Non-interest expense increased 37.4% for the nine months and 65.7% for the quarter ended September 30, 2006, compared to the same periods in 2005. Expense increases were primarily due to the acquisition of F&M and attendant higher staffing levels, occupancy related costs and CDI amortization. In addition, other expenses grew with strong business volumes.
Income tax expense increased between the periods presented primarily as a result of higher pre-tax income.
At September 30, 2006 total assets increased 76.9% to $2.2 billion compared to $1.3 billion at December 31, 2005. The majority of the increase is attributable to the acquisition of F&M but strong organic loan growth during the first nine months of 2006 also contributed to the overall increase. The acquisition also led to a larger investment portfolio at $126.3 million on September 30, 2006 as compared to $59.3 million at year-end 2005. Asset growth was funded by increased deposits and borrowings over the past 9 months. Primarily because of the acquisition, deposits have increased $565 million to $1.6 billion at September 30, 2006 as compared to $1.1 billion at December 31, 2005. Deposit growth is also a function of ongoing growth in relationship customer balances and is positively impacted by the strong economies in which Cascade operates.
During the first quarter of 2006, the Bank joined the Certificate of Account Registry Service (CDARS) that enables Cascade to distribute (and/or receive reciprocal) time deposits with other banks participating in the CDARS network on behalf of customers that are sensitive to the $100,000 FDIC insurance limitation. Such deposits are considered to be brokered funds and totaled approximately $43.2 million at September 30, 2006. In addition, during the second and third quarters of 2006, the Company participated in the States of Oregon and Idaho CD programs and at September 30, 2006, time deposits included approximately $25 million of such time deposits.
The Company had no material off balance sheet derivative financial instruments as of September 30, 2006 and December 31, 2005.
The objective of 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. The Bank’s present funding mix is diverse, with approximately 76% of its checking account balances arising from business and public accounts and 24% from consumers. The composition of money market and interest-bearing demand accounts was 46% business and 54% consumer. During the periods presented, deposit growth has generally been sufficient to fund increases in loans. Management invests excess funds in short-term and overnight money market instruments. Since December 31, 2005, the average amount of overnight investments declined by approximately $58 million on average, with such funds redeployed to fund loan growth. At September 30, 2006, total borrowings included Cascade’s issuance of approximately $68.6 million in junior subordinated trust preferred securities.
A further source of funds and liquidity is the Company’s capability to borrow from reliable counterparties. The Bank utilizes its investment securities, certain loans, FHLB Stock and certain deposits to provide collateral to support its borrowing needs.
Policy requires the analysis and testing of liquidity 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 including relative returns available in stock or bond markets or other unforeseen circumstances, which could have liquidity implications that may require different strategic or operational actions.
The Bank’s primary counterparty for borrowing purposes is the Federal Home Loan Bank (FHLB). At September 30, 2006, the FHLB had extended the Bank a secured line of credit of $310.2 million that may be accessed for short or long-term borrowings given sufficient qualifying collateral. The Bank also had $41.0 million in short-term borrowing availability from the Federal Reserve Bank that requires specific qualifying collateral. In addition, the Bank maintained unsecured lines of credit totaling $105.0 million for the purchase of funds on a short-term basis from several commercial bank counterparties. At September 30, 2006, the Bank had aggregate remaining available borrowing sources totaling $233.2 million, given sufficient collateral.
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, 2006 the Bank had approximately $749.7 million in outstanding commitments to extend credit, compared to approximately $446.6 million at year-end 2005. Management believes that the Bank’s available resources will be sufficient to fund its commitments in the normal course of business.
JUNIOR SUBORDINATED DEBENTURES
The purpose of the Company’s $68.6 million of trust preferred securities was to fund the cash portion of the F&M acquisition, to support general corporate purposes and to augment regulatory capital. Management believes the securities qualify as Tier 1 regulatory capital and are priced at a competitive level. The Company’s obligations under the Debentures and related agreements, taken together, constitute a full and irrevocable guarantee by the Company of the obligations of the Trusts. The TPS are mandatorily redeemable upon the maturity of the Debentures, or upon earlier redemption as provided in the Indenture related to the Debentures. The TPS may be called by the Company at par at varying times subsequent to September 15, 2011, and may be redeemed earlier upon the occurrence of certain events that impact the income tax or the regulatory capital treatment of the TPS. See footnote 7 of the accompanying condensed consolidated financial statements for additional details.
OTHER BORROWINGS
The Company has increased its borrowings since the acquisition of F&M as it deployed a strategy that allowed relatively higher priced deposits to runoff while concentrating its energies on retaining and expanding relationship deposits. At September 30, 2006 the Bank had a total of approximately $100.6 million in long-term borrowings from FHLB with maturities from 2007 to 2025, bearing a weighted-average interest rate of 4.63%. In addition, at September 30, 2006, the Bank had short-term borrowings with FHLB and FRB of approximately $108.8 million and $3.8 million, respectively. At year-end 2005, the Bank had a total of $61.1 million in long-term borrowings from FHLB bearing a weighted-average interest rate of 3.91%, and short-term borrowings with FRB of approximately $3.2 million. See “Liquidity and Sources of Funds” section on page 22 for further discussion.
CAPITAL RESOURCES
The Company’s total stockholders’ equity at September 30, 2006 was $252.4 million, an increase of $148.0 million from December 31, 2005. The increase primarily resulted from the issuance of stock in connection with the acquisition of F&M in the amount of $124.6 million, net income for the nine months ended September 30, 2006 of $25.5 million, less cash dividends paid to shareholders of $5.6 million during the same period.�� In addition, at September 30, 2006 the Company had accumulated other comprehensive income of approximately $.4 million.
At September 30, 2006, the Company’s Tier 1 and total risked-based capital ratios under the Federal Reserve Board’s (“FRB”) risk-based capital guidelines were 9.71% and 10.91%, respectively. The FRB’s minimum risk-based capital ratio guidelines for Tier 1 and total capital are 4% and 8%, respectively.
23
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Market risk is the risk of loss from adverse changes in market prices and rates. The Company’s market risk arises principally from interest rate risk in its lending, deposit and borrowing activities. Management actively monitors and manages its interest rate risk exposure. Management considers interest rate risk to be a significant market risk, which could have the largest material effect on the Company’s financial condition and results of operations.
There has not been any material change in the market risk disclosure contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2005.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934, as amended) as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”). Based on such evaluation and because of the remediation of the material weakness described below prior to issuance of this quarterly report, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the Evaluation Date, our disclosure controls and procedures are effective in alerting them on a timely basis to material information relating to the Company required to be included in our reports filed or submitted under the Securities Exchange Act of 1934, as amended.
Material weakness in internal control with respect to recent acquisition:
As discussed earlier in this report, the Company acquired Farmers & Merchants State Bank in Idaho on April 20, 2006. At September 30, 2006, Cascade had determined that a material weakness in the Company’s internal control over financial reporting existed at the newly acquired F&M with respect to monitoring of certain construction loans and disbursements thereof. Section 404 of the Sarbanes-Oxley Act of 2002 (“SOX 404”) requires disclosure should the Company discover a “material weakness” as defined by the Public Company Oversight Board as “a significant deficiency or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.”
Specifically, Cascade believes that it is important to monitor progress of construction projects and has identified key controls related to periodic independent inspections and monitoring of disbursements to ensure projects are not over-disbursed prior to completion. Although some of these key controls were not consistently performed at September 30, 2006, such controls have since been implemented and the material weaknesses remediated as of the filing date of this report. Therefore, Cascade does not believe a misstatement of interim financial statements existed or will exist as a result of this weakness.
Remediation:
Upon discovery of this situation in the third quarter of 2006, the Company has taken various corrective actions to remediate monitoring deficiencies with respect to F&M construction loans and related disbursements. By their nature, such actions require a period of time to implement across the entire F&M portfolio. However, Cascade believes it has successfully completed this effort as of the date of this filing.
Remediation actions include hiring of qualified independent inspectors who have inspected substantially all of the construction loans subject to such review. Disbursement tracking has been implemented on a substantial portion of the portfolio, and loan disbursement exceptions are being monitored by credit administration. Other factors used in assessing the likelihood that this situation will cause a material misstatement includes information and analysis performed in the course of the Company’s acquisition due diligence during which all F&M loans over $.5 million were examined and found to reflect reasonable underwriting standards and practices including appropriate loan to value metrics and collateral levels. Pre – existing F&M control procedures called for Loan Officers to conduct periodic inspections, indicating their was some disbursement monitoring control in place (however, it was not an independent process).
24
With the implementation of internal control improvements in this regard, we expect the situation will not result in a material weakness in internal control over financial reporting when the Company next reports its financial results at December 31, 2006. As of December 31, 2006, management, and the Company’s independent registered public accounting firm will report on the effectiveness of the Company’s internal control over financial reporting under the Section 404 provisions of the Sarbanes-Oxley Act.
Internal control over financial reporting, no matter how well designed, has inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. The Company will continue to improve the design and effectiveness of disclosure controls and procedures and internal control over financial reporting to the extent necessary in the future to provide our senior management with timely access to such material information, and to correct any deficiencies that we may discover in the future.
Changes in Internal Controls
Except as noted above, there were no changes in the Company’s internal control over financial reporting that occurred during the quarter ended September 30, 2006 that materially affected, or that are reasonably likely to materially affect, the Company’s internal control over financial reporting.
25
PART II - OTHER INFORMATION
Item 1A. | Risk Factors |
| |
| There are no material changes to the risk factors disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2005. |
| |
Item 5. | Other Information |
| | |
| (b) | Reports on Form 8-K |
| | | |
| | The Company filed a report on Form 8-K on October 16, 2006 to announce both a 5-for-4 stock split and quarterly cash dividend of $.09 per share (applied to split adjusted shares) – resulting in a 25% dividend payout increase. |
| | | |
| | The Company filed a report on Form 8-K on October 12, 2006, in regards to release of the Company’s third quarter 2006 earnings. |
| | | |
Item 6. | Exhibits |
| | | |
| (a) | Exhibits |
| | | |
| | 31.1 | Certification of Chief Executive Officer |
| | 31.2 | Certification of Chief Financial Officer |
| | 32 | Certification Pursuant to Section 906 |
26
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.
| CASCADE BANCORP |
|
|
| (Registrant) |
| | |
| | |
Date 11/8/2006 | By | /s/ Patricia L. Moss |
| |
|
| | Patricia L. Moss, President & CEO |
| | |
| | |
Date 11/8/2006 | By | /s/ Gregory D. Newton |
| |
|
| | Gregory D. Newton,
EVP/Chief Financial Officer |
27
