8. Adoption of New Accounting Standards In December 2002, the Financial Accounting Standards Board (FASB) issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.” SFAS No. 148 amends SFAS No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation. It also amends the disclosure provisions of SFAS No. 123 to require prominent disclosure about the effects on reported net income of an entity’s accounting policy decisions with respect to stock-based employee compensation. In addition, SFAS No. 148 amends Accounting Principles Board (APB) Opinion No. 28, “Interim Financial Reporting,” to require disclosure about those effects in interim financial information. As of June 30, 2003, the Company had not implemented the fair value based method of accounting for stock-based compensation under SFAS No. 148 or decided whether it would implement this method in the future. However, the related disclosures of SFAS No. 148 are included within the accompanying notes, as applicable. In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” This interpretation expands the disclosures to be made by a guarantor in its financial statements about its obligations under certain guarantees and requires the guarantor to recognize a liability for the fair value of an obligation assumed under a guarantee. Certain guarantees are subject to the disclosure requirements of FIN 45 but not to the recognition provisions. Such guarantees include, among others, a guarantee accounted for as a derivative instrument under SFAS No. 133, a parent’s guarantee of debt owed to a third party by its subsidiary or vice versa, and a guarantee which is based on performance, not price. The disclosure requirements of FIN 45 are effective for the Company as of December 31, 2002, and require disclosure of the nature of the guarantee, the maximum potential amount of future payments that the guarantor could be required to make under the guarantee, and the current amount of the liability, if any, for the guarantor’s obligations under the guarantee. The recognition requirements of FIN 45 are to be applied prospectively to guarantees issued or modified after December 31, 2002. The effect of adopting FIN 45 did not have a material effect on the Company’s condensed consolidated financial statements. 10
In January 2003, the FASB issued FASB Interpretation No. 46, (FIN46), “Consolidation of Variable Interest Entities”. FIN 46 provides accounting requirements for business enterprises to consolidate related entities in which they are determined to be the primary beneficiary as a result of their variable economic interests. The interpretation provides guidance in judging multiple economic interests in an entity and in determining the primary beneficiary. The interpretation outlines disclosure requirements for variable interest entities (“VIEs”) in existence prior to January 31, 2003, and provides consolidation requirements for VIEs created after January 31, 2003. The effect of adopting FIN 46 did not have a material effect on the Company’s condensed consolidated financial statements. In April 2003, the FASB issued Statement No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. This Statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities. This statement is effective for contracts entered into or modified after June 30, 2003 and is not expected to have an impact on the Company’s condensed consolidated financial statements or results of operations. In May 2003, the FASB issued Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity. This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, except for mandatory redeemable financial instruments of nonpublic companies. The effect of adopting SFAS No. 150 is not expected to have a material impact on the Company’s condensed consolidated financial statements or results of operations. 11
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the Company’s unaudited condensed consolidated financial statements and the notes thereto as of June 30, 2003 and the operating results for the six and three months then ended, included elsewhere in this report. Cautionary Information Concerning Forward-Looking Statements The following section contains forward-looking statements which are not historical facts and pertain to our future operating results. These statements include, but are not limited to, our plans, objectives, expectations and intentions and are not statements of historical fact. When used in this report, the word “expects,” “believes,” “anticipates” and other similar expressions are intended to identify forward-looking statements, which are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected. Specific risks and uncertainties include, but are not limited to, general business and economic conditions, changes in interest rates including timing or relative degree of change, and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business conditions, strategies and decisions, and such assumptions are subject to change. Results may differ materially from the results discussed due to changes in business and economic conditions that negatively affect credit quality, which may be exacerbated by our concentration of operations in the areas of Central Oregon, Salem/Keizer and Medford, Oregon. Likewise, competition or changes in interest rates could negatively affect the net interest margin, as could other factors listed from time to time in the Company’s SEC reports. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The Company undertakes no obligation to publish revised forward-looking statements to reflect the occurrence of unanticipated events or circumstances after the date hereof. Critical Accounting Policies Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and could potentially result in materially different results under different assumptions and conditions. We believe that our most critical accounting policy upon which our financial condition depends, and which involve the most complex or subjective decisions or assessments is as follows: Reserve for Loan Losses:Arriving at an appropriate level of reserve for loan losses involves a high degree of judgment. The Company’s reserve for loan losses provides for probable losses based upon evaluations of known and inherent risks in the loan portfolio. To estimate and assess the adequacy of the reserve for loan losses, management analyzes historical loss information and evaluates how the prevailing economic environment could impact the adequacy of the reserve. However, such analysis may be inexact, and changing economic circumstances could have an unforeseen impact on the estimate. The reserve for loan losses is increased by provisions for loan losses and by recoveries of loans previously charged-off and reduced by loans charged-off. For a full discussion of the Company’s methodology of assessing the adequacy of the reserve for loan losses, see the Management’s Discussion and Analysis of Financial Condition and Results of Operation in the Company’s Annual Report on Form 10K. HIGHLIGHTS FOR THE QUARTER: The Company continued strong second quarter 2003 growth and profitability, highlighted by robust deposit growth and solid increase in loan volumes. Net loans at June 30, 2003 were at $541.1 million, up 17.8% compared to the year ago level. Deposits surged to $597.1 million at quarter end, up 32.0% compared to a year ago and up 18.9% since year end 2002. At June 30, 2003, 97.1% of deposits were “core” in nature (demand, interest bearing demand, savings and time deposits less than $100,000). Net income for the quarter ended June 30, 2003 increased 27.4% to approximately $3,623,000, or $.28 diluted earnings per common share, as compared to net income of approximately $2,843,000, or $.22 diluted earnings per common share, for the same period in 2002. For the six months ended June 30, 2003, net income was up 28.2% to approximately $6,855,000 or $.53 diluted net income per common share, up from net income of approximately 5,349,000, or $.42 diluted net income per common share, for the same period in 2002. Stronger earnings during the periods were primarily due to higher net interest income resulting from growth in the Company’s loan portfolio. In addition, net income benefited from a lower provision for loan losses during the six months and three months ended June 30, 2003. The provision was $1,400,000 for the six-month period ended June 30, 2003 compared to $1,830,000 for the year earlier period and was $700,000 for the quarter ended June 30, 2003 compared to $900,000 for the same quarter the prior year. The reduced provision reflects a continued sound credit quality profile, lower delinquent loans, reduced net loan charge-offs and stable non-performing assets. Based upon its ongoing analytic and evaluative assessment, management believes the current level of the loan loss reserve is appropriate. 12
Noninterest income was up 27.5% for the six months and up 37.4% in the first quarter of 2003 as compared to the same periods in 2002. These increases were primarily due to increases in service charge income and strong revenues associated with the origination and sale of residential mortgage loans. Service charge income increased 39.6% and 44.5% for the six months and quarter ended June 30, 2003, respectively, compared to the year ago periods primarily due to higher transaction activity levels, pricing and product line enhancements and customer growth. Net mortgage revenue increased approximately 13.4% for the six months and 24.3% for the quarter ended June 30, 2003 compared to the year ago periods. As part of its long-term objective to deliver superior long-term growth in earnings per share, the Company expects to open several new banking offices over the net several quarters. On July 7th, the Company enhanced its current network of three Salem, Oregon branches with the opening of a new West Salem branch. In addition, the Company opened its first branch in Medford, Oregon on July 14, 2003, initiating its expansion into Southern Oregon. The aggregate start-up costs of these investments are expected to reduce earnings per share by approximately $.01 to $.02 per share in each of the next several quarters. Management forecasts that this initial affect on earnings will moderate as loan and deposit volumes build, and that these locations will reach the breakeven point within two years. Plans also call for the opening of a new branch in the Old Mill district of Bend early in 2004, as well as one to two additional branch openings during that year. In addition, on July 31, 2003, the Company announced an agreement to acquire Community Bank of Grants Pass (CBGP), a community bank headquartered in Grants Pass, Oregon with approximately $50 million in assets. The transaction will jump-start the Company’s recently announced expansion into Southern Oregon. CBGP shareholders will receive one share of CACB stock for each share of CBGP stock. At CACB’s recent stock price of $18, the value of the transaction is approximately $11.9 million, about 2.3 times book value or 17.6 times the last twelve months earnings reported by CBGP. The Company anticipates the acquisition will be accretive to shareholders within the first full year of operations. The combination is subject to due diligence, regulatory and CBGP shareholder approval. RESULTS OF OPERATIONS – Six months and Three months ended June 30, 2003 and 2002 Net Interest Income Net interest income increased 12.6% for the six months and increased 11.2% for the quarter ended June 30, 2003 as compared to the same periods in 2002, as interest earned on higher loan volumes outweighed the effect of a lower net interest margin. The net interest margin (NIM) was 6.36% for the second quarter ended June 30, 2003, compared to the year ago margin of 6.89%, and the preceding quarter’s margin of 6.52%. The ongoing low interest rate climate continues to cause declining loan yields that compress against an already low cost of funds. During the second quarter of 2003, yields earned on loans and investments stood at 7.06% compared to 7.26% in the prior quarter, down from 7.90% a year earlier. Meanwhile the average cost of funds for the quarter ended June 30, 2003 was relatively stable at 0.73% versus 0.77% in the first quarter and 1.04% a year ago. The net interest margin is a key indicator of profitability in the banking industry, reflecting the difference between rates earned on loans and investments compared to the cost of funds supporting these assets. As market interest rates have declined over the past several years, the banking industry in general has experienced margin compression, as banks have seen lower loan yields on both new and refinanced loans. At the same time, funding costs are already at low levels. With the Federal Reserve recently lowering federal funds rate to 1.00% in June 2003 – a level not seen since the 1950s – management forecasts that by year end 2003 the net interest margin may moderate toward a range between 6.20% and 6.00%. Forecasting the net interest margin is difficult, as unforeseen changes can occur in interest rates, the economy, or shape of the yield curve. In addition, customer and competitor behavior are difficult to predict and can affect yields on loans and rates on deposits. Please see the Company’s Annual Report on Form 10K for further information on interest rate risk. 13
As a result of higher loan volume, total interest income increased approximately $1,566,800 (or 8.5%) for the six months and increased approximately $711,900 (or 7.6%) for the quarter ended June 30, 2003 as compared to the same periods in 2002. Total interest expense decreased approximately $449,300 (or 18.3%) for the six months and decreased approximately $207,000 (or 17.1%) for the quarter ended June 30, 2003 as compared to the same periods in 2002. All categories of interest expense have decreased over the periods presented, with the exception of borrowings expense which increased for both periods presented primarily due to the interest expense incurred on $14 million fixed rate FHLB term advances, which is included in borrowings at period end. Average Balances and Average Rates Earned and Paid The following table sets forth for the quarter ended June 30, 2003 and 2002 information with regard to average balances of assets and liabilities, as well as total dollar amounts of interest income from interest-earning assets and interest expense on interest-bearing liabilities, resultant average yields or rates, net interest income, net interest spread, net interest margin and the ratio of average interest-earning assets to average interest-bearing liabilities for the Company: (Dollars in thousands) |
