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Columbia Bancorp 10-Q 2008 Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-Q
For the quarterly period ended September 30, 2008
For the transition period from to to
Commission file number: 0-27938
COLUMBIA BANCORP
(Exact name of registrant as specified in its charter)
401 East Third Street, Suite 200
The Dalles, Oregon 97058 (Address of principal executive offices) (541) 298-6649
(Registrant’s telephone number, including area code) Not Applicable
(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, 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):
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 7, 2008, there were 10,080,909 shares of common stock of Columbia Bancorp, no par
value, outstanding.
COLUMBIA BANCORP
FORM 10-Q
September 30, 2008
Table of Contents
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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 Company’s report on
Form 10-K for the year ended December 31, 2007, 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
(Unaudited)
See accompanying notes.
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COLUMBIA BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(Unaudited)
See accompanying notes.
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COLUMBIA BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(Unaudited)
See accompanying notes.
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COLUMBIA BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
See accompanying notes.
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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 bank 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. Columbia’s
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. The results of operations for the three months and nine months
ended September 30, 2008, are not necessarily indicative of results to be anticipated for the year
ending December 31, 2008.
2. Management’s Estimates and Assumptions
Various elements of Columbia’s 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 Columbia’s annual report on Form 10-K, filed March
17, 2008.
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.
During the third quarter of 2008, the Bank entered into and executed a contract with Élan to sell
the credit card portfolio. The sale transaction transferred all credit card loans to Élan as of
August 31, 2008. In conjunction with the sale, Élan assumed the associated liability for scorecard
rewards, totaling approximately $244,000. In addition, the associated
allowance for loan and lease losses totaling approximately $219,000,
was written off. As a result of these transactions we recognized a gain of
$1.23 million, which is included in the income statement under the heading “gain on sale of credit
card portfolio”.
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The loan portfolio consisted of the following as of September 30, 2008 and December 31, 2007:
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. As of September 30, 2008, no
loans in default 90 days or more were still accruing interest. Non-accrual loans are considered
impaired loans. Each impaired loan is carried at the present value of expected future cash flows
discounted at the loan’s effective interest rate, the loan’s market price, or the net realizable
value of collateral if the loan is collateral-dependent. When a loan is placed on non-accrual
status, all unpaid accrued interest is reversed. Cash payments received on non-accrual loans are
applied to the principal balance of the loan. 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, 2008 and December 31, 2007, were $63.23 million and
$9.87 million, respectively.
The allowance for loan losses represents management’s best estimate of probable losses associated
with the Bank’s loan portfolio and deposit account overdrafts. The estimate is based on
evaluations of loan collectability and prior loan loss experience. The appropriateness of the
recorded 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
Statement of Financial Accounting Standard (SFAS) No. 5 and No. 114. In determining the level of
the allowance, the Bank estimates 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. The Bank regularly reviews the
loan portfolio to evaluate the accuracy of risk ratings throughout the life of loans.
The methodology for estimating inherent losses in the portfolio takes into consideration all loans
in the portfolio, segmented by industry type and risk rating, and utilizes a number of subjective
factors in
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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 amounts are expensed to the provision for loan losses or when
there is a recovery for a loan previously charged-off or overdrafts. Decreases occur when loans
are charge-off loans or for overdrafts that are deemed uncollectible. The Bank determines the
appropriateness and amount of these charges by assessing the risk potential in the portfolio on an
ongoing basis. Loan charge-offs do not necessarily result in the recognition of additional
expense, except in cases where the amount of a loan charge-off exceeds the loss amount previously
provided for in the allowance for loan losses.
The
liability for off-balance-sheet financial instruments represents
managements best estimate of probable
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. The liability is included as a component of “Accrued interest payable and other
liabilities” on the balance sheet.
The adequacy of the liability for credit losses from off-balance-sheet financial instruments are
evaluated 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.
Various regulatory agencies, as a regular part of their examination process, periodically review
the Bank’s 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.
In response to the unprecedented
economic events and market conditions, the Bank obtained updated
appraisals on many of its residential construction and development loans during the third quarter
of 2008. The new appraisals showed a continued and significant decline in the fair values of
properties that secure these loans, centered primarily in the Central Oregon and Portland /
Vancouver Metro areas. In many cases, the refreshed appraisals showed significant declines in
values from appraisals obtained as recently as January 2008 and in some instances, from March 2008.
Owing to the overall declines in market conditions, which directly affect the Company’s collateral
values and continue to impact the financial condition of its borrowers, the Company recorded a loan
loss provision of $25.4 million for the third quarter 2008.
Changes in the allowance for loan losses were as follows for the three months and nine months ended
September 30, 2008 and 2007:
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4. Other Real Estate Owned
Other real estate owned represents property acquired through foreclosure or deeds in lieu of
foreclosure and is carried at the lower of cost or estimated net realizable value. Net realizable
value is determined based on real estate appraisals less estimated selling costs. When property is
acquired, any excess of the loan balance over its estimated net realizable value is charged to the
allowance for loan losses. Subsequent write-downs to net realizable value, if any, or any
disposition gains or losses are included in non-interest income. As of September 30, 2008 and
December 31, 2007, other real estate owned totaled $5.62 million and $515,701, respectively, and is
included in the balance sheet under the caption “other assets.”
5. Federal Funds Purchased and Federal Home Loan Bank Advances
As of September 30, 2008, the Bank had federal funds line of credit agreements with six financial
institutions and the Federal Reserve Bank of San Francisco. Maximum aggregate borrowings available
under these credit lines totaled $46.40 million. Borrowings are not collateralized. These credit
lines support short-term liquidity requirements and cannot be used for more than 1 to 30
consecutive business days, depending on the lending institution. There were no borrowings
outstanding under these agreements outstanding as of September 30, 2008 and December 31, 2007.
The Bank is a member of the Federal Home Loan Bank (“FHLB”) of Seattle and has entered into credit
arrangements with the FHLB under which authorized borrowings are collateralized by the Bank’s FHLB
stock as well as loans or other instruments which may be pledged. Interest rates on outstanding
borrowings range from 2.40% to 5.48%. As of September 30, 2008, maximum FHLB borrowings were
limited to $55.77 million, of which $14.98 million was available based on outstanding borrowings
and collateral balances.
Three of the credit lines with other financial institutions were rescinded subsequent to September
30, 2008. Maximum borrowings available under the remaining credit lines totaled $16.40 million as
of October 31, 2008. In addition, FHLB reduced the maximum borrowings available subsequent to
September 30, 2008. Maximum borrowings available with FHLB totaled $46.29 million as of October
31, 2008, of which $9.56 million was available based on outstanding
borrowings and collateral balances. To offset the decrease in credit
lines at other financial institutions and the FHLB the Bank has
established a secured borrowing line with the Federal Reserve Bank
(“FRB”) and has pledged additional collateral to the
Federal Reserve. As of October 31, 2008, maximum FRB borrowings were limited to
$33.86 million based on outstanding borrowings and collateral
balances.
FHLB borrowings outstanding as of September 30, 2008 and December 31, 2007 were as follows:
6. Earnings (Loss) Per Share
Basic earnings (loss) per share
is computed by dividing net income (loss) 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 (loss) per share is computed
similar to basic earnings (loss) 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, unless the
impact is anti-dilutive. Due to the quarterly and year to date net
loss position of the company we have excluded potentially
dilutive common shares from the calculation of diluted weighted
average shares outstanding, including un-exercised stock options and unvested restricted stock awards,
totaling 475,838 and
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472,225 weighted average shares, respectively, for the three and nine months
ended September 30, 2008.
7. Fair Value Measurements
On January 1, 2008, Columbia adopted FASB SFAS No. 157. 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 provides the following hierarchy of valuation techniques:
Certain assets and liabilities are measured at fair value on a recurring or non-recurring basis.
Assets and liabilities measured at fair value on a recurring basis are initially measured at fair
value and then re-measured at fair value at each financial statement reporting date. Assets and
liabilities measured at fair value on a non-recurring basis result from write-downs due to
impairment or lower-of-cost-or-market accounting on assets or liabilities not initially measured at
fair value.
In accordance with FASB Staff Position No. FAS 157-2, Columbia will apply the fair value
measurement and disclosures provisions of SFAS No. 157 to nonfinancial assets and liabilities
measured at fair value on a non-recurring basis for the year beginning January 1, 2009. As of
September 30, 2008, goodwill and other real estate owned are the only nonfinancial assets measured
at fair value on a non-recurring basis.
The following table presents financial assets and liabilities measured at fair value on a recurring
basis as of September 30, 2008:
Fair values of available-for-sale securities are based on quoted-market prices when available. If
quoted prices are not available, fair value is based on an independent vendor pricing models, which
utilizes quoted prices of similar securities, discounted cash flows, market interest rate curves,
credit spreads, and estimated pre-payment rates, as applicable. Changes in the fair value of
available-for-sale securities are recorded in other comprehensive income.
The following table presents financial assets and liabilities measured at fair value on a
non-recurring basis as of September 30, 2008:
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Fair values of collateral-dependent impaired loans are based on loan collateral values, which are
supported by property appraisals and management’s judgment. Adjustments to reflect the fair value
of collateral-dependent impaired loans are a component in determining an appropriate allowance for
loan losses. As a result, adjustments to the fair value of collateral-dependent impaired loans may
result in increases or decreases to the provision for loan losses recorded in current earnings.
For the nine months ended September 30, 2008, in accordance with SFAS
No. 114, we recognized $21.11 million in impairment charges through
the allowance for loan losses to adjust the collateral-dependent
loans to their net realizable value. The increase in allowance for
loan losses is reflected in the provision for loan losses in the
income statement.
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ITEM 2. MANAGEMENT’S 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 sometimes are accompanied by 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 AND ESTIMATES
The “Management’s 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, 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 the best estimate of probable losses associated with our
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 portfolio’s risk ratings, current economic conditions, loan
concentrations, loan growth rates, past-due and non-performing loan trends, evaluation of specific
loss estimates for all significant problem loans, historical charge-off and recovery experience and
other pertinent information. Approximately 75%, or $677.37 million, of our loan portfolio is
secured by real estate collateral. Within the total balance of loans secured by real estate,
$78.95 million is secured by commercial property (office buildings, warehouse, commercial lot pads,
etc.) and $195.67 million is secured by residential property (residential subdivisions, 1-4 family
dwellings, homes under construction by developers, etc.). Based on current property appraisals, we
have evidence of declining real estate values in the residential sector of the portfolio in parts
of Oregon and Washington. In addition, due to the downturn in the national and regional real
estate sales, a number of our residential real estate construction and acquisition and development
customers have been unable to sell existing inventories and that the repayment of these loans is
now solely dependent on the liquidation of the collateral. Loans of this nature were written down
to their estimated fair market value less estimated costs to sell, resulting in significant
charge-offs during the three and nine months ended September 30, 2008. Based on this experience, we
believe there is an increased risk in our remaining real estate loan portfolio, and as such we
recognized additional loan loss provision during the three months ended September 30, 2008. Further
increases in the allowance for loan
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losses may be considered necessary during the remainder of 2008 if real estate values continue to
decline; however, we expect future provisions will be at significantly lower levels than those
experienced in the third quarter of 2008.
As of September 30, 2008, our goodwill totaled $7.39 million as a result of a business combination
in 1998. 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 assessment of the fair value of goodwill is based on our
current market capitalization, discounted cash flows from forecasted earnings and an evaluation of
current purchase transactions. Our evaluation of the fair value of goodwill involves a substantial
amount of judgment. Given the current economic environment, our goodwill impairment testing was
evaluated under the “stage two” analysis defined in SFAS No. 142. The stage two analysis of
goodwill required us to evaluate the fair market value of our company from the perspective of a
potential purchaser. In that light, we utilized public information for sales transactions, of
organizations similar to ours, occurring within the last 5 years, as well as discrete information
from loan sales occurring in a similar economic environment of the 1980’s. Based on this analysis,
with a valuation date of September 30, 2008, we identified no impairment of goodwill. No impairment
of goodwill has been identified during the initial and subsequent annual assessments (annual
assessment occurs as of December 31), or during tests between annual assessments.
OVERVIEW
Columbia Bancorp (“Columbia”) is a bank holding company organized in 1996 under Oregon Law.
Columbia’s common stock is traded on the Nasdaq Global Select Market under the symbol “CBBO.”
Columbia’s 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 22 full-service branches throughout Oregon and Washington. In Oregon, we
operate 15 branches. These 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 branches. These branches serve the communities of Goldendale, White
Salmon, Pasco, Yakima, Sunnyside, Richland and Vancouver. The Lake Oswego Branch, which specialized
in residential construction lending, was closed October 31, 2008.
Business Developments:
During the year, we have experienced a significant amount of change from internal and external
forces. Internally, we have seen a significant change in leadership during the year with a new
Chief Credit Officer, Craig Hummel, a new Chief Executive Officer and President, Terry Cochran and
a new Chief Financial Officer, Staci Coburn. In addition we opened two permanent branches, Yakima
and Sunnyside, Washington, and continued to make improvements upon our technology and delivery to
customers. One such improvement was the centralization of our core operations in Vancouver,
Washington.
Columbia River Bank is considered “adequately-capitalized” for regulatory purposes as of September
30, 2008. Only one ratio does not quantitatively qualify as “well-capitalized”, and that is the
total risk-based capital ratio, which is 8.50% and is estimated to be 1.50% short of meeting the
quantitative threshold for well-capitalized. The ratio of Tier 1 risk-based capital and Leverage
ratio are 7.24% and 6.60%, respectively, which exceeds the minimum threshold for
“well-capitalized”. In the previous quarters in 2008 and 2007, we were considered
“well-capitalized” for regulatory purposes.
Externally, there have been a number of changes in the banking industry, especially surrounding the
initiatives made by the U.S. Department of the Treasury (“Treasury”) to provide relief to financial
institutions and ease depositor and investor concerns. Specifically, there are now sources of
relief for
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financial intuitions provided by the Treasury through their newly enacted Troubled Asset Relief
Program (“TARP”) and other similar initiatives, including:
We believe that initiatives like this have real value for community banks. Like most financial
institutions across the nation, we are being affected by the results of an economy that has been
described as being the worst economic situation in recent memory. The weakening economy appears to
be a direct result of the real estate lending crisis that began to manifest in 2007 and accelerated
dramatically in 2008. We have observed a general weakening of our
credit quality. We believe this is a
result of fewer residential home sales and increasing inventories of new homes and residential
building lots, coupled with declining property values. This has reduced the available cash flows
for repayment of loans from our builder and developer borrowers. This has led to the need for
increased provisions for loan losses as well as higher charge-offs. The adverse national and
regional market climates have exacerbated our current financial condition. We are an organization
that has historically experienced growth year over year, with much of that growth in the
residential real estate acquisition and development market.
In response to these forces, we have already begun to take the following measures:
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Financial Overview:
The following table presents an overview of our key financial performance indicators:
Key Financial Performance Indicators:
(dollars in thousands except per share data)
The decrease noted in earnings per share for each period was primarily due to an increase in the
provision for loan losses, the effect of net interest margin compression and increases in
non-interest expenses related to the administrative expansion and centralization into Vancouver,
Washington.
Significant items for the three and nine months ended September 30, 2008 were as follows:
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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)
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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 3.86% for the three months ended September 30, 2008, compared to 5.61% for the same
period in 2007. The decrease is primarily due to two factors. First, loan yields decreased as our
variable rate loans tied to the prime rate charged by major financial institutions re-priced,
following cuts in the Fed Funds rate. The prime rate has historically followed changes in the Fed
Funds rate. Second, we reversed approximately $1.26 million of interest income from loans placed
on non-accrual status during the third quarter of 2008. When a loan is placed on non-accrual
status, we reverse all interest recognized as income, but not yet paid. The current period
reversal resulted in a decrease in our net interest margin by 47 basis points for the three months
ended September 30, 2008. As a result of the same factors, our tax equivalent net interest margin
decreased to 4.51% for the nine months ended September 30, 2008 from 5.65% for the same period in
2007.
Our balance sheet is currently asset sensitive, meaning that interest earning assets mature or
re-price more frequently than interest bearing liabilities in a given period. As a result, net
interest income should increase slightly when rates increase and shrink somewhat when rates fall in
an interest rate shift that is parallel across all terms of the yield curve (see also Item 3 of
this report “Quantitative and Qualitative Disclosures about Market Risk”).
We have incorporated interest rate floors into $578.17 million, or 64%, of our loans, in order to
mitigate the adverse effects of falling interest rates. As of September 30, 2008, our
weighted-average floor rate was 6.89%, whereas the weighted-average rate on loans with floors was
7.39%. Loan interest income will continue to decrease, primarily on loans without floors, as the
Fed Funds rate falls. We anticipate that interest income will decrease as a result of the October
2008 reduction of the Fed Funds rate by 50 basis points.
Re-pricing of our deposit interest rates has lagged the more immediate decrease in earning asset
yields which resulted from a need to retain deposit customers since the Fed Funds rate began
decreasing in September 2007. The Fed Funds rate has decreased 275 basis points from September 30,
2007 to September 30, 2008. Further decreases in the Fed Funds rate will cause our net interest
margin to continue to trend downward. We expect continued pressure on our costs of funds due to
the competitive deposit environment.
The following table presents increases in net interest income attributable to volume changes versus
rate changes:
Volume
vs. Rate Changes:
(dollars in thousands)
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Net interest income before provision for loan losses decreased 25% and 15% for the three and nine
months ended September 30, 2008, respectively, compared to the same periods in 2007. The decrease
is primarily attributable to lower yields on loans following a series of Fed Funds rate cuts since
September 2007. Decreases in net interest income were partially offset by volume increases in
loans and lower rates paid on interest bearing liabilities. Due to the competitive deposit
environment, decreases in interest rates paid on deposits have lagged decreases in interest rates
on interest earning assets. For instance, during the three months ended September 30, 2008, rates
on certificates of deposit ranged between 1.26% and 4.54%, which was an increase of 84 — 167 basis
points, dependant on the duration of the certificate, at the same time the Fed Funds rates was
unchanged.
Non-Interest Income
Non-interest income is comprised of service charges and fees, credit card discounts, financial
services revenues, mortgage banking revenues and gains and losses 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. In conjunction with
the sale of our credit card portfolio and exit from the mortgage business, we expect the income
from credit card discounts and mortgage banking revenue will reduce to zero in the coming quarter
and years.
Service charges on deposits has increased 16% and 12% for the three and nine months ended September
30, 2008, respectively, compared to the same period in 2007. The increase is primarily
attributable to an increase in the volume of deposit accounts in the current period compared to the
similar period in 2007.
The decrease in non-interest income is attributable to the loss on other real estate owned, which
has decreased by $1.97 million and $1.92 million for the three and nine months ended September 30,
2008, respectively. This is attributable to impairment write-downs recognized on two real estate
development projects held as other real estate owned, to re-value the asset at the lower of cost
basis or the net realizable value of the property, in compliance with SFAS’s No. 66 and 144, as
applicable. This impairment was recognized in the third quarter of 2008 as the result of new
appraisals or new evaluations obtained on those two properties.
Provision for Loan Losses
Our provision for loan losses represents an expense against current period income that allows us to
establish an appropriate allowance for loan losses and deposit account overdraft exposure. Charges
to the provision for loan losses result from our ongoing analysis of probable losses in our loan
portfolio and probable losses from deposit account overdrafts.
For the three and nine months ended September 30, 2008, compared to the same period in 2007, the
provision for loan loss was significantly higher primarily due to deteriorating credit quality
indicators in our residential construction loan portfolio. Risks contributing to this increase in
provision are discussed in more detail in the section entitled “Allowance for Loan Losses” below.
Non-Interest Expense
Non-interest expense consists of salaries and benefits, occupancy costs and various other
non-interest expenses.
Total non-interest expense has increased 12% and 11% for the three and nine months ended September
30, 2008, respectively. These increases are attributable to increases noted in occupancy expenses
and other non-interest expenses.
Occupancy expense has increased 18% and 16% for the three and nine months ended September 30, 2008,
respectively, in comparison to the same periods in 2007. This increase is primarily due to the
rental expense associated with the administrative offices opened in Vancouver, Washington during
the year. The increase in occupancy expense for the three months ended September 30, 2008 compared
to the same period in 2007 is due to the same factors. We have identified some excess office space
with the
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closure of the Lake Oswego office and the relocation of our core operations team to Vancouver,
Washington. We are currently evaluating whether or not sub-leasing these spaces would be a viable
income source to off-set the increase in occupancy expense in the coming quarters in 2008 and 2009.
Other non-interest expense has increased 25% and 20% for the three and nine months ended September
30, 2008, respectively, in comparison to the same periods in 2007. The most significant increases
noted in the Federal Deposit Insurance Corporation Insurance (FDIC) Premium which has increased
$405 thousand, or 248% for the nine months ended, and repossession, collection and other real
estate expenses which have increased $297 thousand, or 176% for the nine months ended. The
increase in other non-interest expense for the three months ended September 30, 2008 compared to
the same period in 2007 is due to the same factors.
The increase in the FDIC premium is a result of the increase in our asset levels year over year. We
anticipate that this premium will continue to rise in the coming quarters as a result of our status
of adequately capitalized, and the noted rise of financial institution failures throughout 2008.
Increases noted in repossession, collection and other real estate expense are a result of the
increase in non-performing assets, which is discussed in further detail in the section entitled
“Non-Performing Assets”
The efficiency ratio, which measures overhead costs as a percentage of total revenues, is an
important measure of productivity in the banking industry. Because of higher non-interest expenses
and lower revenues, resulting from the combination of the write-down of other real estate owned,
the reversal of interest income due to loans placed on non-accrual status, and one-time severance
costs related to our exit from the mortgage business, and our reduction in force, our efficiency
ratio increased to 83.42% and 71.59%, respectively, for the three and nine months ended September
30, 2008, compared to 56.95% and 56.88%, respectively, for the same periods in 2007. We expect
efficiency rate will improve in the following quarters.
Provision for Income Taxes
The following table presents the provision for income taxes and effective tax rates:
Provision
for (Benefit from) Income Taxes:
(dollars in thousands)
Our normal, expected statutory rate is 38.8%, representing a blend of the statutory federal income
tax rate of 35% and apportioned effect of the Oregon income tax rate of 6.6%. For the three and
nine months ended September 30, 2008, we have recognized a tax benefit due to net pre-tax losses
generated in the same periods. Our effective rate for these periods is higher than the expected
statutory rate primarily due to tax-exempt municipal interest, bank owned life insurance and tax
credits. Our effective rate for the three and nine months ended September 30, 2007 was slightly
lower than our expected statutory rate primarily due to the previously mentioned tax-exempt
interest, bank owned life insurance and tax credits.
MATERIAL CHANGES IN FINANCIAL CONDITION
ASSETS
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.
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Loans
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.
During the third quarter of 2008, the Bank entered into and executed a contract with Élan to sell
the credit card portfolio. The sale transaction transferred all credit card loans to Élan as of
August 31, 2008. In conjunction with the sale, Élan assumed the associated liability for scorecard
rewards, totaling approximately $244,000. In addition, the associated
allowance for loan and lease losses totaling approximately $219,000
was written off. As a result of these transactions we recognized a gain of
$1.23 million, which is included in the income statement under the heading “gain on sale of credit
card loans”. In addition we also entered into a marketing agreement with Élan, which we believe
will improve the product to our customer base.
The following table presents our loan portfolio by loan type:
Gross loans increased 6% since December 31, 2007 primarily due to real estate secured farmland and
commercial loan growth. Since June 30, 2008, gross loans decreased $11.22 million or 1% due
primarily to the charge-off of selected loan balances, combined with the sale of the credit card
portfolio.
Our loan
portfolio continues to have a concentration of loans secured by real estate, as of
September 30, 2008. This includes $195.67 million of construction loans secured by residential
properties and $78.95 secured by commercial properties. Although this general real estate
concentration is consistent with our Pacific Northwest community bank peers, we could be subject to
further losses resulting from declines in real estate values and the related effects on our
borrowers. It should be noted that some loans that are designated as being “real estate” secured
were granted for consumer and business purposes other than the acquisition of real estate. While it
is difficult to predict when the local real estate market will return to a more normalized
position, we believe that the risk is limited to some extent in our portfolio, because loans
included in this category include those that are secured by real estate but for which repayment is
not expected to come directly from the liquidation of the real estate. However, given the current
economic environment and the volatility in the residential real estate market, we do recognize
additional risk in real
estate loans in our allowance for loan losses; see additional information the “Allowance for loan
and lease losses” section below.
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The following table presents our construction and land development loans by region:
Construction and Land Development Loans by Region:
(dollars in thousands)
We participate in non-real estate agricultural lending, which comprises approximately 9% of our net
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 13% of our agricultural loans are
guaranteed through this program; however, these guarantees are limited and loans under this program
are not without credit risk.
Allowance for Loan Losses
Our allowance for loan losses represents our best estimate of probable losses associated with our
loan portfolio and deposit account overdrafts as of the reporting date. The appropriateness 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 evaluated for impairment and not requiring a specific allocation, because the loan is
determined not to be impaired, 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.
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The following table presents activity in the allowance for loan and credit losses:
Allowance for Loan and Credit Losses:
(dollars in thousands)
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. Loan charge-offs do
not necessarily result in the recognition of additional expense, except in cases where the amount
of a loan charge-off exceeds the loss amount previously provided for in the allowance for loan
losses.
On loans of either a larger size or troubled industry type, we may perform an individual analysis
of the loss or risk potential of specific loans. This individual analysis may include factors such
as an updated review of the value of the collateral securing the loan, the geographic location of
the loan, the expected or potential cash flows from the borrowers operations, the relative strength
and liquidity of the guarantors and the past payment performance on the loan. In cases where
existing collateral appraisals or evaluations are dated or stale in our opinion, we will typically
obtain new appraisals or evaluations and these new values will be used to evaluate the risk of the
loan and resulting provision for loan losses.
Furthermore, in cases where the cash flow of the borrower or the absence of guarantor strength or
liquidity has been eliminated, we may deem the loan to be totally collateral dependent. In such
cases, if
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the analysis of the underlying collateral value of the loan is determined to be deficient, that
deficiency is charged-off.
The liability for off-balance-sheet financial instruments represents our best estimate of probable
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. 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.
During the three months ended September 30, 2008, we recognized $25.40 million of provision for
loan losses, bringing the year-to-date allocations to $34.10 million. As of September 30, 2008,
our allowance for credit losses totaled $21.91 million, including the liability for
off-balance-sheet financial instruments. The significant increase in the allowance was in response
to internal downgrades of credits, primarily residential real estate construction projects, and the
declining land values on such residential construction collateral. It is important to note that
during the third quarter of 2008 the bank refreshed appraisals for a large number of its
residential construction and development loans. The new appraisals showed a continued and
significant decline in the fair values of properties that secure these loans, centered primarily in
Central Oregon and Portland/Vancouver metropolitan areas. In many cases, the refreshed appraisals
showed significant declines in fair values from appraisals obtained as recently as January 2008 and
in some instances, from March 2008. This directly influenced the large loan loss provision taken
in the third quarter of 2008.
For the three and nine months ended September 30, 2008, we recognized $21.42 million and $24.37
million in loan charge-offs, respectively. The large increase in charge-offs during the three
months ended September 30, 2008 were the result of partially charged-off construction land
development loans which were considered to be “collateral dependent” loans. A collateral dependent
loan is one for which the primary source of repayment is considered to be the liquidation of the
underlying collateral. Following SFAS No. 114, we have recognized an impairment charge on these
loans as a result of declining market values.
In our 30 year history, our average charge-off rate has traditionally been much lower than the
above results. Our annual charge-offs as a percentage of average gross loans ranged between 0.21%
and 0.52% for the five year period from 2003 to 2007. Our annualized net charge-offs as a
percentage of average gross loans was 3.49% for the nine months ended September 30, 2008. Our
expectation is that we will return to a more normalized level of charge-off activity when, and if,
the economic environment begins to rebound and real estate values in our key markets stabilize.
As previously disclosed, in response to the changes in the economic environment, our credit
administration and risk management teams have examined loan relationships within the residential
construction portfolio for indications of credit weaknesses. This is an ongoing and dynamic
process and concentrated efforts were put forth to accelerate the examination of credits to ensure
substantially all real estate construction credits were examined during the second and third
quarter of 2008. The charge-offs noted during the third quarter are a result of this effort. This
examination process includes the review of new or updated appraisals and resulting real estate
collateral values. All appraisals are reviewed by our real estate risk management team, which
includes three licensed appraisers and support staff.
The Reserve Adequacy Committee that was established during the second quarter of 2008 is an active
component of our heightened loan management. On a quarterly basis, all problem loan reports are
formally updated for all our lending units and formal action plans are either developed or reviewed
for effectiveness. Even though threshold guidelines for reporting to the committee exist, it does
not preclude discussion of other credits or concerns that are present in the geographic areas that
we service. The committee includes the Chief Credit Officer and other key members of executive
management, including the Chief Executive Officer. As a result of this action, we were able to
pull together previous lending unit processes and identify the underlying risks inherent in our
loan portfolio. In addition, specific allocations
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to the allowance for loan losses and the adequacy of our current loan loss allowance were
appropriately adjusted based on the review of affected loans. The Reserve Adequacy Committee will
continue meeting on a quarterly basis. The resulting action plans will be dynamic and followed
closely by the lending teams, credit administration, risk management and our special assets team.
This will ensure appropriate risk identification, timely meetings with customers and achievement of
these plans.
On a bi-weekly basis, the updates on action plans on selected problem loan amounts are reviewed
during a meeting conducted by the Chief Credit Officer and other members of the Executive Team.
This meeting allows for timely decisions on these action plans.
While we have been reserving for these weakened credits as a result of our internal risk ratings,
as new appraisals are received and if land values continue to decline, more allocations to the
allowance for loan losses are possible, as are further impairment write downs. When such write
downs or charge offs are necessary, the allowance for loan losses will be impacted accordingly.
Non-Performing Assets
Non-performing assets (“NPA”) 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. We also have a policy to place any loan past due 90
days or more on non-accrual status. 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 borrower’s
weakened financial condition. OREO represents real estate assets held through loan foreclosure
(either voluntary or involuntary) or recovery activities.
The following table presents information about our non-performing assets:
Non-Performing Assets:
(dollars in thousands)
The increase of $58.4 million from December 31, 2007 to September 30, 2008, is primarily due to an
increase in loans placed on non-accrual status during the second and third quarter of 2008. See the
sections below entitled “Non-Accrual Loans” and “Other Real Estate Owned” for more discussion of
the loans and properties comprising the total non-performing asset value.
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Non-Accrual Loans:
The following table provides expanded detail of our non-accrual loans:
Non-Accrual Loans by Type:
(dollars in thousands)
As the year has progressed, our non-accrual loans have steadily increased with a significant
increase noted in the quarter ended September 30, 2008. The increases noted throughout the year are
directly related to the ongoing economic uncertainly and conditions surrounding the subprime
lending crisis and slow down in residential real estate demand. As the more liberal mortgage
products were eliminated from the market, the number of potential home buyers has declined,
resulting in an inventory of new homes and residential lots that exceeds current demand. This
excess inventory is driving down current market prices. The reduction in the sales of residential
lots and homes has created cash flow difficulties for builders and developers, forcing them to turn
to personal reserves to help meet loan repayment requirements and ongoing operating needs.
Reserves have continued to dwindle and a number of them were exhausted during the second and third
quarter of 2008, resulting in past due loans and difficultly meeting ongoing operating expenses.
We have observed that this is a nationwide trend affecting many banks.
During the nine months ended September 30, 2008, the majority of the increase in non-accrual loans
was centered in residential land development loans, including loans to build both speculative and
presold homes. Approximately 64% of our non-accrual loans are lot development credits and 15% are
for residential homes loans for a total of 79% related to residential construction projects. The
remaining 21% of our non-accrual totals are from all other areas of our loan portfolio.
During the third quarter of 2008, several individual loans to residential developers were placed on
non-accrual status when clients were no longer able to meet required interest or principal
reduction payments. In September 2008, a number of the loans, primarily construction and land
development loans were evaluated and considered to be collateral dependent. A loan is considered
to be collateral dependent when the only source of repayment is from the liquidation of the
underlying collateral. Due to the declining fair market measures, several of these loans had loan
balances in excess of the estimated fair market value and were considered to be impaired. Based on
our impairment analysis, we charged-off approximately $21.00 million of loans to reduce the
balances to current fair value. Many of these loans will end up in foreclosure and OREO in the
months to come.
Other Real Estate Owned (“OREO”):
As of September 30, 2008, six OREO properties comprised $5.62 million, or 8%, of total
non-performing assets. Two of the six OREO properties totaled $4.52 million, or 80% of the OREO
balance as of September 30, 2008.
The balance of OREO has fluctuated during the quarter ended September 30, 2008. The balance in OREO
at the beginning of the quarter was $7.21 million. The reduction during the third quarter was the
result of an impairment write-down totaling $1.97 million for two of the properties. The impairment
write-down was a result of declining fair market values based on new appraisals or evaluations
received during the third quarter. This reduction was partially off-set by the addition of two
properties during the third quarter totaling $305 thousand.
We expect OREO properties will substantially increase for the remainder of 2008 and into 2009 as
foreclosures take place on several of the land development projects currently on non-accrual
status. To
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facilitate the management and timely liquidation of OREO properties, we formed an OREO
committee in the second quarter of 2008 comprised of senior members of our real estate risk
management, credit administration and risk management teams.
LIABILITIES
Our liabilities consist primarily of retail and wholesale deposits, interest accrued on deposits
and notes payable. 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, borrowings from the Federal Home Loan
Bank (“FHLB”) and federal funds purchased. 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.
Deposits
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. Our goal remains to maximize our
non-interest bearing demand deposits relative to other deposits and borrowings, in order to
minimize our interest expense.
The following table presents the composition of our deposits:
Deposits:
(dollars in thousands)
Total deposits increased 10% since December 31, 2007. Non-interest bearing deposits decreased
primarily due to lower deposit balances from customers affected by the real estate slowdown, as the
need to utilize cash reserves increased. Interest bearing deposits decreased due to reductions
noted in balances on deposit from a number of title companies, which trends in conjunction with
residential home sales. Time certificates increased as a result of the increase in brokered
certificates of deposits. Our investment in brokered certificate of deposit was a result of an
effort to increase our cash position. See additional information surrounding our liquidity
management in the section entitled “Liquidity Analysis” below.
Deposit totals are presented as of September 30, 2007 for comparative purposes because of the
seasonal nature of our business. Compared to September 30, 2007, total deposits increased 11%
primarily due to time certificate growth.
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The following table presents the maturities of all time certificates of deposit, including retail
and wholesale time certificates of deposit, as of September 30, 2008:
The following table presents a comparison of wholesale deposit balances, which are included in
total deposits and maturity tables shown above:
Wholesale Deposits:
(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. Certificate of deposit account registry
system (“CDARS”) deposits are obtained through a broker and represent certificates of deposits in
other financial institutions for which we assume a portion, not to exceed $100,000 per certificate
holder.
Brokered, direct certificates of deposit and CDARs deposits 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, 2008, maturities of brokered certificates of deposit ranged between 1 month and
60 months, including $21.00 million maturing during the remainder of 2008. Mutual fund money
market deposits and out-of-market public funds are payable on demand.
See the “Liquidity Analysis” below for further discussion regarding the availability of brokered
deposits and our planned liquidity strategies.
Federal Home Loan Bank Advances and Federal Funds Purchased
As of September 30, 2008, FHLB borrowings totaled $40.78 million, an increase of $35.35 million
from the December 31, 2007 balance of $5.43 million and an increase of $34.74 million compared to
the $6.04 million balance as of September 30, 2007. Since December 31, 2007, FHLB borrowings
increased primarily due to new borrowings totaling $40.00 million at a weighted average interest
rate of 2.87%.
The following table presents year-to-date FHLB balances and interest rates:
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FHLB Borrowings:
(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 $44.40 million as of September
30, 2008 and $64.40 million at December 31, 2007. There were no outstanding borrowings on these
lines at September 30, 2008 or December 31, 2007. The available borrowing lines have been
subsequently reduced, see further discussion in Note 5 of the consolidated financial statements and
the “Liquidity Analysis” section below.
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 qualified as Tier 1 capital under guidance issued by the Board of
Governors of the Federal Reserve System. Under the terms of the debenture, the debt was
mandatorily redeemable on January 7, 2033, with an early redemption clause that required
notification three months prior to the early termination date of January 7, 2008. In accordance
with the agreement, Columbia chose to exercise its right to early redemption and provided
notification in October 2007. In January 2008, we exercised our right to redeem the debentures
resulting in the payment of principal and accrued interest totaling $4.21 million.
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:
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Commitments:
(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 may be cancelled or voided in the event
of a violation of the loan covenants or material adverse change in the financial condition of the
borrower. 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. Commitments
to originate loans held-for-sale decreased due to our closure of the CRB Mortgage Team, and are
expected to be exhausted by the end of the year. In part, the drop in commitments since September
2007 reflects management’s desire to reduce our activity in residential real estate development and
construction loans. Commitments for undisbursed credit card lines of credit have been reduced to
zero in conjunction with our sale of the credit card portfolio.
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.
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.
The following table presents the distribution of commitments to extend credit classified by loan
type as of September 30, 2008:
Commitments to Extend Credit:
(dollars in thousands)
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, 2008, commitments to extend credit for overdrafts totaled $12.53 million, which
represents our estimated total exposure if every customer utilized the full amount of this
protection at the same time.
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Year-to-date average usage outstanding was approximately 2% of the
total exposure as of September 30, 2008, December 31, 2007 and September 30, 2007.
Commitments and Contingencies
During the ordinary course of business, 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 be no assurance
that all matters that may be brought against us are known to us at any point in time. We are not
presently aware of any legal proceedings for which we are the defendant.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity Analysis
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 of loans; sales and maturities of investment securities; overnight federal funds
purchases; advances from the Federal Home Loan Bank; short-term borrowings from the Federal Reserve
Discount Window; 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: cash 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 $141.17 million, or 12% of total assets, as of September 30, 2008, compared to
$87.51 million, or 8% of total assets, as of December 31, 2007.
As of September 30, 2008, we had federal funds line of credit agreements with six financial
institutions and the Federal Reserve Bank of San Francisco. Maximum aggregate borrowings available
under these credit lines totaled $49.18 million. These credit lines support short-term liquidity
requirements and generally cannot be used for more than 1 to 30 consecutive business days,
depending on the lending institution. During the three months ended September 2008, two financial
institutions withdrew lines of credit totaling $30.00 million. Subsequent to September 30, 2008,
three additional financial institutions withdrew lines of credit totaling $28.0 million. As of
October 31, 2008, our maximum aggregate available borrowing lines totaled $16.40 million.
We have credit arrangements with the Federal Home Loan Bank of Seattle (“FHLB”) providing
short-term and long-term borrowings collateralized by our FHLB stock and other instruments we may
pledge. As of September 30, 2008, our maximum borrowing capacity totaled approximately $55.77
million with approximately $14.99 million available based on outstanding borrowings. Subsequent to
September 30, 2008, our maximum borrowing capacity at the FHLB
has reduced to $46.29 million, with
approximately $9.56 million available based on outstanding borrowings, as of October 31, 2008.
During the nine months ended September 30, 2008, our liquidity was strained as loan growth outpaced
retail deposit growth. As a result, we relied on wholesale borrowing sources to support loan
growth and meet liquidity requirements. However, due to our current status as “adequately
capitalized” we are limited in our involvement in brokered deposits, which are obtained through
third parties, such as brokered certificates of deposits, certificate of deposit account registry
system deposits, and other out-of-market deposits. As a result, the balance of certificate of
deposits is expected to decline. In that light, we are working to reposition our balance sheet in
order to decrease the ratio of loans to deposits. To accomplish this repositioning of our balance
sheet, we plan to sell and participate loans to other financial institutions. In addition, we plan
to be very selective in the renewal of loans at maturity and will likely decline loan renewals for
borrowers who have violated loan terms, have poor repayment history or have other risk factors that
we find unacceptable going forward.
The credit and financial crisis affecting financial institutions across the country may become more
acute and may cause significant liquidity shortages. In our case, our liquidity may potentially be
affected by the
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loss of lines of credit with other banks and by the rapid withdrawal of deposits.
In response, we have accumulated a higher than normal level of liquid assets to prepare for these
possibilities. More recently we have also pledged additional assets to FHLB and the Federal
Reserve to increase our borrowing capacity. In addition, the increase in FDIC insurance limits from
$100,000 to $250,000, along with the extension of FDIC coverage to all non-interest bearing
transaction deposits is increasing our overall insured deposit balances.
Our statement of cash flows reports the net changes in our cash and cash equivalents by operating,
investing and financing activities. Net cash provided by operating activities increased $4.29
million, or 32%, for the nine months ended September 30, 2008 compared to the same period in 2007.
This was the net result of an increase in the provision for loan losses and higher funding of
mortgages held-for-sale, offset by a decrease in net income.
Net cash used in investing activities increased $11.54 million, or 17%, for the nine months ended
September 30, 2008 compared to the same period in 2007. The increase was primarily the result of an
increase in loan growth during the nine months ended September 30, 2008, compared to the same
period in 2007, offset by net proceeds from maturity or sale of investment securities.
Net cash provided by financing activities increased $128.27 million, or 1569% for the nine months
ended September 30, 2008 compared to the same period in 2007. The increase was primarily due to
increases in time certificates of deposit, which is attributable to the increase in wholesale time
certificates, and long-term and short-term borrowings during the nine months ended September 30,
2008.
As noted in our section entitled “Deposits” during the fourth quarter of 2008 we have a total of
$100.3 million of time certificates of deposit maturing. This total is partially comprised of
brokered certificates of deposit, representing $21.00 million of the total, which we will not be
able to retain. The remaining $79.30 million of maturing time certificates of deposit are retail
deposits. We are actively working to retain those deposits, one of our strategies is to provide a
competitive rate to attract new customers and retain those who are reaching maturity. In the event
that we see rate sensitive attrition on these deposits, we will rely upon our borrowing capacity to
supplement our cash position.
Shareholders’ Equity
As of September 30, 2008 and December 31, 2007, shareholders’ equity totaled $88.25 and $102.24,
respectively.
All capital management options are being analyzed, including the capital-raising initiative
recently outlined in the TARP capital program and an evaluation of our balance sheet structure. In
addition we have taken steps to preserve capital including the reduction of the quarterly dividend
from $0.10 per share as of March 31, 2008, to $0.01 per share as of June 30, 2008, and the
suspension of the dividend for the current and near-term quarters.
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.
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The following table presents our capital ratios as compared to regulatory minimums:
Capital Ratios:
We intend to return to “well-capitalized” by regulatory definition, and we plan to consider all
options, including, raising capital, to do so. All other capital management options are being
analyzed, including an evaluation of our balance sheet structure. Steps taken to preserve capital
include the reduction in force, which is expected to decrease our salary and benefit expense on a
go-forward basis, a discontinuation of quarterly dividends, and the elimination of Board of
Director fees for the remainder of 2008.
Stock Repurchase Plan
The repurchase plan authorized us to repurchase common stock in an amount up to $1.50 million
expired on June 30, 2008 and was not renewed by the Board of Directors. During the nine months
ended September 30, 2008, we did not repurchase any stock under a stock repurchase plan. In August
2008, we repurchased shares following the vesting of stock awards based on employee elections to
redeem shares to cover tax withholding obligations.
The following table presents all stock repurchases during the three months ended September 30,
2008:
Stock Repurchases:
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk Management
In the banking industry, a major risk involves changing interest rates, which can have a
significant impact on our profitability. We manage exposure to changes in interest rates through
asset and liability management activities within the guidelines established by our Asset Liability
Committees (“ALCO”). We have two levels of ALCO oversight and management: Management ALCO, which
meets monthly, and Board ALCO, which meets quarterly. Our Board ALCO has responsibility for
establishing the tolerances and monitoring compliance with asset-liability management policies,
including interest rate risk exposure, capital position, liquidity management and the investment
portfolio. Our Management ALCO has responsibility to manage the daily activities necessary to
ensure compliance with asset-liability management policies and tolerances. Board ALCO minutes are
provided to the Board of Directors for review and approval.
Asset-liability management simulation models are used to measure interest rate risk. The models
quantify interest rate risk through simulating forecasted net interest income and the economic
value of equity over a 12-month forward-looking time line under various rate scenarios. The
economic value of equity is defined as the difference between the market value of current assets
less the market value of liabilities. By measuring the change in the present value of equity under
different rate scenarios, we identify interest rate risk that may not be evident in simulating
changes in the forecasted net interest income.
The table below shows the simulated percentage change in forecasted net interest income and the
economic value of equity based on changes in the interest rate environment as of September 30,
2008. The change in interest rates assumes an immediate, parallel and sustained shift in the base
interest rate forecast. Through these simulations, we estimate the impact on net interest income
and present value of equity based on a 100 and 300 basis point upward and downward gradual change
of market interest rates over a one-year period. The analysis did not allow rates to fall below
zero.
As illustrated in the above table, our balance sheet is currently asset sensitive, meaning that
interest earning assets mature or re-price more frequently than interest bearing liabilities in a
given period. Therefore, according to the model, net interest income should increase slightly when
rates increase and shrink somewhat when rates fall in an interest rate shift that is parallel
across all terms of the yield curve. This is primarily a result of the concentration of variable
rate and short-term commercial loans in our portfolio.
The simulation model does not take into account future management actions that could be undertaken,
should a change occur in actual market interest rates. Also, assumptions underlying the modeling
simulation may have significant impact on the results. These include assumptions regarding the
level of interest rates and balance changes of deposit products that do not have stated maturities.
These assumptions have been developed through a combination of industry standards and historical
pricing behavior and modeled for future expectations. The model also includes assumptions about
changes in the composition or mix of the balance sheet. Results derived from the simulation model
could vary
significantly due to external factors such as changes in prepayment assumptions, early withdrawals
of deposits and unforeseen competitive factors.
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ITEM 4. CONTROLS AND PROCEDURES
Columbia’s 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 Columbia’s internal control over financial reporting that occurred during
the period covered by this report that have materially affected, or are likely to materially
affect, Columbia’s 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 Columbia’s 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 not presently aware of any legal proceedings for which we are the defendant.
ITEM 1A. RISK FACTORS
RISK FACTORS
Our past experience may not be indicative of future performance, and as noted elsewhere in this
report, we have included forward-looking statements about our business, plans and prospects that
are subject to change. Forward-looking statements are particularly located in, but not limited to,
the sections “Management’s Discussion and Analysis of Financial Condition and Results of
Operations.” In addition to the other risks or uncertainties contained in this report, the
following risks may affect our operating results, financial condition and cash flows. If any of
these risks occur, either alone or in combination with other factors, our business, financial
condition or operating results could be adversely affected. Moreover, readers should note this is
not an exhaustive list of the risks we face; some risks are unknown or not quantifiable, and other
risks that we currently perceive as immaterial may ultimately prove more significant than expected.
Statements about plans, predictions or expectations should not be construed to be assurances of
performance or promises to take a given course of action.
Risks Relating to our Company
We are operating under certain regulatory restrictions that may further impair our revenues,
operating income and financial condition.
We operate in a highly regulated industry and are subject to examination, supervision, and
comprehensive regulation by the Oregon Division of Finance and Corporate Securities (“DFCS”), the
FDIC, and the Federal Reserve Board. Our compliance with these regulations is costly and restricts
certain of our activities, including payment of dividends, mergers and acquisitions, investments,
loans and interest rates charged, interest rates paid on deposits, access to capital and brokered
deposits and locations of banking offices. If we are unable to meet these regulatory requirements,
our financial condition, liquidity and results of operations would be materially and adversely
affected.
We must also meet regulatory capital requirements imposed by our regulators. An inability to meet
these capital requirements would result in numerous mandatory supervisory actions and additional
regulatory
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restrictions, and could have a negative impact on our financial condition, liquidity and
results of operations. At September 30, 2008, we were “adequately capitalized” by regulatory
definition. This designation affects our eligibility for a streamlined review process for
acquisition proposals as well as our ability to accept brokered deposits without the prior approval
of the FDIC. If we do not remain “adequately capitalized” we would be subject to further
restrictions, including restrictions on our ability to make capital distributions and our ability
to grow.
Failure to meet capital requirements imposed by certain regulatory restrictions will have a
negative impact on our financial conditions, liquidity and results of operations.
We are subject to regulatory capital guidelines, which are used to evaluate our capital adequacy
based primarily on the regulatory weighting for credit risk associated with certain balance sheet
assets and certain off-balance sheet exposures such as unfunded loan commitments and letters of
credit. To be “adequately capitalized” we must have a Tier 1 capital ratio of at least 4%, a
combined Tier 1 and Tier 2 risk-based capital ratio of at least 8%, and a leverage ratio of at
least 4%, and not be subject to a directive, order, or written agreement to meet and maintain
specific capital levels. To be “well-capitalized” we must have a Tier 1 ratio of at least 6%, a
combined Tier 1 and Tier 2 risk-based capital ratio of at least 10%, and a leverage ratio of at
least 5%, and not be subject to a directive, order, or written agreement to meet and maintain
specific capital levels. If we are unable to meet these capital and other regulatory requirements,
our financial condition, liquidity, and results of operations would be materially and adversely
affected.
Federal banking regulators are required to take prompt corrective action if an insured depository
institution fails to satisfy certain minimum capital requirements, including a leverage limit, a
risk-based capital requirement, and any other measure of capital deemed appropriate by the federal
banking regulator for measuring the capital adequacy of an insured depository institution. At
September 30, 2008, we were deemed “adequately capitalized” by regulatory definition.
Our inability to remain “adequately capitalized” in the future would result in numerous mandatory
supervisory actions and additional regulatory restrictions, including restrictions on our ability
to make capital distributions, our ability to grow, our ability to raise deposits (particularly in
the wholesale market) and could negatively impact the manner in which we are regulated by state and
federal banking regulators. As of September 30, 2008 our primary sources for liquidity are from
retail deposits and available borrowings at the Federal Home Loan Bank (“FHLB”) and the Federal
Reserve Board (“FRB”).
Liquidity risk could impair our ability to fund operations and jeopardize our financial
condition.
Liquidity is essential to our business. An inability to raise funds through deposits, borrowings,
the sale of loans and other sources could have a substantial negative effect on our liquidity. Our
access to funding sources in amounts adequate to finance our activities or on terms which are
acceptable to us could be impaired by factors that affect us specifically or the financial services
industry or economy in general, including a decrease in the level of our business activity as a
result of the downturn in the Washington or Oregon markets in which our loans are concentrated or
adverse regulatory action against us. Our ability to borrow could also be impaired by factors not
specific to us, such as a disruption in the financial markets or negative views and expectations
about the prospects for the financial services industry in light of the recent turmoil faced by
banking organizations and the continued deterioration in credit markets.
Our liquidity may be impaired due to sharp declines in retail deposit balances or inability to
access wholesale liability sources.
Liquidity measures our ability to meet loan demand and deposit withdrawals and to service
liabilities as they come due. Our liquidity is primarily dependent on retail deposits gathered
from our branch network and wholesale liability sources. During 2007 and 2008, retail deposit
growth slowed significantly due to the general economic downturn and competition from other
financial institutions. As a result, our liquidity management has become more dependent on
wholesale liabilities. Wholesale liability sources include correspondent banks, the Federal Home
Loan Bank, deposit brokers and other institutional depositors. In the event our customers were to
lose confidence in our ability to remain solvent, we may experience a
rapid decline in retail deposits. This could force us to borrow heavily from the FHLB and FRB, or
if more pronounced, may require us to seek protection from the Federal Deposit Insurance
Corporation.
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Depending on the funding source, our access to wholesale liabilities is limited by various factors.
These factors include our financial performance, the level of assets that can be pledged to
borrowing sources and our credit ratings calculated by external rating agencies. One independent
rating agency, the Institutional Deposit Corporation (“IDC”), rates banks for safety and soundness.
We expect our IDC rating will decrease in the third quarter of 2008 due to a higher provision for
loan losses. Our access to brokered deposit markets may be significantly limited if our IDC rating
decreases. Moreover, correspondent banks have reduced their letters of credit overall and a lower
IDC rating may cause correspondent banks to cancel or reduce amounts available on our lines of
credit. A decline in our IDC rating will impair our liquidity, which will have an adverse effect on
our operating income and financial condition.
Recent and continuing adverse developments in the financial industry and the domestic and
international credit markets may further affect our operations and results and the value of our
common stock.
The national and global economic downturn has recently resulted in unprecedented levels of
financial market volatility which may depress overall the market value of financial institutions,
limit access to capital, or have a material adverse effect on the financial condition or results of
operations of banking companies in general and the Company in particular. As a result of this
“credit crunch,” commercial as well as consumer loan portfolio performances have deteriorated at
many institutions and the competition for deposits and quality loans has increased significantly.
In addition, the values of real estate collateral supporting many commercial loans and home
mortgages have declined and may continue to decline. Bank and bank holding company stock prices
have been negatively affected, as has the ability of banks and bank holding companies to raise
capital or borrow in the debt markets. As a result, there is a potential for new federal or state
laws and regulations regarding lending and funding practices and liquidity standards, and bank
regulatory agencies are expected to be very aggressive in responding to concerns and trends
identified in examinations, including the expected issuance of many formal enforcement orders.
Negative developments in the financial industry and the domestic and international credit markets,
and the impact of new legislation in response to such developments, may negatively impact our
operations by restricting our business operations, including our ability to originate or sell
loans, and may adversely impact our financial performance and the value of our common stock. In
addition, the possible duration and severity of the adverse economic cycle is unknown and may
exacerbate the Company’s exposure to credit risk. Treasury and FDIC programs have been initiated
to address economic stabilization, yet the efficacy of these programs in stabilizing the economy
and the banking system at large are uncertain. Details as to the Company’s participation or access
to such programs and their subsequent impact on the Company also remain uncertain.
Our allowance for loan losses is based on significant estimates and may be inadequate to cover
actual losses.
We are exposed to the risk that our customers will be unable to repay their loans in a timely
fashion and that collateral securing the payment of loans may be insufficient to ensure timely
repayment. Borrowers’ inability to timely repay their loans could erode our bank’s earnings and
capital. Our allowance for loan losses represents our best estimate of probable losses inherent in
our loan portfolio. Estimation of the allowance requires us to make various assumptions and
judgments about the collectability of loans in our portfolio. These assumptions and judgments
include historical loan loss experience, current credit profiles of our borrowers, adverse
situations that have occurred that may affect a borrower’s ability to meet his financial
obligations, the estimated value of underlying collateral and general economic conditions.
Determining the appropriateness of the allowance is complex and requires judgment by management
about the effect of matters that are inherently uncertain. The amount of future loan losses is
susceptible to changes in economic, operating, and other conditions that may be beyond our control.
Because our assumptions and judgments may not adequately predict future loan losses, actual loan
losses may be significantly higher than provided for in the allowance. In these cases, we would be
required to recognize higher provisions for loan losses, which would decrease our net income and
negatively impact our results of operations.
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Banking industry regulators may require us to recognize additional loan losses based on their
examination and review of our business.
Representatives of the Federal Reserve Board, the FDIC, and the DFCS, our principal regulators,
have publicly expressed concerns about the banking industry’s lending practices and have
particularly noted concerns about real estate-secured lending. Further, state and federal
regulatory agencies, as an integral part of their examination process, review our loans and our
allowance for loan losses. As a result of examination, we might be required to recognize
additional provisions for loan losses or charge-off selected loans. Any additional provision for
loan losses or charge-off of loans would adversely impact our results of operations and financial
condition.
Our loan portfolio is heavily concentrated in real estate lending and much of that portfolio
is collateralized only by real estate mortgages. As a result of this concentration and an overall
decline in real estate markets generally, and particularly in our geographic markets, we may face
greater than average exposure to loan losses.
In the past, we have focused a substantial portion of our lending business on residential and
commercial construction lending and in commercial leased or owner-occupied real property. A
substantial majority of our loan portfolio is secured by mortgages on real property. Real estate
lending is accompanied by two specific risks: the risk that real estate developers and builders (in
the case of construction real estate) and business owners (in the case of leased and owner-occupied
commercial real estate) cannot generate cash flows sufficient to repay their loans in a timely
manner, and the risk that the underlying collateral may decline in value, increasing the risk that
we may be unable to recover the full value of any defaulted loans by foreclosing on the real estate
that secures the loans.
During 2008, and in the third quarter in particular, we have experienced significant increases in
non-performing assets relating to our real estate lending, primarily in residential sub division
projects. We could see an increase in non-performing assets if more borrowers fail to perform
according to loan terms and if we take possession of real estate properties. If these effects
continue or become more pronounced, loan losses may increase more than we expect and our financial
condition and results of operations may be adversely impacted.
Our earnings may be impacted negatively by changes in market interest rates.
Our profitability depends in large part on our net interest income, which is the difference between
interest income from interest-earning assets, such as loans and securities, and interest expense on
interest-bearing liabilities, such as deposits and borrowings. Changes in market interest rates
affect the demand for new loans, the credit profile of existing loans, rates received on loans and
securities, and rates paid on deposits and borrowings. Based on our current volume and mix of
interest bearing liabilities and interest earning assets, net interest spread could generally be
expected to increase during times when interest rates rise and, conversely, to decline during times
of falling interest rates. Our net interest income will be adversely affected if the market
interest rate changes such that the interest we earn on loans and investments decreases faster than
the interest we pay on deposits and borrowings. We manage our interest rate risk exposure by
monitoring the re-pricing frequency of our rate-sensitive assets and rate-sensitive liabilities
over any given period.
Because of the differences in maturities and repricing characteristics of our interest-earning
assets and interest-bearing liabilities, changes in interest rates do not produce equivalent
changes in interest income earned on interest-earning assets and interest paid on interest-bearing
liabilities. Accordingly, fluctuations in interest rates could adversely affect our net interest
income and, in turn, our profitability. In addition, loan volumes are affected by market interest
rates on loans. Interest rates also affect how much money we can lend. When interest rates rise,
the cost of borrowing increases. Accordingly, changes in market interest rates could materially and
adversely affect our net interest income, asset quality, and loan origination volume.
If conditions in non-real estate sectors of the economy worsen, we may experience an increase
in loan delinquencies and losses in other parts of our portfolio.
During 2008, loan losses have been centered in real estate construction and development loans.
Ongoing weakness in the residential real estate market or other unexpected events may cause other
areas of the
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economy to falter. In particular, the effects of higher unemployment, declining consumer
confidence and difficulties in other non-real estate sectors of the economy may stress other parts
of our loan portfolio not currently experiencing problems. This may result in a higher level of
non-accrual loans and loan losses in these parts of the portfolio, which would negatively impact
our results of operations and financial condition.
The Company May Be Adversely Effected By The FDIC’s Recently Announced Temporary Liquidity
Guarantee Program
Due to recent bank failures, the FDIC insurance fund reserve ratio has fallen below 1.15 percent,
the statutory minimum. The FDIC has developed a proposed restoration plan that will uniformly
increase insurance assessments by 7 basis points (annualized). The plan also proposes changes to
the deposit insurance assessment system requiring riskier institutions to pay a larger share. An
increase in premium assessments would increase the Company’s expenses.
The Emergency Economic Stabilization Act of 2008 included a provision for an increase in the amount
of deposits insured by the Federal Deposit Insurance Corporation (FDIC) to $250,000. On October 14,
2008, the FDIC announced a new program — the Temporary Liquidity Guarantee Program that provides
unlimited deposit insurance on funds in noninterest-bearing transaction deposit accounts not
otherwise covered by the existing deposit insurance limit of $250,000. All eligible institutions
will be covered under the program for the first 30 days without incurring any costs. After the
initial period, participating institutions will be assessed a 10 basis point surcharge on the
additional insured deposits. The behavior of depositors in regard to the level of FDIC insurance
could cause our existing customers to reduce the amount of deposits held at the Bank, and could
cause new customers to open deposit accounts at the Bank. The level and composition of the Bank’s
deposit portfolio directly impacts the Bank’s funding cost and net interest margin. The Federal
Reserve Bank has been providing vast amounts of liquidity into the banking system to compensate for
weaknesses in short-term borrowing markets and other capital markets. A reduction in the Federal
Reserve’s activities or capacity could reduce liquidity in the markets, thereby increasing funding
costs to the Bank or reducing the availability of funds to the Bank to finance its existing
operations. In the event that the Bank’s funding costs are increased or the availability of funds
from the Federal Reserve is reduced it could have a negative material effect on the Company’s
earnings and results of operations.
We are subject to federal and state regulations which undergo frequent and often significant
changes.
Federal and state regulation of financial institutions is designed primarily to protect depositors,
borrowers and shareholders. These regulations can sometimes impose significant limitations on our
operations. Moreover, federal and state banking laws and regulations undergo frequent and often
significant changes and have been subject to significant change in recent years, sometimes
retroactively applied, and may change significantly in the future. Changes in laws and regulations
may affect our cost of doing business, limit our permissible activities (including insurance and
securities activities), or our competitive position in relation to credit unions, savings
associations and other financial institutions. These changes could also reduce federal deposit
insurance coverage, broaden the powers or geographic range of financial holding companies, alter
the taxation of financial institutions and change the structure and jurisdiction of various
regulatory agencies.
Federal monetary policy, particularly as implemented through the Federal Reserve System, can
significantly affect credit availability. Other federal legislation such as the Sarbanes-Oxley Act
can dramatically shift resources and costs to ensure adequate compliance. The effect of laws and
regulations may have an adverse impact on our business, financial condition and results of
operations.
A significant decline in the market value of our company may result in an impairment of
goodwill.
Columbia has a recorded balance of $7.39 million in goodwill associated with its acquisition
of Valley Community Bancorp in 1998. Accounting standards require us to evaluate goodwill for
impairment and to write down the goodwill if the business unit associated with the goodwill cannot
sustain the value attributed to it. Over the last several months, our common stock has been
trading below our book value per share. As a result of this and due to the current economic
environment, we hired a third party valuation specialist to assist us in evaluating whether our
goodwill was impaired as of September 30,
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2008. While no impairment was considered necessary as of September 30, 2008, further declines in
market value, or other factors, could result in a need for impairment in future quarters. A
write-down of goodwill due to impairment would adversely impact our results of operations and
financial condition. However, a write-down would not have an impact on regulatory capital ratios,
as goodwill is excluded from the calculation.
The weakened housing market may result in a decline in fair value of Other Real Estate Owned
(“OREO”).
In recent months we have foreclosed on certain real estate development loans and have taken
possession of several residential subdivision properties. OREO is initially recorded at its
estimated fair value less costs to sell. Because of the weak housing market and declining land
values, we may incur losses to write-down OREO to new fair values or losses from the final sale of
properties. Moreover, our ability to sell OREO properties is affected by public perception that
banks are inclined to accept large discounts from market value in order to quickly liquidate
properties. Write-downs on OREO or an inability to sell OREO properties will have a material
adverse effect on our results of operations and financial conditions.
We are a holding company and depend on our subsidiaries for dividends, distributions and other
payments.
We are a separate and distinct legal entity from our banking subsidiary, Columbia River Bank, and
depend on dividends, distributions and other payments from the Bank to fund any cash dividend
payments on our common stock and to fund payments on our other obligations. The Bank is subject to
laws and regulations that restrict, or authorize regulatory bodies to restrict or reduce, the flow
of funds from the Bank to us. Restrictions of that kind could impede access to funds we need to
make dividend payments on our common stock, or payments on our other obligations. Furthermore, our
right to participate in a distribution of assets upon a subsidiary’s liquidation or reorganization
is subject to the prior claims of the subsidiary’s creditors.
There are regulatory and contractual limitations that may limit or prevent us from paying
dividends on the common stock and we may limit or eliminate our dividends to shareholders.
As a bank holding company, our ability to declare and pay dividends is dependent on certain federal
regulatory considerations. We are an entity separate and distinct from our subsidiary, Columbia
River Bank, and derive substantially all of our revenue in the form of dividends from the Bank.
Accordingly, we are dependent upon dividends from the Bank to pay the principal of and interest on
its indebtedness, to satisfy its other cash needs and to pay dividends on its common stock. The
Bank’s ability to pay dividends is subject to its ability to earn net income and to meet certain
regulatory requirements. In the event the Bank is unable to pay dividends to us, we may not be
able to service our debt, pay our obligations or pay dividends on our common stock. In addition,
our right to participate in a distribution of assets upon the Bank’s liquidation or reorganization
is subject to the prior claims of the Bank’s creditors.
Our board of directors regularly reviews our dividend policy in light of current economic
conditions for financial institutions as well as our capital needs. On a quarterly basis, the board
of directors determines whether a dividend will be paid and in what amount. No assurance can be
given concerning dividend payments in future periods.
Our business operations are geographically concentrated in Oregon and Washington and our
business is sensitive to the economic conditions of those areas.
Substantially all of our business is derived from a twelve—county area in northern and central
Oregon and southern and central Washington. The communities we serve typically have population
bases of 20,000 to 250,000, and have traditionally created employment opportunities in the areas of
agriculture, timber, electrical power generation, light manufacturing, construction and
transportation. While we have built our expansion strategy around these growing and diverse
geographic markets, our business is and will remain sensitive to economic factors that relate to
these industries and local and regional business conditions. As a result, local or regional
economic downturns, or downturns that disproportionately affect one or more of the key industries
in regions we serve, may have a more pronounced effect upon our business than they might on an
institution that is more geographically diversified. The extent of the future
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impact of these events on economic and business conditions cannot be predicted; however, prolonged
or acute fluctuations could have a material and adverse impact upon our results of operation and
financial condition.
The financial services business is intensely competitive and our success will depend on our
ability to compete effectively.
The financial services business has become increasingly competitive due to changes in regulation,
technological advances, and the accelerating pace of consolidation among financial services
providers. We face competition both in attracting deposits and in originating loans. We compete for
loans principally based on the efficiency and quality of our service and also based on pricing of
interest rates and loan fees. Some of the financial services organizations with which we compete
are not subject to the same degree of regulation as is imposed on bank holding companies and
federally insured state-chartered banks, national banks and federal savings institutions. As a
result, these non-bank competitors have certain advantages over us in accessing funding and in
providing various services. Some of these competitors are subject to similar regulation but have
the advantages of larger established client bases, higher lending limits, no federal income or
state franchise taxation, extensive branch networks, numerous ATMs, greater advertising-marketing
budgets and other factors. Increasing levels of competition in the banking and financial services
industries may limit our ability to attract new customers, reduce our market share or cause the
prices charged for our services to fall. Our future growth and success will depend on our ability
to compete effectively in this highly competitive financial services environment.
We rely heavily on our management team and the unexpected loss of any of those personnel could
adversely affect our operations; we depend on our ability to attract and retain key personnel.
We are a client-focused and relationship-driven organization. We expect our future success to be
driven in large part by the relationships maintained with our clients by our executives and senior
lending officers. We have entered into employment agreements with several members of senior
management. The existence of such agreements, however, does not necessarily ensure that we will be
able to continue to retain their services. The unexpected loss of key employees could have a
material adverse effect on our business and possibly result in reduced revenues and earnings.
Our future success will also require us to continue to attract, hire, motivate and retain skilled
personnel to develop new client relationships as well as new financial products and services. Many
experienced banking professionals employed by our competitors are covered by agreements not to
compete or solicit their existing clients if they were to leave their current employment. These
agreements make the recruitment of these professionals more difficult. The market for these
resources is competitive, and we cannot assure you that we will be successful in attracting,
hiring, motivating or retaining them.
Our ability to operate profitably may depend on our ability to implement various technologies
into our operations.
The market for financial services, including banking services and consumer finance services is
increasingly affected by advances in technology, including developments in telecommunications, data
processing, computers, automation, and internet-based banking. Our ability to compete successfully
in our markets may depend on the extent to which we are able to exploit such technological changes.
If we are not able to afford such technologies, properly or timely anticipate or implement such
technologies, or properly train our staff to use such technologies, our business, financial
condition or operating results could be adversely affected.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
Exhibits
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SIGNATURES
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.
COLUMBIA BANCORP
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