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UCBH Holdings 10-Q 2007 Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
For the quarterly period ended September 30, 2007.
OR
For the transition period from to
.
Commission File Number: 000-24947
UCBH HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
Registrant’s telephone number, including area code: (415) 315-2800
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 whether the registrant is a large accelerated filer, an accelerated filer,
or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in
Rule 12b-2 of the Exchange Act. (Check One):
Large accelerated filer þ Accelerated filer o
Non-accelerated filer o
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
As of October 31, 2007, the Registrant had 104,362,428 shares of common stock, par value $0.01 per
share, outstanding.
UCBH HOLDINGS, INC. AND SUBSIDIARIES
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PART I — FINANCIAL INFORMATION
Item 1. Financial Statements
UCBH HOLDINGS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets (Dollars in Thousands, Except Share and Par Value Amounts) (Unaudited)
See accompanying notes to consolidated financial statements.
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UCBH HOLDINGS, INC. AND SUBSIDIARIES
Consolidated Statements of Operations (Dollars in Thousands, Except Per Share Amounts) (Unaudited)
See accompanying notes to consolidated financial statements.
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UCBH HOLDINGS, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income (Dollars in Thousands, Except Share and Per Share Amounts) (Unaudited)
See accompanying notes to consolidated financial statements.
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UCBH HOLDINGS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Dollars in Thousands) (Unaudited)
See accompanying notes to consolidated financial statements.
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UCBH HOLDINGS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited)
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UCBH HOLDINGS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements-Continued (Unaudited)
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UCBH HOLDINGS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements-Continued (Unaudited)
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UCBH HOLDINGS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements-Continued (Unaudited)
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UCBH HOLDINGS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements-Continued (Unaudited)
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UCBH HOLDINGS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements-Continued (Unaudited)
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UCBH HOLDINGS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements-Continued (Unaudited)
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UCBH HOLDINGS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements-Continued (Unaudited)
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UCBH HOLDINGS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements-Continued (Unaudited)
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UCBH HOLDINGS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements-Continued (Unaudited)
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UCBH HOLDINGS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements-Continued (Unaudited)
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UCBH HOLDINGS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements-Continued (Unaudited)
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UCBH HOLDINGS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements-Continued (Unaudited)
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UCBH HOLDINGS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements-Continued (Unaudited)
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UCBH HOLDINGS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements-Continued (Unaudited)
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UCBH HOLDINGS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements-Continued (Unaudited)
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UCBH HOLDINGS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements-Continued (Unaudited)
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
FORWARD LOOKING STATEMENTS
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 management’s current beliefs and expectations and
are not guarantees of future performance, nor should they be relied upon as representing
management’s 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 management’s 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:
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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 Company’s 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.
MANAGEMENT OVERVIEW
UCBH Holdings, Inc. (“UCBH”) and its consolidated subsidiaries (collectively referred to as the
“Company”, “we”, “us” or “our”) is a bank holding company headquartered in San Francisco,
California with total assets of $11.08 billion. The Company’s operations are conducted primarily
through its banking subsidiary, United Commercial Bank (“UCB”). UCB operates through seventy-four
offices and branches in the United States and Asia and is a leader in providing financial services
to Asians in the United States. At September 30, 2007, we had seventy 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, eight in the New York metropolitan area,
two in the Seattle metropolitan area and a branch in Houston. UCB also has a branch in Hong Kong
and representative offices in Shanghai and Shenzhen, China; and Taipei, Taiwan.
The Company’s primary or “core” business consists of providing commercial and retail banking
services to both individuals and companies in markets with high concentration of Asians. We
believe that this core banking business performed well during the nine months ended September 30,
2007 as the general economic environment in these markets has improved. However, the challenges
presented by the general interest rate environment that we must work within did impact the
Company’s performance during the nine months ended September 30, 2007.
The Company reported earnings for the three months ended September 30, 2007, of $30.8 million or
$0.29 per diluted share. This compares with $25.6 million or $0.26 per diluted share for the three
months ended September 30, 2006, and $28.2 million or $0.27 per diluted share for the three months
ended June 30, 2007. Return on average equity (“ROE”) was 13.37% and return on average assets
(“ROA”) was 1.15% for the three months ended September 30, 2007, compared with a ROE of 15.51% and
ROA of 1.24% for the three months ended September 30, 2006, and a ROE of 12.90% and a ROA of 1.10%
for the three months ended June 30, 2007.
CORPORATE DEVELOPMENTS
Acquisition of CAB Holding, LLC. UCBH and CAB Holding, LLC (“CAB”), the holding company of The
Chinese American Bank, a New York state-chartered bank, entered into an Agreement and Plan of
Merger dated as of January 10, 2007. On May 23, 2007, UCBH completed its acquisition of CAB for a
total consideration of approximately $132.6 million consisting of 3,711,580 shares of UCBH’s common
stock valued at $66.1 million and $66.5 million in cash, which includes direct acquisition costs of
$1.5 million. The results of CAB’s operations have been included in the consolidated financial
statements since that date.
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The purchase price, including direct acquisition costs, has been allocated to the assets acquired
and liabilities assumed based on fair values at the acquisition date. The allocation of purchase
price at the date of acquisition was as follows (dollars in thousands):
The purchase price allocation reflected above is preliminary and subject to final determination of
valuation of the fair value of assets acquired and liabilities assumed. The Company expects to
finalize the valuation in the fourth quarter of 2007 and does not expect this to have a material
impact on the Company’s financial position or results of operations.
Acquisition of Business Development Bank Ltd. On March 26, 2007, UCB entered into two agreements
to purchase the Business Development Bank Ltd. (“BDB”), a wholly foreign owned enterprise
established and existing under the laws of the People’s Republic of China, for a total
consideration of $205.0 million in cash. The parties to the agreements may terminate the
transaction for various reasons prior to the consummation of the acquisition. This acquisition
will provide the Company with bank branches in Shanghai and Shantou, China and representative
offices in Beijing and Guangzhou, China, which in turn will accelerate the implementation of the
Company’s Greater China expansion strategy. The transaction is subject to both U.S. regulatory and
China Banking Regulatory Commission approvals and is anticipated to close in the fourth quarter of
2007. BDB had total assets of $242.8 million, total loans of $214.2 million and total deposits of
$20.1 million at September 31, 2007.
Investment Agreement with China Minsheng Banking Corp., Ltd. On October 7, 2007, UCBH and China
Minsheng Banking Corp., Ltd., a Chinese joint stock commercial bank (“Minsheng”), entered into an
Investment Agreement (the “Investment Agreement”), pursuant to which Minsheng will acquire 9.9% of
shares of UCBH common stock in two phases, with a mutual option to increase Minsheng ownership to
20.0%.
In the first phase, which is anticipated to close in the fourth quarter of 2007, UCBH will issue
approximately 5.4 million shares of its common stock to Minsheng at a price per share of $17.79,
representing the 90-day average UCBH closing price as of the close on September 30, 2007. In the
second phase, which is anticipated to close in 2008, Minsheng will increase its ownership to 9.9%
(calculated on a post closing basis) through, at the discretion of UCBH, a combination of the
purchase of secondary shares and/or the issuance of primary shares. By June 30, 2009, conditioned
upon mutual agreement and regulatory approvals, Minsheng may increase its share ownership to 20.0%
(calculated on a post closing basis) through, at the discretion of UCBH, a combination of the
purchase of secondary shares and/or the issuance of primary shares.
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CRITICAL ACCOUNTING POLICIES AND SIGNIFICANT ESTIMATES
Other than as discussed below, the Company has made no significant changes in its critical
accounting policies and significant estimates from those disclosed in its Annual Report on Form
10-K for the fiscal year ended December 31, 2006.
Allowance for Loan Losses
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 September 30, 2007, UCB’s total allowance for loan losses was $68.5 million, which
represented 0.89% of loans held in portfolio.
UCB’s 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).
UCB’s 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. 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. UCB’s 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. The quantitative 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.
UCB regularly assesses the loss factors that are applied to loan portfolio categories on a
quarterly basis, and as part of the assessment concluded during the nine months ended September 30,
2007, UCB effected further refinements in the determination of certain loss factors. In addition,
UCB performs its annual allowance methodology review during the second quarter of each year. 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 expected loss approach.
The factor refinement in the third quarter 2007 included the effects of both the regular quarterly
qualitative factor assessment and the completion of the annual allowance methodology review during
the second quarter of 2007, which resulted in a revision and net reduction of the loss factors
applicable to various pass rated portfolio segments.
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 loan’s
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 loan’s 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.
During the nine months ended September 30, 2007, the allowance for loan losses increased $6.5
million from the balance at December 31, 2006. The increase is due to $3.8 million of allowance
for loan losses acquired in connection with the purchase of The Chinese American Bank, an increase
in specific valuation allowances
associated with impaired loans, and growth in the Company’s loan portfolio. These increases were
offset by a $6.4 million reduction from changes in loss factors and a $5.4 million reduction
attributable to net loan charge-offs.
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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 statement of financial position.
The reserve for unfunded commitments, which is included in other liabilities on the balance sheet,
decreased $1.9 million from December 31, 2006. The decrease was primarily a result of the change in
the loss factor of $3.7 million.
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 UCB’s estimates and projections
could require an additional allowance for loan losses, which would negatively impact the Company’s
results of operations in future periods. UCB continually monitors and evaluates its allowance for
loan losses methodology, seeking to refine and enhance the processes used to estimate incurred
losses in our loan portfolios as appropriate.
Income Taxes
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 Company’s 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 assumption 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 in future periods.
The Company adopted the provisions of FIN 48 effective January 1, 2007. See management’s discussion
over “recent accounting pronouncements” for management’s evaluation of FIN 48.
Recent Accounting Pronouncements
Fair Value Option for Financial Assets and Financial Liabilities
In February 2007, the Financial Accounting Standards Board (the “FASB”) issued SFAS No. 159, The
Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB
Statement No. 115. SFAS No. 159 provides entities with an option to report selected financial
assets and liabilities at fair value. Unrealized gains and losses on items for which the fair
value option has been elected are reported in earnings. SFAS No. 159 is effective for fiscal years
beginning after November 15, 2007. The Company will adopt SFAS No. 159 effective January 1, 2008.
In connection therewith, management of the Company does not expect the adoption of SFAS No. 159 to
have a material impact on the Company’s financial position or results of operations.
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Fair Value Measurements
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS No. 157 defines
fair value, establishes a framework for measuring fair value and expands disclosures about fair
value measurements. SFAS No. 157 clarifies the principle that fair value should be based on the
assumptions market participants would use when pricing an asset or liability and establishes a fair
value hierarchy that prioritizes the information used to develop those assumptions. Under the
standard, fair value measurements would be separately disclosed by level within the fair value
hierarchy. SFAS No. 157 is effective for financial statements issued for fiscal years beginning
after November 15, 2007, and interim periods within those fiscal years. The Company will adopt
SFAS. No 157 effective January 1, 2008. In connection therewith, management of the Company does not
expect the adoption of SFAS No. 157 to have a material impact on the Company’s financial position
or results of operations. The Company is, however, in the process of evaluating the various
valuation models and methodologies that the Company will need to implement, in order to comply with
the disclosure requirements of SFAS No. 157.
Accounting for Uncertainty in Income Taxes
In July 2006, the FASB issued FIN 48, Accounting for Uncertainty in Income Taxes, an interpretation
of FASB Statement No. 109. FIN 48 clarifies the accounting for income tax uncertainties that have
been recognized in an enterprise’s financial statements in accordance with SFAS No. 109, Accounting
for Income Taxes. FIN 48 prescribes a recognition threshold and measurement attribute for the
financial statement recognition and measurement of a tax position taken or expected to be taken in
a tax return. FIN 48 requires that the Company recognize in the financial statements the impact of
a tax position, if that position is more likely than not of being sustained on audit, based on the
technical merits of the position. FIN 48 also provides additional guidance on accounting for tax
uncertainties, including derecognition, classification, interest and penalties, accounting in
interim periods, disclosure and transition. The provisions of FIN 48 are effective for fiscal
years beginning after December 15, 2006, with the cumulative effect of the change in accounting
principle recorded as an adjustment to opening retained earnings. The Company adopted the
provisions of FIN 48 effective January 1, 2007. The impact of adopting FIN 48 resulted in a
cumulative effect adjustment of $3.0 million with a $2.6 million decrease in goodwill, and an
offsetting $2.6 million decrease in current taxes payable. There were no cumulative effect
adjustments to the Company’s opening retained earnings as of January 1, 2007. Additionally, in
connection with the adoption of FIN 48, the Company will continue to classify interest and
penalties related to unrecognized tax positions as components of interest expense.
Accounting for Servicing of Financial Assets
In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets, an
amendment of FASB Statement No. 140. SFAS No. 156 permits entities to choose either to measure
servicing rights subsequent to initial valuation at fair value and report changes in fair value in
earnings or to amortize the servicing rights in proportion to and over the estimated net servicing
income or loss and assess the servicing rights for impairment or the need for an increased
obligation. SFAS No. 156 also clarifies when a servicer should separately recognize servicing
assets and liabilities, requires that all separately recognized assets and liabilities be initially
measured at fair value, if practicable, permits a one-time reclassification of available for sales
securities to trading securities by an entity with recognized servicing rights and requires
additional disclosures for all separately recognized servicing assets and liabilities. SFAS No.
156 is effective as of the beginning of an entity’s fiscal year that begins after September 15,
2006. In accordance with SFAS No. 156, the Company has initially measured mortgage servicing
rights at fair value and will continue to subsequently amortize its mortgage servicing rights based
on estimated future net servicing income, with quarterly assessments for impairment. The Company
adopted the provisions of SFAS No. 156 effective January 1, 2007. The adoption did not have a
material impact on the Company’s financial position or results of operations.
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Accounting for Certain Hybrid Financial Instruments
In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial
Instruments, an amendment of FASB Statements No. 133 and 140. SFAS No. 155 permits fair value
remeasurement for any hybrid financial instrument that contains an embedded derivative that
otherwise would require bifurcation; clarifies which interest-only strips and principal-only strips
are not subject to the requirements of SFAS No. 133; establishes a requirement to evaluate
interests in securitized financial assets to identify interests that are freestanding derivatives
or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation;
clarifies that concentrations of credit risk in the form of subordination are not embedded
derivatives; and amends SFAS No. 140 to eliminate the prohibition on a qualifying special-purpose
entity from holding a derivative financial instrument that pertains to a beneficial interest other
than another derivative financial instrument. The new standard is effective for all financial
instruments acquired or issued after the beginning of the Company’s first fiscal year that begins
after September 15, 2006. The adoption of SFAS No. 155 did not have a material impact on the
Company’s financial position or results of operations.
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RESULTS OF OPERATIONS
Financial Highlights (Dollars in Thousands, Except Per Share Amounts)
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Three Months Ended September 30, 2007, Compared to Three Months Ended September 30, 2006
The consolidated net income of the Company for the three months ended September 30, 2007, increased
by $5.3 million, or 20.5%, to $30.8 million, compared to $25.6 million for the same period in 2006.
The annualized ROE and ROA ratios for the three months ended September 30, 2007, were 13.37% and
1.15%, respectively. These amounts compare with the ROE ratio of 15.51% and the ROA ratio of 1.24%
for the three months ended September 30, 2006. 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 Company’s expansion and the Summit Bank Corporation (“Summit”) and CAB Acquisitions that were
consummated on December 29, 2006, and May 23, 2007, respectively. The efficiency ratio was 45.99%
for the three months ended September 30, 2007, compared with 48.54% for the same period in 2006.
The decrease in the efficiency ratio is reflective of the growth in net interest income that
exceeded the growth in noninterest expense, resulting from the increase in average interest-earning
assets. Diluted earnings per share were $0.29 and $0.26 for the three months ended September 30,
2007 and 2006, respectively.
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Net Interest Income and Net Interest Margin. 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 three months ended
September 30, 2007 and 2006 (dollars in thousands):
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The increase in net interest income for the three months ended September 30, 2007, compared to the
same period in 2006 was principally due to a $2.10 billion increase in average interest-earning
assets, which resulted primarily from organic loan growth along with increases resulting from the
Summit and CAB acquisitions. The average cost of deposits increased 21 basis points from 3.59% for
the three months ended September 30, 2006, to 3.80% for the three months ended September 30, 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 38 basis point increase in average loan yields reflecting the
timing of the repricing of adjustable-rate loans, as well as the continued change in our loan
portfolio mix. The yield on taxable securities also increased for the three months ended September
30, 2007, compared to the same period in 2006 as a result of purchases of higher-yielding
securities during 2007.
The net interest margin of 3.44%, on a tax equivalent basis, for the three months ended September
30, 2007, remained consistent at 3.43% with the three months ended September 30, 2006.
Provision for Loan Losses. The provision for loan losses for the three months ended
September 30, 2007 is reflective of loan growth, changes in the mix of the loan portfolio,
reductions in certain historical and qualitative loss factors, increases in specific reserves and
in classified loans, and charge-offs, all of which combined resulted in a net increase in the
provision as compared with 2006. 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 $146,000, or 1.3%, to $10.8 million
for the quarter ended September 30, 2007, compared with $11.0 million for the corresponding quarter
of 2006. The decrease reflected a reduction in gain on sale of loans and a higher equity loss in
other equity investments, largely offset by an increase in commercial banking fees and service
charges on deposits. The reduction in the gain on sale of loans of $3.5 million, or 59.7%,
reflected the planned decrease in volume of loan sales in the third quarter of 2007. UCB had an
increase of equity losses in other equity investments to $900,000 for the three months ended
September 30, 2007, from $253,000 for the same period in 2006, primarily attributable to equity
losses from the Community Reinvestment Act (“CRA”) qualified investments. UCB increased its
commercial banking fees to $5.2 million for the three months ended September 30, 2007, compared to
$3.7 million for the same period in 2006. The $1.5 million increase in commercial banking fees
reflects the increased activities in the trade finance, consumer loan portfolios and fee based
products. Service charges on deposits increased to $1.8 million for the three months ended
September 30, 2007, compared to $1.0 million for the same period in 2006.
Noninterest Expense. Noninterest expense increased $6.2 million, or 16.5%, for the three
months ended September 30, 2007, compared to the same period in 2006. For the three months ended
September 30, 2007, personnel expenses increased $4.5 million, or 22.6%. The increase in personnel
expenses reflects the additional staffing required to support the growth of UCB’s commercial
banking business, the opening of new branches earlier during the year, the additional staffing
resulting from the Summit and CAB acquisitions and the expansion of UCB’s infrastructure to support
a larger and growing organization. Personnel expenses also included $933,000 in stock compensation
expense for the three months ended September 30, 2007, compared to $642,000 for the same period in
2006. Occupancy expenses increased $1.1 million, or 25.2%, for the three months ended September 30,
2007, compared to the same period in 2006 as a result of the opening of new branches and the
acquisition of Summit in December, 2006 and the CAB acquisition in May 2007. Core deposit
intangible amortization increased $250,000, or 37.4%, for the three months ended September 30,
2007, compared to the same period in 2006 as a result of the additional amortization of the core
deposit intangibles associated with the Summit and CAB acquisitions.
Income Tax Expense. The effective tax rate for the three months ended September 30, 2007,
was 36.0%, compared with 34.0% for the three months ended September 30, 2006. The reduced tax rate
in 2006 reflects the utilization of Enterprise Zone tax credits. 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, tax-exempt income, and the net impact of our
operating in multiple tax jurisdictions, both within and outside of the United States of America.
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Nine Months Ended September 30, 2007, Compared to Nine Months Ended September 30, 2006
The consolidated net income of the Company for the nine months ended September 30, 2007, increased
by $11.7 million, or 15.7%, to $86.1 million, compared to $74.4 million for the same period in
2006. The annualized ROE and ROA ratios for the nine months ended September 30, 2007, were 13.30%
and 1.11%, respectively. These amounts compare with the ROE ratio of 15.68% and the ROA ratio of
1.22% for the nine months ended September 30, 2006. 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 Company’s expansion and the Summit acquisition that was consummated on December 29, 2006 and
the CAB acquisition on May 23, 2007. The efficiency ratio was 48.31% for the nine months ended
September 30, 2007, compared with 50.36% for the same period in 2006. The decrease in the
efficiency ratio is reflective of the growth in net interest income that exceeded the growth in
noninterest expense, resulting from the increase in average interest-earning assets. Diluted
earnings per share were $0.82 for the nine months ended September 30, 2007, compared with $0.76 for
the same period in 2006.
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Net Interest Income and Net Interest Margin. 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 nine months ended
September 30, 2007 and 2006 (dollars in thousands):
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The increase in net interest income for the first nine months of 2007 compared to 2006 was
principally due to a $1.91 billion increase in average interest-earning assets, which resulted
primarily from organic loan growth and the previously discussed Summit and CAB acquisitions. The
average cost of deposits increased 52 basis points from 3.24% for the nine months ended September
30, 2006, to 3.76% for the nine months ended September 30, 2007, as a result of an increase in
market interest rates during the past twelve months and the change in the composition of deposits.
These factors were partially offset by a 57 basis point increase in average loan yields reflecting
the timing of the repricing of adjustable-rate loans, as well as the continued change in our loan
portfolio mix. The yield on taxable securities yield also increased in the first nine months of
2007 compared to the first nine months of 2006 as a result of the purchase of higher-yielding
securities during 2007.
The decline in the net interest margin for the first nine months of 2007 compared to the first nine
months of 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.
Provision for Loan Losses. The provision for loan losses for 2007 is reflective of loan
growth, changes in the mix of the loan portfolio, reductions in certain historical and qualitative
loss factors, increases in specific reserves and in classified loans, and charge-offs, all of which
together resulted in a net increase in the provision as compared with 2006. 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 $2.0 million, or 5.6%, for the nine
months ended September 30, 2007, compared to the nine months ended September 30, 2006. Additional
explanations of variances follow.
Commercial banking fees increased to $15.1 million for the nine months ended September 30, 2007,
compared to $11.2 million for the same period in 2006, a 35.3% increase. The increase reflects the
growth in trade finance activity, other commercial banking fees and increase in fees from UCB
Investment Services, Inc. Gain on sale of securities increased to $3.8 million for the nine months
ended September 30, 2007, from $206,000 for the same period of 2006. Additionally, UCB had an
increase in equity losses in other equity investments to $2.2 million for the nine months ended
September 30, 2007 from $761,000 for the same period in 2006 primarily attributable to CRA
qualified investments. Also, noninterest income for the nine months ended September 30, 2006
included the $5.0 million acquisition termination fee from Great Eastern Bank received in the first
quarter of 2006.
Noninterest Expense. Noninterest expense increased $13.0 million, or 11.1%, for the nine
months ended September 30, 2007, compared to the nine months ended September 30, 2006.
Explanations previously provided for the quarterly changes also apply to the year-to-date changes.
Additional explanations of variances follow.
For the nine months ended September 30, 2007, occupancy expenses increased $3.7 million or 31.5%
related to the acquisitions of Summit in December 2006 and CAB in May 2007. Core deposit
intangible amortization increased $1.6 million, or 96.5%, for the nine months ended September 30,
2007 compared to the same period in 2006 as a result of the additional amortization of the deposit
intangibles primarily associated with the Summit and CAB acquisitions. Other general and
administrative expenses increased by $2.0 million, or 12.8%, for the nine months ended September
30, 2007 compared to the same period in 2006 primarily as a result of increased merchant card
expenses, foreign exchange losses, marketing related expenses and bank service fees.
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Income Tax Expense. The effective tax rate for the nine months ended September 30, 2007,
was 35.4%, compared with 34.2% for the nine months ended September 30, 2006. The reduced tax rate
in 2006 reflects the utilization of Enterprise Zone tax credits. 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, tax-exempt income, and the net impact of our
operating in multiple tax jurisdictions, both within and outside of the United States.
BALANCE SHEET ANALYSIS
Investment Securities
At the end of each month, UCB adjusts the carrying value of its Available for Sale (“AFS”)
Investment Securities Portfolio to reflect the current fair value of each security. The Held to
Maturity (“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 management has the positive intent and ability to hold such securities to
maturity.
The amortized cost and approximate market value of investment and mortgage-backed securities
classified as AFS and HTM, along with the portions of the portfolio with unrealized loss positions
at September 30, 2007, were as follows (dollars in thousands):
The investment portfolio decreased by $673.0 million from December 31, 2006. This decrease is
primarily due to the sale and maturity of securities available for sale.
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As of September 30, 2007, the amortized cost and the market value of the available for sale
investment securities portfolio were $1.53 billion and $1.49 billion, respectively. The total net
of tax unrealized loss on these securities
was $19.2 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 unrealized gain of $2.6 million, has not been recognized in the
financial statements as of September 30, 2007. Additionally, certain securities that UCB holds
have unrealized losses that extend for periods in excess of twelve months. These securities are
comprised primarily of U.S. Government sponsored enterprise notes, mortgage-backed securities and
municipal securities. The U.S. Government sponsored enterprise notes are issued by one of the
several government sponsored enterprises, such as FNMA, Government National Mortgage Association
(“GNMA”) or Federal Home Loan Bank. The unrealized losses associated with these securities
resulted from rising interest rates subsequent to purchase. The unrealized losses will decline as
interest rates fall to the purchased yield and as the securities approach maturity. Management does
not believe that there have been any deteriorations of credit quality that would contribute to any
impairment of these securities.
The amortized cost and approximate market value of investment and mortgage-backed securities
classified as available for sale and held to maturity, along with the portions of the portfolio
with unrealized loss positions at December 31, 2006, were as follows (dollars in thousands):
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Loans
The components of UCB’s loans held in portfolio for each major loan category at September 30, 2007,
and December 31, 2006, were as follows (dollars in thousands):
During the nine months ended September 30, 2007, loans held in portfolio increased by $1.06
billion. This increase resulted primarily from organic growth in commercial loans and loans
resulting from the CAB acquisition, which were offset by a transfer of commercial real estate loans
of $137.3 million from held in portfolio to held for sale. Commercial loans at September 30, 2007,
increased 16.4% from the December 31, 2006, balance. Consumer loans increased 11.66% at September
30, 2007, from the December 31, 2006, balance.
At September 30, 2007, and December 31, 2006, UCB had cash secured loans of $254.7 million and
$292.0 million, respectively, which were primarily commercial business loans.
UCB continues to earmark certain SBA loans as held for sale. Although UCB has the intent and
ability to hold commercial real estate loans for the foreseeable future or until maturity or
pay-off, UCB will periodically sell certain commercial real estate loans from held in portfolio, in
order to manage its loan concentration. When a determination is made to sell loans, such loans are
classified as held for sale. During the nine months ended September 30, 2007, UCB transferred
$159.2 million of loans from held in portfolio to held for sale. UCB also transferred at the lower
of cost or market value, $56.7 million of loans that did not attract a potential buyer or meet our
pricing requirements from held for sale to held in portfolio during the nine months ended September
30, 2007. The loans held for sale for each major loan category at September 30, 2007, and
December 31, 2006, were as follows (dollars in thousands):
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Consistent with UCB’s stated long-term objectives, UCB will continue to systematically reduce its
concentration in commercial real estate loans while increasing its concentration in commercial
business loans.
Loan commitments related to loans held for sale and held in portfolio for the three and nine months
ended September 30, 2007 and 2006, were as follows (dollars in thousands):
As a result of changing the loan origination focus to commercial business loans, UCB is originating
more loans that reprice in shorter periods. Construction loans, commercial business loans and SBA
loans generally have monthly repricing terms. Commercial real estate loans generally reprice
monthly or are intermediate fixed, meaning that the loans have interest rates that are fixed for a
period, typically five years, after which the loans generally reprice monthly or become due and
payable. Multifamily real estate loans are generally intermediate fixed. Residential mortgage
(one-to-four family) loans may be adjustable rate that reprice semiannually or annually; fixed
rate, meaning that the loans have interest rates that are fixed over the term of the loans,
typically 15 or 30 years; or have interest rates that are fixed for a period, typically five years,
and then generally reprice semiannually or annually,
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thereafter. The components of gross loans held in portfolio by interest type for each major loan
category at September 30, 2007, were as follows (dollars in thousands):
Adjustable-rate loans increased $617.6 million from December 31, 2006, to September 30, 2007.
Intermediate fixed-rate loans increased $64.2 million from December 31, 2006, to September 30,
2007. Fixed-rate loans increased $377.0 million from December 31, 2006, to September 30, 2007.
Deposits
The balances and rates paid for categories of deposits at September 30, 2007, and December 31,
2006, were as follows (dollars in thousands):
Deposits have traditionally been UCB’s primary source of funding to use in its lending and
investment activities. At September 30, 2007, 55.88% of UCB’s deposits were time deposits, 31.41%
were negotiable order of withdrawal (“NOW”) accounts, demand deposits and money market accounts,
and 12.71% were savings accounts. By comparison, at December 31, 2006, 56.45% of UCB’s deposits
were time deposits, 30.46% were NOW accounts, demand deposits and money market accounts, and 13.09%
were savings accounts. With the exception of state and federal government entities contributing
6.0% and 6.4% to total deposits as of September 30, 2007, and December 31, 2006, respectively, no
other material portion of UCB’s deposits were from or were dependent upon any one customer, source
or industry. State of California certificates of deposits are collateralized by certain investment
securities of UCB.
Included in time deposits at September 30, 2007, are $2.87 billion of deposits of $100,000 or
greater, compared to $2.66 billion at December 31, 2006. Such deposits made up 36.91% of total
deposits at September 30, 2007, compared to 36.87% at December 31, 2006. Also included in time
deposits are $186.9 million and $179.3 million of brokered deposits at September 30, 2007, and
December 31, 2006, respectively.
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Borrowings
Borrowings as of and for the nine months ended September 30, 2007, and the year ended December 31,
2006, were as follows (dollars in thousands):
Securities sold under agreements to repurchase are recorded net of certain reverse repurchase
agreements. FIN 41, Offsetting of Amounts Related to Certain Repurchase and Reverse Repurchase
Agreements—an interpretation of APB Opinion No. 10 and a modification of FASB Interpretation No.
39, allows for the netting of repurchase agreements and reverse repurchase agreements if certain
conditions are met. These conditions were met for two reverse repurchase agreements totaling $100.0
million as of September 30, 2007.
UCB maintains a secured credit facility with the FHLB of San Francisco, Seattle and Boston
(collectively referred to as “FHLB”) against which UCB may take advances. The terms of this credit
facility requires UCB to maintain in safekeeping with the FHLB eligible collateral of at least 100%
of outstanding advances. Short-term borrowings with the FHLB totaled $90.0 million at September 30,
2007, and $534.2 million at December 31, 2006. At September 30, 2007, the advances were secured
with $18.2 million of securities and $4.16 billion of loans, and at December 31, 2006, $41.6
million of securities and $3.34 billion of loans secured the advances. At September 30, 2007,
credit availability under this facility was approximately $1.37 billion.
Subordinated Debentures
UCBH formed or acquired special purpose trusts in 1997, 2001, 2002, 2005, 2006, and 2007 for the
purpose of issuing guaranteed preferred beneficial interests in its junior subordinated debentures
(the “Capital Securities”) and investing the proceeds thereof in the junior subordinated debentures
issued by UCBH. Payment of distributions out of the monies held by the trusts and payments on
liquidation of the trusts or the redemption of the Capital Securities are guaranteed by UCBH to the
extent the trusts have funds available. The obligations of UCBH under the guarantees and the
junior subordinated debentures are subordinate and junior in right of payment to all indebtedness
of UCBH and will be structurally subordinated to all liabilities and obligations of UCBH’s
subsidiaries. UCBH had
$406.6 million and $240.5 million of subordinated debentures outstanding at September 30, 2007, and
December 31, 2006, respectively.
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On September 28, 2007, UCB issued $75.0 million aggregate principal amount of subordinated
debentures due September 30, 2017. The purchase agreement is dated as of September 28, 2007 and is
made between United Commercial Bank, as borrower, and USB Capital Funding Corp., as lender. The
subordinated debentures bear interest at a variable rate per annum equal to the 3-month LIBOR plus
1.50%. The Subordinated Debt is intended to qualify as Tier 2 capital under applicable rules and
regulations promulgated by the State of California and the FDIC.
Junior Subordinated Debentures
On June 21, 2007, UCB issued $50.0 million aggregate principal amount of junior subordinated
debentures due September 15, 2022. The debentures were issued pursuant to Floating Rate Junior
Subordinated Debentures (the Debentures), dated June 21, 2007 between UCB, as issuer, and
Wilmington Trust Company, as Trustee. The Debentures bear interest at a variable rate per annum
equal to the 3-month LIBOR plus 1.34%.
Under applicable regulatory guidelines, the Debentures qualify as Tier 2 capital. The Debentures
have not been registered under the Securities Act of 1933, as amended (the “Securities Act”). The
Debentures are subordinated to claims of depositors and all other creditors of UCB, are unsecured
and are ineligible as collateral for a loan by UCB.
RISK ELEMENTS
Since risk is inherent in substantially all of the Company’s operations, management of risk is
integral to its successful operations and is also a key determinant of its overall performance. We
manage all major aspects of our business through an integrated risk infrastructure that includes
planning and review processes. We evaluate our risk and returns to produce sustainable revenue, to
reduce earnings volatility and increase shareholder value. As part of this evaluation, we apply
various strategies to identify, manage and reduce the risks to which the Company’s operations are
exposed, namely credit, operational, interest rate and market, and liquidity risks.
We evaluate risk through various management committees with the oversight of the Board of
Directors. The key risk management committees of the Company are:
Management has established control processes and procedures to align risk-taking and risk
management throughout our organization. Each of our business groups is responsible for
identifying, quantifying, mitigating and managing all risks associated with their operations. In
addition, each business unit prepares and executes business plans, which must address the changing
nature of these risks making them best able to take actions to manage and mitigate those risks.
Credit Risk Management
Credit risk is the possibility of loss from the failure of a borrower or contractual counterparty
to fully perform under the terms of a credit-related contract. Credit risk arises primarily from
UCB’s lending activities, as well as from other on- and off-balance sheet credit instruments.
Effective management of credit risk is essential in maintaining a safe and sound financial
institution. We have in place a set of formal loan policies and procedures, which provide UCB with
a framework for consistent loan underwriting and a basis for sound credit decisions. In addition,
UCB has a well-defined set of standards for evaluating its loan portfolio and management utilizes a
comprehensive loan grading system to identify the risk potential in the portfolio. Loans are
periodically reviewed with regard to the borrower’s ability to repay the loan
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during which a risk grade is assigned to the loan. The reviews include evaluations of various
factors including, the borrower’s debt capacity and financial flexibility, the borrower’s earnings,
the sources of repayment, the level and nature of any contingencies, the quality of any collateral,
and the industry in which the borrower operates. The reviews also address an evaluation of
historical information as well as subjective assessments and interpretations. Further, an
independent internal credit review function periodically conducts reviews of UCB’s lending
operations and loan portfolios. These reviews are designed to place an emphasis on the early
detection of problem credits so that action plans can be developed and implemented on a timely
basis to mitigate any potential losses.
UCB also assigns a loss rating to each credit facility. These loss ratings are determined by
borrower and by type of collateral, based principally upon our own historical loss experience or on
independent verifiable data that help to estimate these ratings. The ratings are used as a tool to
monitor a loan’s performance and also in estimating any potential loss associated with it.
Another aspect of UCB’s credit risk management strategy is to maintain diversification in loans
held in portfolio. The components of UCB’s loans held in portfolio by amount and percentage of
gross loans held in portfolio for each major loan category at September 30, 2007, and December 31,
2006, were as follows (dollars in thousands):
UCB actively monitors the levels of loans as a percentage of its loans held in portfolio and of its
risk-based capital. Consistent with our planned long-term objectives, UCB will continue to
systematically reduce the concentration in commercial and multifamily real estate loans, while
increasing the portfolio of commercial business loans. During the nine months ended September 30,
2007, $217.2 million in commercial real estate loans were sold. Additionally, $137.3 million of
commercial real estate loans were transferred from held in portfolio to held for sale, in an effort
to further reduce UCB’s concentration of commercial real estate loans.
UCB also manages its loans held in portfolio to avoid the risk of undue concentration of credits in
a particular industry, trade group or property type. UCB has no significant exposure to highly
leveraged transactions or to any individual customer or counterparty.
Nonperforming Assets
Nonperforming assets include nonaccrual and restructured loans from loans held in portfolio and
other real estate owned (“OREO”), but exclude any loans held for sale. Loans are generally placed
on nonaccrual status when a loan becomes 90 days past due as to principal and interest, unless the
loan is both well secured and in the process of collection. Loans may be placed on nonaccrual
earlier if, in management’s opinion, the full and timely collection of principal or interest
becomes uncertain. When a loan is placed on nonaccrual status, any accrued but unpaid interest is
reversed and charged against interest income. UCB charges off loans when it determines that
collection becomes unlikely. OREO is acquired primarily through or in lieu of foreclosure on loans
secured by real estate.
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UCB’s nonperforming assets from loans held in portfolio and OREO as of September 30, 2007, and
December 31, 2006, were as follows (dollars in thousands):
The level of UCB’s nonperforming assets increased as of September 30, 2007, compared to
December 31, 2006. The increase was a result primarily of $17.9 million of construction and
commercial loan moving into nonaccrual status.
Included in nonaccrual loans are loans that we have determined to be impaired. Loans, other than
those included in large groups of smaller-balance homogeneous loans, are considered to be impaired
when, based on current information and events, it is probable that UCB will be unable to collect
all amounts due in accordance with the contractual terms of the loan agreement, including scheduled
interest payments. The amount of a loan’s 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.
At September 30, 2007, and December 31, 2006, UCB’s investment in loans that were considered to be
impaired was $46.5 million and $12.0 million, respectively. Estimated losses on impaired loans are
added to the allowance for loan losses through the provision for loan losses. At September 30,
2007, the allowance for loan losses included $5.7 million for impaired loans with a $22.5 million
recorded investment. At December 31, 2006, the allowance included $1.4 million for impaired loans
with a recorded investment of $6.9 million.
Management cannot predict the extent to which economic conditions in UCB’s market areas may change
or the full impact that such changes may have on UCB’s loan portfolio. Accordingly, there can be
no assurance that additional loans will not become 90 days or more past due, be placed on
nonaccrual status, or become impaired or restructured loans or OREO in the future.
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Allowances for Credit Losses
Allowance for Loan Losses. The components of the allowance for loan losses and allowance
for losses related to unfunded commitments for the three and nine months ended September 30, 2007
and 2006, were as follows (dollars in thousands):
During the nine months ended September 30, 2007, the allowance for loan losses increased $6.5
million from the balance at December 31, 2006. The increase is due primarily to $3.8 million of
allowance for loan losses acquired in connection with the CAB acquisition, an increase in specific
valuation allowances associated with impaired loans, and growth in the Company’s loan portfolio.
These increases were offset by a $6.4 million reduction from changes in loss factors and a $5.4
million reduction attributable to net-loan charge-offs.
If interest rates rise, additional pressure may be placed on our borrowers’ abilities to meet their
contractual loan obligations, which may result in future increases to the allowance for loan losses
and, in turn, higher provisions for loan losses. In addition, it is probable that the allowance
for loan losses may increase in future quarters if we are successful in implementing our strategies
for loan growth and for changing the mix of the commercial loan portfolio
to reduce multifamily and commercial real estate loans and increase construction and commercial
business loans. These latter two loan types generally contain higher credit risk attributes.
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Allowance for Unfunded 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 overall reserve decreased $1.9 million from December 31, 2006. The decrease was
primarily a result of the change in the loss factor of $3.7 million. The reserve for unfunded
commitments is included in other liabilities on the statement of financial position. Commitments to
extend credit at September 30, 2007, and December 31, 2006, were $2.56 billion and $2.12 billion,
respectively.
Market Risk Management
Interest rate risk is the potential for loss resulting from adverse changes in the level of
interest rates on UCB’s net interest income. Market risk is the potential for loss arising from
adverse changes in the prices of UCB’s financial instruments as a result of changes in interest
rates or other factors. As a financial institution that engages in transactions involving an array
of financial products, UCB is constantly exposed to both interest rate risk and market risk.
Interest rate risk is one of the most significant risks to which UCB is regularly exposed and is
managed centrally in the Corporate Treasury function. It is the primary driver behind our market
risk exposure and affects both the values of our financial assets and the interest we earn and pay
out. A sudden and substantial change in interest rates could negatively affect our earnings if the
rates of interest UCB earns on its loans and investments do not change at the same speed, to the
same extent, or on the same basis as the interest rates UCB pays on its deposits and borrowings.
One of UCB’s highest priorities is to actively monitor and manage its exposure to interest rate
risk. UCB accomplishes this by first evaluating the interest rate risk and, in turn, market risk
that is inherent in the makeup of its assets and liabilities. UCB then determines an appropriate
level of risk that it is willing to assume considering its business strategy, current operating
environment, capital and liquidity requirements, as well as our current performance objectives.
Interest rate risk is managed in a number of ways. UCB actively manages the rates on the various
types of loans and deposits that it offers its customers. These offering rates are a primary tool
for encouraging or discouraging the production of loans with specific characteristics such as
repricing frequency, amortization term and maturity; certificates of deposits with longer or
shorter terms; and the mix of deposits. Nevertheless, banking is a competitive industry and
although we endeavor to influence the types of loans and deposits that we produce, market
conditions ultimately govern the outcome of those efforts.
UCB also manages market risk through changing the composition of its assets by selling loans with
specific repricing characteristics, adjusting the relative size of its investment securities
portfolio, which are predominately fixed-rate, and replenishing the investment securities portfolio
with securities of specific durations and final maturities. UCB also manages the composition of its
liabilities by choosing borrowings with longer or shorter expected maturities.
UCB monitors its interest rate and market sensitivities through the use of a model, which estimates
the change in our net portfolio value (“NPV”) and net interest income in the event of a range of
assumed changes in market interest rates. NPV is defined as the current market value of our
assets, less the current market value of our liabilities, plus or minus the current value of
off-balance sheet items. As market interest rates decline, the average expected lives of our
fixed-rate loans and investment securities shorten due to quicker prepayments, causing a relatively
moderate increase in their value. The value of our deposit portfolio exhibits only relatively
minor movements in a declining interest rate environment, since they are primarily short term in
nature. This results in the value of deposits decreasing more quickly than the value of assets
increasing. As market interest rates rise, the average expected life of our fixed-rate loans and
securities lengthens as prepayments decrease, causing a decline in value. The value of our
deposits decreases slowly in a rising rate environment, due to the concentration of time deposits
in our deposit base, which have terms of one year or less.
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UCB may use certain derivative financial instruments for hedging purposes, such as interest rate
swaps, caps and floors as part of our hedging program, to help mitigate our interest rate risk.
Such instruments involve, to varying degrees, elements of credit and interest rate risk in excess
of the amount that is presented on our balance sheet. See the “Contractual Obligation and
Off-Balance Sheet Arrangements” section for additional information.
The percentage change in UCB’s NPV and net interest income, assuming an immediate change in
interest rates of plus or minus 100 and 200 basis points, at September 30, 2007, has not changed
substantially from December 31, 2006.
Operational Risk Management
Operational risk is the potential for unexpected losses attributable to human error, systems
failures, fraud, or inadequate internal controls and procedures. Successful operational risk
management is particularly important to a diversified financial services company like ours because
of the nature, volume and complexity of our various businesses.
We classify operational risk into two major categories: business specific and corporate-wide
affecting all business lines. Management of operational risk requires a different strategy for
each category. For business-specific risks, the Operational Risk Management Committee works with
the divisions to ensure consistency in policies, processes and assessments. With respect to
corporate-wide risks, such as information security, business recovery, legal and compliance, the
Operational Risk Management Committee assesses the risks, develops a consolidated corporate view
and communicates that view to the business groups.
In addition, to help manage company-wide risks, we have specialized support groups, such as the
Legal Department, Information Security, Business Recovery, Corporate Finance, Corporate Compliance,
Information Technology and Operations. These groups assist the lines of business in the
development and implementation of risk management practices specific to the needs of the business
groups.
Liquidity Risk
Liquidity Management. Liquidity is managed centrally for both UCBH and UCB. UCBH’s cash
requirements consist primarily of debt service, operating expenses, income taxes and dividends to
stockholders. UCBH’s cash needs are routinely met through dividends from UCB, investment income
and debt issuances. UCB’s cash requirements consist primarily of funding loans and deposit
maintenance such as interest payments and deposit withdrawals. UCB’s primary source of funding is
its core deposits.
Operational cash flows, while constituting a potential funding source for the Company, are
typically not large enough to provide funding in the amounts that fulfill the needs of UCBH and
UCB. As a result, the Company utilizes other sources at its disposal to manage its liquidity
needs.
For the nine months ended September 30, 2007, UCBH received $20.5 million in dividends from UCB.
At September 30, 2007, $275.9 million of dividend capacity was available for UCB to pay UCBH
without obtaining regulatory approval. The dividend capacity is dependent upon the continued
profitability of UCB and on no significant changes taking place in the current regulatory
environment. While we have no current expectation that these two conditions will change, should a
change take place in the future, the source of funding to UCBH may become more limited or even
unavailable.
As mentioned earlier, UCB’s primary source of funding is its deposits. For the nine months ended
September 30, 2007, deposit increases resulted in net cash inflows of $578.3 million. Our
liquidity may be adversely affected by unexpected withdrawals of deposits, which would require us
to seek alternative funding sources, such as federal funds and other borrowings.
UCB maintains borrowing lines with numerous correspondent banks and brokers, and several agreements
to repurchase securities sold with major brokerage houses to supplement its supply of lendable
funds and to manage liquidity. In addition, the FHLB allows member banks to borrow against their
eligible loans to help meet liquidity requirements. These borrowings are generally secured with
mortgage loans and/or securities with a market value at
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least equal to outstanding balances. In addition to loans and securities, advances from the FHLB
are typically secured by a pledge of FHLB stock that UCB holds. UCB had $1.22 billion and $1.43
billion of FHLB advances outstanding at September 30, 2007, and December 31, 2006, respectively.
At September 30, 2007, UCB had $1.37 billion of additional FHLB borrowings available for future
borrowing capacity. At September 30, 2007, UCB had $500.0 million of securities sold under
agreements to repurchase. The Company also has a $35.0 million unsecured borrowing line with Wells
Fargo Bank. As of September 30, 2007, no advances had been drawn against this line.
At September 30, 2007, the Company had $90.0 million of FHLB short-term, fixed-rate advances that
mature within one year. The $1.13 billion in FHLB long-term advances mature between November 14,
2007, and November 30, 2020. As of September 30, 2007, $1.02 billion of these advances may be
terminated at the option of the FHLB. For the nine months ended September 30, 2007, the activity
in short-term FHLB borrowings resulted in a net cash outflow of $444.2 million, and activity in
long-term borrowings result | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||