Average yields on earning assets decreased 193 basis points to 5.91% in the second quarter of 2008 from 7.84% in the second quarter of 2007 due primarily to decreasing interest rates, the effect of a materially lower volume of interest accruing construction loans, interest reversals on two-step loans and a higher balance of nonperforming construction loans to carry in our loan portfolio. Average interest earning assets increased $83 million, or 4%, to $2.5 billion in the second quarter of 2008 from $2.4 billion for the same period in 2007. Second quarter 2008 average rates paid on interest bearing liabilities decreased 132 basis points to 2.52% from 3.84%, from the same period in 2007, while average interest bearing liabilities increased $100 million, or 5%, to $1.9 billion. Interest earning assets have re-priced more quickly than our interest bearing liabilities in the decreasing rate environment during the first half of 2008, leading to additional pressure on the net interest margin.
The net interest margin for the second quarter of 2008 decreased to 3.94% from 4.90% in the second quarter of 2007. The lower net interest margin was partly due to the 61 basis point decrease in spreads between earning assets and rates paid on interest bearing liabilities. The combination of interest reversals on two-step loans and cost of carrying the nonaccrual two-step loan balances reduced the spread by approximately 37 basis points. The remaining 24 basis point contraction in the spread resulted from competitive pressures for interest bearing deposits, lower construction loan fees and the aggressive decrease in the federal funds rate in early 2008, which reduced our loan yields. Additionally, the net interest margin was negatively affected by lower value and balances of noninterest bearing demand deposits.
As shown in the following table, interest reversals in the most recent quarter had a significant effect on the net interest margin. Excluding the effects of interest reversals on two-step loans in the second quarter of 2008, the net interest margin would have been 4.19% instead of the reported net interest margin for the period of 3.94%.
The following table reconciles the net interest margin for the periods shown to the net interest margin excluding the effect of interest reversals:
Management uses this net interest margin data internally and has disclosed it to investors based on its belief it makes it easier to compare the Company's performance across the periods shown by highlighting the impact from material factors.
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 June 30, 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 half of 2008 compared to the first half 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, and lower value of noninterest bearing deposits are projected to continue to put pressure on our net interest margin for the remainder of 2008.
Provision for Credit Losses.Bancorp recorded provision for credit losses for the second quarters of 2008 and 2007 of $6.0 million and $3.5 million, respectively. Of the $6.0 million in provision in the current quarter, $1.9 million related to the two-step loan portfolio. The $4.1 million provision for credit losses for loans other than two-step represented an increase of $1.3 million from second quarter 2007. This higher provision was generally consistent with the current credit cycle and predominantly due to unfavorable risk rating migrations, higher general valuation allowances, and increased net charge-offs in the residential construction loan portfolio outside the two-step program and also in the commercial portfolio. The provision for credit losses for the six months ended June 30, 2008 was $14.7 million, up from $6.3 million in the same period in 2007. For more information, see the discussion below under the subheading “Allowance for Credit Losses and Net Loan Charge-offs” below.
Noninterest Income. Total noninterest income was $9.0 million for the three months ended June 30, 2008, an increase of 4% compared to $8.7 million in the second quarter of 2007. As a result of steady account growth in both business and consumer transaction accounts and cards associated with those new accounts, along with a decline in earnings credit for business accounts, deposit service charge revenues grew a robust 24% or $.7 million from same quarter a year ago. The account growth also boosted payment systems revenues which increased $.3 million, or 16%, over the second quarter 2007, with particularly strong growth in card related revenues. Gain on sales of loans declined 20% or $.2 million compared to the second quarter 2007 as a result of significantly lower residential mortgage market activity. In addition, we realized a $.2 million gain on sales of investment securities in the most recent quarter. Noninterest income for the six months ended June 30, 2008 was $19.2 million, up from $16.7 million in the first six months of 2007.
Changing general economic conditions and interest rate environments, including the shape, change in and level of the yield curve, could lead to decreases in noninterest 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. Moreover, a decline or significant volatility in the equity market may negatively impact trust and investment revenues.
Noninterest Expense. Noninterest expense for the three months ended June 30, 2008, was $23.3 million, an increase of $1.8 million, or 9%, compared to $21.5 million for the same period in 2007. Personnel expense increased slightly in second quarter 2008 as lower performance-related pay nearly offset annual merit increases, additional team members, and materially lower deferred construction loan origination costs compared to second quarter 2007. Other significant variances between second quarter 2008 and second quarter 2007 include a $.5 million increase in legal expense, the majority of which relates to the two-step program, an increase in FDIC insurance premium expense of $.5 million, and $.5 million in expenses associated with the OREO portfolio related to two-step program loans. Noninterest expense for the six months ended June 30, 2008 was $45.6, up from $42.5 million for the same period in 2007.
We expect noninterest expense associated with two-step related foreclosures and nonperforming two-step assets to stay elevated in the second half of 2008, due to higher personnel costs, legal, insurance and property tax expenses, maintenance 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 the second half of 2008 compared to the same period in 2007.
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 June 30, 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 June 30, 2008 was 21.2%, down from 34.6% for the same period in 2007. Bancorp’s effective tax rate for the six months ended June 30, 2008 was 25.0%, down from 34.7% 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 June 30, 2008 substantially unchanged since year end 2007. Period end total loans decreased by 1% or $19 million since December 31, 2007, while total deposits remained approximately unchanged 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.
In order to fund our growth, we put an emphasis on launching depository services to satisfy the cash and deposit transaction needs of business customers. 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, if any, overall asset growth this year, and total loan balances will likely 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:
| | | June 30, 2008 | | December 31, 2007 |
| | | Amortized | | | | Unrealized | | Amortized | | | | | Unrealized |
| (Dollars in thousands) | | Cost | | Fair Value | | Gain/(Loss) | | Cost | | Fair Value | | Gain/(Loss) |
| Treasury securities | | $ | 199 | | $ | 209 | | $ | 10 | | | $ | 199 | | $ | 207 | | $ | 8 | |
| U.S. Government agency securities | | | 25,293 | | | 25,445 | | | 152 | | | | 60,554 | | | 61,557 | | | 1,003 | |
| Corporate securities | | | 18,694 | | | 15,280 | | | (3,414 | ) | | | 20,201 | | | 19,568 | | | (633 | ) |
| Mortgage-backed securities | | | 104,475 | | | 102,849 | | | (1,626 | ) | | | 85,050 | | | 84,197 | | | (853 | ) |
| Obligations of state and political subdivisions | | | 84,138 | | | 83,582 | | | (556 | ) | | | 85,877 | | | 86,106 | | | 229 | |
| Equity and other securities | | | 7,960 | | | 7,007 | | | (953 | ) | | | 7,963 | | | 7,495 | | | (468 | ) |
| Total Investment Portfolio | | $ | 240,759 | | $ | 234,372 | | $ | (6,387 | ) | | $ | 259,844 | | $ | 259,130 | | $ | (714 | ) |
The June 30, 2008, investment portfolio balance of $234.4 million decreased $24.8 million from December 31, 2007. At June 30, 2008, total investment securities available for sale had a pre-tax net unrealized loss of $6.4 million. Our US Government agency portfolio consisted of $24.4 million of AAA rated debt and $1 million of agency debt rated AA-.
There was a $3.4 million unrealized loss in corporate securities at June 30, 2008, which was associated with the decline in market value of our $13.9 million carrying value of investment in collateralized debt obligations collateralized by pools of trust preferred securities issued primarily by banks and insurance companies. These securities are rated A- or better and have several features that reduce credit risk, including subordination and collateral coverage tests.
The investment portfolio has limited direct exposure to “subprime” mortgages. Our mortgage-backed security portfolio consists of $61 million of US agency backed mortgages and $42 million of non-agency mortgages. The majority of our non-agency mortgage-backed securities portfolio is comprised of securities secured by 15 year fully amortizing jumbo loans. All of our non-agency mortgage-backed securities are rated AAA or Aaa.
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Included in equity and other securities is a $2.9 million investment in Freddie Mac preferred stock. At June 30, 2008, we had a $.8 million unrealized loss on this investment. The market value of this investment has been volatile as the market situation for Freddie Mac remains very fluid and lacks clarity for investors. There are multiple scenarios for government intervention and we expect decisions impacting the future structure of Freddie Mac to be made in the next few months. The outcome is expected to help preferred stock investors better assess the market value of Freddie Mac preferred stock. Based on the current evaluation, management has concluded there is no other-than-temporary-impairment on Freddie Mac preferred stock at June 30, 2008.
Finally, consistent with the industry, we have experienced an adverse change in the credit ratings of our securities representing obligations of state and political subdivisions, which is comprised solely of municipal bonds. Several municipal bond insurers were downgraded by credit rating agencies, which impacted the municipal bonds that we own. At June 30, 2008 the ratings were: 59% AAA, 22% AA, 15% A and 4% BBB. At December 31, 2007 the ratings were: 91% AAA, 6% AA, 2% A and 1% BBB.
We regularly review investment securities for the presence of other-than-temporary impairment (‘OTTI”), taking into consideration current market conditions, fair value relationship to cost, extent and nature of change in fair value, issuer rating changes and trends, our ability to hold investments until a recovery of fair value, which may be maturity, and other factors. Future reviews for OTTI will consider the particular facts and circumstances during the reporting period in review. For additional detail, see Note 3 “Investment Securities Available for Sale” of our interim financial statements included under Item 1 of this report.
Loan Portfolio
The composition of Bancorp’s loan portfolio as of June 30, 2008, as compared to December 31, 2007 is as follows:
| | | | | | | | | | | | | | | | | Change |
| (Dollars in thousands) | | | June 30, 2008 | | December 31, 2007 | | Amount | | % |
| | | Amount | | Percent | | Amount | | Percent | | | | |
| Commercial | | $ | 512,689 | | | 23.8 | % | | $ | 504,101 | | | 23.2 | % | | $ | 8,588 | | | 2 | % |
| Real estate construction | | | 392,724 | | | 18.2 | % | | | 517,988 | | | 23.8 | % | | | (125,264 | ) | | -24 | % |
| Real estate mortgage | | | 377,771 | | | 17.5 | % | | | 330,803 | | | 15.2 | % | | | 46,968 | | | 14 | % |
| Commercial real estate | | | 847,430 | | | 39.4 | % | | | 796,622 | | | 36.7 | % | | | 50,808 | | | 6 | % |
| Installment and other consumer | | | 23,102 | | | 1.1 | % | | | 23,155 | | | 1.1 | % | | | (53 | ) | | 0 | % |
| Total loans | | | 2,153,716 | | | 100 | % | | | 2,172,669 | | | 100 | % | | $ | (18,953 | ) | | -1 | % |
| Allowance for loan losses | | | (35,723 | ) | | 1.66 | % | | | (46,917 | ) | | 2.16 | % | | | | | | | |
| Total loans, net | | $ | 2,117,993 | | | | | | $ | 2,125,752 | | | | | | | | | | | |
The Company’s total loan portfolio was $2.2 billion at June 30, 2008, a decrease of $19 million, or 1%, from December 31, 2007. 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 June 30, 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 June 30, 2008, and December 31, 2007, Bancorp had no bankers’ acceptances.
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Below is a discussion of our loan portfolio by category.
Commercial. The Commercial loan portfolio grew $9 million, or 2%, since year end 2007. During the first half of 2008 we tactically placed strict limits on financing for selective market sectors in order to manage our risk exposure and manage our risk weighted asset base in this uncertain environment. However, in terms of our long term strategy we expect the commercial loan portfolio to be an important contributor to growth in future revenues. We believe we have been successful in growing our commercial portfolio over the past few years as a result of strong, experienced commercial lending teams throughout our market areas. In addition, over the past several years developments in our treasury management product line, including the introduction of our iDeposit and Re$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%.
Real Estate Construction. The composition of real estate construction loans by type of project as of June 30, 2008, and December 31, 2007, is as follows:
| | | | | | | | | | | | | | | | | |
| | | June 30, 2008 | | December 31, 2007 | | Change |
| (Dollars in thousands) | | | Amount | | Percent | | Amount | | Percent | | Amount | | Percent |
| Commercial construction | | $ | 94,779 | | | 24 | % | | $ | 90,670 | | | 17 | % | | $ | 4,109 | | | 5 | % |
| Two-step residential construction to individuals | | | 145,703 | | | 37 | % | | | 262,952 | | | 51 | % | | | (117,249 | ) | | -45 | % |
| Residential construction to builder | | | 77,129 | | | 20 | % | | | 80,737 | | | 16 | % | | | (3,608 | ) | | -4 | % |
| Residential subdivision or site development | | | 75,626 | | | 19 | % | | | 84,620 | | | 16 | % | | | (8,994 | ) | | -11 | % |
| Net deferred fees | | | (513 | ) | | 0 | % | | | (991 | ) | | 0 | % | | | 478 | | | -48 | % |
| Total real estate construction loans | | $ | 392,724 | | | 100 | % | | $ | 517,988 | | | 100 | % | | $ | (125,264 | ) | | -24 | % |
At June 30, 2008, real estate construction loans were $393 million, down $125 million or 24% from $518 million at December 31, 2007 predominantly due to the decline in the two-step loan portfolio over the same period. Real estate construction loans represented 18% of the loan portfolio at the end of the second quarter, down from 24% at December 31, 2007, and we expect this percentage to continue to decline materially in the second half of 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 initial loan to value ratios in the range of 75% to 85%. Given the 11 months inventory of residential homes in our market in June 2008, double the 5.7 months inventory in June 2007, 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 material decrease in the demand for residential construction loans in the market place. We are not currently pursuing acquisition of new builder clients for single family residential financing, nor are we financing additional residential land or the development of residential lots at this time.
The real estate construction loan category expanded rapidly until late 2007, reflecting the high levels of construction activity within the markets we operate. We expect these balances to continue to decline throughout 2008 as existing loan commitments decrease and there are few new residential construction commitments extended to new borrowers, removing an important source of loan revenues and earnings growth in prior periods.
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The following table shows the components of our construction and land loans outside the two-step portfolio as of the dates shown:
| (Dollars in thousands) | | | June 30, 2008 | | March 31, 2008 | | June 30, 2007 |
| | | Amount | | Percent | | Amount | | Percent | | Amount | | Percent |
| Land loans1 | | $ | 44,256 | | 15 | % | | $ | 44,422 | | 15 | % | | $ | 41,615 | | 14 | % |
| Residential construction loans other than two-step loans | | | 152,755 | | 52 | % | | | 158,565 | | 53 | % | | | 149,572 | | 52 | % |
| Commercial construction loans | | | 94,779 | | 33 | % | | | 94,878 | | 32 | % | | | 96,164 | | 34 | % |
| Total construction and land loans other than two-step loans | | $ | 291,790 | | 100 | % | | $ | 297,865 | | 100 | % | | $ | 287,351 | | 100 | % |
| |
| Components of residential construction and land loans other than two-step | | | | | | | | | | | | | | | | | | |
| loans: | | | | | | | | | | | | | | | | | | |
| Land loans1 | | $ | 25,809 | | 15 | % | | $ | 25,588 | | 14 | % | | $ | 20,206 | | 12 | % |
| Site development | | | 75,790 | | 42 | % | | | 76,322 | | 41 | % | | | 81,172 | | 48 | % |
| Vertical construction | | | 76,965 | | 43 | % | | | 82,243 | | 45 | % | | | 68,400 | | 40 | % |
| Total residential construction and land loans other than two-step loans | | $ | 178,564 | | 100 | % | | | 184,153 | | 100 | % | | | 169,778 | | 100 | % |
| |
| Components of commercial construction and land loans: | | | | | | | | | | | | | | | | | | |
| Land loans1 | | $ | 18,447 | | 16 | % | | $ | 18,834 | | 17 | % | | $ | 21,409 | | 18 | % |
| Site development | | | 1,122 | | 1 | % | | | 1,107 | | 1 | % | | | - | | 0 | % |
| Vertical construction | | | 93,657 | | 83 | % | | | 93,771 | | 82 | % | | | 96,164 | | 82 | % |
| Total commercial construction and land loans | | $ | 113,226 | | 100 | % | | $ | 113,712 | | 100 | % | | $ | 117,573 | | 100 | % |
| |
| Components of total construction and land loans other than two-step loans: | | | | | | | | | | | | | | | | | | |
| Land loans1 | | $ | 44,256 | | 15 | % | | $ | 44,422 | | 15 | % | | $ | 41,615 | | 15 | % |
| Site development | | | 76,912 | | 26 | % | | | 77,429 | | 26 | % | | | 81,172 | | 28 | % |
| Vertical construction | | | 170,622 | | 59 | % | | | 176,014 | | 59 | % | | | 164,564 | | 57 | % |
| Total construction and land loans other than two-step loans | | $ | 291,790 | | 100 | % | | $ | 297,865 | | 100 | % | | $ | 287,351 | | 100 | % |
1 Land loans represent balances that are carried in the Company's residential real estate mortgage of $26 million and commercial real estate loan portfolios of $18 million in the period shown.
As shown in the table above, residential construction loans represented slightly over half of the real estate construction and land loans outside the two-step portfolio, while the commercial construction category accounted for about one third. In terms of the construction and land loan components, the majority or $171 million was for vertical construction purposes, with the land component at 15% and site development at 26%. Within the commercial construction category, vertical construction accounted for 83% of loan balances. In the residential category, the loan balances were more evenly split between the site development and vertical construction components. At this time, we believe the risk and loss exposure associated with residential vertical construction is less than with the land and site development components.
At $44 million, land loans account for just 2% of the Company’s total loan portfolio at June 30, 2008. Our land loans typically had loan to value ratios of 60% or less. The Bank's land commitments were split between commercial and residential uses. Geographically, neither residential nor commercial land is heavily concentrated in any single county within our market areas. At June 30, 2008, the land portfolio had nonaccrual loans of $1 million. No land loans were past due.
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Real Estate Mortgage. The following table presents the components of our real estate mortgage loan portfolio.
| | | | June 30, 2008 | | March 31, 2008 | | Change |
| (Dollars in thousands) | | | Amount | | Percent | | Amount | | Percent | | Amount | | Percent |
| Standard mortgage | | $ | 87,526 | | 23 | % | | $ | 86,901 | | 26 | % | | $ | 625 | | 1 | % |
| Nonstandard mortgage product | | | 30,745 | | 8 | % | | | 7,495 | | 2 | % | | | 23,250 | | 310 | % |
| Home equity loans and lines of credit | | | 259,500 | | 69 | % | | | 236,407 | | 72 | % | | | 23,093 | | 10 | % |
| Total real estate mortgage | | $ | 377,771 | | 100 | % | | $ | 330,803 | | 100 | % | | $ | 46,968 | | 14 | % |
At June 30, 2008, real estate mortgage loan balances were $378 million or approximately 18% of the Company’s total loan portfolio. We have developed a set of mortgage loan products to provide bridge financing and 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 June 30, 2008, there were 83 loans in the nonstandard real estate mortgage program, with an outstanding loan balance of $31 million and a related loan loss reserve of $2.5 million. Looking forward, we anticipate the number of nonstandard loan originations to decline.
Home equity lines and loans represented about 69% or $260 million of the real estate mortgage portfolio. The Bank’s home equity lines and loans were generated by our branches within our market area. The portfolio has grown steadily over the past few years as a result of focused and ongoing marketing efforts. As shown below, the home equity line utilization percentage has averaged approximately 51% and has been fairly consistent across the various origination vintages.
| | | Year of Origination |
| (Dollars in thousands) | | June '08 | | 2007 | | 2006 | | 2005 | | 2004 | | 2003&Earlier | | Total |
| Home Equity Lines | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Commitments | | $ | 49,260 | | | $ | 94,185 | | | $ | 98,970 | | | $ | 94,941 | | | $ | 36,719 | | | $ | 71,460 | | | $ | 445,535 | |
| Outstanding Balance | | | 24,209 | | | | 50,398 | | | | 56,721 | | | | 43,967 | | | | 18,587 | | | | 31,790 | | | | 225,672 | |
| |
| Utilization | | | 49.1 | % | | | 53.5 | % | | | 57.3 | % | | | 46.3 | % | | | 50.6 | % | | | 44.5 | % | | | 50.7 | % |
| |
| Home Equity Loans | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Outstanding Balance | | | 7,634 | | | | 9,837 | | | | 8,447 | | | | 2,097 | | | | 1,343 | | | | 4,470 | | | | 33,828 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Home Equity Outstanding | | $ | 31,843 | | | $ | 60,235 | | | $ | 65,168 | | | $ | 46,064 | | | $ | 19,930 | | | $ | 36,260 | | | $ | 259,500 | |
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As indicated in the table below, the average Beacon score for the home equity line and loan portfolios were 768 and 730, respectively. The average Beacon scores for the home equity line and loan portfolios were rescored in the first quarter of 2008 and showed a slight improvement from prior data. Additionally, the delinquencies and charge-offs have been very modest within these portfolios. The original loan-to-value ratios of 63% and 62% for home equity line and loan portfolios, respectively, reflect that the majority of the originations were done at loan-to-value ratios of less that 80%. The significant amount of related loans and deposits is a result of our home equity line and loan portfolios being sourced to relationship customers through our branch network.
The following table presents an overview of home equity lines and loans of credit at June 30, 2008.
| (Dollars in thousands) | | Lines | | Loans |
| Total Outstanding | | $ | 225,672 | | | $ | 33,828 | |
| |
| Average Beacon Score (Current) | | | 768 | | | | 730 | |
| |
| Delinquent % 30 Days or Greater | | | 0.09 | % | | | 0.30 | % |
| % Net Charge-Offs (YTD) | | | -0.01 | % | | | 0.06 | % |
| |
| % 1st Lien Position | | | 36 | % | | | 39 | % |
| % 2nd Lien Position | | | 74 | % | | | 61 | % |
| |
| Overall Original Loan-to-Value | | | 63 | % | | | 62 | % |
| |
| Loan-to-Value < 80% | | | 78 | % | | | 68 | % |
| Loan-to-Value > 80, < 90% | | | 21 | % | | | 26 | % |
| Loan-to-Value > 90, < 100% | | | 1 | % | | | 6 | % |
| | | 100 | % | | | 100 | % |
| |
| Total $ Related Loans / Deposits1 | | $ | 368,714 | | | $ | 54,587 | |
| 1 | | These amounts represent other loan and deposit balances associated with our customers having a home equity line or loan. |
The following table shows home equity lines and loans of credit by market areas at June 30, 2008, and indicates a geographic distribution of balances representative of our branch presence in these markets.
| (Dollars in thousands) | | | |
| | June 30, |
| Region | | 2008 |
| Portland, Oregon / Vancouver, Washington | | $ | 107,755 |
| Western Washington (Olympia, Seattle) | | | 35,067 |
| Central Oregon (Bend, Redmond) | | | 7,201 |
| Oregon Coast (Newport, Lincoln City) | | | 24,083 |
| Willamette Valley (Salem, Eugene) | | | 83,203 |
| Southern Oregon (Medford, Roseburg) | | | 156 |
| Other | | | 2,035 |
| Total home equity loans and lines of credit | | $ | 259,500 |
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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) | | | June 30, 2008 | | December 31, 2007 |
| | Amount | | Percent | | Amount | | Percent |
| Office Buildings | | $ | 191,300 | | 22.6 | % | | $ | 179,000 | | 22.5 | % |
| Retail Facilities | | | 115,300 | | 13.5 | % | | | 110,100 | | 13.8 | % |
| Medical Offices | | | 61,000 | | 7.2 | % | | | 51,400 | | 6.5 | % |
| Commercial/Agricultural | | | 57,800 | | 6.8 | % | | | 54,400 | | 6.8 | % |
| Multi-Family - 5+ Residential | | | 55,900 | | 6.6 | % | | | 61,600 | | 7.7 | % |
| Industrial parks and related | | | 51,100 | | 6.0 | % | | | 48,800 | | 6.1 | % |
| Manufacturing Plants | | | 38,900 | | 4.6 | % | | | 39,200 | | 4.9 | % |
| Hotels/Motels | | | 32,200 | | 3.8 | % | | | 42,100 | | 5.3 | % |
| Land Development and Raw Land | | | 30,100 | | 3.6 | % | | | 25,000 | | 3.1 | % |
| Assisted Living | | | 22,500 | | 2.7 | % | | | 12,400 | | 1.6 | % |
| Mini Storage | | | 21,600 | | 2.5 | % | | | 17,000 | | 2.1 | % |
| Food Establishments | | | 18,400 | | 2.2 | % | | | 18,300 | | 2.3 | % |
| Other | | | 151,300 | | 17.9 | % | | | 137,300 | | 17.3 | % |
| Total commercial real estate loans | | $ | 847,400 | | 100 | % | | $ | 796,600 | | 100 | % |
As shown above, the commercial real estate portfolio balance increased $51 million or 6% from December 31, 2007 to June 30, 2008 with most of the growth coming in the non-owner occupied segment which represented 54% of the total commercial real estate loans portfolio at June 30, 2008. Office buildings, retail facilities, medical offices and commercial/agricultural categories account for half of the collateral securing our $847 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:
| | June 30, 2008 | | December 31, 2007 | | Change |
| (Dollars in thousands) | | | Amount | | Percent | | Amount | | Percent | | Amount | | Percent |
| Owner occupied | | $ | 390,724 | | 46 | % | | $ | 382,387 | | 48 | % | | $ | 8,337 | | 2 | % |
| Non-owner occupied | | | 456,706 | | 54 | % | | | 414,235 | | 52 | % | | | 42,471 | | 10 | % |
| Total commercial real estate loans | | $ | 847,430 | | 100 | % | | $ | 796,622 | | 100 | % | | $ | 50,808 | | 6 | % |
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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 an 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” under Part II, Item 1A of this report and in our 2007 10-K.
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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) | | | June 30, 2008 | | March 31, 2008 | | December 31, 2007 |
| Loans on nonaccrual status: | | | | | | | | | | | | |
| Commercial | | $ | 4,168 | | | $ | 4,336 | | | $ | 2,401 | |
| Real estate construction | | | 105,270 | | | | 91,630 | | | | 22,121 | |
| Real estate mortgage: | | | | | | | | | | | | |
| Standard mortgage | | | 1,888 | | | | 936 | | | | 552 | |
| Nonstandard mortgage product | | | 5,849 | | | | 295 | | | | - | |
| Home equity lines of credit | | | 278 | | | | 274 | | | | - | |
| Total real estate mortgage | | | 8,015 | | | | 1,505 | | | | 552 | |
| Commercial real estate | | | 2,074 | | | | 1,565 | | | | 1,353 | |
| Installment and consumer | | | 2 | | | | 2 | | | | - | |
| Total nonaccrual loans | | | 119,529 | | | | 99,038 | | | | 26,427 | |
| Other real estate owned | | | 27,892 | | | | 5,688 | | | | 3,255 | |
| Total nonperforming assets | | $ | 147,421 | | | $ | 104,726 | | | $ | 29,682 | |
| |
| Nonperforming loans to total loans | | | 5.55 | % | | | 4.51 | % | | | 1.22 | % |
| Nonperforming assets to total assets | | | 5.60 | % | | | 4.00 | % | | | 1.12 | % |
At June 30, 2008, total nonperforming assets were $147.4 million, or 5.60% of total assets, compared to $29.7 million, or 1.12%, at December 31, 2007, and $104.7 million, or 4.00%, at March 31, 2008. The two-step loan portfolio accounted for $125.1 million or 85% of total nonperforming assets at June 30, 2008. 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.
The following table presents activity in the OREO portfolio for the periods shown.
| | Six months ended | | Six months ended | | Twelve months ended |
| | June 30, 2008 | | June 30, 2007 | | December 31, 2007 |
| (Dollars in thousands, unaudited) | | | Amount | | Number | | Amount | | Number | | Amount | | Number |
| Beginning balance | | $ | 3,255 | | | 15 | | | $ | - | | | 1 | | | $ | - | | | 1 | |
| Additions to OREO | | | 27,669 | | | 104 | | | | 340 | | | 1 | | | | 3,713 | | | 15 | |
| Capitalized improvements | | | 428 | | | | | | | | | | | | | | 57 | | | | |
| Valuation adjustments | | | (245 | ) | | | | | | | | | | | | | (175 | ) | | | |
| Disposition of OREO | | | (3,215 | ) | | (11 | ) | | | (340 | ) | | (1 | ) | | | (340 | ) | | (1 | ) |
| Ending balance | | $ | 27,892 | | | 108 | | | $ | - | | | 1 | | | $ | 3,255 | | | 15 | |
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 108 OREO properties at June 30, 2008, with a total net book value of $27.9 million. Of the 108 OREO properties at June 30, 2008, 101 were related to two-step loans. OREO is recorded at the lower of the carrying amount of the loan or fair value less estimated costs to sell. During the first six months of 2008, the Company sold 11 OREO properties, all of which were two-step related. Outside of the OREO portfolio the Bank also closed 14 two-step related short sales in the same period. Short sales occur when we accept an agreement with a loan obligor to sell the Bank's collateral on a loan that produces net proceeds that is less than what is owed. The obligor receives no proceeds, however, the debt is fully extinguished. A short sale is an alternative to foreclosure. The majority of the combined 25 OREO and short sales were completed in the second quarter. The losses on short sales and write-downs on loans prior to taking ownership of property in OREO were recorded directly to the two-step allowance for loan losses.
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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. OREO operational expense increased $.5 million in second quarter 2008 compared to first quarter 2008. We expect this expense to continue to increase in future periods as a result of the projected increase in the number of OREO properties.
Delinquencies.The following table summarizes delinquency loan balances by type of loan as of the dates shown:
| (Dollars in thousands) | | | June 30, 2008 | | March 31, 2008 | | December 31, 2007 |
| Loans 30-89 days past due, not in nonaccrual status | | | | | | | | | | | | |
| Commercial | | $ | 983 | | | $ | 2,485 | | | $ | 6,086 | |
| Real estate construction | | | 7,521 | | | | 18,826 | | | | 36,941 | |
| Real estate mortgage: | | | | | | | | | | | | |
| Standard mortgage | | | 914 | | | | 3,035 | | | | 486 | |
| Nonstandard mortgage product | | | 3,846 | | | | 1,996 | | | | - | |
| Home equity lines of credit | | | 598 | | | | 52 | | | | 45 | |
| Total real estate mortgage | | | 5,358 | | | | 5,083 | | | | 531 | |
| Commercial real estate | | | 824 | | | | 604 | | | | 792 | |
| Installment and consumer | | | 208 | | | | 97 | | | | 134 | |
| Total loans 30-89 days past due, not in nonaccrual status | | $ | 14,894 | | | $ | 27,095 | | | $ | 44,484 | |
| |
| Delinquent loans past due 30-89 days to total loans | | | 0.69 | % | | | 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 ..69% of total loans at June 30, 2008, down from 2.05% at December 31, 2007, primarily as a result of a shift of a large amount of two-step loans from delinquent to nonaccrual status during 2008, fewer two-step loans becoming delinquent in the second quarter of 2008, as well as lower delinquencies in commercial and construction other than two-step loan categories. Delinquencies in the real estate construction category decreased materially from $36.9 million at December 31, 2007, to $7.5 million at June 30, 2008. The significant reduction in real estate construction delinquencies was also impacted by 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. However, the reduction in delinquencies in the two-step loan portfolio did not reflect an improvement in credit quality but reflected fewer two-step loans outstanding as of June 30, 2008 compared to December 31, 2007. Nonstandard mortgage loans, which are associated with two-step loans, also experienced increased delinquency levels. For further discussion, see sections “Nonperforming Assets and Delinquencies – Other Than Two-Step Loans” and “Nonperforming Assets and Delinquencies – Two-Step Loans” below.
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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.”
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.
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Changes in the allowance for credit losses for year to date June 30, 2008, and full year ended December 31, 2007, are presented in the following table.
| | Six months ended | | Year ended |
| (Dollars in thousands) | | | June 30, 2008 | | December 31, 2007 |
| Loans outstanding at end of period | | $ | 2,153,716 | | | $ | 2,172,669 | |
| Average loans outstanding during the period | | | 2,181,273 | | | | 2,094,977 | |
| |
| Allowance for credit losses, beginning of period | | | 54,903 | | | | 23,017 | |
| Loan charge-offs: | | | | | | | | |
| Commercial | | | (2,741 | ) | | | (3,798 | ) |
| Real estate construction | | | (30,422 | ) | | | (2,540 | ) |
| Real estate mortgage | | | (259 | ) | | | (71 | ) |
| Commercial real estate | | | - | | | | - | |
| Installment and consumer | | | (119 | ) | | | (254 | ) |
| Overdraft | | | (605 | ) | | | (1,050 | ) |
| Total loan charge-offs | | | (34,146 | ) | | | (7,713 | ) |
| Recoveries: | | | | | | | | |
| Commercial | | | 32 | | | | 269 | |
| Real estate construction | | | 1,305 | | | | 7 | |
| Real estate mortgage | | | 52 | | | | 33 | |
| Commercial real estate | | | - | | | | 2 | |
| Installment and consumer | | | 54 | | | | 112 | |
| Overdraft | | | 120 | | | | 220 | |
| Total recoveries | | | 1,563 | | | | 643 | |
| Net loan charge-offs | | | (32,583 | ) | | | (7,070 | ) |
| Provision for credit losses | | | 14,725 | | | | 38,956 | |
| Allowance for credit losses, end of period | | $ | 37,045 | | | $ | 54,903 | |
| |
| Components of allowance for credit losses | | | | | | | | |
| Allowance for loan losses | | $ | 35,723 | | | $ | 46,917 | |
| Reserve for unfunded commitments | | | 1,322 | | | | 7,986 | |
| Total allowance for credit losses | | $ | 37,045 | | | $ | 54,903 | |
| |
| Net loan charge-offs to average loans annualized | | | 3.00 | % | | | 0.34 | % |
| |
| Allowance for loan losses to total loans | | | 1.66 | % | | | 2.16 | % |
| Allowance for credit losses to total loans | | | 1.72 | % | | | 2.53 | % |
At June 30, 2008, the Company’s allowance for credit losses was $37.1 million, consisting of a $31.8 million formula allowance, a $.4 million specific allowance, a $3.6 million unallocated allowance and a $1.3 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 six months of 2008 were due primarily to unfavorable migration of risk ratings within our portfolio, change in delinquencies, increased general valuation percentages associated with specific loan portfolio segments, as well as loan charge-offs and recovery activities. Also, a large portion of the year to date 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.
At June 30, 2008, Bancorp’s allowance for credit losses and loan losses were 1.72% and 1.66% of total loans compared with an allowance for credit losses and loan losses at December 31, 2007, of 2.53% and 2.16% of total loans. The decline in allowance for credit loss and loan losses related to charge-offs of two-step loans against the allowance for credit losses established at year end 2007.
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Overall, we believe that the allowance for credit losses is adequate to absorb losses in the loan portfolio at June 30, 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 six months ended June 30, 2008, total net loan charge-offs were $32.6 million compared to $7.1 million for the year ended December 31, 2007. The 2008 year to date annualized net loan charge-offs to total average loans outstanding were 3.00%, up from .34% in the same period in 2007. See “Two-Step Loan Portfolio” below for more information.
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) | | June 30, | | March 31, | | December 31, |
| | 2008 | | 2008 | | 2007 | | 2006 |
| Commercial loans | | $ | 512,689 | | $ | 529,519 | | $ | 504,101 | | $ | 463,188 |
| Real estate construction loans1 | | | 392,724 | | | 464,028 | | | 517,988 | | | 365,954 |
| Real estate mortgage loans: | | | | | | | | | | | | |
| Standard mortgage | | | 88,106 | | | 87,621 | | | 86,901 | | | 71,189 |
| Nonstandard mortgage product | | | 30,902 | | | 25,107 | | | 7,495 | | | - |
| Home equity line of credit | | | 258,763 | | | 243,457 | | | 236,407 | | | 216,306 |
| Total real estate mortgage loans | | | 377,771 | | | 356,185 | | | 330,803 | | | 287,495 |
| Commercial real estate loans | | | 847,430 | | | 819,586 | | | 796,622 | | | 804,865 |
| Installment and other consumer loans | | | 23,102 | | | 24,993 | | | 23,155 | | | 26,188 |
| Total loans | | $ | 2,153,716 | | $ | 2,194,311 | | $ | 2,172,669 | | $ | 1,947,690 |
| |
| 1 Two-step loans | | $ | 145,703 | | $ | 211,406 | | $ | 262,952 | | $ | 171,692 |
| All other construction loans | | | 247,021 | | | 252,622 | | | 255,036 | | | 194,262 |
| Total real estate construction loans | | $ | 392,724 | | $ | 464,028 | | $ | 517,988 | | $ | 365,954 |
| |
| Two-step loans | | $ | 145,703 | | $ | 211,406 | | $ | 262,952 | | $ | 171,692 |
| Total loans other than two-step loans | | | 2,008,013 | | | 1,982,905 | | | 1,909,717 | | | 1,775,998 |
| Total loans | | $ | 2,153,716 | | $ | 2,194,311 | | $ | 2,172,669 | | $ | 1,947,690 |
As shown above, loans other than two-step loans were $2.0 billion at June 30, 2008, up $98 million, or 5%, 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.
| | June 30, | | March 31, | | December 31, |
| (Dollars in thousands) | | | 2008 | | 2008 | | 2007 | | 2006 |
| Commercial loans | | $ | 4,168 | | | $ | 4,336 | | | $ | 2,401 | | | $ | 385 | |
| Real estate construction loans | | | 6,542 | | | | 2,846 | | | | 1,576 | | | | - | |
| Real estate mortgage loans: | | | | | | | | | | | | | | | | |
| Standard mortgage | | | 1,888 | | | | 936 | | | | 552 | | | | - | |
| Nonstandard mortgage product | | | 5,849 | | | | 295 | | | | - | | | | - | |
| Home equity line of credit | | | 278 | | | | 274 | | | | - | | | | - | |
| Total real estate mortgage loans | | | 8,015 | | | | 1,505 | | | | 552 | | | | - | |
| Commercial real estate loans | | | 2,074 | | | | 1,565 | | | | 1,353 | | | | 516 | |
| Installment and other consumer loans | | | 2 | | | | 2 | | | | - | | | | - | |
| Total nonaccrual loans | | | 20,801 | | | | 10,254 | | | | 5,882 | | | | 901 | |
| 90 day past due and accruing interest | | | - | | | | - | | | | - | | | | - | |
| Total nonperforming loans other than two-step loans | | | 20,801 | | | | 10,254 | | | | 5,882 | | | | 901 | |
| |
| Other real estate owned other than two-step loans | | | 1,432 | | | | - | | | | - | | | | - | |
| Total nonperforming assets other than two-step loans | | $ | 22,233 | | | $ | 10,254 | | | $ | 5,882 | | | $ | 901 | |
| |
| Delinquent other than two-step loans 30-89 days past due | | $ | 9,432 | | | $ | 12,826 | | | $ | 7,706 | | | $ | 6,953 | |
| |
| Nonperforming loans other than two-step loans to total loans other than two-step loans | | | 1.04 | % | | | 0.52 | % | | | 0.31 | % | | | 0.05 | % |
| Nonperforming assets other than two-step assets to total assets | | | 0.84 | % | | | 0.39 | % | | | 0.22 | % | | | 0.04 | % |
| Allowance for loan losses other than two-step loan losses to nonperforming loans other than two-step loans | | | 148 | % | | | 289 | % | | | 391 | % | | | 2264 | % |
| Delinquent loans other than two-step loans to total loans other than two-step loans | | | 0.47 | % | | | 0.65 | % | | | 0.40 | % | | | 0.39 | % |
Nonperforming assets other than two-step loans increased from $5.9 million at year end 2007 to $22.2 million, or ..84% of total assets, at June 30, 2008. The increase in nonperforming loans was primarily due to higher nonaccrual loans which increased $14.9 million from December 31, 2007. The majority of the increase in nonperforming loans since March 31, 2008 was comprised of $3.7 million growth in nonaccrual residential construction loans and $5.6 million growth in nonaccrual nonstandard residential mortgage loans made to two-step borrowers.
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The following table shows the components of our nonaccrual construction and land loans outside the two-step portfolio as of the dates shown.
| (Dollars in thousands) | | June 30, 2008 | | June 30, 2007 | | March 31, 2008 |
| | | | | Percent of | | | | Percent of | | | | | Percent of |
| | Amount | | loan category2 | | Amount | | loan category | | Amount | | loan category2 |
| Land loans1 | | $ | 1,396 | | 0.48 | % | | $ | 306 | | 0.11 | % | | $ | 709 | | 0.24 | % |
| Residential construction loans other than two-step loans | | | 6,542 | | 2.24 | % | | | - | | 0.00 | % | | | 2,846 | | 0.96 | % |
| Commercial construction loans | | | - | | 0.00 | % | | | - | | 0.00 | % | | | - | | 0.00 | % |
| Total nonaccrual construction and land loans other than two-step loans | | $ | 7,938 | | 2.72 | % | | $ | 306 | | 0.11 | % | | $ | 3,555 | | 1.19 | % |
| |
| Components of nonaccrual residential construction and land loans other than two-step loans: | | | | | | | | | | | | | | | | | | |
| Land loans1 | | $ | 1,396 | | 0.78 | % | | $ | 306 | | 0.18 | % | | $ | 709 | | 0.39 | % |
| Site development | | | 2,830 | | 1.58 | % | | | - | | 0.00 | % | | | 620 | | 0.34 | % |
| Vertical construction | | | 3,712 | | 2.08 | % | | | - | | 0.00 | % | | | 2,226 | | 1.21 | % |
| Total nonaccrual residential construction and land loans other than two-step loans | | $ | 7,938 | | 4.45 | % | | $ | 306 | | 0.18 | % | | $ | 3,555 | | 1.93 | % |
| |
| Components of nonaccrual commercial construction and land loans: | | | | | | | | | | | | | | | | | | |
| Land loans1 | | | - | | 0.00 | % | | | - | | 0.00 | % | | | - | | 0.00 | % |
| Site development | | | - | | 0.00 | % | | | - | | 0.00 | % | | | - | | 0.00 | % |
| Vertical construction | | | - | | 0.00 | % | | | - | | 0.00 | % | | | - | | 0.00 | % |
| Total nonaccrual commercial construction and land loans | | $ | - | | 0.00 | % | | $ | - | | 0.00 | % | | $ | - | | 0.00 | % |
| |
| Components of total nonaccrual construction and land loans other than two-step loans: | | | | | | | | | | | | | | | | | | |
| Land loans1 | | $ | 1,396 | | 0.48 | % | | $ | 306 | | 0.11 | % | | $ | 709 | | 0.24 | % |
| Site development | | | 2,830 | | 0.97 | % | | | - | | 0.00 | % | | | 620 | | 0.21 | % |
| Vertical construction | | | 3,712 | | 1.27 | % | | | - | | 0.00 | % | | | 2,226 | | 0.75 | % |
| Total nonaccrual construction and land loans other than two-step loans | | $ | 7,938 | | 2.72 | % | | $ | 306 | | 0.11 | % | | $ | 3,555 | | 1.19 | % |
| 1 | | Land loans represent balances that are carried in the Company's residential real estate mortgage and commercial real estate loan portfolios in the period |
| 2 | | Calculations have been based on more detailed information and therefore may not recompute exactly due to rounding. |
As indicated in the above table and reflecting the difficulties in the housing market, the $7.9 million in nonaccrual construction and land loan balances outside the two-step portfolio were all related to the residential category. There were no nonaccrual commercial construction loans. The nonaccrual balance increased from prior periods and represented 2.72% of outstanding construction and land loan balances at June 30, 2008. The residential nonaccruals were spread across the land, site development and vertical construction components.
- 40 - -
Delinquencies - Loans Other Than Two-Step Loans.As shown in the table on page 39, delinquencies in the other than two-step loan portfolio increased to 47basis points at June 30, 2008, compared to 40 basis points at December 31, 2007.
The following table shows the components of our delinquent construction and land loans outside the two-step portfolio as of the dates shown.
| (Dollars in thousands) | | June 30, 2008 | | June 30, 2007 | | March 31, 2008 |
| | | | | Percent of | | | | | Percent of | | | | | Percent of |
| | | | | loan | | | | | loan | | | | | loan |
| | Amount | | category2 | | Amount | | category | | Amount | | category2 |
| Land loans1 | | $ | - | | 0.00 | % | | $ | - | | 0.00 | % | | $ | 336 | | 0.12 | % |
| Residential construction loans other than two-step loans | | | 1,976 | | 0.68 | % | | | 6,150 | | 2.11 | % | | | 4,557 | | 1.56 | % |
| Commercial construction loans | | | 83 | | 0.03 | % | | | - | | 0.00 | % | | | - | | 0.00 | % |
| Total 30-89 days past due construction loans other than two-step loans | | $ | 2,059 | | 0.71 | % | | $ | 6,150 | | 2.11 | % | | $ | 4,893 | | 1.68 | % |
| | | | | | | | | | | | | | | | | | | |
Components of 30-89 days past due residential construction and land loans
other than two-step loans: | | | | | | | | | | | | | | | | | | |
| Land loans1 | | $ | - | | 0.00 | % | | $ | - | | 0.00 | % | | $ | 336 | | 0.19 | % |
| Site development | | | - | | 0.00 | % | | | 6,150 | | 3.44 | % | | | 2,119 | | 1.19 | % |
| Vertical construction | | | 1,976 | | 1.11 | % | | | - | | 0.00 | % | | | 2,438 | | 1.37 | % |
Total 30-89 days past due residential construction and land loans other than
two-step loans | | $ | 1,976 | | 1.11 | % | | $ | 6,150 | | 3.44 | % | | $ | 4,893 | | 2.74 | % |
| |
| Components of 30-89 days past due commercial construction and land loans: | | | | | | | | | | | | | | | | | | |
| Land loans1 | | $ | - | | 0.00 | % | | $ | - | | 0.00 | % | | $ | - | | 0.00 | % |
| Site development | | | - | | 0.00 | % | | | - | | 0.00 | % | | | - | | 0.00 | % |
| Vertical construction | | | 83 | | 0.07 | % | | | - | | 0.00 | % | | | - | | 0.00 | % |
| Total 30-89 days past due commercial construction and land loans | | $ | 83 | | 0.07 | % | | $ | - | | 0.00 | % | | $ | - | | 0.00 | % |
| |
Components of total 30-89 days past due construction and land loans other
than two-step loans: | | | | | | | | | | | | | | | | | | |
| Land loans1 | | $ | - | | 0.00 | % | | $ | - | | 0.00 | % | | $ | 336 | | 0.12 | % |
| Site development | | | - | | 0.00 | % | | | 6,150 | | 2.11 | % | | | 2,119 | | 0.73 | % |
| Vertical construction | | | 2,059 | | 0.71 | % | | | - | | 0.00 | % | | | 2,438 | | 0.84 | % |
Total 30-89 days past due construction and land loans other than two-step
loans | | $ | 2,059 | | 0.71 | % | | $ | 6,150 | | 2.11 | % | | $ | 4,893 | | 1.68 | % |
| 1 | | Land loans represent balances that are carried in the Company's residential real estate mortgage and commercial real estate loan portfolios in the period shown. |
| 2 | | Calculations have been based on more detailed information and therefore may not recompute exactly due to rounding. |
Overall, delinquent construction and land loans outside the two-step portfolio were modest at .71% of such loans as of June 30, 2008, down from 2.11% at June 30, 2007. Furthermore, at the end of the second quarter 2008 there were no delinquent land or site development loans and minimal delinquent commercial construction loans. All of the $2.1 million in delinquent loans was concentrated in the vertical construction component of the residential category.
- 41 -
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.
| | Year to date | | Quarter ended | | Year ended |
| (Dollars in thousands) | | June 30, | | March 31, | | December 31, |
| | 2008 | | 2008 | | 2007 | | 2006 |
| Allowance for credit losses other than two-step loans, beginning of period | | $ | 23,838 | | | $ | 23,838 | | | $ | 20,399 | | | $ | 19,303 | |
| Provision for credit losses other than two-step loans | | | 11,998 | | | | 7,945 | | | | 7,976 | | | | 1,281 | |
| |
| Charge-offs other than two-step loans | | | | | | | | | | | | | | | | |
| Loan charge-offs: | | | | | | | | | | | | | | | | |
| Commercial | | | (2,741 | ) | | | (623 | ) | | | (3,798 | ) | | | (831 | ) |
| Real estate construction | | | (573 | ) | | | (295 | ) | | | - | | | | (48 | ) |
| Real estate mortgage | | | (259 | ) | | | - | | | | (71 | ) | | | - | |
| Commercial real estate | | | (32 | ) | | | - | | | | | | | | | |
| Installment and consumer | | | (119 | ) | | | (74 | ) | | | (254 | ) | | | (130 | ) |
| Overdraft | | | (605 | ) | | | (302 | ) | | | (1,050 | ) | | | (912 | ) |
| Total loan charge-offs other than two-step loans | | | (4,329 | ) | | | (1,294 | ) | | | (5,173 | ) | | | (1,921 | ) |
| Recoveries: | | | | | | | | | | | | | | | | |
| Commercial | | | 32 | | | | 32 | | | | 269 | | | | 501 | |
| Real estate construction | | | - | | | | - | | | | - | | | | - | |
| Real estate mortgage | | | 52 | | | | 27 | | | | 33 | | | | 36 | |
| Commercial real estate | | | - | | | | - | | | | 2 | | | | 4 | |
| Installment and consumer | | | 54 | | | | 26 | | | | 112 | | | | 75 | |
| Overdraft | | | 120 | | | | 68 | | | | 220 | | | | 233 | |
| Total recoveries other than two-step loans | | | 258 | | | | 153 | | | | 636 | | | | 849 | |
| Net loan charge-offs other than two-step loans | | | (4,071 | ) | | | (1,141 | ) | | | (4,537 | ) | | | (1,072 | ) |
| |
| Allowance for credit losses, from acquisition | | | - | | | | - | | | | - | | | | 887 | |
| |
| Total allowance for credit losses other than two-step loans | | $ | 31,765 | | | $ | 30,642 | | | $ | 23,838 | | | $ | 20,399 | |
| |
| Components of allowance for credit losses other than two-step loans | | | | | | | | | | | | | | | | |
| Allowance for loan losses other than two-step loans | | $ | 30,865 | | | $ | 29,611 | | | $ | 23,000 | | | $ | 20,399 | |
| Reserve for unfunded commitments other than two-step loans | | | 900 | | | | 1,031 | | | | 838 | | | | - | |
| Total allowance for credit losses other than two-step loans | | $ | 31,765 | | | $ | 30,642 | | | $ | 23,838 | | | $ | 20,399 | |
| |
| Net loan charge-offs to average loans other than two-step loans annualized | | | 0.38 | % | | | 0.21 | % | | | 0.22 | % | | | 0.06 | % |
| Allowance for other than two-step loan losses to total other than two-step loans | | | 1.54 | % | | | 1.49 | % | | | 1.20 | % | | | 1.15 | % |
| Allowance for other than two-step credit losses to total other than two-step loans | | | 1.58 | % | | | 1.55 | % | | | 1.25 | % | | | 1.15 | % |
The allowance for credit losses for loans other than two-step loans at June 30, 2008 was $31.8 million, up from $23.8 million at December 31, 2007. The drivers of the higher allowance for credit losses, and thus an increased provision for credit losses for loans other than two-step, were unfavorable risk rating migrations, higher general valuation allowance percentages for specific loan segments in the allowance for credit loss model, and increased net charge-offs. These factors were only partly offset by lower loan balances. The unfavorable risk rating migration largely consisted of commercial loans and residential construction loans to builders being moved to higher risk rating categories. At June 30, 2008, the allowance for credit losses for loans other than two-step loans totaled $31.8 million and consisted of a $27.8 million formula allowance, a $.4 million specific allowance, a $2.7 million unallocated allowance and a $.9 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 six months ended June 30, 2008 for loans other than two-step loans were $4.1 million, and largely attributable to losses related to commercial and construction loans and overdrafts, compared to $2.8 million in the same period ended June 30, 2007. Net commercial charge-offs accounted for $2.7 million in the first six months of 2008 down from $3.5 million for the same period in 2007. The 2008 year to date annualized net loan charge-offs as a percentage of average loans other than two-step loans was .38%, an increase from ..22% for the entire year ended December 31, 2007.
- 42 -
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 balances, 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 |
| Second quarter 2008 | | | 145,703 | | | 12,628 | | | 158,331 |
Total two-step loan balances plus unused commitments (“two-step total commitments”) peaked in second quarter 2007 and has since contracted by $247.9 million, or 61%, to $158.3 million as of June 30, 2008. At June 30, 2008, the outstanding balance of loans originated in the two-step loan program was $145.7 million, down 45% from $263.0 million at December 31, 2007. Included in the $145.7 million loan balance at June 30, 2008 was $98.7 million in nonaccrual loans and $47.0 million in loans that were accruing interest. Remaining unused commitments totaled $12.6 million at June 30, 2008, down from $149.9 million a year ago.
It is anticipated that the two-step loan balances will continue to run-off over the next six to nine months as performing loans are paid off and nonaccrual loans which do not pay off become OREO property.
The following table presents two-step total commitments outstanding at June 30, 2008, by the scheduled period in which the underlying loans mature or matured.
| (Dollars in thousands) | | Two-step loan |
| | total commitments |
| Maturities in period ended | | commitment maturities |
| Fourth quarter 2007 | | $ | 12,095 |
| First quarter 2008 | | | 29,509 |
| Second quarter 2008 | | | 39,369 |
| Third quarter 2008 | | | 58,483 |
| Fourth quarter 2008 | | | 18,475 |
| First quarter 2009 | | | 400 |
| Total | | $ | 158,331 |
Substantially all future maturities are scheduled to occur in 2008. Actual maturities may occur somewhat later than indicated in the table as certain commitments may be extended in the regular course of the construction lending business.
- 43 -
The following table illustrates two-step total commitments by geographic areas as of the dates shown.
| (Dollars in thousands) | | | | | | |
| | June 30, | | December 31, |
| Region | | 2008 | | 2007 |
| Portland, Oregon / Vancouver, Washington | | $ | 45,681 | | $ | 102,336 |
| Western Washington (Olympia, Seattle) | | | 48,040 | | | 113,331 |
| Central Oregon (Bend, Redmond) | | | 21,920 | | | 44,310 |
| Oregon Coast (Newport, Lincoln City) | | | 16,168 | | | 32,655 |
| Willamette Valley (Salem, Eugene) | | | 20,010 | | | 34,331 |
| Southern Oregon (Medford, Roseburg) | | | 6,512 | | | 14,574 |
| Total residential real estate construction loan commitments | | $ | 158,331 | | $ | 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. We have also formed a dedicated team to address all of the activities associated with acquiring, maintaining, and disposing of two-step OREO properties.
Providing mortgage loans to two-step borrowers who qualify. We have developed a set of mortgage loan products to provide bridge financing and 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. Under certain circumstances, we may consider discounting debt in order to restructure the loan to fit the borrower’s debt service capacity. We expect nonperforming assets to be higher in this portfolio as compared to our standard mortgage products. During the second quarter, short term extensions represented a significant component of nonaccrual non standard loans. Going forward, we will no longer offer short term extensions in the non standard program.
- 44 -
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 and second quarters. The application of these profiles caused a certain number of additional loans that were either current or 30-89 days past due to be included in nonaccrual loans at June 30, 2008.
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 continues to accelerate the timing of charge-offs associated with collateral dependent two-step loans.
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) | | June 30, | | March 31, | | December 31, |
| | 2008 | | 2008 | | 2007 | | 2006 |
| Non-accruing two-step loans | | $ | 98,728 | | | $ | 88,784 | | | $ | 20,545 | | | $ | 567 | |
| 90 days past due and accruing interest two-step loans | | | - | | | | - | | | | - | | | | - | |
| Total nonperforming two-step loans | | | 98,728 | | | | 88,784 | | | | 20,545 | | | | 567 | |
| |
| Other real estate owned two-step | | | 26,460 | | | | 5,688 | | | | 3,255 | | | | - | |
| Total nonperforming two-step assets | | $ | 125,188 | | | $ | 94,472 | | | $ | 23,800 | | | $ | 567 | |
| |
| Delinquent two-step loans 30-89 days past due | | $ | 5,462 | | | $ | 14,269 | | | $ | 36,778 | | | $ | 2,969 | |
| |
| Nonperforming two-step loans to total two-step loans | | | 67.76 | % | | | 42.00 | % | | | 7.81 | % | | | 0.33 | % |
| Nonperforming two-step assets to total assets | | | 4.75 | % | | | 3.60 | % | | | 0.90 | % | | | 0.02 | % |
| Allowance for two-step loan losses to nonperforming two-step loans | | | 4.92 | % | | | 11.25 | % | | | 116 | % | | | 462 | % |
| Allowance for two-step loan losses to nonperforming two-step assets | | | 3.88 | % | | | 10.58 | % | | | 100 | % | | | 462 | % |
| Delinquent two-step loans to total two-step loans | | | 3.75 | % | | | 6.75 | % | | | 13.99 | % | | | 1.73 | % |
Nonperforming two-step assets were $125.2 million at June 30, 2008, up from $23.8 million at December 31, 2007. At June 30, 2008, total nonperforming two-step assets of $125.2 million consisted of $98.7 million in nonaccrual loans and the book value of 101 residential properties carried in OREO in the amount of $26.5 million. We anticipate nonperforming two-step loans to decline and two-step related OREO balances to increase in the second half of 2008. Furthermore, in future periods we project a significantly lower level of growth, if any, in nonperforming assets associated with the two-step portfolio.
The substantial increase in nonperforming loans during the first half of 2008 was partly attributable to a loan policy change implemented in the first quarter of 2008, 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 June 30, 2008, the $98.7 million two-step nonaccrual balance included $9.1 million in loan balances where payments are current, $27.8 million that were 30-89 days past due, and $61.8 million that were over 90 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. In addition to the 101 properties in the two-step OREO portfolio at June 30, 2008, we had approximately 249 additional two-step related properties in various stages of foreclosure, representing a total of $74 million included in our nonperforming loans. We expect to have approximately 60 of these properties representing an estimated $21 million in balances booked into OREO during the third quarter of 2008. As this occurs, the balances are moved from nonperforming loan status 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 both the OREO balance associated with two-step properties and the number of such OREO properties sold to increase over the next 6 months.
- 45 -
Delinquencies - Two-Step Loans.Delinquencies in the two-step loan portfolio decreased to $5.5 million at June 30, 2008 from $36.8 million at year end 2007, primarily 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 and materially fewer loans with scheduled maturity in the most recent quarter compared to prior quarters. Delinquent two-step loans were 3.75% of total two-step loans at June 30, 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.
| | Year to date | | Quarter to date | | | | | | | | |
| (Dollars in thousands) | | June 30, | | March 31, | | December 31, |
| | 2008 | | 2008 | | 2007 | | 2006 |
| Allowance for credit losses two-step loans, beginning of period | | $ | 31,065 | | | $ | 31,065 | | | $ | 2,618 | | | $ | 1,166 | |
| Provision for credit losses two-step loans | | | 2,727 | | | | 780 | | | | 30,980 | | | | 1,452 | |
| |
| Loan charge-offs two-step loans | | | (29,817 | ) | | | (20,099 | ) | | | (2,540 | ) | | | - | |
| Recoveries two-step loans | | | 1,305 | | | | 66 | | | | 7 | | | | - | |
| Net loan charge-offs two-step loans | | | (28,512 | ) | | | (20,033 | ) | | | (2,533 | ) | | | - | |
| Total allowance for credit losses two-step loans | | $ | 5,280 | | | $ | 11,812 | | | $ | 31,065 | | | $ | 2,618 | |
| |
| Components of allowance for credit losses two-step loans | | | | | | | | | | | | | | | | |
| Allowance for loan losses two-step loans | | $ | 4,858 | | | $ | 9,991 | | | $ | 23,917 | | | $ | 2,618 | |
| Reserve for unfunded commitments two-step loans | | | 422 | | | | 1,821 | | | | 7,148 | | | | - | |
| Total allowance for credit losses two-step loans | | $ | 5,280 | | | $ | 11,812 | | | $ | 31,065 | | | $ | 2,618 | |
| |
| Net charge-offs two-step loans to average total loans annualized | | | 2.63 | % | | | 3.70 | % | | | 0.12 | % | | | 0.00 | % |
| Allowance for two-step loan losses to total two-step loans | | | 3.33 | % | | | 4.73 | % | | | 9.10 | % | | | 1.52 | % |
| Allowance for two-step credit losses to total two-step loans | | | 3.62 | % | | | 5.59 | % | | | 11.81 | % | | | 1.52 | % |
The provision for two-step credit losses was $2.7 million year to date 2008. The allowance for credit losses associated with the two-step loan portfolio decreased to $5.3 million, or 3.62%, of total two-step loans at June 30, 2008, down from $31.1 million, or 11.8%, at year end 2007. The $5.3 million two-step allowance for credit losses is allocated into three separate components as follows: a pool based formula allowance of $4.0 million, a $.9 million unallocated allowance, and a $.4 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. As presented below, the allowance for credit losses as a percentage of accruing two-step loans and the total commitment associated with those accruing loans has been relatively stable since the allowance was established at year end 2007. There was no allowance for credit losses established for nonperforming two-step loans at June 30, 2008, as these collateral dependent loans have been impaired with a corresponding charge-off down to estimated fair market value less sales expense in accordance with the new loan policy established in the first quarter.
The reserve model utilized to establish the loan loss reserve for the two-step portfolio at year end 2007 included estimates for two key variables: the probability of default and the loss rate upon default. As of June 30, 2008, we reevaluated both variables and determined actual experiences for closed and pending OREO and short sales were within a reasonable range of the estimates made at year end. A number of data elements were reviewed, including change from original to updated appraised value, sales price relative to updated appraised value, sales expenses, and commitment draw percentage.
- 46 -
The following table provides additional two-step loan and allowance for credit losses information.
| (Dollars in thousands) |
| |
| | | | | | | | | | | | | | | | | Allowance for | | Allowance for |
| | | | | | | | | | | | | | | | | credit losses on | | credit losses on |
| | | | | | | | | | | | | | | | | two-step loans | | two-step loans as |
| | | | | | | | | | | Total accruing | | Allowance for | | as a % of | | a % of total |
| | Total two-step | | Nonperforming | | Accruing two- | | two-step loan | | credit losses on | | accruing two- | | accruing two-step |
| Period ended | | loans | | two-step loans | | step loans | | commitments | | two-step loans | | step loans | | loan commitments |
| 12/31/2007 | | $ | 262,952 | | $ | 20,545 | | $ | 242,407 | | $ | 320,991 | | $ | 31,065 | | 12.8% | | 9.7% |
| 3/31/2008 | | | 211,406 | | | 88,784 | | | 122,622 | | | 156,823 | | | 11,812 | | 9.6% | | 7.5% |
| 6/30/2008 | | | 145,703 | | | 98,728 | | | 46,975 | | | 59,603 | | | 5,280 | | 11.2% | | 8.9% |
The table above indicates that the allowance for credit losses on two-step loans has been fairly consistent relative to the remaining portfolio of performing two-step loans and the commitments associated with those loans. As previously noted at June 30, 2008 there was no allowance for credit losses associated with nonperforming two-step loans because all those loans had previously been deemed impaired and charged off to their fair market value less selling costs.
Net Loan Charge-offs – Two-Step Loans.Net charge-offs in the two-step loan portfolio were $28.5 million in the first six months of 2008. The charge-offs and interest reversal amounts in the two-step loan portfolio during the first six months of 2008 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.
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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 second quarters of 2008 and 2007.
| | Second Quarter 2008 | | Second Quarter 2007 |
| | Quarterly Average | | Percent | | Rate | | Quarterly Average | | Percent | | Rate |
| (Dollars in thousands) | | Balance | | of total | | Paid | | Balance | | of total | | Paid |
| Demand deposits | | $ | 467,664 | | 22.8 | % | | - | | | $ | 470,622 | | 23.3 | % | | - | |
| Interest bearing demand | | | 288,425 | | 14.1 | % | | 0.67 | % | | | 276,387 | | 13.7 | % | | 1.17 | % |
| Savings | | | 69,239 | | 3.4 | % | | 0.36 | % | | | 71,699 | | 3.6 | % | | 0.70 | % |
| Money market | | | 662,962 | | 32.4 | % | | 1.96 | % | | | 659,817 | | 32.7 | % | | 3.84 | % |
| Time deposits | | | 558,087 | | 27.3 | % | | 3.81 | % | | | 538,713 | | 26.7 | % | | 4.67 | % |
| Total deposits | | | 2,046,377 | | 100 | % | | 2.40 | % | | | 2,017,238 | | 100 | % | | 3.64 | % |
| |
| Short-term borrowings | | | 183,827 | | | | | 2.73 | % | | | 159,811 | | | | | 5.34 | % |
| Long-term borrowings(1) | | | 157,751 | | | | | 4.38 | % | | | 114,282 | | | | | 6.22 | % |
| Total borrowings | | | 341,578 | | | | | 3.49 | % | | | 274,093 | | | | | 5.71 | % |
| |
| Total deposits and borrowings | | $ | 2,387,955 | | | | | 2.52 | % | | $ | 2,291,331 | | | | | 3.84 | % |
(1) Long-term borrowings include junior subordinated debentures.
Second quarter 2008 average total deposits increased 1%, or $29 million, from the second quarter 2007. Our deposit mix remained fairly consistent year over year second quarter, with slightly more growth in the interest bearing demand and time deposit categories. The important average noninterest bearing demand category was 22.8% of total deposits, down slightly from 23.3% in the prior year second quarter. The rate paid on deposits in the most recent quarter declined 144 basis points from second quarter 2007 primarily due to lower market interest rates. The growth in interest bearing deposits for the remainder of 2008 will depend upon funding needs, customer demand, and relative cost of and availability of other funding sources including FHLB borrowings.
Average borrowings increased 25% or $67 million from the second quarter of 2007 as a result of higher borrowings from the Federal Home Loan Bank (“FHLB”) in the most recent quarter. Such borrowings were competitively priced relative to interest bearing deposits, including certificates of deposit.
Our deposit and borrowing cost decreased 132 basis points since the second quarter of 2007, primarily reflecting the decline in short-term market interest rates over the past year. Looking forward, we intend to price our deposit products competitively in connection with our efforts to maintain and grow our strong relationship deposit base. Whether we will be successful in not only maintaining, but also growing, our deposit base will depend on various factors, including pricing and our success in competing in uncertain economic and market conditions.
The balance of junior subordinated debentures at June 30, 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 following table summarizes the consolidated risk based capital ratios of Bancorp and the Bank at June 30, 2008, and December 31, 2007.
| | June 30, 2008 | | December 31, 2007 |
| | | | | | | | Amount | | Minimum | | | | | | | | | Amount | | Minimum |
| | | | | | | | Required For | | percent | | | | | | | | | Required For | | percent |
| | | | | | | | Well | | required for | | | | | | | | | Well | | required for |
| | Actual | | | | | Capitalized | | Well | | Actual | | | | | Capitalized | | Well |
| (Dollars in thousands) | | Amount | | Ratio | | Status | | Capitalized | | Amount | | Ratio | | Status | | Capitalized |
| Tier 1 Capital | | | | | | | | | | | | | | | | | | | | | | | | | |
| Common stockholders' equity | | $ | 205,508 | | | | | | | | | | | $ | 208,241 | | | | | | | | | | |
| Qualifying capital securities | | | 51,000 | | | | | | | | | | | | 51,000 | | | | | | | | | | |
| Less: Goodwill | | | 14,253 | | | | | | | | | | | | 14,491 | | | | | | | | | | |
| Other adjustments | | | 3,361 | | | | | | | | | | | | (585 | ) | | | | | | | | | |
| West Coast Bancorp total tier 1 capital | | $ | 245,616 | | 10.00 | % | | $ | 147,406 | | 6 | % | | $ | 244,165 | | | 9.88 | % | | $ | 148,206 | | 6 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Common stockholders' equity | | $ | 241,841 | | | | | | | | | | | $ | 244,047 | | | | | | | | | | |
| Qualifying capital securities | | | - | | | | | | | | | | | | - | | | | | | | | | | |
| Less: Goodwill | | | 14,253 | | | | | | | | | | | | 14,491 | | | | | | | | | | |
| Other adjustments | | | 3,369 | | | | | | | | | | | | (580 | ) | | | | | | | | | |
| West Coast Bank total tier 1 capital | | $ | 230,957 | | 9.45 | % | | $ | 146,655 | | 6 | % | | $ | 228,976 | | | 9.28 | % | | $ | 148,030 | | 6 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Tier 2 Capital | | | | | | | | | | | | | | | | | | | | | | | | | |
| Allowance for loans losses | | $ | 30,788 | | | | | | | | | | | $ | 31,141 | | | | | | | | | | |
| West Coast Bancorp total tier 2 capital | | $ | 30,788 | | | | | | | | | | | $ | 31,141 | | | | | | | | | | |
| |
| Allowance for loans losses | | $ | 30,633 | | | | | | | | | | | $ | 31,104 | | | | | | | | | | |
| West Coast Bank total tier 2 capital | | $ | 30,633 | | | | | | | | | | | $ | 31,104 | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Capital | | | | | | | | | | | | | | | | | | | | | | | | | |
| West Coast Bancorp | | $ | 276,404 | | 11.25 | % | | $ | 245,677 | | 10 | % | | $ | 275,306 | | | 11.15 | % | | $ | 247,010 | | 10 | % |
| West Coast Bank | | | 261,591 | | 10.70 | % | | | 244,425 | | 10 | % | | | 260,080 | | | 10.54 | % | | | 246,717 | | 10 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Leverage Ratio | | | | | | | | | | | | | | | | | | | | | | | | | |
| West Coast Bancorp | | $ | 245,616 | | 9.46 | % | | $ | 129,872 | | 5 | % | | $ | 244,165 | | | 9.41 | % | | $ | 129,759 | | 5 | % |
| West Coast Bank | | | 230,957 | | 8.90 | % | | | 129,796 | | 5 | % | | | 228,976 | | | 8.83 | % | | | 129,714 | | 5 | % |
| |
| Risk weighted assets | | | | | | | | | | | | | | | | | | | | | | | | | |
| Risk weighted assets on balance sheet | | $ | 2,301,245 | | | | | | | | | | | $ | 2,309,966 | | | | | | | | | | |
| Risk weighted assets off balance sheet exposure | | | 176,036 | | | | | | | | | | | | 195,781 | | | | | | | | | | |
| Less: Goodwill | | | 14,253 | | | | | | | | | | | | 14,491 | | | | | | | | | | |
| Less: Disallowed allowance for loan losses | | | 6,257 | | | | | | | | | | | | 21,159 | | | | | | | | | | |
| Other adjustments | | | - | | | | | | | | | | | | - | | | | | | | | | | |
| West Coast Bancorp risk weighted assets | | $ | 2,456,771 | | | | | | | | | | | $ | 2,470,097 | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Risk weighted assets on balance sheet | | $ | 2,288,881 | | | | | | | | | | | $ | 2,307,070 | | | | | | | | | | |
| Risk weighted assets off balance sheet exposure | | | 176,036 | | | | | | | | | | | | 195,781 | | | | | | | | | | |
| Less: Goodwill | | | 14,253 | | | | | | | | | | | | 14,491 | | | | | | | | | | |
| Less: Disallowed allowance for loan losses | | | 6,412 | | | | | | | | | | | | 21,195 | | | | | | | | | | |
| Other adjustments | | | - | | | | | | | | | | | | - | | | | | | | | | | |
| West Coast Bank total risk weighted assets | | $ | 2,444,252 | | | | | | | | | | | $ | 2,467,165 | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Average total assets | | | | | | | | | | | | | | | | | | | | | | | | | |
| West Coast Bancorp | | $ | 2,597,436 | | | | | | | | | | | $ | 2,595,174 | | | | | | | | | | |
| West Coast Bank | | | 2,595,920 | | | | | | | | | | | | 2,594,280 | | | | | | | | | | |
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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 6%, and a ratio of total capital to total risk-weighted assets of 10% or greater to be considered well capitalized. In addition, the leverage ratio of tier one capital to total assets less intangibles is required to be at least 5% to be considered well capitalized. As of June 30, 2008, Bancorp and the Bank are considered “Well Capitalized” under the regulatory risk based capital guidelines.
Bancorp’s stockholders' equity was $205 million at June 30, 2008, down from $208 million at December 31, 2007. The Company increased its capital ratios at June 30, 2008 from year end 2007 mainly as a result of declining risk weighted assets during the six month period. For example, the total capital ratio at the Bank was 10.70% at June 30, 2008, 70 basis points over minimum for well capitalized status and increased from 10.54% at December 31, 2007 while Bank Tier 1 capital increased from 9.28% to 9.45% over the same period.
Due to the uncertainty about the health of the economy and the local residential housing market, the Company has been and will continue to monitor and manage its capital position. In conjunction with those efforts, the Company expects risk weighted assets to decline in the second half of 2008, primarily as a result of declining loan balances. The Company may also evaluate slowing new loan commitments, participating out additional loans, and selling certain assets including loans. Furthermore, at this point, we do not anticipate any stock repurchase activity in the foreseeable future. The degree to which and the duration of time during which the Company may take steps to preserve and increase its capital will depend on various factors including general economic and real estate market conditions in our service areas, regulatory considerations, the level of consumer confidence in our institution and the banking sector generally, and our ability to manage and limit the adverse effects of losses on existing loans.
The risk based capital ratios of Bancorp include $51 million of trust preferred securities that qualify as Tier 1 capital at June 30, 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. The Company may also elect to reduce or eliminate its quarterly cash dividend to shareholders to preserve or grow its capital base.
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.”
Since December 31, 2007 all capital ratios shown in the table above increased for both Bancorp and Bank.
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 June 30, 2008. Except for stock repurchased in conjunction with the payment of taxes due on the vesting of restricted stock, the Company did not repurchase any shares during the first half of 2008.
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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 |
| Six months ended June 30, 2008 | | 18 | | - | | 18 | | | 184 | | | 10.22 |
| Total | | 277 | | 3,828 | | 4,105 | | $ | 71,711 | | $ | 17.47 |
Please also see discussion of stock repurchase activity during the quarter ended June 30, 2008, under Part II, Item 2, “Unregistered Sales of Equity Securities and Use of Proceeds” below.
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 June 30, 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. While, due to the nature of the placement of funds, CDARS deposits are defined as "brokered deposits" by regulatory agencies, the Company does not have any other forms of deposits considered brokered deposits. The Company’s CDARS balance at June 30, 2008, was $7.2 million in reciprocal balances. With media focus on and customer awareness of bank failures over the past month, it is possible that customer interest in and demand for CDARS deposits will increase. There can be no assurance that CDARS deposits will be available for the Company to offer its customers in the future.
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 June 30, 2008, the holding company did not have any borrowing arrangements of its own.
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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. Other potential sources of funds include lines of credit with correspondent banking partners. 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, changes in consumer confidence in depository institutions, 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.
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 unfunded commitments as of the dates displayed.
| (Dollars in thousands) | | Contract or | | Contract or |
| | Notional Amount | | Notional Amount |
| | June 30, 2008 | | December 31, 2007 |
| Financial instruments whose contract amounts represent credit risk: | | | | | | |
| Commitments to extend credit in the form of loans | | | | | | |
| Commercial | | $ | 364,810 | | $ | 395,203 |
| Real estate construction | | | | | | |
| Two-step loans | | | 12,628 | | | 78,585 |
| Other than two-step loans | | | 95,811 | | | 149,833 |
| Total real estate construction | | | 108,439 | | | 228,418 |
| Real estate mortgage | | | | | | |
| Standard mortgage | | | 5,655 | | | 7,320 |
| Non-standard mortgage | | | - | | | - |
| Home equity line of credit | | | 201,847 | | | 198,331 |
| Total real estate mortgage loans | | | 207,502 | | | 205,651 |
| Commercial real estate | | | 21,779 | | | 27,116 |
| Installment and consumer | | | 17,888 | | | 19,232 |
| Other1 | | | 23,073 | | | 24,223 |
| Standby letters of credit and financial guarantees | | | 10,843 | | | 8,081 |
| Account overdraft protection instruments | | | 68,314 | | | 54,093 |
| Total | | $ | 822,648 | | $ | 962,017 |
1 The 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 unfunded commitments to make loans decreased $139 million or 14% since December 31, 2007, primarily as a result of lower unused commitments in its commercial and real estate construction portfolio. Loan commitments extended longer than one year qualify as risk weighted assets and impact our risk based capital ratios. By decreasing the volume of loan commitments extended longer than one year risk weighted assets decline and, all else equal, capital ratios improve.
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.
During the second quarter 2008, the Company finalized and implemented changes in its internal control over financial reporting that are designed to timely identify impaired loans for non-accrual status, calculate applicable reversal of previously capitalized interest for impaired loans, and calculate charge-offs resulting from the recorded impairment. These controls include manual review and attestation steps designed to identify loans for impairment, place them on non-accrual, and calculate associated capitalized interest reversals and impaired loan charge-offs. To support these control steps, redundant controls over these financial reporting controls were also implemented. Specifically, secondary review processes, whereby an independent verification of the manual steps described above is performed and documented, were implemented to maximize the accuracy and completeness in performing the described control activities and properly record the results of these activities into the Company's applicable loan processing and financial reporting systems.
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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. We expect to take a significant number of properties into OREO in the third and fourth quarter of 2008 and, consequently we expect a larger OREO balance. 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. We will also be at risk of further declines in real estate prices and liquidity in the market areas in which we conduct our lending business.
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 of goodwill 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.
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We may need to raise additional capital which may not be available or may adversely affect existing shareholders. Alternatively, we may have to take steps to preserve capital.
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. In the event additional capital is projected to be or becomes needed and is unavailable on acceptable terms through available financing sources, we may need to take steps to preserve capital, including possibly slowing our lending activities and new loan commitments, selling certain assets, or increasing loan participations. We may also reduce or eliminate our cash dividend to shareholders or take other steps to preserve capital resources.
Market and other constraints on our construction loan origination volumes are expected to lead to decreases in our interest and fee income that are not expected to be offset by reductions in our non-interest expenses.
Due to existing conditions in housing markets in the areas where we operate and other factors, we project our construction loan originations to be materially constrained for the remainder of 2008. This will lower interest income and fees generated from this part of our business. Unless this revenue decline is offset by other areas of our operations, our total revenues may decline relative to our total non-interest expenses. We expect that it will be difficult to find new revenue sources in the near term to completely offset expected declines in our interest income, and we do not plan steps to significantly trim our non-interest expenses at this time because management believes such actions would be imprudent.
The value of certain securities in our investment securities portfolio may be negatively affected by disruptions in the market for these securities.
The market for certain investment securities held within our investment portfolio has over the past year become more volatile. The volatile market may affect the value of these securities, such as through reduced valuations due to the perception of heightened credit and liquidity risks, in addition to interest rate risk typically associated with these securities. There can be no assurance that the declines in market value associated with these disruptions will not result in impairments of these assets, which would lead to accounting charges that could have a material adverse effect on our net income, equity, and capital ratios.
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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 June 30, 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 |
| 4/1/08 - 4/30/08 | | 14,058 | | $ | 12.87 | | - | | 1,051,821 |
| 5/1/08 - 5/31/08 | | - | | $ | 0.00 | | - | | 1,051,821 |
| 6/1/08 - 6/30/08 | | - | | $ | 0.00 | | - | | 1,051,821 |
| Total for quarter | | 14,058 | | | | | - | | |
| | (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 14,058 shares, 0 shares, and 0 shares, respectively, for the periods indicated. There were no shares repurchased in the periods indicated 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 June 30, 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
Bancorp held its Annual Meeting of Shareholders on April 22, 2008. Below is a brief description of matters considered and voted on by shareholders and the number of votes cast for, against or withheld on such matters.
| 1. | | Electing nine directors to serve for one-year terms. |
| | Director | | | Votes for | | Votes withheld |
| Lloyd D. Ankeny | | 12,047,731 | | 232,330 |
| Michael J. Bragg | | 12,104,419 | | 175,643 |
| Duane C. McDougall | | 12,080,298 | | 199,763 |
| | Steven J. Oliva | | 12,105,348 | | 174,714 |
| J.F. Ouderkirk | | 12,094,756 | | 185,306 |
| Steven N. Spence | | 12,082,053 | | 198,009 |
| Robert D. Sznewajs | | 12,100,587 | | 179,475 |
| David J. Truitt | | 12,105,708 | | 174,354 |
| Nancy A. Wilgenbusch | | 12,081,034 | | 199,028 |
| 2. | | Ratification of the appointment of Deloitte & Touche LLP as our independent registered public accounting firm for 2008. |
| | Votes for | | | Votes against |
| 12,060,423 | | 37,741 |
Item 5. Other Information
None
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Item 6. Exhibits
| Exhibit No. | | Exhibit | |
| | 10.1 | | Form of Restricted Stock Performance Award Agreement (for Employee) under the West Coast Bancorp 2002 Stock Incentive Plan. |
| 31.1 | | Certification of CEO under Rule 13(a) – 14(a) of the Exchange Act. |
| 31.2 | | Certification of CFO under Rule 13(a) – 14(a) of the Exchange Act. |
| 32 | | Certification of CEO and CFO under 18 U.S.C. Section 1350. |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, this registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | | WEST COAST BANCORP |
| | | (Registrant) |
| |
| |
| |
| Dated: August 6, 2008 | | /s/ Robert D. Sznewajs |
| | | Robert D. Sznewajs |
| | | President and Chief Executive Officer |
| |
| |
| |
| Dated: August 6, 2008 | | /s/ Anders Giltvedt |
| | | Anders Giltvedt |
| | | Executive Vice President and Chief Financial Officer |
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