Columbia Bancorp 10-Q 2007
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the quarterly period ended September 30, 2007
For the transition period from to to
Commission file number: 0-27938
(Exact name of registrant as specified in its charter)
401 East Third Street, Suite 200
The Dalles, Oregon 97058
(Address of principal executive offices)
(Registrants telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o Accelerated filer þ Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
As of November 5, 2007, there were 10,040,935 shares of common stock of Columbia Bancorp, no par value, outstanding.
September 30, 2007
Table of Contents
PART I. FINANCIAL INFORMATION
These consolidated financial statements should be read in conjunction with the financial statements, accompanying notes and other relevant information included in the Companys report on Form 10-K for the year ended December 31, 2006, and the notes and other information included in this report.
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED FINANCIAL STATEMENTS OF COLUMBIA BANCORP AND SUBSIDIARY
COLUMBIA BANCORP AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
See accompanying notes.
COLUMBIA BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
See accompanying notes.
COLUMBIA BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY
See accompanying notes.
COLUMBIA BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes.
COLUMBIA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
The interim consolidated financial statements include the accounts of Columbia Bancorp (Columbia or the Company), an Oregon corporation and a registered financial holding company, and its wholly-owned subsidiary Columbia River Bank (CRB or the Bank), after elimination of intercompany transactions and balances. CRB is an Oregon state-chartered bank, headquartered in The Dalles, Oregon. Substantially all activity of Columbia is conducted through its subsidiary bank, CRB.
The interim financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. The financial information included in this interim report has been prepared by Management. Columbias annual report contains audited financial statements. All adjustments, including normal recurring accruals necessary for the fair presentation of results of operations for the interim periods included herein, have been made. Certain amounts for 2006 have been reclassified to conform to the 2007 presentation. The results of operations for the three months and nine months ended September 30, 2007, are not necessarily indicative of results to be anticipated for the year ending December 31, 2007.
2. Managements Estimates and Assumptions
Various elements of Columbias accounting policies are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. In particular, Management has identified certain policies that are critical to an understanding of the consolidated financial statements due to the judgments, estimates and assumptions inherent in those policies. These policies and judgments, estimates and assumptions are described in greater detail in the notes to the consolidated financial statements included in Columbias annual report on Form 10-K, filed March 16, 2007.
Management believes the judgments, estimates and assumptions used in the preparation of the consolidated financial statements are appropriate given the factual circumstances at the time. However, given the sensitivity of the consolidated financial statements to these critical accounting policies, the use of other judgments, estimates and assumptions could result in material differences in the results of operations or financial conditions.
3. Loans and Allowance for Loan Losses
Loans are stated at the amount of unpaid principal, reduced by an allowance for loan losses and by unearned loan fees, net of deferred loan costs. Interest on loans is calculated using the simple-interest method on daily balances of the principal amount outstanding. Loan origination fees and certain direct origination costs are capitalized and recognized as an adjustment of the yield over the life of the related loan.
The Bank does not accrue interest on loans for which payment in full of principal and interest is not expected, or for which payment of principal or interest has been in default 90 days or more, unless the loan is well-secured and in the process of collection. Non-accrual loans are considered impaired loans. Each impaired loan is carried at the present value of expected future cash flows discounted at the loans effective interest rate, the loans market price, or the fair value of collateral if the loan is collateral-dependent. When a loan is placed on non-accrual status, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received or when the loan is returned to accrual status. Large groups of smaller balance, homogeneous loans may be collectively evaluated for impairment. Accordingly, the Bank may not separately identify individual consumer and residential loans for evaluation of impairment.
Loans on non-accrual status as of September 30, 2007 and December 31, 2006, were $8.97 million and $4.94 million, respectively.
The allowance for loan losses represents an estimate of possible losses associated with the Banks loan portfolio and deposit account overdrafts. The estimate is based on evaluations of loan collectibility and prior loan loss experience. Evaluations consider factors such as changes in the nature and volume of the loan portfolio, overall portfolio quality, Managements review of specific problem loans and current economic conditions that may affect a borrowers ability to pay.
Increases to the allowance for loan losses occur when amounts are expensed to the provision for loan losses or when previously charged-off loans or overdrafts are recovered; decreases occur when loans or overdrafts are charged-off.
Various regulatory agencies, as a regular part of their examination process, periodically review the Banks allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowance based on their judgment of information available to them at the time of the examinations.
4. Earnings Per Share
Basic earnings per share is computed by dividing net income available to shareholders by the weighted-average number of common shares outstanding during the period, after giving retroactive effect to stock dividends and splits. Diluted earnings per share is computed similar to basic earnings per share except the denominator is increased to include the number of additional common shares that would have been outstanding if dilutive potential common shares had been issued. Included in the denominator is the dilutive effect of stock options and awards computed by the treasury stock method.
5. Recently Issued Accounting Standards
In June 2006, the FASB issued FASB Interpretation 48, Accounting for Uncertainty in Income Taxesan interpretation of FASB Statement No. 109. FIN 48 clarifies the accounting and reporting for income taxes where interpretation of the law is uncertain. FIN 48 prescribes a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of income tax uncertainties with respect to positions taken or expected to be taken in income tax returns. FIN 48 is effective for fiscal years beginning after December 15, 2006. Columbia adopted FIN 48 on January 1, 2007. As a result of the adoption, it was not necessary for Columbia to recognize any liability for unrecognized tax benefits.
Columbia and its subsidiary file income tax returns in the U.S. federal jurisdiction and in the State of Oregon jurisdiction. Columbia is no longer subject to examinations by tax authorities in U.S. federal and state jurisdictions for years before 2003. Columbia recognizes interest and penalties accrued related to unrecognized tax benefits in income tax expense.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. The provisions of this standard apply to other accounting pronouncements that require or permit fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. Management does not expect the adoption of SFAS No. 157 to have a material impact on the consolidated financial statements.
In September 2006, the FASB issued SFAS No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans. SFAS No. 158 requires employers to recognize the funded status of defined benefit postretirement plans as a net asset or liability in its statement of financial position and to recognize changes in the funded status in the year in which the changes occur through accumulated other comprehensive income. SFAS No. 158 also requires employers to measure the funded status of a plan as of the date of its year-end statement of financial position. The new reporting requirements and related new footnote disclosure rules of SFAS No. 158 are effective for fiscal years ending after December 15, 2006. The new measurement date requirement applies for fiscal years ending after December 15, 2008. Management does not expect SFAS No.158 to have a material impact on the consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. SFAS No. 159 permits companies to choose, at specified election dates, to measure eligible items at fair value. The standard is designed to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007, or if adopted early, within 120 days of the fiscal year of adoption. Management elected not to apply the early adoption provisions of the standard and is evaluating whether it will choose to apply the fair value option provided by SFAS No. 159.
In September 2006, the FASBs Emerging Issues Task Force (EITF) reached a final consensus on Issue 06-04, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements. EITF 06-04 addresses employer accounting for endorsement split-dollar life insurance arrangements that provide a benefit to an employee that extends to postretirement periods and requires the employer to recognize a liability for future benefits in accordance with SFAS No. 106, Employers Accounting for Postretirement Benefits Other Than Pensions, or Accounting Principles Board (APB) Opinion No. 12, Omnibus Opinion1967. EITF 06-04 is effective for fiscal years beginning after December 15, 2007. The effects of applying this Issue are recognized through either (a) a change in accounting principle through a cumulative-effect adjustment to retained earnings or to other components of equity or net assets in the statement of financial position as of the beginning of the year of adoption or (b) a change in accounting principle through retrospective application to all prior periods. Columbia has endorsement split-dollar life insurance policies that serve as a post-employment benefit to covered employees. Columbia is evaluating the potential impact of this Issue on its consolidated financial statements.
ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
DISCLOSURE REGARDING FORWARD LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains various forward-looking statements that are intended to be covered by the safe harbor provided by Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act). These statements include statements about our present plans and intentions, about our strategy, growth, and deployment of resources, and about our expectations for future financial performance. Forward-looking statements use prospective language, including words like may, will, should, expect, anticipate, estimate, continue, plans, intends, or other similar terminology.
Because forward-looking statements are, in part, an attempt to project future events and explain current plans, they are subject to various risks and uncertainties, which could cause our actions and our financial and operational results to differ materially from those projected in forward-looking statements. These risks and uncertainties include, without limitation, the risks described in Part II Other Information Item 1A Risk Factors.
Information presented in this report is accurate as of the date the report is filed with the SEC. We do not undertake any duty to update our forward-looking statements or the factors that may cause us to deviate from them, except as required by law.
CRITICAL ACCOUNTING POLICIES
The Managements Discussion and Analysis of Financial Condition and Results of Operations, as well as disclosures included elsewhere in this Form 10-Q, are based upon consolidated financial statements which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires Management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an ongoing basis, Management evaluates the estimates used, including the adequacy of the allowance for loan losses, impairment of intangible assets, and contingencies and litigation. Estimates are based upon historical experience, current economic conditions and other factors that Management considers reasonable under the circumstances. These estimates result in judgments regarding the carrying values of assets and liabilities when these values are not readily available from other sources as well as assessing and identifying the accounting treatments of commitments and contingencies. Actual results may differ from these estimates under different assumptions or conditions. The following critical accounting policies involve the more significant judgments and assumptions used in the preparation of the consolidated financial statements.
The allowance for loan losses represents an estimate of possible losses associated with the Banks loan portfolio and deposit account overdrafts. On an ongoing basis, we evaluate the adequacy of the allowance based on numerous factors. These factors include the quality of the current loan portfolio, the trend in the loan portfolios risk ratings, current economic conditions, loan concentrations, loan growth rates, past-due and non-performing loan trends, evaluation of specific loss estimates for significant problem loans, historical charge-off and recovery experience and other pertinent information. Approximately 74% of our loan portfolio is secured by real estate. If there were a significant decrease in real estate values in Oregon and Washington, it may be necessary to increase the allowance for loan losses. A decline in real estate values represents one possible risk factor; other risk factors may also necessitate an increase in the allowance for loan losses.
As of September 30, 2007, our goodwill totaled $7.39 million as a result of business combinations. We follow Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 142, which requires us to evaluate goodwill for impairment not less than annually and to write down the goodwill if the business unit associated with the goodwill cannot sustain the value attributed to it. Our evaluation of the fair value of goodwill involves a substantial amount of judgment. No impairment of goodwill has been identified during the initial and subsequent annual assessments.
Columbia Bancorp (Columbia) is a financial holding company organized in 1996 under Oregon Law. Columbias common stock is traded on the Nasdaq Global Select Market under the symbol CBBO. Columbias wholly-owned subsidiary, Columbia River Bank (CRB or the Bank), is an Oregon state-chartered bank, headquartered in The Dalles, Oregon, through which substantially all business is conducted. CRB offers a broad range of services to its customers, primarily small and medium sized businesses and individuals.
We have a network of 21 full-service branches and 1 commercial service branch. In Oregon, we operate 14 full-service branches and 1 commercial service branch. Our branches serve the northern and eastern Oregon communities of The Dalles, Hood River, Pendleton and Hermiston, the central Oregon communities of Madras, Redmond, and Bend, and the Willamette Valley communities of McMinnville, Canby, Lake Oswego and Newberg. In Washington, we operate 7 full-service branches that serve the communities of Goldendale, White Salmon, Pasco, Yakima, Sunnyside, Richland and Vancouver.
Our goal is to grow our earning assets while maintaining a high return on equity and strong asset quality. We will achieve this goal by emphasizing personalized, quality banking products and services for our customers; by hiring and retaining high performing, experienced branch and administrative personnel; and by responding quickly to customer demand and growth opportunities. We intend to increase market share in our existing markets and expand into new high growth markets through suitable acquisitions and new branch openings.
In September 2007, we announced that Greg Spear, who formerly served as Chief Financial Officer and Chief Administrative Officer, will now serve as Vice Chair and continue as Chief Financial Officer overseeing our finance, information technology and operations teams. We also announced that Staci Coburn moved from Senior Vice President and Controller of CRB to Corporate Vice President and Chief Accounting Officer, as well as Principal Accounting Officer for Columbia Bancorp. In October 2007, we announced the hiring of a new Executive Vice President and Chief Operating Officer, Brian Devereux, who will report to Mr. Spear. In addition to these changes, we realigned the reporting structure of our retail functions to streamline reporting relationships and focus our activities around growing low cost deposits.
Following a period of significant growth and expansion over the last several years, we believe community banks are now facing a changing and more challenging environment due to the real estate market slowdown and competition for low cost deposits. We expect that during the remainder of 2007 and into 2008, balance sheet and earnings growth will moderate from the levels we experienced during the past several years. We have seen these same trends with many of our community bank peers. We believe our current and planned investments in highly skilled personnel and new technologies, along with our existing business strategies, will contribute to our success in the current competitive environment and will position us for the next growth cycle.
The following table presents an overview of our key financial performance indicators:
Key Financial Performance Indicators:
(dollars in thousands except per share data)
Our diluted earnings per share for the three months and nine months ended September 30, 2007 decreased 10% and 11%, respectively, compared to the same periods in 2006. These decreases were primarily due to the effect of our compressing net interest margin, an increase in provision for loan losses and increases in expenses related to expansion of our branch network and administrative operations.
Significant items for the three months and nine months ended September 30, 2007 were as follows:
RESULTS OF OPERATIONS
Net Interest Income
Net interest income, our primary source of operating income, is the difference between interest income and interest expense. Interest income is earned primarily from our loan and investment security portfolios. Interest expense results primarily from customer deposits and borrowings from other sources, including Federal Home Loan Bank advances, wholesale deposits and trust preferred securities. Like most financial institutions, our net interest income increases as we are able to charge higher interest rates on loans while paying relatively lower interest rates on deposits and other borrowings.
The following table presents a comparison of average balances and interest rates:
Net Interest Income Average Balances and Rates:
(dollars in thousands)
Net interest income before provision for loan losses decreased 3% for the three months ended September 30, 2007 compared to same period in 2006. The decrease is primarily attributable to higher interest rates paid on deposits.
Net interest income before provision for loan losses increased 3% for the nine months ended September 30, 2007 compared to same period in 2006. Increases in net interest income on a year-over-year basis were primarily due to loan growth throughout our market areas and new branches in our Columbia Basin region. Interest income increases were partially offset by increases in our cost of funds due to higher wholesale liability balances and promotional certificate of deposits priced in the top quartile of our market.
The following table presents increases in net interest income attributable to volume changes versus rate changes:
Volume vs. Rate Changes:
(dollars in thousands)
From 2006 to 2007, net interest income growth was primarily due to an increase in loan volume offset by approximately equal increases in the volume of, and rates paid on, deposits. Loan volume increases resulted from strong demand for construction and commercial real estate loans throughout our market areas. Deposit volume increased primarily due to wholesale deposits added during 2007 and promotional certificate of deposit offerings. While rates on interest earning assets remained stable since September 2006, rates paid on deposits increased due to the re-pricing of maturing certificates of deposit and competitive pressures to attract and retain deposit customers.
Net interest margin (net interest income as a percentage of average earning assets) measures how well a bank manages its asset and liability pricing and duration. Our tax equivalent net interest margin measured 5.61% and 5.65%, respectively, for the three months and nine months ended September 30, 2007. For the three months and nine months ended September 30, 2006, our net interest margin measured 6.44% and 6.47%, respectively. Compared to 2006, our net interest margin decreased primarily due to an increase in our cost of funds. The increase in our cost of funds resulted from customer deposit balances that shifted towards higher rate deposit accounts due to competitive factors, promotional certificate of deposit offerings and an increase in wholesale liability borrowings to support loan growth.
We expect our net interest margin will trend downward for the remainder of 2007 due to the effect of Fed Funds rate cuts in September 2007 and October 2007. Because our balance sheet is asset sensitive, further decreases in the Fed Funds rate would negatively impact interest income as variable rate loans tied to the Prime Rate would immediately re-price (the Prime Rate has historically followed changes in the Fed Funds rate). In order to mitigate the negative effect of falling interest rates, we have incorporated interest rate floors into approximately 62% of our loans. As of September 30, 2007, our weighted-average floor rate was 7.72%, whereas the weighted-average rate on loans with floors was 8.66% as of September 30, 2007. As a result, loan interest income will continue to decrease if the Fed Funds rate decreases.
Non-interest income is comprised of service charges and fees, credit card discounts, financial services revenues, mortgage banking revenues and gains from the sale of loans, securities and other assets. Mortgage banking revenues include service release premiums and revenues from the origination and sale of mortgage loans. Financial services income is derived from the sale of investments and financial planning services to our customers.
The following table presents the balances and percentage changes in non-interest income:
(dollars in thousands)
Due to an increase in loan production volume in the first half of 2007 and the hiring of seasoned mortgage loan officers, mortgage banking revenues increased during the nine months ended September 30, 2007 compared to the same period in 2006. For the three months ended September 30, 2007, compared to the same period in 2006, mortgage banking revenues decreased primarily due to a volume decrease caused by the slowing residential real estate market, particularly in our Central Oregon region.
From 2006 to 2007, financial services revenue increased due to higher sales per sales representative and changes in product mix.
Provision for Loan Losses
Our provision for loan losses represents an expense against current period income that allows us to establish an adequate allowance for loan and deposit account overdraft losses. Charges to the provision for loan losses result from our ongoing analysis of possible losses in our loan portfolio and possible losses from deposit account overdrafts (see Allowance for Loan Losses section of this report).
For the nine months ended September 30, 2007, compared to the same period in 2006, the provision for loan loss was higher primarily due to collateral deterioration on an agricultural loan to a potato grower during the first six months of 2007.
Non-interest expense consists of salaries and benefits, occupancy costs and various other non-interest expenses.
The following table presents the components of and changes in non-interest expense:
(dollars in thousands)
For the three months ended September 30, 2007, salaries and employee benefits were lower compared to 2006 due to the net effect of several factors. First, incentive compensation decreased in 2007 due to lower financial performance. Second, expense in the third quarter of 2006 was higher due to a salary continuation measurement adjustment totaling $329,260. Third, loan origination costs, which offset salaries and benefits, were higher in 2007 following an update of our cost model (loan origination costs are deferred and recognized over the life of a loan as a reduction in the loan yield). Finally, expense decreases were partially offset by higher salary costs due to an increase in the number of employees. We expect salaries and employee benefits for 2007 will be higher than 2006 primarily due to employees hired for key operational positions.
Occupancy expense and other non-interest expense increased primarily due to the incremental expenses of new branches and office space opened during 2006. Consulting fees increased primarily due to security and compliance testing of our information technology systems, as well as projects to improve those systems. Software licensing expense increased due to new software applications in use during 2007.
The efficiency ratio, which measures overhead costs as a percentage of total revenues, is an important measure of productivity in the banking industry. Because non-interest expense growth outpaced income growth, our efficiency ratio increased to 56.95% and 56.88%, respectively, for the three months and nine months ended September 30, 2007, compared to 56.45% and 54.89% for the same periods in 2006. Increases in our efficiency ratio are primarily attributable to our branch expansion and related administrative overhead expenses.
Provision for Income Taxes
The following table presents the provision for income taxes and effective tax rates:
Provision for Income Taxes:
(dollars in thousands)
We expect our 2007 annual effective tax rate will range between 37.00% and 38.00% and may vary depending on our level of participation in state income tax credits.
MATERIAL CHANGES IN FINANCIAL CONDITION
Our assets are comprised primarily of loans for which we receive interest and principal repayments from our customers, as well as cash and investment securities.
Our investment securities portfolio consists of bank-qualified municipal debt securities, debt securities issued by government agencies, mortgage-backed securities, equity securities and restricted equity securities. Investment securities totaled $34.12 million as of September 30, 2007, a decrease of $3.59 million compared to December 31, 2006. During the nine months ended September 30, 2007, we purchased $4.01 million of government agency bonds to replace matured and called government agency and municipal bonds totaling $7.76 million. We also purchased $733,331 of Community Reinvestment Act eligible securities.
Qualifying securities may be pledged as collateral for public agency deposits or other borrowings. As of September 30, 2007, pledged securities totaled $21.15 million, compared to $23.13 million as of December 31, 2006.
Net unrealized losses on available-for-sale debt and equity securities totaled $24,012, or $14,671 net of tax, as of September 30, 2007, compared to net unrealized losses of $154,422, or $94,815 net of tax, as of December 31, 2006. Net unrealized losses decreased primarily due to changes in the bond market as investors measure the effects of interest rates on the discounted interest payments of bond investments. We currently have no plans to liquidate our available-for-sale securities; we expect to recover the losses over time because we have the ability to hold the securities until a market price recovery or until maturity.
Our loan portfolio reflects our efforts to diversify risk across a range of loan types and industries, and thereby complement the markets in which we do business. Loan products include construction, land development, real estate, commercial, consumer, agriculture and credit cards.
The following table presents our loan portfolio by loan type:
(dollars in thousands)
Gross loans increased 8% and 12% since December 31, 2006 and September 30, 2006, respectively. This was primarily due to real estate construction loan growth throughout our market areas. Due to the strong real estate loan demand of recent years, gross loans have grown at a compounded annual rate of 20% since 2003. Beginning in the second quarter of 2007, we noted a slowing demand for real estate loans throughout our market areas. Due to the recent residential real estate slowdown, we expect loan growth will moderate from the levels we experienced over the last several years. We believe, however, that our growth rate will keep pace with our community bank peers in the Pacific Northwest at relative levels consistent with the last several years.
As of September 30, 2007, construction, land development and commercial real estate loans comprised 74% of our loan portfolio, compared to 70% as of December 31, 2006 and 70% as of September 30, 2006. This concentration is consistent with our Pacific Northwest community bank peers, and like our peers, we could become subject to future losses resulting from declines in real estate development markets and the negative economic effects of fluctuating interest rates. Some borrowers use proceeds from real estate loans for purposes other than real estate development, such as inventory and equipment purchases. In these cases, real estate market declines would represent a more indirect risk of loss because the primary source of repayment is not from real estate, but from other activities.
We participate in non-real estate agricultural lending, which comprises approximately 9% of our total loan portfolio. Agricultural lending has unique challenges that require special expertise. We employ experienced agriculture consultants and loan officers with experience in underwriting and monitoring agricultural loans. In addition, we diversify our agricultural loan portfolio across numerous commodity types and maintain Preferred Lender Status with the Farm Service Agency. This status allows us to participate in Farm Loan Government Guarantee Programs, which provide guarantees of up to 90% on qualified loans. Approximately 15% of our agricultural loans are guaranteed through this program; however, these guarantees are limited and loans under this program are not without credit risk.
We originate and fund single-family mortgage loans that are usually committed for sale to mortgage investors and held for less than 30 days. Mortgage loans held for sale are reported as Loans held-for-sale on our balance sheet. As of September 30, 2007, mortgage loans held for sale totaled $6.36 million compared to $7.54 million as of December 31, 2006.
Allowance for Loan Losses
Our allowance for loan losses represents an estimate of possible losses associated with our loan portfolio and deposit account overdrafts as of the reporting date. The adequacy of the allowance is evaluated each quarter in a manner consistent with the Interagency Policy Statement issued by the Federal Financial Institutions Examination Council (FFIEC) and with FASB SFAS Nos. 5 and 114. In determining the level of the allowance, we estimate losses inherent in all loans, and evaluate non-performing loans to determine the amount, if any, necessary for a specific reserve. Loans not evaluated for impairment and not requiring a specific allocation are subject to a general allocation based on historical loss rates and other subjective factors. An important element in determining the adequacy of the allowance is an analysis of loans by loan risk rating categories. We regularly review our loan portfolio to evaluate the accuracy of risk ratings throughout the life of loans.
Our methodology for estimating inherent losses in the portfolio takes into consideration all loans in our portfolio, segmented by industry type and risk rating, and utilizes a number of subjective factors in addition to historical loss rates. Subjective factors include: the economic outlook on both a national and regional level; the volume and severity of non-performing loans; the nature and value of collateral securing the loans; trends in loan growth; concentrations in borrowers, industries and geographic regions; and competitive issues that impact loan underwriting.
Increases to the allowance occur when we expense amounts to the provision for loan losses or when we recover previously charged-off loans or overdrafts. Decreases occur when we charge-off loans or overdrafts that are deemed uncollectible. We determine the appropriateness and amount of these charges by assessing the risk potential in our portfolio on an ongoing basis.
In 2006, we reclassified our exposure for credit losses related to off-balance-sheet financial instruments to a liability account. The liability represents our estimate of possible losses associated with off-balance-sheet financial instruments, which consist of commitments to extend credit, commitments under credit card arrangements, and commercial and standby letters of credit. We had previously included the liability as a component of the allowance for loan losses. Following the reclassification, the liability is included as a component of Accrued interest payable and other liabilities on our balance sheet.
We evaluate the adequacy of the liability for credit losses from off-balance-sheet financial instruments based upon reviews of individual credit facilities, current economic conditions, the risk characteristics of the various categories of commitments and other relevant factors. The liability is based on estimates, which are evaluated on a regular basis, and, as adjustments become necessary, they are reported in earnings in the periods in which they become known.
The following table presents activity in the allowance for loan and credit losses:
Allowance for Loan and Credit Losses:
(dollars in thousands)
During the nine months ended September 30, 2007, we charged-off $3.22 million of an agricultural loan to a potato grower. We previously charged-off $878,574 of this loan relationship in 2006. As of September 30, 2007, there was no remaining loan balance to this borrower.
On an annualized basis, net charge-offs as a percentage of average gross loans was 0.56% and 0.20% for the nine months ended September 30, 2007 and 2006, respectively. Our net charge-offs as a percentage of average gross loans has ranged between 0.17% and 0.52% over the 5-year period from 2002 to 2006, averaging 0.28% on an annual basis. This percentage has increased during 2007 due to charge-offs of the potato grower loan. We expect charge-offs during the remainder of 2007 will range between $200,000 and $400,000. If these additional charge-offs occur, they would probably be related to the softening real estate market.
As a percentage of gross loans at year-end, our allowance for credit losses has ranged between 1.34% and 1.46% over the 5-year period from 2002 to 2006, averaging 1.40% on an annual basis. Because of a general trend toward relatively higher credit quality during recent years, this percentage had been trending downward through the second quarter of 2007. Beginning in the second quarter of 2007, we noted an increase in real estate loans assigned higher risk ratings (indicating greater risk) in our loan portfolioa trend we believe is facing banks across the United States. Consistent with the real estate market slowdown, our allowance for credit losses as a percentage gross loans increased from 1.27% as of June 30, 2007 to 1.32% as of September 30, 2007. We expect the allowance for credit loss percentage to trend upward for the remainder of 2007 and into 2008.
Non-performing assets consist of loans on non-accrual status, delinquent loans past due greater than 90 days, troubled debt restructured loans and other real estate owned (OREO). We do not accrue interest on loans for which full payment of principal and interest is not expected, or for which payment of principal or interest has been in default 90 days or more, unless the loan is well-secured and in the process of collection. Troubled debt restructured loans are those for which the interest rate, principal balance, collateral support or payment schedules were modified from original terms, beyond what is ordinarily available in the marketplace, to accommodate a borrowers weakened financial condition. OREO represents real estate assets held through loan foreclosure or recovery activities.
The following table presents information about our non-performing assets:
(dollars in thousands)
As of September 30, 2007, two real estate loans to land developers in the Portland, Oregon metro area comprised $7.33 million, or 81%, of non-performing assets. These loans were placed on non-accrual status during the second and third quarters of 2007. Development activities on the land underlying both loans have been completed. We believe both loans are adequately collateralized by the underlying real estate and that there is a minimal loss potential based on current appraisals of the collateral.
An agricultural loan to a potato grower comprised $3.38 million, or 65%, of non-performing assets as of December 31, 2006. We charged-off $3.22 million of this loan during the first and second quarters of 2007. During the second quarter of 2007, we repossessed approximately $120,000 of equipment, $31,950 of which remained held-for-sale as of September 30, 2007. There was no remaining loan balance to this borrower as of September 30, 2007.
Last year, as of September 30, 2006, the same agricultural loan totaling $3.53 million comprised 72% of non-performing assets.
Non-performing asset balances can vary significantly from period to period because they typically do not follow a seasonal pattern.
Our liabilities consist primarily of retail and wholesale deposits, interest accrued on deposits, notes payable and obligations to pay interest and principal on junior subordinated debentures. Retail deposits include all deposits obtained within our branch network and represent our primary source for funding loans. Wholesale liabilities include deposits obtained outside of our branch network, correspondent bank borrowings and borrowings from the Federal Home Loan Bank (FHLB). We utilize wholesale liabilities to manage interest rate and liquidity risk. These funding sources support loan growth at times when loan growth outpaces retail deposit growth.
We offer various deposit accounts, including non-interest bearing checking and interest bearing checking, savings, money market and certificates of deposit. The accounts vary as to terms, with principal differences being minimum balances required, length of time the funds must remain on deposit, interest rate and deposit or withdrawal options. In order to minimize our interest expense, our goal is to maximize our non-interest bearing demand deposits relative to other deposits and borrowings.
The following table presents the composition of our deposits:
(dollars in thousands)
Total deposits increased $58.08 million, or 7%, since December 31, 2006 primarily due to promotional certificates of deposit priced in the top quartile of our market and the addition of $59.37 million of wholesale deposits. As of December 31, 2006, interest bearing deposits included a $37.00 million temporary overnight deposit, which was subsequently withdrawn at the beginning of 2007.
Deposit totals are presented as of September 30, 2006 for comparative purposes because of the seasonal nature of our business. Compared to September 30, 2006, total deposits increased $104.15 million, or 13%, primarily due to promotional certificate of deposit offerings and additional wholesale deposits.
We believe that increasing retail deposits will be an ongoing challenge for community banks. Deposit customers expect innovative banking products tailored to their needs and expect interest rates that are competitive in the market place. In addition, we compete for deposits with brokerage firm money market funds that offer pricing indexed to market interest rates. We are also experiencing continued deposit pricing pressure from credit unions and other financial service providers. We will continue to address these challenges by further developing our infrastructure and technologies to focus on customer convenience and efficiency. We now have two employees who focus exclusively on deposit gathering activities for existing and potential customers. We continue to reinforce the importance of providing superior customer service. This allows us to expand and enhance our banking relationships with our customers. These efforts begin during the initial stages of the hiring process and continue with ongoing training and regular staff meetings focused on providing superior customer service.
The following table presents a comparison of wholesale deposit balances, which are included in total deposits shown above:
(dollars in thousands)
Brokered certificates of deposit are obtained through intermediary brokers that sell the certificates on the open market. Direct certificates of deposit are obtained through a proprietary network that solicits deposits from other financial institutions or from public entities. Mutual fund money market deposits are obtained from an intermediary that provides cash sweep services to broker-dealers and clearing firms. Out-of-market public fund depositors typically expect higher interest rates consistent with other wholesale borrowings.
Brokered and direct certificates of deposit are classified as Time certificates on our balance sheet. Mutual fund money market deposits and out-of-market public funds are classified as Interest bearing demand deposits on our balance sheet.
As of September 30, 2007, maturities of brokered certificates of deposit ranged between one month and three years, including $14.23 million maturing during the remainder of 2007. Direct certificate of deposit maturities ranged from one month to sixteen months. Mutual fund money market deposits and out-of-market public funds are payable on demand. During the second quarter of 2007, we added a new mutual fund money market relationship totaling $35.00 million. In October 2007, we were notified that this $35.00 million will be incrementally withdrawn by December 2007 (see additional discussion under Liquidity and Capital Resources section)
Borrowings from Federal Home Loan Bank (FHLB) comprise the majority of our notes payable. As of September 30, 2007, FHLB borrowings totaled $6.04 million, a decrease of $63.35 million from the December 31, 2006 balance of $69.39 million, and a decrease of $63.96 million compared to the $70.00 million balance as of September 30, 2006. Since December 31, 2006, FHLB borrowings decreased due to the repayment of a $50.00 million short-term borrowing from December 2006 and other scheduled maturities during the year. We use short-term borrowings from FHLB to support liquidity requirements.
The following table presents year-to-date FHLB balances and interest rates:
(dollars in thousands)
We also use lines of credit at correspondent banks to purchase federal funds for short-term funding. Available borrowings under these lines of credit totaled $66.40 million as of September 30, 2007 and December 31, 2006. No line of credit borrowings were outstanding as of September 30, 2007 and December 31, 2006. Notes payable includes a Treasury Tax and Loan note payable for $364,579 and $627,093 as of September 30, 2007 and December 31, 2006, respectively.
Trust Preferred Securities
In December 2002, Columbia formed Columbia Bancorp Trust I (Trust), a Delaware statutory business trust, for the purpose of issuing guaranteed undivided beneficial interests in junior subordinated debentures (trust preferred securities). In 2002, the Trust issued $4.00 million in trust preferred securities. The $4.12 million in debentures issued by Columbia as collateral for the trust preferred securities continue to qualify as Tier 1 capital under guidance issued by the Board of Governors of the Federal Reserve System. We will consider retiring at least a portion of the trust preferred securities at the first available prepayment date in January 2008.
Off-Balance Sheet Items Commitments/Letters of Credit
In the normal course of business to meet the financing needs of our customers, we are party to financial instruments with off-balance-sheet risk. These financial instruments include commitments to extend credit and the issuance of letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized on our balance sheet.
Our potential exposure to credit loss for commitments to extend credit and for letters of credit is limited to the contractual amount of those instruments. A credit loss would be triggered in the event of nonperformance by the other party. When extending off-balance sheet commitments and conditional obligations, we follow the same credit policies established for our on-balance-sheet instruments.
We may or may not require collateral or other security to support financial instruments with credit risk, depending on our loan underwriting guidelines.
The following table presents a comparison of contract commitment amounts:
(dollars in thousands)
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn, total commitment amounts do not necessarily represent future cash requirements.
The amount of collateral obtained to secure a loan or commitment, if deemed necessary, is based on our credit evaluation of the borrower. The majority of commitments are secured by real estate or other types of qualifying collateral. Types of collateral vary, but may include accounts receivable, inventory, property and equipment, and income-producing properties. Less than 10% of our commitments are unsecured.
The following table presents the distribution of commitments to extend credit classified by loan type as of September 30, 2007:
Commitments to Extend Credit:
(dollars in thousands)
Letters of credit are conditional commitments that we issue to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions. The credit risk involved in issuing letters of credit parallels the risk involved in extending loans to customers. When considered necessary, we hold deposits, marketable securities, real estate or other assets as collateral for letters of credit.
Although not a contractual commitment, we offer an overdraft protection product that allows certain deposit accounts to be overdrawn up to a set dollar limit before checks will be returned. As of September 30, 2007, commitments to extend credit for overdrafts totaled $11.71 million, which represents our estimated total exposure if every customer utilized the full amount of this protection at the same time. Year-to-date average usage outstanding is much lower than this commitment, totaling approximately $228,000, or 2% of the total exposure as of September 30, 2007; approximately $233,000, or 2% of the total exposure as of December 31, 2006; and approximately $238,000, or 2% of the total exposure as of September 30, 2006.
Derivative Instruments Interest Rate Swap
In January 2003, in connection with the issuance of $4.00 million of floating-rate trust preferred securities by Columbia Bancorp Trust I, we entered into an interest rate swap agreement (swap) with an unrelated third party. The swap expires in January 2008. Under the terms of the swap, we pay interest at a rate of 3.27% on a notional amount of $4.00 million and we then receive interest at the 90-day London Inter-Bank Offered Rate (LIBOR) on the same amount. The swap effectively converts interest payments on the $4.00 million trust preferred securities from a variable interest rate of 90-day LIBOR plus 3.30% to a fixed interest rate of 6.57% until January 2008. In January 2008, we have the option to prepay the trust preferred securities. We have classified the swap agreement as a cash flow hedge in accordance with Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities. The purpose of the swap is to mitigate variability in our cash flows by establishing a fixed interest payment during the initial five years of the trust preferred securities.
Commitments and Contingencies
We may become party to various legal proceedings. These matters have a high degree of uncertainty associated with them. There can be no assurance that the ultimate outcome will not differ materially from the assessment of them. There can also be no assurance that all matters that may be brought against us are known to us at any point in time.
LIQUIDITY AND CAPITAL RESOURCES
We have adopted policies to address our liquidity requirements, particularly with respect to customer needs for borrowing and deposit withdrawals. Our main sources of liquidity are customer deposits; sales and maturities of investment securities; the use of federal funds; brokered certificates of deposit; and net cash provided by operating activities. Scheduled loan repayments are a relatively stable source of funds, whereas deposit inflows and unscheduled loan prepayments are variable and are often influenced by general interest rate levels, competing interest rates available on alternative investments, market competition, economic conditions and other factors.
Measurable liquid assets include the following: cash and due from banks, excluding vault cash; interest bearing deposits with other banks; federal funds sold; held-to-maturity securities maturing within three months that are not pledged; and available-for-sale securities not pledged. Measurable liquid assets totaled $83.31 million, or 8% of total assets, as of September 30, 2007, compared to $146.34 million, or 14% of total assets, as of December 31, 2006.
During the nine months ended September 30, 2007, we added $59.37 million of wholesale deposits to support loan growth and liquidity requirements. We also repaid $63.61 million of borrowings, most of which was the repayment of a $50.00 million short-term borrowing added at the end of 2006. Because of modest loan growth, liquidity was strong throughout the third quarter of 2007.
In October 2007, we were notified that one of our wholesale mutual fund money market relationships totaling $35.00 million will be incrementally withdrawn by December 2007. In addition, $14.23 million of brokered certificates of deposit will mature during the remainder of 2007. Depending on retail branch deposit growth during the fourth quarter, we plan to replace these wholesale deposits with a mix of retail and wholesale deposits. In general, we will continue to rely on retail branch deposit growth and, when necessary, we will utilize wholesale liabilities and other borrowings to meet our liquidity needs.
Our statement of cash flows reports the net changes in our cash and cash equivalents by operating, investing and financing activities. Net cash from operating activities increased $1.73 million, or 15%, for the nine months ended September 30, 2007 compared to the same period in 2006. This was the net result of the decrease in net income and timing differences in the receipt and payment of accrued interest and accrued expenses.
Net cash from investing activities increased $35.89 million, or 35%, for the nine months ended September 30, 2007 compared to the same period in 2006. The increase was primarily the result of a decrease in loan growth during the nine months ended September 30, 2007, compared to the same period in 2006. To a lesser extent, the increase was also due to a decrease in investment security purchases.
Net cash from financing activities decreased $136.47 million, or 106%, for the nine months ended September 30, 2007 compared to the same period in 2006. The decrease was the result of a decrease in the growth of deposits and higher borrowing repayments.
As of September 30, 2007, shareholders equity totaled $99.07 million, compared to $91.02 million as of December 31, 2006, an increase of 9%. The 2007 year-to-date change is primarily attributable to year-to-date net income totaling $10.34 million, which was partially offset by cash dividends totaling $3.01 million.
During the third quarter of 2007, the Board of Directors declared a dividend of $0.10 per share, payable October 31, 2007 to shareholders of record as of October 15, 2007. Based on cash dividends paid and declared in 2007, approximately 29% of our year-to-date earnings will have been returned to shareholders, with the remainder being retained to leverage future balance sheet growth.
Capital Requirements and Ratios
The Federal Reserve Board (FRB) and the Federal Deposit Insurance Corporation (FDIC) have established minimum requirements for capital adequacy for bank holding companies and member banks. The requirements address both risk-based capital and leveraged capital. The regulatory agencies may establish higher minimum requirements if, for example, a corporation has previously received special attention or has a high susceptibility to interest rate risk.
The following table presents Columbias capital ratios as compared to regulatory minimums:
We intend to remain well-capitalized by regulatory definition. Regulatory capital levels historically decrease during the second and third quarters as capital is leveraged primarily due to the increased demand for loans.
We plan to use our excess capital for continued cash dividends, stock repurchases and new branch expansion. We will also consider retiring at least a portion of the trust preferred securities at the first available prepayment date in January 2008.
From now through the end of 2008, we expect to open two new branches, including one branch in Vancouver, Washington. In addition, we plan to construct new branch facilities in Yakima and Sunnyside, Washington in order to replace our temporary branch locations. New branch openings will require capital resources for the following: construction of branch buildings and/or commitments on leased property, hiring new branch personnel, hiring administrative personnel to support branch operations and costs related to general overhead. We plan to further leverage our capital for continuing improvement of our core operations and technology and for future branch expansion.
Stock Repurchase Plan
In June 2007, the Board of Directors renewed a plan to repurchase shares of Columbias common stock. The Board believes the repurchases constitute a sound investment and use of our shareholders equity to reduce excess capital. Any stock repurchases would be made on the open market pursuant to Rule 10b-18 of the Exchange Act at the sole discretion of Management. The repurchase plan authorizes us to repurchase common stock in an amount up to $1.50 million until the expiration date, June 30, 2008, or sooner if the maximum authorized amount of shares is repurchased prior to that date. Management determines the timing, price and number of the shares of common stock repurchased. During the nine months ended September 30, 2007, we did not repurchase any stock under the stock repurchase plan. We did purchase stock pursuant to vesting of stock award shares in August 2007. We allow employees to surrender stock to satisfy payroll tax withholding obligations on vesting of stock awards.
The following table presents our common stock repurchases during the three months ended September 30, 2007:
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes to Columbias market risk position from the information provided in Part II Item 7A Quantitative and Qualitative Disclosures about Market Risk of Columbias Form 10-K filed with the SEC on March 16, 2007 for the year ended December 31, 2006.
ITEM 4. CONTROLS AND PROCEDURES
Columbias Management, including the Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this quarterly report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, to the best of their knowledge, as of the end of the period covered by this quarterly report, the disclosure controls and procedures are effective in ensuring all material information required to be filed in this quarterly report has been made known to them in a timely fashion.
There were no changes in Columbias internal control over financial reporting that occurred during the period covered by this report that have materially affected, or are likely to materially affect, Columbias internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
During the normal course of its business, Columbia is a party to various debtor-creditor legal actions, which individually or in the aggregate, could be material to Columbias business, operations or financial condition. These include cases filed as a plaintiff in collection and foreclosure cases, and the enforcement of creditors rights in bankruptcy proceedings. Management is presently aware of one legal proceeding, detailed below.
Columbia Bancorp and Columbia River Bank were named as defendants in the United States District Court for the District of Oregon in a case captioned Smith-Rattray Farms, et al. v. Columbia River Bank, et al. The plaintiffs sought compensatory, punitive and other damages totaling approximately $48.40 million, as well as injunctive and other relief. At a judicial settlement conference on March 28, 2007, all parties to the case agreed to a confidential settlement. The settlement does not involve a payment from either Columbia Bancorp or Columbia River Bank to the plaintiffs that would have any material effect on Columbia Bancorps earnings.
ITEM 1A. RISK FACTORS
There have been no material changes to Columbias risk factors previously disclosed in Part I Item 1A Risk Factors of Columbias Form 10-K filed with the SEC on March 16, 2007 for the year ended December 31, 2006.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
See Stock Repurchase Plan under Part I Item 2 of this report.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
ITEM 5. OTHER INFORMATION
ITEM 6. EXHIBITS
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.