141R retains the fundamental requirements of SFAS No. 141 that the acquisition method of accounting be used for all business combinations and for the acquirer to be identified for each business combination. SFAS No. 141R requires an acquirer to recognize the assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of the acquisition date. SFAS No. 141R also requires an acquirer to recognize assets acquired and liabilities assumed arising from contractual contingencies as of the acquisition date, measured at their acquisition-date fair values. This changes the requirements of SFAS No. 141 which permitted deferred recognition of preacquisition contingencies, until the recognition criteria for SFAS No. 5, “Accounting for Contingencies” were met. SFAS No. 141R will also require acquirers to expense acquisition-related costs as incurred rather than require allocation of such costs to the assets acquired and liabilities assumed. SFAS No. 141R is effective for business combination reporting for fiscal years beginning after December 15, 2008. The Company expects SFAS No. 141R to have a material impact on the accounting for any business combination occurring on or after January 1, 2009.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements - an amendment of ARB No. 51.” SFAS No. 160 amends Accounting Research Bulletin (ARB) No. 51, “Consolidated Financial Statements,” to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS No. 160 also clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. SFAS No. 160 requires consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the noncontrolling interest. Prior to SFAS No. 160, net income attributable to the noncontrolling interest generally was reported as an expense or other deduction in arriving at consolidated net income. Additional disclosures are required as a result of SFAS No. 160 to clearly identify and distinguish between the interests of the parent’s owners and the interests of the noncontrolling owners of a subsidiary. SFAS No. 160 is effective for fiscal years beginning after December 15, 2008. The Company is currently evaluating the impact that SFAS No. 160 may have on its future consolidated financial statements.
In March 2008, the FASB issued SFAS No. 161, “Disclosures About Derivative Instruments and Hedging Activities - an Amendment of FASB Statement No. 133.” SFAS No. 161 expands disclosure requirements regarding an entity’s derivative instruments and hedging activities. Expanded qualitative disclosures that will be required under SFAS No. 161 include: (1) how and why an entity uses derivative instruments; (2) how derivative instruments and related hedged items are accounted for under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,”and related interpretations; and (3) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. SFAS No. 161 also requires several added quantitative disclosures in financial statements. SFAS No. 161 will be effective for the Company on January 1, 2009. Management is currently evaluating the effect that the provisions of SFAS No. 161 will have on the Company’s consolidated financial statements.
On October 10, 2008, the FASB issued FSP FAS 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active. The FSP clarifies the application of FASB Statement No. 157, Fair Value Measurements, in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. The FSP is effective immediately, and includes prior period financial statements that have not yet been issued, and therefore the Company is subject to the provision of the FSP effective September 30, 2008. The implementation of FSP FAS 157-3 did not affect the Company’s fair value measurement as of September 30, 2008.
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 September 30, 2008 and the operating results for the nine months 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,” “could,” “may,” “will,” “should,” “plan,” “predicts,” “projections,” “continue” and other similar expressions constitute forward-looking statements, as do any other statements that expressly or implicitly predict future events, results or performance, and such statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Certain risks and uncertainties and the Company’s success in managing such risks and uncertainties may cause actual results to differ materially from those projected, including among others, the risk factors described in this report as well as general business and economic conditions, including conditions in residential and commercial real estate markets; volatility and disruption in financial markets; changes in regulatory conditions or requirements or new legislation; including government intervention in the U.S. financial system; changes in interest rates including timing or relative degree of change and the interest rate policies of the FRB; competition in the industry, including our ability to attract deposits; changes in the demand for loans and changes in consumer spending, borrowing and savings habits; changes in credit quality and in estimates of future reserve requirements; changes in the level of nonperforming assets and charge-offs; and changes in accounting policies: 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 States of Oregon and Idaho generally, including the Oregon communities of Central Oregon, Northwest Oregon, Southern Oregon, and the greater Boise area, specifically. 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. Readers should carefully review all disclosures filed by the Company from time to time with the SEC.
Recent Developments
The Emergency Economic Stabilization Act of 2008, signed into law on October 3, 2008, provides authority to the United States Treasury Department (“UST”) to, among other things, purchase up to $700 billion of mortgages, mortgage backed securities and certain other financial instruments from financial institutions. On October 14, 2008, the UST announced it will offer to qualifying U.S. banking organizations the opportunity to issue and sell preferred stock, along with warrants to purchase common stock, to the UST on what may be considered attractive terms under the Troubled Asset Relief Program (“TARP”) Capital Purchase Program. Although Cascade’s capital ratios remain well above the minimum levels required for well capitalized status, it is currently evaluating the TARP Capital Purchase Program. In addition, the FDIC has initiated the Temporary Liquidity Guarantee Program that will provide a 100 percent guarantee for a limited period of time to newly issued senior unsecured debt and non-interest bearing transaction deposits. Coverage under the Temporary Liquidity Guarantee Program is available for 30 days without charge and thereafter at a cost of 75 basis points per annum for senior unsecured debt and 10 basis points per annum for non-interest bearing transaction deposits. Management is currently evaluating possible participation in the Liquidity Guarantee Programs.
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 policies upon which our financial condition depends, and which involve the most complex or subjective decisions or assessments are as follows:
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Reserve for Credit Losses: The Company’s reserve for credit losses provides for probable losses based upon evaluations of known and inherent risks in the loan portfolio and related loan commitments. Arriving at an estimate of the appropriate level of reserve for credit losses (reserve for loan losses and loan commitments) involves a high degree of judgment and assessment of multiple variables that result in a methodology with relatively complex calculations and analysis. Management uses historical information to assess the adequacy of the reserve for loan losses as well as consideration of the prevailing business environment. On an ongoing basis the Company seeks to refine its methodology such that the reserve is responsive to the effect that qualitative and environmental factors have upon the loan portfolio. However, external factors and changing economic conditions may impact the portfolio and the level of reserves in ways currently unforeseen. 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. The reserve for loan commitments is increased and decreased through non interest expense. For a full discussion of the Company’s methodology of assessing the adequacy of the reserve for credit losses, see “Reserve for Credit Losses” in Management’s Discussion and Analysis of Financial Condition and Results of Operation in the Company’s Annual Report on Form 10K.
Mortgage Servicing Rights (MSRs): Determination of the fair value of MSRs requires the estimation of multiple interdependent variables, the most impactful of which is mortgage prepayment speeds. Prepayment speeds are estimates of the pace and magnitude of future mortgage payoff or refinance behavior of customers whose loans are serviced by the Company. Errors in estimation of prepayment speeds or other key servicing variables could subject MSRs to impairment risk. On a quarterly basis, the Company engages a qualified third party to provide an estimate of the fair value of MSRs using a discounted cash flow model with assumptions and estimates based upon observable market-based data and methodology common to the mortgage servicing market. Management believes it applies reasonable assumptions under the circumstances, however, because of possible volatility in the market price of MSRs, and the vagaries of any relatively illiquid market, there can be no assurance that risk management and existing accounting practices will result in the avoidance of possible impairment charges in future periods. See also “Non-Interest Income” below and footnote 5 of the Condensed Consolidated Financial Statements.
Goodwill and other intangibles: Net assets of entities acquired in purchase transactions are recorded at fair value at the date of acquisition. Identified intangibles are amortized on a straight-line basis over the period benefited. Goodwill is not amortized, although it is reviewed for impairment on an annual basis or if events or circumstances indicate a potential impairment. The impairment test is performed in two phases. The first step is to estimate the fair value of the reporting unit assuming it is sold in an orderly transaction between knowledgeable market participants. If the estimated fair value of the reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired; however, if the carrying amount of the reporting unit exceeds its estimated fair value, an additional procedure must be performed. That additional procedure compares the implied fair value of the reporting unit’s goodwill (as defined in SFAS No. 142, Goodwill and Other Intangible Assets) with the carrying amount of that goodwill. An impairment loss is recorded to the extent that the carrying amount of goodwill exceeds its implied fair value. At September 30, 2008, the Company performed its annual impairment test and concluded that no impairment existed at that time. Management continues to monitor the Company’s goodwill for potential impairment on an ongoing basis.
Highlights and Summary of Performance - Third Quarter of 2008
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| • | Credit Quality: Reserve for credit losses increased to $44.8 million or a strong 2.18% of total loans. |
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| • | Credit Quality: Non-performing assets (NPA’s) eased from immediately preceding (linked) quarter. |
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| • | Capital Ratios: up to 11.47% with $53 million surplus above “well-capitalized.” (tax equivalent basis) |
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| • | Earnings Per Share: at $0.02 with net income at $0.6 million. |
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| • | Total Deposits: 1.9% below year ago; up 10.8% on a linked-quarter basis. |
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| • | Total Loans: up 0.4% year-over-year and down slightly from the linked-quarter. |
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| • | Net Interest Margin: 4.42% vs. 4.52% on a linked-quarter basis. |
Cascade reported third quarter 2008 diluted earnings per share (EPS-diluted) at $0.02 per share compared to $0.35 for the year-ago quarter and $0.01 for the linked-quarter. The Company reported continued
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positive net income for the third quarter 2008 of $0.6 million versus $10.0 million a year-ago and up from $0.2 million for the linked-quarter. Year- to-date net income is $6.8 million or $0.24 per share.
Management believes Cascade’s credit quality issues continue to be largely confined within the residential development portfolio, which represents approximately 13% of total loans. Accordingly, third quarter 2008 includes a $15.0 million (pre-tax) provision for credit losses and net loan charge-offs of $8.2 million (pre-tax) mainly related to the residential development portfolio. As a result of the heightened provision, the reserve for credit losses increased to nearly $45 million or a solid 2.18% of total loans, up from 1.94% and 1.37% for the linked-quarter and year-ago period, respectively. In addition to its strong reserves, the Company has $163.3 million in tangible capital and is designated a “well-capitalized” bank according to regulatory guidelines with estimated total risk-based capital at 11.47% as of September 30, 2008, exceeding the 10% benchmark by a tax-effected margin of approximately $53.3 million. Further, Cascade’s pre-tax, pre-provision earnings are in the top 15% of banks in the nation its size. With the heightened risk in national and global economic outlook no assurance can be given that increased credit quality stress will not occur in the Bank’s loan portfolios.
Loan portfolio and credit quality
At September 30, 2008, Cascade’s loan portfolio was approximately $2.0 billion, essentially flat as compared to a year-ago and on a linked-quarter basis. Management believes that overall loan growth will likely remain muted until such time as the economic downturn runs its course. We continue to assist consumer and business relationship customers with their credit needs. Because of the nature of its markets, real estate has historically represented a significant portion of the Company’s overall loan portfolio and is frequently a material component of collateral for the Company’s loans.
At September 30, 2008, loans delinquent >30 days were steady at 0.21% of total loans compared to 0.19% for the linked-quarter and 0.46% at year-end 2007. This compares favorably to peer banks whose average delinquency rates were 0.89% at June 30, 2008. The Company’s delinquency rates in commercial real estate (CRE) and commercial (C&I) portfolios were 0.03% and 0.08% respectively, indicating continued stable credit quality at this time.
NPA’s (including non-performing loans and certain other real estate owned (OREO)) were modestly lower at $109.1 million, or 4.5% of total assets compared to $127.1 million or 5.2% of total assets for the linked-quarter. NPA’s are primarily related to the Company’s residential land acquisition and development loan portfolio. The decrease in NPA’s primarily resulted largely from reclassification of a previously reported non performing OREO to a performing status as discussed below.
OREO was $37.2 million at September 30, 2008 compared to $33.9 million in the prior quarter. During the quarter the Company sold 10 OREO lots, while approximately $5.5 million in assets were added to OREO at estimated fair value, primarily in residential land development assets. Note that beginning with the third quarter approximately $16.2 million of OREO balance is not classified as non-performing because it was determined that the commercial building revenues being received on a particular OREO property exceeded the interest income previously received on the underlying loan. Apart from this adjustment, NPA’s were slightly lower as compared to the prior quarter.
The Company carries NPA’s at the estimated net realizable fair value; however, because of the uncertain real estate market, no assurance can be given that the ultimate disposition of such assets will be at or above such value. The orderly resolution of non-performing loans as well as expedient disposition of OREO properties is a priority for management.
Management believes the reserve for credit losses is at an appropriate level based on frequently updated evaluation and analysis of portfolio credit quality in conjunction with prevailing economic conditions. With uncertainty as to the depth and duration of the current economic downturn forward assurances cannot be given that the reserve will be adequate in future periods or that the level of NPA’s will subside. Further provisioning and charge-offs may be required before values stabilize.
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Deposits
Customer relationship deposits1 continued to ease during the third quarter reflecting the slowing economy. Such deposits totaled $1.4 billion at September 30, 2008, down 12.6% compared to a year-ago and down 3.1% on a linked-quarter basis. Total deposits were $1.8 billion at September 30, 2008, down 1.9% compared to a year-ago but up 10.8% on a linked-quarter basis primarily due to increased brokered time deposits. At September 30, 2008 such deposits totaled $211.6 million as compared to $24.7 million at December 31, 2007. Note that Cascade’s proportion of time deposits to total deposits continues to remain well below its peer banks because of its focus on relationship deposits.
RESULTS OF OPERATIONS – Nine Months and Three Months ended September 30, 2008 and 2007
Income Statement
Net Income
Net income decreased $22.9 million (or 77.1%) for the nine months and decreased $9.4 million (or 94.3%) for the three months ended September 30, 2008 as compared to the same periods in 2007. These decreases were primarily due to an elevated level of loan loss provisioning for each period presented. Net interest income decreased $8.5 million for the nine months and decreased $3.8 million for the quarter ended September 30, 2008. Non-interest income and non-interest expenses were up slightly for the nine months ended September 30, 2008, meanwhile non-interest income increased 6.4% for the quarter primarily resulting from approximately $0.4 million in gains on sales of investment securities and $0.3 million in realized revenue on a performing OREO property as previously mentioned in this report.
Non-interest expense increased slightly in the nine months ended September 30, 2008 compared to the year earlier period primarily due to expenses related to OREO. Non-interest expense decreased in the third quarter of 2008 primarily due to a $2.1 million reduction in the estimated reserve for unfunded commitments as a result of declining outstanding commitments and lower estimated funding rates.
Net Interest Income / Net Interest Margin
Yields on earning assets during the third quarter of 2008 were 6.28% compared to 6.38% in the linked-quarter and down from 8.29% in the year ago quarter. The year-over-year and linked-quarter decline in yields were mainly a result of declining market rates as well as the effect of interest forgone and reversed on non-performing loans. The average rate paid on interest bearing liabilities was relatively flat at 2.35% for the current quarter as compared to 2.37% for the linked-quarter and is below the 4.11% for the year ago quarter due to the declining market rates.
Third quarter 2008 net interest margin (NIM) was 4.42% compared to 4.52% for the linked-quarter, and 5.24% for the year ago quarter. While the overall cost of funds remained unchanged at 1.90% from the prior quarter, the lower NIM was primarily due to interest reversed and foregone on non-performing loans and lower loan fees.
Because one of Cascade’s strengths is its relatively high proportion of non-interest bearing deposits, lower market interest rates may modestly compress the Company’s NIM as yields decline against an already low cost of funds. Importantly, this effect should also reverse once the economy rebounds. See cautionary “Forward Looking Statements” below and in Cascade’s Form 10-K report [and Item 2A below] for further information on risk factors including interest rate risk.
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1 Customer relationship deposits include core deposit transaction accounts such as checking, money market and savings, while excluding all wholesale or brokered deposits and time deposits greater than $100,000. |
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Components of Net Interest Margin
The following table sets forth for the quarter’s ended September 30, 2008 and 2007 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 and net interest margin for the Company (dollars in thousands):
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| | Quarter ended
September 30, 2008 | | Quarter ended
September 30, 2007 | |
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| | Average
Balance | | Interest
Income/
Expense | | Average
Yield or
Rates | | Average
Balance | | Interest
Income/
Expense | | Average
Yield or
Rates | |
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Assets | | | | | | | | | | | | | | | | | | | |
Taxable securities | | $ | 82,857 | | $ | 1,096 | | | 5.25 | % | $ | 93,995 | | $ | 1,313 | | | 5.54 | % |
Non-taxable securities (1) | | | 4,291 | | | 40 | | | 3.70 | % | | 7,249 | | | 66 | | | 3.61 | % |
Interest bearing balances due from FHLB | | | — | | | — | | | 0.00 | % | | 93 | | | 1 | | | 4.27 | % |
Federal funds sold | | | 1,457 | | | 6 | | | 1.63 | % | | 3,423 | | | 41 | | | 4.75 | % |
Federal Home Loan Bank stock | | | 13,351 | | | 45 | | | 1.34 | % | | 6,991 | | | 11 | | | 0.62 | % |
Loans (1)(2)(3)(4) | | | 2,060,256 | | | 33,042 | | | 6.36 | % | | 1,997,010 | | | 42,631 | | | 8.47 | % |
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Total earning assets/interest income | | | 2,162,212 | | | 34,229 | | | 6.28 | % | | 2,108,761 | | | 44,063 | | | 8.29 | % |
Reserve for loan losses | | | (39,073 | ) | | | | | | | | (24,665 | ) | | | | | | |
Cash and due from banks | | | 50,938 | | | | | | | | | 51,306 | | | | | | | |
Premises and equipment, net | | | 36,492 | | | | | | | | | 38,141 | | | | | | | |
Bank-owned life insurance | | | 33,946 | | | | | | | | | 32,711 | | | | | | | |
Accrued interest and other assets | | | 177,872 | | | | | | | | | 148,002 | | | | | | | |
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Total assets | | $ | 2,422,387 | | | | | | | | $ | 2,354,256 | | | | | | | |
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Liabilities and Stockholders’ Equity | | | | | | | | | | | | | | | | | | | |
Interest bearing demand deposits | | $ | 803,886 | | | 3,396 | | | 1.68 | % | $ | 918,875 | | | 8,389 | | | 3.62 | % |
Savings deposits | | | 37,561 | | | 36 | | | 0.38 | % | | 40,406 | | | 49 | | | 0.48 | % |
Time deposits | | | 401,770 | | | 3,045 | | | 3.01 | % | | 366,111 | | | 4,368 | | | 4.73 | % |
Other borrowings and F&M Holdback | | | 471,979 | | | 3,669 | | | 3.08 | % | | 242,082 | | | 3,426 | | | 5.61 | % |
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Total interest bearing liabilities/interest expense | | | 1,715,196 | | | 10,146 | | | 2.35 | % | | 1,567,474 | | | 16,232 | | | 4.11 | % |
Demand deposits | | | 407,420 | | | | | | | | | 476,707 | | | | | | | |
Other liabilities | | | 16,628 | | | | | | | | | 31,080 | | | | | | | |
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Total liabilities | | | 2,139,244 | | | | | | | | | 2,075,261 | | | | | | | |
Stockholders’ equity | | | 283,143 | | | | | | | | | 278,995 | | | | | | | |
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Total liabilities and stockholders’ equity | | $ | 2,422,387 | | | | | | | | $ | 2,354,256 | | | | | | | |
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Net interest income | | | | | $ | 24,083 | | | | | | | | $ | 27,831 | | | | |
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Net interest spread | | | | | | | | | 3.93 | % | | | | | | | | 4.18 | % |
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Net interest income to earning assets | | | | | | | | | 4.42 | % | | | | | | | | 5.24 | % |
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(1) | Yields on tax-exempt municipal loans and securities have been stated on a tax-equivalent basis. |
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(2) | Average non-accrual loans included in the computation of average loans was approximately $93.5 million for 2008 and $14.6 million for 2007. |
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(3) | Loan related fees recognized during the period and included in the yield calculation totalled approximately $1.1 million in 2008 and $1.5 million in 2007. |
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(4) | Includes mortgage loans held for sale. |
Analysis of Changes in Interest Income and Expense
The following table shows the dollar amount of increase (decrease) in the Company’s consolidated interest income and expense for the nine months and quarter ended September 30, 2008, and attributes such variance to “volume” or “rate” changes. Variances that were immaterial have been allocated equally between rate and volume categories (dollars in thousands):
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| | Quarter ended
September 30, 2008 vs. 2007 | |
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| | Total | | Volume | | Rate | |
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Interest income: | | | | | | | | | | |
Interest and fees on loans | | $ | (9,589 | ) | $ | 1,350 | | $ | (10,939 | ) |
Investments and other | | | (245 | ) | | (197 | ) | | (48 | ) |
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Total interest income | | | (9,834 | ) | | 1,153 | | | (10,987 | ) |
Interest expense: | | | | | | | | | | |
Interest bearing demand | | | (4,993 | ) | | (1,050 | ) | | (3,943 | ) |
Savings | | | (13 | ) | | (3 | ) | | (10 | ) |
Time deposits | | | (1,323 | ) | | 425 | | | (1,748 | ) |
Other borrowings | | | 243 | | | 3,254 | | | (3,011 | ) |
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Total interest expense | | | (6,086 | ) | | 2,626 | | | (8,712 | ) |
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Net interest income | | $ | (3,748 | ) | $ | (1,473 | ) | $ | (2,275 | ) |
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Loan Loss Provision
The loan loss provision was $32.1 million for the nine months and $15.0 million for the three months ended September 30, 2008 due to elevated credit risk in the loan portfolio. At September 30, 2008, the reserve for credit losses (reserve for loan losses and loan commitments) was 2.18% of outstanding loans, as compared to 1.37% for the year ago period. At this date, management believes that its reserve for credit losses is at an appropriate level under current circumstances and prevailing economic conditions. For further discussion, see “Critical Accounting Policies - Reserve for Credit Losses” and “Loan Portfolio and Credit Quality” above. There can be no assurance that the reserve for credit losses will be sufficient to cover actual loan related losses.
Non-Interest Income
Non-interest income increased 0.1% for the nine months and increased 6.4% for the quarter ended September 30, 2008 compared to the year ago periods. The increase for the quarter was primarily due to $0.4 million in gain on the sales of investment securities. Service charges remained relatively flat in both periods presented however other income was up in 2008 as a result of approximately $0.3 million in realized revenue primarily on the performing OREO property. See “Highlights – Loan Growth and Credit Quality” above for further discussion. Non-Interest Income for the third quarter of 2008 was $5.5 million, up compared to the year-ago quarter and up modestly from the linked-quarter.
As a result of tightening credit conditions in national markets and related home-buyer caution, residential mortgage originations were down 41.3% to $21.3 million for the current quarter ended September 30, 2008 compared to $36.3 million in the linked-quarter and down 45.1% from the year-ago period totaled. Logically, net mortgage related revenue was down in the third quarter of 2008, compared to the linked-quarter and year-ago periods. Note that the Company has focused on originating conventional mortgage products throughout its history while purposefully avoiding sub-prime / option-ARM type products. As a result, the delinquency rate within Cascade’s $510 million portfolio of serviced residential mortgage loans is only 0.55%, notably below the national mortgage delinquency rate of 6.41% at September 30, 2008. The fair value of servicing portfolio is estimated to exceed book value by amounts ranging from $1.2 million to $2.3 million.
Non-Interest Expense
Non-interest expense for the nine months was up 2.7% year-over-year but down 9.9% on a linked quarter basis. The 2008 increase was mainly due to higher OREO and related legal costs. The decrease in the current quarter was primarily due to a $2.1 million reduction in the estimated reserve for unfunded commitments as a result of declining outstanding commitments and lower estimated funding rates. Excluding this factor, normalized non interest expense levels for the three months ended September 30, 2008, were down 5.1% compared to the prior quarter and up 3.9% from the year-ago period. When compared to the year-ago quarter, adjusted expenses were higher due to OREO and related costs which totaled approximately $0.5 million. Management anticipates that aside from possible volatility of OREO related costs, normalized non interest expense levels should be flat to down slightly during the next quarter. However, note that the FDIC has recently announced an increase in insurance assessments which may affect non interest expense in the future. Management is presently analyzing the FDIC announcement and its impact on the Company.
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Income Taxes
Income tax expense decreased 86.1% for the nine months and decreased 98.5% for the three months ended September 30, 2008 compared to the year ago periods, primarily as a result of lower pre-tax income.
Financial Condition
Balance Sheet Overview
At September 30, 2008 total assets slightly increased 0.7% to $2.4 billion compared to $2.3 billion at December 31, 2007. During the quarter, the Company accessed the brokered time deposit market to augment aggregate deposits. This increase was partially offset by a decrease in interest bearing demand accounts, federal funds purchased and other borrowings during the period.
The Company had no material off balance sheet derivative financial instruments as of September 30, 2008 and December 31, 2007.
Capital Resources
The Company’s total stockholders’ equity at September 30, 2008 was $276.7 million, an increase of $1.4 million from December 31, 2007. The increase primarily resulted from net income for the nine months ended September 30, 2008 of $6.8 million, less cash dividends paid to shareholders of $5.9 million during the same period.
The Company and Bank continue to exceed the regulatory benchmarks for ‘well capitalized’ institutions. At September 30, 2008, the Company’s Tier 1 and total risked-based capital ratios were 10.22% and 11.47%, respectively. The FRB’s minimum risk-based capital ratio guidelines for Tier 1 and total capital are 4% and 8%, respectively.
From time to time the Company may determine that it is appropriate to seek additional capital to maintain an appropriate level of capital, improve its financial condition, or to take advantage of possible future opportunities. The ability to raise capital may depend upon market and economic circumstances. Accordingly no assurance can be given that possible capital transactions will be available or will be available on terms that are favorable to the Company. In the case of equity financings, dilution to the Company’s shareholders could result while debt financing could also negatively affect future earnings due to interest charges.
Cascade is currently evaluating the federal government’s Troubled Asset Relief Program created pursuant to the recently enacted Emergency Economic Stabilization Act, which includes legislation concerning access to capital, problem asset resolution and other items.
Off-Balance Sheet Arrangements
A summary of the Bank’s off-balance sheet commitments at September 30, 2008 and December 31, 2007 is included in the following table (dollars in thousands):
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| | September 30, 2008 | | December 31, 2007 | |
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Commitments to extend credit | | $ | 572,055 | | $ | 669,336 | |
Commitments under credit card lines of credit | | | 30,030 | | | 30,490 | |
Standby letters of credit | | | 20,364 | | | 27,602 | |
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Total off-balance sheet financial instruments | | $ | 622,449 | | $ | 727,428 | |
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Liquidity and Sources of Funds
Bancorp is a single bank holding company and its primary ongoing source of liquidity is from dividends received from the Bank. Such dividends arise from the cash flow and earnings of the bank. Banking regulations and authorities may limit the amount or require certain approvals of the dividend that the Bank may pay to the Bancorp. In addition, Bancorp receives cash from the exercise of incentive stock options and the issuance of trust preferred securities. If the Company desires to raise funds in the future management may consider engaging in further offerings of trust preferred securities, debentures or other borrowings as well as issuance of capital stock.
The objective of the Bank’s liquidity management is to maintain ample cash flows to meet obligations for depositor withdrawals, fund the borrowing needs of loan customers, and to fund ongoing operations. Core relationship deposits are the primary source of the Bank’s liquidity. As such, the Bank focuses on deposit relationships with local business and consumer clients who maintain multiple accounts and services at the Bank. Management views such deposits as the foundation of its long-term liquidity because it believes such core deposits are more stable and less sensitive to changing interest rates and other economic factors compared to large time deposits or wholesale purchased funds. The Bank’s customer relationship strategy has resulted in a relatively higher percentage of its deposits being held in checking and money market accounts, and a lesser percentage in time deposits. Over the past several quarters customer relationship deposits have declined in tandem with the slowing economy. Accordingly the Bank has increased its overall use of wholesale funding sources and anticipates that such will be the case until the economy rebounds.
Diversified and reliable sources of wholesale funds are utilized to augment core deposit funding. Borrowings may be used on a long or short-term basis to compensate for reduction in other sources of funds or on a long term basis to support lending activities. The Bank utilizes its investment securities, certain loans and FHLB Stock to provide collateral to support its borrowing needs. Policy requires the analysis and testing of such sources to ensure ample cash flow is available under a range of circumstances. Management believes that its focus on core relationship deposits coupled with access to borrowing through reliable counterparties provides reasonable and prudent assurance that ample liquidity is available. However, depositor or counterparty behavior could change in response to competition, economic or market situations or other unforeseen circumstances, which could have liquidity implications that may require different strategic or operational actions. One source of wholesale funding is brokered deposits. Consistent with its risk management policy and in response to the general tightening of credit and liquidity conditions in the financial markets at large, the Bank recently increased its use of brokered deposits. At September 30, 2008, such deposits totaled approximately $211.6.1 million compared to $24.7 million at December 31, 2007.
The Bank’s primary counterparty for borrowing purposes is the FHLB. At September 30, 2008, the FHLB had extended the Bank a secured line of credit of $854.5 million that may be accessed for short or long-term borrowings given sufficient qualifying collateral. As of September 30, 2008, the Bank had qualifying collateral pledged for FHLB borrowings totaling $352.3 million. The Bank also had $147.2 million in borrowing availability from the FRB that requires specific qualifying collateral. In addition, the Bank maintained unsecured lines of credit totaling $35.1 million for the purchase of funds on a short-term basis from several commercial bank counterparties. Borrowing capacity may fluctuate based upon collateral and other factors. At September 30, 2008, the Bank had remaining available borrowing capacity on its aggregate lines of credit totaling $761.3 million given sufficient collateral.
Recently the U.S. Treasury announced a program under which the FDIC would temporarily provide a guarantee of the senior debt of all FDIC-insured institutions and their holding companies. Coverage under the Temporary Liquidity Guarantee Program is available for 30 days without charge and thereafter at a cost of 75 basis points per annum for senior unsecured debt and 10 basis points per annum for non-interest bearing transaction deposits. Management is assessing the possible effect of these programs on liquidity.
Liquidity may be affected by the Bank’s routine commitments to extend credit. Historically a significant portion of such commitments (such as lines of credit) have expired or terminated without funding. In addition, more than one-third of total commitments pertain to various construction projects. Under the terms of such construction commitments, completion of specified project benchmarks must be certified before funds may be drawn. At September 30, 2008, the Bank had approximately $578.7 million in outstanding commitments to extend credit, compared to approximately $727.4 million at year-end 2007. At this time, management believes
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that the Bank’s available resources will be sufficient to fund its commitments in the normal course of business.
Inflation
The effect of changing prices on financial institutions is typically different than on non-banking companies since virtually all of a bank’s assets and liabilities are monetary in nature. In particular, interest rates are significantly affected by inflation, but neither the timing nor magnitude of the changes are directly related to price level indices; therefore, the Company can best counter inflation over the long term by managing net interest income and controlling net increases in noninterest income and expenses.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The disclosures in this item are qualified by the Risk Factors set forth in Item 1A and the Section entitled “Cautionary Information Concerning Forward-Looking Statements” included in Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations in this report and any other cautionary statements contained herein.
Refer to the disclosures of market risks included in Item 7A Quantitative and Qualitative Disclosures about Market Risks in the Company’s 2007 Form 10-K.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedure
As required by Rule 13a-15 under the Exchange Act of 1934, the Company carried out an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of the end of the period covered by this report. This evaluation was carried out under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and the Company’s Chief Financial Officer. Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective as of the end of the period covered by this report.
Changes in Internal Controls
During the third quarter of 2008, the Company had no changes to identified internal controls that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is from time to time a party to various legal actions arising in the normal course of business. Management does not expect the ultimate disposition of these matters to have a material adverse effect on the business or financial position of the Company.
ITEM 1A. RISK FACTORS
In addition to the risk factor detailed below, please see “Item 1A. Risk Factors” of our 2007 Annual Report on Form 10-K for discussion of risks that may affect our business.
The Company May Be Adversely Affected by Current Economic and Market Conditions
The national and global economic downturn has recently resulted in unprecedented levels of financial market volatility which may depress overall the market value of financial institutions, limit access to capital, or have a material adverse effect on the financial condition or results of operations of banking companies in general and the Company in particular. In addition, the possible duration and severity of the adverse economic cycle is unknown and may exacerbate Cascade’s exposure to credit risk. Treasury and FDIC programs have been initiated to address economic stabilization, yet the efficacy of these programs in stabilizing the economy and the banking system at large are uncertain. Details as to Cascade’s participation or access to such programs and their subsequent impact on the Company also remain uncertain.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
During the quarter ended September 30, 2008, the Company did not repurchase any shares under its currently authorized repurchase plan and does not expect to engage in repurchase for the foreseeable future. As of September 30, 2008, the Company could repurchase up to an additional 1,423,526 shares under this repurchase plan.
ITEM 6. EXHIBITS
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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| CASCADE BANCORP | |
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| (Registrant) | |
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Date | 10/28/2008 | | By | /s/ Patricia L. Moss |
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| | | | Patricia L. Moss, President & CEO |
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Date | 10/28/2008 | | By | /s/ Gregory D. Newton |
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| | | | Gregory D. Newton, EVP/Chief Financial Officer |
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