As Filed with the Securities & Exchange Commission on November 4, 2010.
SECURITIES & EXCHANGE COMMISSION
FORM 10-Q
[ X ] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Actof 1934 for the quarterly period ended September 30, 2010.
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Actof 1934 For the transition period from _______________ to ________________
Commission File Number: 0-30106
PACIFIC CONTINENTAL CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
OREGON | 93-1269184 |
(State or Other Jurisdiction of | (I.R.S. Employer |
Incorporation or Organization) | Identification Number) |
111 West 7th Avenue
Eugene, Oregon 97401
(Address of principal executive offices) (Zip Code)
(541) 686-8685
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No __
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes __No __
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definition of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Act.
(Check one).
Large accelerated filer __ Accelerated filer X 160; Non-accelerated filer __
Smaller Reporting company __
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act. Yes __ No X
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date:
Common Stock outstanding as of October 31, 2010: 18,404,725
PACIFIC CONTINENTAL CORPORATION
FORM 10-Q
QUARTERLY REPORT
TABLE OF CONTENTS
PART I | FINANCIAL INFORMATION | Page | |
Item 1. | Financial Statements | ||
Item 2. | |||
Item 3. | |||
Item 4. | |||
PART II | OTHER INFORMATION | ||
Item 1. | Legal Proceedings | none | |
Item 1a. | |||
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | none | |
Item 3. | Defaults Upon Senior Securities | none | |
Item 4. | Removed and Reserved | none | |
Item 5. | Other Information | none | |
Item 6. | |||
Page 2
Item 1. Financial Statements
Consolidated Balance Sheets
(In thousands, except share amounts)
(Unaudited)
September 30, | December 31, | September 30, | ||||||||||
2010 | 2009 | 2009 | ||||||||||
ASSETS | ||||||||||||
Cash and due from banks | $ | 18,424 | $ | 16,698 | $ | 17,624 | ||||||
Interest-bearing deposits with banks | 269 | 272 | 266 | |||||||||
Total cash and cash equivalents | 18,693 | 16,970 | 17,890 | |||||||||
Securities available-for-sale | 215,259 | 167,618 | 115,585 | |||||||||
Loans held-for-sale | 1,397 | 745 | 453 | |||||||||
Loans, less allowance for loan losses and net deferred fees | 864,604 | 930,997 | 940,754 | |||||||||
Interest receivable | 4,247 | 4,408 | 4,110 | |||||||||
Federal Home Loan Bank stock | 10,652 | 10,652 | 10,652 | |||||||||
Property, plant and equipment, net of accumulated depreciation | 21,169 | 20,228 | 20,132 | |||||||||
Goodwill and other intangible assets | 22,514 | 22,681 | 22,737 | |||||||||
Deferred tax asset | 9,749 | 7,177 | 6,301 | |||||||||
Taxes receivable | 1,460 | 5,299 | 4,707 | |||||||||
Other real estate owned | 15,422 | 4,224 | 4,247 | |||||||||
Prepaid FDIC assessment | 4,950 | 6,242 | - | |||||||||
Other assets | 1,888 | 1,872 | 2,940 | |||||||||
Total assets | $ | 1,192,004 | $ | 1,199,113 | $ | 1,150,508 | ||||||
LIABILITIES AND SHAREHOLDERS' EQUITY | ||||||||||||
Deposits | ||||||||||||
Noninterest-bearing demand | $ | 220,104 | $ | 202,088 | $ | 196,320 | ||||||
Savings and interest-bearing checking | 545,032 | 475,869 | 461,723 | |||||||||
Time $100,000 and over | 60,083 | 68,031 | 71,526 | |||||||||
Other time | 99,704 | 81,930 | 96,951 | |||||||||
Total deposits | 924,923 | 827,918 | 826,520 | |||||||||
Federal funds and overnight funds purchased | 12,380 | 63,025 | 90,000 | |||||||||
Federal Home Loan Bank advances and other borrowings | 68,500 | 130,000 | 101,000 | |||||||||
Junior subordinated debentures | 8,248 | 8,248 | 8,248 | |||||||||
Accrued interest and other payables | 5,374 | 4,260 | 4,430 | |||||||||
Total liabilities | 1,019,425 | 1,033,451 | 1,030,198 | |||||||||
Shareholders' equity | ||||||||||||
Common stock; authorized 50,000,000 shares; issued and | ||||||||||||
outstanding 18,404,725 shares (18,393,773 shares at | ||||||||||||
December 31, 2009 and 12,872,781 shares at September 30, 2009) | 136,845 | 136,316 | 90,522 | |||||||||
Retained earnings | 32,962 | 29,613 | 29,773 | |||||||||
Accumulated other comprehensive income (loss) | 2,772 | (267 | ) | 15 | ||||||||
172,579 | 165,662 | 120,310 | ||||||||||
Total liabilities and shareholders’ equity | $ | 1,192,004 | $ | 1,199,113 | $ | 1,150,508 | ||||||
See accompanying notes. | ||||||||||||
Page 3
Consolidated Statements of Operations
(In thousands, except share and per share amounts)
(Unaudited)
Three months ended | Nine months ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Interest and dividend income | ||||||||||||||||
Loans | $ | 14,070 | $ | 15,659 | $ | 43,233 | $ | 46,308 | ||||||||
Securities | 1,791 | 1,325 | 4,745 | 3,495 | ||||||||||||
Federal funds sold & interest-bearing deposits with banks | 3 | 2 | 6 | 4 | ||||||||||||
15,864 | 16,986 | 47,984 | 49,807 | |||||||||||||
Interest expense | ||||||||||||||||
Deposits | 2,395 | 2,481 | 7,069 | 7,080 | ||||||||||||
Federal Home Loan Bank & Federal Reserve borrowings | 563 | 633 | 1,788 | 2,005 | ||||||||||||
Junior subordinated debentures | 133 | 132 | 393 | 392 | ||||||||||||
Federal funds purchased | 15 | 23 | 39 | 76 | ||||||||||||
3,106 | 3,269 | 9,289 | 9,553 | |||||||||||||
Net interest income | 12,758 | 13,717 | 38,695 | 40,254 | ||||||||||||
Provision for loan losses | 3,750 | 8,300 | 11,750 | 29,000 | ||||||||||||
Net interest income after provision for loan losses | 9,008 | 5,417 | 26,945 | 11,254 | ||||||||||||
Noninterest income | ||||||||||||||||
Service charges on deposit accounts | 418 | 465 | 1,247 | 1,401 | ||||||||||||
Bankcard fee income | 385 | 317 | 1,078 | 899 | ||||||||||||
Loan servicing fees | 31 | 18 | 63 | 55 | ||||||||||||
Mortgage banking income | 69 | 61 | 144 | 247 | ||||||||||||
Gain on sale of investment securities | - | - | 45 | - | ||||||||||||
Impairment losses on investment securities (OTTI) | - | - | (226 | ) | - | |||||||||||
Other noninterest income | 286 | 248 | 806 | 725 | ||||||||||||
1,189 | 1,109 | 3,157 | 3,327 | |||||||||||||
Noninterest expense | ||||||||||||||||
Salaries and employee benefits | 4,071 | 3,810 | 13,054 | 12,908 | ||||||||||||
Premises and equipment | 909 | 747 | 2,580 | 2,431 | ||||||||||||
Bankcard processing | 131 | 135 | 424 | 381 | ||||||||||||
Business development | 225 | 342 | 931 | 1,272 | ||||||||||||
FDIC insurance assessment | 491 | 291 | 1,477 | 1,508 | ||||||||||||
Other real estate expense | 803 | 32 | 904 | 597 | ||||||||||||
Other noninterest expense | 1,558 | 1,657 | 4,934 | 4,613 | ||||||||||||
8,188 | 7,014 | 24,304 | 23,710 | |||||||||||||
Income (loss) before provision (benefit) for income taxes | 2,009 | (488 | ) | 5,798 | (9,129 | ) | ||||||||||
Provision (benefit) for income taxes | 857 | (767 | ) | 1,897 | (4,226 | ) | ||||||||||
Net income (loss) | $ | 1,152 | $ | 279 | $ | 3,901 | $ | (4,903 | ) | |||||||
Earnings (loss) per share | ||||||||||||||||
Basic | $ | 0.06 | $ | 0.02 | $ | 0.21 | $ | (0.38 | ) | |||||||
Diluted | $ | 0.06 | $ | 0.02 | $ | 0.21 | $ | (0.38 | ) | |||||||
Weighted average shares outstanding | ||||||||||||||||
Basic | 18,399,442 | 12,872,781 | 18,396,990 | 12,852,063 | ||||||||||||
Common stock equivalents | ||||||||||||||||
attributable to stock-based awards | 16,161 | 35,869 | 18,620 | - | ||||||||||||
Diluted | 18,415,603 | 12,908,650 | 18,415,610 | 12,852,063 | ||||||||||||
See accompanying notes. |
Page 4
Consolidated Statements of Changes in Shareholders’ Equity
(In thousands, except share amounts)
(Unaudited)
Pacific Continental Corporation and Subsidiaries | ||||||||||||||||||||
Consolidated Statements of Changes in Shareholder's Equity | ||||||||||||||||||||
(In thousands, except shares) | ||||||||||||||||||||
(Unaudited) | ||||||||||||||||||||
Accumulated | ||||||||||||||||||||
Other | ||||||||||||||||||||
Number | Common | Retained | Comprehensive | |||||||||||||||||
of Shares | Stock | Earnings | Income (Loss) | Total | ||||||||||||||||
Balance, December 31, 2008 | 12,079,691 | $ | 80,019 | $ | 37,764 | $ | (1,618 | ) | $ | 116,165 | ||||||||||
Net loss | (4,879 | ) | (4,879 | ) | ||||||||||||||||
Other comprehensive income: | ||||||||||||||||||||
Unrealized gain on securities | 2,158 | |||||||||||||||||||
Deferred income taxes | (807 | ) | ||||||||||||||||||
Other comprehensive income | 1,351 | 1,351 | ||||||||||||||||||
Comprehensive loss | (3,528 | ) | ||||||||||||||||||
Stock issuance, net of costs | 6,270,000 | 55,293 | 55,293 | |||||||||||||||||
Stock options exercised and related tax benefit | 44,082 | 440 | 440 | |||||||||||||||||
Share-based compensation | 564 | 564 | ||||||||||||||||||
Cash dividends | (3,272 | ) | (3,272 | ) | ||||||||||||||||
Balance, December 31, 2009 | 18,393,773 | 136,316 | 29,613 | (267 | ) | 165,662 | ||||||||||||||
Net income | 3,901 | 3,901 | ||||||||||||||||||
Other comprehensive income: | ||||||||||||||||||||
Unrealized gain on securities | 4,925 | |||||||||||||||||||
Deferred income taxes | (1,886 | ) | ||||||||||||||||||
Other comprehensive income | 3,039 | 3,039 | ||||||||||||||||||
Comprehensive income | 6,940 | |||||||||||||||||||
Stock issuance, net of costs | 4,952 | 38 | 38 | |||||||||||||||||
Stock options exercised and related tax benefit | 6,000 | 38 | 38 | |||||||||||||||||
Share-based compensation | 453 | 453 | ||||||||||||||||||
Cash dividends | (552 | ) | (552 | ) | ||||||||||||||||
Balance, September 30, 2010 | 18,404,725 | $ | 136,845 | $ | 32,962 | $ | 2,772 | $ | 172,579 |
Page 5
Consolidated Statements of Cash Flows
(Dollars in thousands)
(Unaudited)
Nine months ended September 30, | ||||||||
2010 | 2009 | |||||||
Cash flows from operating activities: | ||||||||
Net income (loss) | $ | 3,901 | $ | (4,903 | ) | |||
Adjustments to reconcile net income to net cash | ||||||||
from operating activities: | ||||||||
Depreciation and amortization, net of accretion | 3,130 | 790 | ||||||
Other than temporary impairment on investment securities | 226 | - | ||||||
Valuation adjustment on foreclosed assets | 762 | 436 | ||||||
Provision for loan losses | 11,750 | 29,000 | ||||||
(Gains) losses on foreclosed assets | (47 | ) | (8 | ) | ||||
Deferred income taxes | 349 | (1,303 | ) | |||||
Share-based compensation | 509 | 407 | ||||||
Production of mortgage loans held-for-sale | (8,086 | ) | (15,664 | ) | ||||
Proceeds from the sale of mortgage loans held-for-sale | 7,434 | 15,621 | ||||||
Change in: | ||||||||
Interest receivable | 161 | (89 | ) | |||||
Deferred loan fees | (1,036 | ) | (200 | ) | ||||
Accrued interest payable and other liabilities | (2,797 | ) | (1,402 | ) | ||||
Income taxes receivable | 2,955 | (6,766 | ) | |||||
Other assets | 1,346 | (731 | ) | |||||
Net cash provided by operating activities | 20,557 | 15,188 | ||||||
Cash flow from investing activities: | ||||||||
Proceeds from maturities of available for sale investment securities | 32,436 | 20,704 | ||||||
Purchase of available for sale investment securities | (77,237 | ) | (78,341 | ) | ||||
Net loan principal collections (originations) | 41,793 | (26,239 | ) | |||||
Purchase of loans | (40 | ) | (151 | ) | ||||
Cash paid for acquisitions | - | (11 | ) | |||||
Purchase of property | (2,029 | ) | (438 | ) | ||||
Proceeds on sale of foreclosed assets | 1,909 | 3,215 | ||||||
Purchase of energy tax credits | (12 | ) | (74 | ) | ||||
Net cash used by investing activities | (3,180 | ) | (81,335 | ) | ||||
Cash flow from financing activities: | ||||||||
Change in deposits | 97,005 | 104,083 | ||||||
Change in federal funds purchased and FHLB and FRB | ||||||||
short-term borrowings | (103,145 | ) | 11,000 | |||||
Proceeds from FHLB term advances originated | 3,500 | (581,000 | ) | |||||
FHLB term advances paid-off | (12,500 | ) | 522,500 | |||||
Proceeds from stock options exercised | 38 | 452 | ||||||
Proceeds from stock issuance, net of costs | - | 9,635 | ||||||
Dividends paid | (552 | ) | (3,088 | ) | ||||
Net cash provided by financing activities | (15,654 | ) | 63,582 | |||||
Net increase in cash and cash equivalents | 1,723 | (2,565 | ) | |||||
Cash and cash equivalents, beginning of period | 16,970 | 20,455 | ||||||
Cash and cash equivalents, end of period | $ | 18,693 | $ | 17,890 | ||||
Supplemental information: | ||||||||
Noncash investing and financing activities: | ||||||||
Transfers of loans to foreclosed assets | $ | 13,822 | $ | 4,100 | ||||
Change in unrealized gain on securities, net of | ||||||||
deferred income taxes | $ | 3,039 | $ | 1,633 | ||||
Cash paid during the period for: | ||||||||
Income taxes | $ | 4,219 | $ | 208 | ||||
Interest | $ | 8,884 | $ | 9,680 | ||||
See accompanying notes. |
Page 6
Notes to Consolidated Financial Statements
(Unaudited)
A complete set of Notes to Consolidated Financial Statements is a part of the Company’s 2009 Form 10-K filed March 16, 2010. The notes below are included due to material changes in the financial statements or to provide the reader with additional information not otherwise available. In preparing these financial statements, the Company has evaluated subsequent events and transactions for potential recognition or disclosure in the financial statements. All dollar amounts in the following notes are expressed in thousands, except share and per share data.
Certain amounts contained in the prior period consolidated financial statements have been reclassified where appropriate to conform to the financial statement presentation used in the current period. These reclassifications had no effect on previously reported net income.
1. Basis of Presentation
The accompanying interim consolidated financial statements include the accounts of Pacific Continental Corporation (the “Company”), a bank holding company, and its wholly-owned subsidiary, Pacific Continental Bank (the “Bank”) and the Bank’s wholly-owned subsidiaries, PCB Services Corporation and PCB Loan Services Corporation (both of which are presently inactive). All significant intercompany accounts and transactions have been eliminated in consolidation.
The accompanying consolidated financial statements have been prepared by the Company without audit and in conformity with generally accepted accounting principles in the United States of America for interim financial information. The financial statements include all adjustments and normal accruals, which the Company considers necessary for a fair presentation of the results of operations for such interim periods. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, as of the date of the balance sheets and income and expenses for the periods. Actual results could differ from those estimates.
The balance sheet data as of December 31, 2009 was derived from audited financial statements, but does not include all disclosures contained in the Company’s 2009 Form 10-K.�� The interim consolidated financial statements should be read in conjunction with the December 31, 2009 consolidated financial statements, including the notes thereto, included in the Company’s 2009 Form 10-K.
Page 7
2. Securities Available-for-Sale:
The amortized costs, unrealized gains, unrealized losses, and estimated fair values of securities available-for-sale at September 30, 2010 are as follows:
September 30, 2010 | ||||||||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||
Securities in | Securities in | |||||||||||||||||||||||
Continuous | Continuous | |||||||||||||||||||||||
Unrealized | Unrealized | |||||||||||||||||||||||
Loss | Loss | |||||||||||||||||||||||
Gross | Gross | Estimated | Position for | Position For | ||||||||||||||||||||
Amortized | Unrealized | Unrealized | Fair | Less Than | 12 Months | |||||||||||||||||||
Cost | Gains | Losses | Value | 12 Months | or Longer | |||||||||||||||||||
Unrealized Loss Positions | ||||||||||||||||||||||||
Obligations of states and political subdivisions: | $ | 2,796 | $ | - | $ | (70 | ) | $ | 2,726 | $ | 2,726 | $ | - | |||||||||||
Mortgage-backed securities: | ||||||||||||||||||||||||
Agency mortgage-backed securities | 31,869 | - | (210 | ) | 31,659 | 31,659 | - | |||||||||||||||||
Private-label mortgage-backed securities | 7,424 | - | (936 | ) | 6,488 | 1,188 | 5,300 | |||||||||||||||||
$ | 42,089 | $ | - | $ | (1,216 | ) | $ | 40,873 | $ | 35,573 | $ | 5,300 | ||||||||||||
Unrealized Gain Positions | ||||||||||||||||||||||||
Obligations of U.S. government agencies | $ | 7,054 | $ | 338 | $ | - | $ | 7,392 | ||||||||||||||||
Obligations of states and political subdivisions | 15,290 | 715 | - | 16,005 | ||||||||||||||||||||
Mortgage-backed securities: | ||||||||||||||||||||||||
Agency mortgage-backed securities | 131,111 | 4,041 | - | 135,152 | ||||||||||||||||||||
Private-label mortgage-backed securities | 15,222 | 615 | - | 15,837 | ||||||||||||||||||||
168,677 | 5,709 | - | 174,386 | |||||||||||||||||||||
$ | 210,766 | $ | 5,709 | $ | (1,216 | ) | $ | 215,259 | ||||||||||||||||
At September 30, 2010, there were 46 investment securities in unrealized loss positions, of which 10 have been in a continuous unrealized loss position for twelve months or longer. The fair value of the investment securities in a continuous loss position for twelve months or longer was $5,300. The unrealized loss associated with these securities was $901 at September 30, 2010. The projected average life of the securities portfolio is approximately two years. The Company has no intent, nor is it more likely than not, that it will be required to sell these securities before their recovery.
When a security experiences a decline in fair value below its amortized cost basis, it is deemed to be impaired. Management reviews the Company’s impaired investment securities on a quarterly basis for the presence of other-than-temporary impairment (“OTTI”). We assess whether OTTI is present when the fair value of a debt security is less than its amortized cost basis at the balance sheet date. Under these circumstances, OTTI is considered to have occurred, (1) if we intend to sell the security, (2) if it is “more likely than not” we will be required to sell the security before recovery of its amortized cost basis, or (3) the present value of expected cash flows is not sufficient to recover the entire amortized cost basis. The “more likely than not” criteria is a lower thr eshold than the “probable” criteria used under previous guidance.
At September 30, 2010, impairment exists on certain securities classified as obligations of U.S. government agencies and mortgage-backed securities. The impairment on obligations of U.S. government agencies is deemed to be temporary. Additionally, the impairment on agency mortgage-backed securities is deemed to be temporary, as these securities retain strong credit ratings, continue to perform adequately, and are backed by various government-sponsored enterprises (“GSEs”). These impairments are deemed to be associated with the changes in market interest rates or the widening of market spreads subsequent to the initial purchase of the securities, and not due to concerns regarding the underlying credit of the issuers or the underlying colla teral. The decline in value of these securities has resulted from current economic conditions. Although yields on these securities may be below market rates during the period, no loss of principal is expected.
During the second quarter 2010, Management performed a detailed review of its private-label mortgage-backed securities and identified five individual securities which were deemed to have OTTI. Management’s evaluation included the use of independently-generated third-party credit surveillance reports that analyze the loans underlying each security. These reports include estimates of default rates and severities, life collateral loss rates, and static voluntary prepayment assumptions to generate estimated cash flows at the individual security level. Additionally, Management considered factors such as downgraded credit ratings, severity and duration of the impairments, the stability of the issuers, and any discounts paid when the securities were purchased.
Page 8
The OTTI identified during the second quarter 2010 was divided into two components; the amount representing credit loss and the amount related to all other factors. The amount representing credit loss was $226, and was recognized in the second quarter 2010 against earnings. The amount representing all other factors was $140, and was recognized in other comprehensive income, net of applicable taxes. During the third quarter 2010, Management reviewed all of its private-label mortgage-backed securities and identified no additional OTTI. Management has considered all available information related to the collectability of the impaired investment securities and believes that the estimated credit loss is appropriate.
Following is a tabular roll-forward of the amount of credit-related OTTI recognized in earnings during the three and nine months ended September 30, 2010 and 2009:
Three months ended | Nine months ended | |||||||||||||||
September 30, 2010 | September 30, 2009 | September 30, 2010 | September 30, 2009 | |||||||||||||
Balance, beginning of period: | $ | 226 | $ | - | $ | - | $ | - | ||||||||
Additions: | ||||||||||||||||
Initial OTTI credit loss | - | - | 226 | - | ||||||||||||
Additional OTTI credit loss | - | - | - | - | ||||||||||||
Balance, end of period: | $ | 226 | $ | - | $ | 226 | $ | - | ||||||||
The amortized costs, unrealized gains, unrealized losses, and estimated fair values of securities available-for-sale at December 31, 2009 and September 30, 2009 are as follows:
December 31, 2009 | ||||||||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||
Securities in | Securities in | |||||||||||||||||||||||
Continuous | Continuous | |||||||||||||||||||||||
Unrealized | Unrealized | |||||||||||||||||||||||
Loss | Loss | |||||||||||||||||||||||
Gross | Gross | Estimated | Position for | Position For | ||||||||||||||||||||
Amortized | Unrealized | Unrealized | Fair | Less Than | 12 Months | |||||||||||||||||||
Cost | Gains | Losses | Value | 12 Months | or Longer | |||||||||||||||||||
Unrealized Loss Positions | ||||||||||||||||||||||||
Obligations of U.S. government agencies | $ | 5,047 | $ | - | $ | (47 | ) | $ | 5,000 | $ | 5,000 | $ | - | |||||||||||
Mortgage-backed securities | 61,721 | - | (2,511 | ) | 59,210 | 53,048 | 6,162 | |||||||||||||||||
$ | 66,768 | $ | - | $ | (2,558 | ) | $ | 64,210 | $ | 58,048 | $ | 6,162 | ||||||||||||
Unrealized Gain Positions | ||||||||||||||||||||||||
Obligations of states and political subdivisions | $ | 6,372 | $ | 337 | $ | - | $ | 6,709 | ||||||||||||||||
Mortgage-backed securities | 94,910 | 1,789 | - | 96,699 | ||||||||||||||||||||
101,282 | 2,126 | - | 103,408 | |||||||||||||||||||||
$ | 168,050 | $ | 2,126 | $ | (2,558 | ) | $ | 167,618 | ||||||||||||||||
September 30, 2009 | ||||||||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||
Securities in | Securities in | |||||||||||||||||||||||
Continuous | Continuous | |||||||||||||||||||||||
Unrealized | Unrealized | |||||||||||||||||||||||
Loss | Loss | |||||||||||||||||||||||
Gross | Gross | Estimated | Position for | Position For | ||||||||||||||||||||
Amortized | Unrealized | Unrealized | Fair | Less Than | 12 Months | |||||||||||||||||||
Cost | Gains | Losses | Value | 12 Months | or Longer | |||||||||||||||||||
Unrealized Loss Positions | ||||||||||||||||||||||||
Mortgage-backed securities | $ | 23,814 | $ | - | $ | 2,270 | $ | 21,544 | $ | 14,003 | $ | 7,541 | ||||||||||||
$ | 23,814 | $ | - | $ | 2,270 | $ | 21,544 | $ | 14,003 | $ | 7,541 | |||||||||||||
Unrealized Gain Positions | ||||||||||||||||||||||||
Obligations of states and political subdivisions | $ | 6,379 | $ | 387 | $ | - | $ | 6,766 | ||||||||||||||||
Mortgage-backed securities | 85,368 | 1,907 | - | 87,275 | ||||||||||||||||||||
91,747 | 2,294 | - | 94,041 | |||||||||||||||||||||
$ | 115,561 | $ | 2,294 | $ | 2,270 | $ | 115,585 | |||||||||||||||||
Page 9
September 30, 2010 | December 31, 2009 | September 30, 2009 | ||||||||||||||||||||||
Estimated | Estimated | Estimated | ||||||||||||||||||||||
Amortized | Fair | Amortized | Fair | Amortized | Fair | |||||||||||||||||||
Cost | Value | Cost | Value | Cost | Value | |||||||||||||||||||
Due in one year or less | $ | 24,815 | $ | 24,961 | $ | 32,730 | $ | 33,110 | $ | 15,766 | $ | 15,928 | ||||||||||||
Due after one year through 5 years | 161,574 | 165,742 | 122,580 | 122,063 | 89,648 | 89,678 | ||||||||||||||||||
Due after 5 years through 10 years | 21,212 | 21,435 | 12,740 | 12,445 | 10,147 | 9,979 | ||||||||||||||||||
Due after 10 years | 3,165 | 3,121 | - | - | - | - | ||||||||||||||||||
$ | 210,766 | $ | 215,259 | $ | 168,050 | $ | 167,618 | $ | 115,561 | $ | 115,585 | |||||||||||||
One investment security was sold during the second quarter of 2010 resulting in a gain on sale of $45.
At September 30, 2010, securities with amortized costs of $27,512 (estimated market values of $28,910) were pledged to secure certain Treasury and public deposits as required by law, and to secure a borrowing line with the Federal Home Loan Bank of Seattle.
Page 10
3. Loans
Major classifications of period end loans are as follows:
September 30, | % of gross | December 31, | % of gross | September 30, | % of gross | ||||||||||||||||||||
2010 | loans | 2009 | loans | 2009 | loans | ||||||||||||||||||||
LOANS BY TYPE | LOANS BY TYPE | ||||||||||||||||||||||||
Real estate secured loans: | |||||||||||||||||||||||||
Permanent Loans: | |||||||||||||||||||||||||
Multifamily residential | $ | 56,124 | 6.4 | % | $ | 68,509 | 7.2 | % | $ | 67,654 | 7.0 | % | |||||||||||||
Residential 1-4 family | 80,551 | 9.1 | % | 86,795 | 9.2 | % | 95,761 | 10.0 | % | ||||||||||||||||
Owner-occupied commercial | 201,075 | 22.8 | % | 197,884 | 20.9 | % | 200,569 | 20.9 | % | ||||||||||||||||
Non-owner-occupied commercial | 163,054 | 18.5 | % | 147,605 | 15.6 | % | 145,975 | 15.3 | % | ||||||||||||||||
Other loans secured by real estate | 25,013 | 2.9 | % | 37,404 | 4.0 | % | 36,546 | 3.8 | % | ||||||||||||||||
Total permanent real estate loans | 525,817 | 59.6 | % | 538,197 | 56.9 | % | 546,505 | 56.9 | % | ||||||||||||||||
Construction Loans: | |||||||||||||||||||||||||
Multifamily residential | 15,279 | 1.6 | % | 18,472 | 2.0 | % | 20,994 | 2.1 | % | ||||||||||||||||
Residential 1-4 family | 26,830 | 3.0 | % | 41,714 | 4.4 | % | 42,813 | 4.5 | % | ||||||||||||||||
Commercial real estate | 18,077 | 2.0 | % | 38,921 | 4.1 | % | 40,914 | 4.3 | % | ||||||||||||||||
Commercial bare land and acquisition & development | 26,073 | 3.0 | % | 30,169 | 3.2 | % | 28,907 | 3.0 | % | ||||||||||||||||
Residential bare land and acquisition & development | 18,998 | 2.2 | % | 30,484 | 3.2 | % | 30,879 | 3.2 | % | ||||||||||||||||
Other | - | 0.0 | % | 1,582 | 0.2 | % | 5,198 | 0.5 | % | ||||||||||||||||
Total construction real estate loans | 105,257 | 11.9 | % | 161,342 | 17.1 | % | 169,705 | 17.7 | % | ||||||||||||||||
Total real estate loans | 631,074 | 71.5 | % | 699,539 | 74.0 | % | 716,210 | 74.6 | % | ||||||||||||||||
Commercial loans | 242,904 | 27.5 | % | 233,821 | 24.7 | % | 229,881 | 23.9 | % | ||||||||||||||||
Consumer loans | 6,742 | 0.8 | % | 6,763 | 0.7 | % | 7,125 | 0.7 | % | ||||||||||||||||
Other loans | 2,239 | 0.3 | % | 5,629 | 0.6 | % | 7,420 | 0.8 | % | ||||||||||||||||
Gross loans | 882,959 | 100.0 | % | 945,752 | 100.0 | % | 960,636 | 100.0 | % | ||||||||||||||||
Deferred loan origination fees | (586 | ) | (1,388 | ) | (1,534 | ) | |||||||||||||||||||
882,373 | 944,364 | 959,102 | |||||||||||||||||||||||
Allowance for loan losses | (17,769 | ) | (13,367 | ) | (18,348 | ) | |||||||||||||||||||
Loans, less allowance for loan losses and net deferred fees | $ | 864,604 | $ | 930,997 | $ | 940,754 | |||||||||||||||||||
Real estate loans held for sale | $ | 1,397 | $ | 745 | $ | 453 |
Outstanding loans to dental professionals totaled $172,849 and represented 19.6% of total outstanding loans at September 30, 2010. At December 31, 2009 and September 30, 2009, loans to dental professionals totaled $158,433 and $150,360 or 16.8% and 15.7% of total outstanding loans, respectively. There are no other industry concentrations in excess of 10% of total outstanding loans.
At September 30, 2010, outstanding residential construction loans totaled $26,830 and represented 3.0% of total outstanding loans. In addition, at September 30, 2010, unfunded loan commitments for residential construction totaled $8,823. Outstanding residential construction loans at December 31, 2009 and September 30, 2009 were $41,714 or 4.4% and $42,813 or 4.5%, respectively, of total outstanding loans, and unfunded commitments for residential construction totaled $9,990 and $11,371, respectively.
Approximately 71.5% of the Bank’s loans are secured by real estate. Management believes the granular nature of the portfolio, from industry mix, geographic location and loan size, mitigates concentration risk to some degree.
Page 11
4. Allowance for loan losses
Below is a summary of additions, charge-offs and recoveries within the allowance for loan losses for the three and nine months ended September 30, 2010 and 2009:
Three months ended | Nine months ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Balance, beginning of period | $ | 17,854 | $ | 18,680 | $ | 13,367 | $ | 10,980 | ||||||||
Provision charged to income | 3,750 | 8,300 | 11,750 | 29,000 | ||||||||||||
Loans charged against allowance | (4,240 | ) | (8,822 | ) | (10,189 | ) | (21,872 | ) | ||||||||
Recoveries credited to allowance | 405 | 190 | 2,841 | 240 | ||||||||||||
Balance, end of period | $ | 17,769 | $ | 18,348 | $ | 17,769 | $ | 18,348 | ||||||||
The recorded investment in impaired loans, net of government guarantees, totaled $42,540, $32,346, and $25,896 at September 30, 2010, December 31, 2009 and September 30, 2009, respectively. The specific valuation allowance for impaired loans was $2,231, $1,048 and $1,802 at September 30, 2010, December 31, 2009 and September 30, 2009, respectively, and is included in the ending allowance shown above. The average recorded investment in impaired loans was approximately $42,542 and $21,668 during the first nine months of 2010 and 2009, respectively. Interest income recognized on impaired loans was $585 and $325 in the three months ended September 30, 2010 and 2009, respectively. Interest income recognized on impaired loans was $739 and $1,180 for the nine months ended September 30, 2010 and 2009 , respectively. At September 30, 2010, there were three restructured loans which were on nonaccrual status, totaling $6,355.
Page 12
5. Federal Funds and Overnight Funds Purchased:
The Bank has unsecured federal funds borrowing lines with various correspondent banks totaling $88,000. Below is a summary of the outstanding balances on these lines as of September 30, 2010, December 31, 2009, and September 30, 2009:
September 30, 2010 | Maximum Line Amount | Balance Outstanding | Due Date | Weighted Average Interest Rate | |||||||||
Bank of America | $ | 15,000 | $ | - | |||||||||
US Bank | 30,000 | 12,380 | 10/1/2010 | 1.00 | % | ||||||||
Zions Bank | 20,000 | - | |||||||||||
FTN | 18,000 | - | |||||||||||
Wells Fargo | 5,000 | - | |||||||||||
Total | $ | 88,000 | $ | 12,380 | |||||||||
December 31, 2009 | Maximum Line Amount | Balance Outstanding | Due Date | Weighted Average Interest Rate | ||||||||||||
Bank of America | $ | 15,000 | $ | 10,000 | 1/4/10 | 0.45 | % | |||||||||
US Bank | 25,000 | - | - | - | ||||||||||||
Zions Bank | 20,000 | - | - | - | ||||||||||||
FTN | 18,000 | - | - | - | ||||||||||||
Wells Fargo | 5,000 | - | - | - | ||||||||||||
Total | $ | 83,000 | $ | 10,000 | ||||||||||||
September 30, 2009 | Maximum Line Amount | Balance Outstanding | Due Date | Weighted Average Interest Rate | ||||||||||||
Bank of America | $ | 25,000 | $ | 10,000 | 10/1/09 | 0.45 | % | |||||||||
US Bank | 25,000 | - | - | - | ||||||||||||
Key Bank | 25,000 | - | - | - | ||||||||||||
Zions Bank | 20,000 | - | - | - | ||||||||||||
FTN | 18,000 | - | - | - | ||||||||||||
Wells Fargo | 5,000 | - | - | - | ||||||||||||
Total | $ | 118,000 | $ | 10,000 | ||||||||||||
The Bank also has a secured overnight borrowing line available from the Federal Reserve Bank totaling $94,385 at September 30, 2010. The Federal Reserve Bank borrowing line is secured through the pledging of approximately $183,276 of commercial loans under the Bank’s Borrower-In-Custody program. At September 30, 2010 there were no funds borrowed on this line. At December 31, 2009 and September 30, 2009, the Company had $53,025 and $80,000 borrowed against this line.
Page 13
6. Federal Home Loan Bank Advances and Other Borrowings:
The Bank has a borrowing limit with the FHLB equal to 30% of total assets, subject to discounted collateral and stock holdings. At September 30, 2010, the available borrowing line was approximately $357,601. FHLB stock, funds on deposit with FHLB, securities and loans are pledged as collateral for borrowings from FHLB. At September 30, 2010, the Bank had pledged approximately $340,051 in real estate loans and securities to the FHLB ($226,118 in discounted pledged collateral). At September 30, 2010, there was $68,500 in term advances borrowed on this line.
Federal Home Loan Bank borrowings by year of maturity and applicable interest rate are summarized as follows:
Current | September 30, | December 31, | September 30, | |||||||||||||
Rates | 2010 | 2009 | 2009 | |||||||||||||
Cash Management Advance | $ | - | $ | - | $ | 25,000 | ||||||||||
2009 | - | - | 17,000 | |||||||||||||
2010 | 4.96 | % | 1,500 | 66,500 | 11,500 | |||||||||||
2011 | 2.93 - 5.28 | % | 10,000 | 10,000 | 10,000 | |||||||||||
2012 | 2.02 - 5.28 | % | 16,000 | 16,000 | 14,000 | |||||||||||
2013 | 2.46 - 4.27 | % | 22,000 | 22,000 | 17,000 | |||||||||||
2014 | 2.78 - 3.25 | % | 13,500 | 13,500 | 4,500 | |||||||||||
2015 | 2.19 - 2.86 | % | 3,500 | - | - | |||||||||||
2016 | 5.05 | % | 2,000 | 2,000 | 2,000 | |||||||||||
$ | 68,500 | $ | 130,000 | $ | 101,000 | |||||||||||
7. Stock-based Compensation Plans
Incentive stock options, nonqualified stock options, restricted stock awards, restricted stock units, or stock appreciation rights (“SARs”) may be awarded to attract and retain the best available personnel for positions of responsibility with the Company and its subsidiaries. The Compensation Committee of the Board of Directors may impose any terms or conditions on the vesting of an award that it determines to be appropriate. Awards granted generally vest over three or four years and have a maximum life of ten years. Awards settled in stock are recognized as equity-based awards while awards settled in cash are recognized on the balance sheet as liability-based awards, both of which are granted at the fair market value of the Company’s common stock at the grant date. Equity-b ased awards are expensed over the vesting period based on the grant date fair market value. Liability-based awards are expensed over the vesting period based on the current fair market value and an offsetting adjustment is recorded to the liability.
For the three months ended September 30, 2010 and 2009, no equity or liability-based awards were granted. During the nine months ended September 30, 2010, 197,926 equity-based shares were granted. During the nine months ended September 30, 2009, 268,416 equity-based shares were granted and 95,523 shares were granted as liability-based awards.
During the nine months ended September 30, 2010, 6,000 stock options were exercised with a weighted average exercise price of $6.38 per share and an intrinsic value of $11. During the nine months ended September 30, 2009, 5,367 stock options were exercised with a weighted average exercise price of $10.35 per share and an intrinsic value of $13. The fair value of shares vested during the nine months ended September 30, 2010 and 2009 was $686 and $496, respectively.
No liability-based awards were exercised in 2010 or 2009.
Page 14
The following table summarizes the weighted-average fair market values of the awards granted during the nine months ended September 30, 2010 and 2009:
Nine months ended | ||||||||||||||||
September 30, | ||||||||||||||||
2010 | 2009 | |||||||||||||||
Shares | Fair Market Value | Shares | Fair Market Value | |||||||||||||
Equity-based awards: | ||||||||||||||||
Director restricted stock | 4,952 | $ | 56 | 5,715 | $ | 63 | ||||||||||
Employee stock options | 62,475 | 269 | 115,747 | 323 | ||||||||||||
Employee stock SARs | 130,499 | 529 | 146,954 | 406 | ||||||||||||
Liability-based awards: | ||||||||||||||||
Employee cash SARs | - | - | 95,523 | 243 | ||||||||||||
197,926 | $ | 854 | 363,939 | $ | 1,035 | |||||||||||
The following tables identify the compensation expense recorded and tax benefits received by the Company on its stock-based compensation plans for the three and nine months ended September 30, 2010 and 2009:
Three months ended | ||||||||||||||||
September 30, | ||||||||||||||||
2010 | 2009 | |||||||||||||||
Compensation Expense (Benefit) | Tax Benefit (Expense) | Compensation Expense | Tax Benefit | |||||||||||||
Equity-based awards: | ||||||||||||||||
Director restricted stock | $ | - | $ | - | $ | 25 | $ | 10 | ||||||||
Director stock options | 5 | 2 | 7 | 3 | ||||||||||||
Employee stock options | 66 | - | 60 | - | ||||||||||||
Employee stock SARs | 90 | 31 | 68 | 26 | ||||||||||||
Liability-based awards: | ||||||||||||||||
Employee cash SARs | (38 | ) | (13 | ) | (12 | ) | (5 | ) | ||||||||
$ | 123 | $ | 20 | $ | 148 | $ | 34 | |||||||||
Nine months ended | ||||||||||||||||
September 30, | ||||||||||||||||
2010 | 2009 | |||||||||||||||
Compensation Expense | Tax Benefit | Compensation Expense | Tax Benefit | |||||||||||||
Equity-based awards: | ||||||||||||||||
Director restricted stock | $ | 56 | 20 | $ | 39 | $ | 15 | |||||||||
Director stock options | 13 | 4 | 21 | 8 | ||||||||||||
Employee stock options | 197 | - | 164 | - | ||||||||||||
Employee stock SARs | 243 | 85 | 183 | 70 | ||||||||||||
Liability-based awards: | ||||||||||||||||
Employee cash SARs | 93 | 33 | 77 | 30 | ||||||||||||
$ | 602 | 142 | $ | 484 | $ | 123 | ||||||||||
At September 30, 2010, the Company has estimated unrecognized compensation expense of approximately $440, $672 and $144 for unvested stock options, SAR stock awards, and SAR cash awards, respectively. These amounts are based on forfeiture rates of 20% for all awards granted to employees. The weighted-average period of time the unrecognized compensation expense will be recognized for the unvested stock options, SAR stock awards and SAR cash awards is approximately 2.69, 2.90, and 2.13 years, respectively.
Page 15
8. Fair Value
The Company adheres to FASB Accounting Standards Codification (ASC) topic 825, “Financial Instruments”, which requires disclosure of the carrying amount and the fair value of financial assets and liabilities. The use of different assumptions and estimation methods could have a significant effect on fair value amounts. Accordingly, the estimates of fair value herein are not necessarily indicative of the amounts that might be realized in a current market exchange.
The table below shows the estimated fair values of financial instruments at September 30, 2010, December 31, 2009, and September 30, 2009:
September 30, 2010 | December 31, 2009 | September 30, 2009 | ||||||||||||||||||||||
Carrying | Carrying | Carrying | ||||||||||||||||||||||
Amount | Fair Value | Amount | Fair Value | Amount | Fair Value | |||||||||||||||||||
Financial assets: | ||||||||||||||||||||||||
Cash and cash equivalents | $ | 18,693 | $ | 18,693 | $ | 16,970 | $ | 16,970 | $ | 17,890 | $ | 17,890 | ||||||||||||
Securities available for sale | 215,259 | 215,259 | 167,618 | 167,618 | 115,585 | 115,585 | ||||||||||||||||||
Loans held-for-sale | 1,397 | 1,397 | 745 | 745 | 453 | 453 | ||||||||||||||||||
Loans | 882,959 | 871,318 | 945,752 | 932,608 | 960,636 | 951,081 | ||||||||||||||||||
Federal Home Loan Bank stock | 10,652 | 10,652 | 10,652 | 10,652 | 10,652 | 10,652 | ||||||||||||||||||
Accrued interest receivable | 4,247 | 4,247 | 4,408 | 4,408 | 4,110 | 4,110 | ||||||||||||||||||
Financial liabilities: | ||||||||||||||||||||||||
Deposits | 924,923 | 927,345 | 827,918 | 829,893 | 826,520 | 828,606 | ||||||||||||||||||
Federal funds and overnight funds purchased | 12,380 | 12,380 | 63,025 | 63,025 | 10,000 | 10,000 | ||||||||||||||||||
Federal Home Loan Bank advances and | ||||||||||||||||||||||||
other borrowings | 68,500 | 71,765 | 130,000 | 130,787 | 181,000 | 182,477 | ||||||||||||||||||
Junior subordinated debentures | 8,248 | 1,908 | 8,248 | 7,987 | 8,248 | 7,944 | ||||||||||||||||||
Accrued interest payable | 611 | 611 | 623 | 623 | 666 | 666 | ||||||||||||||||||
Cash and cash equivalents – The carrying amount approximates fair value.
Securities available–for-sale – Fair value is based on quoted market prices. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.
Loans held–for-sale – Fair value represents the anticipated proceeds from the sale of related loans.
Loans – For variable-rate loans that reprice frequently and have no significant change in credit risk, fair values is based on carrying values. Fair value of fixed-rate loans is estimated by discounting the future cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Fair values for impaired loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.
Federal Home Loan Bank stock – Fair value is base on the most recent redemption price. The carrying amount approximates fair value.
Accrued interest receivable – The carrying amount approximates fair value.
Deposits – Fair value of demand, interest-bearing demand and savings deposits is the amount payable on demand at the reporting date. Fair value of time deposits is estimated using the interest rates currently offered for deposits of similar remaining maturities.
Federal funds and overnight funds purchased – The carrying amount approximates fair value due to the short-term nature of these borrowings.
Page 16
Federal Home Loan Bank advances and other borrowings – Fair value of Federal Home Loan Bank and other borrowings are estimated by discounting future cash flows at rates currently available to the Bank for debt with similar terms and remaining maturities.
Junior subordinated debentures – Fair value of junior subordinated debentures is estimated by discounting future cash flows at rates currently available to the Bank for debt with similar terms and remaining maturities.
Accrued interest payable – The carrying amount approximates fair value.
Off-balance sheet financial instruments – The carrying amount and fair value are based on fees charged for similar commitments and are not deemed to be material.
Effective January 1, 2008, the Company adopted the FASB guidance with regards to ASC 820, “Fair Value Measures”. This guidance defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. The statement requires fair value measurement disclosure of all assets and liabilities that are carried at fair value on either a recurring or non-recurring basis. The Company determines fair value based upon quoted prices when available or through the use of alternative approaches, such as matrix or model pricing, when market quotes are not readily accessible or available. The valuation techniques used are based on observable and unobservable inputs. Observable inputs reflect mar ket data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. These two types of inputs create the following fair value hierarchy:
Level 1 – Quoted prices for identical instruments in active markets.
Level 2 – Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-derived valuations whose inputs are observable or whose significant value drivers are observable.
Level 3 – Unobservable inputs are used to measure fair value to the extent that observable inputs are not available. The Company’s own data used to develop unobservable inputs is adjusted for market consideration when reasonably available.
Financial instruments are broken down in the table below by recurring or nonrecurring measurement status. Recurring assets are initially measured at fair value and are required to be remeasured at fair value in the financial statements at each reporting date. Assets measured on a nonrecurring basis are assets that, due to an event or circumstance, were required to be remeasured at fair value after initial recognition in the financial statements at some time during the reporting period.
Page 17
The tables below show assets measured at fair value for the periods ended September 30, 2010, December 31, 2009, and September 30, 2009:
September 30, 2010 | |||||||||||||||||
Quoted | |||||||||||||||||
Prices in | |||||||||||||||||
Active | |||||||||||||||||
Markets | Significant | ||||||||||||||||
for | Other | Significant | Period End | ||||||||||||||
Identical | Observable | Unobservable | September 30, | ||||||||||||||
Carrying | Assets | Inputs | Inputs | 2010 | |||||||||||||
Value | (Level 1) | (Level 2) | (Level 3) | Total Loss | |||||||||||||
Recurring Items | |||||||||||||||||
Obligations of U.S. Government agencies | $ | 7,392 | $ | 7,392 | |||||||||||||
Obligations of state and political subdivisions | 18,731 | 18,731 | |||||||||||||||
Mortgage-backed securities | 189,136 | 189,136 | |||||||||||||||
Non-Recurring Items | |||||||||||||||||
Loans measured for impairment | |||||||||||||||||
(net of guarantees) | $ | 33,601 | $ | 33,601 | $ | 2,231 | |||||||||||
Other real estate owned | 15,422 | 15,422 | 909 | ||||||||||||||
Total | $ | 264,282 | $ - | $ | 215,259 | $ | 49,023 | $ | 3,140 | ||||||||
December 31, 2009 | ||||||||||||||||||||
Quoted | ||||||||||||||||||||
Prices in | ||||||||||||||||||||
Active | ||||||||||||||||||||
Markets | Significant | |||||||||||||||||||
for | Other | Significant | Period End | |||||||||||||||||
Identical | Observable | Unobservable | December 31, | |||||||||||||||||
Carrying | Assets | Inputs | Inputs | 2009 | ||||||||||||||||
Value | (Level 1) | (Level 2) | (Level 3) | Total Loss | ||||||||||||||||
Recurring Items | ||||||||||||||||||||
Obligations of U.S. Government agencies | $ | 5,000 | $ | - | $ | 5,000 | $ | - | $ | - | ||||||||||
Obligations of state and political subdivisions | 6,709 | - | 6,709 | - | - | |||||||||||||||
Mortgage-backed securities | 155,909 | - | 155,909 | - | - | |||||||||||||||
Non-Recurring Items | ||||||||||||||||||||
Loans measured for impairment | ||||||||||||||||||||
(net of guarantees) | $ | 41,114 | $ | - | $ | - | $ | 41,114 | $ | 25,631 | ||||||||||
Other real estate owned | 4,224 | - | - | 4,224 | 515 | |||||||||||||||
Total | $ | 212,956 | $ | - | $ | 167,618 | $ | 45,338 | $ | 26,146 | ||||||||||
Page 18
September 30, 2009 | ||||||||||||||||||||
Quoted | ||||||||||||||||||||
Prices in | ||||||||||||||||||||
Active | ||||||||||||||||||||
Markets | Significant | |||||||||||||||||||
for | Other | Significant | Period End | |||||||||||||||||
Identical | Observable | Unobservable | September 30, | |||||||||||||||||
Carrying | Assets | Inputs | Inputs | 2010 | ||||||||||||||||
Value | (Level 1) | (Level 2) | (Level 3) | Total Loss | ||||||||||||||||
Recurring Items | ||||||||||||||||||||
Obligations of state and political subdivisions | $ | 6,766 | $ | - | $ | 6,766 | $ | - | $ | - | ||||||||||
Mortgage-backed securities | 108,819 | - | 108,819 | - | - | |||||||||||||||
Non-Recurring Items | ||||||||||||||||||||
Loans measured for impairment | ||||||||||||||||||||
(net of guarantees) | $ | 29,843 | $ | - | $ | - | $ | 29,843 | $ | 17,648 | ||||||||||
Other real estate owned | 4,247 | - | - | 4,247 | 436 | |||||||||||||||
Total | $ | 149,675 | $ | - | $ | 115,585 | $ | 34,090 | $ | 18,084 | ||||||||||
9. Regulatory Matters:
The Company and the Bank are subject to the regulations of certain federal and state agencies and receive periodic examinations by those regulatory authorities. In addition, they are subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory – and possibly additional discretionary – actions by regulators that, if undertaken, could have a direct material effect on the consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory acco unting practices. The Company and the Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of Total and Tier I capital to risk-weighted assets and of Tier I capital to leverage assets. Management believes, as of September 30, 2010, that the Company and the Bank meet all capital adequacy requirements to which they are subject.
As of September 30, 2010 and according to FDIC guidelines, the Company and the Bank are considered to be well-capitalized. To be categorized as well-capitalized, the Bank must maintain minimum Total risk-
Page 19
based,Tier I risk-based, and Tier I leverage ratios as set forth in the following table. The Bank’s and the Company’s actual capital amounts and ratios are presented below:
To Be Well- | ||||||||||||||||||||||||
Capitalized Under | ||||||||||||||||||||||||
For Capital | Prompt Corrective | |||||||||||||||||||||||
Actual | Adequacy Purposes | Action Provisions | ||||||||||||||||||||||
Amount | Ratio | Amount | Ratio | Amount | Ratio | |||||||||||||||||||
As of September 30, 2010: | ||||||||||||||||||||||||
Total capital (to risk | ||||||||||||||||||||||||
weighted assets) | ||||||||||||||||||||||||
Bank: | $ | 157,951 | 16.12 | % | $ | 78,388 | 8 | % | $ | 97,984 | 10 | % | ||||||||||||
Company: | $ | 167,532 | 17.10 | % | $ | 78,378 | 8 | % | $ | 97,972 | 10 | % | ||||||||||||
Tier I capital (to risk | ||||||||||||||||||||||||
weighted assets) | ||||||||||||||||||||||||
Bank: | $ | 145,712 | 14.87 | % | $ | 39,196 | 4 | % | $ | 58,794 | 6 | % | ||||||||||||
Company: | $ | 155,293 | 15.85 | % | $ | 39,191 | 4 | % | $ | 58,786 | 6 | % | ||||||||||||
Tier I capital (to leverage | ||||||||||||||||||||||||
assets) | ||||||||||||||||||||||||
Bank: | $ | 145,712 | 12.59 | % | $ | 46,295 | 4 | % | $ | 57,868 | 5 | % | ||||||||||||
Company: | $ | 155,293 | 13.34 | % | $ | 46,565 | 4 | % | $ | 58,206 | 5 | % | ||||||||||||
As of December 31, 2009: | ||||||||||||||||||||||||
Total capital (to risk | ||||||||||||||||||||||||
weighted assets) | ||||||||||||||||||||||||
Bank: | $ | 153,904 | 14.64 | % | $ | 84,120 | 8 | % | $ | 105,150 | 10 | % | ||||||||||||
Company: | $ | 164,401 | 15.63 | % | $ | 84,140 | 8 | % | $ | 105,175 | 10 | % | ||||||||||||
Tier I capital (to risk | ||||||||||||||||||||||||
weighted assets) | ||||||||||||||||||||||||
Bank: | $ | 140,749 | 13.39 | % | $ | 42,060 | 4 | % | $ | 63,090 | 6 | % | ||||||||||||
Company: | $ | 151,248 | 14.38 | % | $ | 42,070 | 4 | % | $ | 63,105 | 6 | % | ||||||||||||
Tier I capital (to leverage | ||||||||||||||||||||||||
assets) | ||||||||||||||||||||||||
Bank: | $ | 140,749 | 12.24 | % | $ | 46,006 | 4 | % | $ | 57,508 | 5 | % | ||||||||||||
Company: | $ | 151,248 | 13.66 | % | $ | 44,292 | 4 | % | $ | 55,365 | 5 | % | ||||||||||||
As of September 30, 2009: | ||||||||||||||||||||||||
Total capital (to risk | ||||||||||||||||||||||||
weighted assets) | ||||||||||||||||||||||||
Bank: | $ | 118,826 | 11.87 | % | $ | 80,118 | 8 | % | $ | 100,148 | 10 | % | ||||||||||||
Company: | $ | 118,179 | 11.81 | % | $ | 80,054 | 8 | % | $ | 100,067 | 10 | % | ||||||||||||
Tier I capital (to risk | ||||||||||||||||||||||||
weighted assets) | ||||||||||||||||||||||||
Bank: | $ | 106,304 | 10.61 | % | $ | 40,059 | 4 | % | $ | 60,089 | 6 | % | ||||||||||||
Company: | $ | 105,593 | 10.55 | % | $ | 40,035 | 4 | % | $ | 60,053 | 6 | % | ||||||||||||
Tier I capital (to leverage | ||||||||||||||||||||||||
assets) | ||||||||||||||||||||||||
Bank: | $ | 106,304 | 9.65 | % | $ | 44,044 | 4 | % | $ | 55,054 | 5 | % | ||||||||||||
Company: | $ | 105,593 | 9.67 | % | $ | 43,679 | 4 | % | $ | 54,598 | 5 | % | ||||||||||||
Page 20
The following discussion contains a review of Pacific Continental Corporation’s and its wholly-owned subsidiary Pacific Continental Bank’s operating results and financial condition for the three and nine months ended September 30, 2010. When warranted, comparisons are made to the same period in 2009 and to the previous year ended December 31, 2009. The discussion should be read in conjunction with the financial statements (unaudited) and related notes contained elsewhere in this report. The reader is assumed to have access to the Company’s Form 10-K for the previous year ended December 31, 2009, which contains additional statistics and explanations. All dollar amounts, except per share data, are expressed in thousands of dollars.
In addition to historical information, this report may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, but are not limited to, statements about management’s plans, objectives, expectations and intentions that are not historical facts, and other statements identified by words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “should,” “projects,” “seeks,” “estimates” or words of similar meaning. These forward-looking statements are based on current beliefs and expectations of management and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond the Company’s control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. In addition to the factors set forth in (i) this report, and (ii) the sections titled “Business,” “Risk Factors,” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” from the Company’s 2009 Annual Report on Form 10-K, the following factors, among others, could cause actual results to differ materially from the anticipated results:
· | local and national economic conditions could be less favorable than expected or could have a more direct and pronounced effect on us than expected and adversely affect our ability to continue internal growth at historical rates and maintain the quality of our earning assets; |
· | the local housing / real estate market could continue to decline; |
· | the risks presented by a continued economic recession, which could adversely affect credit quality, collateral values, including real estate collateral, investment values, liquidity and loan originations and loan portfolio delinquency rates; |
· | interest rate changes could significantly reduce net interest income and negatively affect funding sources; |
· | projected business increases following any future strategic expansion or opening of new branches could be lower than expected; |
· | competition among financial institutions could increase significantly; |
· | the goodwill we have recorded in connection with acquisitions could become impaired, which may have an adverse impact on our earnings and capital; |
· | the reputation of the financial services industry could deteriorate, which could adversely affect our ability to access markets for funding and to acquire and retain customers; |
· | the efficiencies we may expect to receive from any investments in personnel, acquisitions and infrastructure may not be realized; |
· | the level of non-performing assets and charge-offs or changes in the estimates of future reserve requirements based upon the periodic review thereof under relevant regulatory and accounting requirements may increase; |
· | changes in laws and regulations (including laws and regulations concerning taxes, banking, securities, executive compensation and insurance) could have a material adverse effect on our business, financial conditions and results of operations; |
· | acts of war or terrorism, or natural disasters, such as the effects of pandemic flu, may adversely impact our business; |
· | the timely development and acceptance of new banking products and services and perceived overall value of these products and services by users may adversely impact our ability to increase market share and control expenses; |
· | changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters may impact the results of our operations; |
· | the costs and effects of legal and regulatory developments including the resolution of legal proceedings or regulatory or other governmental inquiries and the results of regulatory examinations or reviews may adversely impact our ability to increase market share and control expenses; and |
· | our success at managing the risks involved in the foregoing items will have a significant impact upon our results of operations and future prospects. |
Page 21
Additional factors that could cause actual results to differ materially from those expressed in the forward-looking statements are discussed in Risk Factors in Item 1A. Please take into account that forward-looking statements speak only as of the date of this report or documents incorporated by reference. The Company does not undertake any obligation to publicly correct or update any forward-looking statement if we later become aware that it is not likely to be achieved.
SUMMARY OF CRITICAL ACCOUNTING POLICIES
We follow accounting standards set by the Financial Accounting Standards Board, commonly referred to as the “FASB.” The FASB sets generally accepted accounting principles (GAAP) that we follow to ensure we consistently report our financial condition, results of operations, and cash flows. References to GAAP issued by the FASB in this report are to the “FASB Accounting Standards Codification”, sometimes referred to as the “Codification” or “ASC”. The FASB finalized the Codification effective for periods ending on or after September 15, 2009. Prior FASB Statements, Interpretations, Positions, EITF consensuses, and AICPA Statements of Position are no longer being issued by the FASB. The Codification does not change how the Company accoun ts for its transactions or the nature of related disclosures made. However, when referring to guidance issued by the FASB, the Company refers to topics in the ASC rather than the specific FASB statement. We have updated references to GAAP in this report to reflect the guidance in the Codification.
The SEC defines “critical accounting policies” as those that require the application of management’s most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in future periods. Significant accounting policies are described in Note 1 of the Notes to Consolidated Financial Statements for the year ended December 31, 2009 in Item 7 in the Company’s Form 10-K. Management believes that the following policies and those disclosed in the Notes to Consolidated Financial Statements should be considered critical under the SEC definition:
Securities
Securities are classified based on management’s intention on the date of purchase and recorded on the Consolidated Balance Sheet as of the trade date. Currently the Company has all securities classified as available-for-sale (AFS) and carried at fair value with net unrealized gains and losses included in accumulated OCI on an after-tax basis. The Corporation regularly evaluates each AFS security whose value has declined below amortized cost to assess whether the decline in fair value is other-than-temporary. In determining whether an impairment is other-than-temporary, the Corporation considers the severity and duration of the decline in fair value, the length of time expected for recovery, the financial condition of the issuer, and other qualitative factors, as well as whether the Corporation either plans to sell the security or it is more-likely-than-not that it will be required to sell the security before recovery of its amortized cost. Beginning in 2009, under new accounting guidance for impairments of debt securities that are deemed to be other-than-temporary, the credit component of an other-than-temporary impairment loss is recognized in earnings and the non-credit component is recognized in accumulated OCI in situations where the Corporation does not intend to sell the security and it is more-likely-than-not that the Corporation will not be required to sell the security prior to recovery.
Page 22
Allowance for Loan Losses and Reserve for Unfunded Commitments
The allowance for outstanding loans is classified as a contra-asset account offsetting outstanding loans, and the allowance for unfunded commitments is classified as an “other” liability on the balance sheet. The allowance for loan losses is established through a provision for loan losses charged against earnings. The balances of the allowance for loan losses for outstanding loans and unfunded commitments are maintained at an amount management believes will be adequate to absorb known and inherent losses in the loan portfolio and commitments to loan funds. The appropriate balance of the allowance for loan losses is determined by applying loss factors to the credit exposure from outstanding loans and unfunded loan commitments. Estimated loss factors are based on subjective measurem ents including management’s assessment of the internal risk classifications, changes in the nature of the loan portfolios, industry concentrations, and the impact of current local, regional, and national economic factors on the quality of the loan portfolio. Changes in these estimates and assumptions are reasonably possible and may have a material impact on the Company’s consolidated financial statements, results of operations, or liquidity.
Goodwill and Intangible Assets
At September 30, 2010, the Company had $22,514 in goodwill and other intangible assets. FASB ASC 350, “Intangibles – Goodwill and Other”, requires that goodwill be tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis (and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. These events or circumstances could include a significant change in the business climate, legal factors, operating performance indicators, competition or sale or disposition of a significant portion of a reporting unit). Application of the goodwill impairment test requires judgment, including the identification of reporting units, assignment of assets an d liabilities to reporting units, assignment of goodwill to reporting units, and determination of the fair value of each reporting unit. The fair value of each reporting unit is estimated using a discounted cash flow of forecasted earnings, estimated sales price multiples based on recent observable market transactions and market capitalization based on current stock prices. This analysis requires significant judgment, including estimation of future cash flows, which is dependent on internal forecasts, estimation of the long-term rate of growth, the useful life over which cash flows will occur, and determination of our weighted average cost of capital. Changes in these estimates and assumptions could materially affect the determination of fair value and goodwill impairment for the Company’s single reporting unit (Commercial Banking).
Share-based Compensation
We account for share-based compensation in accordance with FASB ASC 718, “Compensation – Stock Compensation”. Under the fair value recognition provisions of this statement, share-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the requisite service period. Liability classified share-based awards are remeasured at fair value each reporting period. Determining the fair value of share-based awards at the grant date requires judgment, including estimating expected dividends. In addition, judgment is also required in estimating the amount of share-based awards that are expected to be forfeited. If actual results differ significantly from these estimates, share-based compensation expense and our results of operations could be materially impacted.
Recent Accounting Pronouncements
On June 12, 2009 the FASB issued FASB ASC 860, “Accounting for Transfers of Financial Assets”. FASB ASC 860 is a revision to preceding guidance and will require more information about transfers of financial assets, including securitization transactions, and where entities have continuing exposure to the risks related to transferred financial assets. It eliminates the concept of a “qualifying special purpose entity,” changes the requirements for derecognizing financial assets, and requires additional disclosures. In December 2009, the FASB issued Accounting Standards Update No. 2009-16, “Transfers and Servicing – Accounting for Transfers of Financial Assets.” This update formally codifies FASB Statement No. 166, “Accounting for Transfers of Finan cial Assets” and provides a revision for Topic 860 to require more information about transfers of financial assets. This statement and update were effective for interim and annual reporting periods beginning January 1, 2010. The impact of adoption did not have a material impact on the Company’s consolidated financial statements, however all loan participations sold are being thoroughly reviewed to ensure that they meet the criteria for sale treatment.
Page 23
In January 2010, the FASB issued Accounting Standards Update 2010-06, “Fair Value Measurements and Disclosures – Improving Disclosures about Fair Value Measurements”. This update requires additional disclosure regarding transfers in and out of Levels 1 and 2. It also requires the reporting of Level 3 fair value measurements on a gross, rather than a net basis. This includes presenting information about purchases, sales, issuances, and settlements separately. Additionally, fair value measurement disclosures are required for each class of assets and liabilities, with separate disclosures about valuation techniques and inputs used to measure fair value. The guidance is effective for interim and annual reporting periods beginning after December 15, 2009, except for th e disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in the Level 3 fair value measurements. These disclosures are effective for fiscal years and interim periods beginning after December 15, 2010. The impact of adoption of the additional Level 1 and 2 disclosures did not have a material impact on the Company’s consolidated financial statements. The impact of adoption of the additional Level 3 disclosures is not expected to be material to the Company’s consolidated financial statements.
In February 2010, the FASB issued Accounting Standards Update No. 2010-09, “Subsequent Events – Amendments to Certain Recognition and Disclosure Requirements”. This update removed the requirement for an SEC filer to disclose the date through which subsequent events have been evaluated in both issued and revised financial statements. Revised financial statements include financial statements revised as a result of either correction of an error or retrospective application of U.S. GAAP. The amendments removed potential conflicts with the SEC’s literature. This guidance was effective February 24, 2010. The impact of adoption did not have a material impact on the Company’s consolidated financial statements.
In April, 2010, the FASB issued Accounting Standards Update No. 2010-18, “Effect of a Loan Modification When the Loan Is Part of a Pool That Is Accounted for as a Single Asset”. This update affects any entity that acquires loans that have evidence of credit deterioration upon acquisition, accounts for those loans in the aggregate as a pool under Subtopic 310-30, and subsequently modifies one or more of those loans. Modifications of loans that are accounted for within a pool do not result in the removal of those loans from the pool even if the modification of those loans would otherwise be considered a troubled debt restructuring. This guidance is effective for modification of loans accounted for within pools occurring in the first interim or annual period ending on or after July 15, 2010. 60; The impact of adoption is not expected to have a material impact on the Company’s consolidated financial statements.
In July 2010, the FASB issued Accounting Standards Update No. 2010-20, “Receivables: Disclosure about the Credit Quality of Financing Receivables and the Allowance for Credit Losses”. This update requires additional disclosures on a disaggregated basis on two defined levels: (1) portfolio segment; and (2) class of financing receivable. The disclosures should include credit quality indicators of financing receivables, the aging of past due financing receivables, and the nature and extent of troubled debt restructurings that occurred during the period by class of financing receivables and their effect on the allowance for credit losses. This guidance is effective for interim and annual reporting periods ending on or after December 15, 2010. The impact of adoption is not expected to have a material impact on the Company’s consolidated financial statements, but it will result in the significant expansion of the Company’s credit disclosures.
Page 24
HIGHLIGHTS
For the three months ended September 30, | For the nine months ended September 30, | |||||||||||||||||||||||
2010 | 2009 | % Change | 2010 | 2009 | % Change | |||||||||||||||||||
Net income (loss) | $ | 1,152 | $ | 279 | 312.9 | % | $ | 3,901 | $ | (4,903 | ) | NM | ||||||||||||
Earnings (loss) per share | ||||||||||||||||||||||||
Basic | $ | 0.06 | $ | 0.02 | 200.0 | % | $ | 0.21 | $ | (0.38 | ) | NM | ||||||||||||
Diluted | $ | 0.06 | $ | 0.02 | 200.0 | % | $ | 0.21 | $ | (0.38 | ) | NM | ||||||||||||
Assets, period-end | $ | 1,192,004 | $ | 1,150,508 | 3.6 | % | ||||||||||||||||||
Loans, period-end (1) | 882,373 | 959,102 | -8.0 | % | ||||||||||||||||||||
Core deposits, period end (2) | 850,894 | 751,653 | 13.2 | % | ||||||||||||||||||||
Deposits, period-end | 924,923 | 826,520 | 11.9 | % | ||||||||||||||||||||
Return on avg. assets (3) | 0.38 | % | 0.10 | % | 0.44 | % | -0.59 | % | ||||||||||||||||
Return on avg. equity (3) | 2.66 | % | 0.92 | % | 3.07 | % | -5.25 | % | ||||||||||||||||
Return on avg. tangible equity (3) (4) | 3.06 | % | 1.14 | % | 3.54 | % | -6.42 | % | ||||||||||||||||
(1) Excludes loans held-for-sale. | ||||||||||||||||||||||||
(2) Defined by the Company as demand, interest checking, money market, savings, and local | ||||||||||||||||||||||||
non-public time deposits, including local non-public time deposits in excess of $100. | ||||||||||||||||||||||||
(3) Amounts annualized. | ||||||||||||||||||||||||
(4) Tangible equity excludes goodwill and core deposit intangibles related to acquisitions. | ||||||||||||||||||||||||
NM - Not meaningful | ||||||||||||||||||||||||
The following table reconciles average shareholders’ equity (GAAP) to average tangible equity (non-GAAP):
For the three months ended September 30, | For the nine months ended September 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Average shareholders' equity (GAAP) | $ | 172,091 | $ | 120,130 | $ | 170,136 | $ | 129,258 | ||||||||
Average goodwill and other intangible assets | 22,544 | 22,767 | 22,599 | 22,823 | ||||||||||||
Average tangible equity (non-GAAP) | $ | 149,547 | $ | 97,363 | $ | 147,537 | $ | 106,435 | ||||||||
The Company earned $1,152 in the third quarter of 2010, compared to $279 reported for the third quarter 2009. The improvement in third quarter 2010 earnings when compared to the same quarter last year was primarily due to a lower provision for loan losses of $3,750 in the current quarter versus $8,300 for the same quarter last year. Offsetting a portion of the lower provision for loan losses was an increase in noninterest expense in third quarter 2010 compared to third quarter 2009.
Noninterest expense in the current quarter was up $1,174 over the same quarter last year. This increase in noninterest expense was the result of a number of factors, including a $771 increase in other real estate expense primarily related to valuation write downs and a $200 increase in FDIC insurance assessments due to increased rates and higher deposit levels. In addition, third quarter 2009 noninterest expenses were significantly lower than the normal expense run rate as a result of one-time reversals of accruals related to incentive compensation, 401k contributions, and group insurance.
Operating revenue, which consists of net interest income and noninterest income, was $13,947 for the third quarter of 2010, down $879 or 6% from third quarter of 2009. The decline in operating revenue was entirely due to a decrease in net interest income due to the continued decline in loans which contributed to a lower net interest margin.
Nonperforming assets increased by $9,041 from the end of the second quarter 2010. This increase was attributable to a delay in the resolution of three problem loans that were expected during third quarter 2010. However, management believes those resolutions are on track to be executed during the fourth quarter 2010.
Period-end assets at September 30, 2010 were $1,192,004, compared to $1,150,508 at September 30, 2009. The increase in period-end assets was primarily attributable to growth in the Company’s securities portfolio as outstanding loans at September 30, 2010 were down from the same period last year. The Company continued to experience growth in core deposits during third quarter 2010 with outstanding core deposits at September 30, 2010 up $9,281 over the end of second quarter 2010 and are up $78,908 from December 31, 2009. Core deposits, which are defined as demand deposits, interest checking, money market accounts, and local non-public time deposits (including local non-public time deposits over $100) were $850,894 and constituted 92% of September 30, 2010 outstanding deposits and were up 13% over co re deposits at September 30, 2009. Non-interest bearing deposits (a subset of core deposits) were $220,104 or 24% of total deposits and 26% of core deposits at September 30, 2010.
Page 25
RESULTS OF OPERATIONS
Net Interest Income
Net interest income is the primary source of the Company’s revenue. Net interest income is the difference between interest income derived from earning assets, principally loans, and interest expense associated with interest-bearing liabilities, principally deposits. The volume and mix of earning assets and funding sources, market rates of interest, demand for loans, and the availability of deposits affect net interest income.
The net interest margin as a percentage of average earning assets for the third quarter of 2010 was 4.68%, down 6 basis points from the 4.74% margin reported for second quarter 2010, and down 56 basis points from the net interest margin reported for the third quarter of 2009. Quarterly margins in 2009 have been adjusted to remove FHLB stock from earning assets. The decline in the linked-quarter net interest margin was due to a drop in the yield on earning assets in third quarter 2010 when compared to second quarter 2010, while the cost of interest-bearing liabilities remained constant. The decline in linked-quarter earning asset yields was primarily associated with the decline in the yield on the Bank’s loan portfolio, which dropped from 6.46% in second quarter 2010 to 6.35% in third quarter 2010. The decline in the yield on loans was attributable to an increase in interest reversed on loans placed on nonaccrual status during third quarter 2010 of $232 compared to interest reversed of $82 in second quarter 2010.
The decline in the third quarter 2010 net interest margin of 56 basis points from the net interest margin reported for the third quarter 2009 was also attributable to the decline in earning asset yields. The decline in earning asset yields was primarily attributable to the change in mix of earning assets as lower yielding securities constituted 19% of total average earning assets in third quarter 2010 compared to 10% for the third quarter 2009. In addition, the growth in the Bank’s core deposit base during the last year that was used to pay down short-term and overnight borrowings also negatively impacted the margin as a result of the higher cost of core deposits when compared to short-term and overnight wholesale funding.
Despite the elevated levels of nonperforming loans, our net interest margin continues to remain high relative to peers. A number of factors contribute to this performance including the historically low cost of short-term funding, less pricing pressure on loan rates due to changes in the competitive landscape, and the Bank’s practice of using floors on variable rate loans which has successfully stabilized loan yields despite the low interest rate environment. At September 30, 2010, interest rate floors were active on approximately $275,579 of prime-based variable rate loans with the majority of active floors at 6.00% or higher.
Looking forward to the fourth quarter of 2010, a moderate increase in the securities portfolio is anticipated along with possible contraction in the loan portfolio, which would suggest a lower margin; however, to the extent fewer loans are placed on non-accrual status and current nonperforming loans are resolved and return to accrual status, there is potential to lower and recover past quarters’ reversals of interest that may mitigate any margin compression.
Page 26
The following table presents condensed average balance sheet information, together with interest income and yields on average interest-earning assets, and interest expense and rates on interest-bearing liabilities for the quarter ended September 30, 2010 compared to the quarter ended September 30, 2009:
Table I | ||||||||||||||||||||||||
Average Balance Analysis of Net Interest Income | ||||||||||||||||||||||||
(dollars in thousands) | ||||||||||||||||||||||||
Three Months Ended | Three Months Ended | |||||||||||||||||||||||
September 30, 2010 | September 30, 2009 | |||||||||||||||||||||||
Interest | Average | Interest | Average | |||||||||||||||||||||
Average | Income or | Yields or | Average | Income or | Yields or | |||||||||||||||||||
Balance | (Expense) | Rates | Balance | (Expense) | Rates | |||||||||||||||||||
Interest earning assets | ||||||||||||||||||||||||
Federal funds sold and interest bearing deposits | $ | 561 | $ | 3 | 2.12 | % | $ | 371 | $ | 2 | 2.14 | % | ||||||||||||
Securities available-for-sale: | ||||||||||||||||||||||||
Taxable | 192,114 | 1,712 | 3.54 | % | 93,760 | 1,273 | 5.39 | % | ||||||||||||||||
Tax-exempt | 9,186 | 79 | 3.41 | % | 5,434 | 49 | 3.58 | % | ||||||||||||||||
Loans held-for-sale | 556 | 9 | 6.42 | % | 655 | 6 | 3.63 | % | ||||||||||||||||
Loans, net of deferred fees and allowance (1) (2) | 878,995 | 14,061 | 6.35 | % | 937,638 | 15,652 | 6.62 | % | ||||||||||||||||
Total interest earning assets | 1,081,412 | 15,864 | 5.82 | % | 1,037,858 | 16,982 | 6.49 | % | ||||||||||||||||
Non earning assets | ||||||||||||||||||||||||
Cash and due from banks | 19,252 | 16,611 | ||||||||||||||||||||||
Premises and equipment | 21,224 | 20,234 | ||||||||||||||||||||||
Goodwill & other intangibles | 22,544 | 22,768 | ||||||||||||||||||||||
Interest receivable and other (3) | 46,630 | 29,782 | ||||||||||||||||||||||
Total non earning assets | 109,650 | 89,395 | ||||||||||||||||||||||
Total assets | $ | 1,191,062 | $ | 1,127,253 | ||||||||||||||||||||
Interest bearing liabilities | ||||||||||||||||||||||||
Money market and NOW accounts | $ | 507,423 | $ | (1,385 | ) | -1.08 | % | $ | 422,282 | $ | (1,400 | ) | -1.32 | % | ||||||||||
Savings deposits | 31,540 | (75 | ) | -0.94 | % | 25,721 | (82 | ) | -1.26 | % | ||||||||||||||
Time deposits - core (4) | 88,300 | (568 | ) | -2.55 | % | 88,761 | (644 | ) | -2.88 | % | ||||||||||||||
Total interest bearing core deposits | 627,263 | (2,028 | ) | -1.28 | % | 536,764 | (2,126 | ) | -1.57 | % | ||||||||||||||
Time deposits - non-core | 68,016 | (367 | ) | -2.14 | % | 84,908 | (355 | ) | -1.66 | % | ||||||||||||||
Federal funds purchased | 11,286 | (15 | ) | -0.53 | % | 19,180 | (23 | ) | -0.48 | % | ||||||||||||||
FHLB & FRB borrowings | 73,685 | (563 | ) | -3.03 | % | 166,413 | (633 | ) | -1.51 | % | ||||||||||||||
Trust preferred | 8,248 | (133 | ) | -6.40 | % | 8,248 | (128 | ) | -6.16 | % | ||||||||||||||
Total interest-bearing wholesale funding | 161,235 | (1,078 | ) | -2.65 | % | 278,749 | (1,139 | ) | -1.62 | % | ||||||||||||||
Total interest bearing liabilities | 788,498 | (3,106 | ) | -1.56 | % | 815,513 | (3,265 | ) | -1.59 | % | ||||||||||||||
Noninterest bearing liabilities | ||||||||||||||||||||||||
Demand deposits | 219,512 | 187,996 | ||||||||||||||||||||||
Interest payable and other | 10,961 | 3,617 | ||||||||||||||||||||||
Total noninterest liabilities | 230,473 | 191,613 | ||||||||||||||||||||||
Total liabilities | 1,018,971 | 1,007,126 | ||||||||||||||||||||||
Shareholders' equity | 172,091 | 120,127 | ||||||||||||||||||||||
Total liabilities and shareholders' equity | $ | 1,191,062 | $ | 1,127,253 | ||||||||||||||||||||
Net interest income | $ | 12,758 | $ | 13,717 | ||||||||||||||||||||
Net interest income as a percent of earning assets | 4.68 | % | 5.24 | % | ||||||||||||||||||||
(1) Nonaccrual loans have been included in average balance totals. | ||||||||||||||||||||||||
(2) Interest income includes recognized loan origination fees of $74 and $317 for the | ||||||||||||||||||||||||
quarter-to-date period ended September 30, 2010 and 2009, respectively. | ||||||||||||||||||||||||
(3) Federal Home Loan Bank stock is included in interest receivable and other assets. | ||||||||||||||||||||||||
(4) Defined by the Company as demand, interest checking, money market, savings, and local | ||||||||||||||||||||||||
non-public time deposits, including local non-public time deposits in excess of $100. |
Page 27
Table I above shows that earning asset yields declined by 67 basis points in the third quarter 2010 from the third quarter 2009 from 6.49% to 5.82%. This decline in earning asset yields was primarily attributable to a significant change in the earning asset mix in third quarter 2010 when compared to the same quarter last year, combined with a 185 basis point decline in the yield on the taxable securities portfolio. In third quarter 2010, average taxable securities held-for-sale yielding 3.54% totaled $192,114 and represented 18% of total average earning assets and average loans, net of deferred fees and allowance yielding 6.35% represented 81% of total average earning assets. This compares to third quarter 2009, when the average taxable securities held-for-sale portfolio was $93,760 and yielding 5.39% r epresented 9% of total average earning assets, while average loans, net of deferred fees and allowance, yielding 6.62% represented 90% of total average earning assets. In addition, the net interest margin for third quarter 2010 was negatively impacted by higher levels of nonperforming assets and interest reversals on loans placed on nonaccrual status during the current quarter when compared to last year.
Table I also illustrates the significant change in funding mix between core deposits and wholesale funding as evidenced by the increase in average interest-bearing core deposits of $90,499 or 17%, combined with a $31,516 or 17% increase in demand deposits in third quarter 2010 when compared to the same quarter last year. On the other hand, due to this significant increase in core deposits the use of wholesale funding declined by $117,514 or 42% in third quarter 2010 when compared to third quarter 2009.
While earning asset yields dropped 67 basis points in third quarter 2010 compared to third quarter 2009, the cost of interest-bearing liabilities declined by only 3 basis points. Table I shows that the cost of interest-bearing core deposits fell by 29 basis points from 1.57% in third quarter 2009 to 1.28% in third quarter 2010, and declines in rates are evident in all core deposit categories. However, the cost of wholesale funding moved up from 1.62% in third quarter 2009 to 2.65% in third quarter 2010. This increase in wholesale funding costs was due to higher rates on FHLB and FRB borrowings as during the first quarter 2010, the Bank exited the use of its FRB overnight borrowing line as the FRB terminated the use of short-term auction advances at a rate of 0.25%. In addition, this increase reflects the Bank’s strategy to extend the maturity structure of its liabilities and refinancing overnight and short-term borrowings into long-term FHLB advances and callable brokered time deposits ranging from three to ten years. This strategy was to mitigate the Bank’s liability sensitive position.
Page 28
The following table sets forth a summary of changes in net interest income due to changes in average asset and liability balances (volume) and changes in average rates (rate) for the quarters ended September 30, 2010 and September 30, 2009.
Table II | ||||||||||||
Analysis of Changes in Interest Income and Interest Expense | ||||||||||||
(dollars in thousands) | ||||||||||||
Three Months Ended | ||||||||||||
September 30, 2010 | ||||||||||||
compared to September 30, 2009 | ||||||||||||
Increase (decrease) due to | ||||||||||||
Volume | Rate | Net | ||||||||||
Interest earned on: | ||||||||||||
Federal funds sold and interest bearing deposits | $ | 1 | $ | - | $ | 1 | ||||||
Securities available-for-sale: | ||||||||||||
Taxable | 1,335 | (896 | ) | 439 | ||||||||
Tax-exempt | 34 | (4 | ) | 30 | ||||||||
Loans held-for-sale | (1 | ) | 4 | 3 | ||||||||
Loans, net of deferred fees and allowance | (979 | ) | (612 | ) | (1,591 | ) | ||||||
Total interest earning assets | 390 | (1,508 | ) | (1,118 | ) | |||||||
Interest paid on: | ||||||||||||
Money market and NOW accounts | 282 | (297 | ) | (15 | ) | |||||||
Savings deposits | 19 | (26 | ) | (7 | ) | |||||||
Time deposits - core (1) | (3 | ) | (73 | ) | (76 | ) | ||||||
Total interest bearing core deposits | 298 | (396 | ) | (98 | ) | |||||||
Time deposits - non-core | (71 | ) | 83 | 12 | ||||||||
Federal funds purchased | (9 | ) | 1 | (8 | ) | |||||||
FHLB & FRB borrowings | (353 | ) | 283 | (70 | ) | |||||||
Trust preferred | - | 5 | 5 | |||||||||
Total interest-bearing wholesale funding | (433 | ) | 372 | (61 | ) | |||||||
Total interest bearing liabilities | (135 | ) | (24 | ) | (159 | ) | ||||||
Net interest income | 525 | (1,484 | ) | (959 | ) | |||||||
(1) Defined by the Company as demand, interest checking, money market, savings, and local | ||||||||||||
non-public time deposits, including local non-public time deposits in excess of $100. |
The rate/volume analysis shows that third quarter 2010 net interest income decreased by $959 from third quarter 2009. Third quarter 2010 interest income including loan fees declined by $1,118 from the same quarter last year with higher volumes of earning assets, primarily securities, increasing interest income by $390, which was more than offset by lower rates on earning assets that lowered interest income by $1,508. Interest expense in third quarter 2010 was relatively unchanged showing a $159 decrease.
Page 29
The following table presents condensed average balance sheet information, together with interest income and yields on average interest-earning assets, and interest expense and rates on interest-bearing liabilities for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009:
Table III | ||||||||||||||||||||||||
Average Balance Analysis of Net Interest Income | ||||||||||||||||||||||||
(dollars in thousands) | ||||||||||||||||||||||||
Nine Months Ended | Nine Months Ended | |||||||||||||||||||||||
September 30, 2010 | September 30, 2009 | |||||||||||||||||||||||
Interest | Average | Interest | Average | |||||||||||||||||||||
Average | Income or | Yields or | Average | Income or | Yields or | |||||||||||||||||||
Balance | (Expense) | Rates | Balance | (Expense) | Rates | |||||||||||||||||||
Interest earning assets | ||||||||||||||||||||||||
Federal funds sold and interest bearing deposits | $ | 487 | $ | 6 | 1.65 | % | $ | 314 | $ | 4 | 1.70 | % | ||||||||||||
Securities available-for-sale: | ||||||||||||||||||||||||
Taxable | 180,060 | 4,571 | 3.39 | % | 74,940 | 3,348 | 5.97 | % | ||||||||||||||||
Tax-exempt | 6,633 | 174 | 3.51 | % | 5,444 | 147 | 3.61 | % | ||||||||||||||||
Loans held-for-sale | 626 | 23 | 4.91 | % | 809 | 27 | 4.46 | % | ||||||||||||||||
Loans, net of deferred fees and allowance (1) (2) | 900,052 | 43,210 | 6.42 | % | 946,026 | 46,281 | 6.54 | % | ||||||||||||||||
Total interest earning assets | 1,087,858 | 47,984 | 5.90 | % | 1,027,533 | 49,807 | 6.48 | % | ||||||||||||||||
Non earning assets | ||||||||||||||||||||||||
Cash and due from banks | 19,670 | 17,107 | ||||||||||||||||||||||
Premises and equipment | 20,742 | 20,454 | ||||||||||||||||||||||
Goodwill & other intangibles | 22,599 | 22,823 | ||||||||||||||||||||||
Interest receivable and other (3) | 43,786 | 26,705 | ||||||||||||||||||||||
Total non earning assets | 106,797 | 87,089 | ||||||||||||||||||||||
Total assets | $ | 1,194,655 | $ | 1,114,622 | ||||||||||||||||||||
Interest bearing liabilities | ||||||||||||||||||||||||
Money market and NOW accounts | $ | 479,494 | $ | (3,927 | ) | -1.09 | % | $ | 411,572 | $ | (4,063 | ) | -1.32 | % | ||||||||||
Savings deposits | 30,004 | (221 | ) | -0.98 | % | 23,177 | (239 | ) | -1.38 | % | ||||||||||||||
Time deposits - core (4) | 91,372 | (1,833 | ) | -2.68 | % | 71,794 | (1,603 | ) | -2.99 | % | ||||||||||||||
Total interest bearing core deposits | 600,870 | (5,981 | ) | -1.33 | % | 506,543 | (5,905 | ) | -1.56 | % | ||||||||||||||
Time deposits - non-core | 79,926 | (1,088 | ) | -1.82 | % | 84,810 | (1,175 | ) | -1.85 | % | ||||||||||||||
Federal funds purchased | 10,265 | (39 | ) | -0.51 | % | 21,637 | (76 | ) | -0.47 | % | ||||||||||||||
FHLB & FRB borrowings | 103,741 | (1,788 | ) | -2.30 | % | 187,682 | (2,005 | ) | -1.43 | % | ||||||||||||||
Trust preferred | 8,248 | (393 | ) | -6.37 | % | 8,248 | (392 | ) | -6.35 | % | ||||||||||||||
Total interest-bearing wholesale funding | 202,180 | (3,308 | ) | -2.19 | % | 302,377 | (3,648 | ) | -1.61 | % | ||||||||||||||
Total interest bearing liabilities | 803,050 | (9,289 | ) | -1.55 | % | 808,920 | (9,553 | ) | -1.58 | % | ||||||||||||||
Noninterest bearing liabilities | ||||||||||||||||||||||||
Demand deposits | 211,646 | 177,047 | ||||||||||||||||||||||
Interest payable and other | 9,823 | 3,802 | ||||||||||||||||||||||
Total noninterest liabilities | 221,469 | 180,849 | ||||||||||||||||||||||
Total liabilities | 1,024,519 | 989,769 | ||||||||||||||||||||||
Shareholders' equity | 170,136 | 124,853 | ||||||||||||||||||||||
Total liabilities and shareholders' equity | $ | 1,194,655 | $ | 1,114,622 | ||||||||||||||||||||
Net interest income | $ | 38,695 | $ | 40,254 | ||||||||||||||||||||
Net interest income as a percent of earning assets | 4.76 | % | 5.24 | % | ||||||||||||||||||||
(1) Nonaccrual loans have been included in average balance totals. | ||||||||||||||||||||||||
(2) Interest income includes recognized loan origination fees of $517 and $1,033 for the | ||||||||||||||||||||||||
year-to-date period ended September 30, 2010 and 2009, respectively. | ||||||||||||||||||||||||
(3) Federal Home Loan Bank stock is included in interest receivable and other assets. | ||||||||||||||||||||||||
(4) Defined by the Company as demand, interest checking, money market, savings, and local | ||||||||||||||||||||||||
non-public time deposits, including local non-public time deposits in excess of $100. |
Page 30
Table III shows that year-to-date September 30, 2010 earning asset yields declined by 58 basis points from year-to-date September 30, 2009 from 6.48% to 5.90%. The decline in earning asset yields was primarily attributable to a 258 basis point drop in yields on average taxable securities and a change in asset mix, which resulted from the significant level of securities purchased during this historically low interest rate environment.
Table III also shows that the yield on earning assets fell much faster than rates paid on interest-bearing funding, which dropped only 3 basis points from 1.58% to 1.55%. Table III also shows the impact of the significant shift in funding as average year-to-date September 30, 2010 core deposits increased significantly allowing for a reduction in average wholesale funding of more than $100,000.
The following table sets forth a summary of changes in net interest income due to changes in average asset and liability balances (volume) and changes in average rates (rate) for the nine months ended September 30, 2010 and September 30, 2009:
Table IV | ||||||||||||
Analysis of Changes in Interest Income and Interest Expense | ||||||||||||
(dollars in thousands) | ||||||||||||
Nine Months Ended | ||||||||||||
September 30, 2010 | ||||||||||||
compared to September 30, 2009 | ||||||||||||
Increase (decrease) due to | ||||||||||||
Volume | Rate | Net | ||||||||||
Interest earned on: | ||||||||||||
Federal funds sold and interest bearing deposits | $ | 2 | $ | - | $ | 2 | ||||||
Securities available-for-sale: | ||||||||||||
Taxable | 4,696 | (3,473 | ) | 1,223 | ||||||||
Tax-exempt | 32 | (5 | ) | 27 | ||||||||
Loans held-for-sale | (6 | ) | 2 | (4 | ) | |||||||
Loans, net of deferred fees and allowance | (2,249 | ) | (822 | ) | (3,071 | ) | ||||||
Total interest earning assets | 2,475 | (4,298 | ) | (1,823 | ) | |||||||
Interest paid on: | ||||||||||||
Money market and NOW accounts | 671 | (807 | ) | (136 | ) | |||||||
Savings deposits | 70 | (88 | ) | (18 | ) | |||||||
Time deposits - core (1) | 437 | (207 | ) | 230 | ||||||||
Total interest bearing core deposits | 1,178 | (1,102 | ) | 76 | ||||||||
Time deposits - non-core | (68 | ) | (19 | ) | (87 | ) | ||||||
Federal funds purchased | (40 | ) | 3 | (37 | ) | |||||||
FHLB & FRB borrowings | (897 | ) | 680 | (217 | ) | |||||||
Trust preferred | - | 1 | 1 | |||||||||
Total interest-bearing wholesale funding | (1,005 | ) | 665 | (340 | ) | |||||||
Total interest bearing liabilities | 173 | (437 | ) | (264 | ) | |||||||
Net interest income | 2,302 | (3,861 | ) | (1,559 | ) | |||||||
(1) Defined by the Company as demand, interest checking, money market, savings, and local | ||||||||||||
non-public time deposits, including local non-public time deposits in excess of $100. |
Page 31
The rate/volume analysis shows that year-to-date net interest income decreased by $1,559 from the same period last year. 2010 year-to-date interest income including loan fees declined by $1,823 from last year with higher volumes of earning assets, primarily securities, increasing interest income by $2,475, which was more than offset by lower rates on earning assets that lowered interest income by $4,298. Interest expense through the end of third quarter 2010 was relatively unchanged showing only a $264 decrease. However, the rate/volume analysis does show the impact of the shift in funding with the decline in wholesale funding and increase in core deposits as evidenced by the increase of $76 for interest expense on interest-bearing core deposits, which was offset by a $340 decline in interest expense on wholesale funding.
Loan Loss Provision and Allowance
Below is a summary of the Company’s allowance for loan losses for the three month and nine month periods ended September 30, 2010 and 2009:
Three months ended | Nine months ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Balance, beginning of period | $ | 17,854 | $ | 18,680 | $ | 13,367 | $ | 10,980 | ||||||||
Provision charged to income | 3,750 | 8,300 | 11,750 | 29,000 | ||||||||||||
Loans charged against allowance | (4,240 | ) | (8,822 | ) | (10,189 | ) | (21,872 | ) | ||||||||
Recoveries credited to allowance | 405 | 190 | 2,841 | 240 | ||||||||||||
Balance, end of period | $ | 17,769 | $ | 18,348 | $ | 17,769 | $ | 18,348 | ||||||||
The provision for loan losses recorded during the third quarter of 2010 was $3,750, compared to $8,300 for the same period last year. On a linked-quarter basis, the third quarter 2010 provision for loan losses was the same as recorded for second quarter 2010. The year-to-date September 30, 2010 provision for loan losses was $11,750 compared to $29,000 for the same period in 2009. The decrease in both the third quarter and year-to-date provision for loan losses was attributable to a significant decline in net loan charge offs.
For the third quarter of 2010 and year-to-date September 30, 2010, net charge-offs were $3,835 and $7,348 compared to $8,632 and $21,632 for the same periods last year, respectively. When annualized, year-to-date September 30, 2010 net charge offs were 1.69% of average loans compared to 3.58% for the same period last year. On a linked-quarter basis, net loan charge offs of $3,835 in third quarter 2010 were up over the $753 recorded during second quarter 2010.
The allowance for loan losses at September 30, 2010 was 2.01% of the period end loans, compared to 1.42% and 1.91% at December 31, 2009 and September 30, 2009, respectively. The allowance at September 30, 2010 includes $2,231 in specific allowance (included in the ending allowance above) for impaired loans, which total $42,540 net of government guarantees. That compares to total impaired loans of $32,346 at December 31, 2009 with a specific allowance of $1,048 assigned.
Page 32
The following table shows a summary of nonaccrual loans, loans past due 90 days or more, and other real estate owned for the periods covered in this report:
September 30, | December 31, | September 30, | ||||||||||
2010 | 2009 | 2009 | ||||||||||
NONPERFORMING ASSETS | ||||||||||||
Non-accrual loans | ||||||||||||
Real estate secured loans: | ||||||||||||
Permanent loans: | ||||||||||||
Multifamily residential | $ | 6,594 | $ | - | $ | - | ||||||
Residential 1-4 family | 4,945 | 704 | 1,283 | |||||||||
Owner-occupied commercial | 4,306 | 375 | 2,204 | |||||||||
Non-owner-occupied commercial | 7,359 | - | - | |||||||||
Other loans secured by real estate | 1,379 | 1,097 | - | |||||||||
Total permanent real estate loans | 24,583 | 2,176 | 3,487 | |||||||||
Construction loans: | ||||||||||||
Multifamily residential | 2,033 | 4,409 | - | |||||||||
Residential 1-4 family | 3,099 | 4,903 | 2,817 | |||||||||
Commercial real estate | 4,262 | 5,537 | 7,551 | |||||||||
Commercial bare land and acquisition & development | 669 | 2,338 | 8,070 | |||||||||
Residential bare land and acquisition & development | 90 | 8,122 | 71 | |||||||||
Other | - | - | - | |||||||||
Total construction real estate loans | 10,153 | 25,309 | 18,509 | |||||||||
Total real estate loans | 34,736 | 27,485 | 21,996 | |||||||||
Commercial loans | 8,602 | 5,268 | 4,036 | |||||||||
Consumer loans | - | 39 | - | |||||||||
Other loans | - | - | - | |||||||||
Total nonaccrual loans | 43,338 | 32,792 | 26,032 | |||||||||
90 days past due and accruing interest | - | - | - | |||||||||
Total nonperforming loans | 43,338 | 32,792 | 26,032 | |||||||||
Nonperforming loans guaranteed by government | (798 | ) | (446 | ) | (136 | ) | ||||||
Net nonperforming loans | 42,540 | 32,346 | 25,896 | |||||||||
Other real estate owned | 15,422 | 4,224 | 4,247 | |||||||||
Total nonperforming assets, net of guaranteed loans | $ | 57,962 | $ | 36,570 | $ | 30,143 | ||||||
At September 30, 2010, total nonperforming assets were $57,962 and represented 4.86% of total assets. At December 31, 2009 and September 30, 2009, total nonperforming assets were $36,570 or 3.05% of total assets and $30,143 or 2.62% of total assets, respectively. Nonperforming assets at September 30, 2010 were up $21,392 and $27,819 over December 31, 2009 and September 30, 2009, respectively. The increase in nonperforming assets at September 30, 2010 when compared to prior periods was primarily attributable to an increase in nonaccrual loans secured by real estate reflecting the weak real estate market in the Northwest economy. Other real estate owned also showed a significant increase as the Bank gained control of collateral through foreclosures.
On a linked-quarter basis, nonperforming assets at September 30, 2010 were up $9,041 over nonperforming assets at the end of second quarter 2010. This represents a 70 basis point increase in nonperforming assets as a percentage of total assets.. The increase in linked quarter nonperforming assets was attributable to a delay in planned resolutions on three problem loans expected during third quarter 2010, combined with additional loans placed on nonaccrual status during the quarter. Management believes the resolutions of problem loans expected during third quarter are on track to be executed during the fourth quarter 2010. However, due to the weak economic conditions in the Northwest economy and in the markets in which the Bank operates, planned resolutions are not certain, and there are conti nued prospects for further additions to nonperforming loans in future quarters. During third quarter 2010, there continued to be movement between nonaccrual loans and other real estate owned as other real estate owned at September 30, 2010 was up $5,771 from the end of second quarter 2010. This movement indicates the Company is gaining control of collateral associated with nonperforming loans and allows for possible future reductions in total nonperforming assets as the year progresses through disposal of collateral.
.
Page 33
Noninterest Income
Year-to-date noninterest income through September 30, 2010 was $3,157, down $170 or 5% from the same period last year. Excluding the $226 OTTI recognized during the second quarter 2010, noninterest income would have been up $56 at September 30, 2010 over last year. Through the first nine months of 2010, other fee income, which consists primarily of merchant bankcard fees, was up $179 or 20% as sales transaction volumes rose significantly in 2010 when compared to last year. In addition, the other income category was up $81 or 11% due to increased fees on business credit card interchange. In addition, through September 30, 2010, the Company recorded a $45 gain on sale of securities. The increase in these categories was offset by declines in account service charges of $154 and mortgag e banking revenues of $103. Account service charges were down due to lower volumes of not sufficient funds (“NSF”) and overdraft (“OD”) fees and a decline in hard dollar fee income from analyzed business accounts. The decline in NSF/OD fees reflects continued trends of lower transaction volumes. The decline in hard dollar fee income on analyzed accounts was the result of higher balances maintained by clients and a higher earnings credit during the first nine months of the current year, both of which contributed to lower levels of fees collected on analyzed accounts. The decline in mortgage revenues of $103 was related to a much lower level of new originations as home sales volumes continue to decline and refinancing opportunities have dropped due to the decline in home values.
On a linked-quarter basis, third quarter 2010 noninterest income was up $267 over second quarter 2010. Approximately $226 of the increase in linked-quarter revenue was the result of the OTTI recorded during second quarter 2010 with the remainder of the increase primarily attributable to higher merchant bank card fees.
Looking forward to the fourth quarter 2010, the Company expects noninterest income will be up over third quarter 2010 as merchant bank card sales transaction volume typically increases during this period.
Noninterest Expense
Year-to-date noninterest expense through September 30, 2010 was $24,304, up $594 or 3% from the same period last year. Virtually all categories of expense were up over the prior year with the exception of business development costs, which were down $341 at September 30, 2010 when compared to the same period last year. Total personnel expenses were up by $146 entirely due to a $277 increase in 401k contribution accruals, which was partially offset by an increase in loan origination costs. The 401k contribution accrual for 2009 was fully reversed during third quarter last year due to the anticipated net loss expected for the year. Both other real estate expense and the other expense category also showed a significant increase, up $307 and $321, respectively. The increase in other rea l estate expense was due to $803 in valuation write downs taken during third quarter 2010. The increase in the other expense category was primarily due to the increase in legal fees and repossession and collection costs associated with the resolution of problem loans. While FDIC insurance assessments through September 30, 2010 were relatively flat with a year ago, during 2009, the Bank recorded an expense of $510 for a special assessment. Excluding the special assessment recorded last year, FDIC insurance assessments would have been up $479 over the prior year as a result of both higher premiums combined with higher deposit levels.
On a linked-quarter basis, third quarter 2010 noninterest expense was up $287 over second quarter 2010. This increase was entirely attributable to a $791 increase in other real estate expense related to valuation write downs, which was partially offset by declines in personnel expense and business development costs.
Looking forward to the fourth quarter 2010, noninterest expense is expected to be down from third quarter 2010 levels as personnel expense is expected to decline along with other real estate expense. However, due to the current weak economic conditions, expenses related to other real estate, including potential valuation write downs, and legal fees that may be incurred related to problem loans, quarterly expense levels are volatile and actual results may differ significantly from anticipated results.
Page 34
BALANCE SHEET
Loans
At September 30, 2010, outstanding gross loans, net of deferred fees were $882,373, a decline of $61,991 and $76,729 from December 31, 2009 and September 30, 2009, respectively. The overall decline in loans reflects weak economic conditions together with planned contractions in the construction and land development loan portfolios. A summary of outstanding loans by market at September 30, 2010, December 31, 2009 and September 30, 2009 follows:
September 30, 2010 | December 31, 2009 | September 30, 2009 | ||||||||||
Eugene Market, loans, period end | $ | 266,512 | $ | 259,435 | $ | 256,291 | ||||||
Portland Market, loans, period end | 409,702 | 435,304 | 437,674 | |||||||||
Seattle Market, loans, period end | 206,159 | 249,625 | 265,137 | |||||||||
Total | $ | 882,373 | $ | 944,364 | $ | 959,102 | ||||||
The decrease in Portland and Seattle loans from December 31, 2009 and September 30, 2009 was primarily related to a planned contraction in residential and commercial construction loans. A portion of this contraction was offset by increased lending in permanent commercial real estate loans and commercial and industrial loans, primarily related to new loans in the health care industry. The Eugene market on the other hand saw expansion in outstanding loans over the prior year and year end December 31, 2009 as this market was not as exposed to real estate lending, thus new production more than offset any contraction.
During the third quarter, the Company experienced improved lending activity with approximately $102,719 in production of which approximately $39,353 were new loans. The Company continued to expand outstanding loans to dental professionals during the current quarter as well. In addition to growth in the dental industry, growth was also experienced in the wider health care field with loans to physicians, surgeons, optometrists, family practitioners, and medical specialists.
Detailed information on loans by type may be found in Note 3 on Page 11 of this report.
Securities
At September 30, 2010, the Bank had $215,259 in securities classified as available-for-sale. At September 30, 2010, $28,910 of these securities were pledged as collateral for FHLB of Seattle borrowings, public deposits in Oregon and Washington, and to the Federal Reserve Bank of San Francisco to support balances in its Treasury, Tax and Loan deposit account.
At quarter end, $22,325 or 10.0% of the total securities portfolio was composed of private-label mortgage-backed securities. During the second quarter 2010, management determined it was prudent to recognize OTTI on five of its private-label mortgage-backed securities. The OTTI resulted in a principal write down of $226. Management reviews monthly all available information related to the collectability of its impaired investment securities and determined no additional OTTI was required in third quarter 2010. However, recognition of additional OTTI on these five securities and other securities in this portion of the portfolio is possible in future quarters depending upon economic conditions.
In Management’s opinion, the remaining securities in an unrealized loss position are considered only temporarily impaired. The Company has no intent, nor is it more likely than not, that it will be required to sell its impaired securities before their recovery. The impairment is due to changes in market interest rates or the widening of market spreads subsequent to the initial purchase of the securities, and not due to concerns regarding the underlying credit of the issuers or the underlying collateral. The decline in value of these securities has resulted from current economic conditions. Although yields on these securities may be below market rates during that period, no loss of principal is expected.
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Compared to the third quarter of 2009, the securities portfolio grew by $99,674 and has grown by $47,641 since December 31, 2009. Purchases during this time period were high-quality agency mortgage-backed securities, many of which were zero percent risk-weighted, bullet agencies, and longer-term municipals. These purchases were part of a three-pronged strategy to 1) add liquidity to the asset side of the balance sheet; 2) provide earnings in light of declining loan volumes and growth in core deposits; and 3) hedge the balance sheet against a rates-up scenario due to the Company’s liability sensitive position. However, due to the prospect of a low interest rate environment for an extended period of time, the Bank expanded purchases of longer-term municipals to take advantage of the steep yield curve and provide addition al income. At September 30, 2010, the portfolio had an average life of 2.7 years and duration of 2.5 years. That compares to an average life and duration of 2.0 years and 1.8 years, respectively at June 30, 2010. While a portion of the increase in average life and duration were related to recent purchases of longer-term municipals, the increase was also influenced by the extension in the agency mortgage-backed securities portfolio. As a result of higher unemployment levels, stricter underwriting standards and the decline of home values nationally, the level of refinancing activity is atypically low given the historical low long-term interest rates. This in effect has slowed anticipated prepayment speeds on the agency mortgage-backed securities, thus extending their expected average life and duration. Going forward, the portfolio is expected to increase moderately and purchases will be dependent upon core deposit growth, loan growth, and the Ba nk’s interest rate risk position.
Goodwill and Intangible Assets
At September 30, 2010, the Company had a recorded balance of $22,031 in goodwill from the November 30, 2005 acquisition of Northwest Business Financial Corporation (“NWBF”). In addition, at September 30, 2010 the Company had $483 of core deposit intangible assets resulting from the acquisition of NWBF. The core deposit intangible was determined to have an expected life of approximately seven years and is being amortized over that period using the straight-line method and has approximately two years remaining on the amortization schedule. In accordance with generally accepted accounting principles, the Company does not amortize goodwill or other intangible assets with indefinite lives, but instead periodically tests these assets for impairment. Management performs an impairmen t analysis of the intangible assets with indefinite lives at least annually. The last impairment test was performed during the third quarter 2010, at which time no impairment was determined to exist.
Deposits
Core deposits, which are defined by the Company as demand, interest checking, money market, savings, and local non-public time deposits, including local non-public time deposits in excess of $100, were $850,894 and represented 92% of total deposits at September 30, 2010. Outstanding core deposits at September 30, 2010 were up $99,241 or 13% over the same period last year, and up $78,908 or 10% over December 31, 2010. All three of the Bank’s primary markets had growth in core deposits over the past year and also showed growth over the prior year end.
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A summary of outstanding core deposits and average core deposits by market and other deposits classified as wholesale funding at September 30, 2010, December 31, 2009, and September 30, 2009 follows:
September 30, 2010 | December 31, 2009 | September 30, 2009 | ||||||||||
Eugene Market core deposits, period end (1) | $ | 515,164 | $ | 492,012 | $ | 480,033 | ||||||
Portland Market core deposits, period end (1) | 221,407 | 165,716 | 162,574 | |||||||||
Seattle Market core deposits, period end (1) | 114,323 | 114,258 | 109,046 | |||||||||
Total core deposits | 850,894 | 771,986 | 751,653 | |||||||||
Other deposits | 74,029 | 55,932 | 74,867 | |||||||||
Total | $ | 924,923 | $ | 827,918 | $ | 826,520 | ||||||
Quarters Ended | ||||||||||||
September 30, 2010 | December 31, 2009 | September 30, 2009 | ||||||||||
Eugene Market core deposits, average (1) | $ | 510,594 | $ | 487,202 | $ | 458,121 | ||||||
Portland Market core deposits, average (1) | 216,818 | 165,125 | 159,670 | |||||||||
Seattle Market core deposits, average (1) | 119,364 | 111,817 | 106,969 | |||||||||
Total core deposits, average | 846,776 | 764,144 | 724,760 | |||||||||
Other deposits, average | 68,015 | 61,525 | 84,908 | |||||||||
Total | $ | 914,791 | $ | 825,669 | $ | 809,668 | ||||||
(1) Core deposits include all demand, interest checking, money market, savings and local non-public time deposits, | ||||||||||||
including local non-public time deposits in excess of $100. |
Junior Subordinated Debentures
The Company had $8,248 in junior subordinated debentures at September 30, 2010, which were issued in conjunction with the acquisition of NWBF. At September 30, 2010, the entire $8,248 in junior subordinated debentures had an interest rate of 6.265% that is fixed through January 2011 and qualified as Tier 1 capital under regulatory capital purposes. In January 2011, the rate on the junior subordinated debentures will be 3-month LIBOR plus 140 basis points. If the current interest rate environment persists, in January 2011, the rate on junior subordinated debentures would fall below 2.00%. Additional information regarding the terms of the junior subordinated debentures, including maturity/repricing dates and interest rate, is included in Note 10 of the Notes to Consolidated Financial Statements in the Company’s 2009 annual Form 10-K.
Capital Resources
Capital is the shareholders’ investment in the Company. Capital grows through the retention of earnings and the issuance of new stock whether through stock offerings or through the exercise of stock options. Capital formation allows the Company to grow assets and provides flexibility in times of adversity.
Shareholders’ equity at September 30, 2010 was $172,579, an increase of $6,917 and $52,269 over December 31, 2009 and September 30, 2009, respectively. The increase in shareholders’ equity during the first nine months of 2010 over the prior year end was attributable to increased retained earnings and an increase in the unrealized gain on the Bank’s securities portfolio. The increase in September 30, 2010 shareholders’ equity over the same period last year resulted primarily from a successful capital raise of $45.6 million during fourth quarter 2009. For additional details regarding the changes in equity, review the Consolidated Statements of Changes in Shareholders’ Equity on page 5 of this report.
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The Federal Reserve Board and the FDIC have in place guidelines for risk-based capital requirements applicable to U.S. bank holding companies and banks. These risk-based capital guidelines take into consideration risk factors, as defined by regulation, associated with various categories of assets, both on and off-balance sheet. Under the guidelines, capital strength is measured in three ways, first by measuring Tier 1 capital to leverage assets, followed by capital measurement in two tiers, which are used in conjunction with risk-adjusted assets to determine the risk-based capital ratios. These guidelines require a minimum of 4% Tier 1 capital to leverage assets, 4% Tier 1 capital to risk-weighted assets, and 8% total capital to risk-weighted assets. In order to be classified as well-capitali zed, the highest capital rating, by the Federal Reserve and FDIC, these three ratios must be in excess of 5.00%, 6.00%, and 10.00%, respectively. The Company’s leverage capital ratio, Tier 1 risk-based capital ratio, and Total risk-based capital ratio were 13.34%, 15.85%, and 17.10%, respectively at September 30, 2010. For the same period, the subsidiary Bank’s ratios were 12.59%, 14.87%, and 16.12%, respectively. The Company’s and Bank’s ratios are all well above the minimum well-capitalized designation.
On March 25, 2010, the Company filed a shelf registration statement with the SEC providing for the offer and sale of up to $75 million of securities, including equity, debt and other securities. On April 7, 2010, the SEC declared the shelf registration effective providing the Company with flexibility for future capital planning. At present the Company has no current commitments to sell additional securities.
The Company pays cash dividends on a quarterly basis, typically in March, June, September and December of each year. The Board of Directors considers the dividend amount quarterly and takes a broad perspective in its dividend deliberations including a review of recent operating performance, capital levels, and concentrations of loans as a percentage of capital, and growth projections. The Board also considers dividend payout ratios, dividend yield, and other financial metrics in setting the quarterly dividend.
On August 17th, 2010, the Board of Directors approved a quarterly dividend of $0.01 per share which was paid on September 15, 2010. If continued for each quarter during 2010, this would result in an annual dividend of $0.04 for each outstanding share of common stock in 2010. The Company has sufficient liquidity to maintain this level of dividend throughout 2010 and 2011 if approved by regulators and would not require any dividend from the Bank to the Company in support of the cash dividend to shareholders.
The Company and the Bank project that earnings retention in 2010 and existing capital will be sufficient to fund anticipated organic asset growth, while maintaining a well-capitalized designation from all regulatory agencies.
OFF-BALANCE SHEET ARRANGEMENTS AND COMMITMENTS
In the normal course of business, the Bank commits to extensions of credit and issues letters of credit. The Bank uses the same credit policies in making commitments to lend funds and conditional obligations as it does for other credit products. In the event of nonperformance by the customer, the Bank’s exposure to credit loss is represented by the contractual amount of the instruments. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established by the contract. Since some commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. At September 30, 2010, the Bank had $113,975 in commitments to extend credit.
Letters of credit written are conditional commitments issued by the Bank to guarantee performance of a customer to a third party. The credit risk involved is essentially the same as that involved in extending loan facilities to customers. At September 30, 2010, the Bank had $1,483 in letters of credit and financial guarantees written.
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LIQUIDITY
Liquidity is the term used to define the Company’s ability to meet its financial commitments. The Company maintains sufficient liquidity to ensure funds are available for both lending needs and the withdrawal of deposit funds. The Company derives liquidity through core deposit growth, maturity of investment securities, and loan payments. Core deposits include demand, interest checking, money market, savings, and local non-public time deposits, including local non-public time deposits in excess of $100. Additional liquidity and funding sources are provided through the sale of loans, sales of securities, access to national CD markets, and both secured and unsecured borrowings. The Bank uses a number of measurements to monitor its liquidity position on a daily, weekly, and monthly basis, w hich includes its ability to meet both short-term and long-term obligations, and requires the Company to maintain a certain amount of liquidity on the asset side of its balance sheet. The Bank also prepares quarterly projections of its liquidity position 90 days and 180 days into the future. In addition, the Bank prepares a Liquidity Contingency Plan at least semi-annually that is strategic in nature and forward-looking to test the ability of the Bank to fund a liquidity shortfall arising from various escalating events. The Liquidity Contingency Plan is presented and reviewed by the Bank’s Asset and Liability Committee.
Core deposits at September 30, 2010 were $850,894 and represented 92% of total deposits. During the first nine months of 2010, the Bank experienced strong growth in its core deposit base. The strong growth in core deposits and the continued decline in loans contributed to growth in the securities portfolio which led to an improvement in the Bank’s overall liquidity position. Over the last year, the Bank has built up significant liquidity on the asset side of the balance sheet. The securities portfolio represents 18% of total assets at September 30, 2010, compared to 10% at September 30, 2009. At September 30, 2010, $28,910 of the securities portfolio was pledged to support public deposits and a portion of the Bank’s secured borrowing line at the FHLB leaving $186,349 of the securities portfo lio unencumbered and available for sale. In addition, at September 30, 2010, the Bank had $40,357 of government guaranteed loans that could be sold in the secondary market to support the Bank’s liquidity position.
Due to its strategic focus to market to specific segments, the Bank has been successful in developing deposit relationships with several large clients, which are generally defined as deposit relationships of $1,000 or more, which are closely monitored by management and Bank officers. At September 30, 2010, 33 large deposit relationships with the Bank account for $275,080 or 32% of total outstanding core deposits. The single largest client represented 4.4% of outstanding core deposits at September 30, 2010. The loss of this deposit relationship or other large deposit relationships could cause an adverse effect on short-term liquidity. The Bank employs a 10-point risk-rating system to evaluate each of its large depositors in order to assist management in its daily monitoring of the volatility o f this portion of its core deposit base. The risk-rating system attempts to determine the stability of the deposits of each large depositor, evaluating among other things the length of time the depositor has been with the Bank and the likelihood of loss of individual large depositor relationships. Risk ratings on large depositors are reviewed at least quarterly and adjusted if necessary. Bank management and officers maintain close relationships and hold regular meetings with its large depositors to assist in management of these relationships. The Bank expects to maintain these relationships and believes it has sufficient sources of liquidity to mitigate the loss of one or more of these clients and regularly tests its ability to mitigate the loss of multiple large depositor relationships in its Liquidity Contingency Plan.
Borrowing lines have been established at various correspondent banks, the Federal Home Loan Bank of Seattle and with the Federal Reserve Bank of San Francisco. At September 30, 2010, the Bank had secured and unsecured borrowing lines totaling approximately $408,503 consisting of $226,118 and $94,385 in secured borrowing lines with the Federal Home Loan Bank of Seattle and the Federal Reserve Bank of San Francisco, respectively and $88,000 in unsecured borrowing lines with various correspondent banks. The borrowing lines with the Federal Home Loan Bank and Federal Reserve Bank of San Francisco are limited by the value of collateral pledged. The Bank pledges real estate loans and commercial loans in support of its secured borrowing lines. At September 30, 2010, the Bank had $68,500 in borrowing s outstanding from the FHLB, $0 outstanding with the Federal Reserve Bank of San Francisco, and $12,380 outstanding on its overnight correspondent bank lines, leaving $252,003 available on the Bank’s secured borrowing lines with the FHLB and Federal Reserve Bank of San Francisco and $75,620 available on its unsecured lines with correspondent banks.
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There has been no material change in the Company’s exposure to market risk since December 31, 2009. Readers are referred to the Company’s Form 10-K and the Annual Report to Shareholders for the year ended December 31, 2009, for specific discussion.
Evaluation of Disclosure Controls and Procedures
The Company’s Chief Executive Officer and Chief Financial Officer have reviewed and evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 240.13a-15(e) and 15d-15(e)) as of September 30, 2010, the measurement date for purposes of this quarterly report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s current disclosure controls and procedures are effective and timely, providing them with material information relating to the Company required to be disclosed in the reports we file or submit under the Exchange Act.
Changes in Internal Controls
There have not been any changes in our internal controls or in other factors during the first nine months of 2010 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. We are not aware of any significant deficiencies or material weaknesses in our internal controls, therefore no corrective actions were taken.
PART II. Other Information
The following is a discussion of the most significant risks and uncertainties that may affect our business, financial condition and future results.
The continued challenging economic environment could have a material adverse effect on our future results of operations or market price of our stock.
The national economy, and the financial services sector in particular, are still facing significant challenges. Substantially all of our loans are to businesses and individuals in western Washington and Oregon, markets facing many of the same challenges as the national economy, including elevated unemployment and declines in commercial and residential real estate. Although some economic indicators are improving both nationally and in the markets we serve, unemployment remains high and there remains substantial uncertainty regarding when and how strongly a sustained economic recovery will occur. A further deterioration in economic conditions in the nation as a whole or in the markets we serve could result in the following consequences, any of which could have an adverse impact, which may be materia l, on our business, financial condition, results of operations and prospects, and could also cause the market price of our stock to decline:
· | economic conditions may worsen, increasing the likelihood of credit defaults by borrowers; |
· | loan collateral values, especially as they relate to commercial and residential real estate, may decline further, thereby increasing the severity of loss in the event of loan defaults; |
· | demand for banking products and services may decline, including services for low cost and non-interest-bearing deposits; and |
· | changes and volatility in interest rates may negatively impact the yields on earning assets and the cost of interest-bearing liabilities. |
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Our allowance for loan losses may not be adequate to cover actual loan losses, which could adversely affect our earnings.
We maintain an allowance for loan losses in an amount that we believe is adequate to provide for losses inherent in our loan portfolio. While we strive to carefully manage and monitor credit quality and to identify loans that may be deteriorating, at any time there are loans included in the portfolio that may result in losses, but that have not yet been identified as potential problem loans. Through established credit practices, we attempt to identify deteriorating loans and adjust the loan loss reserve accordingly. However, because future events are uncertain, there may be loans that deteriorate in an accelerated time frame. As a result, future additions to the allowance at elevated levels may be necessary. Because the loan portfolio contains a number of commercial real estate loa ns with relatively large balances, deterioration in the credit quality of one or more of these loans may require a significant increase to the allowance for loan losses. Future additions to the allowance may also be required based on changes in the financial condition of borrowers, such as have resulted due to the current, and potentially worsening, economic conditions. Additionally, federal banking regulators, as an integral part of their supervisory function, periodically review our allowance for loan losses. These regulatory agencies may require us to recognize further loan loss provisions or charge-offs based upon their judgments, which may be different from ours. Any increase in the allowance for loan losses would have an adverse effect, which may be material, on our financial condition and results of operations.
Concentration in real estate loans and the deterioration in the real estate markets we serve could require material increases in our allowance for loan losses and adversely affect our financial condition and results of operations.
The recent economic downturn and sluggish recovery is significantly impacting our market area. We have a high degree of concentration in loans secured by real estate (see Note 3 in the Notes to Consolidated Financial Statements included in this report). Further deterioration in the local economies we serve could have a material adverse effect on our business, financial condition and results of operations due to a weakening of our borrowers’ ability to repay these loans and a decline in the value of the collateral securing them. Our ability to recover on these loans by selling or disposing of the underlying real estate collateral is adversely impacted by declining real estate values, which increases the likelihood we will suffer losses on defaulted loans secured by real estate beyond the amounts pr ovided for in the allowance for loan losses. This, in turn, could require material increases in our allowance for loan losses and adversely affect our financial condition and results of operations, perhaps materially.
Non-performing assets take significant time to resolve and adversely affect our results of operations and financial condition.
At September 30, 2010, our non-performing loans (which include all non-accrual loans, net of government guarantees) were 4.82% of the loan portfolio. At September 30, 2010, our non-performing assets (which include foreclosed real estate) were 4.86% of total assets. These levels of non-performing loans and assets are at elevated levels compared to historical norms. Non-performing loans and assets adversely affect our net income in various ways. Until economic and market conditions improve, we may expect to continue to incur losses relating to non-performing assets. We generally do not record interest income on non-performing loans or other real estate owned, thereby adversely affecting our income, and increasing our loan administration costs. When we take collateral in fo reclosures and similar proceedings, we are required to mark the related asset to the then fair market value of the collateral, which may ultimately result in a loss. An increase in the level of non-performing assets increases our risk profile and may impact the capital levels our regulators believe are appropriate in light of the ensuing risk profile. While we reduce problem assets through loan sales, workouts, and restructurings and otherwise, decreases in the value of the underlying collateral, or in these borrowers’ performance or financial condition, whether or not due to economic and market conditions beyond our control, could adversely affect our business, results of operations and financial condition, perhaps materially. In addition, the resolution of non-performing assets requires significant commitments of time from management and our directors, which can be detrimental to the performance of their other responsibilities. There can be no assurance tha t we will not experience future increases in non-performing assets.
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Tightening of credit markets and liquidity risk could adversely affect our business, financial condition and results of operations.
A tightening of the credit markets or any inability to obtain adequate funds for continued loan growth at an acceptable cost could adversely affect our asset growth and liquidity position and, therefore, our earnings capability. In addition to core deposit growth, maturity of investment securities and loan payments, the Company also relies on wholesale funding sources including unsecured borrowing lines with correspondent banks, secured borrowing lines with the Federal Home Loan Bank of Seattle and the Federal Reserve Bank of San Francisco, public time certificates of deposits and out of area and brokered time certificates of deposit. Our ability to access these sources could be impaired by deterioration in our financial condition as well as factors that are not specific to us, such as a disruption in the financia l markets or negative views and expectations for the financial services industry or serious dislocation in the general credit markets. In the event such disruption should occur, our ability to access these sources could be adversely affected, both as to price and availability, which would limit, or potentially raise the cost of, the funds available to the Company.
The FDIC has increased insurance premiums to rebuild and maintain the federal deposit insurance fund and there may be additional future premium increases and special assessments.
The FDIC recently adopted a new deposit insurance fund restoration plan to ensure that the fund reserve ratio reaches 1.35 percent by September 30, 2020, as required by financial reform legislation passed in 2010.
The FDIC has required insured institutions to prepay estimated quarterly risk-based assessments for the fourth quarter of 2009 and for 2010, 2011 and 2012, and. The prepayment totaling $6.2 million was collected on December 30, 2009, and was accounted for as a prepaid expense amortized over the prepayment period. In 2009, the FDIC also adopted a final rule revising its risk-based assessment system, which became effective April 1, 2009. The changes to the assessment system involve adjustments to the risk-based calculation of an institution’s unsecured debt, secured liabilities and brokered deposits.
In 2009, the FDIC imposed a special deposit insurance assessment of five basis points on all insured institutions. This emergency assessment was calculated based on the insured institution’s assets at June 30, 2009, totaled $510 for the Bank, and was collected on September 30, 2009.
Despite the FDIC’s recently adopted plan to restore the deposit insurance fund, the fund may suffer additional losses in the future due to bank failures. There can be no assurance that there will not be additional significant deposit insurance premium increases, special assessments or prepayments in order to restore the insurance fund’s reserve ratio. Any significant premium increases or special assessments could have a material adverse effect on our financial condition and results of operations.
We may not have the ability to continue paying dividends on our common stock at current or historic levels.
Our ability to pay dividends on our common stock depends on a variety of factors. On August 18, 2010, we announced a quarterly dividend of $0.01 per share, payable September 15, 2010, which was a continuation of the prior quarter’s dividend. There can be no assurance that we will be able to continue paying quarterly dividends commensurate with historic levels, if at all. Cash dividends will depend on sufficient earnings to support them and approval of appropriate bank regulatory authorities.
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We may be required, in the future, to recognize impairment with respect to investment securities, including the FHLB stock we hold.
Our securities portfolio contains whole loan private mortgage-backed securities and currently includes securities with unrecognized losses. We may continue to observe volatility in the fair market value of these securities. We evaluate the securities portfolio for any other-than-temporary-impairment (“OTTI”) each reporting period, as required by generally accepted accounting principles. In the second quarter of 2010, we recognized OTTI on five of our private-label mortgage-backed securities. There can be no assurance that future evaluations of the securities portfolio will not require us to recognize additional impairment charges with respect to these and other holdings.
In addition, as a condition to membership in the Federal Home Loan Bank of Seattle (“FHLB”), we are required to purchase and hold a certain amount of FHLB stock. Our stock purchase requirement is based, in part, upon the outstanding principal balance of advances from the FHLB. At September 30, 2010, we had stock in the FHLB of Seattle totaling approximately $10.7 million. The FHLB stock held by us is carried at cost and is subject to recoverability testing under applicable accounting standards. The FHLB has discontinued the repurchase of their stock and discontinued the distribution of dividends. As of September 30, 2010, we did not recognize an impairment charge related to our FHLB stock holdings. There can be no assurance, however, that future negative chan ges to the financial condition of the FHLB may require us to recognize an impairment charge with respect to such holdings.
If the goodwill we have recorded in connection with acquisitions becomes impaired, it could have an adverse impact on our earnings and book capital.
At September 30, 2010, we had approximately $22.0 million of goodwill on our balance sheet. In accordance with generally accepted accounting principles, our goodwill is not amortized but rather evaluated for impairment on an annual basis or more frequently if events or circumstances indicate that a potential impairment exists. Such evaluation is based on a variety of factors, including the quoted price of our common stock, market prices of common stocks of other banking organizations, common stock trading multiples, discounted cash flows, and data from comparable acquisitions. There can be no assurance that future evaluations of goodwill will not result in findings of impairment and write-downs, which could be material. At September 30, 2010, we did not recognize an impairment charge related to our goodwill.
Recent levels of market volatility were unprecedented and we cannot predict whether they will return.
From time to time over the last few years, the capital and credit markets have experienced volatility and disruption at unprecedented levels. In some cases, the markets have produced downward pressure on stock prices and credit availability for certain issuers without regard to those issuers’ underlying financial strength. If similar levels of market disruption and volatility return, there can be no assurance that we will not experience an adverse effect, which may be material, on our ability to access capital and on our business, financial condition and results of operations.
We operate in a highly regulated environment and we cannot predict the effect of recent and pending federal legislation.
As discussed more fully in the section entitled “Supervision and Regulation” in our Annual Report on Form 10-K for the year ended December 31, 2009, we are subject to extensive regulation, supervision and examination by federal and state banking authorities. In addition, as a publicly traded company, we are subject to regulation by the Securities and Exchange Commission. Any change in applicable regulations or federal, state or local legislation could have a substantial impact on us and our operations. Additional legislation and regulations that could significantly affect our powers, authority and operations may be enacted or adopted in the future, which could have a material adverse effect on our financial condition and results of operations
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In that regard, sweeping financial regulatory reform legislation was enacted in July 2010. Among other provisions, the new legislation (i) creates a new Bureau of Consumer Financial Protection with broad powers to regulate consumer financial products such as credit cards and mortgages, (ii) creates a Financial Stability Oversight Council comprised of the heads of other regulatory agencies, (iii) will lead to new capital requirements from federal banking agencies, (iv) places new limits on electronic debit card interchange fees, and (v) will require the Securities and Exchange Commission and national stock exchanges to adopt significant new corporate governance and executive compensation reforms. The new legislation and regulations are likely to increase the overall costs of regulatory compliance.
Further, regulators have significant discretion and authority to prevent or remedy unsafe or unsound practices or violations of laws or regulations by financial institutions and holding companies in the performance of their supervisory and enforcement duties. Recently, these powers have been utilized more frequently due to the serious national, regional and local economic conditions we are facing. The exercise of regulatory authority may have a negative impact on our financial condition and results of operations.
We cannot accurately predict the actual effects of recent legislation or the various governmental, regulatory, monetary and fiscal initiatives which have been and may be enacted on the financial markets, on the Company and on the Bank. The terms and costs of these activities, or the failure of these actions to help stabilize the financial markets, asset prices, market liquidity and a continuation or worsening of current financial market and economic conditions could materially and adversely affect our business, financial condition, results of operations, and the trading price of our common stock.
Fluctuating interest rates could adversely affect our profitability.
Our profitability is dependent to a large extent upon our net interest income, which is the difference between the interest earned on loans, securities and other interest-earning assets and interest paid on deposits, borrowings, and other interest-bearing liabilities. 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 margin, and, in turn, our profitability. We manage our interest rate risk within established guidelines and generally seek an asset and liability structure that insulates net interest income from large deviations attributable to changes in market rates. However, our interest rate risk management practices may not be effective in a highly volatile rate environment.
We face strong competition from financial services companies and other companies that offer banking services.
Our three major markets are in Oregon and Washington. The banking and financial services businesses in our market area are highly competitive and increased competition may adversely impact the level of our loans and deposits. Ultimately, we may not be able to compete successfully against current and future competitors. These competitors include national banks, foreign banks, regional banks and other community banks. We also face competition from many other types of financial institutions, including savings and loan associations, finance companies, brokerage firms, insurance companies, credit unions, mortgage banks and other financial intermediaries. In particular, our competitors include major financial companies whose greater resources may afford them a marketplace advantage by en abling them to maintain numerous locations and mount extensive promotional and advertising campaigns. Areas of competition include interest rates for loans and deposits, efforts to obtain loan and deposit customers and a range in quality of products and services provided, including new technology driven products and services. If we are unable to attract and retain banking customers, we may be unable to continue our loan growth and level of deposits.
Future acquisitions and expansion activities may disrupt our business and adversely affect our operating results.
We regularly evaluate potential acquisitions and expansion opportunities. To the extent that we grow through acquisitions, we cannot ensure that we will be able to adequately or profitably manage this growth. Acquiring other banks, branches or other assets, as well as other expansion activities, involve various risks including the risks of incorrectly assessing the credit quality of acquired assets, encountering greater than expected costs of incorporating acquired banks or branches into our Company, and being unable to profitably deploy funds acquired in an acquisition.
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We may pursue additional capital in the future, which could dilute the holders of our outstanding common stock and may adversely affect the market price of our common stock.
From time to time, particularly in the current uncertain economic environment, we may consider alternatives for raising capital when opportunities present themselves, in order to further strengthen our capital and/or better position ourselves to take advantage of identified or potential opportunities that may arise in the future. Such alternatives may include issuance and sale of common or preferred stock, trust preferred securities, or borrowings by the Company, with proceeds contributed to the Bank. Any such capital raising alternatives could dilute the holders of our outstanding common stock and may adversely affect the market price of our common stock.
Anti-takeover provisions in our amended and restated articles of incorporation and bylaws and Oregon law could make a third party acquisition of us difficult.
Our amended and restated articles of incorporation contain provisions that could make it more difficult for a third party to acquire us (even if doing so would be beneficial to our shareholders) and for holders of our common stock to receive any related takeover premium for their common stock. We are also subject to certain provisions of Oregon law that could delay, deter or prevent a change in control of us. These provisions could limit the price that investors might be willing to pay in the future for shares of our common stock.
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(a) | Exhibits |
31.1 302 Certification, Hal Brown, Chief Executive Officer
31.2 302 Certification, Michael A. Reynolds, Executive Vice President and
Chief Financial Officer
32 Certifications Pursuant to 18 U.S.C. Section 1350
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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.
PACIFIC CONTINENTAL CORPORATION
(Registrant)
Dated November 4, 2010 | /s/ Hal Brown | |
Hal Brown | ||
Chief Executive Officer | ||
Dated November 4, 2010 | /s/ Michael A. Reynolds | |
Michael A. Reynolds | ||
Executive Vice President and Chief Financial Officer |
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