The following table presents information regarding yields on interest earning assets, expense on interest-bearing liabilities, and net interest margin on average interest-earning assets for the periods indicated on a tax equivalent basis:
The net interest margin for the second quarter of 2007 decreased to 4.90% from 5.06% in the second quarter of 2006, mainly due to higher rates paid on interest bearing liabilities that were only partially offset by the higher yield on earning assets and higher value of non-interest bearing demand deposits. The second quarter 2007 net interest margin of 4.90% was consistent with our expectations despite higher than expected interest bearing liability costs. Stronger than anticipated construction loan balances and fees helped offset the increased costs. For more information regarding the growth in construction loans, see the discussion under the heading “Balance Sheet Overview.”
Average yields on earning assets increased 54 basis points to 7.84% in the second quarter of 2007 from 7.30% in the second quarter of 2006. Average interest earning assets increased $404 million, or 20%, to $2.38 billion in the second quarter of 2007 from $1.98 billion for the same period in 2006. Second quarter 2007 average rates paid on interest bearing liabilities increased 81 basis points to 3.84%, from 3.03% for the same period in 2006, while average interest bearing liabilities increased $358.5 million, or 25%, to $1.82 billion.
Changing interest rate environments, including the slope and level of, as well as changes in, the yield curve, and competitive pricing pressure, could lead to higher deposit costs, lower loan yields, reduced net interest margin and spread, and lower loan fees, all of which could lead to a decrease in net interest income.
Provision for Loan LossesBancorp recorded provisions for loan loss for the second quarters of 2007 and 2006 of $3.5 million and $.5 million, respectively. The provision for loan losses for the six months ended June 30, 2007, was $6.3 million, up from $.9 million in the same period in 2006. Consistent with the current credit cycle, the higher loan loss provision in the three and six months ended June 30, 2007, compared to the respective periods in 2006, reflects the impact of loan growth, loan mix changes, higher net charge-offs, and a moderately unfavorable migration in our loan risk ratings reserve percentage in the 2007 periods. In 2007, we had a greater proportion of our loan portfolio in construction loans, which inherently have a higher risk, consequently construction loans are allocated a higher loan loss provision relative to other loans in the Bank’s loan portfolio.
The provision for loan losses is recorded to bring the allowance for loan losses to an amount considered appropriate by management based on factors which are described in the “Loan Portfolio and Credit Management” and “Allowance for Loan Losses” sections of this report. The provision for loan losses is highly dependent on the local economy and real estates markets and our ability to manage asset quality and control the level of net charge-offs through prudent credit underwriting standards. In addition, a decline in general economic conditions could increase future provisions for loan loss.
Non-interest IncomeTotal non-interest income was $8.7 million for the three months ended June 30, 2007, an increase of 23% compared to $7.1 million in the second quarter of 2006. Consistent with recent quarterly trends, we experienced broad-based fee income growth. Successful product introductions helped us produce double-digit revenue growth in all major fee income categories compared to the second quarter of 2006. In the second quarter 2007, deposit service charges increased $.3 million, or 11%, and payment systems revenues increased $.5 million, or 32%, over the same period in 2006 with continued solid growth in consumer and business accounts. Due to a strong equity market, as well as growth in the number of client relationships and sales of investment products, trust and investment services revenue grew 17% from the same quarter of 2006. Additionally, second quarter 2007 gains on sales of loans revenue jumped $.3 million, or 40%, from the second quarter of 2006, due to strong SBA production in the most recent quarter compared to the same period a year ago.
Changing interest rate environments, including the slope and level of, as well as changes in, the yield curve, could lead to decreases in fee income, including lower gains on sales of loans and reduced deposit service charges, two key components of our non-interest income. Also, increased competition and other competitive factors could adversely affect our ability to sustain fee generation.
Non-interest Expense Non-interest expense for the three months ended June 30, 2007, was $21.5 million, a modest increase of $.9 million, or 5%, compared to $20.6 million for the same period in 2006. The slower growth was partly due to lower second quarter marketing expenses, which declined $.7 million from the same quarter of 2006 in accordance with our plans. Salaries and employee benefits expense increased $.6 due primarily to our hiring additional relationship managers and branch personnel. Equipment expense increased 15% over second quarter 2006, mainly because of technology investments to support our products and delivery capabilities, including those in the payment systems area. Occupancy expense increased 30% from the same quarter in 2006, with a large portion of the increase caused by rent and depreciation on new or relocated branches.
Income taxesThe provision for income taxes increased in the three and six months ended June 30, 2007, from the same periods in 2006, primarily due to an increase in income before taxes. Bancorp’s effective tax rate for the three and six months ended June 30, 2007, remained flat compared to the same period in 2006.
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Balance Sheet Overview
Period end total assetsincreased to $2.6 billion as ofJune 30, 2007, up from $2.3 billion at June 30, 2006. Our balance sheet growth has reflected successful efforts in targeted areas that support our corporate objectives, including small business and middle market commercial lending, construction and home equity lending, as well as core deposit production. Our average earning assets increased in excess of 20% for both the year and quarter to date 2007 compared to the prior year periods.
Investment PortfolioThe investment portfolio at June 30, 2007, decreased $61.0 million compared to December 31, 2006. At June 30, 2007, total investment securities available for sale had a pre-tax net unrealized loss of $3.0 million. The decrease in our investment portfolio reflects recent strong loan growth as investment maturities have been utilized to fund loans. The composition and carrying value of Bancorp’s investment portfolio is as follows:
| | June 30, | | December 31, |
| (Dollars in thousands) | 2007 | | 2006 |
| Investments available for sale (at fair value) | | | | | |
| Treasury securities | $ | 196 | | $ | - |
| U.S. Government agency securities | | 78,972 | | | 125,455 |
| Corporate securities | | 22,086 | | | 23,885 |
| Mortgage-backed securities | | 75,468 | | | 84,477 |
| Obligations of state and political subdivisions | | 72,966 | | | 75,873 |
| Equity and other securities | | 17,926 | | | 18,962 |
| Total Investment Portfolio | $ | 267,614 | | $ | 328,652 |
Bancorp’s investment portfolio has very limited exposure to “subprime” mortgages. The majority of our mortgage-backed securities portfolio is comprised of 15 year fully amortizing jumbo loans. All of our non-agency mortgage-backed securities are rated AAA or Aaa.
Loan Portfolio and Credit ManagementInterest and fees earned on our loan portfolio is our primary source of revenue.Loans represented 83% of total assets or $2.1 billion as of June 30, 2007, compared to 79% or $1.9 billion at December 31, 2006. A certain degree of credit risk is inherent in our lending activities. The Company manages the general risks inherent in the loan portfolio by following loan policies and underwriting practices designed to result in prudent lending activities. In addition, we attempt to manage our risk through our credit administration and credit review functions, which are designed to help ensure compliance with our credit standards. Through the credit review function, the Company is able to monitor all credit-related policies and practices on a post approval basis, ensuring uniform application. The findings of these reviews are communicated with senior management and the Loan, Investment, and Asset/Liability Committee, which is made up of certain directors. As part of our ongoing lending process, internal risk ratings are assigned to each commercial and commercial real estate, including commercial construction, credit before the funds are extended to the customer. Credit risk ratings are based on apparent credit worthiness of the borrower at the time the loan is made. Large balance accounts have the credit risk rating reviewed on at least an annual basis. Credit files are examined periodically on a sample test basis by internal and external auditors as well as by regulatory examiners.
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Although a risk of nonpayment exists with respect to all loans, certain specific types of risks are associated with different types of loans. As a result of the nature of our customer base and the growth experienced in the market areas served, real estate is frequently a material component of collateral for the Company’s loans. The expected source of repayment of these loans is generally the cash flow of the project, operations of the borrower's business, or personal income. Risks associated with real estate loans include decreasing land and property values, material increases in interest rates, deterioration in local economic conditions, changes in tax policies, and a concentration of loans within any one area.
We produced strong loan growth over the past year with a 24%, or $405 million, increase in average quarterly loans in the second quarter 2007 compared to the same period in 2006. Part of this growth is attributable to our acquisition of Mid-Valley Bank at the end of second quarter 2006. Slightly over half of this growth was generated by average construction loans which increased $218 million or 85%. Average commercial loans also exhibited strong growth of $99 million or 24% over the same period. Period end loans increased $339 million from June 30, 2006.
As part of our strategic efforts over the last seven years, we have placed an emphasis on increasing the commercial, construction and home equity loan segments of our portfolio. Our strategy has resulted in the loan portfolio being more interest rate sensitive. While our total loan portfolio is more diversified from a credit risk perspective, historically commercial loans tend to exhibit more credit losses than commercial real estate loans. This is partly due to the collateral not being based in real estate but assets such as inventory, accounts receivable, etc. Commercial and construction loans each represent 24% of the loan portfolio as of the end of the second quarter, compared to 16% and 19%, respectively, at December 31, 2000. Commercial real estate loans have declined from 58% to less than 38% of the loan portfolio over the same time period. We believe our focus on commercial businesses has been and remains a key contributor to growing low cost deposits.
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The composition of Bancorp’s loan portfolio is as follows:
| (Dollars in thousands) | | June 30, 2007 | | December 31, 2006 |
| | Amount | | | Percent | | Amount | | | Percent |
| Commercial | $ | 515,590 | | | 24.1 | % | | $ | 463,188 | | | 23.8 | % |
| Real estate construction | | 503,414 | | | 23.5 | % | | | 365,954 | | | 18.8 | % |
| Real estate mortgage | | 294,447 | | | 13.8% | % | | | 287,495 | | | 14.8 | % |
| Real estate commercial | | 803,155 | | | 37.5 | % | | | 804,865 | | | 41.3 | % |
| Installment and other consumer | | 24,336 | | | 1.1 | % | | | 26,188 | | | 1.3 | % |
| Total loans | | 2,140,942 | | | 100 | % | | | 1,947,690 | | | 100 | % |
| Allowance for loan losses | | (26,496 | ) | | 1.24 | % | | | (23,017 | ) | | 1.18 | % |
| Total loans, net | $ | 2,114,446 | | | | | | $ | 1,924,673 | | | | |
The composition of commercial real estate loan types based on collateral is as follows:
| (Dollars in thousands) | | June 30, 2007 | | December 31, 2006 |
| | Amount | | Percent | | Amount | | Percent |
| Office Buildings | $ | 187,900 | | 23.4 | % | | $ | 205,100 | | 25.5 | % |
| Retail Facilities | | 102,400 | | 12.8 | % | | | 103,900 | | 12.9 | % |
| Multi-Family - 5+ Residential | | 78,300 | | 9.7 | % | | | 78,200 | | 9.7 | % |
| Medical Offices | | 51,700 | | 6.4 | % | | | 54,700 | | 6.8 | % |
| Hotels/Motels | | 47,500 | | 5.9 | % | | | 52,400 | | 6.5 | % |
| Commercial/Agricultural | | 53,600 | | 6.7 | % | | | 47,300 | | 5.9 | % |
| Industrial parks and related | | 47,900 | | 6.0 | % | | | 50,300 | | 6.2 | % |
| Manufacturing Plants | | 29,900 | | 3.7 | % | | | 29,700 | | 3.7 | % |
| Assisted Living | | 20,500 | | 2.6 | % | | | 22,200 | | 2.8 | % |
| Land Development and Raw Land | | 23,500 | | 2.9 | % | | | 19,300 | | 2.4 | % |
| Food Establishments | | 20,600 | | 2.6 | % | | | 17,500 | | 2.2 | % |
| Mini Storage | | 16,200 | | 2.0 | % | | | 16,100 | | 2.0 | % |
| Other | | 123,200 | | 15.3 | % | | | 108,200 | | 13.4 | % |
| Total real estate commercial loans | $ | 803,200 | | 100 | % | | $ | 804,900 | | 100 | % |
Office buildings, retail facilities, and multi-family residential categories account for nearly half of the collateral securingour $803 million commercial real estate portfolio, down slightly from year end 2006. We believe Bancorp’s underwriting of commercial real estate loans is conservative with loan to value ratios generally not exceeding 75% and debt service coverage ratios generally at 120% or better.
Composition by occupancy type in the commercial real estate loan portfolio is as follows:
| | June 30, | | December 31, | | | |
| | 2007 | | 2006 | | Change |
| (Dollars in thousands) | | Amount | | Percent | | Amount | | Percent | | Amount | | Percent |
| Owner-occupied | $ | 373,896 | | 47 | % | | $ | 349,341 | | 43 | % | | $ | 24,555 | | | | 7 | % |
| Non-owner occupied | | 429,259 | | 53 | % | | | 455,524 | | 57 | % | | | (26,265 | ) | | | -6 | % |
| Total real estate commercial loans | $ | 803,155 | | 100 | % | | $ | 804,865 | | 100 | % | | $ | (1,710 | ) | | | 0 | % |
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At June 30, 2007, real estate construction loans were $503 million, up $232 million or 86%, compared to $271 million at June 30, 2006. Real estate construction loans represent nearly 24% of our loan portfolio at June 30, 2007, compared to 15% at June 30, 2006.
The composition of real estate construction loans is as follows:
| | June 30, | | |
| | 2007 | | 2006 | | Change |
| (Dollars in thousands) | | Amount | | Percent | | Amount | | Percent | | | | Amount | | | Percent | |
| Commercial construction | $ | 96,164 | | | | 19 | % | | $ | 43,232 | | | 16 | % | | $ | 52,932 | | | 122 | % |
| Residential construction to homeowner | | 272,709 | | | | 54 | % | | | 126,717 | | | 47 | % | | | 145,992 | | | 115 | % |
| Pre sold / speculative residential construction to builder | | 55,826 | | | | 11 | % | | | 43,346 | | | 16 | % | | | 12,480 | | | 29 | % |
| Residential subdivision/site development | | 81,172 | | | | 16 | % | | | 59,697 | | | 22 | % | | | 21,475 | | | 36 | % |
| Net deferred fees | | (2,457 | ) | | | 0 | % | | | (1,832 | ) | | -1 | % | | | (625 | ) | | 34 | % |
| Total real estate construction loans | $ | 503,414 | | | | 100 | % | | $ | 271,160 | | | 100 | % | | $ | 232,254 | | | 86 | % |
We experienced continued strong expansion in construction loan balances, which, consistent with recent periods, exceeded our expectations. However, partly due to the underwriting changes discussed below, construction commitments in the second quarter of 2007 declined approximately 25% from the commitments in each of the prior two quarters. Therefore, the construction portfolio draw percentage at June 30, 2007, reached its highest level since the first quarter of 2004, which was prior to the current surge in the construction portfolio. We believe this indicates the balance in the construction portfolio may be at or near its peak.
As the tables indicate, over half of our construction loan growth since June 30, 2006, has been in residential construction loans to homeowners generally referred to as two-step loans. In these transactions, the Bank does not commit to permanent take-out financing when the construction loan commitment is made, but all borrowers do have in place a pre-qualified loan application with another financial institution.
The Bank originated $192.3 million in two-step residential real estate construction loans in the six months ending June 30, 2007, compared to $47.8 million in the same period of 2006. The Portland/Vancouver market area accounted for the largest origination volume year to date June 30, 2007. Approximately 51% of the 2007 two-step construction loan originations were for single family residential owner occupied homes, while another 38% was for single family residential investment and rental income producing purposes and the remaining balance of 11% were for second homes.
The following table illustrates residential real estate construction loan originations by region.
| | Period ending | | Period ending |
| (Dollars in thousands) | | June 30, | | June 30, |
| Region | 2007 | | 2006 |
| Portland, Oregon / Vancouver, Washington | $ | 70,539 | | $ | 10,692 |
| Western Washington (Olympia, Seattle) | | 45,434 | | | 25,880 |
| Central Oregon (Bend, Redmond) | | 35,201 | | | 3,461 |
| Oregon Coast (Newport, Lincoln City) | | 18,135 | | | 2,682 |
| Willamette Valley (Salem, Eugene) | | 15,016 | | | 2,036 |
| Southern Oregon (Medford, Roseburg) | | 7,954 | | | 3,045 |
| Total residential real estate construction loan originations | $ | 192,279 | | $ | 47,796 |
Commercial construction and residential subdivision/site development loans accounted for the majority of the remainder of the construction portfolio expansion. Commercial construction loans include financing provided for non-residential business properties and multifamily dwellings while pre-sold/speculative residential construction loans are generally made to finance builders and developers of residential properties.
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Management is closely monitoring the growth rate in our real estate construction category. In 2007, we have instituted more conservative underwriting policies including more stringent borrower income verification, lowered maximum loan-to-value limits, and decreased our concentration limits in housing subdivisions. In addition, we are raising the level of customer contact as loans near maturity. We continually review our lending policies and approval criteria to align them with the strategic objectives of the Bank, including policies that attempt to ensure a healthy diversification in our real estate construction portfolio. Loan repayments, particularly those related to construction lending, can be subject to the volatility of the real estate market.
The composition of real estate construction loans for the past three years ended December 31, is as follows:
| | December 31, |
| | 2006 | | 2005 | | 2004 |
| (Dollars in thousands) | | Amount | | Percent | | Amount | | Percent | | Amount | | Percent |
| Commercial construction | $ | 63,592 | | | 17 | % | | $ | 45,278 | | | 21 | % | | $ | 39,564 | | | 35 | % |
| Residential construction to homeowner | | 187,596 | | | 51 | % | | | 82,427 | | | 39 | % | | | 30,421 | | | 26 | % |
| Pre sold / speculative residential construction to builder | | 46,805 | | | 13 | % | | | 31,375 | | | 15 | % | | | 17,982 | | | 15 | % |
| Residential subdivision/site development | | 70,351 | | | 20 | % | | | 53,367 | | | 26 | % | | | 29,632 | | | 25 | % |
| Net deferred fees | | (2,390 | ) | | -1 | % | | | (1,619 | ) | | -1 | % | | | (625 | ) | | -1 | % |
| Total real estate construction loans | $ | 365,954 | | | 100 | % | | $ | 210,828 | | | 100 | % | | $ | 116,974 | | | 100 | % |
As indicated in the table above, the total real estate construction loan category has expanded rapidly reflecting the high activity in our local construction real estate markets over the past few years. The construction category, consequently, has been an important contributor to the overall loan revenue and earnings growth for the Company over this period. As construction activity in our markets, particularly for residential units, has slowed and is anticipated to remain below the robust level of the past few years, we anticipate a corresponding decline in the Company’s construction loan production volumes and associated revenue and earnings contribution growth from this segment..
At June 30, 2007, real estate mortgage loan balances were $294 million or approximately 14% of the Company’s total loan portfolio. Home equity loans and lines represented about 75% or $223 million of the real estate mortgage portfolio. The Bank’s home equity loans and lines are substantially generated by our branches within our market area without the use of brokers. As of June 30, 2007, slightly less than half of our home equity portfolio was secured by a first lien, with the remainder of the portfolio generally secured by junior liens. In excess of 97% of our home equity loans had an original loan to value of less than 85%, and the average FICO credit score for originations since January 1, 2005, was approximately 748. A study by the Consumer Bankers Association found that the average home equity borrower in 2006 had a FICO credit score of 730, which is about the same as the prior year.
As of June 30, 2007, the Company had outstanding loans to persons serving as directors, officers, principal stockholders and their related interests. These loans, when made, were on substantially the same terms, including interest rates, maturities and collateral, as comparable loans made to other customers of the Company. At June 30, 2007, and December 31, 2006, Bancorp had no bankers acceptances.
Nonperforming Assets and Other Real Estate Owned Properties (“OREO”)Nonperforming assets include nonaccrual loans and loans past due more than 90 days. At June 30, 2007, nonperforming assets were $6.1 million, or 0.24%, of total assets, compared to $1.8 million, or 0.08%, at June 30, 2006. Interest income on loans is accrued daily on the principal balance outstanding. Generally, no interest is accrued on loans when factors indicate collection of all contractually due interest or principal is doubtful or when the principal or interest payment becomes 90 days past due. Nonaccrual loans increased to $6.1 million at June 30, 2007, from $1.8 million at June 30, 2006. The Company had one OREO property at June 30, 2007 with a full valuation allowance and no net book value.
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Nonperforming assets consist of the following:
| (Dollars in thousands) | | June 30, 2007 | | December 31, 2006 |
| Loans on nonaccrual status: | | | | | | | |
| Commercial | $ | 833 | | | $ | 385 | |
| Real estate construction | | 4,375 | | | | 567 | |
| Real estate mortgage | | 413 | | | | - | |
| Real estate commercial | | 484 | | | | 516 | |
| Installment and consumer | | 11 | | | | - | |
| Total nonaccrual loans | $ | 6,116 | | | $ | 1,468 | |
| Loans past due greater than 90 days | | | | | | | |
| not on nonaccrual status | | - | | | | - | |
| Other real estate owned | | - | | | | - | |
| Total nonperforming assets | $ | 6,116 | | | $ | 1,468 | |
| | |
| Nonperforming loans to total loans | | 0.29 | % | | | 0.08 | % |
| Nonperforming assets to total assets | | 0.24 | % | | | 0.06 | % |
| Allowance for loan losses to non-performing assets | | 433 | % | | | 1568 | % |
Real estate construction loans comprised $4.4 million, or 72%, of the $6.1 million total nonaccrual loan balance at June 30, 2007. The growth in nonperforming real estate construction loans has been largely caused by our two-step residential construction lending product. The remaining nonaccrual loans are made up of $.8 million in commercial loans and $.5 and $.4 million in commercial real estate and real estate mortgage loans, respectively.
The combination of what we believe is a return to a historically more normal credit environment for the industry and a moderate unfavorable migration of our internal risk ratings, we project a modest but manageable increase in nonperforming assets over the remainder of the year. At this point, and unless any material unforeseen events occur, we believe the nonperforming asset to total asset ratio should remain within our historical range of .06% to .54% since December 31, 1999.
Delinquencies (defined as balances over 30 days past due, not in nonaccrual status) were .94% of total loans at June 30, 2007, up from .59% at December 31, 2006, due to increased real estate construction loan delinquencies. The overall portfolio delinquency ratio of .94% at June 30, 2007, was well within the historical range of .25% to 2.07% over the past seven years. The delinquency ratio of the two-step real estate construction loans to total two-step loans real estate construction loans was 3.47% at June 30, 2007. While we have had an increase in our delinquency level in the two-step construction area, year to date June 30, 2007 charge-offs in this program remain very low at $75,000. Reflecting the changing credit cycle, we anticipate that the Company’s delinquencies will increase moderately from the June 30, 2007 delinquency level.
In the quarter ending June 30, 2007, the Bank’s watch and classified loans increased $14 million to $68 million or 3.2% of total outstanding loans. Our seven year historic range for the watch and classified loan category is from a low of 1.9% at September 30, 2006 to 7.6% at March 31, 2004. As with delinquency percentages, watch and classified loans reached their low point in the third quarter of 2006, and have since trended gradually upward. The increase in the second quarter of 2007 was primarily due to classifying a single commercial relationship as a watch credit. Based on what we know today, the potential for loss on this credit is considered low.
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Allowance for Loan Losses and Net Charge-offs Please see the Company’s 2006 10-K under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Loan Loss Allowance and Provision” for a discussion of Bancorp’s methodologies underlying the calculation of the Company’s allowance for loan losses.
At June 30, 2007, the Company’s allowance for loan losses was $26.5 million, consisting of a $24.2 million formula allowance, a $1.1 million specific allowance, and a $1.2 million unallocated allowance. At December 31, 2006, our allowance for loan losses was $23.0 million, consisting of a $20.7 million formula allowance, a $1.2 million specific allowance, and a $1.1 million unallocated allowance. The changes in the allocation of the allowance for loan losses in the first six months of 2007 were due primarily to changes in the loan portfolio and its mix, changes in the risk ratings of our loans, as well as charge-offs and recovery activities.
At June 30, 2007, Bancorp’s allowance for loan losses was 1.24% of total loans and 433% of total nonperforming loans, compared with an allowance for loan losses at December 31, 2006, of 1.18% of total loans, and 1568% of total nonperforming loans, respectively. Changes in the allowance for loan losses are as follows for year to date June 30, 2007, and full year ended December 31, 2006, respectively:
| | Six months ended | | Year ended |
| (Dollars in thousands) | | June 30, 2007 | | December 31, 2006 |
| Loans outstanding at end of period | $ | 2,140,942 | | | $ | 1,947,690 | |
| Average loans outstanding during the period | | 2,029,418 | | | | 1,745,777 | |
| | |
| Allowance for loan losses, beginning of period | | 23,017 | | | | 20,469 | |
| Allowance for loan losses, from acquisition | | - | | | | 887 | |
| Loans charged off: | | | | | | | |
| Commercial | | (2,466 | ) | | | (831 | ) |
| Real estate construction | | (75 | ) | | | - | |
| Real estate mortgage | | - | | | | (48 | ) |
| Real estate commercial | | - | | | | - | |
| Installment and consumer | | (101 | ) | | | (130 | ) |
| Overdraft | | (445 | ) | | | (912 | ) |
| Total loans charged off | | (3,087 | ) | | | (1,921 | ) |
| Recoveries: | | | | | | | |
| Commercial | | 79 | | | | 501 | |
| Real estate construction | | - | | | | - | |
| Real estate mortgage | | 9 | | | | 36 | |
| Real estate commercial | | 1 | | | | 4 | |
| Installment and consumer | | 66 | | | | 75 | |
| Overdraft | | 111 | | | | 233 | |
| Total recoveries | | 266 | | | | 849 | |
| Net loans charged off | | (2,821 | ) | | | (1,072 | ) |
| | |
| Provision for loan losses | | 6,300 | | | | 2,733 | |
| Allowance for loan losses, end of period | $ | 26,496 | | | $ | 23,017 | |
| | |
| Ratio of net loans charged off to average loans | | | | | | | |
| outstanding, annualized | | 0.28 | % | | | 0.06 | % |
Ratio of allowance for loan losses to loans | | | | | | | |
| outstanding at end of period | | 1.24 | % | | | 1.18 | % |
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During the first six months of 2007, net loan charge-offs were $2.8 million compared to $.4 million for the same period in 2006. The annualized percentage of net loans charged off year to date to average loans outstanding was 0.28% for the six months ended June 30, 2007, up from of 0.05% in the six months ended June 30, 2006. One commercial relationship represented $2.4 million, or the majority, of the total net charge-offs during the first six months of 2007. At June 30, 2007, the remaining loan balance with this commercial relationship is $.5 million. The remaining charge-offs during the first six months of 2007 were largely the result of overdraft losses.
Since December 31, 1999, the overall net charge-off percentage has ranged from .05% to .30%, and we anticipate net charge-offs in 2007 will be within this range. Net charged off loans reflect the realization of losses less recoveries in the portfolio that were recognized previously through the provision for loan losses.
Deposits and Borrowings The following table summarizes the quarterly average amount in, and the average interest rate paid on, each of the deposit and borrowing categories for the second quarters of 2007 and 2006.
| | Second Quarter 2007 | | Second Quarter 2006 |
| | Quarterly Average | | | | | Rate | | Quarterly Average | | | | | | |
| (Dollars in thousands) | Balance | | Percent | | Paid | | Balance | | Percent | | Rate Paid |
| Demand deposits | $ | 470,622 | | 23 | % | | - | | | $ | 446,421 | | 26 | % | | - | |
| Savings and interest bearing demand | | 348,086 | | 17 | % | | 1.07 | % | | | 340,183 | | 20 | % | | 0.75 | % |
| Money market | | 659,817 | | 33 | % | | 3.84 | % | | | 511,841 | | 30 | % | | 3.17 | % |
| Time deposits | | 538,713 | | 27 | % | | 4.67 | % | | | 402,239 | | 24 | % | | 3.74 | % |
| Total deposits | | 2,017,238 | | 100 | % | | | | | | 1,700,684 | | 100 | % | | | |
| | |
| Short-term borrowings | | 159,811 | | | | | 5.34 | % | | | 95,429 | | | | | 5.14 | % |
| Long-term borrowings (1) | | 114,282 | | | | | 6.22 | % | | | 112,559 | | | | | 5.00 | % |
| Total deposits and borrowings | $ | 2,291,331 | | | | | 3.84 | % | | $ | 1,908,672 | | | | | 3.03 | % |
(1) Long-term borrowings include junior subordinated debentures.
Second quarter 2007 average total deposits increased 19%, or $317 million, from the second quarter 2006. Our average deposits increase was mainly due to the combination of higher interest rates on and therefore, increased customer demand for money market and time deposits, the Mid-Valley acquisition, and consistent sales practices by the branches and commercial teams resulting in both consumer and business deposit growth. The Company believes interest bearing deposits such as money market and time deposits can be generated with competitive interest rate pricing of such deposits.
As a result of higher short term interest rates, our deposit and borrowing cost increased 81 basis points since the second quarter of 2006. Additionally, the local market areas in which we operate have exhibited strong loan growth and consequently the market participants have experienced a need for a robust deposit funding growth as well.
While perhaps not quite as drastic of a change in deposit mix as our Pacific Northwest peers, we have not escaped the deposit mix migration caused by changing customer behavior from the sustained flat yield curve. Growth in average non-interest demand deposits and interest bearing demand deposit balances slowed materially with the rate driven time deposits and money market categories picking up the pace to support our earning asset expansion. Average non-interest bearing demand balances declined to 23% of total deposits from 26% prior year second quarter, and this mix change caused our overall deposit funding cost to increase more than from higher deposit pricing alone. On a linked quarter basis, the noninterest bearing demand deposit to total deposits percentage remained constant at 23%.
The current balance of junior subordinated debentures of $51 million includes $5 million in debentures issued by Bancorp in June 2007 and $12.5 million issued in March 2007. For additional detail regarding Bancorp’s outstanding debentures, please see the 2006 10-K under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Sources of Funds.”
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Capital Resources
The Federal Reserve Bank (“FRB”) and the Federal Deposit Insurance Corporation (“FDIC”) have established minimum requirements for capital adequacy for bank holding companies and state non-member banks. The requirements address both risk-based capital and leveraged capital. The regulatory agencies may establish higher minimum requirements if, for example, a corporation has previously received special attention or has a high susceptibility to interest rate risk. The FRB and FDIC risk-based capital guidelines require banks and bank holding companies to have a ratio of tier one capital to total risk-weighted assets of at least 4%, and a ratio of total capital to total risk-weighted assets of 8% or greater. In addition, the leverage ratio of tier one capital to total assets less intangibles is required to be at least 3%. As of June 30 2007, Bancorp and the Bank are considered “Well Capitalized” under the regulatory risk based capital guidelines.
The following table summarizes the consolidated risk based capital ratios of Bancorp and the Bank at June 30, 2007, and December 31, 2006.
| | | June 30, 2007 | | December 31, 2006 |
| |
| | | | | | | Amount | | | | | | | | Amount | | |
| | | | | | | Required For | | Percent | | | | | | Required For | | Percent |
| | | | | | | Minimum | | required for | | | | | | Minimum | | required for |
| | | | | | | Capital | | Minimum | | | | | | Capital | | Minimum |
| (Dollars in thousands) | | Actual | | | | Adequacy | | Capital | | Actual | | | | Adequacy | | Capital |
| | | Amount | | Ratio | | Amount | | Adequacy | | Amount | | Ratio | | Amount | | Adequacy |
| Tier 1 Capital | | | | | | | | | | | | | | | | | | | | | | |
| West Coast Bancorp | | $ | 251,951 | | 10.25 | % | | $ | 98,332 | | 4% | | $ | 227,165 | | 9.85 | % | | $ | 92,277 | | 4% |
| West Coast Bank | | | 234,846 | | 9.57 | % | | | 98,204 | | 4% | | | 212,446 | | 9.22 | % | | | 92,156 | | 4% |
| | | | | | | | | | | | | | | | | | | | | | | |
| Total Capital | | | | | | | | | | | | | | | | | | | | | | |
| West Coast Bancorp | | $ | 278,569 | | 11.33 | % | | $ | 196,665 | | 8% | | $ | 250,406 | | 10.85 | % | | $ | 184,555 | | 8% |
| West Coast Bank | | | 261,464 | | 10.65 | % | | | 196,408 | | 8% | | | 235,688 | | 10.23 | % | | | 184,311 | | 8% |
| | | | | | | | | | | | | | | | | | | | | | | |
| Risk weighted assets | | | | | | | | | | | | | | | | | | | | | | |
| West Coast Bancorp | | $ | 2,458,309 | | | | | | | | | | $ | 2,306,935 | | | | | | | | |
| West Coast Bank | | | 2,455,106 | | | | | | | | | | | 2,303,893 | | | | | | | | |
| |
| Leverage Ratio | | | | | | | | | | | | | | | | | | | | | | |
| West Coast Bancorp | | $ | 251,951 | | 10.03 | % | | $ | 75,390 | | 3% | | $ | 227,165 | | 9.64 | % | | $ | 70,721 | | 3% |
| West Coast Bank | | | 234,846 | | 9.35 | % | | | 75,368 | | 3% | | | 212,446 | | 9.01 | % | | | 70,701 | | 3% |
| | | | | | | | | | | | | | | | | | | | | | | |
| Average total assets | | | | | | | | | | | | | | | | | | | | | | |
| West Coast Bancorp | | $ | 2,512,993 | | | | | | | | | | $ | 2,357,369 | | | | | | | | |
| West Coast Bank | | | 2,512,263 | | | | | | | | | | | 2,356,715 | | | | | | | | |
Stockholders' equity was $214 million at June 30, 2007, up from $201 million at December 31, 2006. The increase was due to net income, restricted stock grants and stock option exercises, including tax benefits associated with those option exercises, offset in part by unrealized losses on the investment portfolio, quarterly cash dividends to shareholders and Bancorp’s activity in its corporate stock repurchase program. The total capital ratio at the Bank was 10.65% at June 30, 2007, 65 basis points over minimum for well capitalized status. We anticipate stock repurchase activity and the actual number of shares repurchased for the remainder of 2007 will in large part be dictated by Bancorp’s earnings and risk weighted asset growth.
The risk based capital ratios of Bancorp include $51 million of trust preferred securities that qualify as tier 1 capital at June 30, 2007, under guidance issued by the Board of Governors of the Federal Reserve System. Bancorp will continue to rely upon trust preferred securities to remain well-capitalized. For a further discussion of the amount and terms of issuances of pooled trust preferred securities, see Bancorp’s 2006 10-K under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operation – Liquidity and Sources of Funds,” and Note 9 in the financial statements of this report.
In July 2000, the Company announced a corporate stock repurchase program that was expanded in September 2000, September 2001, September 2002, and April 2004. Under this plan, the Company may buy up to a total of 3.88 million shares of the Company’s common stock, including completed purchases. The Company anticipates using existing funds, future net income, and/or long-term borrowings to finance future repurchases. During the first six months of 2007, the Company repurchased 15,000 common shares pursuant to its corporate stock repurchase program and redeemed 19,322 shares related to its incentive plans. Total shares available for repurchase under the Company’s stock repurchase program were approximately 242,000 at June 30, 2007.
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The following table presents information with respect to Bancorp’s stock repurchases.
| | Shares repurchased | | Shares repurchased as | | Total shares | | Total cost of | | |
| (Shares and dollars in thousands, other | related to stock options | | part of the corporate | | repurchased in the | | shares | | Average total |
| than per share amounts) | and restricted stock | | stock repurchase plan | | period | | repurchased | | cost per share |
| Year ended 2000 | 15 | | 573 | | 588 | | $ | 5,454 | | $ | 9.28 |
| Year ended 2001 | 28 | | 534 | | 562 | | | 6,879 | | | 12.24 |
| Year ended 2002 | 35 | | 866 | | 901 | | | 13,571 | | | 15.06 |
| Year ended 2003 | 29 | | 587 | | 616 | | | 10,927 | | | 17.74 |
| Year ended 2004 | 49 | | 484 | | 533 | | | 11,502 | | | 21.58 |
| Year ended 2005 | 44 | | 484 | | 528 | | | 12,856 | | | 24.35 |
| Year ended 2006 | 37 | | 95 | | 132 | | | 3,852 | | | 29.18 |
| Six months ended June 30, 2007 | 19 | | 15 | | 34 | | | 1,089 | | | 32.03 |
| Total | 256 | | 3,638 | | 3,894 | | $ | 66,130 | | $ | 16.98 |
Please also see discussion of stock repurchase activity during the quarter ended June 30, 2007, under Part II, Item 2, “Unregistered Sales of Equity Securities and Use of Proceeds” below.
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Liquidity and Sources of Funds
The Company’s primary sources of funds are customer deposits, maturities of investment securities, sales of "Available for Sale" securities, loan sales, loan repayments, net income, advances from the Federal Home Loan Bank (“FHLB”), and the use of Federal Funds markets. The Company specifically relies on dividends from the Bank and proceeds from the issuance of trust preferred securities to fund dividends to stockholders and stock repurchases.
Scheduled loan repayments are a relatively stable source of funds, while deposit inflows and unscheduled loan prepayments are not. Deposit inflows and unscheduled loan prepayments are influenced by general interest rate levels, interest rates available on other investments, competition, economic conditions, and other factors.
Deposits are the primary source of new funds. Total deposits were $2.05 billion at June 30, 2007, up from $2.01 billion at December 31, 2006.
The Company entered into an agreement with Promontory Interfinancial Network that makes it possible to offer FDIC insured deposits in excess of the current deposit limits. This Certificate of Deposit Account Registry Service (“CDARS”) uses a deposit-matching program to match CDARS deposits in other participating banks, dollar for dollar. This product is designed to enhance customer attraction and retention and increase deposits, while providing additional FDIC coverage to customers. Due to the nature of the placement of funds, CDARS deposits are defined as "brokered deposits" by regulatory agencies. The Company’s CDARS balance at June 30, 2007, was $10,000. The Bank does not currently have any additional brokered deposits.
The holding company is a separate entity from the Bank and must provide for its own liquidity. Substantially all of the holding company’s liquidity comes from dividends declared and paid by the Bank. There are statutory and regulatory provisions that could limit the ability of the Bank to pay dividends to the holding company. We believe that such restrictions will not have an adverse impact on the ability of the holding company to meet its liquidity needs which include quarterly cash dividend distributions to shareholders and debt service on the $51 million of outstanding junior subordinated debentures. In addition, the holding company receives cash from the exercise of options and the issuance of trust preferred securities. During the second quarter of 2007, Bancorp redeemed $7.5 million in trust preferred securities and issued an additional $5.0 million to take advantage of lower current rates on trust preferred securities. As of June 30, 2007, the holding company did not have any borrowing arrangements of its own. For a further discussion of the amount and terms of other issuances of pooled trust preferred securities, see Bancorp’s 2006 10-K under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operation – Liquidity and Sources of Funds,” and Note 9 in the financial statements of this report.
Management expects to continue relying on customer deposits, cash flow from investment securities, sales of "Available for Sale" securities, loan sales, loan repayments, net income, Federal Funds markets, advances from the FHLB, and other borrowings to provide liquidity. Management may also consider engaging in further offerings of trust preferred securities if the opportunity presents an attractive means of raising funds in the future. Although deposit balances at times have shown historical growth, such balances may be influenced by changes in the financial services industry, interest rates available on other investments, general economic conditions, competition, customer management of cash resources and other factors. Borrowings may be used on a short-term and long-term basis to compensate for reductions in other sources of funds. Borrowings may also be used on a long-term basis to support expanded lending activities and to match maturities, duration, or repricing intervals of assets. The sources of such funds may include, but are not limited to, Federal Funds purchased, reverse repurchase agreements and borrowings from the FHLB.
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Off-Balance Sheet Arrangements
The Company’s primary off-balance sheet arrangements consist of commitments to make loans and extend credit. The follow table summarizes the Bank’s off balance sheet commitments as of the dates displayed.
| (Dollars in thousands) | Contract or | | Contract or |
| | Notional Amount | | Notional Amount |
| | June 30, 2007 | | December 31, 2006 |
| Financial instruments whose contract amounts represent credit risk: | | | | | |
| Commitments to extend credit in the form of loans | | | | | |
| Commercial | $ | 381,141 | | $ | 379,090 |
| Real estate construction | | 267,676 | | | 291,485 |
| Real estate mortgage | | 197,672 | | | 184,571 |
| Real estate commercial | | 16,354 | | | 16,452 |
| Installment and consumer | | 20,015 | | | 19,100 |
| Other | | 49,486 | | | 58,816 |
| Standby letters of credit and financial guarantees | | 6,382 | | | 6,837 |
| Account overdraft protection instruments | | 34,318 | | | 32,714 |
| Total | $ | 973,044 | | $ | 989,065 |
The Bank’s commitments to make loans decreased slightly since December 31, 2006. Loan commitments qualify as risk weighted assets and impact our risk based capital ratios by decreasing them.
For a further discussion of off-balance sheet arrangements, see Bancorp’s 2006 10-K financials statements, Note 20, “Financial Instruments with Off-Balance Sheet Risk.”
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Critical Accounting Policies
Critical accounting policies and estimates relating to our allowance for loan losses are discussed in our 2006 10-K under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operation – Critical Accounting Policies.” That discussion highlights estimates the Company makes that involve uncertainty or potential for substantial change. There have not been any material changes in our critical accounting policies and estimates relating to our allowance for loan losses as compared to that contained in our disclosure in our 2006 10-K.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
There has not been any material change in the market risk disclosure from that contained in the Company’s 2006 10-K.
Item 4. Controls and Procedures
Our disclosure controls and procedures are designed to ensure that information the Company must disclose in its reports filed or submitted under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized, and reported on a timely basis. Our management has evaluated, with the participation and under the supervision of our chief executive officer (“CEO”) and chief financial officer (“CFO”), the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) as of the end of the period covered by this report. Based on this evaluation, our CEO and CFO have concluded that, as of such date, the Company’s disclosure controls and procedures are effective in ensuring that information relating to the Company, including its consolidated subsidiaries, required to be disclosed in reports that it files under the Exchange Act is (1) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.
No change in the Company’s internal control over financial reporting occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
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PART II: OTHER INFORMATION
Item 1. Legal Proceedings
Not applicable
Item 1A. Risk Factors
There has not been any material change in the risk factors disclosure from that contained in the Company’s 2006 10-K.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
| (c) | | The following table provides information about repurchases of common stock by the Company during the quarter ended June 30, 2007: |
| |
| | | | | | Total Number of Shares | | |
| | | | | | Purchased as Part of Publicly | | Maximum Number of Shares Remaining |
| | Total Number of Shares | | Average Price Paid | | Announced Plans or Programs | | at Period End that May Be Purchased |
| Period | Purchased (1) | | per Share | | (2) | | Under the Plans or Programs |
| 4/1/07 - 4/30/07 | 11,212 | | $ | 32.16 | | - | | 241,821 |
| 5/1/07 - 5/31/07 | 1,620 | | $ | 31.35 | | - | | 241,821 |
| 6/1/07 - 6/30/07 | 37 | | $ | 30.53 | | - | | 241,821 |
| Total for quarter | 12,869 | | | | | - | | |
| | (1) | | Shares repurchased by Bancorp during the quarter include: (a) shares repurchased pursuant to the Company’s corporate stock repurchase program publicly announced in July 2000 (the “Repurchase Program”) and described in footnote 2 below, and (b) shares repurchased from employees in connection with stock option swap exercises and cancellation of restricted stock to pay withholding taxes totaling 11,212 shares, 1,620 shares, and 37 shares, respectively, for the periods indicated. |
| |
| (2) | | Under the Repurchase Program, the board of directors originally authorized the Company to repurchase up to 330,000 common shares, which amount was increased by 550,000 shares in September 2000, by 1.0 million shares in September 2001, by 1.0 million shares in September 2002, and by 1.0 million shares in April 2004, for a total authorized repurchase amount as of June 30, 2007, of approximately 3.9 million shares. |
Item 3. Defaults Upon Senior Securities
None
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Item 4. Submission of Matters to a Vote of Security Holders
Bancorp held its Annual Meeting of Shareholders on April 24, 2007. Below is a brief description of matters considered and voted on by shareholders and the number of votes cast for, against or withheld on such matters.
| 1. | Electing nine directors to serve for one-year terms. | |
| | | | |
| | Director | | Votes for | | Votes withheld | | |
| Lloyd D. Ankeny | 13,476,215 | 190,316 | |
| Michael J. Bragg | 13,602,004 | 64,526 | |
| Duane C. McDougall | 13,579,040 | 87,490 | |
| Steven J. Oliva | 13,602,815 | 63,716 | |
| J.F. Ouderkirk | 13,581,778 | 84,752 | |
| | Steven N. Spence | 13,578,809 | 87,721 | |
| Robert D. Sznewajs | 13,578,067 | 88,463 | |
| David J. Truitt | 13,604,237 | 62,293 | |
| Nancy A. Wilgenbusch | 13,579,039 | 87,491 | |
| | | | |
| 2. | Ratification of the appointment of Deloitte & Touche LLP as our independent registered public accounting firm for 2007. |
| | | | | |
| Votes for | | Votes withheld | | | | |
| 13,443,950 | | 222,580 | | | |
Item 5. Other Information
None
Item 6. Exhibits
| | Exhibit No. | | Exhibit | |
| 31.1 | | Certification of CEO under Rule 13(a) – 14(a) of the Exchange Act. |
| 31.2 | | Certification of CFO under Rule 13(a) – 14(a) of the Exchange Act. |
| 32 | | Certification of CEO and CFO under 18 U.S.C. Section 1350. |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, this registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | WEST COAST BANCORP |
| | (Registrant) |
| |
| |
| |
| Dated: August 6, 2007 | /s/ Robert D. Sznewajs |
| | Robert D. Sznewajs |
| | Chief Executive Officer and President |
| |
| |
| |
| Dated: August 6, 2007 | /s/ Anders Giltvedt |
| | Anders Giltvedt |
| | Executive Vice President and Chief Financial Officer |
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