Average yields on earning assets decreased 146 basis points to 6.33% in the first quarter of 2008 from 7.79% in the first quarter of 2007 due primarily to decreasing interest rates and the effect of having fewer performing construction loans in our portfolio. Average interest earning assets increased $164 million, or 7%, to $2.5 billion in the first quarter of 2008 from $2.3 billion for the same period in 2007. First quarter 2008 average rates paid on interest bearing liabilities decreased 54 basis points to 3.14%, from 3.68%, from the same period in 2007, while average interest bearing liabilities increased $135 million, or 8%, to $1.9 billion. Interest earning assets have re-priced more quickly than our interest bearing liabilities in the decreasing rate environment of the first quarter, leading to additional pressure on the net interest margin.
As shown in the following table, interest reversals in the most recent quarter and interest restitution expense in the fourth quarter 2007 each had a significant effect on the net interest margin. The following table reconciles the net interest margin for the periods shown to the net interest margin excluding those effects:
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 additional pressure on our net interest income. At March 31, 2008 we remain asset sensitive, meaning that earning assets mature or reprice more quickly than interest-bearing liabilities in a given time period. For more information see the discussion under the heading "Quantitative and Qualitative Disclosures about Market Risk" in our 2007 10-K.
Loans transitioning into nonaccrual status require interest income reversals, consequently decreasing interest income. We expect the level of interest reversals associated with borrowers defaulting on two-step loans to moderate in the second and future quarters of 2008 and therefore to have less negative impact on net interest income and net interest margin. However, we anticipate construction loan balances and loan fee revenue to decline further. Additionally, the cost of holding nonperforming loans and OREO properties, lower value of noninterest bearing deposits, and further reductions in fed funds rates are projected to continue to put pressure on our net interest margin for the remainder of 2008, particularly as compared to that of 2007.
Provision for Credit Losses.Bancorp recorded provision for credit losses for the first quarters of 2008 and 2007 of $8.7 million and $2.8 million, respectively. Of the $8.7 million in provision in the current quarter, $.78 million related to the two-step loan portfolio. The increased provision for credit losses was generally consistent with the current credit cycle and was predominantly due to unfavorable risk rating changes in the residential construction loan portfolio outside the two-step program and also in the commercial portfolio. Net loan charge-offs, which are an important component of our calculation of required provision for loan losses, increased to $21.2 million from $1.4 million in the same period in 2007, caused by the significant charge-offs in the two-step loan portfolio. For more information, see section “Allowance for Credit Losses – Two-Step Loans” below.
Noninterest Income. Total noninterest income was $10.2 million for the three months ended March 31, 2008, an increase of 27% compared to $8.0 million in the first quarter of 2007. The two components which exhibited particularly solid growth were deposit service charges, which increased $.8 million, or 26%, and payment systems revenue, which grew $.5 million, or 27%. Gain on sales of loans declined 34% or $.4 million since the first quarter 2007 as a result of significantly lower residential mortgage market activity. Included in other noninterest income, we recognized a $.7 million gain from the VISA initial public offering. In addition, we realized a $.6 million gain on sales of investment securities in the most recent quarter.
Changing interest rate environments, including the shape, change in and level of the yield curve, could lead to decreases in fee income, including lower gains on sales of loans, a key component of our noninterest income. Also, increased competition, other competitive factors or regulatory changes, could adversely affect our ability to sustain fee generation from deposit service charges and payment systems related revenues or from the sales of SBA loans or investment products.
Noninterest Expense. Noninterest expense for the three months ended March 31, 2008, was $22.2 million, an increase of $1.2 million, or 6%, compared to $21.0 million for the same period in 2007. Personnel expense declined slightly in first quarter 2008 as lower performance-related pay more than offset annual merit increases, additional team members, and materially lower deferred construction loan origination costs, compared to first quarter 2007. Enhanced system and product capabilities along with new and relocated branches over the past 12 months explain the majority of the equipment and occupancy expense increase from the same quarter in 2007. The $.2 million, or 27%, increase in year over year first quarter payment system expense was largely due to significantly higher transaction volumes across our payment systems product offerings.
We expect noninterest expenses associated with two-step related foreclosures and nonperforming two-step assets to increase materially in 2008 over 2007, due to higher personnel costs, insurance and tax expenses, completion and repair costs, and other costs associated with property ownership.
An FDIC deposit insurance expense credit was applied against FDIC insurance expense during 2007; consequently, FDIC insurance expense will increase significantly in 2008.
Changing business conditions, increased costs in connection with retention of, or a failure to retain key employees, lower loan production volumes causing deferred loan origination costs to decline, or a failure to manage our operating and control environments could adversely affect our ability to limit expense growth in the future.
Income taxes.The provision for income taxes decreased in the three months ended March 31, 2008, from the same period in 2007, primarily due to a decrease in income before taxes. Bancorp’s effective tax rate for the three months ended March 31, 2008 was 29.6%, down from 34.9% for the same period in 2007. Our effective tax rate remains lower than the statutory tax rate due to our nontaxable income generated from investments in bank owned life insurance, tax-exempt municipal bonds, business energy tax credits and low income housing credits. We continue to evaluate strategies to manage our income tax expense on an on-going basis, including additional investments in tax credits or other non-taxable income.
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Balance Sheet Overview
Period end total assets were $2.6 billion as of March 31, 2008, up from $2.5 billion at March 31, 2007 and substantially unchanged since year end 2007. Period end total loans grew by 1% or $22 million since December 31, 2007, while total deposits decreased 2% or $33 million in the same period. Our balance sheet management efforts are focused on growth in targeted areas that support our corporate objectives and include:
Small business and middle market commercial lending;
Commercial, commercial real estate and construction lending;
Home equity lending; and
Core deposit production.
Over the past two years we have generated strong growth in commercial, construction, and mortgage loan categories as a result of the growth of local economies and strength in local real estate markets along with our investments in new products, branches, and most importantly, people with experience in the local markets in which we are operating. In order to fund that growth, we put an emphasis on launching depository services to satisfy the transaction needs of business customers with a need to manage their cash and deposit balances. In terms of net account growth over the past 12 months, both business non-interest bearing demand deposit and consumer interest bearing demand deposit accounts grew a solid 11%. Our success in growing and retaining low cost demand deposit balances over this past year can be attributed to the continued emphasis on our free checking products for both the business and consumer segments. Customer demand deposit balances and the attractiveness of interest bearing deposit products, such as money market and time deposit products, are influenced by the level and shape of the yield curve. This, in turn, influences whether we pursue time deposits or other funding sources on a short term basis.
We anticipate real estate construction loan balances will continue to materially contract in 2008. As a result, we anticipate little overall asset growth this year, and total loan balances may be lower at the end of 2008 compared to year end 2007. Our ability to achieve loan and deposit growth in the future will be dependent on many factors, including the effects of competition, health of the real estate market, economic conditions in our markets, availability of capital, retention of key personnel and valued customers, and our ability to close loans in the pipeline.
Investment Portfolio
The composition and carrying value of Bancorp’s investment portfolio is as follows:
| Investments available for sale (at fair value) | March 31, | | December 31, |
| (Dollars in thousands) | 2008 | | 2007 |
| Treasury securities | $ | 216 | | $ | 207 |
| U.S. Government agency securities | | 37,438 | | | 61,557 |
| Corporate securities | | 17,773 | | | 19,568 |
| Mortgage-backed securities | | 80,565 | | | 84,197 |
| Obligations of state and political subdivisions | | 85,983 | | | 86,106 |
| Equity and other securities | | 20,188 | | | 17,790 |
| Total Investment Portfolio | $ | 242,163 | | $ | 269,425 |
The investment portfolio at March 31, 2008, decreased $27 million compared to December 31, 2007. At March 31, 2008, total investment securities available for sale had a pre-tax net unrealized loss of $1 million. The decrease in our investment portfolio partly reflects loan growth that has exceeded deposit growth and investment maturities have been utilized to fund loans.
Bancorp’s investment portfolio has very limited direct 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. For additional detail, see Note 3 of our interim financial statements included under Item 1 of this report.
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Loan Portfolio
The composition of Bancorp’s loan portfolio as of March 31, 2008, as compared to December 31, 2007 is as follows:
| (Dollars in thousands) | March 31, 2008 | | December 31, 2007 |
| | Amount | | Percent | | Amount | | Percent |
| Commercial | $ | 529,519 | | | 24.1% | | $ | 504,101 | | | 23.2% |
| Real estate construction | | 464,028 | | | 21.1% | | | 517,988 | | | 23.8% |
| Real estate mortgage | | 356,185 | | | 16.2% | | | 330,803 | | | 15.2% |
| Commercial real estate | | 819,586 | | | 37.5% | | | 796,622 | | | 36.7% |
| Installment and other consumer | | 24,993 | | | 1.1% | | | 23,155 | | | 1.1% |
| Total loans | | 2,194,311 | | | 100% | | | 2,172,669 | | | 100% |
| Allowance for loan losses | | (39,602 | ) | | 1.80% | | | (46,917 | ) | | 2.16% |
| Total loans, net | $ | 2,154,709 | | | | | $ | 2,125,752 | | | |
The Company’s loan portfolio was $2.2 billion at March 31, 2008, an increase of $174 million, or 9%, from March 31, 2007, and an increase of $22 million from year end 2007. Solid growth in commercial, real estate mortgage and commercial real estate since December 31, 2007 offset the $54 million or 10% decline in construction loans caused by the $52 million decline in the two-step loan portfolio over the same period. A sustained slow rate of home sales and an elevated housing inventory level, or negative impacts from worsening economic conditions could hinder our efforts to grow our loan portfolio for the remainder of 2008. Interest and fees earned on our loan portfolio is our primary source of revenue, and a decline in loan originations will not only have a negative impact on loan balances but also, interest income and loan fees earned from loans.
As of March 31, 2008, 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 March 31, 2008, and December 31, 2007, Bancorp had no bankers’ acceptances. As a result of discontinuing the two-step loan program and the rapid increase in the inventory of residential homes for sale within our markets, we expect real estate construction loan balances to decrease materially in the coming year. See “Two-Step Loan Portfolio” below.
Below is a discussion of our loan portfolio by category.
Commercial.The Commercial loan portfolio grew 10% or $47 million over the past year. Increased draws on commercial lines of credit supported the 5% growth in this portfolio since year end 2007. We believe we have been successful in growing our commercial portfolio over the past few years as a result of strong, experienced commercial lending teams throughout our market areas. In addition, over the past several years developments in our treasury management product line, including the introduction of our iDeposit and Re$ubmitIt products, we have enhanced our ability to attract and retain commercial core deposit and lending relationships. We also believe that our expanding branch network continues to be an important point of service contact for not only our retail customers but also our commercial relationships.
In making commercial loans, our underwriting standards may include maximum loan to value ratios, target levels for debt service coverage, and other financial covenants specific to the loan and the borrower. Common forms of collateral pledged to secure our commercial loans are real estate, accounts receivable, inventory, equipment, agricultural crops and/or livestock, and marketable securities. Commercial loans typically have maximum terms of one to ten years and loan to value ratios in the range of 50% to 80%.
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Real Estate Construction. The composition of real estate construction loans by type of project as of March 31, 2008, and December 31, 2007, is as follows:
| | March 31, 2008 | | December 31, 2007 | | Change |
| (Dollars in thousands) | Amount | | Percent | | Amount | | Percent | | Amount | | Percent |
| Commercial construction | $ | 94,878 | | | 20% | | $ | 90,670 | | | 17% | | $ | 4,208 | | | 5% |
| Two-step residential construction to individuals | | 211,406 | | | 46% | | | 262,952 | | | 51% | | | (51,546 | ) | | -20% |
| Residential construction to builder | | 82,243 | | | 18% | | | 80,737 | | | 16% | | | 1,506 | | | 2% |
| Residential subdivision or site development | | 76,322 | | | 16% | | | 84,620 | | | 16% | | | (8,298 | ) | | -10% |
| Net deferred fees | | (821 | ) | | 0% | | | (991 | ) | | 0% | | | 170 | | | -17% |
| Total real estate construction loans | $ | 464,028 | | | 100% | | $ | 517,988 | | | 100% | | $ | (53,960 | ) | | -10% |
Real estate construction loans represented 21% of the loan portfolio at the end of the first quarter, compared to 24% at December 31, 2007, and we expect this percentage to continue to decline materially in 2008. Real estate construction loans to builders and developers are secured by the underlying property financed. Construction loans typically have terms from 12 to 24 months. Most real estate construction loans have loan to value ratios in the range of 75% to 85%. Given the excess inventory of residential homes in our market currently, we are limiting the origination of new residential construction loans to specific sectors with less risk, for example construction loans for pre-sold homes to well qualified borrowers. For the same reason, we are also seeing a decrease in the demand for residential construction loans in the market place. Additionally, we are not currently pursuing acquisition of new builder clients for single family residential financing, nor are we financing the development of residential lots at this time.
At March 31, 2008, real estate construction loans were $464 million, up $24 million or 5% compared to $440 million at March 31, 2007, but down $54 million or 10% from $518 million at December 31, 2007 due to the decline in the two-step loan portfolio. The real estate construction loan category expanded rapidly in recent years, reflecting the high levels of construction activity in the markets in which we operated until late 2007. We expect these balances to continue to decline throughout 2008, removing an important source of loan revenues and earnings growth in prior periods.
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Real Estate Mortgage. The following table presents the components of our real estate mortgage loan portfolio.
| | March 31, 2008 | | December 31, 2007 | | Change |
| (Dollars in thousands) | Amount | | Percent | | Amount | | Percent | | Amount | | Percent |
| Standard mortgage | $ | 87,621 | | 25% | | $ | 86,901 | | 26% | | $ | 720 | | 1% |
| Nonstandard mortgage product | | 25,107 | | 7% | | | 7,495 | | 2% | | | 17,612 | | 235% |
| Home equity loans and lines of credit | | 243,457 | | 68% | | | 236,407 | | 72% | | | 7,050 | | 3% |
| Total real estate mortgage | $ | 356,185 | | 100% | | $ | 330,803 | | 100% | | $ | 25,382 | | 8% |
At March 31, 2008, real estate mortgage loan balances were $356 million or approximately 16% of the Company’s total loan portfolio. Home equity loans and lines represented about 68% or $243 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. As of March 31, 2008, 37% 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 ratio of less than 85%, and the average FICO credit score for originations since January 1, 2005, was approximately 748.
The following table presents home equity lines of credit by region at March 31, 2008.
(Dollars in thousands)
| | March 31, |
| Region | 2008 |
| Portland, Oregon / Vancouver, Washington | $ | 104,201 |
| Western Washington (Olympia, Seattle) | | 32,705 |
| Central Oregon (Bend, Redmond) | | 7,361 |
| Oregon Coast (Newport, Lincoln City) | | 21,454 |
| Willamette Valley (Salem, Eugene) | | 77,605 |
| Southern Oregon (Medford, Roseburg) | | 131 |
| Total home equity loans and lines of credit | $ | 243,457 |
We have developed a set of mortgage loan products to provide bridge financing or permanent mortgage loans, collectively called nonstandard mortgages, to qualified borrowers with maturing two-step loans. This product is designed to assist two-step borrowers in their transition from a construction loan to permanent financing. Financing terms are generally more flexible than our standard products; however, in all cases, each loan request is considered based on a thorough review of the borrower’s repayment capacity. Under certain circumstances, we may consider discounting debt in order to restructure the loan to fit the borrower’s debt service capacity. As of March 31, 2008, there were 68 loans in the nonstandard real estate mortgage program, with an outstanding loan balance of $25 million and a related loan loss reserve of $1.8 million.
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Commercial Real Estate.The composition of commercial real estate loan types based on collateral is as follows:
| (Dollars in thousands, rounded) | March 31, 2008 | | December 31, 2007 |
| | Amount | | Percent | | Amount | | Percent |
| Office Buildings | $ | 188,200 | | 23.0% | | $ | 179,000 | | 22.5% |
| Retail Facilities | | 108,700 | | 13.2% | | | 110,100 | | 13.8% |
| Multi-Family - 5+ Residential | | 59,100 | | 7.2% | | | 61,600 | | 7.7% |
| Medical Offices | | 60,900 | | 7.4% | | | 51,400 | | 6.5% |
| Hotels/Motels | | 35,700 | | 4.4% | | | 42,100 | | 5.3% |
| Commercial/Agricultural | | 54,000 | | 6.6% | | | 54,400 | | 6.8% |
| Industrial parks and related | | 51,400 | | 6.3% | | | 48,800 | | 6.1% |
| Manufacturing Plants | | 36,900 | | 4.5% | | | 39,200 | | 4.9% |
| Assisted Living | | 12,300 | | 1.5% | | | 12,400 | | 1.6% |
| Land Development and Raw Land | | 27,900 | | 3.4% | | | 25,000 | | 3.1% |
| Food Establishments | | 18,300 | | 2.2% | | | 18,300 | | 2.3% |
| Mini Storage | | 19,000 | | 2.3% | | | 17,000 | | 2.1% |
| Other | | 147,200 | | 18.0% | | | 137,300 | | 17.3% |
| Total commercial real estate loans | $ | 819,600 | | 100% | | $ | 796,600 | | 100% |
The commercial real estate portfolio balance increased $23 million or 3% from December 31, 2007 to March 31, 2008 with, as shown below, the growth coming in the non-owner occupied segment which accounts for 53% of the total commercial real estate loans as of March 31, 2008. Office buildings, retail facilities, and multi-family residential categories account for nearly half of the collateral securing our $820 million commercial real estate portfolio. We believe Bancorp’s underwriting of commercial real estate loans is consistent with the industry with loan to value ratios generally not exceeding 75% and debt service coverage ratios generally at 120% or better.
The composition of the commercial real estate loan portfolio by occupancy type is as follows:
| | March 31, 2008 | | December 31, 2008 | | Change |
| (Dollars in thousands) | Amount | | Percent | | Amount | | Percent | | Amount | | Percent |
| Owner occupied | $ | 381,567 | | 47% | | $ | 382,387 | | 48% | | $ | (820 | ) | | 0% |
| Non-owner occupied | | 438,019 | | 53% | | | 414,235 | | 52% | | | 23,784 | | | 6% |
| Total commercial real estate loans | $ | 819,586 | | 100% | | $ | 796,622 | | 100% | | $ | 22,964 | | | 3% |
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Credit Management
Credit risk is inherent in our lending activities. We manage the general risks inherent in the loan portfolio by following loan policies and underwriting practices designed to result in prudent lending activities. We have established minimum underwriting standards that outline our expectations for financial reporting, global cash flow, and guarantor support. In addition, we manage credit risk through our credit administration and credit review functions that are designed to help ensure compliance with our credit standards. Through the credit review function we monitor all credit related policies and practices on a post approval basis. The findings of these reviews are communicated to the chief credit officer and chief executive officer and the Loan, Investment, and Asset Liability Committee, which is made up of certain directors.
Credit risk in the loan portfolio can be amplified by concentrations. Loan concentrations may exist when there are amounts loaned to borrowers engaged in similar activities or similar types of loans extended to a diverse group of borrowers that would cause them to be similarly affected by economic or other conditions. We manage our concentration risk on an ongoing basis by establishing concentration limits by portfolio, portfolio segment and, when appropriate, for individual borrowers.
Our concentration in residential construction, consisting of developers and builders, represents a portfolio we consider higher risk. The current downturn in residential real estate has slowed lot and home sales within our markets and has resulted in lengthening the marketing period for completed homes and negatively affected borrower liquidity and collateral values. Accordingly, we have been reducing our exposure in residential construction by curtailing new originations. We have also increased the frequency of stress testing for individual developers and builders. Our stress testing focuses on examining the range of project performance relative to cash flow and collateral value under different assumptions for interest rates, absorption, and unit sales prices. This heightened level of monitoring assists the Bank in identifying potential problem loans and developing timely action plans, which may include requiring borrowers to replenish interest reserves, making principal curtailments, or transferring the borrowing relationship to our special assets team. In our experience, the downturn in the housing industry has also increased the risk profile of related commercial borrowers. We expect a number of commercial businesses in the supply chain of products and/or services used by the housing industry to face declining revenue and cash flow, i.e. wood products, contractors, wholesale suppliers, and certain product specialized nurseries. In turn, we are monitoring the financial condition of existing borrowers within these segments.
As part of our ongoing lending process, internal risk ratings are assigned to each commercial, commercial real estate and commercial real estate construction loan before the funds are advanced to the customer. Our risk ratings are an important component in determining our allowance for credit losses. Credit risk ratings are based on our assessment of the borrower’s credit worthiness and the quality of our collateral position at the time a particular loan is made. Thereafter, credit risk ratings are evaluated on an ongoing basis focusing on our interpretation of relevant risk factors known to us at the time of each evaluation. Large balance loans have the credit risk rating reviewed on at least an annual basis. Our Reserve Adequacy Committee (“RAC”) also provides oversight in reviewing adversely risk rated loans, loans evaluated for impairment, and large balance loans that can have a important impact on the Bank’s provision requirements should future circumstances cause a downgrade. The RAC committee meets at least quarterly.
Credit files are also examined periodically on a sample test basis by our credit review department and internal auditors, as well as by regulatory examiners. Our relationship managers are also responsible for evaluating the ongoing financial condition of each borrower in their respective portfolio of loans. These activities include, but are not limited to, maintaining open communication channels with borrowers, analyzing periodic financial statements and cash flow projections, evaluating collateral, and monitoring covenant compliance.
Although a risk of nonpayment exists with respect to all loans, certain specific types of risks are associated with different types of loans. The expected source of repayment of Bancorp’s loans is generally the cash flow of a particular project, income from the borrower's business, proceeds from the sale of real property, proceeds of refinancing, or personal income. As a result of the nature of our customer base and the growth experienced in the market areas we serve, real estate is frequently a material component of collateral for the Company’s loans. Risks associated with loans secured by real estate include decreasing land and property values, material increases in interest rates, deterioration in local economic conditions, changes in tax policies, tightening credit or refinancing markets, and a concentration of loans within any one area. See “Risk Factors” in Item 1A of this report.
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Nonperforming Assets and Delinquencies
Nonperforming Assets. Nonperforming assets consist of nonaccrual loans, loans past due more than 90 days and still accruing, and OREO. The following table presents information with respect to nonaccrual loans by category and OREO for the periods presented.
| (Dollars in thousands) | March 31, 2008 | | December 31, 2007 |
| Loans on nonaccrual status: | | | | | | | |
| Commercial | $ | 4,336 | | | $ | 2,401 | |
| Real estate construction | | 91,630 | | | | 22,121 | |
| Real estate mortgage: | | | | | | | |
| Standard mortgage | | 936 | | | | 552 | |
| Nonstandard mortgage product | | 295 | | | | - | |
| Home equity lines of credit | | 274 | | | | - | |
| Total real estate mortgage | | 1,505 | | | | 552 | |
| Commercial real estate | | 1,565 | | | | 1,353 | |
| Installment and consumer | | 2 | | | | - | |
| Total nonaccrual loans | | 99,038 | | | | 26,427 | |
| Other real estate owned | | 5,688 | | | | 3,255 | |
| Total nonperforming assets | $ | 104,726 | | | $ | 29,682 | |
| |
| Nonperforming loans to total loans | | 4.51 | % | | | 1.22 | % |
| Nonperforming assets to total assets | | 4.00 | % | | | 1.12 | % |
At March 31, 2008, total nonperforming assets were $104.7 million, or 4.00%, of total assets, compared to $29.7 million or 1.12% at December 31, 2007, and $3.8 million or 0.15% at March 31, 2007. The two-step loan portfolio accounted for $94.5 million or 90% of total nonperforming assets. For additional information, see “Nonperforming Assets and Delinquencies – Two-Step Loans” below. The amount and level of nonaccrual loans depends on portfolio growth, portfolio seasoning, problem loan recognition and resolution through collections, sales or charge-offs. The performance of any one loan can be affected by external factors, such as economic or market conditions, or factors particular to a borrower, such as actions of a borrower’s management or conditions affecting a borrower’s business.
OREO is real property of which the Bank has taken possession or that has been deeded to the Bank through a deed-in-lieu of foreclosure, non-judicial foreclosure, judicial foreclosure or similar process in partial or full satisfaction of a loan or loans. The Company had 24 OREO properties at March 31, 2008, with a total net book value of $5.7 million. All but one of these properties, which had zero book value, was attributable to the two-step loan portfolio. OREO is recorded at the lower of the carrying amount of the loan or fair value less estimated costs to sell. Management utilizes appraisal valuations and judgment in its assessment of fair market value and estimated selling costs. This amount becomes the property’s book value at the time it is taken into OREO. Any write-downs based on our determination of fair market value less estimated cost to sell at the date a particular property is acquired are charged to the allowance for loan losses. Management then periodically reviews OREO to determine whether the property continues to be carried at the lower of its recorded book value or fair value, net of estimated costs to sell. Any further write-downs of OREO properties or gains on the sale of OREO are recorded to other noninterest expense. Expenses from the maintenance and operations of OREO properties are included in other noninterest expense in the statements of income. While OREO operational expense was minimal in 2007 and relatively minor in the first quarter of 2008, we expect this expense to increase significantly in the second quarter of 2008 and in future periods as a result of the projected increase in the number of OREO properties.
The following table presents activity in the OREO portfolio for the periods shown.
| | | | OREO activity | | |
| | Three months ended | | Three months ended | | Twelve months ended |
| | March 31, | | March 31, | | December 31, |
| (Dollars in thousands, unaudited) | 2008 | | 2007 | | 2007 |
| Beginning balance | $ | 3,255 | | | $ | - | | | $ | - | |
| Additions to OREO including capitalized costs | | 2,707 | | | | 340 | | | | 3,786 | |
| Disposition of OREO | | (274 | ) | | | (340 | ) | | | (531 | ) |
| Ending balance | $ | 5,688 | | | $ | - | | | $ | 3,255 | |
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Delinquencies.The following table summarizes delinquency loan balances by type of loan for the periods shown:
| (Dollars in thousands) | March 31, 2008 | | December 31, 2007 |
| Loans on nonaccrual status: | | | | | | | |
| Commercial | $ | 2,485 | | | $ | 6,086 | |
| Real estate construction | | 18,826 | | | | 36,941 | |
| Real estate mortgage: | | | | | | | |
| Standard mortgage | | 3,035 | | | | 486 | |
| Nonstandard mortgage product | | 1,996 | | | | - | |
| Home equity lines of credit | | 52 | | | | 45 | |
| Total real estate mortgage | | 5,083 | | | | 531 | |
| Commercial real estate | | 604 | | | | 792 | |
| Installment and consumer | | 97 | | | | 134 | |
| Total loans 30-89 days past due, not in nonaccrual status | $ | 27,095 | | | $ | 44,484 | |
| |
| Delinquent loans past due 30-89 days to total loans | | 1.23 | % | | | 2.05 | % |
Bancorp also monitors delinquencies, defined as balances over 30-89 days past due, not in nonaccrual status, as an important indicator for future nonperforming assets. Total delinquencies were 1.23% of total loans at March 31, 2008, down from 2.05% at December 31, 2007, primarily as a result of a shift of a large amount of loans from delinquent to nonaccrual status in first quarter 2008. For further discussion, see section “Nonperforming Assets and Delinquencies – Two-Step Loans” below. Delinquencies in the real estate construction category decreased materially from $36.9 million at December 31, 2007, to $18.8 million at March 31, 2008. All other categories of delinquencies also declined since year end 2007. The significant reduction in real estate construction delinquencies is primarily related to the effect of changes in our loan practices and policies, as applied to the two-step loan portfolio that led to the shift of a large amount of loans from delinquent to nonaccrual status. Accordingly, the reduction in delinquencies in the two-step loan portfolio did not reflect an improvement in credit quality. The majority of loans that became delinquent since year end were associated with the residential construction portfolio, and specifically, the two-step loan portfolio.
Allowance for Credit Losses and Net Loan Charge-offs
Allowance for Credit Losses.An allowance for credit losses has been established based on management’s best estimate, as of the balance sheet date, of probable losses inherent in the loan portfolio. Please see the Company’s 2007 10-K under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Allowance for Credit Losses and Net Loan Charge-offs” for a discussion of Bancorp’s methodologies underlying the calculation of the Company’s allowance for credit losses.
Our allowance incorporates the results of measuring impaired loans as provided in Statement of Financial Accounting Standards (“SFAS”) No. 114, “Accounting by Creditors for Impairment of a Loan,” and SFAS No. 118, “Accounting by Creditors for Impairment of a Loan – Income Recognition and Disclosures.” These accounting standards prescribe the measurement, income recognition and guidelines concerning impaired loans. For example, impairments associated with collateral dependent loans are charged-off promptly, rather than placed in specific reserves. In addition, net overdraft losses are included in the calculation of the allowance for credit losses per the guidance provided by regulatory authorities early in 2005, “Joint Guidance on Overdraft Protection Programs.”
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The Company maintains its allowance for credit losses by charging a provision for credit losses against income in periods in which management believes additional allowance is appropriate to accommodate its estimate of losses in the loan portfolio. The evaluation of the adequacy of specific and general valuation allowances is an ongoing process. This process includes analysis of information derived from many sources: historical loss trends, portfolio risk rating migrations, delinquency and nonaccrual loan growth, portfolio diversification, current and anticipated economic conditions, the effectiveness of loan policies and collection practices, expertise of credit personnel, regulatory guidance and other factors.
Changes in the allowance for credit losses for year to date March 31, 2008, and full year ended December 31, 2007, are presented in the following table.
| | Three months ended | | Year ended |
| (Dollars in thousands) | March 31, 2008 | | December 31, 2007 |
| Loans outstanding at end of period | $ | 2,194,311 | | | $ | 2,172,669 | |
| Average loans outstanding during the period | | 2,176,935 | | | | 2,094,977 | |
| |
| Allowance for credit losses, beginning of period | | 54,903 | | | | 23,017 | |
| Loan charge-offs: | | | | | | | |
| Commercial | | (623 | ) | | | (3,798 | ) |
| Real estate construction | | (20,394 | ) | | | (2,540 | ) |
| Real estate mortgage | | - | | | | (71 | ) |
| Commercial real estate | | - | | | | - | |
| Installment and consumer | | (74 | ) | | | (254 | ) |
| Overdraft | | (302 | ) | | | (1,050 | ) |
| Total loan charge-offs | | (21,393 | ) | | | (7,713 | ) |
| Recoveries: | | | | | | | |
| Commercial | | 32 | | | | 269 | |
| Real estate construction | | 66 | | | | 7 | |
| Real estate mortgage | | 27 | | | | 33 | |
| Commercial real estate | | - | | | | 2 | |
| Installment and consumer | | 26 | | | | 112 | |
| Overdraft | | 68 | | | | 220 | |
| Total recoveries | | 219 | | | | 643 | |
| Net loan charge-offs | | (21,174 | ) | | | (7,070 | ) |
| Provision for credit losses | | 8,725 | | | | 38,956 | |
| Allowance for credit losses, end of period | $ | 42,454 | | | $ | 54,903 | |
| |
| Components of allowance for credit losses | | | | | | | |
| Allowance for loan losses | $ | 39,602 | | | $ | 46,917 | |
| Reserve for unfunded commitments | | 2,852 | | | | 7,986 | |
| Total allowance for credit losses | $ | 42,454 | | | $ | 54,903 | |
| |
| Net loan charge-offs to average loans annualized | | 3.91 | % | | | 0.34 | % |
| |
| Allowance for loan losses to total loans | | 1.80 | % | | | 2.16 | % |
| Allowance for credit losses to total loans | | 1.93 | % | | | 2.53 | % |
At March 31, 2008, the Company’s allowance for credit losses was $42.5 million, consisting of a $37.4 million formula allowance, a $.8 million specific allowance, a $1.4 million unallocated allowance and a $2.9 million reserve for unfunded commitments. At December 31, 2007, our allowance for credit losses was $54.9 million, consisting of a $41.4 million formula allowance, a $3.6 million specific allowance, a $1.9 million unallocated allowance and an $8.0 million reserve for unfunded commitments.
Changes in the allocation of the allowance for loan losses in the first three months of 2008 were due primarily to changes in the risk ratings and delinquencies of our loans, as well as loan charge-offs and recovery activities. Also, a large portion of the current provision relates to construction loans, which have a higher inherent risk profile and are therefore allocated a higher allowance for credit losses relative to other loan categories in the portfolio.
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At March 31, 2008, Bancorp’s allowance for loan losses was 1.80% of total loans and 40% of total nonperforming loans, compared with an allowance for loan losses at December 31, 2007, of 2.16% of total loans, and 178% of total nonperforming loans, respectively.
Overall, we believe that the allowance for credit losses is adequate to absorb losses in the loan portfolio at March 31, 2008, although there can be no assurance that future loan losses will not exceed our current estimates. The process for determining the adequacy of the allowance for credit losses is critical to our financial results. It requires difficult, subjective and complex judgments as a result of the need to make estimates about the effect of matters that are uncertain. Therefore, we cannot provide assurance that, in any particular period, we will not have sizeable credit losses in relation to the amount reserved. We may later need to significantly adjust the allowance for credit losses considering factors in existence at such time, including economic, market, or business conditions and the results of ongoing internal and external examination processes. Please see risk factors under Part II, Item 1A “Risk Factors” in this report and in our 2007 10-K.
Net Loan Charge-offs. For the three months ended March 31, 2008, total net loan charge-offs were $21.2 million compared to $7.1 million for the year ended December 31, 2007. The annualized net loan charge-offs to total average loans outstanding were 3.91% for March 31, 2008, up from .65% at December 31, 2007. See “Two-step Loan Portfolio” below for more information. Loan losses for the first quarter in 2008 also include approximately $.3 million in losses that are related to collateral dependent impaired loans which were charged-off against their respective specific reserve.
Additional Loan Portfolio Disclosure
We are providing additional information below regarding nonperforming assets and the allowance for credit losses that distinguishes loans other than two-step loans from those in our two-step loan portfolio. Management is providing this information to aid in the readers’ understanding of the impact of the two-step loan portfolio on our entire loan portfolio.
The first section includes additional information regarding loans in our loan portfolio other than two-step loans. The second section includes information solely relating to loans in our two-step loan portfolio. For information regarding our total loan portfolio, please see the preceding section.
Loans Other Than Two-Step Loans.The following table shows our total loan portfolio by category, as well as the breakout of the two-step loan portfolio from our other real estate construction loans.
| (Dollars in thousands) | March 31, | | December 31, |
| | 2008 | | 2007 | | 2006 |
| Commercial loans | $ | 529,519 | | $ | 504,101 | | $ | 463,188 |
| Real estate construction loans1 | | 464,028 | | | 517,988 | | | 365,954 |
| Real estate mortgage loans: | | | | | | | | |
| Standard mortgage | | 87,621 | | | 86,901 | | | 71,189 |
| Nonstandard mortgage | | 25,107 | | | 7,495 | | | - |
| Home equity line of credit | | 243,457 | | | 236,407 | | | 216,306 |
| Total real estate mortgage loans | | 356,185 | | | 330,803 | | | 287,495 |
| Commercial real estate loans | | 819,586 | | | 796,622 | | | 804,865 |
| Installment and other consumer loans | | 24,993 | | | 23,155 | | | 26,188 |
| Total loans | $ | 2,194,311 | | $ | 2,172,669 | | $ | 1,947,690 |
| |
| 1Two-step loans | $ | 211,406 | | $ | 262,952 | | $ | 171,692 |
| All other construction loans | | 252,622 | | | 255,036 | | | 194,262 |
| Total real estate construction loans | $ | 464,028 | | $ | 517,988 | | $ | 365,954 |
| |
| Two-step loans | $ | 211,406 | | $ | 262,952 | | $ | 171,692 |
| Total loans other than two-step loans | | 1,982,905 | | | 1,909,717 | | | 1,775,998 |
| Total loans | $ | 2,194,311 | | $ | 2,172,669 | | $ | 1,947,690 |
As shown above, loans other than two-step loans were $1.98 billion at March 31, 2008, up $73 million, or 4%, from December 31, 2007.
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Nonperforming Assets and Delinquencies – Loans Other Than Two-Step Loans
Nonperforming assets - Loans Other Than Two-Step Loans.The following table presents information about nonperforming assets and delinquencies relating to loans other than two-step loans at the dates shown.
| | March 31, | | December 31, |
| (Dollars in thousands) | 2008 | | 2007 | | 2006 |
| Commercial loans | $ | 4,336 | | | $ | 2,401 | | | $ | 385 | |
| Real estate construction loans | | 2,846 | | | | 1,576 | | | | - | |
| Real estate mortgage loans: | | | | | | | | | | | |
| Standard mortgage | | 936 | | | | 552 | | | | - | |
| Nonstandard mortgage | | 295 | | | | - | | | | - | |
| Home equity line of credit | | 274 | | | | - | | | | - | |
| Total real estate mortgage loans | | 1,505 | | | | 552 | | | | - | |
| Commercial real estate loans | | 1,565 | | | | 1,353 | | | | 516 | |
| Installment and other consumer loans | | 2 | | | | - | | | | - | |
| Total nonaccrual loans | | 10,254 | | | | 5,882 | | | | 901 | |
| 90 day past due and accruing interest | | - | | | | - | | | | - | |
| Total nonperforming loans other than two-step loans | | 10,254 | | | | 5,882 | | | | 901 | |
| |
| Other real estate owned other than two-step loans | | - | | | | - | | | | - | |
| Total nonperforming assets other than two-step loans | $ | 10,254 | | | $ | 5,882 | | | $ | 901 | |
| |
| Delinquent other than two-step loans 30-89 days past due | $ | 12,826 | | | $ | 7,706 | | | $ | 6,953 | |
| |
| Nonperforming loans other than two-step loans to total loans other than two-step loans | | 0.52 | % | | | 0.31 | % | | | 0.05 | % |
| Nonperforming assets other than two-step assets to total assets | | 0.39 | % | | | 0.22 | % | | | 0.04 | % |
| Allowance for loan losses other than two-step loan losses to nonperforming loans other than two-step loans | | 289 | % | | | 391 | % | | | 2264 | % |
| Delinquent loans other than two-step loans to total loans other than two-step loans | | 0.65 | % | | | 0.40 | % | | | 0.39 | % |
Nonperforming loans other than two-step loans increased from $5.9 million at year end 2007 to $10.3 million or ..52% of total loans other than two-step loans at March 31, 2008. The increase in nonperforming assets in this portfolio was due to higher levels of nonaccrual loans. Commercial and industrial loans represented $1.9 million of the $4.4 million increase in nonaccrual loans, followed by growth in construction and development nonaccrual loans of $1.3 million.
Delinquencies - Loans Other Than Two-Step Loans. Delinquencies in the other than two-step loan portfolio, defined as loans 30 to 89 days past due, increased to 65basis points at March 31, 2008, compared to 40 basis points at December 31, 2007.
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Allowance for Credit Losses and Net Loan Charge-offs – Loans Other Than Two-Step Loans
Allowance for Credit Losses - Loans Other Than Two-Step Loans. The following table presents information with respect to the change in our allowance for credit losses relating to loans other than two-step loans.
| | Quarter ended | | Year ended |
| (Dollars in thousands) | March 31, | | December 31, |
| | 2008 | | 2007 | | 2006 |
| Allowance for credit losses other than two-step loans, beginning of period | $ | 23,838 | | | $ | 20,399 | | | $ | 19,303 | |
| Provision for credit losses other than two-step loans | | 7,945 | | | | 7,976 | | | | 1,281 | |
| |
| Charge-offs other than two-step loans | | | | | | | | | | | |
| Loan charge-offs: | | | | | | | | | | | |
| Commercial | | (623 | ) | | | (3,798 | ) | | | (831 | ) |
| Real estate construction | | (295 | ) | | | - | | | | (48 | ) |
| Real estate mortgage | | - | | | | (71 | ) | | | - | |
| Installment and consumer | | (74 | ) | | | (254 | ) | | | (130 | ) |
| Overdraft | | (302 | ) | | | (1,050 | ) | | | (912 | ) |
| Total loan charge-offs other than two-step loans | | (1,294 | ) | | | (5,173 | ) | | | (1,921 | ) |
| Recoveries: | | | | | | | | | | | |
| Commercial | | 32 | | | | 269 | | | | 501 | |
| Real estate construction | | - | | | | - | | | | 40 | |
| Real estate mortgage | | 27 | | | | 33 | | | | - | |
| Commercial real estate | | - | | | | 2 | | | | - | |
| Installment and consumer | | 26 | | | | 112 | | | | | |
| Overdraft | | 68 | | | | 220 | | | | 233 | |
| Total recoveries other than two-step loans | | 153 | | | | 636 | | | | 774 | |
| Net loan charge-offs other than two-step loans | | (1,141 | ) | | | (4,537 | ) | | | (1,147 | ) |
| |
| Allowance for credit losses, from acquisition | | - | | | | - | | | | 887 | |
| | | | | | | | | | | | |
| Total allowance for credit losses other than two-step loans | $ | 30,642 | | | $ | 23,838 | | | $ | 20,324 | |
| |
| Components of allowance for credit losses other than two-step loans | | | | | | | | | | | |
| Allowance for loan losses other than two-step loans | $ | 29,611 | | | $ | 23,000 | | | $ | 20,324 | |
| Reserve for unfunded commitments other than two-step loans | | 1,031 | | | | 838 | | | | - | |
| Total allowance for credit losses other than two-step loans | $ | 30,642 | | | $ | 23,838 | | | $ | 20,324 | |
| |
| Net loan charge-offs to average loans other than two-step loans annualized | | 0.21 | % | | | 0.22 | % | | | 0.06 | % |
| Allowance for other than two-step loan losses to total other than two-step loans | | 1.49 | % | | | 1.20 | % | | | 1.15 | % |
| Allowance for other than two-step credit losses to total other than two-step loans | | 1.55 | % | | | 1.25 | % | | | 1.15 | % |
The allowance for credit losses for loans other than two-step loans at March 31, 2008 was $30.7 million, up from $23.8 million at December 31, 2007. The largest driver of the higher allowance for credit losses, and thus an increased provision for credit losses for loans other than two-step, was primarily risk rating migration. The risk rating migration largely consisted of commercial loans and residential construction loans to builders being moved to higher risk rating categories. At March 31, 2008, the allowance for credit losses for loans other than two-step loans totaling $30.7 million consisted of a $27.4 million formula allowance, a $.8 million specific allowance, a $1.4 million unallocated allowance, and a $1.1 million reserve for unfunded commitments. At December 31, 2007, the total allowance for credit losses for loans other than two-step loans of $23.8 million consisted of a $20.3 million formula allowance, a $.7 million specific allowance, a $1.9 million unallocated allowance, and a $.9 million reserve for unfunded commitments.
Net Loan Charge-offs – Loans Other Than Two-Step Loans.The net loan charge-offs in the first quarter 2008 for loans other than two-step were $1.1 million, and largely attributable to losses related to commercial and construction loans and overdrafts, compared to $1.4 million in the same quarter ended March 31, 2007. The annualized net loan charge-offs for loans other than two-step loans was .21%, similar to the .22% for the entire year ended December 31, 2007. Net overdraft losses were $.2 million in first quarter 2008 compared to $.1 million for the same period in 2007.
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Two-Step Loan Portfolio
Our two-step loan program, which involved loans to individual borrowers to finance construction of residential properties, began in the first quarter 2002, but activity in the two-step loan portfolio accelerated significantly beginning in the first quarter of 2005. The program was referred to as the “two-step” loan program because each project involved two steps; initial construction financing that was provided by the Bank and secondary, or take-out, financing that was intended to be provided by third parties. The program was discontinued on October 19, 2007.
The following table presents two-step loan originations by quarter for the past two years:
| (Dollars in thousands) | Two-step residential |
| | construction loan |
| Period ended | originations |
| First quarter 2006 | $ | 49,443 |
| Second quarter 2006 | | 60,553 |
| Third quarter 2006 | | 92,867 |
| Fourth quarter 2006 | | 94,751 |
| Total 2006 | $ | 297,614 |
| |
| First quarter 2007 | $ | 115,715 |
| Second quarter 2007 | | 76,969 |
| Third quarter 2007 | | 45,646 |
| Fourth quarter 2007 | | 14,386 |
| Total 2007 | $ | 252,716 |
The combination of tighter underwriting criteria implemented in the second and third quarters of 2007 and a softer residential housing market slowed origination volumes within the two-step loan program in the second and third quarters of 2007. The continued sharp decline in the fourth quarter of 2007 reflects the impact of discontinuing the two-step loan program.
The following table presents two-step loan balance, unused commitment and total commitment detail as of the end of each period presented:
| (Dollars in thousands) | | | | | Two-step total |
| | Two-step | | Two-step loan | | commitments (loan balance |
| Period ended | loan balance | | unused commitments | | plus unused commitments) |
| First quarter 2006 | $ | 85,129 | | $ | 66,914 | | $ | 152,043 |
| Second quarter 2006 | | 111,256 | | | 77,846 | | | 189,102 |
| Third quarter 2006 | | 138,939 | | | 105,246 | | | 244,185 |
| Fourth quarter 2006 | | 171,692 | | | 132,732 | | | 304,424 |
| First quarter 2007 | | 216,371 | | | 160,918 | | | 377,289 |
| Second quarter 2007 | | 256,332 | | | 149,902 | | | 406,234 |
| Third quarter 2007 | | 274,747 | | | 123,447 | | | 398,194 |
| Fourth quarter 2007 | | 262,952 | | | 78,585 | | | 341,537 |
| First quarter 2008 | | 211,406 | | | 34,201 | | | 245,607 |
At March 31, 2008, the outstanding balance of loans originated in the two-step loan program was $211.4 million, down 20% from $263.0 million at December 31, 2007. Included in the $211.4 million was $88.8 million of nonaccrual loan balances and $122.6 million in loans that are accruing interest.
Total two-step loan balances plus unused commitments (“two-step total commitments”) peaked in second quarter 2007 and has since contracted by $161 million, or 40%, to $246 million as of March 31, 2008. This decrease reflected the substantially lower origination volumes of two-step loans over the last three quarters of 2007. It is anticipated that the two-step loan balances will continue to run-off over the next nine months.
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The following table presents two-step total commitments outstanding at March 31, 2008, by the period in which the underlying loans mature.
| (Dollars in thousands) | Two-step loan |
| | total commitments |
| Maturities in period ended | commitment maturities |
| December 31, 2007 | $ | 33,264 |
| First quarter 2008 | | 46,268 |
| Second quarter 2008 | | 113,924 |
| Third quarter 2008 | | 41,527 |
| Fourth quarter 2008 | | 10,224 |
| First quarter 2009 | | 400 |
| Total | $ | 245,607 |
Approximately 69% of future 2008 maturities are scheduled to occur in the second quarter. Actual maturities may occur somewhat later as certain commitments may be extended in the regular course of our construction lending business. Substantially all of the $33.3 million in two-step loans that matured during 2007 and the majority of the $46.3 million remaining in two-step loans that matured during first quarter 2008 were either delinquent or nonperforming loans at March 31, 2008.
The following table illustrates two-step total commitments by geographic areas as of the dates shown.
| (Dollars in thousands) | | | |
| | March 31, | | December 31, |
| Region | 2008 | | 2007 |
| Portland, Oregon / Vancouver, Washington | $ | 68,840 | | $ | 102,336 |
| Western Washington (Olympia, Seattle) | | 73,328 | | | 113,331 |
| Central Oregon (Bend, Redmond) | | 32,804 | | | 44,310 |
| Oregon Coast (Newport, Lincoln City) | | 24,404 | | | 32,655 |
| Willamette Valley (Salem, Eugene) | | 32,128 | | | 34,331 |
| Southern Oregon (Medford, Roseburg) | | 14,103 | | | 14,574 |
| Total residential real estate construction loan commitments | $ | 245,607 | | $ | 341,537 |
Credit Management - Two-Step Loans
Management action focused on the two-step loan portfolio has been concentrated in the following key areas:
Increasing customer contact prior to loan maturity and encouraging early action to secure permanent financing or identify reasonable alternatives. We are initiating customer contact up to 120 days prior to maturity in order to determine the best strategy for each borrower. This typically includes helping the borrower identify permanent mortgage programs, extending the construction period for successful home completion and if third party or company take-out mortgage financing is not expected to materialize, attempting to pursue the least costly alternative in terms of property disposition.
Identifying higher risk elements within the portfolio and developing risk mitigation strategies. As patterns emerge that allow us to isolate risk elements, we evaluate appropriate action steps for risk mitigation and appropriate reserve adequacy.
Adding resources to assist with collection efforts and the management and sale of OREO property. We have expanded our capacity to address troubled loans by increasing staffing levels in our special assets and collections groups.
Providing mortgage loans to two-step borrowers who qualify. We have developed a set of mortgage loan products to provide bridge financing or permanent mortgage loans, collectively called replacement financing, to qualified borrowers with maturing two-step loans. This program is designed to assist two-step borrowers in their transition from a construction loan to permanent financing. Financing terms are generally more flexible than our standard products; however, in all cases, each loan request is considered based on a thorough review of the borrower’s repayment capacity. Under certain circumstances, we may consider discounting debt in order to restructure the loan to fit the borrower’s debt service capacity.
It has been our experience to date that once a borrower is delinquent, few are able to cure their past due status. Given that most two-step loans have interest reserves, conditions exist where troubled borrowers can draw against their interest reserve to make loan payments. In order to take appropriate action to identify problem loans that should be placed on nonaccrual, a number of profiles were developed based on portfolio experience. These profiles have been systematically applied to all loans in the portfolio. Loans that fit certain profile characteristics were placed on nonaccrual during the first quarter. This caused a certain number of loans either current or 30-89 days past due to be included in nonaccrual loans at March 31, 2008.
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In addition to the new criteria associated with profiles for classifying loans on nonaccrual, we also changed our practice of establishing specific reserves associated with collateral dependent impaired loans. We now charge-off the amount of impairment at the time of impairment, rather than placing the impaired amount in a specific reserve. Applying this new practice has accelerated the timing of charge-offs associated with collateral dependent two-step loans.
At March 31, 2008 approximately 329 two-step loans, which represent 47% of all two-step loans, were classified nonaccrual under the new criteria and measured for impairment. Charge-offs associated with these loans were $20 million.
Nonperforming Assets and Delinquencies – Two-Step Loans
Nonperforming Assets – Two-Step Loans.The following table presents information about nonperforming assets and delinquencies relating to two-step loans at the dates shown.
| Dollars in thousands | March 31, | | December 31, |
| | 2008 | | 2007 | | 2006 |
| Non-accruing two-step loans | $ | 88,784 | | | $ | 20,545 | | | $ | 567 | |
| 90 days past due and accruing interest two-step loans | | - | | | | - | | | | - | |
| Total nonperforming two-step loans | | 88,784 | | | | 20,545 | | | | 567 | |
| |
| Other real estate owned two-step | | 5,688 | | | | 3,255 | | | | - | |
| Total nonperforming two-step assets | $ | 94,472 | | | $ | 23,800 | | | $ | 567 | |
| |
| Delinquent two-step loans 30-89 days past due | $ | 14,269 | | | $ | 36,778 | | | $ | 2,969 | |
| |
| Nonperforming two-step loans to total two-step loans | | 42.00 | % | | | 7.81 | % | | | 0.33 | % |
| Nonperforming two-step assets to total assets | | 3.60 | % | | | 0.90 | % | | | 0.02 | % |
| Allowance for two-step loan losses to nonperforming two-step loans | | 11 | % | | | 116 | % | | | 462 | % |
| Allowance for two-step loan losses to nonperforming two-step assets | | 11 | % | | | 100 | % | | | 462 | % |
| Delinquent two-step loans to total two-step loans | | 6.75 | % | | | 13.99 | % | | | 1.73 | % |
Nonperforming two-step assets were $94.5 million or 90% of total nonperforming assets at March 31, 2008, up from $23.8 million at December 31, 2007. At March 31, 2008, total nonperforming two-step assets of $94.5 million consisted of $88.8 million in nonaccrual loans, and the book value of 23 residential properties carried in OREO in the amount of $5.7 million. Approximately 75% of nonaccruing two-step loans were associated with homes that have been completed with the remaining balance related to homes under construction or where various issues halted construction. We anticipate nonperforming assets associated with the two-step loan portfolio will continue to increase over the next six months of 2008, but at a slower rate than that of the first quarter.
The substantial increase in nonperforming assets was partly attributable to a loan policy change implemented in the first quarter, as disclosed in the Company’s 2007 10-K. The Bank amended its loan policy regarding the timing of placing certain segments of the real estate construction loan portfolio on nonaccrual status, including, as examples, loans that are over 30 days past due and construction is incomplete, loans that are 60 days past due and construction is completed, and for loans made to borrowers that have not commenced construction. At March 31, 2008, the $88.8 million two-step nonaccrual balance included $14.0 million in loan balances where payments are current and $24.5 million that are 30-89 days past due. The amendments to our loan policy applied to the entire construction loan portfolio; however, primarily the two-step loan portfolio was affected by the amended loan policy.
Two-step OREO property represents real property which the Bank has taken possession of that has been deeded to the Bank through a deed-in-lieu of foreclosure, non-judicial foreclosure, judicial foreclosure or similar process in partial or full satisfaction of a loan or loans. It typically takes two to seven months following initial delinquency before property is recorded into OREO depending upon the resolution strategy and the complexities associated with the specific property. At March 31, 2008, we had approximately 225 properties in various stages of foreclosure, representing $68.0 million in loan balances. We expect approximately 80 of these properties to be recorded into OREO during the second quarter and 145 properties to be taken into OREO in the third or fourth quarters of 2008. As this occurs, the balances are moved from nonaccrual status loans to OREO on our balance sheet. To date, the majority of the OREO properties were acquired through non-judicial foreclosures, as the borrowers have not shown capacity to support the debt. Additional recoveries from two-step loan borrowers are expected to be limited. We expect OREO balances to grow rapidly over the next 6 months.
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Delinquencies - Two-Step Loans.Delinquencies in the two-step loan portfolio decreased to $14.3 million at March 31, 2008 from $36.8 million at year end 2007 as a consequence of implementing a modified loan policy during the first quarter which included accelerating the timing of the shift of loans with certain characteristics into nonaccrual status that in prior periods would have been reported as delinquent loans. Delinquent two-step loans were 6.75% of total two-step loans at March 31, 2008, down from 13.99% at December 31, 2007.
Allowance for Credit Losses and Net Loan Charge-offs – Two-Step Loans
Allowance for Credit Losses - - Two-Step Loans.The following table presents information with respect to the change in our allowance for credit losses relating to the two-step loan portfolio.
| | Quarter to date | | |
| (Dollars in thousands) | | March 31, | | December 31, |
| | | 2008 | | 2007 | | 2006 |
| Allowance for credit losses two-step loans, beginning of period | | $ | 31,065 | | | $ | 2,618 | | | $ | 1,166 |
| Provision for credit losses two-step loans | | | 780 | | | | 30,980 | | | | 1,452 |
| |
| Loan charge-offs two-step loans | | | (20,099 | ) | | | (2,540 | ) | | | - |
| Recoveries two-step loans | | | 66 | | | | 7 | | | | - |
| Net loan charge-offs two-step loans | | | (20,033 | ) | | | (2,533 | ) | | | - |
| | | | | | | | | | | | |
| Total allowance for credit losses two-step loans | | $ | 11,812 | | | $ | 31,065 | | | $ | 2,618 |
| |
| Components of allowance for credit losses two-step loans | | | | | | | | | | | |
| Allowance for loan losses two-step loans | | $ | 9,991 | | | $ | 23,917 | | | $ | 2,618 |
| Reserve for unfunded commitments two-step loans | | | 1,821 | | | | 7,148 | | | | - |
| Total allowance for credit losses two-step loans | | $ | 11,812 | | | $ | 31,065 | | | $ | 2,618 |
| |
| Net charge-offs two-step loans to average total loans annualized | | | 3.70% | | | | 0.12% | | | | 0.00% |
| Allowance for two-step loan losses to total two-step loans | | | 4.73% | | | | 9.10% | | | | 1.52% |
| Allowance for two-step credit losses to total two-step loans | | | 5.59% | | | | 11.81% | | | | 1.52% |
The allowance for credit losses associated with the two-step loan portfolio decreased to $11.8 million or 5.6% of total two-step loans at March 31, 2008, down from $31.1 million and 11.8%, respectively, at year end 2007. The allowance for credit losses relating to two-step loans was 7.9% of total loans and commitments associated with performing two-step loans at March 31, 2008 compared to 8.9% at December 31, 2007. The two-step allowance for credit losses is allocated into two separate components as follows: a pool based formula allowance of $10.0 million, and a $1.8 million reserve for unfunded commitments. We will record actual future charge-offs in the two-step loan portfolio against the allowance for loan losses assigned to the portfolio.
Net Loan Charge-offs – Two-Step Loans.Net charge-offs in the two-step loan portfolio were $20.0 million in the first quarter of 2008. The charge-offs associated with the two-step loan portfolio in the first quarter were applied against the allowance for credit losses for the portfolio established at year end 2007. The charge-offs and interest reversal amounts in the two-step loan portfolio during the first quarter reflect a modification in our loan policy regarding the timing of moving particular loans to nonaccrual status. The application of the modified loan policy caused us to recognize significant loan charge-offs and interest reversals in the first quarter that otherwise would have been recognized in later periods. The first quarter 2008 annualized net charge-offs percentage for loans other than two-step were .21%, down from .28% in the first quarter of 2007.
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Deposits and Borrowings
The following table summarizes the quarterly average dollar amount in, and the average interest rate paid on, each of the deposit and borrowing categories for the first quarters of 2008 and 2007.
| | First Quarter 2008 | | First Quarter 2007 |
| | Quarterly Average | | | | Rate | | Quarterly Average | | | | |
| (Dollars in thousands) | | Balance | | Percent | | Paid | | Balance | | Percent | | Rate Paid |
| Demand deposits | | $ | 464,088 | | 22 | % | | - | | | $ | 463,226 | | 23 | % | | - | |
| Interest bearing demand | | | 290,337 | | 14 | % | | 1.03 | % | | | 276,271 | | 14 | % | | 1.26 | % |
| Savings | | | 68,649 | | 3 | % | | 0.50 | % | | | 72,779 | | 4 | % | | 0.67 | % |
| Money market | | | 662,508 | | 33 | % | | 2.76 | % | | | 642,858 | | 32 | % | | 3.67 | % |
| Time deposits | | | 579,157 | | 28 | % | | 4.33 | % | | | 538,304 | | 27 | % | | 4.66 | % |
| Total deposits | | | 2,064,739 | | 100 | % | | 3.05 | % | | | 1,993,438 | | 100 | % | | 3.61 | % |
| |
| Short-term borrowings | | | 146,148 | | | | | 3.78 | % | | | 121,065 | | | | | 5.28 | % |
| Long-term borrowings (1) | | | 138,991 | | | | | 5.06 | % | | | 99,469 | | | | | 5.40 | % |
| Total borrowings | | | 285,139 | | | | | 4.40 | % | | | 220,534 | | | | | 5.33 | % |
| | | | | | | | | | | | | | | | | | | |
| Total deposits and borrowings | | $ | 2,349,878 | | | | | 3.14 | % | | $ | 2,213,972 | | | | | 3.84 | % |
(1) Long-term borrowings include junior subordinated debentures.
First quarter 2008 average total deposits increased 4%, or $71 million, from the first quarter 2007. Our average deposit mix remained fairly consistent year over year first quarter, with slightly more growth across the interest bearing deposit categories. Average noninterest bearing demand balances was 22% of total deposits, or relatively unchanged from 23% in the prior year first quarter.
Average borrowings increased 30% or $65 million from the first quarter of 2007 as a result of higher FHLB borrowings in the most recent quarter. Such borrowings were competitively priced relative to interest bearing deposits, including certificates of deposit. The growth in interest bearing deposits for the remainder of 2008 will depend upon funding needs, mainly influenced by change in loan balances, and relative alternatives and availability of other funding sources including FHLB borrowings.
Our deposit and borrowing cost decreased 70 basis points since the first quarter of 2007, reflecting the 200 basis point reduction in the fed funds rate during the most recent quarter. We repriced our deposits aggressively to protect the Bank spread.
The balance of junior subordinated debentures at March 31, 2008 was $51 million. For additional detail regarding Bancorp’s outstanding debentures, see Note 8 in the financial statements included under Item 1 of this report and our 2007 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 March 31, 2008, 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 March, 31, 2008, and December 31, 2007.
| | March 31, 2008 | | December 31, 2007 |
| | | | | | Amount | | Percent | | | | | | | | Amount | | Percent |
| | | | | | Required For | | required for | | | | | | | | Required For | | required for |
| | | | | | Minimum | | Minimum | | | | | | | | Minimum | | Minimum |
| | | | | | Capital | | Capital | | | | | | | | Capital | | Capital |
| (Dollars in thousands) | | Actual | | | | Adequacy | | Adequacy | | Actual | | | | Adequacy | | Adequacy |
| | Amount | | Ratio | | Amount | | | | Amount | | Ratio | | Amount | | |
| Tier 1 Capital | | | | | | | | | | | | | | | | | | | | | | | | |
| West Coast Bancorp | | $ | 244,888 | | 9.96 | % | | $ | 98,332 | | 4 | % | | $ | 244,165 | | 9.88 | % | | $ | 98,804 | | 4 | % |
| West Coast Bank | | | 227,950 | | 9.32 | % | | | 97,877 | | 4 | % | | | 228,976 | | 9.28 | % | | | 98,687 | | 4 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Capital | | | | | | | | | | | | | | | | | | | | | | | | |
| West Coast Bancorp | | $ | 275,762 | | 11.22 | % | | $ | 196,664 | | 8 | % | | $ | 275,306 | | 11.15 | % | | $ | 197,608 | | 8 | % |
| West Coast Bank | | | 258,683 | | 10.57 | % | | | 195,754 | | 8 | % | | | 260,080 | | 10.54 | % | | | 197,373 | | 8 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Risk weighted assets | | | | | | | | | | | | | | | | | | | | | | | | |
| West Coast Bancorp | | $ | 2,458,305 | | | | | | | | | | | $ | 2,470,097 | | | | | | | | | |
| West Coast Bank | | | 2,446,930 | | | | | | | | | | | | 2,467,165 | | | | | | | | | |
| |
| Leverage Ratio | | | | | | | | | | | | | | | | | | | | | | | | |
| West Coast Bancorp | | $ | 244,888 | | 9.49 | % | | $ | 77,430 | | 3 | % | | $ | 244,165 | | 9.41 | % | | $ | 77,855 | | 3 | % |
| West Coast Bank | | | 227,950 | | 8.84 | % | | | 77,386 | | 3 | % | | | 228,976 | | 8.83 | % | | | 77,828 | | 3 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Average total assets | | | | | | | | | | | | | | | | | | | | | | | | |
| West Coast Bancorp | | $ | 2,581,001 | | | | | | | | | | | $ | 2,595,174 | | | | | | | | | |
| West Coast Bank | | | 2,579,537 | | | | | | | | | | | | 2,594,280 | | | | | | | | | |
Stockholders' equity was $208 million at March 31, 2008 and also at December 31, 2007. The total capital ratio at the Bank was 10.57% at March 31, 2008, 57 basis points over minimum for well capitalized status and substantially unchanged from 10.54% at December 31, 2007. Due to the uncertainty about the health of the economy and the local residential housing market, the Company does not anticipate any stock repurchase activity for the remainder of the year.
The risk based capital ratios of Bancorp include $51 million of trust preferred securities that qualify as tier 1 capital at March 31, 2008, under guidance issued by the Board of Governors of the Federal Reserve System. Bancorp expects to continue to rely on common equity and trust preferred securities to remain well-capitalized, and may also determine to issue other hybrid equity or debt instruments, such as convertible preferred stock or subordinated debt, to maintain its capital ratios or to improve its financial condition. Any equity or debt financing, if available at all, may not be available on terms that are favorable to the Company.
For further discussion of the amount and terms of issuances of pooled trust preferred securities, see Note 8 in the financial statements including under Item 1 of this report and our 2007 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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Under its corporate stock repurchase program the Company may buy up to a total of 4.88 million shares of the Company’s common stock. Since initiating its stock repurchase plan in the year 2000 and including shares repurchased related to stock plans, the Company has repurchased approximately 3.83 million shares, or 25%, of currently outstanding shares at an average price of $17.49 per share. Total shares available for repurchase under the Company’s stock repurchase program were approximately 1.05 million at March 31, 2008.
The following table presents information with respect to Bancorp’s stock repurchases.
| | Shares repurchased or | | | | | | | | | |
| | redeemed related to | | Shares repurchased as | | Total shares | | Total cost of | | | |
| (Shares and dollars in thousands, other than | | stock options and | | part of the corporate | | repurchased in the | | shares | | Average price | |
| per share amounts) | | restricted stock | | stock repurchase plan | | period | | repurchased | | 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 | |
| Year ended 2007 | | 22 | | 205 | | 227 | | | 6,486 | | | 28.57 | |
| Three months ended March 31, 2008 | | 3 | | - | | 3 | | | (1 | )* | | (1 | )* |
| Total | | 262 | | 3,828 | | 4,090 | | $ | 71,527 | | $ | 17.49 | |
| (1)* not meaningful, repurchase related to redemption of stock related to restricted stock vesting. |
Please also see discussion of stock repurchase activity during the quarter ended March 31, 2008, 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 $2.1 billion at March 31, 2008, unchanged from $2.1 billion at December 31, 2007.
The Company has 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 our ability to attract and retain customers and increase deposits, by providing additional FDIC coverage to customers. CDARS deposits can be reciprocal or one-way. 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 March 31, 2008, was $11.3 million in reciprocal balances. 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. As of March 31, 2008, the holding company did not have any borrowing arrangements of its own.
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 |
| | March 31, 2008 | | December 31, 2007 |
| Financial instruments whose contract amounts represent credit risk: | | | | | | |
| Commitments to extend credit in the form of loans | | | | | | |
| Commercial | | $ | 368,095 | | $ | 395,203 |
| Real estate construction | | | | | | |
| Two-step loans | | | 34,201 | | | 78,585 |
| Other than two-step loans | | | 120,103 | | | 149,833 |
| Total real estate construction | | | 154,304 | | | 228,418 |
| Real estate mortgage | | | | | | |
| Standard mortgage | | | 6,351 | | | 7,320 |
| Non-standard mortgage | | | - | | | - |
| Home equity line of credit | | | 198,418 | | | 198,331 |
| Total real estate mortgage loans | | | 204,769 | | | 205,651 |
| Commercial real estate | | | 22,465 | | | 27,116 |
| Installment and consumer | | | 18,164 | | | 19,232 |
| Other1 | | | 61,656 | | | 24,223 |
| Standby letters of credit and financial guarantees | | | 7,085 | | | 8,081 |
| Account overdraft protection instruments | | | 66,823 | | | 54,093 |
| Total | | $ | 903,361 | | $ | 962,017 |
1The category “other” represents commitments extended to clients or borrowers that have not yet been fully executed. While we believe these commitments to be binding, they are not yet classified nor have they been placed into our loan system.
The Bank’s commitments to make loans decreased $59 million or 6% since December 31, 2007, primarily as a result of lower unused commitments in its commercial and real estate construction portfolio. 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 Note 21, “Financial Instruments with Off-Balance Sheet Risk.”in our 2007 10-K financial statements.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
There has been no material change in the market risks disclosure under Item 7A “Quantitative and Qualitative Disclosures about Market Risk” in the Company’s 2007 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
None applicable.
Item 1A. Risk Factors
The following are certain risks that management believes are specific to our business. This should not be viewed as an all inclusive list or in any particular order. See “Item 1A. Risk Factors” of our 2007 10-K for additional risks that may affect our business.
Future loan losses may exceed our allowance for loan losses.
We are subject to credit risk, which is the risk that borrowers will fail to repay loans in accordance with their terms. A downturn in the economy or a specific industry sector or a rapid change in interest rates could adversely affect our borrowers’ ability to repay loans. A downturn in the relevant real estate markets could adversely affect the value and salability of the collateral for many of our loans. Developments of this nature could result in losses in excess of our allowance for loan losses. In addition, to the extent that loan payments from borrowers are not timely, the loans will be placed on nonaccrual status, thereby reducing and/or reversing previously accrued interest income.
We maintain an allowance for loan losses that represents management’s best estimate, as of a particular date, of the probable amount of loan receivables that the Bank will be unable to collect. When available information confirms that specific loans or portions of loans are uncollectible, those amounts are charged off against the allowance for loan losses. Our management establishes the allowance for loan losses based on a continual evaluation of lending concentrations, specific credit risks, past loan loss experience, loan portfolio and collateral quality, and relevant economic, political, and regulatory conditions. Adverse changes in any of these or other factors that management considers relevant may result in an increase in the allowance for loan losses. In addition, federal and state banking regulators periodically review the allowance for loan losses and may require that the Bank increase the allowance or recognize loan charge-offs. Any additional provision for loan losses to increase the allowance for loan losses results in a decrease in net income, and possibly risk-based capital, and may have a material adverse effect on our financial condition and results of operations. For more information on this topic, see “Critical Accounting Policies” and “Allowance for Credit Losses and Net Loan Charge-offs” in our 2007 10-K and related sections in this quarterly report under Part 1, Item 2 above.
Defaults and related losses in our two-step residential construction loan portfolio could be greater than currently anticipated and are expected to result in a significant increase in other real estate owned (“OREO”) balances and number of properties to be disposed, which is expected to adversely affect our financial results.
Actual losses related to loans in the two-step loan portfolio (“two-step loans”) may be greater then anticipated, resulting in additional provision for credit losses in future periods. In addition, as part of our collection process for all nonperforming loans, including nonperforming two-step loans, we may foreclose on and take title to the real estate serving as collateral for the loan. Real estate owned by the Bank and not used in the ordinary course of its operations is referred to as “other real estate owned” or “OREO” property. Increased OREO balances lead to greater expenses as we incur costs to manage and dispose of the properties and, in certain cases, complete construction of residences prior to sale. Any decrease in sale prices on homes may lead to OREO write-downs with a corresponding expense in our income statement. We expect that our earnings over the next several quarters will be negatively affected by various expenses associated with OREO, including personnel costs, insurance and taxes, completion and repair costs, and other costs associated with property ownership, as well as by the funding costs associated with assets that are tied up in real estate properties during the period they are held in OREO.
A significant decline in the Company’s market value could result in an impairment of goodwill.
Recently, the Company’s common stock has been trading at a price below its book value, including goodwill and other intangible assets. If impairment was deemed to exist, we would be required to write down our assets resulting in a charge to earnings. See section titled “Goodwill and Other Intangible Assets” in Item 7 of our 2007 10-K.
We may need to raise additional capital which may not be available or may adversely affect existing shareholders.
Bancorp may need to raise additional capital in the future through financings to maintain desired levels of capital ratios, to improve its financial condition, or to increase liquidity available for operations. Any equity or debt financing, if available at all, may not be available on terms that are favorable to the Company. In the case of equity financings, dilution to Bancorp’s shareholders could result and, in any case, securities may have rights, preferences and privileges that are senior to those of Bancorp’s current shareholders. Debt financing could also negatively affect future earnings due to interest charges.
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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 March 31, 2008: |
| | | | | | 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 |
| 1/1/08 - 1/31/08 | | 47 | | $ | 14.13 | | - | | 1,051,821 |
| 2/1/08 - 2/29/08 | | 112 | | $ | 15.92 | | - | | 1,051,821 |
| 3/1/08 - 3/31/08 | | - | | $ | 0.00 | | - | | 1,051,821 |
| Total for quarter | | 159 | | | | | - | | |
(1) Shares repurchased by Bancorp during the quarter include shares repurchased from employees in connection with stock option swap exercises and cancellation of restricted stock to pay withholding taxes totaling 47 shares, 112 shares, and 0 shares, respectively, for the periods indicated. There were no 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.
(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, by 1.0 million shares in April 2004, and by 1.0 million shares in September 2007 for a total authorized repurchase amount as of March 31, 2008, of approximately 4.9 million shares.
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
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: May 2, 2008 | /s/ Robert D. Sznewajs | | |
| | Robert D. Sznewajs |
| | President and Chief Executive Officer |
| |
| |
| Dated: May 2, 2008 | /s/ Anders Giltvedt | | |
| | Anders Giltvedt |
| | Executive Vice President and Chief Financial Officer |
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