.61% for the year ended December 31, 2007, compared with 49.32% for the same period in 2006. The higher efficiency ratio is reflective of the growth in noninterest expense that exceeded the growth in net interest income and noninterest income, resulting from the Companys expansion and acquisitions. Diluted earnings per share were $0.97 and $1.03 for the years ended December 31, 2007 and 2006, respectively.
Net Interest Income and Net Interest Margin. The increase in net interest income for the year ended December 31, 2007, compared to the same period in 2006 was principally due to a $2.02 billion increase in average interest-earning assets, which resulted primarily from organic loan growth along with the CAB acquisition. The average cost of deposits increased 36 basis points from 3.37% for the year ended December 31, 2006, to 3.73% for the year ended December 31, 2007, as a result of an increase in market interest rates during the past twelve months, the change in the composition of deposits and the procurement of certificates of deposit from brokers. These factors were partially offset by a 44 basis point increase in average loan yields reflecting the repricing of adjustable-rate loans as market interest rate indices rose during parts of 2007. The yield on taxable securities also increased for the year ended December 31, 2007, compared to the same period in 2006 as a result of purchases of higher-yielding securities during 2007.
The following table reflects the distribution of average assets, liabilities and stockholders equity, as well as the amounts of interest income and resultant yields earned from average interest-earning assets, and the amounts of interest expense and resultant rates paid on average interest-bearing liabilities for the years ended December 31, 2007 and 2006 (dollars in thousands):
The decline in the net interest margin for the year ended December 31, 2007, compared to same period in 2006 reflects the impact of increased costs of money market accounts and certificates of deposit resulting from higher market interest rates, the runoff of savings accounts due to the current market interest rates, the change in the composition of deposits and the procurement of costlier certificates of deposit from brokers, all of which were partially offset by higher loan yields.
The net interest margin, calculated on a tax equivalent basis, was 3.36% for the year ended December 31, 2007, as compared to 3.45% for 2006. Certain interest-earning assets of the Company qualify for federal tax exemptions or credits. The net interest margin, calculated on a tax equivalent basis, considers the tax benefit derived from these assets. The net interest margin decline reflects the impact of increased costs of money market accounts and certificates of deposit resulting from higher market interest rates, the change in the composition of deposits and the procurement of costlier certificates of deposit from brokers partially offset by higher loan yields, and decreases in interest rates causing deposits to reprice faster than loans.
Average interest-earning assets for the year ended December 31, 2007, increased 25.8% compared to the year ended December 31, 2006, primarily as a result of organic construction and business loan growth and the assets acquired from the CAB and BDB acquisitions. Average outstanding loans increased by $1.28 billion for the year ended December 31, 2007, from the year ended December 31, 2006, principally as a result of UCBs continued focus on commercial lending activities. Average commercial loan balances increased 24.8% compared to the corresponding period of 2006, primarily due to UCBs past emphasis on commercial real estate, continued emphasis on commercial business loans, expansion of its Hong Kong branch and from the CAB and BDB acquisitions. Average consumer loans for the year ended December 31, 2007, decreased $73.8 million, or 12.1%, compared to the same period in 2006. As of December 31, 2007, total loans represented 67.8% of total assets. New loan commitments of $4.12 billion for the year ended December 31, 2007, were comprised of $3.91 billion in commercial loan commitments and $201.8 million in consumer loan commitments.
Average investment and mortgage-backed securities for the year ended December 31, 2007, increased $510.9 million, or 33.6%, from the year ended December 31, 2006. In preparation for the closing of the acquisitions of Summit and The Chinese American Bank, the Company increased its securities portfolio in the fourth quarter of 2006. The Company experienced a reduction in the securities portfolio during the first and early second quarter of 2007 as Summit was integrated into UCB and as The Chinese American Bank acquisition closed. One of the Companys long-term goals is to reduce the investment and mortgage-backed securities portfolio to a range of 10% to 15% of total assets.
Average total deposits increased $1.17 billion, or 18.8%, for the year ended December 31, 2007, from the year ended December 31, 2006, reflecting UCBs ongoing focus on the generation of commercial and consumer demand deposits and from the CAB and BDB acquisitions. In addition, UCB also had $163.5 million in brokered deposits at December 31, 2007. Average interest-bearing deposits increased to $6.64 billion for the year ended December 31, 2007, up 16.7% from the year ended December 31, 2006, and average noninterest-bearing deposits increased to $767.6 million, up 40.9% for the year ended December 31, 2007, compared to the year ended December 31, 2006.
The changes in interest income and interest expense for the major categories of interest-earning assets and interest-bearing liabilities, and the amount of change that is attributable to volume and rate changes by comparing the years ended December 31, 2007 to 2006, are as follows (dollars in thousands):
Provision for Loan Losses. The provision for loan losses was $20.2 million for 2007, as compared to $3.8 million for 2006. Of the total 2007 provision, $14.0 million was recorded in the fourth quarter of 2007. While the Company is not directly involved in sub-prime lending activities, current economic pressures on housing and land values in certain California markets such as the Inland Empire, Central Valley and Sacramento area have impacted a certain segment of the overall loan portfolio. Approximately 10% of the loan portfolio is concentrated in these stressed California markets, and the Company has noted an increase in loan delinquencies and some migration to criticized credit categories that are predominately related to construction lending. Therefore, in the fourth quarter of 2007, the Company increased its specific valuation allowances by $4.4 million, and increased its economic surcharge factors by $4.3 million, which included $3.3 million specifically related to the construction portfolio. However, year over year changes in loss factors did not materially impact the provision for loan losses. The increase was the result of an increase in classified loans and specific reserves on impaired loans.
For the year ended December 31, 2007, net charge-offs were $9.26 million, a decrease of $0.96 million from the $10.22 million of net charge-offs for the year ended December 31, 2006. Net charge-offs as a percentage of average loans held in portfolio was 0.13% for the year ended December 31, 2007, as compared to 0.17% for the year ended December 31, 2006, a decrease of 4 basis points as compared to 2006. The provision for loan losses was $10.9 million greater than net charge-offs for the year December 31, 2007, which resulted in a corresponding increase in the Companys allowance for loan losses.
See Credit Risk Management for more information on how we determine the appropriate level for the allowances for loan losses and unfunded lending commitments.
Noninterest Income. Noninterest income decreased by $17.6 million, or 40.7%, for the year ended December 31, 2007, compared to the same period in 2006. Noninterest income in 2007 included an $11.6 million charge for realized losses on two of our REIT collateralized debt obligations. Noninterest income in 2006 included a $5.0 million acquisition termination fee from Great Eastern Bank and $1.6 million of interest income related to refunds from amended income tax returns. Commercial banking fees increased to $14.9 million for the year ended
December 31, 2007, compared to $12.0 million for the same period in 2006. The increase reflects the growth in trade finance activity, merchant card activity, other commercial banking fees and fees from UCB Investment Services, Inc. Gain on sale of multifamily and commercial real estate loans decreased to $5.7 million for the year ended December 31, 2007, from $17.8 million for the same period in 2006. The lower of cost or market adjustment related to loans held for sale reflects a $303,000 loss related to loans transferred from held for sale to held in portfolio for the year ended December 31, 2007, compared to a $76,000 recovery related to previously recognized write down of loans held for sale to market for the same period in 2006. Additionally, UCB had an increase for equity losses in other equity investments to $3.0 million for the year ended December 31, 2007, from $1.1 million for the same period in 2006.
Noninterest Expense. Noninterest expense increased $21.3 million, or 14.1%, for the year ended December 31, 2007, compared to the same period in 2006. For the year ended December 31, 2007, personnel expenses increased $9.4 million, or 10.6%, from the same period in 2006 due to additional staffing required to support the growth of UCBs commercial banking business, the opening of new branches, the additional staffing resulting from the Summit Bank, CAB and BDB acquisitions and the expansion of UCBs infrastructure to support a larger and growing organization. Occupancy expenses increased $5.0 million, or 31.0%, for the year ended December 31, 2007, compared to the same period in 2006 as a result of the opening of new branches and the operations of Summit Bank, CAB and BDB. Core deposit intangible amortization increased $2.2 million, or 85.0%, for the year ended December 31, 2007, compared to the same period in 2007 as a result of the additional amortization of the core deposit intangibles associated with the Summit Bank and CAB acquisitions. Other general and administrative expenses increased by $2.3 million, or 14.5%, for the year ended December 31, 2007, compared to the same period in 2006 primarily as a result of increased advertising expenses related to UCBs expansion, market promotions, merchant card expenses and foreign exchange losses.
Income Tax Expense. The effective tax rate for the year ended December 31, 2007, was 34.1% compared with 33.6% for the year ended December 31, 2006. The effective tax rate for the year ended December 31, 2006, reflects an income tax benefit of $4.0 million related to additional Enterprise Zone tax benefits realized in 2006. The effective tax rates are generally lower than the combined federal and state statutory rate of 42.0%, primarily due to federal and state tax credits and incentives, and tax-exempt income.
Currently, UCB comprises substantially all of the Companys operations. In addition, no portion of UCB meets the thresholds designated by generally accepted accounting principles for separate segment disclosures. As a result, the previous discussion of the results of operations and the subsequent balance sheet analyses are applicable to UCB as well as to the Company. See Note 32 to the Consolidated Financial Statements for additional information on the Companys segments.
BALANCE SHEET ANALYSIS
UCB maintains an investment and mortgage-backed securities portfolio (Investment Securities Portfolio) to provide both liquidity and to enhance the income of the organization. The Investment Securities Portfolio is comprised of two segments: Available for Sale (AFS) and Held to Maturity (HTM). UCBs AFS Investment Securities Portfolio is recorded at fair value, with unrealized changes in the fair value of the securities reflected as accumulated other comprehensive income (loss). At the end of each month, UCB adjusts the carrying value of its AFS Investment Securities Portfolio to reflect the current fair value of each security. The HTM Investment Securities Portfolio is carried at amortized cost. At the time a security is purchased, UCB classifies the security as either AFS or HTM. The securities are classified as HTM if UCB has the positive intent and ability to hold such securities to maturity.
UCBs Investment Securities Portfolio investments are governed by an Asset/Liability Policy (A/L Policy), which was approved by UCBs Board of Directors. The A/L Policy sets exposure limits for selected investments, as a function of total assets, total securities and Tier 1 capital, as well as the maximum maturity and duration limits. The A/L Policy also limits the concentration in a particular investment as a function of the total issue. Finally, the A/L Policy sets goals for each type of investment with respect to ROA, ROE and total risk-based capital ratio and also sets limits for interest rate sensitivity.
Investments permitted by the A/L Policy include United States Government obligations, United States Government sponsored enterprises securities, municipal obligations, investment grade securities, commercial paper, corporate debt and money market mutual funds. Other securities include residual interests in a CRE securitization, private-label residential mortgage-backed securities, collateralized debt obligations backed by trust preferred securities, collateralized loan obligation, FNMA and FHLMC preferred stock, and interest-only strips from SBA loans. UCBs Board of Directors has directed management to invest in securities with the objective of optimizing the yield on investments that appropriately balances the risk-based capital utilization and interest rate sensitivity. The A/L Policy requires that all securities be of investment grade at the time of purchase.
The amortized cost and market value of the Investment Securities Portfolio at December 31, 2008, 2007 and 2006, were as follows (dollars in thousands):
As of December 31, 2008, the amortized cost and the market value of the AFS Investment Securities Portfolio were $3.00 billion and $2.96 billion, respectively. The total net of tax unrealized loss on these securities was $21.7 million and is reflected as accumulated other comprehensive loss in stockholders equity. The difference between the carrying value and market value of securities that are held to maturity, aggregating a net gain of $3.8 million, has not been recognized in the financial statements as of December 31, 2008. Additionally, certain securities that UCB holds have unrealized losses that extend for periods in excess of twelve months. These securities are comprised primarily of CDOs, mortgage-backed securities and municipal securities. The unrealized losses associated with these securities are from changes in interest rates due to an increase in risk aversion subsequent to purchase. The unrealized losses would decline should the required yield or interest rates fall to the purchased yield and as the securities approach maturity. Investment securities available for sale with unrealized losses were determined not to be other-than-temporary impaired due to indicators associated with these securities that the Company evaluated. Indicators that the Company evaluated for these securities include the amount of decline in market value below the amount recorded for these securities and the severity of the decline. Other factors that were considered in determining whether these securities were not other- than-temporary impaired include the length of time to which the market value has been less than the book value, any recent events specific to the issuer, the economic conditions of its industry, review of the collateral associated with the securities, and the Companys intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery. Also, in the pricing of investments using the Companys internal model, the Company stress tested cash flows in each scenario.
CDOs with an amortized cost basis of $15.3 million and carrying value of $12.6 million at December 31, 2008, include securities backed by REIT TPS and pooled bank TPS which are included in our available for sale securities. The unrealized losses on these securities have occurred as a result of rising defaults and delinquencies in the subprime residential mortgage markets, coupled with rating agency downgrades of a large number of subprime
residential mortgage-backed securities, which in turn led to continued credit spread widening and ultimately resulted in declines in the valuations of these types of securities and certain indices that serve as a reference point for determining the fair value of such securities. The carrying value at December 31, 2008, reflects the cumulative $15.9 million other-than-temporary impairment charges that we recognized on our pooled bank TPS CDOs and which have been reflected in our results of operations for the year ended December 31, 2008. At December 31, 2007, the carrying value reflected an $11.6 million other-than-temporary impairment charge that we recognized on two REIT TPS CDOs.
Mortgage-backed securities consist primarily of securities guaranteed by FNMA, the Government National Mortgage Association (GNMA) and the Federal Home Loan Mortgage Corporation (FHLMC), as well as certain collateralized mortgage obligations. These securities are collateralized by residential mortgage loans and may be prepaid at par prior to maturity. The unrealized losses on our mortgage-backed securities resulted primarily from changes in interest rates due to an increase in risk aversion subsequent to purchase. The unrealized losses will decline as the required yield fall to the purchased yield and as the securities approach contractual or expected maturity.
The municipal securities are issued by states and their political subdivisions in the U.S. These securities predominantly have ratings of AAA, AA, or A. These securities either have bond insurance or guarantees that originally supported investment grade ratings of AAA or AA. With the recent Nationally Recognized Statistical Rating Organization (NRSRO) downgrades of monoline insurers, we have seen the ratings of our municipal bonds decline, but in no case are the bonds rated below BBB, although some are unrated. Nevertheless, in managements opinion there have not been any material deteriorations of the underlying municipal credit quality that would contribute to other-than-temporary impairment. The unrealized losses on our municipal securities resulted primarily from the lack of market liquidity in the third and fourth quarter, changes in interest rates due to an increase in risk aversion subsequent to purchase and to a lesser extent the uncertainty surrounding the monoline insurers. We expect that the unrealized losses will decline as interest rates fall to the purchased yield and as the securities approach contractual or expected maturity.
On a quarterly basis, the Company makes an assessment to determine whether there has been any credit or economic events to indicate that a security with an unrealized loss in the Companys investment portfolio is impaired on an other-than-temporary basis. The Company considers many factors including the severity and duration of the impairment, the intent and ability for the Company to hold the debt security for a period of time sufficient for a recovery in value, recent downgrades in external credit ratings and other current events specific to the issuer or industry.
Monoline insurers provide credit enhancement to capital market transactions. The current economic and credit market environment has severely affected the financial strength of some of these financial guarantors. The Companys exposure to monoline insurers is limited to municipal bonds that are insured by monolines and the senior commercial mortgage backed securities (CMBS) bond from our 2007 commercial real estate loan securitization. At December 31, 2008, municipal bonds insured by monolines had an amortized cost of approximately $383.9 million and the senior CMBS bond had an amortized cost of $308.3 million. There were no losses related to these exposures that needed to be reflected in the results for year ended December 31, 2008. Furthermore, the monoline insurer for the senior CMBS bond was AAA-rated by Standard & Poors and Aa2-rated by Moodys as of December 31, 2008.