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Cascade Bancorp 10-K 2008 Documents found in this filing:
SECURITIES AND EXCHANGE
COMMISSION ______________________
For the fiscal year ended: December 31, 2007
For the transition period from ______to ______ Commission file number: 0-23322 CASCADE BANCORP
(541) 385-6205 Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: N/A 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 x Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes o No x 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 x 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 registrant’s 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. o 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 definition of “large accelerated filer, accelerated filer and smaller reporting company” in Rule 12b-2 of the Exchange Act (check one): Large Accelerated Filer o Accelerated Filer x Non-accelerated Filer o Smaller Reporting Company 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 x The aggregate market value of the voting stock held by non-affiliates of the Registrant at June 30, 2007 (the last business day of the most recent second quarter) was $639,223,757 (based on the closing price as quoted on the NASDAQ Capital Market on that date). Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date. 28,011,699 shares of no par value Common Stock on February 29, 2008. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant’s definitive Proxy Statement for its 2008 Annual Meeting of Shareholders of Cascade Bancorp to be held on April 28, 2008 are incorporated by reference in this Form 10-K in response to Part III, Items 10, 11, 12, 13 and 14.
PART I ITEM 1. BUSINESS The disclosures in this Item are qualified by the Risk Factors set forth in Item 1A and the Section entitled “Contingency Information Concerning Forward-Looking Statements” included in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations in this report and any other cautionary statements contained herein. Cascade Bancorp The Company Cascade Bancorp (“Bancorp”), is an Oregon chartered Financial Holding Company formed in 1990, headquartered in Bend, Oregon. Bancorp conducts its business activities through its wholly-owned subsidiary, Bank of the Cascades (the Bank) which provides a broad range of commercial and retail banking services (collectively, Bancorp and the Bank are referred to as “the Company” or “Cascade”). At December 31, 2007, the Company had total consolidated assets of approximately $2.4 billion, net loans of approximately $2.0 billion and deposits of approximately $1.7 billion. Overview & Business Strategy Cascade operates in some of the fastest growing markets in the nation. In terms of banking growth markets, the footprint of Cascade’s banking franchise ranks as the top community bank footprint in the Northwest and among the top ten banks in the nation1. Management and directors of Cascade have developed and implemented long-term goals and strategies with the objective of achieving sustainable, above peer diluted earnings per share (EPS) growth for its shareholders while progressively serving the banking and financial needs of its customers and communities. The Company’s business strategies include: 1) operate in and expand into growth markets; 2) strive to recruit and retain the best relationship bankers in such markets; 3) consistently deliver the highest levels of customer service, and; 4) apply state-of-the-art technology for the convenience of customers. Cascade’s mission statement is to “deliver the best in community banking for the financial well-being of customers and shareholders.” The Company is managed by legal entity and not lines of business and therefore it presents one principal operating segment for financial reporting purposes. For more information regarding the Company’s operating segment, see Note 1 to the Company’s consolidated financial statements included under “Basis of Presentation and Summary of Significant Accounting Policies.” The Company’s original market was Central Oregon, whose population has grown in the 96th percentile nationally for the past decade due largely to in-migration of those seeking the quality of life offered by the region. The region has natural high-desert beauty, bountiful recreational and cultural choices, good weather, and premier healthcare services. The Company has grown with the community to a point of holding a 29% deposit market share of this historically fast growing market. The combination of a fast growing economy and powerful market share contributed to sustained high performance over the past decade. In recent years, management has sought to augment its banking footprint by expanding into other attractive Oregon markets, including Northwest and Southwest Oregon. Loans and deposits in these markets total a combined 34% and 29%, respectively of total Company balances. In April of 2006, Cascade acquired Farmers and Merchants Bank (F&M) in Boise, Idaho. F&M held the top community bank deposit market share of 6.9% in Ada County at that time. At December 31, 2007, this newest market held loans and deposits of approximately 31% and 28%, respectively of total Company balances. This expansion furthered the diversification of the Company’s banking business into multiple states and markets. ____________________
3 The following table reflects the compounded growth rates the Company has achieved over the periods indicated, however there can be no assurance as to future results:
Key Performance Indicators The Company has established the following performance goals: 1) consistently achieve growth in EPS that is above the norm of a group of peer banks; 2) consistently exceed 15% return on tangible equity; 3) identify and prudently manage credit and business risk; 4) strive to profitably diversify revenue sources and markets, and; 5) deliver advanced technology for the benefit of its customers. In order to achieve these goals, the Company has established key measures that specify annual and multi-year growth targets for loans and deposits, set benchmarks for its credit quality and the net interest margin. In addition, non-financial measurements are set with respect to sales and customer relationship and retention goals to assist management in directing and monitoring results. In 2007, as a consequence of the downturn in real estate markets, the Company incurred elevated credit losses and was subject to the general slowing of economic growth within its footprint, causing results to fall short of its key performance targets for the first time in many years. No assurance can be provided that key performance indicators can be met or exceeded in the future. Subsidiaries Bank of the Cascades The Bank is an Oregon State chartered bank, opened for business in 1977 and now operates 34 branches serving communities in Central, Southwest and Northwest Oregon, as well as in the greater Boise, Idaho area. The Bank offers a broad range of commercial and retail banking services to its customers. Lending activities serve small to medium-sized businesses, municipalities and public organizations, professional and consumer relationships. The Bank provides commercial real estate loans, real estate construction and development loans, commercial and industrial loans as well as consumer installment, line-of-credit, credit card, and home equity loans. It originates and services residential mortgage loans that are typically sold on the secondary market. The Bank provides consumer and business deposit services including checking, money market, and time deposit accounts and related payment services, internet banking and electronic bill payment. In addition, the Bank serves business customer deposit needs with a suite of cash management services. The Bank also provides investment and trust related services to its clientele. With the sustained increase in population and economy within its Oregon markets, the Company has enjoyed rapid growth in assets and profitability over the past decade. More recently, the Company has diversified its geographic footprint by expanding into growth markets in the greater Boise, Idaho area with its April 2006 acquisition of F&M (see “Completed Acquisition of F&M Holding Company” below.) The principal office of the Bank is at 1100 N.W. Wall Street, Bend, Oregon 97701, 541-385-6205. Cascade Bancorp Statutory Trusts I, II, III and IV Cascade Bancorp Statutory Trusts I, II, III and IV are wholly-owned subsidiary trusts of Bancorp formed to facilitate the issuance of pooled trust preferred securities (“trust preferred securities”). The trusts were organized in December 2004, March 2006, and June 2006, respectively, in connection with four offerings of trust preferred securities. For more information regarding Bancorp’s issuance of trust preferred securities, see Note 9 “Junior Subordinated Debentures” to the Company’s audited consolidated financial statements included in Item 8 of this report. 4 Completed Acquisition of F&M Holding Company On April 20, 2006, the Company completed its acquisition of F&M Holding Company (F&M) of Boise, Idaho and currently operates 12 banking offices in the area. Under the terms of the merger agreement announced December 27, 2005, the stockholders of F&M received 6,656,249 shares of Company common stock and $22.5 million in cash, less a holdback of $3.9 million to assure credit performance regarding certain loans. The assets and liabilities of F&M were recorded on the Company’s consolidated balance sheet at their fair market values as of the acquisition date. F&M’s results of operations have been included in the Company’s consolidated statement of income since acquisition date. At December 31, 2007, the holdback amount has been reduced to $1.7 million as certain loans have either paid-off or been upgraded as to credit quality. Employees The Company views its employees as an integral resource in achieving its strategies and long term goals, and considers its relationship with its employees to be very strong. Bancorp has no employees other than its executive officers, who are also employees of the Bank. The Company had 559 full-time equivalent employees as of December 31, 2007, down from 573 at the prior year-end. This modest decrease primarily resulted from normal attrition of non-essential staff positions. Executive Officers of the Registrant The names, ages as of December 31, 2007, and positions of the current executive officers of Bancorp are listed below.
Risk Management The Company has risk management policies with respect to identification, assessment, and management of important business risks. Such risks include, but are not limited to, credit quality and loan concentration risks, liquidity risk, interest rate risk, economic and market risk, as well as operating risks such as compliance, disclosure, internal control, legal and reputation risks. Credit risk management objectives include loan policies and underwriting practices designed to prudently manage credit risk, and monitoring processes to identify and manage loan portfolio concentrations. Funding policies are designed to maintain an appropriate volume and mix of core relationship deposits and time deposit balances to minimize liquidity risk while efficiently funding its loan and investment activities. In addition, the Company also utilizes borrowings from reliable counterparties such as the Federal Home Loan Bank (“FHLB”) and the Federal Reserve Bank (“FRB”) to augment its liquidity. The Company also utilizes brokered deposits as part of its wholesale funding strategies. The Company monitors and manages its sensitivity to changing interest rates by utilizing simulation analysis and scenario modeling and by adopting asset and liability strategies and tactics to control the volatility of its net interest income in the event of changes in interest rates. Operating related risks are managed through implementation of and adherence to a system of internal controls. Key control processes and procedures are subject to internal and external testing in the course of internal audit and regulatory compliance activities and the Company is subject 5 to the requirements of Sarbanes Oxley Act of 2002. While the Company believes its risk management strategies and processes are prudent and appropriate to manage the wide range of risks inherent in its business, there can be no assurance that such strategies and processes will detect, contain, eliminate or prevent risks that could result in adverse financial results in the future. Competition Commercial and consumer banking in Oregon and Idaho are highly competitive businesses. The Bank competes principally with other commercial banks, savings and loan associations, credit unions, mortgage companies, brokers and other non-bank financial service providers. In addition to price competition for deposits and loans, competition exists with respect to the scope and type of services offered, customer service levels, convenience, as well as competition in fees and service charges. Improvements in technology, communications and the Internet have intensified delivery channel competition. Competitor behavior may result in heightened competition for banking and financial services and thus affect future profitability. The Bank competes for customers principally through the effectiveness and professionalism of its bankers and its commitment to customer service. In addition, it competes by offering attractive financial products and services, and by the convenient and flexible delivery of those products and services. The Company believes its community banking philosophy, technology investments and focus on small and medium-sized business, professional and consumer accounts, enables it to compete effectively with other financial service providers. In addition, the Company’s lending and deposit officers have significant experience in their respective marketplaces. This enables them to maintain close working relationships with their customers. To compete for larger loans, the Bank may participate loans to other financial institutions for customers whose borrowing requirements exceed the Company’s lending limits. Government Policies The operations of Bancorp’s subsidiaries are affected by state and federal legislative changes and by policies of various regulatory authorities. These policies include, for example, statutory maximum legal lending rates, domestic monetary policies of the Board of Governors of the Federal Reserve System, United States fiscal policy, and capital adequacy and liquidity constraints imposed by federal and state regulatory agencies. Supervision and Regulation Bancorp and the Bank are extensively regulated under Federal and Oregon law. These laws and regulations are primarily intended to protect depositors and the deposit insurance fund, not shareholders. To the extent that the following information describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statutory or regulatory provisions. The operations of the Company may be affected by legislative changes and by the policies of various regulatory authorities. Management is unable to predict the nature or the extent of the effects on its business and earnings that fiscal or monetary policies, economic control or new Federal or State legislation may have in the future. The description set forth below of the significant elements of the laws and regulations that apply to the Company is qualified in its entirety by reference to the full statutes, regulations and policies that are described. Bank Holding Company Regulation Bancorp is a one-bank financial holding company within the meaning of the Bank Holding Company Act (“Act”), and as such, is subject to regulation, supervision and examination by the Federal Reserve Bank (“FRB”). Bancorp has been designated a “Financial Holding Company” as defined in the 1999 Gramm-Leach-Bliley Act (see description below), and does not expect such designation to have a material effect on its financial condition or results of operations. Bancorp is required to file annual reports with the FRB and to provide the FRB such additional information as the FRB may require. The Act requires every bank holding company to obtain the prior approval of the FRB before (1) acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after such acquisition, it would own or control more than 5% of such shares (unless it already owns or controls the majority of such shares); (2) acquiring all or substantially all of the assets of another bank or bank holding company; or (3) merging or consolidating with another bank holding company. The FRB will not approve any acquisition, merger or consolidation that would have a substantial anticompetitive result, unless the anticompetitive effects of 6 the proposed transaction are clearly outweighed by a greater public interest in meeting the convenience and needs of the community to be served. The FRB also considers capital adequacy and other financial and managerial factors in reviewing acquisitions or mergers. With certain exceptions, the Act also prohibits a bank holding company from acquiring or retaining direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank or bank holding company, or from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries. The principal exceptions to these prohibitions involve certain non-bank activities, which by statute or by FRB regulation or order, have been identified as activities closely related to the business of banking or of managing or controlling banks. In making this determination, the FRB considers whether the performance of such activities by a bank holding company can be expected to produce benefits to the public such as greater convenience, increased competition or gains in efficiency in resources, which can be expected to outweigh the risks of possible adverse effects such as decreased or unfair competition, conflicts of interest or unsound banking practices. State Regulations Concerning Cash Dividends The principal source of Bancorp’s cash revenues have been provided from dividends received from the Bank. The Oregon banking laws impose certain limitations on the payment of dividends by Oregon state chartered banks. The amount of the dividend may not be greater than the Bank’s unreserved retained earnings, deducting from that, to the extent not already charged against earnings or reflected in a reserve, the following: (1) all bad debts, which are debts on which interest is past due and unpaid for at least six months, unless the debt is fully secured and in the process of collection; (2) all other assets charged off as required by the Director of the Department of Consumer and Business Services or a state or federal examiner; (3) all accrued expenses, interest and taxes of the institution. In addition, the appropriate regulatory authorities are authorized to prohibit banks and bank holding companies from paying dividends, which would constitute an unsafe or unsound banking practice. The Bank and Bancorp are not currently subject to any regulatory restrictions on their dividends other than those noted above. Federal and State Bank Regulation The Bank is a Federal Deposit Insurance Corporation (“FDIC”) insured bank which is not a member of the Federal Reserve System, is subject to the supervision and regulation of the State of Oregon Department of Consumer and Business Services, Division of Finance and Corporate Securities, and the Idaho Department of Finance, respectively, and to the supervision and regulation of the FDIC. These agencies may prohibit the Bank from engaging in what they believe constitute unsafe or unsound banking practices. The Community Reinvestment Act (“CRA”) requires that, in connection with examinations of financial institutions within their jurisdiction, the FRB or the FDIC evaluate the record of the financial institutions in meeting the credit needs of their local communities, including low and moderate income neighborhoods, consistent with the safe and sound operation of those banks. These factors are also considered in evaluating mergers, acquisitions and applications to open a branch or facility. The current CRA rating of the Bank is “satisfactory.” The Bank is subject to certain restrictions imposed by the Federal Reserve Act on extensions of credit to executive officers, directors, principal shareholders or any related interest of such persons. Extensions of credit: (1) must be made on substantially the same terms, collateral and following credit underwriting procedures that are not less stringent than those prevailing at the time for comparable transactions with persons not described above; and (2) must not involve more than the normal risk of repayment or present other unfavorable features. The Bank is also subject to certain lending limits and restrictions on overdrafts to such persons. A violation of these restrictions may result in the assessment of substantial civil monetary penalties on the bank or any officer, director, employee, agent or other person participating in the conduct of the affairs of the bank, the imposition of a cease and desist order, and other regulatory sanctions. Under the Federal Deposit Insurance Corporation Improvement Act (“FDICIA”), each Federal banking agency is required to prescribe by regulation, non-capital safety and soundness standards for institutions under its authority. These standards are to cover internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, such other operational and managerial standards as the agency determines to be appropriate, and standards for asset quality, earnings and 7 stock valuation. An institution, which fails to meet these standards, must develop a plan acceptable to the agency, specifying the steps that the institution will take to meet the standards. Failure to submit or implement such a plan may subject the institution to regulatory sanctions. The Company believes that the Bank meets substantially all the standards that have been adopted. Capital Adequacy and Prompt Corrective Action Banks and bank holding companies are subject to various regulatory capital requirements administered by state and federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weighting and other factors. The Federal Reserve Board, the Office of the Comptroller of the Currency (“OCC”) and the FDIC have substantially similar risk-based capital ratio and leverage ratio guidelines for banking organizations. The guidelines are intended to ensure that banking organizations have adequate capital given the risk levels of assets and off-balance sheet financial instruments. Under the guidelines, banking organizations are required to maintain minimum ratios for Tier 1 capital and total capital to risk-weighted assets (including certain off-balance sheet items, such as letters of credit). For purposes of calculating the ratios, a banking organization’s assets and some of its specified off-balance sheet commitments and obligations are assigned to various risk categories. A depository institution’s or holding company’s capital, in turn, is classified in one of three tiers, depending on type:
Bancorp, like other bank holding companies, currently is required to maintain Tier 1 capital and “total capital” (the sum of Tier 1, Tier 2 and Tier 3 capital) equal to at least 4.0% and 8.0%, respectively, of its total risk-weighted assets (including various off-balance-sheet items, such as letters of credit). The Bank, like other depository institutions, is required to maintain similar capital levels under capital adequacy guidelines. For a depository institution to be considered “well capitalized” under the regulatory framework for prompt corrective action, its Tier 1 and total capital ratios must be at least 6.0% and 10.0% on a risk-adjusted basis, respectively. Bank holding companies and banks subject to the market risk capital guidelines are required to incorporate market and interest rate risk components into their risk-based capital standards. Under the market risk capital guidelines, capital is allocated to support the amount of market risk related to a financial institution’s ongoing trading activities. Bank holding companies and banks are also required to comply with minimum leverage ratio requirements. The leverage ratio is the ratio of a banking organization’s Tier 1 capital to its total adjusted quarterly average assets (as defined for regulatory purposes). The requirements necessitate a minimum leverage ratio of 3.0% for financial holding companies and national banks that either have the highest supervisory rating or have implemented the appropriate federal regulatory authority’s risk-adjusted measure for market risk. All other financial holding companies and national banks are required to maintain a minimum leverage ratio of 4.0%, unless a different minimum is specified by an appropriate regulatory authority. For a depository institution to be considered “well capitalized” under the regulatory framework for prompt corrective action, its leverage ratio must be at least 5.0%. The Federal Deposit Insurance Act, as amended (“FDIA”), requires among other things, the federal banking agencies to take “prompt corrective action” in respect of depository institutions that do not meet minimum capital requirements. The FDIA sets forth the following five capital tiers: “well capitalized,” “adequately capitalized,” 8 “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized.” A depository institution’s capital tier will depend upon how its capital levels compare with various relevant capital measures and certain other factors, as established by regulation. The relevant capital measures are the total capital ratio, the Tier 1 capital ratio and the leverage ratio. Under the regulations adopted by the federal regulatory authorities, a bank will be: (i) “well capitalized” if the institution has a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based capital ratio of 6.0% or greater, and a leverage ratio of 5.0% or greater, and is not subject to any order or written directive by any such regulatory authority to meet and maintain a specific capital level for any capital measure; (ii) “adequately capitalized” if the institution has a total risk-based capital ratio of 8.0% or greater, a Tier 1 risk-based capital ratio of 4.0% or greater, and a leverage ratio of 4.0% or greater and is not “well capitalized”; (iii) “undercapitalized” if the institution has a total risk-based capital ratio that is less than 8.0%, a Tier 1 risk-based capital ratio of less than 4.0% or a leverage ratio of less than 4.0%; (iv) “significantly undercapitalized” if the institution has a total risk-based capital ratio of less than 6.0%, a Tier 1 risk-based capital ratio of less than 3.0% or a leverage ratio of less than 3.0%; and (v) “critically undercapitalized” if the institution’s tangible equity is equal or less than 2.0% of average quarterly tangible assets. An institution may be downgraded to, or deemed to be in, a capital category that is lower than indicated by its capital ratios if it is determined to be in an unsafe or unsound condition or if it receives an unsatisfactory examination rating with respect to certain matters. The Company believes that, as of December 31, 2007, the Bank was “well capitalized,” based on the ratios and guidelines described above. A bank’s capital category is determined solely for the purpose of applying prompt corrective action regulations, and the capital category may not constitute an accurate representation of the bank’s overall financial condition or prospects for other purposes. The FDIA generally prohibits a depository institution from making any capital distributions (including payment of a dividend) or paying any management fee to its parent holding company if the depository institution would thereafter be “undercapitalized.” “Undercapitalized” institutions are subject to growth limitations and are required to submit a capital restoration plan. The agencies may not accept such a plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution’s capital. In addition, for a capital restoration plan to be acceptable, the depository institution’s parent holding company must guarantee that the institution will comply with such capital restoration plan. The aggregate liability of the parent holding company is limited to the lesser of (i) an amount equal to 5.0% of the depository institution’s total assets at the time it became undercapitalized and (ii) the amount which is necessary (or would have been necessary) to bring the institution into compliance with all capital standards applicable with respect to such institution as of the time it fails to comply with the plan. If a depository institution fails to submit an acceptable plan, it is treated as if it is “significantly undercapitalized.” “Significantly undercapitalized” depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become “adequately capitalized,” requirements to reduce total assets, and cessation of receipt of deposits from correspondent banks. “Critically undercapitalized” institutions are subject to the appointment of a receiver or conservator. At December 31, 2007, the Company’s leverage, Tier 1 capital and total risked-based capital ratios were 9.90%, 10.02% and 11.27%, respectively. For information regarding the capital ratios and leverage ratio of Bancorp and the Bank see the discussion under the section captioned “Liquidity and Sources of Funds” included in Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operation and Note 20 — Regulatory Matters in the notes to consolidated financial statements included in Item 8 Financial Statements and Supplementary Data, elsewhere in this report. The federal regulatory authorities’ risk-based capital guidelines are based upon the 1988 capital accord of the Basel Committee on Banking Supervision (the “BIS”). The BIS is a committee of central banks and bank supervisors/regulators from the major industrialized countries that develops broad policy guidelines for use by each country’s supervisors in determining the supervisory policies they apply. In 2004, the BIS published a new capital accord to replace its 1988 capital accord (“BIS II”). BIS II provides two approaches for setting capital standards for credit risk — an internal ratings-based approach tailored to individual institutions’ circumstances and a standardized approach that bases risk weightings on external credit assessments to a much greater extent than permitted in existing risk-based capital guidelines. BIS II also would set capital requirements for operational risk and refine the existing capital requirements for market risk exposures. 9 The U.S. banking and thrift agencies are developing proposed revisions to their existing capital adequacy regulations and standards based on BIS II. In November 2007, the agencies adopted a definitive final rule for implementing BIS II in the United States that would apply only to internationally active banking organizations, or “core banks” — defined as those with consolidated total assets of $250 billion or more or consolidated on-balance sheet foreign exposures of $10 billion or more. The final rule will be effective as of April 1, 2008. Other U.S. banking organizations may elect to adopt the requirements of this rule (if they meet applicable qualification requirements), but they will not be required to apply them. The rule also allows a banking organization’s primary federal supervisor to determine that the application of the rule would not be appropriate in light of the bank’s asset size, level of complexity, risk profile, or scope of operations. This new proposal, which is intended to be finalized before the core banks may start their first transition period year under BIS II, will replace the agencies’ earlier proposed amendments to existing risk-based capital guidelines to make them more risk sensitive (formerly referred to as the “BIS I-A” approach). The Company is not required to comply with BIS II. The Company has not made a determination as to whether it will elect to apply the BIS II requirements when they become effective. Deposit Insurance Substantially all of the deposits of the Bank are insured up to applicable limits by the Deposit Insurance Fund (“DIF”) of the FDIC and are subject to deposit insurance assessments to maintain the DIF. The FDIC utilizes a risk-based assessment system that imposes insurance premiums based upon a risk matrix that takes into account a bank’s capital level and supervisory rating (“CAMELS rating”). As of January 1, 2007, the previous nine risk categories utilized in the risk matrix were condensed into four risk categories which continue to be distinguished by capital levels and supervisory ratings. For large, Risk Category 1 institutions (generally those with assets in excess of $10 billion) that have long-term debt issuer ratings assessment rates are determined from weighted-average CAMELS component ratings and long-term debt issuer ratings. The minimum annualized assessment rate for large institutions is 5 basis points per $100 of deposits and the maximum annualized assessment rate is 7 basis points per $100 of deposits. Quarterly assessment rates for large institutions in Risk Category 1 may vary within this range depending upon changes in CAMELS component ratings and long-term debt issuer ratings. Under the Federal Deposit Insurance Reform Act of 2005, which became law in 2006, the Bank received a onetime assessment credit of $.3 million. This credit was utilized to partially offset $1.1 million of assessments during 2007. This credit was not available to offset Financing Corporation (“FICO”) assessments. DIF-insured institutions are required to pay a FICO assessment, in order to fund the interest on bonds issued to resolve thrift failures in the 1980s. The assessment rate for the fourth quarter of 2007 was 0.0125% of insured deposits and is adjusted quarterly. These assessments, which may be revised based upon the level of DIF deposits, will continue until the FICO bonds mature in the years 2017 through 2019. The Bank’s FICO assessment expense for 2007 was approximately $200,000, and management expects the 2008 expense to be comparable to 2007. USA Patriot Act Under the USA Patriot Act of 2001, adopted by the U.S. Congress on October 26, 2001, FDIC insured banks and commercial banks were required to increase their due diligence efforts for correspondent accounts and private banking customers. The USA Patriot Act requires the Bank to engage in additional record keeping or reporting, requiring identification of owners of accounts, or of the customers of foreign banks with accounts, and restricts or prohibits certain correspondent accounts. Office of Foreign Assets Control Regulation The United States has imposed economic sanctions that affect transactions with designated foreign countries, nationals and others. These are typically known as the “OFAC” rules based on their administration by the U.S. Treasury Department Office of Foreign Assets Control (“OFAC”). The OFAC-administered sanctions targeting countries take many different forms. Generally, however, they contain one or more of the following elements: (i) restrictions on trade with or investment in a sanctioned country, including prohibitions against direct or indirect imports from and exports to a sanctioned country and prohibitions on “U.S. persons” engaging in financial transactions relating to making investments in, or providing investment-related advice or assistance to, a sanctioned country; and (ii) blocking of assets in which the government or specially designated nationals of the sanctioned country have an interest, by prohibiting transfers of property subject to U.S. jurisdiction (including property in the possession or control of U.S. persons). Blocked assets (e.g., property and bank deposits) cannot be paid out, withdrawn, set off or transferred in any manner without a license from OFAC. Failure to comply with these sanctions could have serious legal and reputational consequences. 10 Interstate Banking Legislation Under the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (“Riegle-Neal Act”), as amended, a bank holding company may acquire banks in states other than its home state, subject to certain limitations. The Riegle-Neal Act also authorizes banks to merge across state lines, thereby creating interstate branches. Banks are also permitted to acquire and to establish de novo branches in other states where authorized under the laws of those states. Available Information Bancorp’s filings with the Securities and Exchange Commission (“SEC”), including its annual report on Form 10-K, quarterly reports on Form 10-Q, periodic reports on Form 8-K and amendments to these reports, are accessible free of charge at our website at http://www.botc.com as soon as reasonably practicable after filing with the SEC. By making this reference to our website, Bancorp does not intend to incorporate into this report any information contained in the website. The website should not be considered part of this report. The SEC maintains a website at http://www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers including Bancorp that file electronically with the SEC. ITEM 1A. RISK FACTORS There are a number of risks and uncertainties, many of which are beyond the Company’s control that could have a material adverse impact on the Company’s financial condition or results of operations. The Company describes below the most significant of these risks and uncertainties. These should not be viewed as an all inclusive list or in any particular order. Additional risks that are not currently considered material may also have an adverse effect on the Company. This report is qualified in its entirety by these risk factors. Before making an investment decision you should carefully consider the specific risks detailed in this section and other risks facing the Company including, among others, those certain risks, uncertainties and assumptions identified herein by management that are difficult to predict and that could materially affect the Company’s financial condition and results of operations and other risks described in this Form 10-K, the information in Part I, Item 1 “Business,” Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Company’s cautionary statements as to “Forward-Looking Statements” contained therein. The Company’s business is closely tied to the economies of Idaho and Oregon in general and is particularly affected by the economies of Central, Southern and Northwest Oregon, as well as the Greater Boise, Idaho area. A sustained economic downturn could effect these local economies, resulting in an adverse affect on the Company’s financial condition or results of operations. Many of the Company’s loans are secured by real estate located in Oregon and Idaho. Declining real estate values and fluctuating interest rates may result in customers’ inability to repay loans. See “Loans – Real Estate Loan Concentration” In Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” These trends may continue and may result in losses that exceed the estimates that are currently included in the reserve for credit losses, which could adversely affect the Company’s financial conditions and results of operations. The Company’s reserve for credit losses may not be adequate to cover actual loan losses. The risk of nonpayment of loans is inherent in all lending activities, and nonpayment, if it occurs, may have an adverse effect on the Company’s financial condition or results of operation. The Company maintains a reserve for credit losses to absorb estimated probable loan losses inherent in the loan and commitment portfolios as of the balance sheet date. In determining the level of the reserve, management makes various assumptions and judgments about the loan portfolio. If the Company’s assumptions are incorrect, the reserve for credit losses may not be sufficient to cover losses, which could adversely affect the Company’s financial condition or results of operations. The Company establishes its level of reserve for credit losses as a result of management’s continued evaluation of specific credit risks, loan loss experience, quality of the current loan portfolio, loan concentration, economic conditions, regulations, 11 political climate, new information about borrowers, additional problem loans and other factors. See section “Loans – Loan Portfolio Composition” in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for detailed description of loan portfolio to which the reserve for credit losses applies. Changes in interest rates could adversely impact the Company. The Company’s earnings are highly dependent on the difference between the interest earned on loans and investments and the interest paid on deposits and borrowings. Changes in market interest rates impact the rates earned on loans and investment securities and the rates paid on deposits and borrowings. In addition, changes to the market interest rates may impact the level of loans, deposits and investments, and the credit quality of existing loans. These rates may be affected by many factors beyond the Company’s control, including general and economic conditions and the monetary and fiscal policies of various governmental and regulatory authorities. Changes in interest rates may negatively impact the Company’s ability to attract deposits, make loans and achieve satisfactory interest rate spreads, which could adversely affect the Company’s financial condition or results of operations. The Company is subject to extensive regulation. The Company’s operations are subject to extensive regulation by federal and state banking authorities which impose requirements and restrictions on the Company’s operations. The regulations affect the Company’s investment practices, lending activities, and dividend policy, among other things. Changes to laws and regulations or other actions by regulatory agencies could, among other things, make regulatory compliance more difficult or expensive for the Company, could limit the products the Company can offer or increase the ability of non banks to compete and could adversely affect the Company in significant but unpredictable ways which in turn could have a material adverse effect on the Company’s financial condition or results of operations. Failure to comply with the laws or regulations could result in fines, penalties, sanctions and damage to the Company’s reputation which could have an adverse effect on the Company’s business and financial results. Competition may adversely affect the Company. The Company faces competition for its services from a variety of competitors. The Company’s future growth and success depends on its ability to compete effectively. The Company competes for deposits, loans and other financial services with numerous financial service providers including banks, thrifts, credit unions, mortgage companies, broker dealers, and insurance companies. To the extent these competitors have less regulatory constraints, lower cost structures, or increased economies of scales they may be able to offer a greater variety of products and services or more favorable pricing for such products and services. As a result, the Company’s competitive position could be weakened, which could adversely affect the Company’s financial condition and results of operations. Our information systems may experience an interruption or breach in security. The Company relies on its computer information systems in the conduct of its business. The Company has policies and procedures in place to protect against and reduce the occurrences of failures, interruptions, or breaches of security of these systems, however, there can be no assurance that these policies and procedures will eliminate the occurrence of failures, interruptions or breaches of security or that they will adequately restore or minimize any such events. The occurrence of a failure, interruption or breach of security of the Company’s computer information systems could result in a loss of information, business or regulatory scrutiny, or other events, any of which could have a material adverse effect on the Company’s financial condition or results of operations. We continually encounter technological change. Frequent introductions of new technology-driven products and services in the financial services industry result in the need for rapid technological change. In addition, the effective use of technology may result in improved customer service and reduced costs. The Company’s future success depends, to a certain extent, on its ability to identify the needs of our customers and address those needs by using technology to provide the desired products and services and to create additional efficiencies in its operations. Certain competitors may have substantially greater resources to invest in technological improvements. We may not be able to successfully implement new technology-driven products and services or to effectively market these products and services to our customers. Failure to implement the necessary technological changes could have a material adverse impact on our business and, in turn, our financial condition and results of operations. 12 The Company’s controls and procedures may fail or be circumvented. Management regularly reviews and updates the Company’s internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of the Corporation’s controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on the Company’s business, results of operations and financial condition. See “Item 9A Controls and Procedures.” Bancorp relies on dividends from the Bank. Bancorp is a separate legal entity from the Bank and substantially all of Bancorp’s revenues are derived from Bank dividends. These dividends may be limited by certain federal and state laws and regulations. In addition, any distribution of assets of the Bank upon a liquidation or reorganization would be subject to the prior liens of the Bank’s creditor. If the Bank is unable to pay dividends to Bancorp, Bancorp may not be able to pay dividends on its stock or pay interest on its debt, which would have a material adverse effect on the Company’s financial condition and results of operations. The Company may not be able to attract or retain key banking employees. The Company strives to attract and retain key banking professionals, management and staff. Competition to attract the best professionals in the industry can be intense which will limit the Company’s ability to hire new professionals. Banking related revenues and net income could be adversely affected in the event of the unexpected loss of key personnel. The Company has employment agreements with certain key executive officers. ITEM 1B. UNRESOLVED STAFF COMMENTS None ITEM 2. PROPERTIES At December 31, 2007, the Company conducted full-service community banking through 34 branches, including eleven in Central Oregon, four in the Salem/Keizer area, five in Southern Oregon, one office in Portland, and 13 branches serving the Boise, Idaho/Treasure Valley market. In Oregon, three branch buildings are owned and are situated on leased land. The Bank owns the land and buildings at seven branch locations. The Bank leases the land and buildings at eleven branch locations. In addition, the Bank leases space for the Operations and Information Systems departments located in Bend. All leases include multiple renewal options. In Idaho, Cascade owns the land and buildings at 10 branch locations and leases the land and building at three branch locations. A 13th branch opened in Eagle, Idaho in January 2008, in which the land and building are owned. Cascade’s main office is located at 1100 NW Wall Street, Bend, Oregon, and consists of approximately 15,000 square feet (sq. ft.). The building is owned by the Bank and is situated on leased land. The ground lease term is for 30 years and commenced June 1, 1989. There are ten renewal options of five years each. The current rent is $6,084 per month with adjustments every five years by mutual agreement of landlord and tenant. The main bank branch occupies the ground floor. Human Resources and Executive Offices occupy approximately 8,400 square feet. A separate drive-up facility is also located on this site, which also houses the Finance and Marketing departments. In 2004, the Bank purchased the Boyd Building with 26,035 square feet in downtown Bend. This building is now occupied by Credit Services, Mortgage Division and Trust/Private Financial Services. Including Bank use, the space is near full occupancy. The Bank sold the Cascade Building in the Old Mill district of Bend in early 2007, to the partners in the construction at a cost-plus price basis that was agreed upon earlier. The Bank leased back 2,000 sq. ft. for its Old Mill banking branch. In the opinion of management, all of the Bank’s properties are adequately insured, its facilities are in good condition and together with any anticipated improvements and additions, are adequate to meet it operating needs for the foreseeable future. 13 ITEM 3. LEGAL PROCEEDINGS The Company is from time to time a party to various legal actions arising in the normal course of business. Management does not expect the ultimate disposition of these matters to have a material adverse effect on the business or financial position of the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of shareholders during the fourth quarter of 2007. PART II
Cascade Bancorp common stock trades on the NASDAQ Capital Market under the symbol “CACB.” The high and low sales prices and cash dividends shown below are retroactively adjusted for stock dividends and splits and are based on actual trade statistical information provided by the Nasdaq Capital Market for the periods indicated. Prices do not include retail mark-ups, mark-downs or commissions:
The Company declared a 25% (5:4) stock split in October 2006. The Company announced a policy of declaring regular quarterly cash dividends in 1997. However, there can be no assurance as to future dividends because they are dependent on the Company’s future earnings, capital requirements and financial condition. The dividends declared and paid listed below have been retroactively adjusted for past stock dividends and stock splits.
At February 29, 2008, the Company had 35,000,000 shares of common stock authorized with 28,011,699 shares issued and outstanding, held by approximately 8,100 shareholders of record. The following table sets forth Information regarding securities authorized for issuance under the Company’s equity plans as of December 31, 2007. Additional information regarding the Company’s equity plans is presented in Note 18 of the Notes to Consolidated Financial Statements included in Item 8 of this report.
14 On August 13, 2007, the Board of Directors authorized the Company to purchase up to five percent (5%) of the Company’s issued outstanding common shares. Purchases are to occur at management’s discretion over a two-year period. The following table provides information with respect to purchases made by or on behalf of the Company during the fourth quarter ended December 31, 2007:
Five-Year Stock Performance Graph The graph below compares the yearly percentage change in the cumulative shareholder return on the Company’s common stock during the five years ended December 31, 2007 with: (i) the Total Return Index for the NASDAQ Stock Market (U.S. Companies) as reported by the Center for Research in Securities Prices and (ii) the Total Return Index for NASDAQ Bank Stocks as reported by the Center for Research in Securities Prices. This comparison assumes $100.00 was invested on December 31, 2002, in the Company’s common stock and the comparison groups and assumes the reinvestment of all cash dividends prior to any tax effect and adjusted to give retroactive effect to material changes resulting from stock dividends and splits.
*Northwest Community Banks consists
of publicly traded commercial banks, excluding Cascade Bancorp,
15 ITEM 6. SELECTED FINANCIAL DATA The following consolidated selected financial data is derived from the Company’s audited consolidated financial statements as of and for the five years ended December 31, 2007. The following consolidated financial data should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and related notes included elsewhere in this report. All of the Company’s acquisitions during the five years ended December 31, 2007 were accounted for using the purchase method. Accordingly, the operating results of the acquired companies are included with the Company’s results of operations since their respective dates of acquisition. Dollars in thousands, except per share data and ratios; unaudited
____________________
16 Dollars in thousands, except per share data and ratios; unaudited
____________________ Notes:
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This discussion highlights key information as determined by management but may not contain all of the information that is important to you. For a more complete understanding, the following should be read in conjunction with the Company’s audited consolidated financial statements and the notes thereto as of December 31, 2007 and 2006 and for each of the years in the three-year period ended December 31, 2007 included elsewhere in this report. Cautionary Information Concerning Forward-Looking Statements This annual report on Form 10-K contains forward-looking statements, which are not historical facts and pertain to our future operating results. These statements include, but are not limited to, our plans, objectives, expectations and intentions and are not statements of historical fact. When used in this report, the word “expects,” “believes,” “anticipates,” “could,” “may,” “will,” “should,” “plan,” “predicts,” “expects,” “projections,” “potential,” “continue” and other similar expressions constitute forward-looking statements, as do any other statements that expressly or implicitly predict future events, results or performance, and such statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Certain risks and uncertainties could cause actual results to differ materially from those expressed or implied forward-looking statements, including, among others, the risk factors described in this report as well as general business and economic conditions, including the residential and commercial real estate markets; changes in interest rates including timing or relative degree of change; competition 17 in the industry; changes in regulatory conditions or requirements or new legislation; and changes in accounting policies. In addition, these forward-looking statements are subject to assumptions with respect to future business conditions, strategies and decisions, and such assumptions are subject to change. Results may differ materially from the results discussed due to changes in business and economic conditions that negatively affect credit quality, which may be exacerbated by our concentration of operations in the States of Oregon and Idaho generally, including the Oregon communities of Central Oregon, Northwest Oregon, Southern Oregon, and the greater Boise area, specifically. Likewise, competition or changes in interest rates could negatively affect the net interest margin, as could other factors listed from time to time in the Company’s SEC reports. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The Company undertakes no obligation to publish revised or updated forward-looking statements to reflect the occurrence of unanticipated events or circumstances after the date hereof. Readers should carefully review all disclosures filed by the Company from time to time with the SEC. Critical Accounting Policies Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and could potentially result in materially different results under different assumptions and conditions. We believe that our most critical accounting policies upon which our financial condition depends, and which involve the most complex or subjective decisions or assessments are as follows: Reserve for Credit Losses: Arriving at an appropriate level of reserve for credit losses (reserve for loan losses and loan commitments) involves a high degree of judgment and assessment of multiple variables that result in relatively complex calculations and analysis. The Company’s reserve for credit losses provides for probable losses based upon evaluations of known and inherent risks in the loan portfolio. Management uses historical information to assess the adequacy of the reserve for credit losses and considers factors with respect to the prevailing business environment. The reserve may be affected by changing economic conditions and various external factors, which may impact the portfolio in ways currently unforeseen. The reserve is increased by provisions for loan losses and by recoveries of loans previously charged-off and reduced by loans charged-off. For a full discussion of the Company’s methodology of assessing the adequacy of the reserve for credit losses. See “Reserve for Credit Losses” later in this report. Mortgage Servicing Rights (MSRs): Determination of the fair value of MSRs requires the estimation of multiple interdependent variables, the most impactful of which is mortgage prepayment speeds. Prepayment speeds are estimates of the pace and magnitude of future mortgage payoff or refinance behavior of customers whose loans are serviced by the Company. Errors in estimation of prepayment speeds or other key servicing variables could subject MSRs to impairment risk. On a quarterly basis, the Company engages a qualified third party to provide an estimate of the fair value of MSRs using a discounted cash flow model with assumptions and estimates based upon observable market-based data and methodology common to the mortgage servicing market. Management believes it applies reasonable assumptions under the circumstances, however, because of possible volatility in the market price of MSRs, and the vagaries of any relatively illiquid market, there can be no assurance that risk management and existing accounting practices will result in the avoidance of possible impairment charges in future periods. See also “Non-Interest Income” later in this item, Note 6 of the Consolidated Financial Statements included elsewhere in this report. Highlights and Summary of Performance – Q4 and Full Year 2007 Financial Performance
18 The Company reported 2007 full year diluted earnings per share (EPS-diluted) at $1.05 per share down 21.6% as compared to 2006 with net income at $30.0 million versus $35.7 million for 2006. The fourth quarter included a $15.6 million (pre-tax) provision for loan losses to increase the Company’s level of credit reserves primarily related to deterioration within its residential land development loan portfolio. Of this amount, $1.7 million was to increase the unallocated portion of the reserve for credit losses to approximately 10% of the total reserves. This action is taken in recognition of the elevated level of uncertainty as to the severity of the real estate downturn and its related effects on loan credit quality. These actions resulted in a full year 2007 provision for loan losses of $19.4 million versus $6.0 million in 2006. Fourth quarter 2007 earnings were $0.01 per share on $.3 million of net income, compared to $0.36 per share and $10.2 million for the year ago quarter and as compared to $0.35 for the linked-quarter. Fourth quarter net-charge-offs were approximately $6.5 million, a majority of which were against loans affected by the real estate downturn. With the elevated provision for loan losses in the fourth quarter, return on equity was 0.36% for that period and 10.92% for the full year of 2007. Return on tangible equity was 0.61% for the fourth quarter and 18.83% for the full year, while return on assets was 0.04% for the fourth quarter and 1.28% for the full year. Loan growth and credit quality At December 31, 2007, Cascade’s loan portfolio had grown to $2.04 billion, up 8.2% compared to a year ago. However, due to the general effects of the downturn in the real estate market coupled with seasonal slowing in the pace of construction and real estate activity during the fourth quarter, loan volumes were essentially flat when compared to the linked quarter. “See Loans – Loan Portfolio Comparison” below. Cascade recorded an elevated level of fourth quarter loan loss provision at $15.6 million, which brought the full year provision to $19.4 million. Net loan charge-offs were $6.5 million or 1.27% (annualized) of total loans for the quarter compared to 0.31% (annualized) for the linked-quarter. Non-performing assets (NPA’s) were $55.7 million as of December 31, 2007, or 2.73% of total loans compared to $21.5 million or 1.05% of total loans for the linked-quarter. Of this NPA balance, assets classified as ‘other real estate owned’ totaled $9.8 million. Current NPA’s are primarily comprised of residential land development and construction related credits in the Boise, Idaho and Southern Oregon markets. The reserve for credit losses totaled 1.81% of loans at year end, compared to 1.42% a year earlier and 1.37% for the linked-quarter. The 2007 increase in reserve for credit losses and the elevated level of NPA’s recognized by the Company were mainly due to heightened credit risk in its residential land development portfolio. The nationwide downturn in real estate has slowed lot and home sales within the Company’s markets. This has impacted certain developers by lengthening the marketing period of their projects and negatively affecting borrower liquidity and collateral values. See “Loans – Real Estate Loan Concentration” Below. Management believes reserves are at an appropriate level based upon its current evaluation and analysis of portfolio credit quality and prevailing economic conditions. With uncertainty as to the depth and duration of the real estate slowdown and its economic effect on the communities within Cascades’ banking markets, no assurance can be given that the reserve will be adequate in future periods. If the real estate economy continues to deteriorate, an elevated level of loan loss provisioning may be required in the future. See “Loan Loss Provision” below. Deposit growth At December 31, 2007, customer relationship deposits2 were up 7.2% compared to a year ago but decreased 2.9% on a linked-quarter basis. This decline in part reflects the end of the peak summer and fall tourism and construction season wherein deposit balances typically ease through the winter quarter. However, management also believes a general slowing in real estate activity has contributed to this trend, as deposits in real estate related business accounts show a reduction in average and end of period balances as compared to the prior year and quarter. This is particularly evident in a decline in non-interest bearing deposits where customer retention was strong, but average balances fell $31.2 million or 6.5% between the third and fourth quarters of 2007. The declines were largely in Central Oregon where the Company has 29% deposit market share. Total deposits at December 31, 2007 were $1.7 billion, up 0.3% ____________________
19 compared to a year ago and down 7.0% on a linked-quarter basis, as brokered deposits declined $48.3 million during the quarter. The fourth quarter decline in non-core deposits were mainly because management tactically replaced higher cost brokered deposits with lower cost borrowings. See “Deposit Liabilities and Time Deposit Maturities.” Non-interest income and expense Non-interest income for 2007 was $21.1 million, 16.4% above the prior year, including service fee income which was at $9.7 million, up 20.2% from the prior year mainly because of increased activity and attendant full year effect of additional volumes from the April 2006 acquisition of the F&M bank in Boise, Idaho. For the full year 2007, residential mortgage originations totaled $170.1 million, down 3.2% when compared to $176.6 million in 2006. Related net mortgage revenue was $2.7 million, a decrease 0.1% compared to $3.0 million for the previous year. Fourth quarter net mortgage revenue was $.7 million, slightly less than the third quarter of $.8 million. Note that delinquency rate within Cascade’s nearly $500 million portfolio of serviced residential mortgage loans remains substantially better than national norms at only 0.19% in Oregon and 0.42% in Idaho. Non-interest expense for the year increased 18.0% compared to 2006 and fourth quarter expenses were 4.5% above the year ago quarter. The year-over-year increase was primarily due to higher human resources costs in support of Cascade’s ongoing growth and infrastructure investments. Importantly, the Company successfully converted to a more robust core information technology system during the fourth quarter of 2007, providing an enhanced platform to support growth in the years ahead. As the Company adjusts to a lower level of real estate related business activity, management anticipates a very modest increase in non interest expense for 2008. See “Non-Interest Income / Net Interest Margin” below. RESULTS OF OPERATIONS - Years ended December 31, 2007, 2006, and 2005 Income Statement Overview Net Income Net income for 2007 decreased $5.7 million, or 16.0% compared to 2006. The decrease was primarily due to a year over year increase in loan loss provision of $13.4 million. For the year, net interest income increased $10.2 million or 10.4% and non-interest income was higher by $3.0 million or 16.4%. Non-interest expense increased $9.5 million or 18.0% for the year primarily due to higher human resources costs in support of Cascade’s ongoing growth and infrastructure investments. In addition, tax expense decreased 18.5% as a result of a decrease in net income. Net income for 2006 increased $13.3 million as compared to 2005. This increase was primarily due to Cascade’s acquisition of F&M, along with an increase of $3.0 million in net interest income, offset in part by increases of $9.5 million in non interest expense and $3.0 in loan loss provision. Net Interest Income / Net Interest Margin For most financial institutions, including the Company, the primary component of earnings is net interest income. Net interest income is the difference between interest income earned, principally from loans and investment securities portfolio, and interest paid, principally on customer deposits and borrowings. Changes in net interest income typically result from changes in volume, spread and margin. Volume refers to the dollar level of interest-earning assets and interest-bearing liabilities. Spread refers to the difference between the yield on interest-earning assets and the cost of interest-bearing liabilities. Margin refers to net interest income divided by interest-earning assets and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities. Primarily because of higher loan volumes, total interest income increased approximately $32.6 million (or 23.5%) for 2007. Increased volumes of interest bearing deposits and borrowings in conjunction with higher interest rates paid caused total interest expense to increase approximately $22.4 million (or 55.6%) for 2007 as compared to the prior year. Net interest income increased to $108.5 million or 10.4% in 2007 over 2006 as average earning assets increased 21.5% over 2006. 2006 net interest income increased 65.0% over 2005 primarily due to the acquisition of F&M and continued loan growth. Higher market interest rates contributed to this increase, as yields increased on a larger base of earning assets, exceeding the higher cost of funds on incremental liability balances. Yields earned on assets increased to 8.21% for 2007, as compared to 8.07% in 2006 and 6.94% in 2005. Meanwhile, the average rates paid on interest bearing liabilities for 2007 increased to 4.01% in 2007 from 3.42% in 2006 and 2.07% in 2005. Note that with the Federal Reserve lowering market rates aggressively beginning in late 2007 and early 2008, loan yields and rates paid are likely to decline into 2008. 20 The Company’s net interest margin (NIM) decreased to 5.23% for 2007, as compared to 5.73% for 2006. In addition, the Company reported a decline in its NIM to 4.94% for the fourth quarter of 2007, compared to 5.24% for the preceding quarter and 5.54% for the year ago quarter. Three factors contributed to the lower NIM for the fourth quarter of 2007 including interest forgone and reversed on NPA’s, lower average balances in non-interest bearing deposit accounts for the quarter, and the effect of lower market interest rates on the Company’s asset and liability mix. The margin can also be affected by factors beyond market interest rates, including loan or deposit volume shifts and/or aggressive rate offerings by competitor institutions. The Company’s financial model indicates a relatively stable interest rate risk profile within a reasonable range of rate movements around the forward rates currently predicted by financial markets. Because of its relatively high proportion of non-interest bearing funds, the Company’s NIM is most adversely affected in the event the federal funds rate falls to a very low level. Components of Net Interest Margin The following table presents further analysis of the components of Cascade’s net interest margin and sets forth for 2007, 2006, and 2005 information with regard to average balances of assets and liabilities, as well as total dollar amounts of interest income from interest-earning assets and interest expense on interest-bearing liabilities, resultant average yields or rates, net interest income, net interest spread, net interest margin and the ratio of average interest-earning assets to average interest-bearing liabilities for the Company:
21 ____________________
Changes in Interest Income and Expense The following table shows the dollar amount of the increase (decrease) in the Company’s consolidated interest income and expense, and attributes such variance to “volume” or “rate” changes. Variances that were immaterial have been allocated equally between rate and volume categories:
The amount of change in net interest income attributed to volume was $17.1 million, primarily due to an increase in the average volume of loans from $1.6 billion in 2006 to $2.0 billion in 2007. The amount of change attributed to rate decreased $6.9 million, primarily due to an increase in the yield on interest bearing demand from 2.82% in 2006 to 3.46% in 2007. Loan Loss Provision At December 31, 2007, the reserve for credit losses (reserve for loan losses and reserve for unfunded commitments) was 1.81% of outstanding loans, as compared to 1.42% for the year ago period. The loan loss provision was $19.4 million in 2007, $6.0 million in 2006 and $3.1 million in 2005. Provision expense is determined by the Company’s ongoing analytical and evaluative assessment of the adequacy of the reserve for credit losses. At December 31, 2007, management believes that its reserve for credit losses is at an appropriate level under current circumstances and prevailing economic conditions. For further discussion, see “Reserve for Credit Losses” below. There can be no assurance that the reserve for credit losses will be sufficient to cover actual loan related losses. See Item 1A “Risk Factors” and “Highlights – Loan Growth and Credit Quality” earlier in this item. 22 Non-interest Income Total non-interest income was $21.1 million, 16.4% above the prior year, including service fee income which was at $9.7 million, up 20.2% from the prior year mainly because of increased activity and attendant full year effect of additional volumes from the April 2006 acquisition of the F&M bank in Boise, Idaho. The 2006 increase was due to the acquisition of F&M, which brought increased volume of banking accounts and related fee-based transaction activity in deposit account services and overdraft transactions. Income related to residential mortgage origination activity was slightly lower in 2007 as compared to 2006 due to the slowing real estate activity in both Idaho and Oregon. Mortgage Banking Income - Home Mortgage Originations and Mortgage Related Revenue The Company provides residential mortgage services on a direct to customer basis and does no business through third party (brokerage) channels. The Company has focused its originations in conventional mortgage products while avoiding option-ARM or high leverage products such as those that have led to the much publicized failures of sub-prime type mortgage firms. The low delinquency rate within Cascade’s loan servicing portfolio underscores this long-held discipline in mortgage origination. At year end, the portfolio contained over 3,600 mortgage loans of which only 7 were past due more than 30 days. The delinquency rate on this nearly $500 million portfolio of serviced residential mortgage loans remains substantially better than national norms at only 0.19%. Residential mortgage originations totaled $170.1 million in 2007, down 3.2% when compared to $176.6 million in 2006. Related net mortgage revenue was $2.7 million, a decrease 0.1% compared to $3.0 million for the previous year. Non-Interest income arising from mortgage services totaled approximately $3.0 million in 2006 compared to $2.3 million in 2005. The general level and direction of interest rates directly influence the volume and profitability of mortgage banking. Rates continued to stabilize in 2007 and 2006, compared to a modest increase in 2005. The Company sells a significant portion of its residential mortgage loans to Fannie Mae, a U.S. Government sponsored enterprise and other secondary market investors. The Company services such loans for Fannie Mae and is paid approximately .25% per annum on the outstanding balances for providing this service. Such revenues are included in the above mortgage banking results. Mortgages serviced for Fannie Mae totaled $494.0 million at December 31, 2007, relatively flat as compared to $494.9 million at December 31, 2006 and slightly lower then the $498.7 million at December 31, 2005. The related Mortgage Servicing Rights (MSRs) were approximately $3.8 million in 2007and $4.1 million in 2006. The Company capitalizes the estimated market value of MSRs into income upon the sale of each originated mortgage loan. The Company amortizes MSRs in proportion to the servicing income it receives from Fannie Mae over the estimated life of the underlying mortgages, considering prepayment expectations and refinancing patterns. In addition, the Company amortizes, in full, any remaining MSRs balance that is specifically associated with a serviced loan that is refinanced or paid-off. At December 31, 2007, expressed as a percentage of loans serviced, the book value of MSR was .76% of serviced mortgage loans, while fair value was approximately 1.07% of serviced mortgages. Fair value as a percentage of loans serviced was estimated at 1.12% a year ago. Mortgage loans not sold to the Federal National Mortgage Association (“Fannie Mae” or “FNMA”), are generally sold servicing released to other secondary market investors. Loans sold on this basis generate no future servicing fees for the Company. Non-interest Expenses Total non-interest expense for 2007 increased 18.0% to $62.5 million as compared to 2006. This increase was primarily due to higher human resources costs in support of Cascade’s ongoing growth and infrastructure investments. Importantly, the Company successfully converted to a more robust core information technology system during the fourth quarter of 2007, providing an enhanced platform to support growth in the years ahead. Total non-interest expenses for 2006 were 54.9% higher compared to 2005, primarily due to the acquisition of F&M. The Company’s efficiency ratio was 48.2% in 2007 compared to 45.5% in 2006, notably better than peer banks for the period. As the Company adjusts to a lower level of real estate related business activity, management anticipates a very modest increase in non interest expense for 2008. 23 Income Taxes The provision for income taxes decreased in 2007 primarily as a result of lower pre-tax income and increased in 2006 over 2005 due to higher pre-tax income. The Company’s effective tax rate remains lower than the statutory tax rate due to nontaxable income generated from investments in bank owned life insurance, tax-exempt municipal bonds, business energy tax credits and low income housing credits. Financial Condition Balance Sheet Overview Total assets increased 6.8% to $2.4 billion at December 31, 2007, compared to $2.2 billion at December 31, 2006. Loans grew $159.5 million or 8.5% to $2.0 billion at year-end 2007. Growth in total assets was primarily funded by other borrowings which increased to $327.9 million or 91.4% over 2006. Deposits remained relatively flat at $1.7 billion or .3% above the prior year-end, mainly due to a decrease in brokered time deposits of $86.5 million that were included in 2006. Taking these brokered time deposits into consideration, deposits actually increased approximately 5.8% year-over-year The following sections provide detailed analysis of the Company’s financial condition, describing its investment securities, loan portfolio composition and credit risk management practices (including those related to the loan loss reserve), as well as its deposits, and capital position. Investment Securities The following table shows the carrying value of the Company’s portfolio of investments at December 31, 2007, 2006, and 2005.
Mortgage-backed securities (MBS) are mainly adjustable rate (ARM) MBS. Prepayment speeds on mortgages underlying MBS may cause the average life of such securities to be shorter (or longer) than expected. 24 The Company’s investment portfolio decreased by $19.9 million, or 18.6% from December 31, 2006 to December 31, 2007 as a result of ordinary maturities and prepayments on securities within the portfolio. The following is a summary of the contractual maturities and weighted average yields of investment securities at December 31, 2007:
The average years to maturity of the Company’s investment portfolio was 4.8 years at December 31, 2007 compared to 5.1 years at December 31, 2006. Investments are mainly classified as “available for sale” and consist mainly of MBS and Agency notes backed by government sponsored enterprises, such as the Government National Mortgage Association (“Ginnie Mae”), FNMA and FHLB. The Company regularly reviews its investment portfolio to determine whether any securities are other than temporarily impaired. The Company did not invest in securities backed by sub-prime mortgages and believes its investment portfolio has negligible exposure to such risk at this date. At December 31, 2007, the portfolio had an unrealized loss on available for sale securities of approximately $.1 million and no other than temporary impaired securities. Loans Loan Portfolio Composition Net loans represent 84% of total assets as of December 31, 2007. The Company makes substantially all of its loans to customers located within the Company’s service areas. As a result of the economic conditions and characteristics of the Company’s primary markets, including among others, the rapid growth in population and the nature of the tourism and service industry found in much of its market areas, Cascade’s loan portfolio has historically been concentrated in real estate related loans. At the time of the 2006 acquisition of F&M in Boise, Idaho, F&M’s loan 25 portfolio was similar in composition to that of Cascade. While the Company has sought to increase the diversification of its loan portfolio by geography and loan type, it is expected that real estate lending will continue to be a major concentration within the loan portfolio. The Company has no significant agricultural loans. The following table presents the composition of the Company’s loan portfolio, at the dates indicated:
The following table provides the geographic distribution of the Company’s loan portfolio by region as a percent of total company-wide loans at December 31, 2007:
At December 31, 2007, the contractual maturities of all loans by category were as follows:
At December 31, 2007, variable and adjustable rate loans contractually due after one year totaled $1.0 billion and loans with predetermined or fixed rates due after one year totaled $256.2 million. 26 Real Estate Loan Concentration Risk Real estate loans have historically represented a significant portion of the Company’s overall loan portfolio and real estate is frequently a material component of collateral for the Company’s loans. Approximately two-thirds of total loans have exposure to real estate, including construction and lot loans (comprised of land development plus residential and commercial construction loan types), commercial real estate loans, residential mortgage loans, and consumer real estate. Risks associated with real estate loans include fluctuating land values, demand and prices for housing or commercial properties, national, regional and local economic conditions, changes in tax policies, and concentration within the Bank’s market area. Management believes that, because of the strong historic and projected population in-migration and related economic growth expected in the Bank’s markets, its real estate concentration risk is mitigated to an acceptable level over the long term. However no assurance can be given that the Company’s assessment of its real estate risk will be accurate in either the short or long term. The following paragraphs provide information on portions of the Company’s real estate loan portfolio, specifically Construction/lot and Commercial Real Estate. All such lending activities are subject to the varied risks of real estate lending. The Company’s loan origination process requires specialized underwriting, collateral and approval procedures, which mitigates, but does not eliminate the risk that loans may not be repaid. Note that the minor balance differences between the preceding and following tables are a result of the inclusion of net deferred loan fees in the above tables. (a) Residential land development category. This category is included in the construction/lot portfolio balances above, and represents loans made to developers for the purpose of acquiring raw land and/or for the subsequent development and sale of residential lots. Such loans typically finance land purchase and infrastructure development of properties (i.e. roads, utilities, etc.) with the aim of making improved lots ready for subsequent sale to consumers or builders for ultimate construction of residential units. The primary source of repayment of such loans is generally the cash flow from developer sale of lots or improved parcels of land while real estate collateral, secondary sources and personal guarantees may provide an additional measure of security for such loans. Strong demand for housing as well as the market expansion opportunity associated with the Company’s acquisition of F&M in 2006 has led to loan growth in this category in recent years. However, the recent nationwide downturn in real estate has slowed lot and home sales within the Company’s markets especially in late 2007 and early 2008. This has impacted certain developers by lengthening the marketing period of their projects and negatively affecting borrower liquidity and collateral values. Weakness in this category of loans contributed significantly to the elevated level of provision for loan losses in the fourth quarter of 2007. The situation continues to be closely monitored and an elevated level of provisioning may be required should deterioration continue.
27 (b) Residential construction category. This category is included in the construction/lot portfolio balances above, and represents financing of homeowner or builder construction of new residences where the obligor generally intends to own the home upon construction (pre-sold), or builder construction of homes for resale (speculative construction). Pre-sold construction loans are underwritten to facilitate permanent mortgage (take-out) financing at the end of the construction phase. Especially with the turmoil in mortgage markets of the last year, no assurance can be made that committed take-out financing will be available at conclusion of construction. Speculative construction lending finances builders/contractors who rely on the sale of completed homes to repay loans. The Bank may finance construction costs within residential subdivisions or on a custom site basis. Speculative construction loans increased with the 2006 acquisition of F&M and grew at a steady pace in 2007 as a result of the overall growth in population and demand for housing within the communities served by the Bank. The nationwide downturn in residential real estate has slowed lot and home sales within the Company’s markets. This may impact certain builders by lengthening the marketing period for constructed homes and negatively affecting borrower liquidity and collateral values.
(c) Commercial construction category. This category is included in the construction/lot portfolio balances above, and represents lending to finance the construction or development of commercial properties. Obligors may be the business owner/occupier of the building who intends to operate its business from the property upon construction, or non owner (speculative) developers. The expected source of repayment of these loans is typically the sale or refinancing of the project upon completion of the construction phase. In certain circumstances, the Company may provide or commit to take-out financing upon construction. Take-out financing is subject to the project meeting specific underwriting guidelines. No assurance can be given that such take-out financing will be available upon project completion. 28 The 2007 growth in this portion of the overall construction portfolio is largely a result of opportunities in the Northwest Oregon region of the Bank where the Portland market has remained relatively strong with trade, technology and services. No assurance can be given that the relative economic strength of this market will continue. While the severity of the housing-led downturn generally has not had a proportional impact on the credit quality and performance of commercial construction at this time, no assurance can be given that residential real estate or other economic events will not adversely impact this category of our loan portfolio.
(d) Commercial real estate (CRE) portfolio. This $614.9 million portfolio generally represents loans to finance retail, office and industrial commercial properties. The expected source of repayment of CRE loans is generally the operations of the borrower’s business, rents or the obligor’s personal income. Management believes that commercial real estate collateral may provide an additional measure of security for such loans. CRE loans represent approximately 32% of total loans outstanding as of December 31, 2007. Approximately 53% of CRE loans are made to owner-occupied users of the commercial property, while 47% of CRE loans are to obligors who do not directly occupy the property. Management believes that lending to owner-occupied businesses mitigates, but does not eliminate, commercial real estate risk. While the severity of the housing-led downturn generally has not had a proportional impact on the credit quality and performance of CRE portfolio as of December 31, 2007, no assurance can be given that residential real estate or other economic factors will not adversely impact the CRE portfolio.
The following table provides the geographic distribution of the Company’s CRE loan portfolio by region as a percent of total company-wide CRE loans at December 31, 2007:
29 Lending and Credit Management The Company has a comprehensive risk management process to control, underwrite, monitor and manage credit risk in lending. The underwriting of loans relies principally on an analysis of an obligor’s historical and prospective cash flow augmented by collateral assessment, credit bureau information, as well as business plan assessment. Ongoing loan portfolio monitoring is performed by a centralized credit administration function including review and testing of compliance to loan policies and procedures. Internal and external auditors and bank regulatory examiners periodically sample and test certain credit files as well. Risk of nonpayment exists with respect to all loans, which could result in the classification of such loans as non-performing. Certain specific types of risks are associated with different types of loans. Reserve for Credit Losses The reserve for credit losses (reserve for loan losses and reserve for unfunded commitments) represents management’s recognition of the assumed and present risks of extending credit and the possible inability or failure of the obligors to make repayment. The reserve is maintained at a level considered adequate to provide for losses on loans and unfunded commitments based on management’s current assessment of a variety of current factors affecting the loan portfolio. Such factors include loss experience, review of problem loans, current economic conditions, and an overall evaluation of the quality, risk characteristics and concentration of loans in the portfolio. The level of reserve for credit losses is also subject to review by the bank regulatory authorities who may require increases to the reserve based on their evaluation of the information available to it at the time of its examination of the Bank. The reserve is based on estimates, and ultimate losses may vary from the current estimates. These estimates are reviewed periodically, and, as adjustments become necessary, they are reported in earnings in the periods in which they become known. The reserve is increased by provisions charged to operations and reduced by loans charged-off, net of recoveries. See “Income Statement Overview – Loan Loss Provision” above. The following describes the Company’s methodology for assessing the appropriate level of the reserve for loan losses. For this purpose, loans and related commitments to loan are analyzed and reserves categorized into the allocated reserve, specifically identified reserves for impaired loans, the unallocated reserve, or the reserve for unfunded loan commitments. The allocated portion of the reserve and the reserve for unfunded loan commitments is calculated by applying loss factors to outstanding loan balances and commitments to loan, segregated by differing risk categories. Loss factors are based on historical loss experience, adjusted for current economic trends, portfolio concentrations and other conditions affecting the portfolio. In certain circumstances with respect to adversely risk rated loans, loss factors may utilize information as to estimated collateral values, secondary sources of repayment, guarantees and other relevant factors. The allocated portion of the consumer loan reserve is estimated based mainly upon a quarterly credit scoring analysis. Impaired loans are either specifically allocated for in the reserve for loan losses or reflected as a partial charge-off of the loan balance. The Bank considers loans to be impaired when management believes that it is probable that either principal and/or interest amounts due will not be collected according to the contractual terms. Impairment is measured on a loan-by-loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price or the estimated fair value of the loan’s underlying collateral or related guaranty. Since a significant portion of the Bank’s loans are collateralized by real estate, the Bank primarily measures impairment based on the estimated fair value of the underlying collateral or related guaranty. In certain other cases, impairment is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate. Smaller balance homogeneous loans (typically installment loans) are collectively evaluated for impairment. Accordingly, the Bank does not separately identify individual installment loans for impairment disclosures. Generally, the Bank evaluates a loan for impairment when a loan is determined to be adversely risk rated. The unallocated portion of the reserve is based upon management’s evaluation of various factors that are not directly measured in the determination of the allocated and specific reserves. Such factors include uncertainties in economic conditions, uncertainties in identifying triggering events that directly correlate to subsequent loss rates, risk factors that have not yet manifested themselves in loss allocation factors and historical loss experience data that may not precisely correspond to the current portfolio. Examples of such factors could include originating loans 30 in new or unfamiliar markets, initiating new loan programs or products, or initiating specialty lending to industry sectors that may be new to the Company. Although this allocation process may not accurately predict credit losses by loan type or in aggregate, the total reserve for credit losses is available to absorb losses that may arise from any loan type or category. Due to the subjectivity involved in the determination of the unallocated portion of the reserve for loan losses, the relationship of the unallocated component to the total reserve for loan losses may fluctuate from period to period. During the fourth quarter of 2007, the Company increased its unallocated reserve to approximately $3.7 million or 10% of total reserves in response to the elevated level of uncertainty as to the severity of the real estate downturn and its related effects on loan credit quality. No assurance can be given that this increase in unallocated reserves will be sufficient for future periods or circumstances. The total amount of actual loan losses may vary significantly from the estimated amount. No assurance can be given that, in any particular period, loan losses will not be sustained that are sizable in relation to the amount reserved, or that changing economic factors or other environmental conditions could cause increases in the loan loss provision. The Bank’s ratio of reserve for credit losses to total loans has been relatively stable for the last several years but increased especially in the fourth quarter of 2007 reflecting higher risk resulting from the real estate downturn especially with respect to deterioration in the land development loan portfolio discussed above. The reserve was 1.81% at December 31, 2007 compared to 1.42% at December 31, 2006, and 1.40% at December 31, 2005. At this date, management believes that the Company’s reserve is at an appropriate level under current circumstances and prevailing economic conditions. Effective in the fourth quarter of 2006, the Company began classifying reserves for unfunded commitments as a liability on the consolidated balance sheet. Such reserves are included as part of the overall reserve for credit losses. Prior to 2006, unfunded commitments were classified in accordance with industry practice of other banks in our peer group. Reserves for unfunded commitments totaled approximately $3,163 and $3,213 at December 31, 2007 and 2006, respectively. Allocation of Reserve for Credit Losses The increase in unallocated portion of the reserve as well as the higher reserve allocated to the construction/lot portfolio reflects the elevated level of uncertainty as to the severity of the real estate downturn and its related effects on loan credit quality in general and most specifically as to the land development portfolio. Typical factors leading to changes in reserve allocation include changes in debt service coverage ratios, guarantor and/or collateral valuation as well as economic conditions that may have a specific or generalized impact on the relative risks inherent in various loan portfolios. Although this allocation process may not accurately predict credit losses by loan type or in aggregate, the total reserve for loan losses is available to absorb losses that may arise from any loan type or category. 31 The following table allocates the reserve for credit losses among major loan types.
32 The following table summarizes the Company’s reserve for credit losses and charge-off and recovery activity for each of the last five years:
The following table presents information with respect to non-performing assets:
33 The increase in non-performing assets at year-end 2007 is due to heightened credit risk within the residential land development and construction related credits in the Boise, Idaho and Southern Oregon markets. The increase is a result of the nationwide downturn in real estate which has slowed lot and home sales within the Company’s markets. This has impacted certain developers by lengthening the marketing period of their projects and negatively affecting borrower liquidity and collateral values (for further discussion, see “Real Estate Loan Concentration Risk” above). The accrual of interest on a loan is discontinued when, in management’s judgment, the future collectibility of principal or interest is in doubt. Loans placed on nonaccrual status may or may not be contractually past due at the time of such determination, and may or may not be secured. When a loan is placed on nonaccrual status, it is the Bank’s policy to reverse, and charge against current income, interest previously accrued but uncollected. Interest subsequently collected on such loans is credited to loan principal if, in the opinion of management, full collectibility of principal is doubtful. Interest income that was reversed and charged against income for 2007 was $1.2 million, and was insignificant for the years of 2006 and 2005. During our normal loan review procedures, a loan is considered to be impaired when it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans are measured based on the present value of expected future cash flows, discounted at the loan’s effective interest rate or, as a practical expedient, at the loan’s observable market price or the fair market value of the collateral if the loan is collateral dependent. Impaired loans are currently measured at lower of cost or fair value. Certain large groups of smaller balance homogeneous loans, collectively measured for impairment, are excluded. Impaired loans are charged to the allowance when management believes, after considering economic and business conditions, collection efforts and collateral position that the borrower’s financial condition is such that collection of principal is not probable. In addition, net overdraft losses are included in the calculation of the allowance for loan losses per the guidance provided by regulatory authorities early in 2005, in “Joint Guidance on Overdraft Protection Programs.” At December 31, 2007, the Company’s recorded investment in certain loans that were considered to be impaired was $45.9 million and specific valuation allowances were $3.9 million. Impaired loans were insignificant at year-end 2006. Bank-Owned Life Insurance (BOLI) The Company has purchased BOLI to protect itself against the loss of certain key employees and directors due to death and to offset the Bank’s future obligations to its employees under its retirement and benefit plans. See footnote 1 of the Company’s notes to consolidated financial statements located under item 8 of this report. During 2007 the Bank did not purchase any new BOLI, however for 2006 and 2005, the Bank purchased $13.6 million and $1.4 million, respectively. The cash surrender value of the Bank’s total life insurance policies was $33.3 and $31.7 million at December 31, 2007 and 2006, respectively. The Bank recorded income from the BOLI policies of $1.6 million in 2007, $.8 million in 2006 and $.7 million in 2005. The Company owns both general account and separate account BOLI. The separate account BOLI was purchased in the fourth quarter of 2006 as an investment expected to provide a long-term source of earnings to support existing employee benefit plans. The fair value of the general account BOLI is based on the insurance contract cash surrender value. The cash surrender value of the separate account BOLI is the quoted market price of the underlying securities, further supported by a stable value wrap, which mitigates, but may not fully insulate investment against changes in the fair market value depending on severity and duration of possible market price disruption. Liabilities Deposit Liabilities and Time Deposit Maturities. Total deposits for 2007 remained steady when compared to 2006. Meanwhile, total deposits averaged $1.7 billion for the full year 2007, up 20.0% or $289.4 million from the prior year average. 2007 average non-interest-bearing demand was down $40.0 million or 7.8% and average interest bearing demand (including money market deposits) was up $193.0 million or 27.7%. 34 At December 31, 2007, total deposits were $1.7 billion, relatively unchanged from year-end 2006. In order to fund the Company’s strong asset growth, Cascade utilizes brokered and Certificate of Deposit Registry Program (CDARS™) deposits. At December 31, 2007, such brokered deposits totaled $71.4 million and CDARS™ deposits totaled approximately $80.1 million. Rates paid on all interest bearing deposit categories increased in 2007 as the Federal Reserve continued its program to push market rates higher. In addition, the brokered deposits discussed above carry rates that are often at higher national market levels. Historically Cascade has had a relatively high proportion of its deposits in non-interest bearing accounts. However, especially during the latter half of 2006 and into 2007, non interest bearing balances eased to approximately 26.1% of total deposits as of year-end, compared to a full year average of 27.0%. While it is not atypical for Cascade’s deposits to seasonally slow or even decline modestly late in the year after the peak summer construction season, the decline in 2007 appears to be exacerbated as a consequence of the nation-wide slowing in real estate activity following the excessive pace in 2005 and early 2006. Average time deposits during 2007 increased $141.9 million to $340.3 million as compared to 2006 averages. The increase in time deposits primarily resulted from the use of national market brokered CD’s that were part of the Company’s wholesale funding strategies in 2007. In addition, the Bank began using the CDARS™ program in 2006. CDARS™ deposits are utilized to meet the needs of certain customers whose investment policies may necessitate or require FDIC insurance (see “Deposits, Liabilities and Time Deposit Maturities” and “Liquidity and Sources of Funds” in this item). Of the increase in average time deposits during 2007, brokered CD’s and CDARS™ accounted for approximately $48.2 million and $64.1 million, respectively. The Company does not aggressively market time deposits within local markets as they are not believed to be key to its relationship banking strategy. The following table summarizes the average amount of, and the average rate paid on, each of the deposit categories for the periods shown:
As of December 31, 2007, the Company’s time deposit liabilities had the following times remaining to maturity:
35 Junior Subordinated Debentures. The purpose of the Company’s $68.6 million of trust preferred securities was to fund the cash portion of the F&M acquisition, to support general corporate purposes and to augment regulatory capital. Management believes the securities qualify as Tier 1 regulatory capital and are priced at a competitive level. The Company’s obligations under the Junior Subordinated Debentures (the “Debentures”) and related agreements, taken together, constitute a full and irrevocable guarantee by the Company of the obligations of the trusts. The trust preferred securities are subject to mandatory redemption upon the maturity of the Debentures, or upon earlier redemption as provided in the Indenture related to the Debentures. The trust preferred securities may be called by the Company at par at varying times subsequent to September 15, 2011, and may be redeemed earlier upon the occurrence of certain events that impact the income tax or the regulatory capital treatment of the trust preferred securities. See Note 9 of the consolidated financial statements included in Item 8 of this report for additional details. Other Borrowings. At December 31, 2007 the Bank had a total of $117.4 million in long-term borrowings from FHLB with maturities from 2008 to 2025. Approximately $77.3 million of this amount bears a fixed or adjustable weighted average rate of 3.94% while the remaining $40.0 million float with LIBOR. In addition, at December 31, 2007, the Bank had short-term borrowings with FHLB and FRB of approximately $175.8 million and $34.7 million, respectively. At year-end 2006, the Bank had a total of $120.4 million in long-term borrowings from FHLB bearing a weighted-average interest rate of 4.77%. In addition, at December 31, 2006, the Bank had short-term borrowings with FHLB and FRB of approximately $48.8 million and $2.1 million, respectively. See “Liquidity and Sources of Funds” below for further discussion. Contractual Obligations. As of December 31, 2007, the Company has entered into the contractual obligations to make future payments as listed below:
Off-Balance Sheet Arrangements. A schedule of significant off-balance sheet commitments at December 31, 2007 is included in the following table (dollars in thousands):
See Note 13 of the Notes to Consolidated Financial Statements included in Item 8 hereof for a discussion of the nature, business purpose, and importance of off-balance sheet arrangements. Stockholder’s Equity The Company’s total stockholders’ equity at December 31, 2007 was $275.3 million, an increase of $14.2 million from December 31, 2006. The increase primarily resulted from net income for the year ended December 31, 2007 of $30.0 million, less cash dividends paid to shareholders of $10.5 million during 2007, less the cost to repurchase shares of $9.2 million. In addition, at December 31, 2007 the Company had accumulated other comprehensive income of approximately $.5 million. CAPITAL RESOURCES From time to time the Company makes commitments to acquire banking properties or to make equipment or technology related investments of capital. At December 31, 2007, the Company had no material capital expenditure commitments apart from those incurred in the ordinary course of business. 36 Management believes that the capital resources of the Company will be adequate to meet its needs for the reasonable foreseeable future. Additional information regarding capital resources is located in Note 20 of the Notes to the Consolidated Financial Statements included in item 8 this report. LIQUIDITY AND SOURCES OF FUNDS Bancorp is a holding company and its primary sources of liquidity are the dividends received from the Bank. Banking regulations may limit the amount of the dividend that the Bank may pay to the Bancorp. The objective of the Bank’s liquidity management is to maintain ample cash flows to meet obligations for depositor withdrawals, fund the borrowing needs of loan customers, and to fund ongoing operations. Core relationship deposits are the primary source of the Bank’s liquidity. As such, the Bank focuses on deposit relationships with local business and consumer clients who maintain multiple accounts and services at the Bank. Management views such deposits as the foundation of its long-term liquidity because it believes such core deposits are more stable and less sensitive to changing interest rates and other economic factors compared to large time deposits or wholesale purchased funds. The Bank’s customer relationship strategy has resulted in a relatively higher percentage of its deposits being held in checking and money market accounts, and a lesser percentage in time deposits. Total deposits increased in 2006 and 2007 in part due to the use of brokered CD’s where the Bank pays national market rates. The Bank’s present funding mix is diverse, with approximately 76% of its checking account balances arising from business and public accounts and 24% from consumers. The composition of money market and interest-bearing demand accounts was 58% business and 42% consumer. Management invests excess funds in short-term and overnight money market instruments A further source of funds and liquidity is the Bank’s capability to borrow from reliable counterparties. The Bank utilizes its investment securities, certain loans and FHLB Stock to provide collateral to support its borrowing needs. Diversified and reliable sources of wholesale funds are utilized to augment core deposit funding. Policy requires the analysis and testing of such sources to ensure ample cash flow is available under a range of circumstances. Management believes that its focus on core relationship deposits coupled with access to borrowing through reliable counterparties provides reasonable and prudent assurance that ample liquidity is available. However, depositor or counterparty behavior could change in response to competition, economic or market situations or other unforeseen circumstances, which could have liquidity implications that may require different strategic or operational actions. One source of wholesale funding is brokered deposits. At December 31, 2007, such deposits totaled approximately $24.7 million, down from $114.3 million at December 31, 2006. This decline was a result of redeployment to more cost effective borrowing sources because of high rates on brokered deposits. The Bank’s primary counterparty for borrowing purposes is the FHLB. At December 31, 2007, the FHLB had extended the Bank a secured line of credit of $838.6 million that may be accessed for short or long-term borrowings given sufficient qualifying collateral. As of December 31, 2007, the Bank had qualifying collateral pledged for FHLB borrowings totaling $342.4 million. The Bank also had $70.1 million in short-term borrowing availability from the FRB that requires specific qualifying collateral. In addition, the Bank maintained unsecured lines of credit totaling $105.0 million for the purchase of funds on a short-term basis from several commercial bank counterparties. At December 31, 2007, the Bank had remaining available borrowing capacity on its aggregate lines of credit totaling $691.0 million given sufficient collateral. However at December 31, 2007, the Bank’s collateral availability limited such borrowing capacity to approximately $324.4 million in aggregate. Liquidity may be affected by the Bank’s routine commitments to extend credit. Historically a significant portion of such commitments (such as lines of credit) have expired or terminated without funding. In addition, more than one-third of total commitments pertain to various construction projects. Under the terms of such construction commitments, completion of specified project benchmarks must be certified before funds may be drawn. At December 31, 2007, the Bank had approximately $727.4 million in outstanding commitments to extend credit, compared to approximately $713.9 million at year-end 2006. Management believes that the Bank’s available resources will be sufficient to fund its commitments in the normal course of business. 37 INFLATION The effect of changing prices on financial institutions is typically different than on non-banking companies since virtually all of a bank’s assets and liabilities are monetary in nature. In particular, interest rates are significantly affected by inflation, but neither the timing nor magnitude of the changes are directly related to price level indices; therefore, the Company can best counter inflation over the long term by managing net interest income and controlling net increases in noninterest income and expenses. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The disclosures in this item are qualified by the Risk Factors set forth in Item 1A and the Section entitled “Cautionary Information Concerning Forward-Looking Statements” included in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in this report and any other cautionary statements contained herein. Interest Rate Risk and Asset and Liability Management The goal of the Company’s asset and liability management policy is to maximize long-term profitability under the range of likely interest rate scenarios. Interest rate risk management requires estimating the probability and impact of changes in interest rates on assets and liabilities. The Board of Directors oversees implementation of strategies to control interest rate risk. Management hires and engages a qualified independent service provider to assist in modeling, monthly reporting and assessing interest rate risk. The Company’s methodology for analyzing interest rate risk includes simulation modeling as well as traditional interest rate gap analysis. While both methods provide an indication of risk for a given change in interest rates, it is management’s opinion that simulation is the more effective tool for asset and liability management. The Bank has historically adjusted its sensitivity to changing interest rates by strategically managing its loan and deposit portfolios with respect to pricing, maturity or contractual characteristics. The Bank may also target the expansion or contraction of specific investment portfolio or borrowing structures to further affect its risk profile. In addition, the Bank is authorized to enter into interest rate swap or other hedging contracts with re-pricing characteristics that tend to moderate interest rate risk. However, there are no material structured hedging instruments in use at this time. Because of the volatility of market rates, event risk and other uncertainties described below, there can be no assurance of the effectiveness of management programs to achieve its interest rate risk objectives. To assess and estimate the degree of interest rate risk, the Company utilizes a sophisticated simulation model that estimates the possible volatility of Company earnings resulting from changes in interest rates. Management first establishes a wide range of possible interest rate scenarios over a two-year forecast period. Such scenarios routinely include a “stable” or unchanged scenario and an “estimated” or most likely scenario given current and forecast economic conditions. In addition, scenarios titled “rising rates”, “declining rates”, and “alternate declining rates” are established to stress-test the impact of more dramatic rate movements that are perceived as less likely, but may still possibly occur. Next, net interest income and earnings are simulated in each scenario. Note that earnings projections include the effect of estimated loan and deposit growth that management deems reasonable; however, such volume projections are not varied by rate scenario. Note also that the downturn in real estate has caused elevated levels of non performing loans which lowers reported NIM depending on the absolute volume of such assets. Simulated earnings are compared over a two-year time horizon. The following table defines the market interest rates projected in various interest rate scenarios. Generally, projected market rates are reached gradually over the 2-year simulation horizon.
38 The following table presents percentage changes in simulated future earnings under the above-described scenarios as compared to earnings under the “Estimated” rate scenario calculated as of this year end. The effect on earnings assumes no changes in non-interest income or expense between scenarios.
Management’s assessment of interest rate risk and scenario analysis must be considered in the context of market interest rates and overall economic conditions. Beginning in mid 2004, the Federal Reserve engineered a gradual rising in short term market interest rates. Meanwhile, long term rates remained relatively stable resulting in a flattening of yield curve between short and long term rates. However, with the much publicized subprime, real estate and credit market disruptions of 2007, market participants are currently anticipating a rapid decline in rates in 2008. In management’s judgment and at this date, the interest rate risk profile of the Bank is reasonably balanced within the most likely range of possible outcomes. The model indicates that should future interest rates actually follow the path indicated in the “estimated” rate scenario, the net interest margin would range between 4.70% and 4.80% all else being equal. However, with the more dramatic changes reflected in the “rising” or “declining” scenarios, the model suggests the margin would likely fall outside of this range should such interest rates actually occur. This is mainly because the Bank has a large portion of non-interest bearing funds (approximately 25% of total deposits) that are assumed to be relatively insensitive to changes in interest rates. Thus in the event of rising rates, yields on earning assets would tend to increase at a faster pace than overall cost of funds, leading to an improving margin. Conversely, should rates fall to the very low levels assumed in the declining scenario, yields on loans and securities would compress against an already low cost of funds. Also in this declining rate scenario, the model assumes an annualized 35% prepayment rate on loans currently outstanding that would refinance to lower rates, contributing to margin compression. Thus in the declining rate scenario where the federal fund rates fall to just 0.50%, the model indicates that the net interest margin could average approximately 5.1% below the range noted above during the first 12 months of the forecast horizon, and up to 14.7% below during the second twelve months. Management has concluded that the degree of margin and earnings volatility under the above scenarios is acceptable because of the cost of mitigating such risk and because the model suggests that the Bank would still generate satisfactory returns under such circumstances. Please carefully review and consider the following information regarding the risk of placing undue reliance on simulation models, interest rate projections and scenario results. In all scenarios discussed above, results are modeled using management’s estimates as to growth in loans, deposits and other balance sheet items, as well as the expected mix and pricing thereof. These volume estimates are static in the various scenarios. Such estimates may be inaccurate as to future periods. Model results are only indicative of interest rate risk exposure under various scenarios. The results do not encompass all possible paths of future market rates, in terms of absolute change or rate of change, or changes in the shape of the yield curve. Nor does the simulation anticipate changes in credit conditions that could affect results. Likewise, scenarios do not include possible changes in volumes, pricing or portfolio management tactics that may enable management to moderate the effect of such interest rate changes. Simulations are dependent on assumptions and estimations that management believes are reasonable, although the actual results may vary substantially, and there can be no assurance that simulation results are reliable indicators of future earnings under such conditions. This is, in part, because of the nature and uncertainties inherent in simulating future events including: (1) no presumption of changes in asset and liability strategies in response to changing circumstances; (2) model assumptions may differ from actual outcomes; (3) uncertainties as to customer behavior in response to changing circumstances; (4) unexpected absolute and relative loan and deposit volume changes; (5) unexpected absolute and relative loan and deposit pricing levels; (6) unexpected behavior by competitors; and (7) other unanticipated credit conditions or other events impacting volatility in market conditions and interest rates. 39 Interest Rate Gap Table In the opinion of management, the use of interest rate gap analysis is less valuable than the simulation method discussed above as a means to measure and manage interest rate risk. This is because it is a static measure of rate sensitivity and does not capture the possible magnitude or pace of rate changes. At year-end 2006, the Company’s one-year cumulative interest rate gap analysis indicates that rate sensitive liabilities maturing or available for repricing within one-year exceeded rate sensitive assets by approximately $337.0 million. The Company considers its rate-sensitive assets to be those that either contains a provision to adjust the interest rate periodically or matures within one year. These assets include certain loans and leases and investment securities and interest bearing balances with FHLB. Rate-sensitive liabilities are those liabilities that are considered sensitive to periodic interest rate changes within one year, including maturing time certificates, savings deposits, interest-bearing demand deposits and junior subordinated debentures. Set forth below is a table showing the interest rate sensitivity gap of the Company’s assets and liabilities over various re-pricing periods and maturities, as of December 31, 2007:
40 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The following reports, audited consolidated financial statements and the notes thereto are set forth in this Annual Report on Form 10-K on the pages indicated:
41 REPORT OF SYMONDS, EVANS &
COMPANY, P.C., To the Board of Directors and
We have audited the accompanying consolidated balance sheets of Cascade Bancorp and its subsidiary, Bank of the Cascades (collectively, “the Company”), as of December 31, 2007 and 2006, and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2007. The Company’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Cascade Bancorp and its subsidiary as of December 31, 2007 and 2006, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2007 in conformity with accounting principles generally accepted in the United States of America. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control–Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 5, 2008 expressed an adverse opinion.  Portland, Oregon 42 CASCADE BANCORP AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2007 AND 2006 (Dollars in thousands)
See accompanying notes. 43 CASCADE BANCORP AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005 (Dollars in thousands, except per share amounts)
See accompanying notes. 44 CASCADE BANCORP AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005 (Dollars in thousands, except per share amounts)
See accompanying notes. 45 CASCADE BANCORP AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (continued) YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005 (Dollars in thousands, except per share amounts)
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