ITEM 1. BUSINESS
General
West Coast Bancorp (“Bancorp” or the “Company”) is a bank holding company headquartered in Lake Oswego, Oregon. Bancorp’s principal business activities are conducted through its full-service, commercial bank subsidiary, West Coast Bank (the “Bank”), an Oregon state-chartered bank with deposits insured by the Federal Deposit Insurance Corporation (“FDIC”). At December 31, 2010, the Bank had facilities in 43 cities and towns in western Oregon and southwestern Washington, operating a total of 61 full-service and four limited-service branches and a Small Business Administration (“SBA”) lending office in Vancouver, Washington. Bancorp also owns West Coast Trust Company, Inc. (“West Coast Trust”), an Oregon trust company that provides agency, fiduciary and other related trust services with offices in Portland and Salem, Oregon.
Bancorp reports two principal operating segments in the notes to its financial statements: West Coast Bank and West Coast Trust and parent company related operations. For more information regarding Bancorp’s operating segments, see Note 22 “Segment and Related Information” to the Company’s audited consolidated financial statements included under the section “Financial Statements and Supplementary Data” in Item 8 of this report.
Bancorp experienced rapid balance sheet and loan growth during the period 2002-2007. With the onset of a significant slowdown in economic activity and unprecedented disruptions in the real estate and credit markets, this growth period ended in late 2007 and Bancorp experienced net losses of $6.3 million for 2008 and $91.2 million for 2009. The Bank’s earliest and most significant losses arose out of its two-step residential construction lending program pursuant to which the Bank made residential construction loans to individuals (referred to in this report as the “two-step loan program”). The Bank experienced significant losses in other loan portfolios as well resulting from the economic slowdown. The prolonged recession and severe slump in housing and other real estate markets have hindered the ability of the Bank’s borrowers to repay loans and the value of the property that serves as collateral for many of the Bank’s loans.
During 2008 and 2009, Bancorp and the Bank took several steps to preserve capital and sustain or improve regulatory capital ratios, including careful management of capital and operating expenses along with a reduction of risk weighted assets. Bancorp also sought new capital through various means and successfully raised significant capital as follows:
In October 2009, Bancorp completed a private capital raise (referred to in this report as, the “private capital raise”) in which it received net proceeds of $139.2 million in exchange for various securities that ultimately resulted in the issuance of: 71,442,450 shares of Common Stock, 121,328 shares of mandatorily convertible cumulative participating preferred stock, Series B (“Series B Preferred Stock”), and Class C Warrants exercisable for a total of 240,000 shares of Series B Preferred Stock at a price of $100.00 per share (the “Class C Warrants”), to investors in the private capital raise. Shares of Series B Preferred Stock automatically convert into 6,066,400 shares of Common Stock upon transfer of the Series B shares to third parties in a widely dispersed offering. Similarly, shares of Series B Preferred Stock issuable upon exercise of the Class C Warrants will automatically convert into 12,000,000 shares of Common Stock following exercise of the Class C Warrants and transfer of the Series B shares issuable there under to third parties in a widely dispersed offering.
As a result of the private capital raise, a small group of shareholders own a significant portion of the Company’s stock, which may allow these persons to influence the business through voting of shares and other means and may affect trading and volatility in the Company’s stock. See “Risk Factors” in Item 1A
ITEM 1A. RISK FACTORS
The following are risks that management believes are specific to our business. This should not be viewed as an all inclusive list or in any particular order.
Future loan losses may exceed our allowance for credit losses.
We are subject to credit risk, which is the risk that borrowers will fail to repay loans in accordance with their terms. We maintain an allowance for credit losses that represents management’s best estimate, as of a particular date, of the probable amount of loan receivables and unfunded commitments that the Bank will be unable to collect. An extended recession or further weakening of the economy or a specific industry sector or a rapid change in interest rates could adversely affect our borrowers’ ability to repay loans. Developments of this nature could result in losses in excess of our allowance for credit losses. In addition, to the extent that loan payments from borrowers are not timely, the loans will be placed on nonaccrual status, thereby lowering earning assets balances and reducing future interest income, and, in certain circumstances, requiring reversal of previously accrued interest income. If we determine that it is appropriate to increase the allowance for credit losses to address changing conditions, we will do so through additional provision for credit losses. Any additional provision for credit losses to increase the allowance for credit 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 regarding the Company’s allowance for credit losses, see the discussion under the subheading “Allowance for Credit Losses” and “Critical Accounting Policies” included in Item 7 of this report.
A large percentage of our loan portfolio is secured by real estate. As a result, we are particularly vulnerable to continued deterioration in the real estate market in our market areas.
Approximately 79% of our loan portfolio is secured by real estate. As a result, we are vulnerable to declines in the real estate markets in which we operate. We have experienced declining real estate values over the last three years and have experienced high levels of net charge-offs and provision for credit losses, which have only recently begun to decline. If we experience increases in commercial and consumer delinquency levels or renewed declines in real estate market values, we would expect increased loan charge-offs and provision for credit losses, which could have a material adverse effect on our business, financial condition and results of operations and prospects. Because of our significant concentration in loans secured by real estate, we are particularly vulnerable to such effects.
The recession has been particularly severe in the market areas we serve and our results of operations will continue to be adversely affected if the local economies do not improve or if the recession worsens.
Substantially all of our loans and loan opportunities are to businesses and individuals in our markets in Washington and Oregon. As evidenced by the unemployment rate in Oregon, which has hovered at or above 10% since January 2009, and was at 10.6% in December 2010, our region has been severely impacted by the same challenges facing the economy nationally and perhaps more so. The region has also experienced severe declines in residential and commercial real estate values. If we experience further deterioration in the economic conditions or a prolonged delay in economic recovery in our market areas, we could face the following consequences, any of which could materially and adversely affect our business: the value of assets that serve as collateral for our loans, especially real estate, may decline further in value; loan delinquencies could increase; problem assets and foreclosures may increase; demand for our products and services may decrease; and access to low cost or noninterest bearing deposits may decrease.
Financial services legislation and regulatory reforms may have a significant impact on our businesses and results of operations.
The Dodd-Frank Act was signed into law on July 21, 2010, and many of its provisions have extended implementation periods and delayed effective dates and will require extensive rulemaking by regulatory authorities as well as require multiple studies to be conducted over the next one to two years. The Dodd-Frank Act, including future rules implementing its provisions and the interpretation of those rules, could result in a number of adverse impacts on us. The levels of capital and liquidity with which we and the Bank must operate may be increased, resulting in decreased leverage and reduced earnings. We may also be subjected to new and/or higher fees paid to various regulatory entities, including but not limited to deposit insurance premiums to the FDIC. Revenue on interchange fees may decrease as a result of the level of fees the Federal Reserve deems “reasonable and proportional” when it finalizes its proposed regulation standards on the amount of interchange fees that can be charged to merchants for electronic debit card transactions. The Company may also be subject to additional regulations under the newly established Bureau of Consumer Financial Protection which has been given broad authority to implement new consumer protection regulations. These and other provisions of the Dodd-Frank Act could limit our ability to pursue business opportunities we might otherwise consider engaging in, impose additional costs on us, result in significant loss of revenue, impact the value of assets we hold, or otherwise significantly adversely affect our businesses.
The Bank derives overdraft fee income from its customer’s participation in the Bank’s overdraft service program. Recent amendments to Regulation E and the FDIC’s new Overdraft Guidance may impact our customer’s participation in the program and our overdraft fee income may be negatively affected.
Under recent amendments to Regulation E, customer’s that desire to participate in the Bank’s overdraft service program for ATM and one-time-debit card transactions must affirmatively opt-in because the Bank imposes service fees on such transactions. Although the majority of our customers have elected to opt-in, we are not able to predict future customer behavior or determine whether new customers will elect to opt-in. The FDIC issued guidance on overdraft payment programs in November 2010, which becomes effective July 2011. The guidance requires banks to, among other things, establish an outreach program to customers who excessively overdraw their account and advise them of lower cost alternatives, institute appropriate daily limits on customer costs and consider eliminating overdraft fees for transactions that overdraw an account by a de minimus amount. If customers do not elect to participate or remain in our overdraft protection program, an important source of noninterest income will be negatively affected.
The Congressional and regulatory response to the current economic and credit crisis could have an adverse effect on our business.
Federal and state legislators and regulators are pursuing increased regulation of how loans are originated, purchased, and sold, and properties are foreclosed, as a result of the current economic and credit crisis. Changes in the banking industry, lending markets and secondary markets for loans and related congressional and regulatory responses may impact how the Bank conducts business, makes and underwrites loans, and buys and sells loans in secondary markets. Loan sales are subject to proper compliance with standard underwriting rules that if not met, may allow the secondary market buyer to require the Company to repurchase the note. We are unable to predict whether any legislative or regulatory initiatives or actions will be implemented or what form they will take. Any such actions could affect us in substantial and unpredictable ways and could have an adverse effect on our business, financial condition and results of operations. For more information regarding the regulatory environment in which we operate, see the discussion under the subheading “Supervision and Regulation” included in Item 1 of this report.
Significant legal and regulatory actions could subject us to uninsured liabilities, associated reputational risk, and reduced revenues.
From time to time, we are sued for damages or threatened with lawsuits relating to various aspects of our operations. We may also be subject to investigations and possibly substantial civil money penalties assessed by, or other actions of, federal or state regulators in connection with violations or alleged violations of applicable laws, regulations or standards. We may incur substantial attorney fees and expenses in the process of defending against lawsuits or regulatory actions and our insurance policies may not cover, or cover adequately, the costs of adverse judgments, civil money penalties, and attorney fees and expenses. As a result, we may be exposed to substantial uninsured liabilities, which could adversely affect our results of operations, capital, and financial condition.
We are subject to reputational risk, which is the potential that negative publicity regarding our business practices, whether true or not, could cause a decline in our customer base, stock price, or general reputation in the markets in which we operate. Reputational risk is heightened in the instance of publicity surrounding lawsuits or regulatory actions. We are presently subject to regulatory agreements with the primary regulators for Bancorp and the Bank. These agreements restrict our activities. They also may negatively affect our reputation.
Impairment of investment securities, including Federal Home Loan Bank of Seattle (the “FHLB”) stock, could negatively impact our results of operations.
Our investment securities portfolio currently includes securities with unrecognized losses, including our securities in FHLB. We own common stock of the FHLB with a carrying value of $12.1 million. Ownership of FHLB common stock is a requirement to qualify for membership in the FHLB system, which enables us to borrow funds from the FHLB. Our assessment of the impairment of investment securities, including our investment in FHLB common stock, factors in several uncertain and qualitative factors, including, without limitation, the length of time and extent to which the fair value of a particular security has been less than cost, the financial condition and near-term prospects of the issuer, and our intent and ability to retain a particular investment long enough to recover value in the future. We evaluate the securities portfolio for other-than-temporary impairment each reporting period, as required by generally accepted accounting principles in the United States of America. As of December 31, 2010, we did not recognize any securities as other-than-temporarily impaired. There can be no assurance, however, that future evaluations of the securities portfolio will not lead us to the conclusion that we must recognize an impairment charge with respect to these and other holdings.
The FHLB is under regulatory restrictions on its operations due primarily to credit related charges recorded on private-label mortgage-backed securities and is currently prohibited by its primary regulator, the Federal Housing Finance Authority, from repurchasing or redeeming capital stock or paying dividends to members. Consequently, for this and other reasons, there is a risk that our investment in common stock of the FHLB could be deemed other than temporarily impaired at some time in the future. The impact of each of these impairment matters could have a material adverse effect on our business and results of operations.
We may seek to raise additional capital in the future to enhance capital levels, improve capital ratios, provide capital for acquisitions, or increase liquidity available for operations and other opportunities.
We are not restricted from issuing additional shares of our Common Stock or Preferred Stock. While we have no plans to do so at this time, in the event we desire to raise additional capital, 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, the issuance of additional common stock, convertible preferred stock, warrants, or other convertible securities or the exercise of such securities could be substantially dilutive to holders of our Common Stock and securities issued in such financings may have rights, preferences and privileges that are senior to those of our current shareholders. Any debt financing may include covenants that restrict our operations and interest charges that detract from future earnings.
Bancorp is restricted from paying cash dividends on its Common Stock, and these restrictions may continue for a significant period of time.
Pursuant to the Written Agreement with the Reserve Bank and the DFCS, Bancorp is prohibited from paying dividends without prior consent of the Reserve Bank, the Federal Reserve Director and the DFCS, or extending credit or otherwise supplying funds to, or engaging in certain transactions with the Bank. Additionally, even if Bancorp obtains regulatory approval to pay dividends, we may not pay any cash dividends on our Common Stock until we are current on interest payments on our junior subordinated debentures issued in connection with our trust preferred securities. For these and other reasons, Bancorp may not resume paying cash dividends on its Common Stock for some time into the future, if at all.
Bancorp is a separate and distinct legal entity from its subsidiaries. Substantially all of Bancorp’s funds and revenue is received as dividends paid from the Bank, which is currently restricted from paying dividends. The Bank may not pay dividends to Bancorp in the near future.
Substantially all of Bancorp’s funds and revenue is received as dividends paid from the Bank. Pursuant to the MOU the Bank is prohibited from paying dividends to Bancorp without the consent of the FDIC and the DFCS. We do not know when the FDIC and DFCS would consent to a request from the Bank to pay dividends to Bancorp. In the event the Bank continues to be unable to pay dividends to Bancorp, Bancorp may not be able to service debt or pay other obligations. The inability to receive dividends from the Bank could have a material adverse effect on Bancorp’s business, financial condition, including liquidity, and results of operations. Additionally, we have elected to defer regularly scheduled interest payments on our junior subordinated debentures issued in connection with our trust preferred securities and may be deemed to be in default if payment is not made prior to the end of the deferral period.
During the third quarter of 2009, we began deferring regularly scheduled interest payments of its junior subordinated debentures issued in connection with our trust preferred securities. Under the terms of the junior subordinated debentures and the trust documents, we have the contractual right to defer payments of interest on the junior subordinated debentures for up to 20 consecutive quarterly periods without default. During the deferral period, the respective trusts will likewise suspend the declaration and payment of dividends on the trust preferred securities. If the Company fails to bring the deferred payments current prior to the end of the deferral period, then we may be deemed to be in default under the terms of the notes and subject to various penalties.
Rapidly changing interest rates could reduce our net interest margin, net interest income, fee income and net income.
Interest and fees on loans and investment securities, net of interest paid on deposits and borrowings, are a large part of our net income. Interest rates are a key driver of our net interest margin and are subject to many factors beyond our control. As interest rates change, net interest income is affected. It could also lead to decreased demand for loans and other products that are priced based on interest rates. Rapid increases in interest rates could result in interest expense increasing faster than interest income because of mismatches in financial instrument maturities. Rapid decreases in interest rates could result in interest income decreasing faster than interest expense, for example, if management is unable to match decreases in earning assets yields, with reduced rates paid on deposits or borrowings. Periods of low market interest rates, such as we have today, may adversely affect our net interest spread and net interest income because our earning assets yield decreases and stays low during a time that our cost of interest bearing liabilities is already low and cannot be correspondingly reduced further. For more information regarding interest rates, see the discussion under the section “Quantitative and Qualitative Disclosures about Market Risk” in the Item 7A of this report.
We face liquidity risks in the operation of our business.
Liquidity is crucial to the operation of Bancorp and the Bank. Liquidity risk is the potential that the Company will be unable to fund increases in assets or meet payment obligations, including obligations to depositors, as they become due because of an inability to obtain adequate funding or liquidate assets at a reasonable cost. Funding illiquidity may arise at the Bank if we are unable to, at reasonable terms, attract and retain deposits, secure or renew borrowings from the overnight inter-bank market, the FHLB, or the Federal Reserve discount window, or access other sources of liquidity, as described in more detail under the heading “Liquidity and Sources of Funds” in Item 7 of this report. Changes or disruptions to the FHLB system could adversely impact our ability to meet our short-term and long-term liquidity requirements. If we fail to monitor and control our liquidity risks, there may be materially adverse effects on our results of operations and financial condition.
We face operational risks that may result in unexpected losses.
We face various operational risks that arise from the potential that inadequate information systems, operational problems, failures in internal controls, breaches of our security systems, fraud, the execution of unauthorized transactions by employees, or any number of unforeseen catastrophes could result in unexpected losses. Additionally, third party vendors provide key components of our business infrastructure such as internet connections, network access, data reporting, and data processing. Any problems caused by third parties could adversely affect our ability to deliver products and services to our customers and our revenues, expenses, and earnings. Replacing third party vendors, should that be necessary, may entail significant delay and expense.
The financial services industry is very competitive.
We face competition in attracting and retaining deposits, making loans and providing other financial services. Our competitors include other community banks, larger banking institutions, and a wide range of other financial institutions, such as credit unions, government-sponsored enterprises, mutual fund companies, insurance companies and other non-bank businesses. Many of these competitors have substantially greater resources than us. For a more complete discussion of our competitive environment, see the discussion under the heading “Competition” included in Item 1 of this report. If we are unable to compete effectively, we will lose market share, and income from loans and other products may be reduced.
Inability to hire or retain key professionals, management and staff could adversely affect our revenues and net income.
We rely on key personnel to manage and operate our business, including, but not limited to, major revenue generating functions such as our loan and deposit portfolios. The loss of key staff may adversely affect our ability to maintain and manage these portfolios effectively, which could negatively affect our revenues and earnings.
Market and other constraints on our loan origination volumes may lead to continued pressure on our interest and fee income.
Due to the poor economic conditions in the markets in which we operate and other factors, we expect continued pressure on new loan originations in the near term, particularly with respect to construction loans. If we are unable to increase loan volumes, there will be continued pressure on our interest income and fees generated from our lending operations. Unless we are able to offset the lower interest income and fees with increased activity in other areas of our operations, our total revenues may decline relative to our total noninterest expenses. We expect that it may be difficult to find new revenue sources in the near term.
Our products and services are delivered on a technological platform that is subject to rapid change and transformation.
The financial services industry is undergoing rapid technological change and we face constant evolution of customer demand for technology-driven financial and banking products and services. Many of our competitors have substantially greater resources to invest in technological improvement and product development, marketing, and implementation. Any failure to successfully keep pace with and fund technological innovation in the markets in which we compete could have a material adverse impact on our business and results of operation.
Our Common Stock trades in relatively limited volumes and a significant percentage continues to be owned by investors in the October 2009 private capital raise, resulting in a share price that is volatile and which may be subject to downward pricing pressure in the event significant shareholders decide to dispose of shares of our Common Stock.
Our Common Stock trades on the NASDAQ Global Select Market under the symbol “WCBO" and trading volume is modest. The limited trading market for our Common Stock may lead to exaggerated fluctuations in market prices and possible market inefficiencies, as compared to a more actively traded stock. It may also make it more difficult to dispose of our shares at expected prices, especially for holders seeking to dispose of a large number of our shares. In addition, if a large shareholder or group of investors in our private capital raise elects to sell their shares, such sales or attempted sales could result in significant downward pressure on the market price of our Common Stock and actual price declines.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
The principal properties owned by the Bank include a 40,000-square-foot office and branch facility in downtown Salem, Oregon, a 15,600-square-foot office and branch facility in Newport, Oregon, and a 12,000-square-foot branch and office facility in Lacey, Washington. In total, the Bank owns 27 buildings, primarily to house branch offices. The Bank leases the land under seven buildings and owns the land under 20 buildings. In addition, the Bank leases 42 office spaces and buildings for branch locations.
Other non-branch office facilities are located in leased office space, including our headquarters office in Lake Oswego, Oregon, office and processing space in Salem, Oregon, where the Bank’s data center is located, space in Wilsonville, Oregon, where its loan servicing and operations center is located, space in Vancouver, Washington, where we have lending personnel and a branch office, and space in downtown Portland, where we have commercial banking personnel, West Coast Investment Services and West Coast Trust. In addition, we lease two smaller office spaces for lending personnel in Lake Oswego, Oregon, and in Tukwila, Washington.
The aggregate monthly rental on 49 leased properties is approximately $338,000.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
On June 24, 2009, West Coast Trust was served with an Objection to Personal Representative's Petition and Petition for Surcharge of Personal Representative in Linn County Circuit Court. The petition was filed by the beneficiaries of the estate of Archie Q. Adams, for which West Coast Trust acts as the personal representative. The petitioners allege a breach of fiduciary duty with respect to West Coast Trust's prior sale of real property owned by the Adams estate and sought relief in the form of a surcharge to West Coast Trust of $215,573,115.60, the amount of the alleged loss to the estate. West Coast Trust filed a motion to dismiss on July 2, 2009, which was granted in a letter ruling dated September 15, 2009. Petitioners appealed and opening briefs are due March 22, 2011. The Company believes the appeal and underlying petition are without merit.
Bancorp and its subsidiaries are periodically party to litigation arising in the ordinary course of business. Based on information currently known to management, although there are uncertainties inherent in litigation, we do not believe there is any legal action to which Bancorp or any of its subsidiaries is a party that, individually or in the aggregate, will have a materially adverse effect on Bancorp’s financial condition and results of operations, cash flows, or liquidity.
ITEM 4.
ITEM 4. RESERVED
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Stock Price and Dividends
Bancorp Common Stock trades on the NASDAQ Global Select Market under the symbol “WCBO.” The high and low closing sale prices per share of our Common Stock for each quarter during the last two years are shown in the table below, together with dividend information for each period. The prices below do not include retail mark-ups, mark-downs or commissions, may not represent actual transactions and are not adjusted for dividends. As of December 31, 2010, there were approximately 1,900 holders of record of our Common Stock.
Bancorp dividends are limited under federal and Oregon laws and regulations pertaining to Bancorp’s financial condition. Payment of dividends by the Bank is also subject to limitation under state and federal banking laws and by actions of state and federal banking regulators. For more information on this topic, see the discussion under the section “Supervision and Regulation” included in Item 1 of this report and the section “Liquidity and Sources of Funds” included in Item 7 of this report.
Under Bancorp’s Written Agreement with the Reserve Bank and the DFCS, Bancorp may not pay cash dividends without prior regulatory approval. Similarly, the Bank may not pay dividends to Bancorp without consent of the FDIC and DFCS. Bancorp has also exercised its right to defer regularly scheduled interest payments on its junior subordinated debentures issued in connection with our trust preferred securities. It may not pay any cash dividends on its Common Stock until it is current on interest payments on its junior subordinated debentures.
Information regarding securities authorized for issuance under equity compensation plans is incorporated by reference into Part III, Item 12 of this report.
Issuer Purchases of Equity Securities
The following table provides information about purchases of Common Stock by the Company during the quarter ended December 31, 2010:
1 Shares repurchased by Bancorp during the quarter include shares repurchased from employees in connection with cancellation of restricted stock to pay withholding taxes totaling 1,525 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 purchase 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, and 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 December 31, 2010, of approximately 4.9 million shares, 1.05 million shares remain available for repurchase under the plan subject to any regulatory restrictions.
Five Year Stock Performance Graph
The following chart compares the yearly percentage change in the cumulative shareholder return on our Common Stock during the five years ended December 31, 2010, with (1) the Total Return Index for the NASDAQ Stock Market (U.S. Companies) and (2) the Total Return Index for NASDAQ Bank Stocks. This comparison assumes $100.00 was invested on December 31, 2005, in our Common Stock and the comparison groups and assumes the reinvestment of all cash dividends prior to any tax effect and retention of all stock dividends. Bancorp’s total cumulative return was -87% over the five year period ended December 31, 2010, compared to -31.4% and 25.8% for the NASDAQ Bank Stocks and NASDAQ composite, respectively.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
Consolidated Five Year Financial Data
The following selected consolidated five year financial data should be read in conjunction with Bancorp’s audited consolidated financial statements and the related notes to those statements presented in Item 8 of this report.
The efficiency ratio has been computed as noninterest expense divided by the sum of net interest income on a tax equivalent basis and noninterest income excluding gains/losses on sales of securities.
Interest earned on nontaxable securities has been computed on a 35% tax equivalent basis.
Consolidated Quarterly Financial Data
The following table presents selected consolidated quarterly financial data for each quarter of 2009 and 2010. The financial information contained in this table reflects all adjustments, which, in the opinion of management, are necessary for a fair presentation of the results of the interim periods.
Ratios have been annualized.
Ratios have been annualized.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the audited consolidated financial statements and related notes to those statements as of December 31, 2010 and 2009, and for each of the three years in the period ended December 31, 2010, of West Coast Bancorp and its subsidiaries that appear in Item 8 “Financial Statements and Supplementary Data” of this report. References to “we,” “our” or “us” refer to West Coast Bancorp and its subsidiaries.
Forward-Looking Statement Disclosure
Statements in this Annual Report of West Coast Bancorp (“Bancorp” or the “Company”) regarding future events or performance are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 (the “PSLRA”) and are made pursuant to the safe harbors of the PSLRA. The Company’s actual results could be quite different from those expressed or implied by the forward-looking statements. Words such as “could,” “may,” “should,” “plan,” “believes,” “anticipates,” “estimates,” “predicts,” “expects,” “projects,” “potential,” or “continue,” or words of similar import, often help identify “forward-looking statements,” which include any statements that expressly or implicitly predict future events, results, or performance. Factors that could cause events, results or performance to differ from those expressed or implied by our forward-looking statements include, among others, risks discussed in Item 1A, “Risk Factors” of this report, risks discussed elsewhere in the text of this report, as well as the following specific factors:
General economic conditions, whether national or regional, and conditions in real estate markets, that may affect the demand for our loan and other products, lead to further declines in credit quality and additional loan losses, and negatively affect the value and salability of the real estate that we own or is the collateral for many of our loans and hinder our ability to increase lending activities;
Changing bank regulatory conditions, policies, or programs, whether arising as new legislation or regulatory initiatives or changes in our regulatory classifications, that could lead to restrictions on activities of banks generally or West Coast Bank (the “Bank”) in particular, increased costs, including deposit insurance premiums, price controls on debit card interchange, regulation or prohibition of certain income producing activities, or changes in the secondary market for bank loan and other products;
Competitive factors, including competition with community, regional and national financial institutions, that may lead to pricing pressures that reduce yields earned on loans and increase rates paid on deposits, the loss of our most valued customers, defection of key employees or groups of employees, or other losses;
Increasing or decreasing interest rate environments, including the slope and level of the yield curve, that could lead to decreases in net interest margin, lower net interest and fee income, including lower gains on sales of loans, and changes in the value of Bancorp’s investment securities; and
Changes or failures in technology or third party vendor relationships in important revenue production or service areas or increases in required investments in technology that could reduce our revenues, increase our costs, or lead to disruptions in our business.
Furthermore, forward-looking statements are subject to risks and uncertainties related to the Company’s ability to, among other things: dispose of properties or other assets obtained through foreclosures at expected prices and within a reasonable period of time; attract and retain key personnel; generate loan and deposit balances at projected spreads; sustain fee generation including gains on sales of loans; maintain asset quality and control risk; limit the amount of net loan charge-offs; adapt to changing customer deposit, investment and borrowing behaviors; control expense growth; and monitor and manage the Company’s financial reporting, operating and disclosure control environments.
Readers are cautioned not to place undue reliance on our forward-looking statements, which reflect management’s analysis only as of the date of the statements. Bancorp does not intend to publicly revise or update forward-looking statements to reflect events or circumstances that arise after the date of this report.
Readers should carefully review all disclosures we file from time to time with the Securities and Exchange Commission.
Overview
2010 Financial review
The Company’s operating results in 2010 show several favorable trends. During 2010, we recorded:
Net income of $3.2 million compared to a loss of $91.2 million in 2009;
A net interest margin of 3.48%, an increase of 15 basis points from 3.33% in 2009;
An average rate paid on total deposits of .60%, a decline from 1.17% in 2009;
A provision for credit losses of $18.7 million, down $71.4 million from $90.1 million in 2009;
Net loan charge-offs of $17.0 million, a decline from $80.6 million in 2009; and
Net Other Real Estate Owned (“OREO”) valuation adjustments and gains and losses on sales of $4.4 million, a reduction from $27.0 million in 2009.
The financial condition of Bancorp and the Bank also continued to strengthen in 2010, as evidenced by:
Increasing the Bank’s total and tier 1 risk-based capital ratios to 18.05% and 16.79%, respectively, at December 31, 2010, up from 15.37% and 14.11% at December 31, 2009;
Improving the Bank’s leverage ratio to 12.51% at December 31, 2010, from 10.57% a year ago; and
Reducing total nonperforming assets by 34% or $52.2 million over the past twelve months to $100.7 million at year end.
In addition, the Bank continued to reduce real estate construction loan balances, which contracted 56% from $99.3 million at December 31, 2009, to $44.1 million, or less than 3% of total loans, at December 31, 2010.
Update on Regulatory Actions
On July 15, 2010, the Consent Order issued to the Bank effective on October 22, 2009 by the Oregon Department of Consumer and Business Services Division of Finance and Corporate Securities (the “DFCS”) and the Federal Deposit Insurance Corporation (“FDIC”) was terminated. Although the Consent Order was terminated, the DFCS and FDIC required the Bank enter into a Memorandum of Understanding on October 6, 2010.
Bancorp remains subject to a Written Agreement with the DFCS and the Federal Reserve Bank of San Francisco (the “Reserve Bank”) which was entered into on December 15, 2009. Bancorp’s agreement with the Reserve Bank and DFCS is referred to in this Item 7 as the “Written Agreement.”
For more information, see the discussion under the subheading “Current Regulatory Actions” in the section “Supervision and Regulation” included in Item 1 of this report.
Income Statement Overview
Our net income for the full year 2010 was $3.2 million, compared to net losses of $91.2 million in 2009 and $6.3 million in 2008. Earnings per diluted share for the year ended December 31, 2010 was $.03, while the loss per diluted share for the years ended December 31, 2009 and 2008 was $5.83 and $.41, respectively. Return on average equity improved to 1.2% in 2010 from -45.7% in 2009 and -3.1% in 2008. As discussed below, the improved year-over-year performance was primarily due to reduced provision for credit losses and OREO losses in 2010.
Net Interest Income, Average Balances, Yields Earned, and Rates Paid. The following table displays information on net interest income, average yields earned and rates paid, as well as net interest spread and margin information on a tax equivalent basis for the periods indicated. The adjustment to a taxable equivalent basis increases interest income by an estimate of the additional yield that would have been received by the Company if its tax-exempt securities had been taxable at the statutory rate. This information can be used to follow the changes in our yields and rates and the changes in our earning assets and liabilities over the past three years:
Net interest income on a tax equivalent basis totaled $84.5 million for the year ended December 31, 2010, an increase of $4.3 million or 5.3% from $80.2 million in 2009. The net interest margin increased 15 basis points to 3.48% in 2010 from 3.33% in 2009. The increase in net interest income and margin from 2009 to 2010 was mainly due to lower rates paid on interest bearing deposits, a change in deposit mix to lower cost demand deposits, as well as lower cash balances at the Federal Reserve and lower nonaccrual loan balances. These trends more than offset a significant shift in the Company’s earning assets mix from loan to investment securities balances and the cost of prepaying a portion of our FHLB debt in 2010. The yield on the investment portfolio in 2010 was 2.94% or 250 basis points less than the 5.44% yield on the loan portfolio in 2010. In 2008, net interest income on a tax equivalent basis was $93.9 million and the net interest margin was 3.90%. The $13.7 million decline in net interest income from 2008 to 2009 was primarily driven by lower loan balances, yields, and fees along with higher nonaccrual loan balances, which led to increased interest reversals.
Changing interest rate environments, including the slope, level of, and changes in the yield curve, and competitive pricing pressure, and changing economic conditions, 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. For more information regarding interest rates, see the discussion under the section “Quantitative and Qualitative Disclosures about Market Risk” in the Item 7A
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk
Interest rate, credit and operations risks are the most significant market risks impacting our performance. Other types of market risk, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of our business activities. We rely on loan reviews, prudent loan underwriting standards and an adequate allowance for credit losses to attempt to mitigate credit risk. Interest rate risk is reviewed at least quarterly by the Asset Liability Management Committee (“ALCO”) which includes senior management representatives. The ALCO manages our balance sheet to maintain net interest income and present value of equity within acceptable ranges.
Asset/liability management simulation models are used to measure interest rate risk. The models quantify interest rate risk by simulating forecasted net interest income over a 12-month time horizon under various rate scenarios, as well as monitoring the change in the present value of equity under the same rate scenarios. The present value of equity is defined as the difference between the market value of current assets less current liabilities. By measuring the change in the present value of equity under different rate scenarios, management can identify interest rate risk that may not be evident in simulating changes in forecasted net interest income. Readers are referred to the sections, “Forward Looking Statement Disclosure” and “Risk Factors” of this report in connection with this discussion of market risks.
The following table shows the approximate percentage changes in forecasted net interest income over a 12-month period and in the present value of equity under several rate scenarios. For the net interest income analysis, three rate scenarios are compared to a stable (unchanged from December 31, 2010) rate scenario:
As illustrated in the above table, we estimate our balance sheet was slightly asset sensitive over a 12 month horizon at December 31, 2010, meaning that interest earning assets are expected to mature or reprice more quickly than interest-bearing liabilities in a given period. A decrease in market rates of interest could adversely affect net interest income, while an increase in market rates may increase net interest income slightly. At December 31, 2009, we also estimated that our balance sheet was slightly asset sensitive. We attempt to limit our interest rate risk through managing the repricing characteristics of our assets and liabilities.
For the present value of equity analysis, the results are compared to the net present value of equity using the yield curve as of December 31, 2010. This curve is then shifted up and down and the net present value of equity is computed. This table does not include flattening or steepening yield curve effects.
It should be noted that the simulation model does not take into account future management actions that could be undertaken should a change occur in actual market interest rates during the year. Also, certain assumptions are required to perform modeling simulations that may have a significant impact on the results. These include important assumptions regarding the level of interest rates and balance changes on deposit products that do not have stated maturities, as well as the relationship between loan yields and deposit rates relative to market interest rates. These assumptions have been developed through a combination of industry standards and future expected pricing behavior but could be significantly influenced by future competitor pricing behavior. The model also includes assumptions about changes in the composition or mix of the balance sheet. The results derived from the simulation model could vary significantly due to external factors such as changes in the prepayment assumptions, early withdrawals of deposits and competition. Any transaction activity will also have an impact on the asset/liability position as new assets are acquired and added.
Interest Rate Sensitivity (Gap) Table
The primary objective of our asset/liability management is to maximize net interest income while maintaining acceptable levels of interest-rate sensitivity. We seek to meet this objective through influencing the maturity and repricing characteristics of our assets and liabilities.
The following table sets forth the estimated maturity and repricing and the resulting interest rate gap between interest earning assets and interest bearing liabilities at December 31, 2010. The amounts in the table are derived from internal Bank data regarding maturities and next repricing dates including contractual repayments.
1 Equity investments have been placed in the 0-3 month category.
2 Repricing is based on anticipated call dates and may vary from contractual maturities.
3 Repricing is based on estimated average lives.
Certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, savings, interest bearing demand and money market deposit accounts will very likely experience a change in deposit rates more frequently than in their estimated average lives. Additionally, although certain assets and liabilities may have similar maturities and periods of repricing, they may react differently to changes in market interest rates. Also, interest rates on assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other assets and liabilities may follow changes in market interest rates. Given these shortcomings, management believes that rate risk is best measured by simulation modeling as opposed to measuring interest rate risk through interest rate gap measurement.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following audited consolidated financial statements and related documents are set forth in this Annual Report on Form 10-K on the pages indicated:
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
West Coast Bancorp
Lake Oswego, Oregon
We have audited the accompanying consolidated balance sheets of West Coast Bancorp and subsidiaries (the “Company”) as of December 31, 2010 and 2009, and the related statements of income (loss), changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2010. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of West Coast Bancorp and subsidiaries as of December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2010, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of December 31, 2010, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 10, 2011 expressed an unqualified opinion on the Company's internal control over financial reporting.
/s/ DELOITTE & TOUCHE LLP
Portland, Oregon
March 10, 2011
WEST COAST BANCORP
CONSOLIDATED BALANCE SHEETS
See notes to consolidated financial statements.
WEST COAST BANCORP
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
See notes to consolidated financial statements.
WEST COAST BANCORP
CONSOLIDATED STATEMENTS OF CASH FLOWS
See notes to consolidated financial statements.
WEST COAST BANCORP
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
See notes to consolidated financial statements.
WEST COAST BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations. West Coast Bancorp (“Bancorp” or “the Company”) provides a full range of financial services including lending and depository services through West Coast Bank and its 65 branch banking offices in Oregon and Washington. West Coast Trust Company, Inc. (“West Coast Trust”) provides fiduciary, agency, trust and related services, and life insurance products.
Principles of Consolidation. The accompanying consolidated financial statements include the accounts of Bancorp, and its wholly-owned subsidiaries, West Coast Bank (the “Bank”), West Coast Trust and Totten, Inc., after elimination of material intercompany transactions and balances. West Coast Statutory Trusts III, IV, V, VI, VII and VIII are considered related parties to Bancorp and their financial results are not consolidated in Bancorp’s financial statements. Junior subordinated debentures issued by the Company to West Coast Statutory Trusts are included on the Company’s balance sheet as junior subordinated debentures.
Basis of Financial Statement Presentation and the Use of Estimates in the Financial Statements. The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States and with prevailing practices within the banking and securities industries. Management is required to make certain estimates and assumptions when preparing the financial statements that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the balance sheet and the amounts of income and expense for the reporting period. Actual results could differ significantly from management’s estimates. Certain material estimates subject to significant change relate to the determination of the allowance for credit losses, the provision or benefit for income taxes, and the fair value of other real estate owned.
Subsequent Events. The Company has evaluated events and transactions for potential recognition or disclosure through the day the financial statements were issued.
Cash and Cash Equivalents. Cash and cash equivalents include cash on hand, interest bearing deposits in other banks, amounts due from banks and federal funds sold. Generally, federal funds are purchased or sold for one-day periods.
Supplemental Cash Flow Information. The following table presents supplemental cash flow information for the years ended December 31, 2010, 2009 and 2008.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Trading Securities. Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with realized and unrealized gains and losses included in noninterest income. Trading securities held at December 31, 2010 and 2009 are related solely to assets held in a rabbi trust for the benefit of the Company’s deferred compensation plans.
Investment Securities Available for Sale. Investment securities classified as available for sale are not trading securities but may be sold before maturity in response to changes in the Company’s interest rate risk profile, funding needs or demand for collateralized deposits by public entities. Available for sale securities are carried at fair value with unrealized gains and losses, net of any tax effect, reported within accumulated other comprehensive income (loss) in stockholders’ equity. Premiums and discounts are amortized or accreted over the estimated life of the investment security as an adjustment to the yield. For purposes of computing realized gains and losses, the cost of securities sold is determined using the specific identification method. The Company analyzes investment securities for other-than-temporary impairment (“OTTI”) on a quarterly basis. For equity securities where declines in fair value are deemed other-than-temporary and the Company does not have the ability and intent to hold the securities until recovery, OTTI is recognized in noninterest income. The Company considers whether a debt security will be sold or if it is likely to be required to be sold prior to the recovery of any unrealized loss. Intent to sell or a requirement to sell debt securities prior to recovery would result in recognizing the entire impairment as OTTI in noninterest income. If the Company does not intend to sell impaired debt securities, will not be required to sell them prior to recovery, and the Company does not expect to recover its entire amortized cost basis of the securities, the portion of impairment loss specifically related to credit losses is recognized in noninterest income. The portion of impairment loss related to all other factors is recognized as a separate category in other comprehensive income (loss).
Valuation of Investment Securities Available for Sale. Investment securities are valued utilizing a number of methods including quoted prices in active markets, quoted prices for similar assets, quoted prices for securities in inactive markets and inputs derived principally from or corroborated by observable market data by correlation or other means. In addition, certain investment securities are valued based on the Company’s own assumptions using the best information available using a discounted cash flow model.
Federal Home Loan Bank Stock. Federal Home Loan Bank of Seattle (the “FHLB”) stock is carried at cost which equals its par value because the shares can only be redeemed with the FHLB at par and it lacks a market. The Bank is required to maintain a minimum level of investment in FHLB stock based on specific percentages of its outstanding mortgages and FHLB advances. Stock redemptions are at the discretion of the FHLB or of the Company, upon prior notice to the FHLB of five years for FHLB B stock or six months for FHLB A stock. The Bank considers FHLB stock a restricted security. The Company periodically analyzes FHLB stock for OTTI. The evaluation of OTTI on FHLB stock is based on an assessment of the ultimate recoverability of cost rather than recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of cost is influenced by criteria such as (a) the significance of any decline in net assets of the FHLB as compared to the capital stock amount for the FHLB and the length of time this situation has persisted, (b) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLB, (c) the impact of legislative and regulatory changes on institutions and, accordingly, the customer base of the FHLB, and (d) the liquidity position of the FHLB. The Company analyzed FHLB stock for OTTI and concluded that no impairment exists at December 31, 2010.
Loans Held for Sale. Loans held for sale includes mortgage loans that are carried at the lower of cost or market value. Market value generally approximates cost because of the short duration these assets are held by us. Gains and infrequent losses are recognized in the consolidated statement of income (loss) as the proceeds from sale less the net book value of the loan including unamortized fees and capitalized direct costs. Servicing rights are typically not retained. In addition, we originate loans to customers under Small Business Administration (“SBA”) programs that generally provide for SBA guarantees of 50% to 85% of each loan. We periodically sell the guaranteed portion of certain SBA loans to investors and retain the unguaranteed portion and servicing rights in our loan portfolio. SBA loans are recorded and held within the loan portfolio until designated to be sold. Gains on these sales are earned through the sale of the guaranteed portion of the loan for an amount in excess of the adjusted carrying value of the portion of the loan sold. We allocate the carrying value of such loans between the portion sold, the portion retained and a value assigned to the right to service the loan. The difference between the adjusted carrying value of the portion retained and the face amount of the portion retained is amortized to interest income over the life of the related loan using a straight-line method over the anticipated lives of the pool of SBA loans. Certain sold SBA loans are subject to a borrower three payment “seasoning period” in which loan sale recourse applies if the borrower does not make timely payments. We record a gain on sale only after this seasoning period ends. During the seasoning period and upon receiving the cash proceeds, we record the transaction as a secured borrowing.
Loans. Loans are reported at the amount of unpaid principal balance outstanding net of unearned income and deferred fees and costs. Loan and commitment fees and certain direct loan origination costs are deferred and recognized over the life of the loan and/or commitment period as yield adjustments. Interest income on loans is accrued daily on the unpaid principal balance outstanding as earned.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Nonaccrual Loans. Loans (including impaired loans) are placed on nonaccrual status when the collection of interest or principal has become 90 days past due or is otherwise considered doubtful. When a loan is placed on nonaccrual status, the Company stops accruing interest and unpaid accrued interest is reversed. In addition, the Company stops amortizing deferred fees and costs. For certain real estate construction loans accrued unpaid interest as well as qualifying capitalized interest is reversed. When management determines that the ultimate collectability of principal is in doubt, cash receipts on nonaccrual loans are applied to reduce the principal balance on a cash-basis method until the loans qualify for return to accrual status. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Impaired Loans. A loan is considered to be impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due (both interest and principal) according to the contractual terms of the loan agreement. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, as a practical expedient, at the loan’s observable market price or the fair market value of the collateral less selling costs if the loan is collateral dependent. For loans that are collateral dependent the Company charges off the amount of impairment at the time of impairment, rather than placing the impaired loan amount in a specific reserve allowance. Known impairments on non-real estate secured loans are charged off immediately rather than recording a specific reserve allowance in the allowance for loan losses.
A loan is accounted for as a troubled debt restructure if the Company, for economic or legal reasons related to the borrower’s financial difficulties, grants a concession to the borrower that it would not otherwise consider. A troubled debt restructure typically involves a modification of terms such as a reduction of the stated interest rate or face amount of the loan, a reduction of accrued interest, or an extension of the maturity date(s) at a stated interest rate lower than the current market rate for a new loan with similar risk. Troubled debt restructures are considered impaired and as such are typically measured based on the fair market value of the collateral less selling costs. Certain troubled debt restructures are considered impaired but remain in a performing status based on a current documented evaluation supporting the expectation of performance. These loans are measured for impairment based on the present value of expected future cash flows discounted at the loans original interest rate.
Allowance for Credit Losses. The allowance for credit losses is comprised of two components, the allowance for loan losses and the reserve for unfunded commitments. The allowance for loan losses is a calculation applied to outstanding loan balances, while the reserve for unfunded commitments is based upon a calculation applied to that portion of total loan commitments not yet funded for the period reported.
The allowance for credit losses is based on management’s estimates. Management determines the adequacy of the allowance for credit losses based on evaluations of the loan portfolio, recent loss experience and other factors, including economic conditions. The Company determines the amount of the allowance for credit losses required for certain sectors based on relative risk characteristics of the loan portfolio. Actual losses may vary from current estimates. These estimates are reviewed periodically and, as adjustments become necessary, are reported in earnings in the periods in which they become known. The allowance for credit losses is increased by provisions for credit losses in earnings. Losses are charged to the allowance while recoveries are credited to the allowance.
Commitments to Extend Credit. Unfunded loan commitments are generally related to providing credit facilities to customers of the bank and are not actively traded financial instruments. These unfunded commitments are disclosed as commitments to extend credit in Note 20 in the notes to consolidated financial statements.
Reserve for Unfunded Commitments. As a component of allowance for credit losses, a reserve for unfunded commitments is maintained at a level that, in the opinion of management, is adequate to absorb losses associated with the Bank’s commitment to lend funds under existing agreements such as letters or lines of credit or construction loans. Management determines the adequacy of the reserve for unfunded commitments based upon reviews of individual credit facilities, current economic conditions, the risk characteristics of the various categories of commitments as well as pooled commitments with similar risk characteristics and other relevant factors. The reserve is based on estimates, and ultimate losses may vary from the current estimates. These estimates are evaluated on a regular basis and, as adjustments become necessary, they are reported in the provision for credit losses in the income statement in the periods in which they become known.
Other Real Estate Owned (“OREO”). 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. OREO is initially recorded at the lower of the carrying amount of the loan or fair value of the property less estimated costs to sell. This amount becomes the property’s new basis. Management considers third party appraisals as well as independent fair market value assessments from realtors or persons involved in selling OREO in determining the fair value of particular properties. Accordingly, the valuation of OREO is subject to significant external and internal judgment. Management also 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 OREO valuation adjustments or subsequent gains or losses on the final disposition of OREO are charged to other real estate owned valuation adjustments and (loss) gain on sales. Expenses from the maintenance and operations of OREO are included in other noninterest expense in the statements of income (loss).
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Premises and Equipment. Premises and equipment are stated at cost, less accumulated depreciation and amortization. Land is carried at cost. Depreciation is computed on the straight-line method over the estimated useful lives of the related assets. In general, furniture and equipment is amortized over a useful life of 3 to 10 years, software and computer related equipment is amortized over 3 to 5 years and buildings are amortized over periods up to 40 years. Leasehold improvements are amortized over the life of the related lease, or the life of the related assets, whichever is shorter. Expenditures for major renovations and betterments of the Company’s premises and equipment are capitalized. Improvements are capitalized and depreciated over their estimated useful lives. Minor repairs, maintenance and improvements are charged to operations as incurred. When property is replaced or otherwise disposed of, the cost of such assets and the related accumulated depreciation are removed from their respective accounts. Related gain or loss, if any, is recorded in current operations.
Goodwill and Intangible Assets. At March 31, 2009, based on management’s analysis and continued deteriorating economic conditions and the length of time and amount by which the Company’s book value per share had exceeded its market value per share, the Company determined it was appropriate to write off the entire $13.1 million of goodwill related to its acquisition of Mid-Valley Bank in June, 2006.
Core deposit intangibles are reviewed for impairment at least annually as of year-end. At December 31, 2010 it was determined that core deposit intangibles were not impaired. If impairment were deemed to exist, the core deposit intangibles would be written down to estimated fair value, resulting in a charge to earnings in the period in which the write down occurs.
Income Taxes. Income taxes are accounted for using the asset and liability method. Under this method, a deferred tax asset or liability is determined based on the enacted tax rates that will be in effect when the differences between the financial statement carrying amounts and tax basis of existing assets and liabilities are expected to be reported in Bancorp’s income tax returns. The deferred tax provision (benefit) for the year is equal to the net change in the net deferred tax asset from the beginning to the end of the year, less amounts applicable to the change in value related to investment securities available for sale. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. The Company records net deferred tax assets to the extent these assets will more likely than not be realized. In making such determination, the Company assesses the available positive and negative evidence including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies and recent financial results. A deferred tax asset valuation allowance is established to reduce the net carrying amount of deferred tax assets if it is determined to be more likely than not, that all or some portion of the potential deferred tax asset will not be realized. The Company’s accounting policy is to exclude deferred tax assets related to unrealized losses on its available for sale debt securities as these losses are expected to reverse and realization of the related deferred tax asset is not dependent on future taxable income. It is the Company’s accounting policy to include interest expense and penalties related to income taxes as a component of provision (benefit) for income taxes. See Note 17 “Income taxes” of the notes to consolidated financial statements for more detail.
Operating Segments. Public enterprises are required to report certain information about their operating segments in the financial statements. The basis for determining the Company’s operating segments is the way in which management operates the businesses. Bancorp has identified two reportable segments, “banking” and “other” which includes West Coast Trust. See Note 22, “Segment and Related Information” of the notes to consolidated financial statements for more detail.
Trust Company Assets. Assets (other than cash deposits) held by West Coast Trust in fiduciary or agency capacities for its trust customers are not included in the accompanying consolidated balance sheets, because such items are not assets of West Coast Trust.
Borrowings. Federal funds purchased and securities sold under agreements to repurchase generally mature within one to four days from the transaction date. Other short-term borrowed funds mature within one year from the date of this financial statement. Long-term borrowed funds extend beyond one year and are reclassed to short-term borrowings when the long term borrowed funds mature within one year and there is no intent to refinance.
Earnings (Loss) Per Share. Earnings (loss) per share is calculated under the two-class method. The two-class method is an earnings allocation formula that determines earnings (loss) per share for each class of common stock and participating security according to dividends declared (or accumulated) and participation rights in undistributed earnings. A participating security is an instrument that may participate in undistributed earnings with common stock. The Company has issued restricted stock that qualifies as a participating security. Basic earnings (loss) per share is computed by dividing net income (loss) available to common shareholders by the weighted average number of shares of common stock outstanding during the period. Diluted earnings (loss) per share is computed in the same manner as basic earnings (loss) per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if certain shares issuable upon exercise of options, warrants, conversion of preferred stock, and nonvested restricted stock were included unless those additional shares would have been anti-dilutive. For the diluted earnings (loss) per share computation, the treasury stock method is applied and compared to the two-class method and whichever method results in a more dilutive impact is utilized to calculate diluted earnings per share.
Service Charges on Deposit Accounts. Service charges on deposit accounts primarily represent monthly fees based on minimum balances or transaction-based fees. These fees are recognized as earned or as transactions occur and services are provided.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Payment Systems Revenue. Payment systems revenue includes interchange income from credit and debit cards, annual fees, and other transaction and account management fees. Interchange income is a fee paid by a merchant bank to the card-issuing bank through the interchange network. Interchange fees are set by the credit card associations and are based on cardholder purchase volumes. The Company records interchange income as transactions occur. Transaction and account management fees are recognized as transactions occur or services are provided, except for annual fees, which are recognized over the applicable period. Volume-related payments to partners and credit card associations and expenses for rewards programs are also recorded within payment systems revenue. Payments to partners and expenses related to rewards programs are recorded when earned by the partner or customer. Merchant processing services revenue consists principally of transaction and account management fees charged to merchants for the electronic processing of transactions, net of interchange fees paid to the credit card issuing bank, card association assessments, and revenue sharing amounts, and are all recognized at the time the merchant’s transactions are processed or other services are performed. The Company may enter into revenue sharing agreements with referral partners or in connection with purchases of merchant contracts from sellers. The revenue sharing amounts are determined primarily on sales volume processed or revenue generated for a particular group of merchants. Merchant processing revenue also includes revenues related to point-of-sale equipment recorded as sales when the equipment is shipped or as earned for equipment rentals.
Trust and Investment Services Revenue. Trust and investment management fees are recognized over the period in which services are performed and are based on a percentage of the fair value of the assets under management or administration, fixed based on account type, or transaction-based fees.
New Accounting Pronouncements. In December 2010, the Financial Accounting Standards Board (“FASB”) issued guidance within the Accounting Standards Update (“ASU”) 2010-20 “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” ASU 2010-20 requires entities to provide disclosures designed to facilitate financial statement users’ evaluation of (i) the nature of credit risk inherent in the entity’s portfolio of financing receivables, (ii) how that risk is analyzed and assessed in arriving at the allowance for credit losses and (iii) the changes and reasons for those changes in the allowance for credit losses. Disclosures must be disaggregated by portfolio segment, the level at which an entity develops and documents a systematic method for determining its allowance for credit losses, and class of financing receivable, which is generally a disaggregation of portfolio segment. The required disclosures include, among other things, a roll forward of the allowance for credit losses as well as information about modified, impaired, nonaccrual and past due loans and credit quality indicators. ASU 2010-20 became effective for the Company’s financial statements as of December 31, 2010, as it relates to disclosures required as of the end of a reporting period. Disclosures that relate to activity during a reporting period will be required for the Company’s financial statements that include periods beginning on or after January 1, 2011. The adoption of this guidance did not have any impact on the Company’s consolidated statement of income (loss), its consolidated balance sheet, or its consolidated statement of cash flows.
ASU 2010-20, “Receivables (Topic 310)-Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20,” temporarily deferred the effective date for disclosures related to troubled debt restructurings to coincide with the effective date of a proposed accounting standards update related to troubled debt restructurings, which is currently expected to be effective for periods ending after June 15, 2011. The adoption of this guidance is not expected to have a material impact on the Company’s consolidated statement of income (loss), its consolidated balance sheet, or its consolidated statement of cash flows.
2. INVESTMENT SECURITIES
The following table presents the available for sale investment securities as of December 31, 2010 and 2009:
Gross realized gains on the sale of investment securities included in earnings in 2010, 2009, and 2008 were $1,562,000, $833,000 and $814,000, respectively. Gross realized losses were $34,000 in 2008 and there were no such losses in 2010 and 2009.
In 2008, the Company recorded OTTI charges totaling $6.3 million pretax consisting of $.4 million relating to an investment in a Lehman Brothers bond, $3.1 million related to two pooled trust preferred investments in our corporate securities portfolio, and $2.8 million for an investment in Freddie Mac preferred stock held in our equity and other securities portfolio. The $3.1 million OTTI related to two pooled trust preferred investments was subsequently reversed as of March 31, 2009 as a result of the FASB issuing authoritative guidance included in Accounting Standards Codification (“ASC”) 320 “Investments - Debt and Equity Securities” that amended other-than-temporary impairment guidance for debt securities to require a new other-than-temporary impairment model that shifts the focus from an entity’s intent to hold the debt security until recovery to its intent, or expected requirements to sell the debt security. This guidance is intended to provide greater clarity to investors about the credit and noncredit component of an OTTI event and to more effectively communicate when an OTTI event has occurred. This guidance was applied prospectively with a cumulative effect transition adjustment as of the beginning of the period in which it was adopted.
In the first quarter of 2009, the Company recorded OTTI charges totaling $.2 million pretax consisting of $.1 million relating to a Lehman Brothers bond held in our corporate securities portfolio and $.1 for the investment in Freddie Mac preferred stock held in our equity and other securities portfolio. Both of these investments were sold in the second quarter of 2009 for no additional gain or loss.
Dividends on equity investments for the years 2010, 2009, and 2008 were $105,000, $106,000, and $294,000, respectively.
2. INVESTMENT SECURITIES (continued)
Our U.S. Government agency securities increased by $90.2 million from December 31, 2009, to December 31, 2010, as part of our effort to improve liquidity, maintain portfolio diversification and provide collateral for public funds and borrowing sources such as the FHLB.
The investment securities portfolio had a net unrealized gain of $.9 million at December 31, 2010 compared to a net unrealized loss of $2.3 million at December 31, 2009. Our corporate security portfolio had a $5.1 million unrealized loss at December 31, 2010. The majority of this loss was associated with the decline in market value of our investments in pooled trust preferred securities issued primarily by banks and insurance companies. An increase in credit and liquidity spreads contributed to the unrealized loss associated with these securities which had a $14.0 million amortized cost and an $8.9 million estimated fair value at December 31, 2010. These securities are rated C or better by the rating agencies that cover these securities and they have several features that reduce credit risk, including seniority over certain tranches in the same pool and the benefit of certain collateral coverage tests.
The following tables provide the fair value and gross unrealized losses on securities available for sale, aggregated by category and length of time the individual securities have been in a continuous unrealized loss position:
There were six investment securities with a 12 month or greater continuous unrealized loss in the investment portfolio at December 31, 2010, with a total unrealized loss of $5.2 million. In comparison, at December 31, 2009, there were nine investment securities with a 12 month or greater continuous unrealized loss in the investment portfolio, with a total unrealized loss of $5.7 million. The unrealized loss on these investment securities was primarily due to continued increased credit and liquidity spreads and an extension of expected cash flow causing a decline in the fair market value subsequent to the purchase of our pooled trust preferred securities (corporate security category). These securities had an estimated fair value of $8.9 million compared to a $14.0 million amortized cost at December 31, 2010. The value of most of our securities fluctuates as market interest rates change.
There were a total of 28 securities in Bancorp’s investment portfolio at December 31, 2010, that have been in a continuous unrealized loss position for less than 12 months, with an amortized cost of $159.7 million and a total unrealized loss of $2.9 million. At December 31, 2009, there were a total of 37 securities in Bancorp’s investment portfolio that have been in a continuous unrealized loss position for less than 12 months, with an amortized cost of $211.6 million and a total unrealized loss of $2.7 million. The unrealized loss on these investment securities was predominantly caused by increases in credit and liquidity spreads. The fair value of these securities fluctuates as market interest rates change.
Based on management’s review and evaluation of the Company’s debt securities, the Bank does not intend to sell any debt securities which have an unrealized loss, it is unlikely the Company will be required to sell these securities before recovery, and we expect to recover the entire amortized cost of these impaired securities. Therefore the debt securities with unrealized losses were not considered to have OTTI. In addition, the unrealized loss on equity securities is considered temporary and the Company has the intent and ability to hold equity investments until recovery, therefore these securities were not considered other-than-temporarily impaired.
At December 31, 2010 and 2009, the Company had $504.0 and $399.0 million, respectively, in investment securities being provided as collateral to the FHLB, the Federal Reserve Bank of San Francisco (the “Reserve Bank”), the State of Oregon and the State of Washington, and others for our borrowings and certain public fund deposits. At December 31, 2010 and December 31, 2009, Bancorp had no reverse repurchase agreements.
2. INVESTMENT SECURITIES (continued)
The follow table presents the maturities of the investment portfolio at December 31, 2010:
Mortgage-backed securities, including collateralized mortgage obligations and asset-backed securities, have maturities that will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
3. LOANS AND ALLOWANCE FOR CREDIT LOSSES
The following table presents the loan portfolio as of December 31, 2010 and 2009:
Total loans decreased by 11% or $189 million from the balance at December 31, 2009, and the decrease reflected weak real estate markets and soft loan demand within our operating region which, on a historical basis, contributed to modest new loan origination volumes. At December 31, 2010 and 2009, Bancorp had $1.3 million and $1.2 million, respectively, of overdrafts classified as loans in the installment and other consumer loan category.
The Company has lending policies and underwriting processes in place that are designed to make loans within an acceptable level of risk for the estimated return. Management reviews and approves these policies and processes on a regular basis. Management frequently reviews reports related to loan production, loan quality, loan delinquencies and nonperforming and potential problem loans. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions.
Commercial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and prudently execute its business. Underwriting standards are designed to promote relationship banking rather than transactional banking. The Company’s lending officers examine current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Management monitors and evaluates commercial loans based on collateral, geography and risk rating criteria. Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and typically incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.
Commercial real estate loans are subject to underwriting standards and processes similar to commercial loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful lease-up of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk rating criteria. As a general rule, the Company avoids financing single purpose projects unless other underwriting factors are present to help mitigate risk. The Company also utilizes third parties to provide insight and guidance about economic conditions and trends affecting market areas it serves.
With respect to loans to real estate investors that are secured by non-owner occupied properties that the Company may originate from time to time, the Company generally requires the borrower to have had an existing relationship and have a proven record of positive business performance. Our residential and commercial construction portfolios are portfolios we consider to have higher risk. Construction loans are underwritten utilizing independent appraisal reviews, sensitivity analysis of absorption and lease rates financial analysis of the developers, property owners, and investors as well as on a selective basis, feasibility studies. Construction loans are generally based upon estimates of costs and value associated with the complete project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from the Company or other approved third party long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, pre-leasing that does not materialize, general economic conditions, the availability of long-term financing, and completion of construction within timelines and costs originally set forth.
3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (continued)
The Bank originates fixed and adjustable rate residential mortgages. These residential loans are typically sold on the secondary market with the servicing responsibility released by the Company. These loan sales have no recourse, however sales are subject to proper compliance with standard underwriting rules that if not met, may allow the secondary market buyer to require the Company to repurchase the note. Upon origination, these residential mortgage loans are recorded as loans held for sale until the sale has closed.
The Bank originates home equity loans and lines through an online application system in which all applications are centrally reviewed with underwriting and verifications completed by an experienced underwriter. Monthly loan portfolio reports provide home equity loan performance monitoring. Annual review of credit policies document the acceptance of policy and procedure changes as needed. Credit risk is minimized by accepting borrowers with a proven credit history, verified income sources for repayment and owner occupied properties as acceptable collateral. Portfolio balances, performance and underwriting standards can be influenced by regional economic cycles related to unemployment levels, de-leveraging by borrowers, and market values for residential properties.
The Company originates consumer loans utilizing a computer-based credit scoring analysis to supplement the underwriting process. To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed, jointly by line and staff personnel. This activity, coupled with relatively small loan amounts that are spread across many individual borrowers, minimizes risk. Additionally, trend and outlook reports are reviewed by management on a regular basis.
The Company maintains credit administration and credit review functions that are designed to help confirm our credit standards are being followed. Significant findings and periodic reports are communicated to the Chief Credit Officer and Chief Executive Officer and, in certain cases, to the Loan, Investment & Asset/Liability Committee, which is comprised of certain directors. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Company’s policies and procedures.
Loans greater than 90 days past due are classified into nonaccrual status. The following table presents an age analysis of the loan portfolio as of December 31, 2010 and 2009:
3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (continued)
The following table presents an analysis of impaired loans as of December 31, 2010 and 2009:
At December 31, 2010 and 2009, Bancorp’s recorded investment in loans that were considered to be impaired was $76.7 million and $98.8 million, respectively. A loan is considered to be impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due (both interest and principal) according to the contractual terms of the loan agreement. For loans that are collateral dependent; the Company charges off the amount of impairment at the time of impairment. At December 31, 2010, a specific reserve allowance in the amount of $.6 million was established related to $15.5 million of impaired loans which were considered to be troubled debt restructurings and were on accrual status, compared to no such specific reserve allowance for impaired loans at December 31, 2009.
The average recorded investment in impaired loans for the years ended December 31, 2010, 2009 and 2008 was approximately, $78.0 million, $134.3 million and $128.6 million, respectively. For the years ended December 31, 2010, 2009 and 2008, interest income recognized on impaired loans totaled $568,000, $526,000, and $1,195,000, respectively.
At December 31, 2010, Bancorp had $57.8 million in loans classified as troubled debt restructurings of which $15.5 million was on accrual status, with the remaining $42.3 million on nonaccrual status. The $57.8 million in troubled debt restructurings were considered impaired at December 31, 2010. Troubled debt restructurings were $22.8 million at December 31, 2009, of which $11.7 million was on accrual status, with the remaining $11.1 million on nonaccrual status. The modifications granted on troubled debt restructurings were due to borrower financial difficulty and generally provide for a temporary modification of loan terms.
The following table presents nonaccrual loans by category as of December 31, 2010 and 2009:
Loans on which the accrual of interest has been discontinued were approximately $61.2 million, $99.3 million and $127.6 million at December 31, 2010, 2009, and 2008, respectively. Interest income foregone on nonaccrual loans was approximately $6.5 million, $10.7 million and $13.6 million in 2010, 2009, and 2008, respectively.
3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (continued)
The Company uses a risk rating matrix to assign a risk rating to loans not evaluated on a homogenous pool level. At December 31, 2010, $1.10 billion of loans were risk rated and $439.4 million were evaluated on a homogeneous pool basis. Individually risk rated loans are rated on a scale of 1 to 10. A description of the general characteristics of the 10 risk ratings is as follows:
Ratings 1, 2 and 3 - These ratings include loans to very high credit quality borrowers of investment or near investment grade. These borrowers have significant capital strength, moderate leverage, stable earnings and growth, and readily available financing alternatives. Smaller entities, regardless of strength, would generally not fit in these ratings. These ratings also include loans that are collateralized by U. S. Government securities and certificates of deposits.
Rating 4 - These ratings include loans to borrowers of solid credit quality with moderate risk. Borrowers in these ratings are differentiated from higher ratings on the basis of size (capital and/or revenue), leverage, asset quality and the stability of the industry or market area.
Ratings 5 and 6 - These ratings include “pass rating” loans to borrowers of acceptable credit quality and risk. Such borrowers are differentiated from Rating 4 in terms of size, secondary sources of repayment or they are of lesser stature in other key credit metrics in that they may be over-leveraged, undercapitalized, inconsistent in performance or in an industry or an economic area that is known to have a higher level of risk, volatility, or susceptibility to weaknesses in the economy. However, no material adverse trends are evident with borrowers in these pass ratings.
Rating 7 - This rating includes loans on management’s “watch list” and is intended to be utilized on a temporary basis for pass rating borrowers where a significant risk-modifying action is anticipated in the near term.
Rating 8 - This rating includes “Substandard” loans, in accordance with regulatory guidelines, for which the accrual of interest may or may not been discontinued. By definition under regulatory guidelines, a “Substandard” loan has defined weaknesses which make payment default or principal exposure likely, but not yet certain. Such loans are apt to be dependent upon collateral liquidation, a secondary source of repayment, or an event outside of the normal course of business.
Rating 9 - This rating includes “Doubtful” loans in accordance with regulatory guidelines. Such loans are placed on nonaccrual status and may be dependent upon collateral having a value that is difficult to determine or upon some near-term event which lacks certainty.
Rating 10 - This rating includes “Loss” loans in accordance with regulatory guidelines. Such loans are to be charged-off or charged-down when payment is acknowledged to be uncertain or when the timing or value of payments cannot be determined. “Loss” is not intended to imply that the loan or some portion of it will never be paid, nor does it in any way imply that there has been a forgiveness of debt.
The Company considers loans assigned a risk rating 8 through 10 to be classified loans. The following table presents weighted average risk ratings of the loan portfolio and classified loans by category. The weighted average risk ratings did not exhibit material change from December 31, 2009 to December 31, 2010. Overall classified loans have decreased, both in total and as a percentage of the loan portfolio. Total commercial real estate classified loans increased during 2010, as this portfolio typically is challenged in the latter part of a weak economic period.
3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (continued)
The following table presents loans by category that the credit risk is evaluated on a portfolio basis including our home equity lines of credit and certain small business loans. Important credit quality metrics for this portfolio include nonaccrual and past due status. Total loans evaluated on a homogeneous pool basis were $439.4 million and $527.6 million at December 31, 2010 and 2009, respectively.
The allowance for credit losses is a reserve established through a provision for credit losses charged to expense, which represents management’s best estimate as of the balance sheet date, of probable losses that have been incurred within the existing loan portfolio. The allowance for credit losses is based on historical loss experience by type of credit and internal risk rating, specific homogeneous risk pools and specific loss allocations, with adjustments for current events and conditions. The Company’s process for determining the appropriate amount of the allowance for credit losses is designed to account for credit deterioration as it occurs. The provision for credit losses is reflective of loan quality trends, and considers trends related to nonaccrual loans, past due loans, potential problem loans, criticized loans and net charge-offs or recoveries, among other factors. The provision for credit losses also reflects the totality of actions taken on all loans for a particular period.
The allowance for credit losses reflects management’s continuing evaluation of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. Portions of the allowance may be allocated for specific loans; however, the entire allowance is available for any loan that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond the Company’s control, including, among other things, the performance of the overall loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications.
The Company’s allowance for loan losses consists of three key elements: specific reserve allowances, formula allowance, and an unallocated allowance that represents an amount to capture risk associated with qualitative factors and uncertainty that is inherent in estimates used to determine the allowance.
Specific reserve allowances may be established when management can estimate the amount of an impairment of a loan, typically on a non real estate collateralized loan or to address the unique risks associated with a group of loans or particular type of credit exposure. The Company does not establish specific reserve allowances on collateral dependent impaired loans. Impairment on these loans is charged off to the allowance for credit losses when impairment is established.
The formula allowance is calculated by applying loss factors to individual loans based on the assignment of risk ratings, or through the assignment of loss factors to homogenous pools of loans. Changes in risk ratings of both performing and nonperforming loans affect the amount of the formula allowance. Loss factors are based on our historical loss experience and such other data as management believes to be pertinent, and may be adjusted for significant factors that, in management’s judgment, affect the collectability of the portfolio as of the evaluation date. At December 31, 2010 and 2009, the allowance for loan losses was $40.2 million and $38.5 million, respectively, while the reserve for unfunded commitments was $.8 million and $.9 million, respectively.
The unallocated loan loss allowance represents an amount for imprecision or uncertainty that is inherent in estimates used to determine the allowance. In determining whether to carry an unallocated allowance and, if so, the amount of the allowance, management considers a variety of qualitative factors, including regional economic and business conditions that impact important categories of our portfolio, loan growth rates, the depth and skill of lending staff, the interest rate environment, and the results of bank regulatory examinations and findings of our internal credit examiners. Currently, we have an unallocated allowance for loan losses that is the result of our judgment about risks inherent in the loan portfolio due to economic uncertainties, as well as our evaluation of historical loss experience relative to current trends, and other subjective factors. The current level of unallocated reserves is high by historical standards; however, the Company believes higher levels of unallocated reserves are appropriate given downward pressure on real estate values and higher levels of uncertainty associated with strained economic conditions.
3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (continued)
The following is an analysis of the changes in the allowance for credit losses:
The reduced provision for credit losses of $18.7 million for 2010, as compared to $90.1 million for 2009, was largely due to a slowdown in the unfavorable risk rating migration within the loan portfolio, lower loan net charge-offs, and, to a lesser extent, the release of reserves as certain loans moved from being included in the general valuation allowance to being individually measured for impairment. The provision for credit losses of $90.1 million for 2009 increased $49.7 million as compared to $40.4 million in 2008, primarily caused by negative risk rating changes within the loan portfolio and higher net charge-offs in our loan portfolio.
The following table presents summary account activity of the allowance for credit losses by loan category as of December 31, 2010 and 2009:
4. PREMISES AND EQUIPMENT
Premises and equipment consists of the following:
Depreciation included in occupancy and equipment expense amounted to $3.8 million, $5.9 million, and $4.7 million for the years ended December 31, 2010, 2009, and 2008, respectively. Depreciation for all premises and equipment is calculated using the straight-line method. The Company periodically reviews the recorded value of its long-lived assets, specifically premises and equipment, to determine whether impairment exists. No impairments were recorded during 2010, 2009, or 2008.
5. GOODWILL AND INTANGIBLE ASSETS
The following table summarizes the changes in Bancorp’s goodwill and core deposit intangible asset for the periods shown:
The goodwill impairment analysis requires management to make judgments in determining if an indicator of impairment has occurred and involves a two-step process. The first step was a comparison of the Bank’s fair value to its carrying value. We estimated fair value using a combination of quoted market price and an estimate of a control premium. The results of the analysis concluded that the estimated fair value of the Company’s Bank reporting unit was less than its book value and the carrying amount of the Company’s Bank reporting unit goodwill exceeded its implied fair value. Therefore, the Company failed step one and moved to the second step which required allocation of the fair value to all of the assets and liabilities of the reporting unit, including any unrecognized intangible assets, in a hypothetical analysis that would calculate the implied fair value of goodwill.
At March 31, 2009, based on management’s analysis and continued deteriorating economic conditions and the length of time and amount by which the Company’s book value per share had exceeded its market value per share, the Company determined the Company’s Bank reporting unit goodwill exceeded its implied fair value at March 31, 2009 and it was appropriate to write off the entire $13.1 million of goodwill related to its acquisition of Mid-Valley Bank in June 2006.
The following table presents the forecasted core deposit intangible asset amortization expense for 2011 through 2013:
6. OTHER REAL ESTATE OWNED, NET
The following table summarizes Bancorp’s OREO for the years ended December 31, 2010 and 2009:
The following table summarizes Bancorp’s OREO valuation allowance for the years ended December 31, 2010 and 2009:
7. OTHER ASSETS
The following table summarizes Bancorp’s other assets for the years ended December 31, 2010 and 2009:
Bancorp has invested in two limited partnerships that operate qualified affordable housing properties. Tax credits and tax deductions from operating losses are passed through the partnerships to Bancorp. The Company accounts for these investments using the equity method.
8. BALANCES WITH THE FEDERAL RESERVE BANK
The Bank is required to maintain cash reserves or deposits with the Federal Reserve Bank equal to a percentage of reservable deposits. The average required reserves for the Bank were $6.5 million and $6.1 million during the years ended December 31, 2010 and 2009, respectively.
9. BORROWINGS
The following table summarizes Bancorp’s borrowings for the years ended December 31, 2010 and 2009:
FHLB advances are collateralized, as provided for in an “Advances, Security and Deposit Agreement” with the FHLB, by investment securities and qualifying loans. This advance agreement requires FHLB prior consent to utilize available credit. At December 31, 2010, the Company had additional borrowing capacity available at the FHLB of $504.4 million based on pledged collateral.
Long-term borrowings at December 31, 2010, consisted of notes with fixed maturities (non-putable) and putable advances with the FHLB totaling $168.6 million. Total long-term borrowings with fixed maturities were $138.6 million, with rates ranging from 2.32% to 5.03%. Bancorp had three putable advances totaling $30.0 million, with original terms of five years at rates ranging from 2.45% to 3.78%. The scheduled maturities on these putable advances occur in February 2013, August 2013, and March 2014, although the FHLB may under certain circumstances require repayment of these putable advances prior to maturity. Principal payments due at scheduled maturity of Bancorp’s long-term borrowings at December 31, 2010, were $50.1 million in 2012, $76.3 million in 2013, and $42.2 million in 2014.
Long-term borrowings at December 31, 2009 consisted of notes with fixed maturities and putable advances with the FHLB totaling $250.7 million. Total long-term borrowings with fixed maturities were $220.7 million. Bancorp had three putable advances totaling $30.0 million with original terms of five years, and final maturities in February 2013, August 2013, and March 2014. The FHLB may under certain circumstances require repayment of these putable advances prior to their scheduled maturities.
Bancorp had no outstanding Federal Funds purchased from correspondent banks, borrowings from the discount window, or reverse repurchase agreements at December 31, 2010 and 2009.
10. JUNIOR SUBORDINATED DEBENTURES
At December 31, 2010, six wholly-owned subsidiary grantor trusts established by Bancorp had issued and sold $51 million of trust preferred securities. Trust preferred securities accrue and pay distributions periodically at specified annual rates as provided in each indenture. The trusts used all of the net proceeds from each sale of trust preferred securities to purchase a like amount of junior subordinated debentures of the Company. The junior subordinated debentures are the sole assets of the trusts. The Company’s obligations under the junior subordinated debentures and related documents, taken together, constitute a full and unconditional guarantee by the Company of the obligations of the trusts. The trust preferred securities are mandatorily redeemable upon the maturity of the junior subordinated debentures and may be subject to earlier redemption by the Company as provided in the indentures. The Company has the right to redeem the junior subordinated debentures in whole (but not in part) on or after specific dates, at a redemption price specified in the indentures plus any accrued but unpaid interest to the redemption date. During the third quarter 2009, the Company exercised its right to defer regularly scheduled interest payments on junior subordinated debentures related to its trust preferred securities. At December 31, 2010, the Company had a balance in other liabilities of $1.8 million in accrued and unpaid interest expense related to these junior subordinated debentures, and it may not pay dividends on its capital stock until all accrued but unpaid interest has been paid in full.
The following table is a summary of outstanding trust preferred securities at December 31, 2010:
1 The variable rate preferred securities reprice quarterly.
2 Securities are redeemable at the option of Bancorp following these dates.
The interest rates on the trust preferred securities reset quarterly and are tied to the London Interbank Offered Rate (“LIBOR”) rate.
The junior subordinated debentures issued by Bancorp to the grantor trust are reflected in our consolidated balance sheet in the liabilities section at December 31, 2010 and 2009, as junior subordinated debentures. Bancorp records interest expense on the corresponding junior subordinated debentures in the consolidated statements of income (loss). The common capital securities issued by the trusts are recorded within other assets in the consolidated balance sheets, and totaled $1.6 million at December 31, 2010 and 2009.
11. EMPLOYEE BENEFIT PLANS
Bancorp employee benefits include a plan established under section 401(k) of the Internal Revenue Code for certain qualified employees (the “401(k) plan”). Employee contributions up to 100 percent of salaries under the Internal Revenue Code guidelines can be made under the 401(k) plan, of which Bancorp may match 50 percent of the employees’ contributions up to a maximum of three percent of the employees’ eligible compensation. Bancorp may also elect to make discretionary contributions to the plan. In 2010, Bancorp made a qualified non-elective contribution in the amount of $100 per full-time employee, excluding certain executive officers, prorated for part time employees and with immediate vesting. Bancorp’s 401(k) related discretionary contributions expenses for 2010, 2009, and 2008 were $.1 million, $0, and $0, respectively. Employees vest immediately in their own contributions and earnings, and vest in Bancorp’s contributions over five years of eligible service. Bancorp had no 401(k) plan related expenses in 2010, 2009 and 2008 related to the Company’s 401(k) plan match.
Bancorp provides separate non-qualified deferred compensation plans for directors and executive officers (collectively, “Deferred Compensation Plans”) as supplemental benefit plans which permit directors and selected officers to elect to defer receipt of all or any portion of their future salary, bonus or directors’ fees, including with respect to officers, amounts they otherwise might not be able to defer under the 401(k) plan due to specified Internal Revenue Code restrictions on the maximum deferral that may be allowed under that plan. Under the Deferred Compensation Plans, an amount equal to compensation being deferred by participants is placed in a rabbi trust, the assets of which are available to Bancorp’s creditors and recorded as trading securities in our consolidated balance sheets, and invested consistent with the participants’ direction among a variety of investment alternatives. A deferred compensation liability of $1.6 million was included in other liabilities as of December 31, 2010, compared to $1.5 million at December 31, 2009.
Bancorp has multiple supplemental executive retirement agreements with former and current executives. The following table reconciles the accumulated liability for the benefit obligation of these agreements:
Bancorp’s obligations under supplemental executive retirement agreements are unfunded plans and have no plan assets. The benefit obligation represents the vested net present value of future payments to individuals under the agreements. Bancorp’s benefit expense, as specified in the agreements for the entire year 2011, is expected to be $.2 million. The benefits expected to be paid are presented in the following table:
12. COMMITMENTS AND CONTINGENT LIABILITIES
The Company leases land and office space under 49 leases, of which 46 are long-term operating leases that expire between 2011 and 2024. At the end of most of the respective lease terms, Bancorp has the option to renew the leases at fair market value. At December 31, 2010, minimum future lease payments under these leases and other operating leases were:
Rental expense for all operating leases was $4.2 million, $4.2 million, and $4.1 million for the years ended December 31, 2010, 2009, and 2008, respectively.
Bancorp is periodically party to litigation arising in the ordinary course of business. Based on information currently known to management, although there are uncertainties inherent in litigation, we do not believe there is any legal action to which Bancorp or any of its subsidiaries is a party that, individually or in the aggregate, will have a materially adverse effect on Bancorp’s financial condition and results of operations, cash flows, or liquidity.
13. STOCKHOLDERS’ EQUITY AND REGULATORY CAPITAL
On January 20, 2010, the Company’s shareholders approved (i) an amendment of Bancorp's Restated Articles of Incorporation to increase the number of authorized shares of Common Stock to 250,000,000 and correspondingly to increase the total number of authorized shares of all classes of stock from 60,000,000 to 260,000,000, and (ii) conversion of the outstanding Preferred Stock into Common Stock as required by the rules of The Nasdaq Stock Market. At December 31, 2010, Bancorp had issued and outstanding 96,430,613 shares of Common Stock and 121,328 shares of Series B Preferred Stock.
Authorized capital stock of Bancorp at December 31, 2009, included 50,000,000 shares of Common Stock, no par value, and 10,000,000 shares of Preferred Stock, no par value, of which 2,000,000 shares had been designated as Mandatorily Convertible Cumulative Participating Preferred Stock, Series A (“Series A Preferred Stock”) and 600,000 shares had been designated as Mandatorily Convertible Cumulative Participating Preferred Stock, Series B (“Series B Preferred Stock”).
Preferred Stock. Following the receipt of shareholder approvals on January 20, 2010, 1,428,849 shares of Series A Preferred Stock issued in connection with Bancorp's private capital raise and outstanding at December 31, 2009, automatically converted into an aggregate of 71,442,450 shares of Common Stock. There are no shares of Series A Preferred Stock currently outstanding.
Bancorp also issued an aggregate of 121,328 shares of Series B Preferred Stock in the private capital raise all of which remains outstanding. These shares will automatically convert into an aggregate of 6,066,400 shares of Common Stock upon transfer of the Series B Preferred Stock to third parties in a widely dispersed offering.
The Series B Preferred Stock is not subject to the operation of a sinking fund and has no participation rights. The Series B Preferred Stock is not redeemable by the Company and is perpetual with no maturity. The holders of Series B Preferred Stock have no general voting rights. If the Board of Directors declares and pays a dividend in respect of Common Stock, it must declare and pay to the holders of the Series B Preferred Stock on the same date a dividend in an amount per share of the Series B Preferred Stock determined in accordance with the Restated Articles of Incorporation that is intended to provide such holders dividends in the amount they would have received if shares of Series B Preferred Stock had been converted into Common Stock as of that date. There are no accrued dividends or dividends in arrears on Series B Preferred Stock at December 31, 2010.
Warrants to purchase Series B Preferred Stock. Also in October 2009 as part of the private capital raise, Bancorp issued Class C Warrants to purchase an aggregate of 240,000 shares of Series B Preferred Stock at an exercise price of $100.00 per share. The Warrants were immediately exercisable and will expire on October 23, 2016. Shares of Series B Preferred Stock issuable upon exercise of the Warrants will automatically convert into an aggregate of 12.0 million shares of Common Stock upon transfer of the Series B Preferred Stock to third parties in a widely dispersed offering. The Company allocated the proceeds of $21.1 million from the issuance of the Series B Preferred Stock and Warrants between the two based on their relative fair values. The fair value allocated to the warrants was $11.1 million.
The Company maintains a stock repurchase plan. Under the Company’s stock repurchase plan, the Company can purchase up to 4.88 million shares of the Company’s Common Stock. The Company did not repurchase any shares in 2010 nor does it anticipate repurchasing any shares in the foreseeable future. Total shares available for repurchase under this plan are 1,052,000 at December 31, 2010.
13. STOCKHOLDERS’ EQUITY AND REGULATORY CAPITAL (continued)
Regulatory Capital. The Federal Reserve and Federal Deposit Insurance Corporation (“FDIC”) have established minimum requirements for capital adequacy for bank holding companies and nonmember banks. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, Bancorp and the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities and certain off balance sheet items. The Federal Reserve and FDIC risk based capital guidelines require banks and bank holding companies to have a ratio of Tier 1 capital to total risk weighted assets of at least 4%, and a ratio of total capital to total risk weighted assets of 8% or greater. In addition, the leverage ratio of Tier 1 capital to total average assets less intangibles is required to be at least 4%. Bancorp and its bank subsidiary’s capital components, classification, risk weightings and other factors are also subject to qualitative judgments by regulators. Failure to meet minimum capital requirements can initiate certain action by regulators that, if undertaken, could have a material effect on Bancorp’s financial statements.
Bancorp’s total risk-based capital ratio improved to 18.74% at December 31, 2010, up from 9.13% at December 31, 2009, while Bancorp's Tier 1 risk-based capital ratio increased to 17.47% at current year end, from 7.17% at year end 2009. Bancorp’s capital ratios improved over year end 2009 principally as a result of the mandatory conversion of Series A preferred stock issued in the Company's October 2009 private capital raise into 71.4 million common shares following receipt of shareholder approval. The $9.4 million in net proceeds from the rights offering completed during first quarter 2010, $7.0 million in net proceeds from issuance under our discretionary equity issuance program that was terminated August 6, 2010, and a reduction in the Company’s risk weighted assets over the past 12 months also contributed to improved capital ratios at Bancorp.
The following table presents the capital measures of Bancorp and the Bank as of December 31, 2010 and 2009:
14. STOCK PLANS
At December 31, 2010, Bancorp maintained two stock plans; the 2002 Stock Incentive Plan (“2002 Plan”) and the 1999 Stock Option Plan (“1999 Plan”). No additional grants may be made under the 1999 Plan. The 2002 Plan, which is shareholder approved, permits the grant of stock options, restricted stock and certain other stock based awards. Restricted stock granted under the 2002 Plan generally vests over a two to four year vesting period; however, certain grants have been made that vested over a one year period or immediately, including grants to directors. On April 27, 2010, shareholders approved a 2.0 million share increase in the shares available under the 2002 Plan. The 2002 Plan permits the grant of stock options and restricted stock awards for up to 4.1 million shares, of which 488,116 shares remained available for issuance as of December 31, 2010.
All stock options granted have an exercise price that is equal to the closing fair market value of Bancorp’s stock on the date the options were granted. Options granted under the 2002 Plan generally vest over a two to four year vesting period; however, certain grants have been made that vested immediately, including grants to directors. Stock options have a ten-year maximum term. Options previously issued under the 1999 or prior plans are fully vested. It is Bancorp’s policy to issue new shares for stock option exercises and restricted stock. Bancorp expenses stock options and restricted stock on a straight line basis over the related vesting term.
The following table presents information on stock options outstanding for the periods shown:
The average fair value of stock options granted is estimated on the date of grant using the Black-Scholes option-pricing model. There were no non-qualified director stock options granted in 2010. The following table presents the assumptions used in the fair value calculation:
As of December 31, 2010, outstanding stock options consist of the following:
14. STOCK PLANS (continued)
The following table presents information on stock options outstanding for the periods shown, less estimated forfeitures:
Bancorp grants restricted stock periodically as a part of the 2002 Plan for the benefit of employees and directors. Restricted stock grants are made at the discretion of the Board of Directors, except with regard to grants to certain Company officers, which are made at the discretion of the Board’s Compensation & Personnel Committee. Compensation expense for restricted stock is based on the market price of the Company stock at the date of the grant and amortized on a straight-line basis over the vesting period which is currently one, three or four years for all grants. Recipients of restricted stock do not pay any cash consideration to the Company for the shares, have the right to vote all shares subject to such grant and receive all dividends with respect to such shares, whether or not the shares have vested, except in the case of performance awards granted in 2008 for which dividends are collected and will be forfeited if performance conditions are not met. Restrictions are generally based upon continuous service, except that performance awards vest based on achievement of performance targets based on the Company’s stock price.
Restricted stock consists of the following for the years ended December 31, 2010, 2009 and 2008:
The following table presents stock-based compensation expense for employees and directors related to restricted stock and stock options for the periods shown:
The balance of unearned compensation related to unvested restricted stock granted as of December 31, 2010 and 2009 was $4.5 million and $1.2 million, respectively. The December 31, 2010 unearned compensation balance is expected to be recognized over a weighted average period of 3.0 years. The Company received cash in the amount of $3,523 and $0 from stock option exercises for the twelve months ended December 31, 2010 and 2009, respectively. The Company had no tax benefits from disqualifying dispositions involving incentive stock options, the exercise of non-qualified stock options, and the vesting and release of restricted stock for the twelve months ended December 31, 2010 and 2009.
15. COMPREHENSIVE INCOME (LOSS)
The following table displays the components of other comprehensive income (loss) for the last three years:
16. EARNINGS (LOSS) PER SHARE
The following tables reconcile the numerator and denominator of the basic and diluted earnings (loss) per share computations:
17. INCOME TAXES
The components of the provision (benefit) for income taxes for the last three years were:
The deferred Federal and State tax expense includes a change in the deferred tax asset valuation allowance of $2.5 million and $21.0 million for the years ended December 31, 2010 and 2009, respectively.
The reconciliation between the Company’s effective tax rate on income (loss) and the statutory rate is as follows:
1 Federal income tax provision applied at 34% in 2010 and 2008 and 35% in 2009.
17. INCOME TAXES (continued)
Net deferred taxes are included in other assets on the Company’s balance sheet. The tax effect of temporary differences that give rise to significant components of deferred tax assets and deferred tax liabilities as of December 31, 2010 and 2009 are presented below:
Based on the Company’s evaluation as of December 31, 2010, of the amount of deferred tax assets that more likely than not will be realized, a deferred tax asset valuation allowance of $23.5 million was recorded at year end with a remaining net deferred tax asset balance of $5.8 million.
At December 31, 2010, the Company has deferred tax assets related to state tax net operating loss carryforwards of $3.2 million and state tax credit carryforwards of $.6 million. In addition, the Company has $2.3 million of federal tax credits that must be carried forward against future federal income taxes and cannot be used against current or prior period federal income tax. The following table summarizes the expiration dates of federal tax credits and state net operating loss and tax credit carryforwards:
Bancorp is subject to U.S. federal income taxes and State of Oregon income taxes. The years 2007 through 2010 remain open to examination for federal income taxes, and years 2007 through 2010 remain open for State examination. As of December 31, 2010 and 2009, Bancorp had no unrecognized tax benefits or uncertain tax positions. In addition, Bancorp had $.1 million of accrued interest on taxes and no tax penalties as of December 31, 2010. Bancorp had no accrued interest or penalties as of December 31, 2009.
18. TIME DEPOSITS
Included in time deposits are deposits in denominations of $100,000 or greater, totaling $87.9 million and $211.1 million at December 31, 2010 and 2009, respectively. Interest expense relating to time deposits in denominations of $100,000 or greater was $2.7 million, $5.9 million, and $10.5 million for the years ended December 31, 2010, 2009 and 2008, respectively. Maturity amounts on Bancorp’s time deposits include $211.5 million in 2011, $52.4 million in 2012, $5.2 million in 2013, $4.1 million in 2014, and $2.2 million in 2015. Included in the maturity amounts are $1.9 million in variable rate time deposits that reprice monthly with maturities in the first quarter of 2011.
19. FAIR VALUE MEASUREMENT AND FAIR VALUES OF FINANCIAL INSTRUMENTS
A financial instrument is defined as cash, evidence of an ownership interest in an entity, or a contract that conveys or imposes the contractual right or obligation to either receive or deliver cash or another financial instrument. Examples of financial instruments included in Bancorp’s balance sheet are cash, federal funds sold, debt and equity securities, loans, demand, savings and other interest-bearing deposits, notes and debentures. Examples of financial instruments which are not included in the Bancorp balance sheet are commitments to extend credit and standby letters of credit.
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
Accounting standards require the fair value of deposit liabilities with no stated maturity, such as demand deposits, NOW and money market accounts, to equal the carrying value of these financial instruments and does not allow for the recognition of the inherent value of core deposit relationships when determining fair value.
Bancorp has estimated fair value based on quoted market prices where available. In cases where quoted market prices were not available, fair values were based on the quoted market price of a financial instrument with similar characteristics, the present value of expected future cash flows or other valuation techniques that utilize assumptions which are subjective and judgmental in nature. Subjective factors include, among other things, estimates of cash flows, the timing of cash flows, risk and credit quality characteristics, interest rates and liquidity premiums or discounts. Accordingly, the results may not be precise, and modifying the assumptions may significantly affect the values derived. Further, fair values may or may not be realized if a significant portion of the financial instruments were sold in a bulk transaction or a forced liquidation. Therefore, any aggregate unrealized gains or losses should not be interpreted as a forecast of future earnings or cash flows. Furthermore, the fair values disclosed should not be interpreted as the aggregate current value of Bancorp.
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:
Cash and cash equivalents - The carrying amount is a reasonable estimate of fair value.
Trading securities - Trading securities held at December 31, 2010, are related solely to bonds, equity securities and mutual funds held in a rabbi trust for benefit of the Company’s deferred compensation plans. Fair values for trading securities are based on quoted market prices.
Investment securities - For substantially all securities within the categories U.S. Treasuries, U.S. Government agencies, mortgage-backed, obligations of state and political subdivisions, and equity investments and other securities held for investment purposes, fair values are based on quoted market prices or dealer quotes if available. When quoted market prices are not readily accessible or available, the use of alternative approaches, such as matrix or model pricing or indicators from market makers, is used. If a quoted market price is not available due to illiquidity, fair value is estimated using quoted market prices for similar securities or other modeling techniques. If neither a quoted market price nor market prices for similar securities are available, fair value is estimated by discounting expected cash flows using a market derived discount rate as of the valuation date.
Our level 3 assets consist of pooled trust preferred securities, certain municipal securities and auction rate securities. The fair values of these securities were estimated using the discounted cash flow method. The fair value for these securities used inputs for base case default, recovery and prepayment rates to estimate the probable cash flows for the security. The estimated cash flows were discounted using a rate for comparably rated securities adjusted for an additional liquidity premium.
Loans - The fair value of loans is estimated by discounting the future cash flows using the current rate at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. An additional liquidity discount is also incorporated to more closely align the fair value with observed market prices.
Impaired loans - A loan is considered to be impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due (both interest and principal) according to the contractual terms of the loan agreement. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, as a practical expedient, at the loan’s observable market price or the fair market value of the collateral. A significant portion of the Bank's impaired loans are measured using the fair market value of the collateral.
Bank owned life insurance - The carrying amount is the cash surrender value of all policies, which approximates fair value.
Other real estate owned - Management obtains third party appraisals as well as independent fair market value assessments from realtors or persons involved in selling OREO in determining the fair value of particular properties. Accordingly, the valuation of OREO is subject to significant external and internal judgment. Management periodically reviews OREO and obtains periodic appraisals to determine whether the property continues to be carried at the lower of its recorded book value or fair value less estimated selling costs.
19. FAIR VALUE MEASUREMENT AND FAIR VALUES OF FINANCIAL INSTRUMENTS (continued)
Goodwill - The method used to determine the impairment charge taken first quarter 2009 involved a two step process. The first step estimated fair value using a combination of quoted market price and an estimate of a control premium. It was determined that the estimated fair value of the Company’s Banking reporting unit was less than its book value and the carrying amount of the Company’s Banking reporting unit goodwill exceeded its implied fair value. The second step calculated the implied fair value of goodwill which required allocation of the fair value to all of the assets and liabilities of the reporting unit, including any unrecognized intangible assets, in a hypothetical analysis.
Deposit liabilities - The fair value of demand deposits, savings accounts and other deposits is the amount payable on demand at the reporting date. The fair value of time deposits is estimated using the rates currently offered for deposits of similar remaining maturities.
Short-term borrowings - The carrying amount is a reasonable estimate of fair value given the short-term nature of these financial instruments.
Long-term borrowings - The fair value of the long-term borrowings is estimated by discounting the future cash flows using the current rate at which similar borrowings with similar remaining maturities could be made.
Junior subordinated debentures - The fair value of the variable rate junior subordinated debentures issued in connection with our trust preferred securities approximates the pricing of a preferred security at current market prices.
Commitments to extend credit, standby letters of credit and financial guarantees - The majority of our commitments to extend credit carry current market interest rates if converted to loans.
The tables below present fair value information on certain assets broken down by recurring or nonrecurring measurement status. Recurring assets are initially measured at fair value and are required to be reflected at fair value in the financial statements at each reporting date. Assets measured on a nonrecurring basis are assets that due to an event or circumstance were required to be re-measured at fair value after initial recognition in the financial statements at some time during the reporting period.
Assets are classified as level 1-3 based on the lowest level of input that has a significant effect on fair value. The following definitions describe the level 1-3 categories for inputs used in the tables presented below.
Quoted prices in active markets for identical assets (Level 1): Inputs that are quoted unadjusted prices in active markets for identical assets that the Company has the ability to access at the measurement date. An active market for the asset is a market in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis.
Other observable inputs (Level 2): Inputs that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the reporting entity including quoted prices for similar assets, quoted prices for securities in inactive markets and inputs derived principally from or corroborated by observable market data by correlation or other means.
Significant unobservable inputs (Level 3): Inputs that reflect the reporting entity's own estimates about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances.
19. FAIR VALUE MEASUREMENT AND FAIR VALUES OF FINANCIAL INSTRUMENTS (continued)
The following table presents fair value measurements for assets that are measured at fair value on a recurring basis subsequent to initial recognition:
The Company transferred $14.4 million in U.S. Treasury securities from a level 1 instrument to a level 2 instrument at December 31, 2010. The Company did not have any transfers between level 1, level 2, or level 3 instruments during the year ended December 31, 2009. In addition, the Company had no material changes in valuation techniques for recurring and nonrecurring assets measured at fair value from the year ended December 31, 2009.
19. FAIR VALUE MEASUREMENT AND FAIR VALUES OF FINANCIAL INSTRUMENTS (continued)
The following table represents a reconciliation of level 3 instruments for assets that are measured at fair value on a recurring basis for the full year 2010 and 2009:
The losses from adjustments for OTTI of securities were recognized in noninterest income in the consolidated income statement.
Certain assets and liabilities are measured at fair value on a nonrecurring basis after initial recognition such as loans held for sale, loans measured for impairment and OREO. For the twelve months ended December 31, 2010 and 2009, loans held for sale were subject to the lower of cost or market method of accounting. There was no impairment recognized on loans held for sale at December 31, 2010 or 2009. For the twelve months ended December 31, 2010, certain loans included in Bancorp’s loan portfolio were deemed impaired. OREO that was taken into possession during 2010 was measured at estimated fair value less sales expense. In addition, during 2010, certain properties were written down $6.6 million to reflect additional decreases in their fair market value after initial recognition at the time the property was placed into OREO.
There were no nonrecurring level 1 or 2 fair value measurements in 2010 or 2009. The following table represents the level 3 fair value measurements for nonrecurring assets for the periods presented:
1 Fair value excludes costs to sell collateral.
19. FAIR VALUE MEASUREMENT AND FAIR VALUES OF FINANCIAL INSTRUMENTS (continued)
The estimated fair values of financial instruments at December 31, 2010, are as follows:
The estimated fair values of financial instruments at December 31, 2009 are as follows:
20. FINANCIAL INSTRUMENTS WITH OFF BALANCE SHEET RISK
The Bank has financial instruments with off balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets.
The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as for on-balance sheet instruments. As of December 31, 2010, and 2009, outstanding commitments consist of the following:
The category “other” represents commitments extended to clients or borrowers that have been extended but not yet fully executed. These extended commitments are not yet classified nor have they been placed into our loan system.
Commitments to extend credit are agreements to lend to a customer, as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Many of the commitments may expire without being drawn upon; therefore total commitment amounts do not necessarily represent future cash requirements. Each customer’s creditworthiness is evaluated on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon extension of credit, is based on the Bank’s credit evaluation of the customer. Collateral held varies, but may include real property, accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.
Outstanding commitments for account overdraft protection instruments increased by $41.7 million to $118.6 million in 2010 as a result of an increase in the number of customers in our overdraft protection program and an increase in assigned overdraft limits.
Standby letters of credit are conditional commitments issued to support a customer’s performance or payment obligation to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.
Interest rates on residential 1-4 family mortgage loan applications are typically rate locked during the application stage for periods ranging from 15 to 45 days, the most typical period being 30 days. These loans are locked with various qualified investors under a best-efforts delivery program. The Company makes every effort to deliver these loans before their rate locks expire. This arrangement generally requires the Bank to deliver the loans prior to the expiration of the rate lock. Delays in funding the loans may require a lock extension. The cost of a lock extension at times is borne by the borrower and at times by the Bank. These lock extension costs paid by the Bank are not expected to have a material impact on operations. This activity is managed daily.
21. PARENT COMPANY ONLY FINANCIAL DATA
The following sets forth the condensed financial information of West Coast Bancorp on a stand-alone basis:
21. PARENT COMPANY ONLY FINANCIAL DATA (continued)
During the years ended December 31, 2010 and 2009, the Parent Company made non-cash capital contributions of $.53 million and $.43 million, respectively, to the Bank in the form of an intercompany tax settlement.
22. SEGMENT AND RELATED INFORMATION
Bancorp accounts for intercompany fees and services at an estimated fair value according to regulatory requirements for the service provided. Intercompany items relate primarily to the use of accounting, human resources, data processing and marketing services provided by the Bank, West Coast Trust, and the holding company. All other accounting policies are the same as those described in the summary of significant accounting policies.
Summarized financial information concerning Bancorp’s reportable segments and the reconciliation to Bancorp’s consolidated results is shown in the following table. The “Other” column includes West Coast Trust’s operations and holding company related items including activity relating to trust preferred securities. Investment in subsidiaries is netted out of the presentations below. The “Intercompany” column identifies the intercompany activities of revenues, expenses and other assets, between the “Banking” and “Other” segment.
22. SEGMENT AND RELATED INFORMATION (continued)
23. RELATED PARTY TRANSACTIONS
As of December 31, 2010, the Bank had loan commitments to directors, senior officers, principal stockholders and their related interests totaling $6.3 million, unchanged from December 31, 2009. These commitments and the loan balances below were made substantially on the same terms in the course of ordinary banking business, including interest rates, maturities and collateral as those made to other customers of the Bank.
The following table presents a summary of outstanding balances for loans made to directors, senior officers, and principal stockholders of the Company and their related interests:
24. QUARTERLY FINANCIAL INFORMATION (unaudited)
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure 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 within the time periods specified in the Securities and Exchange Commission’s rules and forms and accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. 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 Securities and Exchange Commission’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.
Material Changes in Internal Control over Financial Reporting
None.
Management’s Report on Internal Control Over Financial Reporting
The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control system is designed to provide reasonable assurance regarding the preparation, reliability and fair presentation of published financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. Management is also responsible for ensuring compliance with the federal laws and regulations concerning loans to insiders and the federal and state laws and regulations concerning dividend restrictions, both of which are designated by the Federal Deposit Insurance Corporation (“FDIC”) as safety and soundness laws and regulations. Nonetheless, all internal control systems, no matter how well designed, have inherent limitations. Even systems determined to be effective as of a particular date can provide only reasonable assurance with respect to financial statement preparation and presentation and may not eliminate the need for restatements.
The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2010. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework. Based on our assessment, we believe that, as of December 31, 2010, the Company’s internal control over financial reporting is effective based on those criteria.
The Company’s management has assessed its compliance with the designated safety and soundness laws and regulations and has maintained records of its determinations and assessments as required by the FDIC. Based on this assessment, management believes that West Coast Bancorp has complied, in all material respects, with the designated safety and soundness laws and regulations for the year ended December 31, 2010.
The Company’s independent registered public accounting firm has audited the Company’s internal control over financial reporting as of December 31, 2010, as stated in their report appearing below.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
West Coast Bancorp
Lake Oswego, Oregon
We have audited the internal control over financial reporting of West Coast Bancorp and subsidiaries (the "Company") as of December 31, 2010, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Because management's assessment and our audit were conducted to meet the reporting requirements of Section 112 of the Federal Deposit Insurance Corporation Improvement Act (FDICIA), management's assessment and our audit of the Company's internal control over financial reporting included controls over the preparation of the schedules equivalent to the basic financial statements in accordance with the instructions for the Consolidated Financial Statements for Bank Holding Companies (Form FR Y-9C). The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying management’s report on internal control over financial reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have not examined and, accordingly, we do not express an opinion or any other form of assurance on management's statement referring to compliance with laws and regulations.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended December 31, 2010 of the Company and our report dated March 10, 2011 expressed an unqualified opinion on those consolidated financial statements.
/s/ DELOITTE & TOUCHE LLP
Portland, Oregon
March 10, 2011
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Information concerning directors and executive officers of Bancorp required to be included in this item is set forth under the headings “Election of Directors,” “Section 16(a) Beneficial Ownership Reporting Compliance,” and “Management” in Bancorp’s Proxy Statement for its 2011 Annual Meeting of Shareholders to be filed within 120 days of Bancorp’s fiscal year end of December 31, 2010 (the “Proxy Statement”), and is incorporated into this report by reference.
Audit and Compliance Committee
Bancorp has a separately-designated standing Audit and Compliance Committee established in accordance with Section 3(a)(58)(A) of the Exchange Act. The members of the Audit and Compliance Committee are Nancy Wilgenbusch (Chair), Lloyd Ankeny, and Duane C. McDougall, each of whom is independent as independence for audit committee members is defined under NASDAQ listing standards applicable to the Company.
Audit Committee Financial Expert
Bancorp’s Board of Directors has determined that Duane C. McDougall is an audit committee financial expert as defined in Item 407(d)(5) of Regulation S-K of the Exchange Act and is independent as independence for audit committee members is defined under NASDAQ listing standards applicable to the Company.
Code of Ethics
We have adopted a code of ethics (the “Code of Ethics”), for our CEO, CFO, principal accounting officer, and persons performing similar functions, entitled the West Coast Bancorp Code of Ethics for Senior Financial Officers. The Code of Ethics is available on our website at www.wcb.com under the tab for investor relations. Stockholders may request a free copy of the Code of Ethics from:
West Coast Bancorp
Attention: Secretary
5335 Meadows Road, Suite 201
Lake Oswego, Oregon 97035
(503) 684-0884
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information concerning executive and director compensation and certain matters regarding participation in Bancorp’s Compensation & Personnel Committee required by this item is set forth under the headings “Executive Compensation” and “Board of Directors” in the Proxy Statement and is incorporated into this report by reference.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCK HOLDER MATTERS
Security Ownership
Information concerning the security ownership of certain beneficial owners and management required by this item is set forth under the heading “Security Ownership of Certain Beneficial Owners and Management” in the Proxy Statement and is incorporated into this report by reference.
Equity Compensation Plan Information
Information concerning Bancorp’s equity compensation plans, required by this item is set forth under the heading “Executive Compensation-Equity Compensation Plan Information” in the Proxy Statement and is incorporated into this report by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Certain Relationships and Related Transactions
Information concerning certain relationships and related transactions required by this item is set forth under the heading “Transactions with Related Persons” in the Proxy Statement and is incorporated into this report by reference.
Director Independence
Information concerning the independence of Bancorp directors required by this item is set forth under the heading “Election of Directors” in the Proxy Statement and is incorporated into this report by reference.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information concerning fees paid to our accountants required by this item is included under the heading “Matters Related to our Auditors-Fees Paid to Independent Registered Public Accounting Firm” in the Proxy Statement and is incorporated into this report by reference.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) (1)
Financial Statements:
The financial statements and related documents listed in the Index set forth in Item 8 of this report are filed as part of this report.
(2)
Financial Statements Schedules:
None.
(3)
Exhibits:
The response to this portion of Item 15 is submitted as a separate section of this report appearing immediately following the signature page and entitled “Index to Exhibits.”
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, on March 10, 2011.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 10, 2011.
Principal Executive Officer:
/s/ Robert D. Sznewajs
President and CEO and Director
Robert D. Sznewajs
Principal Financial Officer:
/s/ Anders Giltvedt
Executive Vice President and Chief Financial Officer
Anders Giltvedt
Principal Accounting Officer:
/s/ Kevin M. McClung
Senior Vice President and Controller
Kevin M. McClung
Remaining Directors:
*Lloyd D. Ankeny, Chairman
*Shmuel (“Sam”) Levinson
*Duane C. McDougall
*Steven J. Oliva
*John T. Pietrzak
*Steven N. Spence
*Nancy A. Wilgenbusch, PhD.
*By /s/ Robert D. Sznewajs
Robert D. Sznewajs
Attorney-in-Fact
INDEX TO EXHIBITS
*Indicates a management contract or compensatory plan, contract or arrangement.
INDEX TO EXHIBITS (continued)
*Indicates a management contract or compensatory plan, contract or arrangement.