ITEM 1. BUSINESS.
Cautionary Information Concerning Forward-Looking Statements
This report contains forward-looking statements about the Company’s business and plans and anticipated results of operations and financial condition and liquidity. These statements include, but are not limited to, our plans, objectives, expectations and intentions and are not statements of historical fact. When used in this report, the word “expects,” “believes,” “anticipates,” “could,” “may,” “will,” “should,” “plan,” “predicts,” “projections,” “continue” and other similar expressions constitute forward-looking statements, as do any other statements that expressly or implicitly predict future events, results or performance, and such statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Certain risks and uncertainties and the Company’s success in managing such risks and uncertainties could cause actual results to differ materially from those projected, including among others, the risk factors described in Item 1A
ITEM 1A. RISK FACTORS.
There are a number of risks and uncertainties, many of which are beyond the Company’s control, that could have a material adverse impact on the Company’s business, financial condition, results of operations, liquidity, regulatory capital levels or prospects. The Company describes below the most significant of these risks and uncertainties in connection with both the Company’s business and operations. These should not be viewed as an all-inclusive list or in any particular order. Additional risks that are not currently considered material may also have an adverse effect on the Company. This report is qualified in its entirety by these risk factors.
Before making an investment decision, investors should carefully consider the specific risks detailed in Item 1A; other risks facing the Company identified in this report, including, risks, uncertainties and assumptions identified in this report that are difficult to predict and that could materially and adversely affect the Company’s business financial condition, results of operations, liquidity, regulatory capital levels and prospects; the information in Item 1; and the information in Item 7, including the Company’s cautionary statements as to forward-looking statements.
Risks related to our business
Our business is closely tied to the local economies of Oregon, Idaho and Washington.
The Company’s business is closely tied to the economies of Oregon, Idaho and Washington in general and is particularly affected by the economies of Central, Southern and Northwest Oregon, as well as the greater Boise/Treasure Valley, Idaho and Seattle, Washington metro areas. In addition, the Company has a significant concentration in real estate lending that is directly affected by local and regional economic conditions. Approximately 72% of the Bank’s loan portfolio at December 31, 2015 consisted of loans secured by real estate, including construction and development loans, residential mortgage loans and commercial loans secured by commercial real estate, a strong majority of which are located in Oregon and Idaho. Since the end of the great recession of 2008, the economies of Oregon, Idaho and Washington have generally stabilized or are recovering, the housing market has improved and prices have increased, and vacancy rates for commercial properties have stabilized. The Company’s markets, however, continue to be sensitive to general economic trends and conditions, including real estate values, and an unforeseen economic shock or a return of adverse economic conditions could cause deterioration of local economies and adversely affect the Company’s business, financial condition and results of operations, and cash flows.
Adverse changes in economic conditions could affect the Company’s business, financial condition and results of operations.
Although economic conditions have improved in recent years, financial institutions are affected by changing conditions in the real estate and financial markets. Between 2008 and 2011, significant declines in the housing market, with falling home prices and increasing foreclosures and unemployment, resulted in significant write-downs of asset values by financial institutions, including the Company. While conditions have improved and continue to indicate a stable recovery, there can be no assurance that these conditions will persist. A return to a recessionary economy could result in financial stress on the Company’s borrowers and other customers that would adversely affect the Company’s business, financial condition and results of operations. The Company may also face the following risks in connection with possible adverse economic events:
•Ineffective monetary policy could cause rapid changes in interest rates and asset values that would have a materially adverse impact on the Company’s profitability and overall financial condition.
•Market developments may affect consumer confidence levels and may cause adverse changes in payment patterns, resulting in increased delinquencies and default rates on loans and other credit facilities.
•Regulatory scrutiny of the industry could increase, leading to increased regulation of our industry that could lead to a higher cost of compliance, limit the Company’s ability to pursue business opportunities and increase the Company’s exposure to the judicial system and the plaintiff’s bar.
The Company may not be able to attract or retain key banking employees, which could adversely impact the Company’s business and operations.
The Company expects future success to be driven in large part by the relationships maintained with its customers by its executives and senior lending officers. The Company has entered into employment agreements with several members of senior management. The existence of such agreements, however, does not necessarily ensure that the Company will be able to continue to retain the services of these senior management members.
The Company’s future successes and profitability are substantially dependent upon the management and banking abilities of its senior executives. The Company strives to attract and retain key banking professionals, management and staff. Competition to attract the best professionals in the industry can be intense which will limit the Company’s ability to hire new professionals. Banking-related revenues and net income could be adversely affected in the event of the unexpected loss of key personnel.
The Company may be required to increase its reserve for credit losses and to charge off additional loans in the future, which could adversely affect the Company’s financial condition and results of operations.
The Company maintains a reserve for credit losses in an amount that the Company believes is adequate to provide for losses inherent in the loan portfolio. The level of the reserve reflects management’s continuing evaluation of specific credit risks; loan loss experience; current loan portfolio quality; present economic, political and regulatory conditions; industry concentrations; and other unidentified losses inherent in the current loan portfolio. The determination of the appropriate level of the reserve for credit losses inherently involves a high degree of subjectivity and judgment and requires the Company to make significant estimates of current credit risks and future trends. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of the Company’s control, may require an increase in the reserve for credit losses. Increases in non-performing loans have a significant impact on the Company’s reserve for credit losses. Generally, the Company’s non-performing loans reflect difficulties of individual borrowers resulting from financial stress on the borrowers’ asset values and cash flow abilities often related to the weakness in general economic conditions and/or adversity in sector specific situations.
If real estate markets or the economy in general deteriorate, the Company may experience increased delinquencies and credit losses. The reserve for credit losses may not be sufficient to cover actual loan-related losses. Additionally, banking regulators may require the Company to increase its reserve for credit losses in the future, which could have a negative effect on the Company’s financial condition and results of operations.
The Company’s reserve for credit losses is a significant accounting estimate and may not be adequate to cover future loan losses, which could adversely affect its business, financial condition and results of operations.
The Company maintains a reserve for credit losses in an amount that the Company believes is adequate to provide for losses inherent in the loan portfolio. While the Company strives to monitor credit quality and to identify adversely risk rated loans on a consistent and timely basis, including those that may become non-performing, at any time there are loans in the portfolio that could result in losses that have not been identified as problem or non-performing loans. Estimation of the reserve requires the Company to make various assumptions and judgments about the collectability of loans in the Company’s loan portfolio. These assumptions and judgments include historical loan loss experience, current credit profiles of the Bank’s borrowers, adverse situations that have occurred that may affect a borrower’s ability to meet its financial obligations, the estimated value of underlying collateral and general economic conditions. Determining the appropriateness of the reserve is complex and requires judgment by management about the effect of matters that are inherently uncertain. The Company cannot be certain that it will be able to identify deteriorating loans before they become non-performing assets or that it will be able to limit losses on those loans that have been identified. As a result, future increases to the reserve for credit losses may be necessary. Additionally, future increases to the reserve for credit losses may be required based on changes in the composition of the loans comprising the loan portfolio, deteriorating values in underlying collateral (most of which consists of real estate in the markets served) and changes in the financial condition of borrowers, such as those that may result from changes in economic conditions or as a result of incorrect assumptions by management in determining the reserve for credit loss. Finally, the Financial Accounting Standards Board has issued a proposed Accounting Standards Update that presents a new credit impairment model, the Current Expected Credit Loss (“CECL”) model, which would require financial institutions to estimate and develop a provision for credit losses at origination for the lifetime of the loan, as opposed to reserving for incurred or probable losses up to the balance sheet date. Under the CECL model, credit deterioration would be reflected in the income statement in the period of origination or acquisition of the loan, with changes in expected credit losses due to further credit deterioration or improvement reflected in the periods in which the expectation changes. Accordingly, the CECL model could require financial institutions like the Bank to increase their allowances for loan losses. Moreover, the CECL model likely would create more volatility in our level of allowance for loan losses. If we are required to materially increase our level of allowance for loan losses for any reason, such increase could adversely affect our business, financial condition and results of operations.
The Company’s profitability and liquidity may be adversely affected by deterioration in the credit quality of, or defaults by, third parties who owe it money.
The Company is exposed to the risk that third parties that owe it money will not perform their obligations. These parties may default on their obligations to the Company due to bankruptcy, lack of liquidity, operational failure or other reasons. The Company’s rights against third parties may not be enforceable in all circumstances. In addition, deterioration in the credit quality of third parties whose securities or obligations the Company holds could result in losses and/or adversely affect the Company’s ability to use those securities or obligations for liquidity purposes. The Company relies on representations of potential borrowers and/or guarantors as to the accuracy and completeness of certain financial information. The Company’s financial condition and results of operations could be negatively impacted if the financial statements or other information that the Company relies upon is materially misleading.
Real estate values could decline leading to additional and greater-than-anticipated loan charge-offs and valuation write downs on OREO and OREO-related management and disposition expenses.
Real estate owned by the Bank and not used in the ordinary course of its operations is referred to as other real estate owned (“OREO”). In its normal lending process, the Bank may take a security interest in real estate as collateral for loans. In the event of obligor default, the Bank may have the right to foreclose on such collateral and take title to it. At December 31, 2015, the Bank had OREO with a carrying value of approximately $3.3 million. Generally, higher levels of OREO lead to greater expenses as the Bank incurs costs to manage and dispose of the properties, including personnel costs, insurance, taxes, completion costs, repair costs and other costs associated with property ownership. There are also funding costs associated with OREO. The Bank evaluates property values periodically and establishes valuation reserves, as appropriate, to adjust the carrying value of the properties to the lesser of book or appraised value, net of selling costs and any additional liquidation reserves to expedite the sale of such properties. Decreases in market prices may lead to additional OREO valuation reserves, with a corresponding expense in the Company’s consolidated statement of income. Further valuation reserves of OREO or an inability to sell OREO properties could have a material adverse effect on the Company’s results of operations and financial condition.
The Company could be subject to environmental liabilities with respect to properties to which it takes title.
In the course of business, the Company may foreclose and take title to real estate and could be subject to environmental liabilities with respect to these properties. The Company may be held liable to a governmental entity or to third parties for property damage, personal injury and investigation and clean-up costs incurred by these parties in connection with environmental contamination or may be required to investigate or remediate hazardous or toxic substances at a property. The costs associated with investigation or remediation activities could be substantial. In addition, if the Company is the owner or former owner of a contaminated site, it may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the contaminated site. If the Company becomes subject to significant environmental liabilities, its business, financial condition and results of operations could be adversely affected.
The Company’s financial condition and ability to fund operations could be impaired by liquidity risk.
Liquidity is essential to the Company’s business. The Company’s primary funding source is customer deposits. In addition, the Bank has historically had access to advances from the FHLB, the FRB discount window and other wholesale sources such as Internet-sourced deposits to fund operations. Although the Company has historically been able to replace maturing deposits and advances as necessary, it might not be able to replace such funds in the future. An inability to raise funds through traditional deposits, brokered deposits, borrowings, or the sale of securities or loans would have a material adverse effect on the Company’s liquidity. The Company’s access to funding sources on terms which are acceptable to the Company could be impaired by factors that affect the Company specifically or the financial services industry or economy in general. The Company has ample liquidity as of December 31, 2015; however, the Company’s ability to borrow or attract and retain deposits in the future could be adversely affected by the Company’s financial condition or regulatory restrictions, or impaired by factors that are not specific to the Company, such as FDIC insurance changes, disruption in the financial markets or negative views and expectations about the prospects for the banking industry. The Bank’s primary counterparty for borrowing purposes is the FHLB and liquid assets are mainly held at correspondent banks or the FRB. Borrowing capacity from the FHLB or FRB may fluctuate based upon the condition of the Bank or the acceptability and risk rating of securities or loan collateral and counterparties could adjust discount rates applied to such collateral at their discretion. The FRB or FHLB could restrict or limit the Company’s access to secured borrowings. Correspondent banks can withdraw unsecured lines of credit or require collateralization for the purchase of federal funds. Liquidity also may be affected by the Bank’s routine commitments to extend credit.
Sources of funds may not remain adequate for liquidity needs and the Company may be compelled to seek additional sources of financing in the future. Additional borrowings, if sought, may not be available or, if available, may not be on favorable terms. If additional financing sources are unavailable or not available on reasonable terms to provide necessary liquidity, the Company’s business, financial condition, results of operations and future prospects could be materially and adversely affected.
Historically low interest rates and changes in interest rates may adversely affect the Company’s net interest income and profitability.
In recent years, it has been the policy of the FRB to maintain interest rates at historically low levels through its targeted federal funds rate. As a result, market rates on the loans the Company has originated and the yields on securities the Company has purchased have been at lower levels than available prior to 2008. As a general matter, the Company’s interest-bearing assets reprice or mature slightly more quickly than the Company’s interest-earning liabilities, which have resulted in decreases in net interest income as interest rates decreased. However, the Company’s ability to lower its interest expense is limited at these interest rate levels while the average yield on the Company’s interest-earning assets may continue to decrease. The FRB has indicated its intention to be patient in its determination whether to increase interest rates in the future.
In addition, the Company’s results of operations are highly dependent on the difference between the interest earned on loans and investments and the interest paid on deposits and borrowings. Changes in market interest rates impact the rates earned on loans and investment securities and the rates paid on deposits and borrowings. In addition, changes to the market interest rates may impact the level of loans, deposits and investments and the credit quality of existing loans. These rates may be affected by many factors beyond the Company’s control, including general economic conditions and the monetary and fiscal policies of various governmental and regulatory authorities. Accordingly, the Company’s net interest income (the difference between interest income earned on assets and interest expense paid on liabilities) may be affected, which could have an adverse effect on the Company's profitability. Also, changes in interest rates may negatively impact the Company’s ability to attract deposits, make loans and achieve satisfactory interest rate spreads, as well as the Company's market values of its financial instruments, which could adversely affect the Company’s business, financial condition and results of operations.
The financial services business is intensely competitive and the Company may not be able to compete effectively.
The Company faces competition for its services from a variety of competitors. The Company’s future growth and success depend on its ability to compete effectively. The Company competes for deposits, loans and other financial services with numerous financial service providers including banks, thrifts, credit unions, mortgage companies, broker dealers and insurance companies and increasingly other non-bank financial services providers who use the Internet as a platform to originate loans and/or acquire deposits. To the extent these competitors have less regulatory constraints, lower cost structures or increased economies of scale, they may be able to offer a greater variety of products and services or more favorable pricing for such products and services. In addition, improvements in technology, communications and the Internet have intensified competition. As a result, the Company’s competitive position could be weakened, which could adversely affect the Company’s business, financial condition and results of operations.
New lines of business or new products and services may subject us to additional risks.
From time to time, the Company may implement new lines of business or offer new products and services within existing lines of business. There may be substantial risks or uncertainties associated with these types of efforts, particularly in instances where the markets may not be fully developed. Significant time and resources may be invested in developing and marketing new lines of business and/or new products and services and successful implementation may not be achieved or price and profitability targets may not be obtained. External factors, such as compliance with regulations, competitive alternatives, and shifting market preferences, may also impact the successful implementation of a new line of business or a new product or service. Additionally, any new line of business and/or new product or service could have a significant impact on the effectiveness of the Company’s system of internal controls. Failure to successfully manage these risks in the development and implementation of new lines of business or new products or services could have a material adverse effect on our business, financial condition and results of operations.
Risks associated with the Company’s Internet-based systems and online commerce security, including “hacking” and “identify theft,” could adversely affect the Company’s business.
The Company delivers its services both through its branch network and the Internet. The Company relies heavily upon data processing, including loan servicing and deposit processing software, communications systems and information systems from a number of third parties to conduct its business. Third party or internal systems and networks may fail to operate properly or become disabled due to deliberate attacks or unintentional events. The Company’s operations are vulnerable to disruptions from human error, natural disasters, power loss, computer viruses, spam attacks, denial of service attacks, unauthorized access and other unforeseen events. Undiscovered data corruption could render the Company’s customer information inaccurate. These events may obstruct the Company’s ability to provide services and process transactions. While the Company believes that it is in compliance with all applicable privacy and data security laws, an incident could put its customer confidential information at risk.
While the Company believes that it has appropriate protective measures in place, the Company can never be certain that all of its systems are entirely free from vulnerability to breaches of security or other technological difficulties or failures. The Company monitors and modifies, as necessary, its protective measures in response to the perpetual evolution of cyber threats.
A breach in the security of any of the Company’s information systems, or other cyber incident, could have a material adverse effect on, among other things, its revenue, ability to attract and maintain customers and business reputation. In addition, as a result of any breach, the Company could incur higher costs to conduct its business, to increase protection, or related to remediation.
Furthermore, the Company’s customers could incorrectly blame the Company and terminate their accounts with the Bank for a cyber-incident which occurred on their own system or with that of an unrelated third party. In addition, a security breach could also subject the Company to additional regulatory scrutiny and expose the Company to civil litigation and possible financial liability.
In response to the Executive Order released by the Obama Administration, Improving Critical Ingrastructure Cybersecurity, referred to as the Executive Order, the Federal Financial Institutions Examination Council developed a cybersecurity
assessment tool to help institutions identify their risks and determine their cybersecurity preparedness. The FFIEC has also published cybersecurity guidance on its website, along with observations from recent cybersecurity assessments. The federal banking agencies have indicated that they will use the assessment tool as guidance during a financial institution’s safety and soundness examination. Although we have used the assessment tool to develop policies and procedures related to our cybersecurity, no assurance can be given that the regulators will believe that our information security systems are adequate or that these policies and procedures will be effective in preventing cyber threats and attacks. Furthermore, the implementation of any recommended guidance could require us to incur additional costs.
The Company continually encounters technological changes and may not have the resources to invest in technological improvements.
Frequent introductions of new technology-driven products and services in the financial services industry result in the need for rapid technological change. In addition, the effective use of technology may result in improved customer service and reduced costs. The Company’s future success depends, to a certain extent, on its ability to identify the needs of customers and address those needs by using technology to provide the desired products and services and to create additional efficiencies in its operations. Certain competitors may have substantially greater resources to invest in technological improvements. The Company may not be able to successfully implement new technology-driven products and services or to effectively market these products and services to the Company’s customers. Failure to implement the necessary technological changes could have a material adverse impact on the Company’s business, financial condition and results of operations.
The Company relies heavily on technology and computer systems, and computer failure could result in loss of business and adversely affect the Company’s financial condition and results of operations.
Advances and changes in technology could significantly affect the Company’s business, financial condition, results of operations and prospects. The Company faces many challenges, including the increased demand for providing customers access to their accounts and the systems to perform banking transactions electronically. The Company’s ability to compete depends on its ability to continue to adapt technology on a timely and cost-effective basis to meet these demands. In addition, the Company’s business and operations are susceptible to negative effects from computer system failures, communication and energy disruption and unethical individuals with the technological ability to cause disruptions or failures of its data processing systems.
The Company could incur losses due to operating disruptions.
Operating disruptions could occur without warning, and the results may be predictable or unknown. Disruptions could be either internal or external, and could include natural disasters, technological failures, pandemic events, human error, or terrorism. In alignment with regulatory guidance, the Company has developed detailed Business Continuity Plans and Disaster Recovery Plans to mitigate the impact of a disaster, provide for operations at backup facilities, and minimize risk to the organization, its customers, stockholders, and reputation. These plans may or may not be sufficient to mitigate or prevent material loss to the Company in an event that disrupts operations. External events could also affect the stability of our deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss of revenue and/or cause us to incur additional expenses.
Changes or disruptions in the market for certain securities in the Company’s investment portfolio could negatively affect the value of those securities.
The Company’s investment portfolio includes a variety of securities that are subject to interest rate risk and credit risk. The portfolio includes obligations of, and mortgage-backed securities guaranteed by, government sponsored enterprises (“GSEs”) such as the Federal National Mortgage Association (“Fannie Mae”), the Government National Mortgage Association (“Ginnie Mae”), the Federal Home Loan Mortgage Corporation (“Freddie Mac”), and the FHLB or otherwise backed by Federal Housing Administration or Veteran’s Administration guaranteed loans. In addition, the porfolio contains non-GSE securities, including debt issued by public entities that are secured by expected future cash flows of the issuer. Adverse general economic conditions, credit risk associated with the collateral or guarantors of securities, and volatility or illiquidity in markets may cause investment securities held within the Company’s investment portfolio to fall in value and/or become less liquid. Should securities become impaired, they may be subject to material write-downs thereby impacting results of operations or financial condition of the Company. In addition, market conditions may reduce valuations due to the perception of heightened credit and liquidity risks in addition to interest rate risk typically associated with these securities. Possible FRB actions to increase interest rates in the future may cause a decline in the value of securities held by the Company. Declines in market value associated with these disruptions would result in impairments of these assets, which would lead to accounting charges that could have a material adverse effect on the Company’s results of operations, equity and capital ratios.
If the goodwill that the Company has recorded or may record in connection with a business acquisition becomes impaired, it could require charges to earnings, which would adversely affect the Company’s business, financial condition and results of operations.
Goodwill represents the amount by which the cost of an acquisition exceeded the fair value of net assets the Company acquired in connection with the purchase of another financial institution. The Company reviews goodwill for impairment at least annually, or more frequently if a triggering event occurs which indicates that the carrying value of the asset might be impaired. If the carrying amount of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. Any such adjustments are reflected in our results of operations in the periods in which they become known. As of December 31, 2015, the Company’s goodwill totaled $78.6 million. While the Company has not recorded any impairment charges since it initially recorded the goodwill, there can be no assurance that future evaluations of the Company’s existing goodwill or goodwill it may acquire in the future will not result in findings of impairment and related write-downs, which could adversely affect the Company’s business, financial condition and results of operations.
The Company has made acquisitions, and may do so in the future, which could dilute current stockholders’ stock ownership and expose it to additional risks.
In accordance with the Company’s strategic plan, it regularly evaluates opportunities to acquire other banks and branch locations to expand the Company. As a result, the Company may engage in acquisitions and other transactions that could have a material effect on its operating results, financial condition and liquidity.
The Company’s acquisition activities could require it to use a substantial amount of cash, other liquid assets, issue shares of common stock and/or incur debt. In addition, if goodwill recorded in connection with potential future acquisitions were determined to be impaired, then the Company would be required to recognize a charge against earnings, which could materially and adversely affect its results of operations during the period in which the impairment was recognized.
The Company’s acquisition activities could involve a number of additional risks, including the risks of:
•the possibility that expected benefits may not materialize in the timeframe expected or at all, or may be more costly to achieve;
•incurring the time and expense associated with identifying and evaluating potential acquisitions and merger partners and negotiating potential transactions, resulting in management’s attention being diverted from the operation of the Company’s existing business;
•using inaccurate estimates and judgments to evaluate credit, operations, management, and market risks with respect to the target institution or assets;
•incurring the time and expense required to integrate the operations and personnel of the combined businesses;
•the possibility that the Company will be unable to successfully implement integration strategies, due to challenges associated with integrating complex systems, technology, banking centers, and other assets of the acquired bank in a manner that minimizes any adverse effect on customers, suppliers, employees, and other constituencies;
•the possibility that the acquisition may not be timely completed, if at all; and
•losing key employees and customers as a result of an acquisition that is poorly received.
If the Company does not successfully manage these risks, its acquisition activities could have a material adverse effect on its operating results, financial condition and liquidity.
New or acquired banking office facilities and other facilities may not be profitable.
The Company may not be able to identify profitable locations for new banking offices. The costs to start up new banking offices or to acquire existing branches, and the additional costs to operate these facilities, may increase the Company’s non-interest expense and decrease our earnings in the short term. If branches of other banks become available for sale, the Company may acquire those offices. It may be difficult to adequately and profitably manage our growth through the establishment or purchase of additional banking offices and the Company can provide no assurance that any such banking offices will successfully attract enough deposits to offset the expenses of their operation. In addition, any new or acquired banking offices will be subject to regulatory approval, and there can be no assurance that the Company will succeed in securing such approval.
The Company’s operations rely on certain external vendors, which presents certain risks to our business, including the risk that they may not perform in accordance with the contracted arrangements under service level agreements.
The Company relies on certain external vendors to provide products and services necessary to maintain day-to-day operations of the Company. Accordingly, external vendors are a course of operational and information security risk to us. The Company’s
operations are exposed to risk that these external vendors will not perform in accordance with the contracted arrangements under service level agreements. Moreover, external vendors’ market power significantly limits our ability to be indemnified for a vendor’s negligence and insurance does not adequately cover all such exposure. The failure of an external vendor to perform in accordance with the contracted arrangements under service level agreements, because of changes in the vendor’s organizational structure, financial condition, support for existing products and services or strategic focus or for any other reason, could be disruptive to the Company’s operations, which could have a material adverse impact on the Company’s business, financial condition and results of operations. In addition, such a failure may force the Company to replace or renegotiate contracts with external vendors which could entail significant operational expense and delays for the Company.
We may be subject to potential liability and business risk from actions by our regulators related to supervision of third parties.
Oversight management by us of third parties by which we acquire deposit accounts and offer products and services, may be required to be expanded by our auditors or regulators. Although we have added significant compliance staff and have used outside consultants, our internal and external compliance examiners must be satisfied with the results of such augmentation and enhancement. We cannot assure you that we will satisfy all related requirements. Not achieving a compliance management system which is deemed adequate could result a wide variety of sanctions, including the required payment of damages and civil money penalties, injunctive relief, imposition of restrictions on merger and acquisition activity and restrictions on expansion activity, which could negatively impact the Bank’s reputation, business, financial condition and results of operations. Our ongoing review and analysis of our compliance management systems and implementation of any changes resulting from that review and analysis will likely result in increased noninterest expense.
The Bank is a community bank and its ability to maintain its reputation is critical to the success of its business and the failure to do so may materially adversely affect the Company’s performance.
The Bank is a community bank, and its reputation is one of the most valuable components of its business. A key component of the Bank’s business strategy is to rely on its reputation for customer service and knowledge of local markets to expand its presence by capturing new business opportunities from existing and prospective customers in its market area and contiguous areas. As such, the Bank strives to conduct its business in a manner that enhances its reputation. This is done, in part, by recruiting, hiring and retaining employees who share the Bank’s core values of being an integral part of the communities the Bank serves, delivering superior service to its customers and caring about its customers and associates. If Bancorp’s or the Bank’s reputation is negatively affected, by the actions of their employees, by their inability to conduct their operations in a manner that is appealing to current or prospective customers, or otherwise, the Company’s business and results of operations may be materially adversely affected.
Changes in accounting standards could affect reported earnings.
The bodies responsible for establishing accounting standards, including the Financial Accounting Standards Board, the SEC and other regulatory bodies, periodically change the financial accounting and reporting guidance that governs the preparation of the Company’s consolidated financial statements. These changes can be hard to predict and can materially impact how the Company records and reports its financial condition and results of operations. In some cases, the Company could be required to apply new or revised guidance retroactively.
The Company’s controls and procedures may fail or be circumvented.
Management regularly reviews and updates the Company’s internal controls, disclosure controls and procedures and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. If our internal controls fail to prevent or detect an occurrence, or if any resulting loss is not insured or exceeds applicable insurance limits, it could adversely affect our business, financial condition and results of operations.
The soundness of other financial institutions could adversely affect the Company.
The Bank is a public depository and, accordingly, accepts deposit funds that belong to, or are held for the benefit of, the State of Oregon, political subdivisions thereof, municipal corporations and other public funds. In accordance with applicable state law, in the event of default of one bank, all participating banks in the state collectively assure that no loss of funds is suffered by any public depositor. Generally, in the event of default by a depository of public funds in excess of collateral pledged, an assessment applicable to all public depositories is allocated on a pro rata basis in proportion to the maximum liability of each public depository as it existed on the date of loss. The maximum liability is dependent upon potential changes in regulations, the occurrence of Oregon bank failures and the level of public fund deposits held by the failing bank and cannot be presently determined.
In 2015, the amount of collateral the Bank was required to pledge against Oregon public deposits was 50% of the uninsured portion of these Oregon public deposits, but the percentage of collateral required to be pledged could be increased in the future.
The Company’s ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. As a result, defaults by, or even rumors or questions about, one or more financial services institutions or the financial services industry generally have led to market-wide liquidity problems and could lead to losses or defaults by the Company or by other institutions. Many of these transactions expose the Company to credit risk in the event of default of the Company’s counterparty or client. In addition, the Company’s credit risk may be exacerbated when the collateral held by the Company cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the financial instrument exposure. Such losses may materially and adversely affect the Company’s results of operations.
Risks related to an investment in Cascade’s common stock
The Company may be restricted from paying or may determine not to pay dividends.
Bancorp is a separate legal entity from the Bank and substantially all of its revenues are derived from the Bank dividends. Oregon law prohibits the Bank from paying dividends to Bancorp unless the Bank has positive retained earnings. The Bank received regulatory approval to adjust retained earnings to zero at September 30, 2012, but the Bank’s payment of dividends will remain constrained under Oregon law by the amount of increases in its retained earnings from that date. In addition, regulators previously have required Bancorp to obtain permission prior to payment of dividends on Cascade common stock and prior to taking a dividend from the Bank. Although such requirements have been terminated, it is possible that regulators may impose the same or similar requirements or limitations on the dividends. If the Bank is unable to pay dividends to Bancorp in the future, Bancorp may not be able to pay dividends on Cascade common stock, which could have a material adverse effect on the Company’s financial condition, results of operations or price of Cascade common stock. In addition, if the Bank is unable to pay dividends to Bancorp in the future, Bancorp may not be able to pay its creditors, which could result in a default or acceleration of Bancorp’s debt obligations or have a material adverse effect on Bancorp’s reputation.
Cascade’s stock price may be volatile, which could result in losses to its investors and litigation against Cascade.
Cascade’s stock price has been volatile in the past, and several factors could cause the price to fluctuate substantially in the future. These factors include but are not limited to: actual or anticipated variations in earnings, changes in analysts’ recommendations or projections, Cascade’s announcement of developments related to its businesses, operations and stock performance of other companies deemed to be peers, new technology used or services offered by traditional and non-traditional competitors, news reports of trends, concerns, irrational exuberance on the part of investors, and other issues related to the financial services industry. Cascade’s stock price may fluctuate significantly in the future, and these fluctuations may be unrelated to its performance. General market declines or market volatility in the future, especially in the financial institutions sector, could adversely affect the price of the Company’s common stock, and the current market price may not be indicative of future market prices.
Stock price volatility may make it more difficult for our investors to sell their common stock when they desire and at prices they find attractive. Moreover, in the past, securities class action lawsuits have been instituted against some companies following periods of volatility in the market price of its securities. The Company could in the future be the target of similar litigation. Securities litigation could result in substantial costs and divert management’s attention and resources from Cascade’s normal business.
The existence of outstanding stock options issued to the Company’s current or former executive officers, directors, and employees may result in dilution of your ownership.
As of December 31, 2015, the Company had outstanding options to purchase 3,375,909 shares of its common stock at a weighted average exercise price of $5.44 per share. All of these options are held by the Company’s current or former executive officers, directors, and employees. As of December 31, 2015, the Company had the ability to issue options and restricted stock to purchase an additional 269,270 shares of our common stock. The issuance of shares subject to options under the equity compensation plans will result in dilution of the Company’s stockholders’ ownership of our common stock.
Regulatory Risks
The banking industry and the Company operate under certain regulatory requirements that may change significantly and in a manner that further impairs revenues, operating income and financial condition.
The Company operates in a highly regulated industry and is subject to examination, supervision and comprehensive regulation by the DFCS, the FDIC and the Federal Reserve Board. The regulations affect the Company’s investment practices, lending activities and dividend policy, among other things. Moreover, federal and state banking laws and regulations undergo frequent and often significant changes and have been subject to significant change in recent years, sometimes retroactively applied, and may change significantly in the future. Changes to these laws and regulations or other actions by regulatory agencies could,
among other things, make regulatory compliance more difficult or expensive for the Company, limit the products the Company can offer or increase the ability of non-banks to compete and could adversely affect the Company’s business in significant but unpredictable ways, which in turn could have a material adverse effect on the Company’s financial condition or results of operations.
The Dodd-Frank Act instituted major changes to the banking and financial institutions regulatory regimes in light of the performance of and government intervention in the financial services sector. Included in the Dodd-Frank Act are, for example, changes related to deposit insurance assessments, executive compensation and corporate governance requirements, payment of interest on demand deposits, interchange fees and overdraft services. The Dodd-Frank Act also resulted in the “Volcker Rule” for banks and bank holding companies, which prohibits proprietary trading, investment in and sponsorship of hedge funds and private equity funds, and otherwise limit the relationships with such funds. Many aspects of the Dodd-Frank Act are subject to rulemaking by various regulatory agencies and will take effect over several years, making it difficult at this time to anticipate the overall financial impact of this expansive legislation on the Company, its customers or the financial industry generally. Likewise, any new consumer financial protection laws enacted by the Consumer Financial Protection Bureau, which was established pursuant to the Dodd-Frank Act, that would apply to all banks and thrifts may increase the Company’s compliance and operational costs in the future.
In addition, the banking regulatory agencies adopted a final rule effective January 1, 2015 that implements the Basel III changes to the international regulatory capital framework and revises the U.S. risk-based and leverage capital requirements for U.S. banking organizations to strengthen identified areas of weakness in the capital rules and to address relevant provisions of the Dodd-Frank Act. The final rule establishes a stricter regulatory capital framework that requires banking organizations to hold more and higher-quality capital to act as a financial cushion to absorb losses and help banking organizations better withstand periods of financial stress.
The Company cannot predict the substance or impact of pending or future legislation or regulation. The Company’s compliance with these laws and regulations is costly and may restrict certain activities, including payment of dividends, mergers and acquisitions, investments, loans and interest rates charged, interest rates paid on deposits, access to capital and brokered deposits and locations of banking offices. Failure to comply with these laws or regulations could result in fines, penalties, sanctions and damage to the Company’s reputation, which could have an adverse effect on the Company’s business, financial condition or results of operations.
If the Company fails to maintain sufficient capital under regulatory requirements, whether due to losses, an inability to raise additional capital or otherwise, that failure would adversely affect the Company’s financial condition, liquidity and results of operations, as well as the Company’s ability to maintain regulatory compliance.
Bancorp and the Bank must meet regulatory capital requirements and maintain sufficient liquidity. The Company’s ability to raise additional capital, when and if needed, will depend on conditions in the capital markets, economic conditions and a number of other factors, including investor preferences regarding the banking industry and market condition and governmental activities, many of which are outside the Company’s control, and on the Company’s financial condition and performance. Accordingly, the Company may not be able to raise additional capital if needed or on terms acceptable to the Company. If the Company fails to meet these capital and other regulatory requirements or is unable to raise additional capital when needed, the Company’s financial condition, liquidity and results of operations would be materially and adversely affected.
The Company may be subject to more stringent capital and liquidity requirements, which would adversely affect the Company’s net income and future growth.
In July 2013, the Federal Reserve Board and the FDIC, issued rules that implemented the Basel III changes to the international regulatory capital framework and revised the U.S. risk-based and leverage capital requirements for U.S. banking organizations in order to strengthen identified areas of weakness in capital rules and to address relevant provisions of the Dodd-Frank Act. The rules apply to both Bancorp and the Bank.
As a result of the enactment of the Basel III Rules, the Company recently became subject to increased required capital levels. The Basel III Rules became effective as applied to us on January 1, 2015, with a phase-in period that generally extends from January 1, 2015 through January 1, 2019. See “Supervision and Regulation - Bank Holding Company Regulation - New Capital Rules.”
Although the Company currently cannot predict the specific impact and long-term effects that Basel III will have on the Company and the banking industry more generally, the Company will be required to maintain higher regulatory capital levels which could impact the Company’s operations, net income and ability to grow. Furthermore, the Company’s failure to comply with the minimum capital requirements could result in regulators taking formal or informal actions against the Company, which could restrict future growth or operations.
The Bank’s deposit insurance premium could be higher in the future, which could have a material adverse effect on its results of operations.
The FDIC insures deposits at FDIC-insured financial institutions, including the Bank. The FDIC charges the insured financial institutions assessments to maintain the Deposit Insurance Fund at a certain level; if an FDIC-insured financial institution fails, payments of deposits up to insured limits are made from the Deposit Insurance Fund. An increase in the risk category of the Bank, adjustments to assessment rates and/or a special assessment could have an adverse effect on the Company’s results of operations.
Changes in the Federal Reserve Board’s monetary or fiscal policies could adversely affect the Company’s results of operations and financial condition.
The Company’s results of operations will be affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The Federal Reserve Board has, and is likely to continue to have, an important impact on the operating results of depository institutions through its power to implement national monetary policy, among other things, in order to curb inflation or combat a recession. The Federal Reserve Board affects the levels of bank loans, investments and deposits through its purchases of government and other securities, its regulation of the discount rate applicable to member banks and its management of bank reserve requirements. The Company cannot predict the nature or impact of future changes in monetary and fiscal policies.
The Company could be subject to fines, sanctions or other adverse consequences if it fails to comply with the USA PATRIOT Act, Bank Secrecy Act, Real Estate Settlement Procedures Act, Truth in Lending Act, Home Mortgage Disclosure Act, Fair Lending Laws or other laws and regulations.
Financial institutions are required under the USA PATRIOT Act and Bank Secrecy Act to develop programs to prevent financial institutions from being used for money-laundering and terrorist activities. Financial Institutions are also obligated to file suspicious activity reports with the United States Treasury Department’s Office of Financial Crimes Enforcement Network if such activities are detected. These rules also require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts. Failure or the inability to comply with these regulations could result in fines or penalties, intervention or sanctions by regulators and costly litigation or expensive additional controls and systems. In recent years, several banking institutions have received large fines for non-compliance with these laws and regulations. In addition, the Company is required to develop compliance management systems designed to detect and prevent violations of the Real Estate Settlement Procedures Act, Truth in Lending Act, Home Mortgage Disclosure Act, Fair Lending Laws and similar laws and regulations. The federal government has imposed and is expected to expand these and other laws and regulations relating to residential and consumer lending activities that create significant new compliance burdens and financial risks. The Company has developed policies and continues to augment procedures and systems designed to assist in compliance with these laws and regulations, however no assurance can be given that these policies and procedures will be effective in preventing violations of these laws and regulations. Failure to comply with these regulations could result in a wide variety of sanctions, including the required payment of damages and civil money penalties, injunctive relief, imposition of restrictions on merger and acquisition activity and restrictions on expansion activity, which could negatively impact the Bank’s reputation, business, financial condition and results of operations.
Our financial condition, earnings and asset quality could be adversely affected if our consumer facing operations do not operate in compliance with applicable regulations.
While all aspects of our operations are subject to detailed and complex compliance regimes, bank regulators have increased their focus on risk management and consumer compliance, and we expect this focus to continue. As a result, those portions of our lending operations which most directly deal with consumers, in particular our mortgage operations, credit card and other consumer lending business, pose particular challenges. While we are not aware of any material issues with our compliance, mortgage and other consumer lending raises significant compliance risks resulting from the detailed and complex nature of mortgage and other consumer lending regulations imposed by federal regulatory agencies, and the relatively independent operating environment in which loan officers operate. As a result, despite the education, compliance training, supervision and oversight we exercise in these areas, failure to comply with these regulations could result in the Bank being strictly liable for restitution or damages to individual borrowers, and to a wide variety of sanctions, including the required payment of damages and civil money penalties, injunctive relief, imposition of restrictions on merger and acquisition activity and restrictions on expansion activity, which could negatively impact the Bank’s reputation, business, financial condition and results of operations.
The Company is subject to commercial real estate lending guidance issued by the federal banking regulators that impacts the Company’s operations and capital requirements.
The federal banking regulators have issued guidance regarding concentrations in commercial real estate lending directed at institutions that have particularly high concentrations of commercial real estate loans within their lending portfolios. This guidance suggests that institutions whose commercial real estate loans exceed certain percentages of capital should implement heightened risk management practices appropriate to their concentration risk and may be required to maintain higher capital ratios than institutions with lower concentrations in commercial real estate lending. Based on our commercial real estate concentration as of December 31, 2015, the Company believes that it is operating within the guidelines. However, increases in the Company’s commercial real estate lending, particularly as it expands into metropolitans markets and make more of these loans, could subject it to additional supervisory analysis. The Company cannot guarantee that any risk management practices it implements will be effective to prevent losses relating to its commercial real estate portfolio. Management has implemented controls to monitor the Company’s commercial real estate lending concentrations, but it cannot predict the extent to which this guidance will impact its operations or capital requirements.
The Company’s ability to continue to receive the benefits of its loss share arrangements with the FDIC is conditioned upon its compliance with certain requirements under the agreements.
The Company is the beneficiary of loss share agreements with the FDIC that call for the FDIC to fund a portion of our losses on a majority of the assets the Company acquired in the Home acquisition that came from Home’s FDIC-assisted transaction, entered into in September 2009 and September 2010. To recover a portion of the losses and retain the loss share protection, the Company must comply with certain requirements imposed by the agreements. The requirements of the agreements relate primarily to the administration of the assets covered by the agreements, as well as the Company obtaining the consent of the FDIC to engage in certain corporate transactions that may be deemed under the agreements to constitute a transfer of the loss share benefits.
When the consent of the FDIC is required under the loss share agreements, the FDIC may withhold its consent or may condition its consent on terms that we do not find acceptable. If the FDIC does not grant its consent to a transaction the Company would like to pursue, or conditions its consent on terms that the Company does not find acceptable, the Company may be unable to engage in a corporate transaction that might otherwise benefit its stockholders or the Company may elect to pursue such a transaction without obtaining the FDIC’s consent, which could result in termination of the loss share agreements with the FDIC.
Additionally, the loss sharing agreements have limited terms (10 years for net losses on single-family residential real estate loans, as defined by the FDIC, five years for losses on non-residential real estate loans, as defined by the FDIC, and an additional three years with respect to recoveries on non-residential real estate loans); therefore, any charge-off of related losses after the term of the loss sharing agreements will not be reimbursed by the FDIC and will negatively impact the Company’s net income. Further, when the loss sharing agreements expire, the Company’s and the Bank’s risk-based capital ratios may be reduced. While the agreements are in place, the covered assets receive a 20% risk-weighting. When the agreements expire, the risk-weighting for previously covered assets will most likely increase to 100%, based on current regulatory capital definitions. Nearly all of the assets remaining in the covered asset portfolios are non-single family covered assets. Therefore, most of the covered assets were no longer indemnified after September 2014 or September 2015.
The loss sharing arrangements with the FDIC will not cover all of the losses on loans the Company acquired through the acquisition of Home.
Although the Company has assumed loss share agreements with the FDIC that provide that the FDIC will bear a significant portion of losses related to specified loan portfolios that it acquired through the Home acquisition, the Company is not protected for all losses resulting from charge-offs with respect to those specified loan portfolios. Additionally, the loss sharing agreements have limited terms (10 years for net losses on single-family residential real estate loans, as defined by the FDIC, five years for losses on non-residential real estate loans, as defined by the FDIC, and an additional three years with respect to recoveries on non-residential real estate loans). Therefore, the FDIC will not reimburse the Company for any charge-off or related losses that it experiences after the term of the loss share agreements, and any such charge-offs would negatively impact its net income. Moreover, the loss share provisions in the loss share agreement may be administered improperly, or the FDIC may interpret those provisions in a way different than the Company does. In any of those events, the Company’s losses on loans could increase.
The FDIC requires that the Company make a “true-up” payment to the FDIC if its realized losses are less than expected.
The loss share agreements that the Company assumed in the acquisition of Home, related to Home’s FDIC-assisted acquisitions of Community First Bank and Liberty Bank, contain a provision that obligates the Company to make a “true-up” payment to the FDIC if the realized losses of that acquired bank are less than expected. The “true-up” calculation is scheduled to be made as of the 45th day following the last day of the calendar month of the tenth anniversary of the closing of the acquisitions of the acquired banks. Any such “true-up” payment that is materially higher than current estimates could have a negative effect on the Company’s business, financial condition and results of operations.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
Not applicable.
ITEM 2.
ITEM 2. PROPERTIES.
The Company’s headquarters is located in downtown Bend, Oregon and the building and land are owned by the Bank. The Company also owns or leases other facilities within the Company’s primary market areas as follows: 23 locations in Oregon located in the counties of Crook, Deschutes, Jackson, Jefferson, Josephine, Klamath, Lane, Marion and Multnomah, and 14 locations in Idaho located in the counties of Ada, Canyon, Elmore, Gem and Payette. The Company considers its properties to be suitable and adequate for its present needs. For information about the Company’s lease commitments, see Note 13 of the "Notes to Consolidated Financial Statements" included elsewhere in this annual report.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
The Company is subject to legal proceedings, claims, and litigation arising in the ordinary course of business. While the outcome of these matters is currently not determinable, management does not expect that the ultimate costs to resolve these matters will have a material adverse effect on the Company’s condensed consolidated financial position, results of operations or cash flows.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES.
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Market Information
Cascade Bancorp common stock trades on the NASDAQ Capital Market under the symbol “CACB.” The following table sets forth, for the quarters shown, the range of high and low sales prices of our common stock on the NASDAQ Capital Market and the cash dividends declared on the common stock. The sales price and cash dividends shown below are retroactively adjusted for stock dividends, stock splits, and reverse stock splits and are based on actual trade statistical information provided by the NASDAQ Capital Market for the periods indicated.
Holders
As of March 2, 2016 Cascade Bancorp had 72,790,373 shares of common stock outstanding, held of record by approximately 859 holders of record. The last reported sales price of our common stock on the NASDAQ Capital Market on March 2, 2016 was $5.49 per share.
Dividends
As noted in the table above, Bancorp has not paid dividends for the last two fiscal years. The amount of future dividends will depend upon our earnings, financial condition, capital requirements and other factors and will be determined by our board of directors. The appropriate regulatory authorities are authorized to prohibit banks and bank holding companies from paying dividends, which would constitute an unsafe or unsound banking practice. Bancorp has no plan to pay dividends at this time. See “Regulations Concerning Cash Dividends” in Item 1 of this report for additional discussion of limitations on the Bank’s and Bancorp’s respective abilities to pay cash dividends.
Securities Authorized for Issuance under Equity Compensation Plans
The following table sets forth information as of December 31, 2015, regarding the number of shares that may be issued upon the exercise of options and other rights that have been granted under all of the Company’s existing equity compensation plans, as well as the number of securities remaining available for issuance under such equity plans.
Stock Performance Graph
The following chart, which is furnished not filed, compares the yearly percentage changes in the cumulative shareholder return on our common stock during the five fiscal years ended December 31, 2015, with (i) the NASDAQ composite index and (ii) the SNL Bank NASDAQ index. This comparison assumes $100.00 was invested on December 31, 2010, in our common stock and the comparison indices, and assumes the reinvestment of all cash dividends prior to any tax effect and retention of all stock dividends. Price information from December 31, 2010 to December 31, 2015, was obtained by using the NASDAQ closing prices as of the last trading day of each year.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
Cascade Bancorp
Annual Financial Trends
1 Tangible book value per common share is a non-GAAP measure defined as total stockholders’ equity, less the sum of core deposit intangible (“CDI”) and goodwill, divided by total number of shares outstanding.
2 Return on average tangible stockholders' equity is a non-GAAP measure defined as average total stockholders' equity, less the sum of average CDI and goodwill, divided by net income.
3 Return on average tangible assets is a non-GAAP measure defined as average total assets, less the sum of average CDI and goodwill, divided by net income.
4 Tangible common stockholders’ equity ratio is a non-GAAP measure defined as total stockholders’ equity, less the sum of CDI and goodwill, divided by total assets.
5 The efficiency ratio is a non-GAAP ratio that is calculated by dividing non-interest expense by the sum of net interest income and non-interest income. Other companies may define and calculate this data differently.
Reconciliation of Non-GAAP measures:
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following is management’s discussion and analysis of the Company’s results of operation, financial condition, cash flows and liquidity. The following should be read in conjunction with the Company’s audited consolidated financial statements and the notes thereto as of December 31, 2015 and 2014 and for each of the years in the three-year period ended December 31, 2015 included in Item 8 of this report.
Cautionary Information Concerning Forward-Looking Statements
This report contains forward-looking statements about the Company’s business and plans and anticipated results of operations and financial condition and liquidity. These statements include, but are not limited to, our plans, objectives, expectations and intentions and are not statements of historical fact. See full discussion of cautionary information concerning forward-looking statements in Item 1 of this report.
Regulatory Orders Terminated in 2013
On September 5, 2013, the FDIC and the DFCS terminated the MOU, issued to the Bank in March 2013. Prior to March 2013, the Bank was under the Order issued by the FDIC and the DFCS in August 2009.
On October 23, 2013, the FRB and the DFCS terminated the FRB-MOU issued to Bancorp in July 2013. Between October 2009 and July 2013, the Company was under the Written Agreement entered into with the FRB and the DFCS in October 2009. See “Supervision and Regulation- Regulatory Actions.”
Critical Accounting Policies and Accounting Estimates
Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and which could potentially result in materially different results under different assumptions and conditions. The Company believes that its most critical accounting policies upon which its financial condition depends, and which involve the most complex or subjective decisions or assessments are set forth below.
Reserve for Credit Losses
The Company’s reserve for credit losses provides for estimated losses based upon evaluations of known and inherent risks in the loan portfolio and related loan commitments. Arriving at an estimate of the appropriate level of reserve for credit losses (which consists of the Company’s reserve for loan losses and reserve for loan commitments) involves a high degree of judgment and assessment of multiple variables that result in a methodology with relatively complex calculations and analysis. Management uses historical information to assess the adequacy of the reserve for loan losses and considers qualitative factors, including national and local macroeconomic conditions, real estate market behavior and a range of other factors, in its determination of the reserve.
On an ongoing basis, the Company seeks to enhance and refine its methodology such that the reserve is at an appropriate level and responsive to changing conditions. The Company is currently working to refine a subset of its methodology with respect to certain components within its qualitative factor analysis.
In this regard, as of December 31, 2015, the Company enhanced its methodology to better estimate reserves through the implementation of a separate qualitative risk assessment process that focuses on the commercial and industrial (“C&I”) portion of the portfolio. The C&I loans portfolio is stratified by industry classification using NAICS codes. At the stratified level, factors considered in the evaluation of the loans include current events, economic or market data, loan performance and concentration risks. This qualitative risk assessment is separate from other qualitative risk assessments included in the allowance methodology.
As of March 31, 2015, the reserve for loan loss methodology was enhanced within the Company’s C&I loan portfolio with respect to shared national credits (“SNCs”). Risk ratings for individual SNCs are estimated using analysis of both public debt ratings and internal ratings. Expected loss rates are determined based upon historical published specific loss data for similar loans based on average losses and losses stratified by public debt ratings. Public ratings combined with internal risk rates are used to determine a minimum historical loss factor for each SNC loan. This amount may be increased for qualitative conditions including macroeconomic environment and observations by the Company’s SNC management group. The SNCs lending strategy is intended to diversify the Company’s credit risk profile geographically and by industry. Additionally, such loans enhance the Company’s interest rate risk profile as they float with LIBOR rates.
Also, as of June 30, 2013, management implemented a homogeneous pool approach to estimate reserves for consumer and small business loans. This change has not had a material effect on the level of the reserve for loan losses. However, the Company’s methodology may not accurately estimate inherent loss or external factors and changing economic conditions may impact the loan portfolio and the level of reserves in ways currently unforeseen.
The reserve for loan losses is increased by provisions for loan losses and by recoveries of loans previously charged-off and reduced by loans charged-off. The reserve for loan commitments is increased and decreased through non-interest expense. For more discussion of Cascade’s methodology of assessing the adequacy of the reserve for credit losses, see “Loan Portfolio and Credit Quality” below in this Item 7.
Deferred Income Taxes
Deferred tax assets (“DTA”) and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision (credit) for income taxes. The Company believes it is more likely than not that the DTA will be realized in a tax year that will be subject to a 35% federal effective tax rate and used that rate in providing deferred taxes. A valuation allowance, if needed, reduces deferred tax assets to the expected amount to be realized.
Deferred tax assets are recognized subject to management’s judgment that realization is “more likely than not.” Uncertain tax positions that meet the more likely than not recognition threshold are measured to determine the amount of benefit to recognize. An uncertain tax position is measured at the amount of benefit that management believes has a greater than 50% likelihood of realization upon settlement. Tax benefits not meeting our realization criteria represent unrecognized tax benefits. We account for interest and penalties as a component of income tax expense.
Cascade reversed its DTA valuation allowance as of June 30, 2013 due to management’s determination that it was more likely than not that the Company’s DTA would be realized. The determination resulted from consideration of both the positive and negative evidence available that can be objectively verified. Considering the guidance in paragraphs 21-23 of Accounting Standards Codification (“ASC”) 740-10-30, forming a conclusion that a valuation allowance is not needed is difficult when there is negative evidence such as cumulative losses in recent years. Such a condition, which existed at June 30, 2013, is considered a significant piece of negative evidence that is difficult to overcome. Accordingly, in its determination of DTA, the Company analyzed and evaluated the nature and timing of relevant facts and circumstances with respect to its cumulative loss. Positive evidence considered by management as of June 30, 2013 included the following:
•
The Company revised and enhanced loan underwriting and credit risk management;
•
The credit risk management infrastructure has been reconstituted with people with a strong depth and breadth of industry experience who have developed sound credit processes and lending initiatives;
•
Since implementation of strengthened policies, historically high loan loss categories such as land acquisition and residential construction and development loans (within the CRE portfolio) have decreased dramatically;
•
Credit risk management developed various strategies for the remediation of criticized and classified assets;
•
Management evaluated the unique and non-recurring loss evidence;
•
Positive considerations also evaluated by management included reduction of the risk inherent in the loan portfolio as indicated by the reduction of classified loans, strengthening of the credit risk management process, elimination of substantially all of the OREO properties, termination of all existing regulatory agreements and orders, profitable performance during the past two years, development of new products and services that strengthen non-interest income, opportunities that exist to bring operating costs in line with peer groups, the Company’s strong capital and liquidity positions, substantial improvements resulting from new members of the Board of Directors and management, new leadership in the production units, strong loan production focused on commercial lending, implementation of a productive sales management culture, strengthening of the Company’s governance and oversight and the sustained improvement in the economic conditions at a national and local level.
The Company refreshed its analysis each year, focusing on the changes in positive and negative evidence. Primary amongst those changes was the elimination of the existence of a cumulative loss position in recent years, with the Company in a three-year cumulative net income position at year end 2015. The Company’s financial position and performance continued to improve substantially during 2014 and 2015. The acquisition and integration of Home during 2014 resulted in an improved earnings performance that is expected to be sustained in future periods. Management continues to believe positive evidence outweighs the negative evidence. As a result of this analysis, management concluded it was more likely than not that forecasted earnings performance would allow for the realization of the DTA in a timely manner.
As of December 31, 2015 and 2014, Cascade had a net deferred tax asset of $50.7 million and $66.1 million, respectively.
OREO and Foreclosed Assets
OREO and other foreclosed assets acquired through loan foreclosure are initially recorded at estimated fair value less costs to sell when acquired, establishing a new cost basis. The adjustment at the time of foreclosure is recorded through the reserve for loan losses. Due to the subjective nature of establishing the asset’s fair value when it is acquired, the actual fair value of the OREO or foreclosed asset could differ from the original estimate. If it is determined that fair value declines subsequent to foreclosure, a valuation allowance is recorded through non-interest expense. Operating costs associated with the assets after acquisition are also recorded as non-interest expense. Gains and losses on the disposition of OREO and foreclosed assets are netted and posted to other non-interest expenses.
Goodwill
Goodwill from an acquisition is the value attributable to unidentifiable intangible elements acquired. At a minimum, annual evaluation of the value of goodwill is required.
An entity may assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Factors assessed include all relevant events and circumstances including macroeconomic conditions, industry and market conditions, cost factors that have a negative effect on earnings and cash flows, overall financial performance, other relevant entity or reporting unit specific events and, if applicable, a sustained decrease in share price.
If after assessing the totality of events or circumstances, such as those described above, an entity determines that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then the entity shall perform a two-step impairment test.
The first step of the impairment test compares the fair value of a reporting unit with its carrying amount, including goodwill. If the carrying amount of a reporting unit exceeds its fair value, the second step of the impairment test shall be performed to measure the amount of impairment loss, if any, when it is more likely than not that goodwill impairment exists.
The second step of the impairment test compares the implied fair value of reporting unit goodwill with the carrying amount of that goodwill. If the carrying amount of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss shall be recognized in an amount equal to that excess.
As of December 31, 2015, management has concluded that there have been no material events or circumstances that have changed since the May 16, 2014 Home acquisition date that lead management to believe it is more likely than not that the fair value of the Bank is less than its carrying amount. Therefore, no further testing is deemed necessary.
Economic Conditions
The Company’s banking business is closely tied to the economies of Idaho, Oregon and Washington, which in turn are influenced by regional and national economic trends and conditions. Idaho, Oregon and Washington have recently been experiencing improved economic trends, including gains in employment and increased real estate activity. National and regional economies and real estate prices have generally improved, as has business and consumer confidence. The Company’s markets, however, continue to be sensitive to general economic trends and conditions, including real estate values, and an unforeseen economic shock or a return of adverse economic conditions could cause deterioration of local economies and adversely affect the Company’s business, financial condition and results of operations.
Consolidated Results of Operations - Years ended December 31, 2015, 2014, and 2013
Net Income/Loss
The Company’s consolidated results of operations are dependent to a large degree on net interest income. Interest income is earned based upon average earning asset yields of our loan portfolio and investment securities, including loan fees generated in connection with origination of such loans. The earnings from such sources are partially offset by the cost of funding such assets, including interest paid on customer deposits and the cost of borrowings, as needed. We generate other income primarily through banking-related service charges and fees, card issuer and merchant service fees, mortgage banking, Small Business Administration (“SBA”) lending and fees on interest rate derivative instruments for certain qualified customers. In addition, the Bank generates revenue from its investment in bank-owned life insurance (“BOLI”) as a means to defray employee benefit expenses.
Net income is also affected when loan loss provisions are made to ensure the reserve for loan losses is adequate.
The Company’s largest operating expenses relate to employee and human resource related costs, including compensation and benefits expense. In addition, to support the provision of banking services to its customers, the Bank incurs expenses related to its branch network and facilities, communications, equipment, information technology, card and mobile transaction related activity, insurance expenses, FDIC and other regulatory assessments, professional and outside services, and expenses related to collection and resolution of credit quality issues. Interest income and cost of funds are affected significantly by general economic conditions, particularly changes in market interest rates, and by government policies and actions of regulatory authorities.
In 2015, the Company recorded net income of $20.6 million, compared to net income of $3.7 million in 2014 and $50.8 million in 2013. During these periods, net income per basic common share was $0.29, $0.06 and $1.08, respectively. Net income in 2015 was a result of growth in net interest income arising from strong loan and deposit growth, while non-interest income was up on higher transaction activity. 2015 net income also benefited from a $4.0 million credit to the provision for loan losses due to increased loan recoveries. The Company recorded no loan loss provision in 2014 and a $1.0 million loan loss provision in 2013. The 2015 year-over-year increase in net income from 2014 was also related to the full year impact of the Home acquisition, which closed on May 16, 2014. Non-interest expenses for 2015 were down $6.9 million as compared to 2014, in part because 2014 included significant Home related non-recurring costs. 2013 net income was above 2015 and 2014 levels because of the reversal of its valuation allowance against the Company’s DTA. The reversal was approximately $50.1 million.
Net Interest Income
For most financial institutions, including the Company, the primary component of earnings is net interest income. Net interest income is the difference between interest income earned, principally from loans and the investment securities portfolio, and interest paid, principally on customer deposits and borrowings. Changes in net interest income typically result from changes in volume, spread and margin. Volume refers to the dollar level of interest-earning assets and interest-bearing liabilities. Spread refers to the difference between the yield on interest-earning assets and the cost of interest-bearing liabilities. Margin refers to net interest income divided by interest-earning assets and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities.
Net interest income was $78.5 million in 2015, a $13.4 million, or 20.6%, increase from 2014. This was mainly attributable to higher volume of average earning assets in 2015 due to increased loan growth as well as the full year effect of the 2014 Home acquisition. Similarly, net interest income in 2014 increased $16.9 million, or 35.0%, from 2013 levels due to higher average earning assets.
Yields on earning assets decreased to 3.75% for 2015 as compared to 3.89% in 2014 and 4.12% in 2013 mainly due to the ongoing period of historically low market interest rates combined with the full year impact of acquired Home assets. Specifically, Home earning assets yields were lower than yields achieved by the Company because Home had a greater portion of lower yielding securities and a lower portion of loans. Meanwhile, lower market interest rates also resulted in the average rates paid on interest bearing liabilities for 2015 declining to 0.14% compared to 0.21% in 2014 and 0.37% in 2013.
Total interest income for 2015 increased $13.0 million, or 19.3%, compared to total interest income in 2014 due mainly to higher average earning loans, for reasons described above. Similarly, total interest income for 2014 increased approximately $16.4 million, or 32.1%, compared to total interest income in 2013 due to increased average earning assets arising from the acquisition of Home in 2014. Total interest expense declined by $0.4 million, or 18.2%, in 2015 as compared to 2014 mainly due to the effect of lower time deposit costs, which were higher in 2014 with the acquisition of Home. Interest expense for 2014 declined $0.5 million, or 17.3%, as compared to 2013 mainly due to a reduction in borrowings which carry higher rates than core deposits. Borrowing rate costs were specifically benefited by the second quarter 2013 pay-off of $60.0 million of FHLB advances bearing a weighted average interest rate of 3.17%, thereby decreasing ongoing interest expense.
Net Interest Margin (NIM)
The Company’s net interest margin (“NIM”) decreased to 3.67% for 2015 compared to 3.76% for 2014 and 3.90% for 2013. The 2015 decrease was largely a result of the impact of lower market interest rates on loan and investment portfolio yields. In addition, certain fixed rate commercial loans originated in 2014 and 2015 with a fixed rate were subject to interest rate swaps. This resulted in the Company’s conversion of fixed rates to a LIBOR floating rate. This strategic increase in the Company’s portfolio of floating rate loans was designed to reduce its future interest rate risk. The NIM decrease in 2014 compared to 2013 was mainly due to the mix of earning assets acquired in the Home transaction in 2014, as described above.
The following table presents further analysis of the components of the Company’s NIM and sets forth for 2015, 2014, and 2013 information with regard to average balances of assets and liabilities, as well as total dollar amounts of interest income from interest-earning assets and interest expense on interest-bearing liabilities, resultant average yields or rates, net interest income, net interest spread, net interest margin and the ratio of average interest-earning assets to average interest-bearing liabilities for the Company:
(1) Average non-accrual loans included in the computation of average loans were $9.3 million for 2015, $13.1 million for 2014, and $15.8 million for 2013.
(2) Loan related fees, including prepayment penalties, recognized during the period and included in the yield calculation totaled $2.6 million in 2015, $2.2 million in 2014, and $1.6 million in 2013.
(3) Includes loans held for sale.
Changes in Interest Income and Expense
The following table shows the dollar amount of increase (decrease) in the Company’s consolidated interest income and expense, and attributes such variance to “volume” or “rate” changes. The changes in net interest income due to changes in both average volume and average interest rate have been allocated to the average volume change or the average interest rate change in proportion to the absolute amounts of the change in each.
Loan Loss Provision
In 2015, the Company recorded a credit to the loan loss provision of $4.0 million, as compared to no provision in 2014 and a $1.0 million provision in 2013. The credit to the provision in 2015 was due primarily to a net recovery of prior loan losses of approximately $6.4 million as well as a generally improving credit risk profile within the loan portfolio. At December 31, 2015, the reserve for loan losses was approximately $24.4 million while the reserve for unfunded commitments was $0.4 million, as compared to a reserve for loan losses of $22.1 million and a reserve for unfunded commitments of $0.4 million at December 31, 2014.
The Bank maintains pooled and impaired loan reserves with additional consideration of qualitative factors and unallocated reserves in reaching its determination of the total reserve for loan losses. The level of reserves is subject to review by the Bank’s regulatory authorities who may require adjustments to the reserve based on their evaluation and opinion of economic and industry factors as well as specific loans in the portfolio. For further discussion, see “Critical Accounting Policies and Estimates” and “Loan Portfolio and Credit Quality” in Item 7 of this report. There can be no assurance that the reserve for credit losses will be sufficient to cover actual loan-related losses.
Non-interest Income
The following table details categories of non-interest income for the years ended December 31, 2015, 2014, and 2013, and the changes therein:
Non-interest income increased $4.8 million, or 23.8%, in 2015 compared to 2014 due to higher activity volumes across all categories of fee businesses and the sale of certain excess branch properties at a gain (other income). The full year effect of the May 2014 acquisition of Home contributed to increases in various banking service charges and card revenues. The 2014 non-interest income increase of $5.7 million, or 39.6%, compared to 2013 was attributable to higher service and card related earnings that resulted from the Home acquisition, which more than offset a decline in 2014 mortgage related revenues. This decline in 2014 was largely due to lower mortgage refinance volumes, mainly related to more volatile mortgage interest rates during the year. 2014 customer interest rate swap fee income and SBA loan origination and sale related revenues improved markedly over 2013 with the successful expansion of these lines of business. The Bank entered these lines of business in 2013 to expand customer services and diversify its revenue sources.
Non-interest Expenses
The following table details categories of non-interest expense for the years ended December 31, 2015, 2014, and 2013, and the changes therein:
Non-interest expense was $74.4 million in 2015 compared to $81.3 million in 2014 and $61.0 million in 2013. 2015 and 2014 included expenses of operating the combined institution after the completion of the Home acquisition, while 2014 also included significant acquisition-related and one-time expenses.
Total salaries and benefits were $43.7 million in 2015 compared to $41.4 million in 2014 and $32.7 million in 2013. The 2015 increase in human resource related costs was mainly due to a higher accrual for the cost of equity incentive grants as well as increased cash incentive performance plan results. Run-rate salary costs were stable, with efficiency improvements such as branch consolidations largely offset by incremental cost of production-oriented staff. The increase in 2014 compared to 2013 primarily relates to the inclusion of former employees of Home who were retained by the Company after the completion of the Home acquisition, as well as severance costs for former Home employees who were not retained by the Company.
In the aggregate, occupancy, information technology, equipment and communications expenses decreased $5.2 million in 2015 compared to 2014 in part due to the one-time costs incurred in 2014 related to the Home acquisition. In addition, expense levels benefited as a result of down-sizing of branch and administrative facilities, efficiency gains in our transition to cloud-based information technology services, and ongoing improvements via contract negotiations for services such as software, equipment and facilities. The increase in occupancy in 2014 as compared to 2013 was primarily related to the effect of an increase in number of branches resulting from the Home acquisition.
FDIC insurance remained stable over the reported periods.
OREO expenses decreased $0.9 million in 2015 compared to 2014, mainly because of recoveries on certain property dispositions during the year, net of valuation adjustments. OREO expenses for 2014 increased $0.5 million compared to 2013 due to the effect of dispositions.
Professional services decreased $2.8 million in 2015 compared to 2014 and increased $3.9 million in 2014 compared to 2013 due primarily to Home acquisition-related expenses incurred in 2014.
The Company has had negligible borrowings since 2013. Accordingly, prepayment penalties on FHLB advances were nil in 2015 and 2014. In 2013, the Company incurred the penalties to prepay $60.0 million of advances to reduce ongoing interest expense.
Card issuer expense was stable in 2015 compared to 2014 and increased $1.5 million in 2014 compared to 2013 primarily due to higher transaction volume, including the impact of the Home acquisition.
Insurance expense decreased $0.5 million in 2015 compared to 2014 because of contract renegotiation and favorable loss performance history. The increase of $0.6 million in 2014 over 2013 was mainly due to the increased scale of the Company, arising from the Home acquisition.
Other expenses were stable in 2015 compared to 2014. The higher expense level in 2014 as compared to 2013 was mainly as a result of the inclusion of expenses related to Home’s former operations.
Income Taxes
In 2015, the Company recorded an income tax provision of $12.5 million as compared to a provision of $0.2 million in 2014 and a benefit of $50.1 million in 2013. The income tax provision in 2015 represents a 37.8% effective tax rate on its $33.1 million pretax income, slightly lower than statutory rates due primarily to the impact of permanent differences. The income tax provision in 2014 represents a 4.5% effective tax rate on its $3.9 million of pretax income. This rate differs from statutory rates due primarily to a revaluation of net deferred tax assets, mainly related to an anticipated change in our applicable Federal rate from 34.0% to 35.0% at the time the net DTA will be utilized, less additional tax of $1.0 million arising from disallowed merger-related costs. Other differences to the effective tax rate were related to normal recurring permanent differences and tax credits. The Company expects its book tax rate for 2016 to continue slightly below its net statutory rate due to continued permanent differences.
The income tax benefit in 2013 is the result of the Company releasing substantially all of its DTA valuation allowance at December 31, 2012 of $41.6 million and the reversal of certain previously written-off deferred tax benefits of $8.5 million resulting from its assessment of the Company’s Internal Revenue Code ("IRC") Section 382 limitations and other analyses.
The DTA valuation allowance was established during 2009 due to uncertainty regarding the Company's ability to generate sufficient future taxable income to fully realize the benefit of the net DTA. At December 31, 2013, the Company determined it was more likely than not that the DTA would be realized and reversed its DTA valuation allowance. In reaching this determination, the Company evaluated its future taxable earnings projections and all other available evidence including the Company’s earnings performance trend, expected continued profitability and improvements in the Company’s financial condition.
At December 31, 2015 and 2014, the Company determined it will generate sufficient taxable income in the future to fully utilize its DTA. In its analysis, the Company considers whether it is more likely than not that some portion or all of the DTA will not be realized. Management considers the nature and amount of historical and projected future taxable income, the scheduled reversal of deferred tax assets and liabilities, and available tax planning strategies in making this assessment. The amount of deferred taxes recognized could be impacted by changes to any of these variables. The ultimate realization of DTA is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible.
Financial Condition
Balance Sheet Overview
At December 31, 2015, total assets were $2.5 billion compared to $2.3 billion at December 31, 2014. The increase in total assets at December 31, 2015 compared to December 31, 2014 relates primarily to increased net loans, partially offset by lower cash and investments.
Net loans increased $193.3 million to $1.7 billion at December 31, 2015 compared to $1.5 billion at December 31, 2014. The higher loan balance was largely attributable to an increase in organic loan growth as well as an increase in the wholesale loan portfolio. Organic loan balances outstanding were higher in all loan categories, including the commercial real estate, small business loans and lines, consumer lending, residential mortgage and C&I portfolios. The wholesale loan book totaled $268.4 million at December 31, 2015 as compared to $222.4 million at December 31, 2014. The increase was mainly related to the purchase of residential mortgage ARMs, partially offset by a decrease in SNCs (included in the C&I balance).
The investment portfolio decreased to $449.7 million at December 31, 2015 from $472.5 million a year earlier, mainly due to the decision to allocate assets to the wholesale residential ARM portfolio as well as the sale of certain short maturity securities during the year. Cash and cash equivalents marginally decreased to $77.8 million at December 31, 2015 from $83.1 million at December 31, 2014. Our investment in FHLB stock decreased from $25.6 million at December 31, 2014 to $3.0 million at December 31, 2015 related to the merger of the FHLB Banks Des Moines and Seattle. As part of the FHLB merger, each share of FHLB Seattle stock outstanding was converted into one share of FHLB Des Moines stock. Immediately following the merger, all excess shares were repurchased or issued as needed to meet the membership stock requirements.
Total deposits increased $101.5 million to $2.1 billion at December 31, 2015, as compared to $2.0 billion at December 31, 2014. The increase in deposits relates mainly to the continued growth in core relationship deposits, in part a function of an improved economic activity in the Company’s footprint.
The Company had no FHLB borrowings outstanding at December 31, 2015 or December 31, 2014.
Stockholders’ equity increased to $336.8 million at December 31, 2015, which is a $21.3 million increase over the balance at December 31, 2014 of $315.5 million. This increase was predominately due to 2015 net income.
The following sections provide detailed analysis of the Company’s financial condition, describing its investment securities, loan portfolio composition and credit risk management practices (including those related to the loan loss reserve), as well as its deposits and capital position.
Investment Securities
The following table, which includes available-for-sale and held-to-maturity securities, shows the carrying value of the Company’s portfolio of investments at December 31, 2015, 2014 and 2013:
(1) U.S. Agency MBS include private label MBS of approximately $7.8 million, $9.3 million and $11.3 million at December 31, 2015, 2014 and 2013, respectively, which are supported by FHA/VA collateral.
The Company’s investment portfolio decreased by $22.8 million from December 31, 2014 to December 31, 2015, primarily as the result of the sale of certain short maturity securities in the third quarter of 2015. The increase in 2015 non-agency MBS is mainly related to acquired AAA rated securities composed of adjustable rate mortgages with significant credit support to protect senior holders. The investment portfolio increased by $276.7 million from December 31, 2013 to December 31, 2014 mainly due to the acquisition of Home.
The following is a summary of the contractual maturities and weighted average yields of investment securities at December 31, 2015:
(1) Yields on tax-exempt securities are not stated on a tax equivalent basis.
Mortgage-backed securities (“MBS”), include collateralized mortgage obligations and adjustable rate mortgages, as well as direct pass through securities. Prepayment speeds on mortgages underlying MBS may cause the average life of such securities to be shorter (or longer) than expected.
Investments are classified as “available-for-sale” and “held-to-maturity” and consist mainly of MBS and agency notes backed by government sponsored enterprises, such as Ginnie Mae, Fannie Mae and FHLB. The Company regularly reviews its investment portfolio to determine whether any securities are other-than-temporarily impaired. At December 31, 2015, the investment portfolio had gross unrealized losses on securities of $1.5 million compared to unrealized losses of $1.4 million at December 31, 2014. Management does not believe that these unrealized losses are other-than-temporary.
Loan Portfolio and Credit Quality
Loan Portfolio Composition
Net loans represented approximately 67.3% of total assets as of December 31, 2015. The Company makes most of its loans to customers located within the Company’s primary markets; however, in 2013 Cascade diversified its portfolio by lending to SNCs, which are loans recorded in the C&I portfolio. Cascade’s loan portfolio remains concentrated in real estate related loans because of the nature of the economies in its primary markets. The Company has no significant agricultural loans.
The following table presents the composition of the Company’s December 31 loan portfolio at the dates indicated:
The following table provides the geographic distribution of the Company’s loan portfolio by region as a percent of total company-wide loans at December 31, 2015. Loans in the Washington market as of December 31, 2015 were negligible. Loans balances outside of bank geographies are inclusive of certain wholesale purchased loans, such as SNCs and those residential loans where collateral is located outside of the Bank geographies.
At December 31, 2015, the contractual maturities of all loans by category were as follows:
Commercial Real Estate Loan Concentration Risk
Real estate loans have historically represented a significant portion of the Company’s overall loan portfolio and real estate is frequently a material component of collateral for the Company’s loans. Risks associated with real estate loans include fluctuating land values, demand and prices for housing or commercial properties, national, regional and local economic conditions, changes in tax policies, and concentration within the Bank’s market area.
The following provides information on the Company’s commercial real estate loan portfolio and is based upon FDIC call report loan type categorization.
The $834.9 million commercial real estate (“CRE”) portfolio generally represents loans to finance retail, office and industrial commercial properties. The expected source of repayment of CRE loans is generally the operations of the borrower’s business, rents or the obligor’s personal income. CRE loans represent approximately 49.5% of total loans outstanding as of December 31, 2015. Approximately 36.9% of CRE loans are made to owner-occupied users of the commercial property, while 63.1% of CRE loans are to obligors who do not directly occupy the property. Management believes that lending to owner-occupied businesses may mitigate, but not eliminate, commercial real estate risk. However, no assurance can be given that residential real estate or other economic factors will not adversely impact the CRE portfolio.
Lending and Credit Risk Management
The Company has a comprehensive risk management process to control, underwrite, monitor and manage credit risk in lending. The underwriting of loans relies principally on an analysis of an obligor’s historical and prospective cash flow augmented by collateral valuation analysis, credit bureau information, as well as business plan assessment. Ongoing loan portfolio monitoring is performed by a centralized credit administration function including review and testing of compliance to loan policies and procedures augmented from time to time with third party credit reviews. Internal auditors and bank regulatory examiners periodically sample and test certain credit files as well. Risk of nonpayment exists with respect to all loans, which could result in the classification of such loans as non-performing. Certain specific types of risks are associated with different types of loans.
Reserve for Credit Losses
The Company’s reserve for credit losses provides for estimated losses based upon evaluations of known and inherent risks in the loan portfolio and related loan commitments. Arriving at an estimate of the appropriate level of reserve for credit losses, which consists of the Company’s reserve for loan losses and the Company’s reserve for loan commitments, involves a high degree of judgment and assessment of multiple variables that result in a methodology with relatively complex calculations and analysis. Management uses historical information to assess the adequacy of the reserve for loan losses and considers qualitative factors including economic conditions and a range of other factors in its determination of the reserve. On an ongoing basis, the Company seeks to enhance and refine its methodology such that the reserve is at an appropriate level and responsive to changing conditions. In this regard, as of December 31, 2015, the Company enhanced its methodology to better estimate reserves through the implementation of a separate qualitative risk assessment process that focuses on the C&I portion of the portfolio. The C&I loan portfolio is stratified by industry classification using NAICS codes. At the stratified level, factors considered in the evaluation of the loans include current events, economic or market data, loan performance and concentration risks. This qualitative risk assessment is separate from other qualitative risk assessments included in the allowance methodology. As of June 30, 2013, management implemented a homogeneous pool approach to estimating reserves for certain consumer and small business loans. These changes have not had a material effect on the level of the reserve for loan losses. Management believes that the reserve for credit losses is adequate, however, the Company’s methodology may not accurately estimate inherent loss or external factors and changing economic conditions may impact the loan portfolio and the level of reserves in ways currently unforeseen.
The reserve for credit losses was $24.9 million, or 1.47% of total loans, as of December 31, 2015, as compared to $22.5 million, or 1.51% of loans, at December 31, 2014. The increase in balance from 2014 to 2015 was a result of net loan recoveries of $6.4 million less a credit to the provision of $4.0 million recorded during 2015. The decline in the ratio in 2015 was mainly a result of increases in loan balances over the course of 2015, including organic growth and wholesale loan acquisition. The reduction was also a affected by improved levels of classified assets and other credit quality related metrics.
Purchase accounting resulted in the recording of Home loans at fair value, including a discount to the stated value of such loans that reflected a credit mark and an interest rate mark. On a periodic basis, the Company will evaluate the ongoing credit
quality of the acquired portfolio to assess whether any remaining credit quality discount balances are adequate. Any deficiency in such determination could result in a provision to the reserve for loan losses.
The reserve for loan losses is increased by provisions for loan losses and by recoveries of loans previously charged-off and reduced by loans charged-off. The reserve for loan commitments is increased and decreased through non-interest expense.
The following table allocates the Company’s reserve for credit losses among major loan types for the years indicated.
In the above table, the percentage of the reserve for loan losses allocated to various loan types generally declined between 2015 and 2014 with the exception of the portion allocated to the C&I category. This general decline in reserve percentage was a result of continuing improvement in credit quality, including ongoing lower historical loss rates. The increase in the portion allocated to C&I loans is related to the reserve methodology enhancements implemented in 2015 (described elsewhere) that enhanced the model’s qualitative factor related to the SNC portfolio industry concentration exposure. Specifically, the qualitative factor related to the mining and energy industry segment increased due to the economic stress resulting from historic lows in energy prices. The bank portfolio holds under 2% of total loans with exposure to this NAICS segment. The portion of the reserve designated as ‘unallocated’ declined in 2015 due to the implementation of the 2015 enhancements described above.
The percentage of the reserve for loan losses allocated to various loan types declined between 2014 and 2013. This is a result of the addition of Home loans to the Company’s portfolio during 2014.
Also the table reflects a decrease in the portion of the reserve designated as unallocated. Unallocated decreased to $2.5 million of the total reserve as of December 31, 2015 as compared to $5.3 million at December 31, 2014. The Company has determined the level of unallocated reserve is appropriate based upon the lack of seasoning with respect to its methodology enhancement, which related to estimating reserves against certain loan pools as opposed to reserving on a loan by loan basis for such loans. In addition, the unallocated reflects the lack of seasoning as to credit quality performance of its recently acquired Home and SNCs portfolios.
The following table summarizes the Company’s reserve for loan losses and charge-off and recovery activity for each of the last five years:
The following table presents information with respect to non-performing assets ("NPAs"), for the years presented.
The following table presents the composition of NPAs for the years presented. As of December 31, 2015, commercial real estate represented 67.2% of NPAs; construction 6.0%; residential real estate 17.0%; C&I 9.6%; and consumer 0.2%.
The accrual of interest on a loan is discontinued when, in management’s judgment, the future collectability of principal or interest is in doubt. Loans placed on nonaccrual status may or may not be contractually past due at the time of such determination, and may or may not be secured. When a loan is placed on nonaccrual status, it is the Bank’s policy to reverse, and charge against current income, interest previously accrued but uncollected. Interest subsequently collected on such loans is credited to loan principal if, in the opinion of management, full collectability of principal is doubtful. Interest income that was reversed and charged against income was $0 in 2015, $0.2 million in 2014, and $0.6 million in 2013. Interest income that would have been recorded in 2015 had nonaccrual loans at December 31, 2015 been on accrual status throughout the year would have been $0.2 million.
During the Company’s normal loan review procedures, a loan is considered to be impaired when it is probable that the Company will be unable to collect all amounts due 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 if the loan is collateral dependent. Impaired loans are currently measured at the lower of cost or fair value. Certain small balance homogeneous loans are collectively measured for impairment. Impaired loans are charged to the allowance when management believes, after considering economic and business conditions, collection efforts and collateral position that the borrower’s financial condition is such that collection of principal is not probable. At December 31, 2015 and 2014, the Company’s recorded investment in certain loans covered by the allowance that were considered to be impaired was $6.9 million and $33.7 million, respectively, and specific valuation allowances were $0.2 million and $0.1 million, respectively. As the acquired loan portfolio is covered by the valuation adjustment taken at the time of acquisition and as the original mark continues to be more than sufficient, the acquired loan portfolio has not required additional impairment under the allowance methodology.
The following table presents the outstanding balance for loans that previously went through a troubled debt restructuring (“TDRs”) for the years presented:
The TDRs for the years presented above are classified as impaired loans and, in the opinion of management, were reserved appropriately.
Management, to the best of its ability, works to properly classify loans. As of December 31, 2015, management was unaware of any loans that are not disclosed above as nonaccrual, past due or TDR and with respect to which there was known information about possible credit problems of the borrowers that caused management to have serious doubts as to the ability of such borrowers to comply with the present loan repayment terms and which may result in disclosure of such loans as nonaccrual, past due or TDR. The decrease in TDR balance outstanding since December 31, 2011 has been a result of management’s efforts to remediate loans that are considered TDR by working with the borrowers to pay the loans off, or down.
Bank-Owned Life Insurance
The Company has purchased bank-owned life insurance (“BOLI”) to protect itself against the loss of certain key employees and directors due to death and to offset the Bank’s future obligations to its employees under its retirement and benefit plans. See Note 1 of the Company’s “Notes to Consolidated Financial Statements” in Item 8 of this report. During 2015, 2014, and 2013, the Bank did not purchase any new BOLI. In 2014, however, the Bank did acquire $15.9 million in policies as part of the Home acquisition. As of December 31, 2015 and 2014, the cash surrender value of the Bank’s total BOLI policies was $54.5 million and $53.4 million, respectively. The Bank recorded income from the BOLI policies of $1.0 million in 2015, $1.0 million in 2014 and $0.9 million in 2013.
The Company owns both general account and separate account BOLI. The separate account BOLI was purchased in the fourth quarter of 2006 as an investment expected to provide a long-term source of earnings to support existing employee benefit plans. The fair value of the general account BOLI is based on the insurance contract cash surrender value. The cash surrender value of the separate account BOLI is the quoted market price of the underlying securities, further supported by a stable value wrap which mitigates, but may not fully insulate against, changes in the fair market value of the underlying securities.
Liabilities
Deposit Liabilities and Time Deposit Maturities
At December 31, 2015, total deposits were $2.1 billion, compared to $2.0 billion at December 31, 2014 and $1.2 billion at December 31, 2013. The increase from December 31, 2014 to December 31, 2015 was primarily in demand and interest bearing demand accounts, offset by a reduction in time deposits.
At December 31, 2015, 2014 and 2013, the Company did not have any wholesale brokered deposits, however, at December 31, 2015, 2014 and 2013, the Company had deposits obtained through the Bank’s reciprocal Certificate of Deposit Account Registry Service (“CDARS”) program totaling $10.0 million, $11.5 million and $21.7 million, respectively. Banks that are not “well-capitalized” or subject to regulatory restrictions are prohibited from acquiring wholesale brokered deposits. Since the lifting of regulatory restrictions in 2013, the Company is under no restrictions with respect to wholesale brokered deposits.
The following table presents the deposit balances by major category as of December 31, 2015 and December 31, 2014:
The following table summarizes the average amount of, and the average rate paid on, each of the deposit categories for the periods shown:
As of December 31, 2015, the Company’s time deposit liabilities had the following times remaining to maturity:
(1) Time deposits of $100,000 or more represent 4.0% of total deposits as of December 31, 2015.
(2) All other time deposits represent 4.5% of total deposits as of December 31, 2015.
Other Borrowings
At December 31, 2015 and 2014, the Bank had no borrowings from the FHLB and no borrowings with FRB. At December 31, 2013, the Bank had $27.0 million in short-term borrowings from FHLB bearing a weighted average rate of 0.25% and no borrowings with FRB. In the second quarter of 2013, the Bank prepaid the $60.0 million of long-term borrowings and incurred prepayment penalties of $3.8 million in 2013. As of December 31, 2015, 2014 and 2013, the Bank had no off-balance sheet FHLB letters of credit used for collateralization of public deposits held by the Bank.
Off-Balance Sheet Arrangements
In the ordinary course of business, the Bank is a party to financial instruments with off-balance sheet risk to meet the financing needs of its customers. These financial instruments include commitments to extend credit, commitments under credit card lines of credit, and standby letters of credit. These financial instruments involve, to varying degrees, elements of credit and interest-rate risk in excess of amounts recognized in the accompanying consolidated balance sheets. The contractual amounts of these financial instruments reflect the extent of the Bank’s involvement in these particular classes of financial instruments. As of December 31, 2015 and 2014, the Bank had no material commitments to extend credit at below-market interest rates.
The Bank’s exposure to credit loss for commitments to extend credit, commitments under credit card lines of credit, and standby letters of credit is represented by the contractual amount of these instruments. The Bank follows the same credit policies in underwriting and offering commitments and conditional obligations as it does for on-balance sheet financial instruments.
A schedule of significant off-balance sheet commitments at December 31, 2015 and 2014 is included in the following table (dollars in thousands):
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 the payment of fees. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank applies established credit related standards and underwriting practices in evaluating the creditworthiness of such obligors. The amount of collateral obtained, if it is deemed necessary by the Bank upon the extension of credit, is based on management’s credit evaluation of the counterparty.
The Bank typically does not obtain collateral related to credit card commitments. Collateral held for other commitments varies but may include accounts receivable, inventory, property and equipment, residential real estate, and income-producing commercial properties.
Standby letters of credit are written conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. These guarantees are primarily issued to support public and private borrowing arrangements. In the event that the customer does not perform in accordance with the terms of the agreement with the third-party, the Bank would be required to fund the commitment. The maximum potential amount of future payments the Bank could be required to make is represented by the contractual amount of the commitment. If the commitment was funded, the Bank would be entitled to seek recovery from the customer. The Bank’s policies generally require that standby letter of credit arrangements contain security and debt covenants similar to those involved in extending loans to customers. The credit risk involved in issuing standby letters of credit is essentially the same as that involved in extending loan facilities to customers.
The Bank considers the fees collected in connection with the issuance of standby letters of credit to be representative of the fair value of its obligations undertaken in issuing the guarantees. In accordance with GAAP related to guarantees, the Bank defers fees collected in connection with the issuance of standby letters of credit. The fees are then recognized in income proportionately over the life of the related standby letter of credit agreement. At December 31, 2015 and 2014, the Bank’s deferred standby letter of credit fees, which represent the fair value of the Bank’s potential obligations under the standby letter of credit guarantees, were insignificant to the accompanying consolidated financial statements.
The following table presents a summary of significant contractual obligations extending beyond one year as of December 31, 2015 and maturing as indicated:
Stockholders’ Equity and Capital Resources
The Company’s total stockholders’ equity at December 31, 2015 was $336.8 million, an increase of $21.3 million from $315.5 million at December 31, 2014. The balance at December 31, 2014 was also an increase of $126.8 million from December 31, 2013. The increase in total stockholders’ equity from December 31, 2014 to December 31, 2015 was predominately due to net income recorded for the year ended December 31, 2015 of $20.6 million. The increase in stockholders’ equity from
December 31, 2013 to December 31, 2014 primarily was due to the effect of the Home acquisition, as well as the net income of $3.7 million recorded for the year ended December 31, 2014.
Federal banking regulators are required to take prompt corrective action if an insured depository institution fails to satisfy certain minimum capital requirements, including a leverage limit, risk-based capital requirements and any other measure of capital deemed appropriate by the federal banking regulator for measuring the capital adequacy of an insured depository institution. As mentioned earlier in this report, the Bank has not been operating under any order since 2013.
Effective January 1, 2015, minimum capital requirements increased for both the quantity and quality of capital held by the Bancorp and the Bank. The rules include a new common equity Tier 1 capital to risk-weighted assets ratio (“CET1” ratio) of 4.5% and a capital conservation buffer of 2.5% above the regulatory minimum risk-based capital requirements, which when fully phased-in, effectively results in a minimum CET1 ratio of 7.0%. Basel III also (i) raises the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0% (which, with the capital conservation buffer, effectively results in a minimum Tier 1 capital ratio of 8.5% when fully phased-in), (ii) effectively results in a minimum total capital to risk-weighted assets ratio of 10.5% (with the capital conservation buffer fully phased-in), and (iii) requires a minimum leverage ratio of 4.0%. Basel III also makes changes to risk weights for certain assets and off-balance-sheet exposures which affects our capital calculations.
At December 31, 2015 and 2014, the Bancorp’s and Bank’s capital ratios exceeded the requirements to be designated as “well-capitalized” under the applicable regulatory capital framework.
Liquidity and Sources of Funds
The objective of the Bank’s liquidity management is to maintain ample cash flows to meet obligations for depositor withdrawals, to fund the borrowing needs of loan customers, and to fund ongoing operations. At December 31, 2015, liquid assets of the Bank were mainly interest bearing balances held at FRB totaling $22.3 million compared to $34.2 million at December 31, 2014.
Core relationship deposits are the Bank’s primary source of funds. As such, the Bank focuses on deposit relationships with local business and consumer clients who maintain multiple accounts and services at the Bank. The Company views such deposits as the foundation of its long-term liquidity because it believes such core deposits are more stable and less sensitive to changing interest rates and other economic factors compared to large time deposits or wholesale purchased funds. The Bank’s customer relationship strategy has resulted in a relatively higher percentage of its deposits being held in checking and money market accounts, and a lesser percentage in time deposits.
As discussed in Item 1 of this report, the Company will acquire 15 branches and approximately $480 million of associated deposits in Oregon and Southwest Washington from Bank of America in March 2016. These deposits are expected to significantly enhance the Company’s liquidity.
The Bank may augment core deposits with borrowings or wholesale funds from time to time, including brokered deposits. Currently, the Bank accepts local relationship-based reciprocal CDARS and Demand Deposit Marketplace ("DDM deposits"). These deposits are technically classified as brokered deposits. At December 31, 2015, the Company had $10.0 million in reciprocal CDARS and $76.0 million in reciprocal DDM deposits. At December 31, 2014, the Company had $11.5 million in reciprocal CDARS and $54.3 million in reciprocal DDM deposits. At December 31, 2013, the Company $21.7 million in reciprocal CDARS and no reciprocal DDM deposits. Banks that are not “well-capitalized” or that are subject to regulatory restrictions are to refrain from acquiring wholesale brokered deposits. Since the lifting of regulatory restrictions in 2013, the Company is under no restrictions with respect to wholesale brokered deposits.
The Bank accepts deposits from public funds within its primary markets. Current rules imposed by the Oregon State Treasury require that the Bank collateralize 50% of the uninsured public funds held by the Bank. At December 31, 2015, the Bank was in compliance with this statute. As of December 31, 2015, there are no collateral requirements set on Idaho public deposits.
The Bank also utilizes borrowings and lines of credit as sources of funds. At December 31, 2015, the FHLB had extended the Bank a secured line of credit of $862.0 million (35.0% of total assets) accessible for short- or long-term borrowings given sufficient qualifying collateral. As of December 31, 2015, the Bank had qualifying collateral pledged for FHLB borrowings totaling $491.2 million, none of which have been utilized by the Bank. At December 31, 2015, the Bank also had undrawn borrowing capacity at FRB of approximately $16.4 million supported by specific qualifying collateral. Borrowing capacity from FHLB or FRB may fluctuate based upon the acceptability and risk rating of loan collateral, and counterparties could adjust discount rates applied to such collateral at their discretion. Also, FRB or FHLB could restrict or limit our access to secured borrowings. Correspondent banks have extended $110.0 million in unsecured or collateralized short-term lines of credit for the purchase of federal funds. At December 31, 2015, the Company had no outstanding borrowings under these federal fund borrowing agreements.
Liquidity may be affected by the Bank’s routine commitments to extend credit. At December 31, 2015, the Bank had approximately $550.4 million in outstanding commitments to extend credit, compared to approximately $404.9 million at December 31, 2014. The increase during 2015 relates to additional volume from the Home acquisition, as well as growth in existing and new customer lending relationships. At this time, management believes that the Bank’s available resources will be sufficient to fund its commitments in the normal course of business.
The investment portfolio also provides a secondary source of funds as investments may be pledged for borrowings or sold for cash. This liquidity is limited, however, by counterparties’ willingness to accept securities as collateral and the market value of securities at the time of sale could result in a loss to the Bank. As of December 31, 2015, the Company held unpledged investments with a book value that totaled $331.7 million compared to $285.2 million at December 31, 2014.
As of December 31, 2015, the Bank’s primary liquidity ratio (net cash, plus short-term and marketable assets divided by net deposits and short term liabilities) was 23.40%.
Bancorp is a single bank holding company and its primary ongoing source of liquidity is dividends received from the Bank. Oregon banking laws impose certain limitations on the payment of dividends by Oregon state chartered banks. The amount of the dividend may not be greater than the Bank’s unreserved retained earnings, deducting from that, to the extent not already charged against earnings or reflected in a reserve, the following: (i) all bad debts, which are debts on which interest is past due and unpaid for at least six months, unless the debt is fully secured and in the process of collection; (ii) all other assets charged off as required by the Director of the Department of Consumer and Business Services or a state or federal examiner; and (iii) all accrued expenses, interest and taxes of the institution. The Bank received regulatory approval to adjust retained earnings to
zero at September 30, 2012. Accordingly, the Bank’s ability to pay dividends is constrained by the amount of increases in retained earnings from that date.
Inflation
The effect of changing prices on financial institutions is typically different than on non-banking companies since a substantial portion of a bank’s assets and liabilities are monetary in nature. In particular, interest rates are significantly affected by inflation, but neither the timing nor magnitude of the changes to interest rates can be directly correlated to price level indices; therefore, the Company can best counter inflation over the long term by managing sensitivity to interest rates of its net interest income and controlling levels of non-interest income and expenses.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The disclosures in this item are qualified by the Risk Factors set forth in Item 1A and the Section entitled “Cautionary Information Concerning Forward-Looking Statements” included in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in this report and any other cautionary statements contained herein.
Interest Rate Risk and Asset and Liability Management
The goal of the Company’s asset and liability management policy is to maximize long-term profitability under the range of likely interest rate scenarios. Interest rate risk management requires estimating the probability and impact of changes in interest rates on assets and liabilities. The Asset/Liability Management Committee (ALCO) formulates and monitors strategies to control interest rate risk in accordance with policies approved by the Board of Directors. Management engages a qualified independent service provider to assist in modeling, assessing and monthly reporting of interest rate risk. The Bank adjusts its sensitivity to changing interest rates by managing its loan and deposit portfolios with respect to pricing, maturity or contractual characteristics. The Bank may also target the expansion or contraction of specific investment portfolio or borrowing structures to further affect its risk profile. In addition, the Bank is authorized to enter into interest rate swap or other hedging contracts with re-pricing characteristics that tend to moderate interest rate risk. However, there are no material structured hedging instruments in use at this time. Because of the volatility of market rates, event risk and other uncertainties described below, there can be no assurance of the effectiveness of management programs to achieve its interest rate risk objectives.
To assess and estimate the degree of market risk, the Bank utilizes a simulation model that estimates the volatility of Bank earnings and market value of equity resulting from changes in interest rates. In addition to conducting static shock analysis, management models earnings in a wide range of interest rate scenarios over a two-year forecast period. Such scenarios routinely include a “stable” or unchanged scenario and an “estimated” or most likely scenario given current and forecast economic conditions. In addition, scenarios titled “rising rates”, “declining rates”, and “alternate rising rates” are established to stress-test the impact of rate movements that are perceived as less likely, but may still occur. The following table defines the market interest rates projected in various interest rate scenarios. Generally, projected market rates are reached gradually over the 2-year simulation horizon.
Earnings projections include the effect of estimated loan and deposit growth that management deems reasonable; however, such volume projections are not varied by rate scenario. Additionally, the effect on earnings assumes no changes in non-interest income or expense between scenarios. As such, management focuses on the projected variances in net interest income between each scenario and the stable rate scenario. The following table presents these variances as of December 31, 2015:
In management’s judgment and at this date, the interest rate risk profile of the Bank is reasonably balanced within the most likely range of possible outcomes. The model indicates that should future interest rates actually follow the path indicated in the “estimated” rate scenario, the net interest margin would range between 3.70% and 4.20% all else being equal. However, with the more dramatic changes reflected in the “rising” or “declining” scenarios, the model suggests the margin would likely move outside of this range should such interest rates actually occur. This is mainly because the Bank has a large portion of non-interest bearing funds (approximately 35% of total deposits) that are assumed to be relatively insensitive to changes in interest rates. Thus in the event of rising rates, yields on earning assets would tend to increase at a faster pace than overall cost of funds, leading to an improving margin. Conversely, should rates fall, yields on loans and securities would compress against an already low cost of funds. Management has concluded that the degree of margin and earnings volatility under the above scenarios is acceptable because of the cost of mitigating such risk and because the model suggests that the Bank would still generate satisfactory returns under such circumstances.
Please carefully review and consider the following information regarding the risk of placing undue reliance on simulation models, interest rate projections and scenario results. In all scenarios discussed above, results are modeled using management’s estimates as to growth in loans, deposits and other balance sheet items, as well as the expected mix and pricing thereof. These volume estimates are static in the various scenarios. Such estimates may be inaccurate as to future periods. Model results are only indicative of interest rate risk exposure under various scenarios. The results do not encompass all possible paths of future market rates, in terms of absolute change or rate of change, or changes in the shape of the yield curve. Nor does the simulation anticipate changes in credit conditions that could affect results. Likewise, scenarios do not include possible changes in volumes, pricing or portfolio management tactics that may enable management to moderate the effect of such interest rate changes.
Simulations are dependent on assumptions and estimations that management believes are reasonable, although the actual results may vary substantially, and there can be no assurance that simulation results are reliable indicators of future earnings under such conditions. This is, in part, because of the nature and uncertainties inherent in simulating future events including: (1) no presumption of changes in asset and liability strategies in response to changing circumstances; (2) model assumptions may differ from actual outcomes; (3) uncertainties as to customer behavior in response to changing circumstances; (4) unexpected absolute and relative loan and deposit volume changes; (5) unexpected absolute and relative loan and deposit pricing levels; (6) unexpected behavior by competitors; and (7) other unanticipated credit conditions or other events impacting volatility in market conditions and interest rates.
In addition to the uncertainties discussed elsewhere in this section, the impact of the Company’s 2016 proposed acquisition of the deposits associated with the 15 branches from Bank of America is not included in this analysis. The proposed acquisition could increase deposits by up to 30%, which is significant. Deployment of these funds into securities and wholesale loans is anticipated and are forecast to yield approximately 2.25% by year end 2016. The result would increase net interest income but is likely to reduce our NIM ratio. The proportions such earning assets ultimately deployed into floating, adjustable or fixed rate instruments will affect the responsiveness of net interest income to future changes in interest rates.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS.
The following reports, audited consolidated financial statements and notes thereto are set forth in this Report on the pages indicated:
REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Cascade Bancorp
Bend, Oregon
We have audited the accompanying consolidated balance sheets of Cascade Bancorp as of December 31, 2015 and 2014 and the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2015. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these 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 financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Cascade Bancorp at December 31, 2015 and 2014, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2015, in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Cascade Bancorp’s internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 4, 2016 expressed an unqualified opinion thereon.
/s/ BDO USA, LLP
Spokane, Washington
March 4, 2016
Cascade Bancorp & Subsidiary
Consolidated Balance Sheets
December 31, 2015 and 2014
(Dollars in thousands)
The accompanying notes are an integral part of the consolidated financial statements.
Cascade Bancorp & Subsidiary
Consolidated Statements of Income
Years ended December 31, 2015, 2014 and 2013
(Dollars in thousands, except per share amounts)
The accompanying notes are an integral part of the consolidated financial statements.
Cascade Bancorp & Subsidiary
Consolidated Statements of Comprehensive Income
Years ended December 31, 2015, 2014 and 2013
(Dollars in thousands)
The accompanying notes are an integral part of the consolidated financial statements.
Cascade Bancorp & Subsidiary
Consolidated Statements of Changes in Stockholders' Equity
Years ended December 31, 2015, 2014 and 2013
(Dollars in thousands)
The accompanying notes are an integral part of the consolidated financial statements.
Cascade Bancorp & Subsidiary
Consolidated Statements of Cash Flows
Years Ended December 31, 2015, 2014 and 2013
(Dollars in thousands)
The accompanying notes are an integral part of the consolidated financial statements.
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
1. Basis of presentation and summary of significant accounting policies
Basis of presentation
The accompanying consolidated financial statements include the accounts of Cascade Bancorp (“Bancorp”), an Oregon chartered single bank holding company, and its wholly-owned subsidiary, Bank of the Cascades (the “Bank”) (collectively, “the Company”). All significant intercompany accounts and transactions have been eliminated in consolidation.
Certain prior year amounts have been reclassified to conform with the 2015 presentation. None of these reclassifications have an effect on net income, net cash flows or equity.
Description of business
The Bank conducts a general banking business, operating branches in Central, Southern, and Northwest Oregon, as well as the greater Boise/Treasure Valley, Idaho and Seattle, Washington metro areas. Banking activities include the usual lending and deposit functions of a community and business bank: commercial, construction, real estate, installment, credit card, and mortgage loans; checking, money market, time deposit, and savings accounts; internet banking and bill payment; automated teller machines, and safe deposit facilities. Additionally, the Bank originates and sells mortgage loans into the secondary market and offers trust and investment services.
Method of accounting
The Company prepares its consolidated financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) and prevailing practices within the banking industry. The Company utilizes the accrual method of accounting which recognizes income and gains when earned and expenses and losses when incurred. The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of income, gains, expenses, and losses during the reporting periods. Actual results could differ from those estimates.
Segment reporting
The Company is managed by legal entity and not by lines of business. The Company has determined that its operations are solely in the community and business banking industry and consist of traditional banking services, including lending activities; acceptance of demand, savings, and time deposits; business services; and trust services. These products and services have similar distribution methods, types of customers and regulatory responsibilities. The performance of the Company is reviewed by the executive management team and the Company’s Board of Directors (the “Board”) on a monthly basis. All of the executive officers of Bancorp are members of the Bank's executive management team, and operating decisions are made based on the performance of the Company as a whole. Accordingly, disaggregated segment information is not required to be presented in the accompanying consolidated financial statements, and the Company will continue to present one segment for financial reporting purposes.
Cash and cash equivalents
For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks (including cash items in process of collection), interest bearing deposits with the FRB and FHLB, and federal funds sold. Generally, any interest bearing deposits are invested for a maximum of 90 days. Federal funds are generally sold for one-day periods.
The Bank maintains balances in correspondent bank accounts which, at times, may exceed federally insured limits. In addition, federal funds sold are essentially uncollateralized loans to other financial institutions. Management believes that its risk of loss associated with such balances is minimal due to the financial strength of the correspondent banks and counterparty financial institutions. The Bank has not experienced any losses in such accounts. At December 31, 2015, the Bank was not required to maintain any specific balances in correspondent bank accounts.
Supplemental disclosures of cash flow information
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
Noncash investing and financing activities consist of unrealized gains and losses on investment securities available-for-sale, net of income taxes, issuance of nonvested restricted stock, and stock-based compensation expense, all as disclosed in the accompanying consolidated statements of changes in stockholders’ equity; the net capitalization of originated mortgage-servicing rights, as disclosed in Note 6; assets and liabilities assumed in the Home acquisition, as disclosed in Note 2; the transfer of approximately $1.6 million, $0.2 million, and $2.1 million of loans to other real estate owned (“OREO”) in 2015, 2014, and 2013, respectively; and the transfer of approximately $0.4 million of fixed assets to other assets in 2015.
During 2015, 2014, and 2013, the Company paid approximately $8.1 million, $8.1 million, and $3.0 million, respectively, in interest expense.
During 2015, 2014 and 2013, the Company made income tax payments of $1.1 million, nil and $0.1 million, respectively.
Investment securities
Investment securities that management has the positive intent and ability to hold to maturity are classified as held-to-maturity securities and reported at cost, adjusted for premiums and discounts that are recognized in interest income using the interest method over the period to maturity.
Investment securities that are purchased and held principally for the purpose of selling in the near term are classified as trading securities and are reported at fair value, with unrealized gains and losses included in non-interest income. The Company had no trading securities during 2015, 2014, and 2013.
Investment securities that are not classified as either held-to-maturity securities or trading securities are classified as available-for-sale securities and are reported at fair value, with unrealized gains and losses excluded from earnings and reported as other comprehensive income or loss, net of income taxes. Management determines the appropriate classification of securities at the time of purchase.
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.
Gains and losses on the sales of available-for-sale securities are determined using the specific-identification method. Premiums and discounts on available-for-sale securities are recognized in interest income using the interest method generally over the period to maturity.
In estimating other-than-temporary impairment (“OTTI”) losses, management considers, among other things, (1) the length of time and the extent to which the fair value has been less than amortized cost, (2) the financial condition and near term prospects of the issuer, (3) the impact of changes in market interest rates, and (4) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery of fair value. Declines in the fair value of individual held-to-maturity and available-for-sale securities below their cost that are deemed to be OTTI would result in write-downs of the individual securities to their fair value. The fair value of the security then becomes the new cost basis. The related write-downs to fair value for available-for-sale equity securities would be included in earnings as realized losses. For individual debt securities which the Company does not intend to sell and for which it is not more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis, the OTTI losses would be evaluated and (1) the portion related to credit losses would be included in earnings as realized losses and (2) the portion related to market or other factors would be recognized in other comprehensive income or loss. Credit loss is recorded if the present value of cash flows is less than the amortized cost. For individual debt securities which the Company intends to sell or for which it more likely than not will not recover all of its amortized cost, the OTTI is recognized in earnings equal to the entire difference between the security’s cost basis and its fair value at the consolidated balance sheet date. For individual debt securities for which credit loss has been recognized in earnings, interest accruals and amortization and accretion of premiums and discounts are suspended when the credit loss is recognized. Interest received after accruals have been suspended is recognized on a cash basis. Management believes that all unrealized losses on investment securities at December 31, 2015 and 2014 are temporary (see Note 4).
FHLB stock
On May 31, 2015, the FHLB Seattle merged with and into FHLB Des Moines, as approved by the FHFA on December 22, 2014. As part of the FHLB merger, each share of FHLB Seattle stock outstanding was converted into one share of FHLB Des Moines stock. Immediately following the merger, all excess shares were repurchased or issued as needed to meet the
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
membership stock requirements. In relation to the FHLB merger, our investment in FHLB stock decreased from $25.6 million at December 31, 2014 to $3.0 million at December 31, 2015.
As a member of the FHLB system, the Bank is required to maintain a minimum investment in FHLB stock based on specific percentages of its outstanding mortgages, total assets, or FHLB advances. At December 31, 2015 and 2014, the Bank met its minimum required investment. The Bank may request redemption at par value of any FHLB stock in excess of the minimum required investment; however, stock redemptions are at the discretion of the FHLB.
Loans Held for Sale
Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or fair value, as determined by outstanding commitments from investors. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings. Mortgage loans held for sale are generally sold with servicing rights retained. The carrying value of mortgage loans sold is reduced by the amount allocated to the servicing right. Gains and losses on sales of mortgage loans are based on the difference between the selling price and the carrying value of the related loan sold.
Loans
Loans are stated at the amount of unpaid principal, net of any premium or discount, reduced by the reserve for loan losses, the undisbursed portion of loans in process, and deferred loan fees.
Interest income on loans is accrued daily based on the principal amounts outstanding. Allowances are established for uncollected interest on loans for which the interest is determined to be uncollectible. Generally, all loans past due (based on contractual terms) 90 days or more are placed on non-accrual status and internally classified as substandard. Any interest income accrued at that time is reversed. Subsequent collections are applied proportionately to past due principal and interest, unless collectability of principal is in doubt, in which case all payments are applied to principal. Loans are removed from non-accrual status only when the loan is deemed current, and the collectability of principal and interest is no longer doubtful, or, on one-to-four family loans, when the loan is less than 90 days delinquent.
The Bank charges fees for originating loans. These fees, net of certain loan origination costs, are deferred and amortized to interest income, on the level-yield basis, over the loan term. If the loan is repaid prior to maturity, the remaining unamortized deferred loan origination fee is recognized in interest income at the time of repayment.
Reserve for loan losses
The reserve for loan losses represents management’s estimate of known and inherent losses in the loan portfolio as of the condensed consolidated balance sheet date and is recorded as a reduction to loans. The reserve for loan losses is increased by charges to operating expense through the loan loss provision, and decreased by loans charged-off, net of recoveries. The reserve for loan losses requires complex subjective judgments as a result of the need to make estimates about matters that are uncertain. The reserve for loan losses is maintained at a level currently considered adequate to provide for potential loan losses based on management’s assessment of various factors affecting the loan portfolio.
At December 31, 2015 and 2014, management believes that the Company’s reserve for loan losses is at an appropriate level under current circumstances and prevailing economic conditions. However the reserve for loan losses is based on estimates and ultimate losses may vary from the current estimates. These estimates are reviewed periodically, and, as adjustments become necessary, they are reported in earnings in the periods in which they become known. Therefore, management cannot provide assurance that, in any particular period, the Company will not have significant losses in relation to the amount reserved. The level of the reserve for loan losses is also determined after consideration of bank regulatory guidance and recommendations and is subject to review by such regulatory authorities who may require increases or decreases to the reserve based on their evaluation of the information available to them at the time of their examinations of the Bank.
Management uses historical information to assess the adequacy of the reserve for loan losses and considers qualitative factors including economic conditions and a range of other factors in its determination of the reserve. On an ongoing basis, the Company seeks to enhance and refine its methodology such that the reserve is at an appropriate level and responsive to changing conditions. In this regard, as of December 31, 2015, the Company enhanced its methodology to better estimate reserves through the implementation of a separate qualitative risk assessment process that focuses on the commercial and industrial (“C&I”) portion of the portfolio. The C&I loan portfolio is stratified by industry classification using NAICS codes. At the stratified level, factors considered in the evaluation of the loans include current events, economic or market data, loan
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
performance and concentration risks. This qualitative risk assessment is separate from other qualitative risk assessments included in the allowance methodology.
As of June 30, 2013, management implemented a homogeneous pool approach to estimating reserves for consumer and small business loans. As of March 31, 2015, the reserve for loan loss methodology was enhanced within the Company’s C&I loan portfolio with respect to its holdings of shared national credits (“SNCs”). Risk ratings for individual SNCs are estimated using analysis of both public debt ratings and internal ratings. Expected loss rates are determined based upon historical published specific loss data for similar loans based on average losses and losses stratified by public debt ratings. Public ratings combined with internal risk rates are used to determine a minimum historical loss factor for each SNC loan. This amount may be increased for qualitative conditions including macroeconomic environment and observations by the Company’s SNC management group. The SNC lending strategy is intended to diversify the Company’s credit risk profile geographically and by industry. Additionally, such loans enhance the Company’s interest rate risk profile as they float with LIBOR rates.
For purposes of assessing the appropriate level of the reserve for loan losses, the Company analyzes loans and commitments to loan, and the amount of reserves allocated to loans and commitments to loan in each of the following reserve categories: pooled reserves, specifically identified reserves for impaired loans, and the unallocated reserve. Also, for purposes of analyzing loan portfolio credit quality and determining the appropriate level of reserve for loan losses, the Company identifies loan portfolio segments and classes based on the nature of the underlying loan collateral.
Reserves for impaired loans are either specifically allocated within the reserve for loan losses or reflected as a partial charge-off of the loan balance. The Bank considers loans to be impaired when management believes that it is probable that either principal and/or interest amounts due will not be collected according to the contractual terms. Impairment is measured on a loan-by-loan basis by the present value of expected future cash flows discounted at the loan’s effective interest rate, including the loan’s observable market price, the estimated fair value of the loan’s underlying collateral, or the value of a related guaranty. A significant portion of the Bank’s loans are either (1) collateralized by real estate, whereby the Bank primarily measures impairment based on the estimated fair value of the underlying collateral less the cost to sell, or the value of a related guaranty, or (2) are supported by underlying cash flows, whereby impairment is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate. Accordingly, changes in such estimated collateral values or future cash flows could result in actual losses which differ from those estimated at the date of the consolidated balance sheets. Impairment measurements may also include consideration of information that becomes available subsequent to year-end. Small balance loans are reserved for based on the applicable loan segment and are reserved at the related pool rate (regardless of dollar amount). Generally, shortfalls on impaired small balance loans are charged off and the Bank does not establish specific reserves. Small balance loans are evaluated for impairment based on the borrower’s difficulty in making payments, an analysis of the borrower’s repayment capacity, collateral coverage, and shortfall, if any, created by reductions in payments or principal. Generally, the Bank evaluates a loan for impairment when a loan is determined to be adversely classified; small balance loans are monitored based on payment performance and are evaluated for impairment no later than 90 days past due.
The reserve for loan losses may include an unallocated amount based upon the Company’s judgment as to possible credit losses inherent in the loan portfolio that may not have been captured by historical loss experience, qualitative factors, or specific evaluations of impaired loans. Unallocated reserves may be adjusted for factors including, but not limited to, unexpected or unusual events, volatile market and economic conditions, effects of changes or seasoning in methodologies, regulatory guidance and recommendations, or other factors that may impact operating conditions and loss expectations. Management’s judgment as to unallocated reserves is determined in the context of, but separate from, the historical loss trends and qualitative factors described above. The unallocated reserve for loan losses of $2.5 million at December 31, 2015 has decreased $2.8 million from the balance at December 31, 2014. Management believes that the amount of unallocated reserve for loan losses is appropriate and will continue to evaluate the amount going forward.
Due to the judgment involved in the determination of the qualitative and unallocated portions of the reserve for loan losses, the relationship of these components to the total reserve for loan losses may fluctuate from period to period.
Troubled debt restructurings (“TDRs”)
A loan is classified as a TDR when a borrower is experiencing financial difficulties and the Company grants a concession to the borrower in the restructuring that the Company would not otherwise consider in the origination of a loan. In some situations a borrower may be experiencing financial distress, but the Company does not provide a concession. These modifications are not considered TDRs. In other cases, the Company might provide a concession, such as a reduction in interest rate, but the borrower is not experiencing financial distress. This could be the case if the Company is matching a competitor’s interest rate. These modifications would also not be considered TDRs. Finally, any renewals at existing terms for borrowers not experiencing financial distress would not be considered TDRs. A TDR loan is considered to be impaired and is individually
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
evaluated for impairment. As with other impaired loans, a specific reserve is estimated for each TDR based on the difference between expected future cash flows discounted at the original contractual rate and the current balance of the loan. For collateral dependent loans, expected future cash flows include the estimated market value less cost to sell.
Reserve for unfunded loan commitments
The Company maintains a separate reserve for losses related to unfunded loan commitments. The reserve for unfunded loan commitments represents management’s estimate of losses inherent in the Bank’s unfunded loan commitments. Management estimates the amount of probable losses related to unfunded loan commitments by applying the loss factors used in the reserve for loan loss methodology to an estimate of the expected amount of funding and applies this adjusted factor to the unused portion of unfunded loan commitments. The reserve for unfunded loan commitments totaled $0.4 million at both December 31, 2015 and 2014 and these amounts are included in other liabilities in the accompanying consolidated balance sheets. Increases (decreases) in the reserve for unfunded loan commitments are recorded in non-interest expenses in the accompanying consolidated statements of income.
Mortgage servicing rights (“MSRs”)
Net MSRs were $2.2 million at December 31, 2015 and 2014. MSRs are capitalized at their allocated carrying value and amortized in proportion to, and over the period of, estimated future net servicing revenue. MSRs are measured by allocating the carrying value of loans between the assets sold and interest retained, based upon the relative estimated fair value at date of sale. Impairment of MSRs is assessed based on the estimated fair value of servicing rights. Fair value is estimated using discounted cash flows of servicing revenue less servicing costs taking into consideration market estimates of prepayments as applied to underlying loan type, note rate, and term. Impairment adjustments, if any, are recorded through a valuation allowance. Fees earned for servicing mortgage loans are reported as income when the related mortgage loan payments are received.
Premises and equipment
Premises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization are computed on the straight-line method over the shorter of the estimated useful lives of the assets or terms of the leases. Estimated useful lives of the assets range predominantly as follows: 3 to 15 years for land improvements, 5 to 39 years for buildings, 3 to 5 years for computers, and 3 to 15 years for furniture, fixtures, and other equipment. Amortization of leasehold improvements is included in depreciation and amortization expense in the accompanying consolidated financial statements.
As part of an ongoing review of the valuation and amortization of premises and equipment, the Company assesses the carrying value of such assets if facts and circumstances suggest that they may be impaired. If this review indicates that the assets will not be fully recoverable, the carrying value of the Company’s premises and equipment would be reduced to its estimated fair value.
Core deposit intangibles (“CDI”)
CDI represents amounts recorded in business combinations or deposit purchase transactions related to the value of transaction-related deposits and the value of the customer relationships associated with the deposits.
The Company has CDI of $6.9 million and $7.7 million at December 31, 2015 and 2014, respectively, resulting from a business combination in 2014 and branch acquisitions in 2013.
Bank-owned life insurance (“BOLI”)
The Company has purchased BOLI to protect itself against the loss of certain key employees and directors due to death and as a source of long-term earnings to support certain employee benefit plans. At December 31, 2015 and 2014, the Company had $28.6 million and $28.3 million, respectively, of separate account BOLI and $25.9 million and $25.1 million, respectively, of general account BOLI.
The cash surrender value of the separate account BOLI is the quoted market price of the underlying securities, further supported by a stable value wrap, which mitigates, but does not fully protect, the investment against changes in the fair market value depending on the severity and duration of market price disruption. The fair value of the general account BOLI is based on the insurance contract cash surrender value. The underlying funds within the separate account structure generated positive performance during 2015, 2014, and 2013. There can be no assurance that losses in excess of the stable value wrap protection will not occur on separate account BOLI in the future.
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
Other Real Estate Owned (“OREO”)
OREO, acquired through foreclosure or deeds in lieu of foreclosure, is carried at the lower of cost or estimated net realizable value. When the property is acquired, any excess of the loan balance over the estimated net realizable value is charged to the reserve for loan losses. Holding costs, subsequent write-downs to net realizable value, if any, and any disposition gains or losses are included in non-interest expenses. The valuation of OREO is subjective in nature and may be adjusted in the future because of changes in economic conditions. The valuation of OREO is also subject to review by federal and state bank regulatory authorities who may require increases or decreases to carrying amounts based on their evaluation of the information available to them at the time of their examinations of the Bank. Management considers third-party appraisals, as well as independent fair market value assessments from realtors or persons involved in selling OREO, in determining the estimated fair value of particular properties. In addition, as certain of these third-party appraisals and independent fair market value assessments are only updated on an annual basis, changes in the values of specific properties may have occurred subsequent to the most recent appraisals. Accordingly, the amounts of any such potential changes - and any related adjustments - are generally recorded at the time such information is received. OREO valuation adjustments have been recorded on certain OREO properties. These adjustments are recorded in OREO expense in the Company’s consolidated statements of income.
OREO, net of specific property valuation allowances, was $3.3 million at both December 31, 2015 and 2014.
Advertising
Advertising costs are generally charged to expense during the year in which they are incurred. Advertising expense was $0.6 million, $0.9 million, and $1.0 million for the years ended December 31, 2015, 2014, and 2013, respectively.
Income taxes
The provision (benefit) for income taxes is based on income and expenses as reported for consolidated financial statement purposes using the “asset and liability method” for accounting for deferred taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision (benefit) for income taxes.
In estimating deferred tax assets (“DTA”), management considers whether it is more likely than not that some portion or all of the DTA will or will not be realized. The Company’s ultimate realization of the DTA is dependent upon the generation of future taxable income during the periods in which temporary differences become deductible. Management considers the nature and amount of historical and projected future taxable income, the scheduled reversal of deferred tax assets and liabilities, and available tax planning strategies in making this assessment. The amount of deferred taxes recognized could be impacted by changes to any of these variables.
At December 31, 2015, 2014 and 2013, the Company had a $0.1 million valuation allowance against its DTA due to reversal of substantially all of the Company’s DTA valuation allowance at December 31, 2012 of $41.7 million and the reversal of certain previously written-off deferred tax benefits of $8.5 million resulting from a reassessment of the Company's Internal Revenue Code (“IRC”) Section 382 limitations and other analyses.
The DTA valuation allowance was established during 2009 due to uncertainty at the time regarding the Company’s ability to generate sufficient future taxable income to fully realize the benefit of the net DTA. Based on its earnings performance trend, expected continued profitability and improvements in the Company’s financial condition; management determined it was more likely than not that our DTA would be realized.
Deferred tax assets are recognized subject to management’s judgment that realization is “more likely than not.” Uncertain tax positions that meet the more likely than not recognition threshold are measured to determine the amount of benefit to recognize. An uncertain tax position is measured at the amount of benefit that management believes has a greater than 50% likelihood of realization upon settlement. Tax benefits not meeting our realization criteria represent unrecognized tax benefits. We account for interest and penalties as a component of income tax expense.
Derivatives and Hedging Activities
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
The Company periodically enters into certain commercial loan interest rate swap agreements in order to provide commercial loan customers the ability to convert from variable to fixed interest rates. Under these agreements, the Company enters into a variable-rate loan agreement with a customer in addition to a swap agreement. This swap agreement effectively converts the customer’s variable rate loan into a fixed rate loan. The Company then enters into a corresponding swap agreement with a third party in order to offset its exposure on the fixed components of the customer agreement. As the interest rate swap agreements with the customers and third parties are not designated as hedges under the Derivatives and Hedging topic of the FASB ASC 815, the instruments are marked to market in earnings. The Company recorded non-interest income of $2.5 million, $1.8 million and $0.4 million related to swap fee income for the years ended December 31, 2015, 2014 and 2013, respectively. The offsetting fair value of the swap agreement assets and liabilities were $8.6 million at December 31, 2015 and $4.8 million as of December 31, 2014. The notional amount of open interest rate swap agreements at December 31, 2015 and December 31, 2014 was $169.7 million and $82.9 million.
Trust assets
Assets of the Bank’s trust department, other than cash on deposit at the Bank, are not included in the accompanying consolidated financial statements, because they are not assets of the Bank. Assets (unaudited) totaling approximately $57.0 million and $58.5 million were held in trust as of December 31, 2015 and 2014, respectively.
Transfers of financial assets
Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Loss contingencies
Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is deemed probable and an amount of loss can be reasonably estimated.
Cash dividend restriction
Payment of dividends by Bancorp and the Bank is subject to restriction by state and federal regulators and the availability of retained earnings (see Note 20).
Preferred stock
Bancorp may issue preferred stock in one or more series, up to a maximum of 5,000,000 shares. Each series shall include the number of shares issued, preferences, special rights, and limitations, all as determined by the Board. Preferred stock may be issued with or without voting rights, not to exceed one vote per share, except in certain circumstances and the shares of preferred stock will not vote as a separate class or series except as required by state law. At December 31, 2015 and 2014, there were no shares of preferred stock issued and outstanding.
Comprehensive income (loss)
Comprehensive income (loss) includes all changes in stockholders’ equity during a period, except those resulting from transactions with stockholders. The Company’s comprehensive income (loss) consists of net income (loss) and the changes in net unrealized increase or decrease in the fair value of investment securities available-for-sale, net of taxes.
New authoritative accounting guidance
In February 2016, the FASB issued ASU 2016-02, “Leases” (“ASU 2016-02”). ASU 2016-02 establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
practical expedients available. We are currently evaluating the impact of our pending adoption of the new standard on our consolidated financial statements.
In January 2016, the FASB issued ASU 2016-01, “Financial Instruments- Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities” (“ASU 2016-01”). ASU 2016-01 simplifies the impairment assessment of equity investments, clarifies reporting disclosure requirements for financial instruments measured at amortized cost, and requires the exit price notion be disclosed when measuring fair value of financial instruments. ASU 2016-01 details the required separate presentation in other comprehensive income for the change in fair value of a liability related to change in instrument specific credit risk and details the required separate presentation of financial assets and liabilities by measurement category, and clarifies the need for a valuation allowance on deferred tax assets related to available-for-sale securities. ASU 2016-01 is effective for annual and interim reporting periods beginning after December 15, 2017. Adoption of ASU 2016-01 is not expected to have a material impact on our consolidated financial statements.
In April 2015, the FASB issued ASU 2015-03, “Interest- Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs” (“ASU 2015-03”). ASU 2015-03 simplifies the presentation of debt issuance costs and requires that the debt issuance costs related to a recognized debt liability be presented in the balance sheet as direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance of debt issuance costs are not affected by the amendments in this update. ASU 2015-03 is effective for annual and interim reporting periods beginning after December 15, 2015. Adoption of ASU 2015-03 is not expected to have a material impact on our consolidated financial statements.
In August 2014, the FASB issued ASU 2014-14. “Receivables- Troubled Debt Structurings by Creditors (Subtopic 310-40): Classification of Certain Government-Guaranteed Mortgage Loans Upon Foreclosure” (“ASU 2014-14”). ASU 2014-14 clarifies accounting and reporting for foreclosed mortgage loans when the loan is subject to a government guarantee. The provisions require that a mortgage loan be derecognized and that a separate other receivable recognized upon foreclosure if 1) the loan has a government guarantee that is not separable from the loan before foreclosure; 2) at the time of foreclosure, the creditor has the intent to convey the real estate property to the guarantor and make claim on the guarantee, and the creditor has the ability to recover under that claim; and 3) at the time of foreclosure, any amount of the claim that is determined on the basis of the fair value of the real estate is fixed. Upon foreclosure, the separate other receivable should be measured based on the amount of the loan balance (principal and interest) expected to be recovered from the guarantor. ASU 2014-14 is effective for annual period and interim periods within those annual periods, beginning after December 15, 2014. ASU 2014-14 was adopted in 2015 and did not have a material impact on our consolidated financial statements.
In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers” (“ASU 2014-09”). ASU 2014-09 establishes a comprehensive revenue recognition standard for virtually all industries under U.S. GAAP, including those that previously followed industry-specific guidance such as the real estate, construction and software industries. The revenue standard’s core principle is built on the contract between a vendor and a customer for the provision of goods and services. It attempts to depict the exchange of rights and obligations between the parties in the pattern of revenue recognition based on the consideration to which the vendor is entitled. To accomplish this objective, the standard requires five basic steps: i) identify the contract with the customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract, and (v) recognize revenue when (or as) the entity satisfies a performance obligation. ASU 2014-09 is effective for annual and interim periods beginning after December 15, 2016 with three transition methods available - full retrospective, retrospective and cumulative effect approach. In August 2015, the FASB issued ASU 2015-14, “Revenue from Contracts with Customers: Deferral of the Effective Date” (“ASU 2015-14”). ASU 2015-14 amended the effective date to December 15, 2017. Adoption of ASU 2014-09 and ASU 2015-14 is not expected to have a material effect on our consolidated financial statements.
In January 2014, the FASB issued ASU 2014-04, “Receivables- Troubled Debt Restructurings by Creditors (subtopic 310-40): Classification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure” (“ASU 2014-04”). The provisions of ASU 2014-04 clarify that when an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either 1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or 2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through similar legal agreement. The provisions of ASU 2014-04 are effective for annual and interim reporting periods beginning on or after December 15, 2014. ASU 2014-04 was adopted by the Company in 2015 and did not have a material impact on its consolidated financial statements.
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
2. Business Combinations
Home Federal Bank (“Home”)
On May 16, 2014 (the “Home Acquisition Date”), pursuant to the Agreement and Plan of Merger, dated as of October 23, 2013 (the “Merger Agreement”), between the Company and Home, Home merged with and into Cascade with Cascade continuing as the surviving corporation (the “Merger”). Immediately after the Merger, Home Federal Bank, a wholly-owned subsidiary of Home, merged with and into Bank of the Cascades, a wholly-owned subsidiary of Cascade, with Bank of the Cascades continuing as the surviving bank. The results of Home’s operations are included in the Company’s financial results beginning on the Home Acquisition Date. The strategic rationale for Home acquisition was to enhance Company’s franchise value by improving earnings, revenue, scale and efficiency and to achieve top community bank deposit market-share in select high growth markets in Oregon and Idaho.
All of Home’s common stock was converted into the right to receive $8.43 in cash and 1.6772 shares of Cascade common stock. The conversion of Home’s common stock into Cascades common stock resulted in Cascade issuing 24,309,131 shares of its common stock.
The Merger was accounted for using the acquisition method of accounting and accordingly, assets acquired, liabilities assumed and consideration exchanged were recorded at estimated fair value on the Home Acquisition Date. Goodwill of $78.6 million was calculated as the purchase premium after adjusting for the fair value of net assets acquired and represents the value expected from the synergies created from combining the two banking organizations as well as the economies of scale expected from combining the operations of the two companies. None of the goodwill is deductible for income tax purposes as the Merger is accounted for as a tax-free exchange.
In most instances, determining the fair value of the acquired assets and assumed liabilities required us to estimate cash flows expected to result from those assets and liabilities and to discount those cash flows at appropriate rates of interest. The most significant of those determinations relates to the valuation of acquired loans. For such loans, the excess of cash flows expected at acquisition over the estimated fair value is recognized as interest income over the remaining lives of the loans. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition reflects the impact of estimated credit losses and other factors, such as prepayments. In accordance with the applicable accounting guidance for business combinations, there was no carry-over of Home’s previously established reserve for loan losses.
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
The following table provides a summary of the purchase price calculation as of the Home Acquisition Date and the identifiable assets purchased and the liabilities assumed at their estimated fair values.
Merger related charges of $11.6 million were recorded in the consolidated statement of comprehensive income for the year to date December 31, 2014. Such expenses were primarily related to professional and legal services, equipment and property maintenance, and information system charges incurred in connection with the acquisition.
The following table provides the unaudited pro forma information for the results of operations for the year to date periods ended December 31, 2014 and 2013, as if the acquisition had occurred on January 1, 2013. These adjustments reflect the impact of certain purchase accounting fair value measurements, primarily comprised of Home’s loan, investment and deposit portfolios. In addition, merger-related expenses and certain change in control costs incurred in 2014 have been excluded from the pro forma December 31, 2014 results and included in the pro forma results for December 31, 2013. These unaudited pro forma results are presented for illustrative purposes only and are not intended to represent or be indicative of the actual results of operations of the combined banking organization that would have been achieved had the Merger occurred on January 1, 2013, nor are they intended to represent or be indicative of future results of operations.
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
AmericanWest Bank (“AWB”) Branch Acquisition
On October 18, 2013, the Bank received required regulatory approval and completed its previously announced purchase of AWB’s Klamath Falls, Oregon branch and the assumption of customer relationships, including deposits and selected loans of AWB’s Bend and Redmond, Oregon branch offices. In total, the Bank acquired approximately $25.5 million of deposits, paying a deposit premium of 2.00% of the balance of core in-market deposits assumed, and approximately $1.6 million of performing loans for a cash purchase price of $2.8 million. The primary purpose of the acquisition was to expand the Company’s market share in the Central Oregon region.
The following is a condensed balance sheet disclosing the estimated fair value amounts of the acquired branches of AWB assigned to the major consolidated asset and liability captions at the acquisition date (dollars in thousands):
The core deposit intangible asset recognized as part of the business combination will be amortized over its estimated useful life of approximately 10 years.
The fair value of deposit accounts acquired from AWB was assumed to approximate the carrying value as these accounts have no stated maturity and are payable on demand. Certificates of deposit were valued by comparing the contractual cost of the portfolio to a similar portfolio bearing current market rates.
Direct costs related to the AWB acquisition were expensed as incurred in the year ended December 31, 2013. These acquisition and integration expenses included technology and communications, occupancy and equipment, professional services and other noninterest expenses. For the year ended December 31, 2013, the Company incurred $0.2 million of expenses related to the AWB acquisition costs.
3. Cash and due from banks
By regulation, the Bank must meet reserve requirements as established by the FRB ($21.9 million and $16.8 million at December 31, 2015 and 2014, respectively). Accordingly, the Bank complies with such requirements by holding cash on hand and maintaining average reserve balances on deposit with the FRB in accordance with such regulations.
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
4. Investment securities
Investment securities at December 31, 2015 and 2014 consisted of the following (dollars in thousands):
* U.S. Agency MBS included private label MBS of approximately $7.8 million and $9.3 million at December 31, 2015 and 2014, respectively, which are supported by FHA/VA collateral.
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
The following table presents the fair value and gross unrealized losses of the Bank’s investment securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2015 and 2014 (dollars in thousands):
The unrealized losses on investments in U.S. Agency and non-agency MBS and U.S. Agency asset-backed securities are primarily due to elevated yield/rate spreads at December 31, 2015 and 2014 as compared to yield/rate relationships prevailing at the time specific investment securities were purchased. Management expects the fair value of these investment securities to recover as market volatility lessens and/or as securities approach their maturity dates. Accordingly, management does not believe that the above gross unrealized losses on investment securities are other-than-temporary. No impairment adjustments have been recorded for the years ended December 31, 2015, 2014 and 2013.
Management intends to hold the investment securities classified as held-to-maturity until they mature, at which time the Company will receive full amortized cost value for such investment securities. Furthermore, as of December 31, 2015, management did not have the intent to sell any of the securities classified as available-for-sale in the table above and believes that it is more likely than not that the Company will not have to sell any such securities before a recovery of cost.
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
The amortized cost and estimated fair value of investment securities at December 31, 2015, by contractual maturity, are shown below (dollars in thousands). Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Investment securities with an estimated fair value of approximately $118.0 million and $187.3 million at December 31, 2015 and 2014, respectively, were pledged or in the process of being pledged, to secure various borrowings and for other purposes as required or permitted by law.
The Company sold $30.0 million, $63.5 million and $0.4 million of investment securities during the years ended December 31, 2015, 2014 and 2013, respectively.
5. Loans and reserve for credit losses
Loans receivable at December 31, 2015 and 2014 consisted of the following (dollars in thousands):
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
The following describes the distinction between originated and acquired loan portfolios and certain significant accounting policies relevant to each of these portfolios.
Originated loans
Loans originated for investment are stated at their principal amount outstanding, net of any premium or discount, adjusted for partial charge-offs, the reserve for loan losses and net deferred loan fees and costs. Interest income on loans is accrued over the term of the loans. Interest is not accrued on loans where collectability is uncertain. Accrued interest on loans is presented in "Other assets" on the consolidated balance sheets. Loan origination fees and certain direct costs incurred to extend credit are deferred and amortized over the term of the loan as an adjustment to the related loan yield.
Approximately 72.3% of the Bank’s originated loan portfolio at December 31, 2015 consisted of real estate-related loans including construction and development loans, residential mortgage loans, and commercial loans secured by commercial real estate. At December 31, 2015, approximately 74.9% of the Bank’s total portfolio (inclusive of acquired loans) consisted of real estate-related loans as described above. The Bank’s results of operations and financial condition are affected by general economic trends and in particular, the strength of the local residential and commercial real estate markets in Central, Southern and Northwest Oregon and the greater Boise/Treasure Valley, Idaho and Seattle, Washington areas. Real estate values could be affected by, among other things, a worsening of national and local economic conditions, an increase in foreclosures, a decline in home sale volumes, and an increase in interest rates. Furthermore, the Bank may experience an increase in the number of borrowers who become delinquent, file for protection under bankruptcy laws, or default on their loans or other obligations to the Bank in the event of a sustained downturn in business and economic conditions generally or specifically in the principal markets in which the Bank does business. An increase in the number of delinquencies, bankruptcies, or defaults could result in a higher level of non-performing assets, net charge-offs, and loan loss provision. Management is targeting to reduce commercial real estate (“CRE”) concentration over the long term, but real estate-related loans will remain a significant portfolio component due to the nature of the economies, businesses, and markets we serve.
The Company originates Commercial and Industrial (“C&I”) loans mainly to businesses in its footprint. Repayment of such loans is dependent upon future cash flows of the obligor businesses that are subject to various industry sector risk. In addition, the Company has purchased C&I participations typically referred to as Shared National Credits (“SNCs”). The SNC portfolio strategy is intended to diversify the Company’s credit risk profile geographically and by industry. Additionally, such loans enhance the Company’s interest rate risk profile as they float with LIBOR rates. C&I loans are subject the the variety of credit risks described above but they are not directly secured by real estate.
In the normal course of business, the Bank may buy or participate portions of loans to third parties in order to extend the Bank’s lending capability or to mitigate risk. At December 31, 2015 and 2014, the portion of loans participated to third-parties (which are not included in the accompanying consolidated balance sheets) totaled $44.2 million and $34.5 million, respectively.
Acquired loans
Acquired loans are those purchased in the Home acquisition (See Note 2 - “Business Combinations” for further information). These loans were recorded at estimated fair value at the Home Acquisition Date. The fair value estimates for acquired loans is based on expected prepayments, charge offs and the amount and timing of undiscounted expected principal, interest and other cash flows. The net fair value adjustment to the acquired loans was a reduction of $6.0 million, representing a valuation adjustment for interest rate and credit which will be accreted over the life of the loans (approximately 10 years).
Of the loans acquired on the Home Acquisition Date and still held at December 31, 2015, $13.7 million or 5.8% were graded substandard. With the amount of classified loans acquired being nominal, all loans acquired are treated in a manner consistent with originated loans for credit risk management and accounting purposes.
As of December 31, 2015, $29.8 million, or 12.7%, of the $235.0 million in acquired loans were covered under loss sharing agreements with the FDIC. The agreements were entered into in September 2009 and September 2010 between the FDIC and Home. The loss sharing agreements have limited terms (10 years for net losses on single-family residential real estate loans, as defined by the FDIC, five years for losses on non-residential real estate loans, as defined by the FDIC, and an additional three years with respect to recoveries on non-residential real estate loans). After the expiration of the loss sharing agreements in September 2014 and 2015, the Company is no longer indemnified for losses and related expenses on covered assets and the risk-based capital ratios have been reduced. While the agreements are in place, the covered assets received a 20% risk-weighting. After the agreements expire, the risk-weighting for previously covered assets most likely increases to 100%, based on current regulatory capital definitions. Nearly all of the assets remaining in the covered asset portfolios are non-single family covered assets. Therefore, most of the covered assets were no longer indemnified after September 2014 or September 2015. With the
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
amount of loans covered under these agreements being nominal, amounts that may be due to or due from the FDIC under loss sharing agreements will be accounted for on a cash basis.
A net loss share payable was recorded at the Home Acquisition Date which represents the estimated value of reimbursement the Company expects to pay to the FDIC for recoveries net of incurred losses on covered loans. These expected reimbursements were recorded as part of covered loans in conjunction with the Home acquisition accounting. Upon the determination of an incurred loss or recovery, the loss share receivable/payable is changed by the amount due to or due from the FDIC.
Changes in the loss share payable (receivable) associated with covered loans for the year ended December 31, 2015 were as follows (dollars in thousands):
Reserve for loan losses
The reserve for loan losses represents management’s estimate of known and inherent losses in the loan portfolio as of the consolidated balance sheet date and is recorded as a reduction to loans. The reserve for loan losses is increased by charges to operating expense through the loan loss provision, and decreased by loans charged-off, net of recoveries. The reserve for loan losses requires complex subjective judgments as a result of the need to make estimates about matters that are uncertain. The reserve for loan losses is maintained at a level currently considered adequate to provide for potential loan losses based on management’s assessment of various factors affecting the loan portfolio.
However, the reserve for loan losses is based on estimates and actual losses may vary from the current estimates. These estimates are reviewed periodically, and, as adjustments become necessary, they are reported in earnings in the periods in which they become known. Therefore, management cannot provide assurance that, in any particular period, the Company will not have significant losses in relation to the amount reserved. The level of the reserve for loan losses is also determined after consideration of bank regulatory guidance and recommendations and is subject to review by such regulatory authorities who may require increases or decreases to the reserve based on their evaluation of the information available to them at the time of their examinations of the Bank.
For purposes of assessing the appropriate level of the reserve for loan losses, the Company analyzes loans and commitments to loan, and the amount of reserves allocated to loans and commitments to loan in each of the following reserve categories: pooled reserves, specifically identified reserves for impaired loans, and the unallocated reserve. Also, for purposes of analyzing loan portfolio credit quality and determining the appropriate level of reserve for loan losses, the Company identifies loan portfolio segments and classes based on the nature of the underlying loan collateral.
The increase in the reserve for loan losses from December 31, 2014 to December 31, 2015 was related to recoveries during the period. The unallocated reserve for loan losses at December 31, 2015 has decreased by $2.8 million from the balance at December 31, 2014. The Company has determined the level of unallocated reserve is appropriate based upon the lack of seasoning with respect to its methodology enhancements, including qualitative adjustments with respect to concentration risk and estimating reserves against certain loan pools and industries as opposed to reserving on a loan by loan basis for such loans. In addition, the unallocated reflects the lack of seasoning as to credit quality performance of its recently acquired Home and SNCs portfolios. Management believes that the amount of unallocated reserve for loan losses is appropriate and will continue to evaluate the amount going forward.
Acquired reserve for loan losses
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
The fair value estimates for acquired loans are based on expected prepayments, charge offs, and the amount and timing of undiscounted expected principal, interest and other cash flows. The net fair value adjustment to the acquired loans was $6.0 million, representing a valuation adjustment for interest rate and credit quality. The credit component of the fair value adjustment not accreted at any point in time represents the estimated reserve for loan losses for acquired loans. If the Company determines that this amount is insufficient a provision to the reserve for loan losses will be made.
Transactions and allocations in the reserve for loan losses and unfunded loan commitments, by portfolio segment, for the years ended December 31, 2015, 2014 and 2013 were as follows (dollars in thousands):
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
An individual loan is impaired when, based on current information and events, management believes that it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement. The following table presents the reserve for loan losses and the recorded investment in loans by portfolio segment and impairment evaluation method at December 31, 2015 and 2014 (dollars in thousands). As the acquired loan portfolio is covered by the valuation adjustment taken at the time of acquisition and as the original mark continues to be more than sufficient, impaired acquired loans are excluded from the individually evaluated for impairment amounts below.
The Company uses credit risk ratings, which reflect the Bank’s assessment of a loan’s risk or loss potential, for purposes of assessing the appropriate level of reserve for loan losses. The Bank’s credit risk rating definitions along with applicable borrower characteristics for each credit risk rating are as follows:
Acceptable
The borrower is a reasonable credit risk and demonstrates the ability to repay the loan from normal business operations. Loans are generally made to companies operating in an economy and/or industry that is generally sound. The borrower tends to operate in regional or local markets and has achieved sufficient revenues for the business to be financially viable. The borrowers financial performance has been consistent in normal economic times and has been average or better than average for its industry.
A loan can also be considered Acceptable even though the borrower may have some vulnerability to downturns in the economy due to marginally satisfactory working capital and debt service cushion. Availability of alternate financing sources may be limited or nonexistent. In some cases, the borrower’s management, may have limited depth or continuity but is still considered capable. An adequate primary source of repayment is identified while secondary sources may be illiquid, more speculative, less readily identified, or reliant upon collateral liquidation. Loan agreements will be well-defined, including several financial performance covenants and detailed operating covenants. This category also includes commercial loans to individuals with average or better than average capacity to repay.
Pass-Watch
Loans are graded Pass-Watch when temporary situations increase the level of the Bank’s risk associated with the loan, and remain graded Pass-Watch until the situation has been corrected. These situations may involve one or more weaknesses in cash flow, collateral value or indebtedness that could, if not corrected within a reasonable period of time, jeopardize the full repayment of the debt. In general, loans in this category remain adequately protected by the borrower’s net worth and paying capacity, or pledged collateral.
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
Special Mention
A Special Mention credit has potential weaknesses that may, if not checked or corrected, weaken the loan or leave the Bank inadequately protected at some future date. Loans in this category are deemed by management of the Bank to be currently protected but reflect potential problems that warrant more than the usual management attention but do not justify a Substandard classification.
Substandard
Substandard loans are those inadequately protected by the net worth and paying capacity of the obligor and/or by the value of the pledged collateral, if any. Substandard loans have a high probability of payment default or they have other well-defined weaknesses. They require more intensive supervision and borrowers are generally characterized by current or expected unprofitable operations, inadequate debt service coverage, inadequate liquidity, or marginal capitalization. Repayment may depend on collateral or other credit risk mitigants.
CRE and construction loans are classified Substandard when well-defined weaknesses are present which jeopardize the orderly liquidation of the loan. Well-defined weaknesses include a project’s lack of marketability, inadequate cash flow or collateral support, failure to complete construction on time, and/or the project’s failure to fulfill economic expectations. These loans are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.
In addition, Substandard loans also include impaired loans. Impaired loans bear the characteristics of Substandard loans as described above, and the Company has determined it does not expect timely payment of all contractually due interest and principal. Impaired loans may be adequately secured by collateral.
During the year ended December 31, 2015 the Bank reduced loans classified as special mention and substandard in the originated portfolio by $20.4 million, while total loans classified as special mention and substandard decreased $17.9 million. Remediation on the originated portfolio was accomplished through credit upgrades mainly owing to improved obligor cash flows as well as payoffs/paydowns, and/or sales. Work began on the acquired loan portfolio at the Home Acquisition Date.
The following table presents, by portfolio class, the recorded investment in loans by internally assigned grades at December 31, 2015 and 2014 (dollars in thousands):
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
The following table presents, by portfolio class, an age analysis of past due loans, including loans placed on non-accrual at December 31, 2015 and 2014 (dollars in thousands):
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
Loans contractually past due 90 days or more on which the Company continued to accrue interest were $0.1 million at both December 31, 2015 and 2014.
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
The following table presents information related to impaired loans, by portfolio class, at December 31, 2015 and 2014 (dollars in thousands):
At December 31, 2015 and 2014, the total recorded balance of impaired loans in the above table included $0.8 million and $22.8 million, respectively, of troubled debt restructuring (“TDR”) loans which were not on non-accrual status.
The following table presents, by portfolio class, the average recorded investment in impaired loans for the years ended December 31, 2015, 2014 and 2013 (dollars in thousands):
Interest income recognized for cash payments received on impaired loans for the year ended December 31, 2015 was $0.6 million and for years ended December 31, 2014 and 2013 was insignificant.
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
Information with respect to the Company’s non-accrual loans, by portfolio class, at December 31, 2015 and 2014 is as follows (dollars in thousands):
TDRs
The Company allocated no specific reserves to customers whose loan terms have been modified in TDRs as of December 31, 2015 and $0.1 million as of December 31, 2014. TDRs involve the restructuring of terms to allow customers to mitigate the risk of foreclosure by meeting a lower loan payment requirement based upon their current cash flow. As indicated above, TDRs may also include loans to borrowers experiencing financial distress that renewed at existing contractual rates, but below market rates for comparable credit quality. The Company has been actively utilizing these programs and working with its customers to improve obligor cash flow and related prospect for repayment. Concessions may include, but are not limited to, interest rate reductions, principal forgiveness, deferral of interest payments, extension of the maturity date, and other actions intended to minimize potential losses to the Company. For each commercial loan restructuring, a comprehensive credit underwriting analysis of the borrower’s financial condition and prospects of repayment under the revised terms is performed to assess whether the new structure can be successful and whether cash flows will be sufficient to support the restructured debt. Generally, if the loan is on accrual at the time of restructuring, it will remain on accrual after the restructuring. After six consecutive payments under the restructured terms, a nonaccrual restructured loan is reviewed for possible upgrade to accrual status.
Typically, once a loan is identified as a TDR it will retain that designation until it is paid off, because restructured loans generally are not at market rates following restructuring. Under certain circumstances a TDR may be removed from TDR status if it is determined to no longer be impaired and the loan is at a competitive interest rate. Under such circumstances, allowance allocations for loans removed from TDR status would be based on the historical allocation for the applicable loan grade and loan class. Consistent with accounting principles, acquired loans previously identified by Home as TDRs were marked to fair value at the acquisition date and accordingly are not included as TDRs on the Company’s books.
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
The following table presents, by portfolio segment, information with respect to the Company’s loans that were modified and recorded as TDRs during the years ended December 31, 2015, 2014 and 2013 (dollars in thousands):
There were no loans modified and recorded as TDRs during the year ended December 31, 2014. There was no change in the pre- and post-TDR outstanding recorded investment for loans restructured during the years ended December 31, 2015, 2014 and 2013. The increase in the outstanding recorded investment of loans modified and recorded as TDRs during the year ended December 31, 2013 was primarily the result of remediation to bolster cash flow of stressed loans, and includes the restructuring of a large CRE credit in the Bank’s loan portfolio during the first quarter of 2013.
At December 31, 2015 and 2014, the Company had no remaining commitments to lend on loans accounted for as TDRs.
The following table presents, by portfolio segment, the post modification recorded investment for TDRs restructured during the years ended December 31, 2015 and 2013 and by the primary type of concession granted (dollars in thousands). There were no restructured TDRs in 2014.
The following table presents, by portfolio segment, the TDRs which had payment defaults during the years ended December 31, 2013 that had been previously restructured within the last twelve months prior to December 31, 2013 (dollars in thousands). There were no TDRs which had payment defaults during the year ended December 31, 2015 and 2014 that had been previously restructured within the last twelve months prior to December 31, 2015 and 2014.
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
6. Mortgage banking activities
Net MSRs, as included in Other Assets, at December 31, 2015 and 2014 were $2.2 million. Transactions in the Company’s MSRs for the years ended December 31, 2015 and 2014 were as follows (dollars in thousands).
Mortgage banking income, net, consisted of the following for the periods shown (dollars in thousands):
7. Premises and equipment
Premises and equipment at December 31, 2015 and 2014 consisted of the following (dollars in thousands):
8. Other real estate owned (“OREO”), net
Transactions in the Company’s OREO for the years ended December 31, 2015, 2014 and 2013 were as follows (dollars in thousands):
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
The following table summarizes activity in the OREO valuation allowance for the years ended December 31, 2015, 2014 and 2013 (dollars in thousands):
The following table summarizes OREO expenses for the years ended December 31, 2015, 2014 and 2013 (dollars in thousands):
9. Goodwill and other intangibles assets
As presented in Note 2, the Company recorded $78.6 million of goodwill in connection with the acquisition of Home in 2014. The change in goodwill in 2015 relates to acquisition accounting adjustments. In accordance with the Intangibles - Goodwill and Other topic of the FASB ASC, goodwill is not amortized but is reviewed for potential impairment at the reporting unit level. Management analyzes its goodwill for impairment on an annual basis and between annual tests in certain circumstances, such as upon material adverse changes in legal, business, regulatory and economic factors. An impairment loss is recorded to the extent that the carrying amount of goodwill exceeds its implied fair value. The Company performed an impairment assessment as of December 31, 2015 and 2014 and concluded that there was no impairment to goodwill.
Core deposit intangibles (“CDI”) are evaluated for impairment on an annual basis and between annuals tests if events and circumstances indicate a possible impairment. The CDI is amortized on a straight-line basis over an estimated life of 10 years. The following table sets forth activity for CDI for the years ended December 31, 2015 and 2014 (dollars in thousands). The Company had $0.5 million recorded CDI and no amortization expense during 2013.
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
The following table provides the estimated future amortization expense of CDI for the succeeding five years (dollars in thousands):
10. Derivatives
Derivative instruments are contracts between two or more parties that have a notional amount and an underlying variable, require no net investment and allow for the net settlement of positions. The notional amount serves as the basis for the payment provision of the contract and takes the form of units, such as shares or dollars. The underlying variable represents a specified interest rate, index, or other component. The interaction between the notional amount and the underlying variable determines the number of units to be exchanged between the parties and influences the market value of the derivative contract. The Company obtains dealer quotations to value its derivative contracts.
The Company periodically enters into certain commercial loan interest rate swap agreements in order to provide commercial loan customers the ability to convert from variable to fixed interest rates. Under these agreements, the Company provides the customer with a variable rate loan and enters into an interest rate swap in which the customer receives a variable rate payment in exchange for a fixed rate payment. The Company offsets its risk exposure by entering into an offsetting interest rate swap with a dealer counterparty for the same notional amount and length of term as the customer interest rate swap providing the dealer counterparty with a fixed rate payment in exchange for a variable rate payment. Generally, these instruments help the Company manage exposure to market risk and meet customer financing needs. Market risk represents the possibility that economic value or net interest income will be adversely affected by fluctuations in external factors such as market-driven interest rates and prices or other economic factors.
The Company is exposed to credit-related losses in the event of nonperformance by the counterparty to these agreements. Credit risk of the financial contract is controlled through the credit approval, limits, and monitoring procedures and management does not expect the counterparties to fail their obligations.
In connection with the interest rate swaps between the Company and the dealer counterparties, the agreements contain a provision where if the Company fails to maintain its status as a well-capitalized institution, then the counterparty could terminate the derivative positions and the Company would be required to settle its obligations. Similarly, the Company could be required to settle its obligations under certain of its agreements if certain credit ratings fall below specified standards or if specific regulatory events occur, such as a publicly issued memorandum of understanding, cease and desist order, or a termination of insurance coverage by the FDIC.
As of December 31, 2015 and 2014, the notional values or contractual amounts and fair values of the Company’s derivatives not designated in hedge relationships were as follows (dollars in thousands).
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
Swap fee income, as included in noninterest income, was $2.5 million, $1.8 million and $0.4 million for the years ended December 31, 2015, 2014 and 2013, respectively.
The Company generally posts collateral against derivative liabilities in the form of cash. Collateral posted against derivative liabilities was $8.6 million and $4.6 million as of December 31, 2015 and 2014, respectively.
Derivative assets and liabilities are recorded at fair value on the balance sheet and do not take into account the effects of master netting agreements. Master netting agreements allow the Company to settle all derivative contracts held with a single counterparty on a net basis and to offset net derivative position with related collateral where applicable.
The following table illustrates the potential effect of the Company’s derivative master netting arrangements, by type of financial instrument, on the Company’s balance sheet as of December 31, 2015 and 2014(dollars in thousands):
11. Time deposits
Time deposits in amounts of $250 thousand or more aggregated to approximately $32.5 million and $45.2 million at December 31, 2015 and 2014, respectively.
At December 31, 2015, the scheduled annual maturities of all time deposits were approximately as follows (dollars in thousands):
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
At December 31, 2015 and 2014, the Bank had no wholesale brokered deposits.
12. Other borrowings
The Bank is a member of the FHLB Des Moines. As a member, the Bank has a committed borrowing line of credit up to 35% of total assets, subject to the Bank pledging sufficient collateral and maintaining the required investment in FHLB stock. At December 31, 2015 and 2014, the Bank had no outstanding borrowings under the committed lines of credit. In June 2013, the Bank elected to prepay $60.0 million in FHLB advances bearing a weighted average interest rate of 3.17% to save in interest expense going forward. As a result of such early prepayments, the Company incurred prepayment penalties of $3.8 million. All outstanding borrowings and letters of credit with the FHLB are collateralized by a blanket pledge agreement on the Bank’s FHLB stock, any funds on deposit with the FHLB, certain investment securities, and certain loans. At December 31, 2015, the Bank had available borrowings with the FHLB of approximately $491.2 million, based on eligible collateral. There can be no assurance that future advances will be allowed by the FHLB.
At December 31, 2015, the Bank had no borrowings outstanding with the FRB and had approximately $16.4 million in available short-term borrowings at FRB, collateralized by certain of the Bank’s loans and securities.
As an additional source of liquidity, the Bank has federal fund borrowing agreements with correspondent banks aggregating approximately $110.0 million at December 31, 2015. At December 31, 2015, the Company had no outstanding borrowings under these federal fund borrowing agreements.
13. Commitments, guarantees and contingencies
Off-balance sheet financial instruments
In the ordinary course of business, the Bank is a party to financial instruments with off-balance sheet risk to meet the financing needs of its customers. These financial instruments include commitments to extend credit, commitments under credit card lines of credit, and standby letters of credit. These financial instruments involve, to varying degrees, elements of credit and interest-rate risk in excess of amounts recognized in the accompanying consolidated balance sheets. The contractual amounts of these financial instruments reflect the extent of the Bank’s involvement in these particular classes of financial instruments. As of December 31, 2015 and 2014, the Bank had no material commitments to extend credit at below-market interest rates.
The Bank’s exposure to credit loss for commitments to extend credit, commitments under credit card lines of credit, and standby letters of credit is represented by the contractual amount of these instruments. The Bank follows the same credit policies in underwriting and offering commitments and conditional obligations as it does for on-balance sheet financial instruments.
A summary of the Bank’s off-balance sheet financial instruments which are used to meet the financing needs of its customers is approximately as follows at December 31, 2015 and 2014 (dollars in thousands):
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
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 the payment of fees. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank applies established credit related standards and underwriting practices in evaluating the creditworthiness of such obligors. The amount of collateral obtained, if it is deemed necessary by the Bank upon the extension of credit, is based on management’s credit evaluation of the counterparty. The increase in commitments between 2014 and 2015 mainly reflect higher residential and commercial construction and C&I lending commitments.
The Bank typically does not obtain collateral related to credit card commitments. Collateral held for other commitments varies but may include accounts receivable, inventory, property and equipment, residential real estate, and income-producing commercial properties.
Standby letters of credit are written conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. These guarantees are primarily issued to support public and private borrowing arrangements. In the event that the customer does not perform in accordance with the terms of the agreement with the third-party, the Bank would be required to fund the commitment. The maximum potential amount of future payments the Bank could be required to make is represented by the contractual amount of the commitment. If the commitment was funded, the Bank would be entitled to seek recovery from the customer. The Bank’s policies generally require that standby letter of credit arrangements contain security and debt covenants similar to those involved in extending loans to customers. The credit risk involved in issuing standby letters of credit is essentially the same as that involved in extending loan facilities to customers.
The Bank considers the fees collected in connection with the issuance of standby letters of credit to be representative of the fair value of its obligations undertaken in issuing the guarantees. In accordance with GAAP related to guarantees, the Bank defers fees collected in connection with the issuance of standby letters of credit. The fees are then recognized in income proportionately over the life of the related standby letter of credit agreement. At December 31, 2015 and 2014, the Bank’s deferred standby letter of credit fees, which represent the fair value of the Bank’s potential obligations under the standby letter of credit guarantees, were insignificant to the accompanying consolidated financial statements.
Lease commitments
The Bank leases certain land and facilities under operating leases, some of which include renewal options and escalation clauses. At December 31, 2015, the aggregate minimum rental commitments under operating leases that have initial or remaining non-cancelable lease terms in excess of one year were approximately as follows (dollars in thousands):
Total rental expense was approximately $2.3 million in 2015, $3.0 million in 2014, and $2.1 million in 2013. The increase in rental expense in 2014 was primarily related to additional leased properties obtained during the Home acquisition.
Litigation
The Company is subject to legal proceedings, claims, and litigation arising in the ordinary course of business. While the outcome of these matters is currently not determinable, management does not expect that the ultimate costs to resolve these matters will have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows as of and for the year ended December 31, 2015.
Other
The Bank is a public depository and, accordingly, accepts deposit funds belonging to, or held for the benefit of, the state of Oregon, political subdivisions thereof, municipal corporations, and other public funds. In accordance with applicable state law,
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
in the event of default of one bank, all participating banks in the state collectively assure that no loss of funds is suffered by any public depositor. Generally, in the event of default by a public depository and to the extent sufficient collateral is unavailable to repay public funds, the assessment applicable to all public depositories is allocated on a pro rata basis in proportion to the maximum liability of each public depository as it existed on the date of loss. The Bank has pledged letters of credit issued by the FHLB which collateralizes public deposits not otherwise insured by the FDIC. At December 31, 2015, there was no liability associated with the Bank’s participation in this pool because all participating banks are presently required to fully collateralize uninsured Oregon public deposits, and there were no occurrences of an actual loss on Oregon public deposits at such participating banks. The maximum future contingent liability is dependent upon the occurrence of an actual loss, the amount of such loss, the failure of collateral to cover such a loss, and the resulting share of loss to be assessed to the Company.
The Company has entered into employment contracts and benefit plans with certain executive officers and members of the Board that allow for payments (or accelerated payments) contingent upon a change in control of the Company.
14. Income taxes
The approximate benefit (provision) for income taxes for the years ended December 31, 2015, 2014, and 2013 was as follows (dollars in thousands):
The benefit (provision) for income taxes results in effective tax rates which are different than the federal income tax statutory rate. A reconciliation of the differences for the years ended December 31, 2015, 2014, and 2013 is as follows (dollars in thousands):
The income tax provision in 2015 represents a 37.8% effective tax rate on the Company’s $33.1 million of pretax income. This rate differs from statutory rates due primarily to a revaluation of net deferred tax assets, mainly related to an anticipated change in our applicable state rate at the time the net DTA will be utilized, less additional tax effect of nontaxable income arising from bank-owned life insurance and municipal securities. Other differences to the effective tax rate were related to normal recurring permanent differences and tax credits.
The significant components of the net deferred tax assets and liabilities at December 31, 2015 and 2014 were as follows (dollars in thousands):
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
The Company recorded an income tax provision of $12.5 million and $0.2 million in 2015 and 2014, respectively, and an income tax benefit of $50.1 million in 2013. The significant income tax benefit in 2013 resulted primarily from reversing substantially all of the Company’s DTA valuation allowance at June 30, 2013 of $41.6 million and the reversal of certain previously written-off deferred tax benefits of $8.5 million resulting from the reassessment of the Company’s Internal Revenue Code (“IRC”) Section 382 limitations and other related analyses.
At December 31, 2015, the Company had deferred tax assets of $22.1 million and $6.0 million for federal and state net operating loss (“NOL”) carry-forwards, respectively. Also, the Company had deferred tax assets of $0, $2.3 million and $0.2 million for charitable contribution carry-forwards, federal and state tax credits, respectively. At December 31, 2014, the Company had deferred tax assets of $32.1 million and $6.6 million relating to federal and state NOL carry-forwards, respectively. Also, the Company had $0.8 million, $1.3 million and $0.1 million relating to charitable contribution carry-forwards, federal and state tax credits, respectively.
At December 31, 2015, the deferred tax assets above correspond to federal and state NOL carry forwards available of $63.0 million and $119.4 million, respectively. The NOLs are available to offset future taxable income through 2034. Also, at December 31, 2015, the Company had charitable contributions carry-forwards of $0.1 million, which will expire in 2018, and federal and state credits of $2.3 million and $0.2 million, respectively, which will expire between 2017 and 2035.
In estimating DTA, management considers whether it is more likely than not that some portion or all of the DTA will or will not be realized. The Company’s ultimate realization of the DTA is dependent upon the generation of future taxable income during the periods in which temporary differences become deductible. Management considers the nature and amount of historical and projected future taxable income, the scheduled reversal of deferred tax assets and liabilities, and available tax planning strategies in making this assessment. The amount of deferred taxes recognized could be impacted by changes to any of these variables.
The valuation allowance for deferred tax assets as of December 31, 2015 and 2014 was $0.1 million. The DTA valuation allowance relates to state attributes that will expire without benefit.
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
In 2009, a valuation allowance was established due to uncertainty at the time regarding the Company’s ability to generate sufficient future taxable income to fully realize the benefit of the net DTA. Due to cumulative losses incurred by the Company in years prior to 2012 and other relevant considerations, the Company was unable to conclude that it was more likely than not that it will realize its net deferred tax asset and, accordingly, maintained a valuation allowance to fully offset its deferred tax asset at December 31, 2012 and 2011.
During 2013, the Company reversed substantially all of its existing valuation allowance due to management’s determination that it was more likely than not that the Company’s deferred tax asset would be realized. The determination resulted from consideration of both the positive and negative evidence available that can be objectively verified.
Management completed its assessment of the Internal Revenue Code Section 382 limitations, resulting from the capital raise conducted by the Company in January 2011 in which it raised $177.0 million, and from the merger with Home in May 2014. As broadly defined in Section 382, both the issuance of common stock in connection with the capital raise as well as the merger resulted in an “ownership change” of the Company. The NOL carry-forwards and tax credits at December 31, 2014 are expected to be utilized over the statutory carry-forward period.
The Company files a U.S. federal income tax return, state income tax returns in Idaho, Oregon, and other state and local income tax returns in various jurisdictions. As of December 31, 2015, our federal tax returns for 2011 and earlier and our state tax returns for 2010 and earlier were no longer subject to examination by the taxing authorities. However, our tax attribute carry-forwards from closed tax years may be subject to examination to the extent utilized in an open tax year.
The Company has evaluated its income tax positions as of December 31, 2015 and 2014. Based on this evaluation, the Company has determined that it does not have any uncertain income tax positions for which an unrecognized tax liability should be recorded. The Company recognizes interest and penalties related to income tax matters as additional income taxes in the consolidated statements of income. The Company had no significant interest or penalties related to income tax matters during the years ended December 31, 2015, 2014 or 2013.
15. Basic and diluted net income per common share
The Company’s basic net income per common share is computed by dividing net income by the weighted-average number of common shares outstanding during the period. The Company’s diluted net income per common share is computed by dividing net income by the weighted-average number of common shares outstanding plus any incremental shares arising from the dilutive effect of stock-based compensation.
The numerators and denominators used in computing basic and diluted net income per common share for the years ended December 31, 2015, 2014 and 2013 can be reconciled as follows (dollars in thousands, except per share data):
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
16. Transactions with related parties
Certain officers and directors (and the companies with which they are associated) are customers of, and have had banking transactions with, the Bank in the ordinary course of the Bank’s business. In addition, the Bank expects to continue to have such banking transactions in the future. All loans and commitments to loan to such parties are generally made on the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons. In the opinion of management, these transactions do not involve more than the normal risk of collectability or present any other unfavorable features.
An analysis of activity with respect to loans to officers and directors of the Bank for the years ended December 31, 2015 and 2014 was approximately as follows (dollars in thousands):
Some officers and directors of the Bank also have credit card lines. The total outstanding balance of their credit cards at December 31, 2015 and 2014 was $0.03 million and $0.01 million, respectively while the total outstanding commitments on these cards were $0.1 million.
17. Benefit plans
401(k) profit sharing plan
The Company maintains a 401(k) profit sharing plan (the “Plan”) that covers substantially all full-time employees. Employees may make voluntary tax-deferred contributions to the Plan, and the Company’s contributions to the Plan are at the discretion of the Board, not to exceed the amount deductible for federal income tax purposes.
Employees vest in the Company’s contributions to the Plan over a period of 5 years. The total amounts charged to operations under the Plan were approximately $0.9 million, $0.7 million and $0.5 million for the years ended December 31, 2015, 2014 and 2013, respectively.
Other benefit plans
The Bank has deferred compensation plans for the Board and certain key executives and managers, and a salary continuation plan and a supplemental executive retirement (“SERP”) plan for certain key executives. In accordance with the provisions of the deferred compensation plans, participants can elect to defer portions of their annual compensation or fees. The deferred compensation plus interest is generally payable upon termination in either a lump-sum or monthly installments.
The salary continuation and SERP plans for certain key executives provide specified benefits to the participants upon termination or change of control. The benefits are subject to certain vesting requirements, and vested amounts are generally payable upon termination or change of control in either a lump-sum or monthly installments. The Bank annually expenses amounts sufficient to accrue for the present value of the benefits payable to the participants under these plans. These plans also include death benefit provisions for certain participants.
To assist in the funding of these plans, the Bank has purchased BOLI policies on the majority of the participants. The cash surrender value of the general account policies at December 31, 2015 and 2014 was approximately $25.9 million and $25.1 million, respectively. The cash surrender value of the separate account policies, including the value of the stable value wraps, was approximately $28.6 million and $28.3 million at December 31, 2015 and 2014, respectively. At both December 31, 2015 and 2014, the liabilities related to the deferred compensation plans included in other liabilities in the accompanying consolidated balance sheets totaled approximately $7.4 million. The amount of expense charged to operations in 2015, 2014, and 2013 related to the deferred compensation plans was approximately $0.4 million, $0.3 million and $0.1 million, respectively. As of December 31, 2015 and 2014, the liabilities related to the salary continuation and SERP plans included in other liabilities in the accompanying consolidated balance sheets totaled approximately $19.1 million and $18.7 million,
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
respectively. The amount of expense charged to operations in 2015, 2014, and 2013 for the salary continuation, SERP and fee continuation plan was $1.4 million, $1.0 million and $0.8 million, respectively.
18. Stock-based compensation
The Company has historically maintained certain stock-based compensation plans, approved by the Company’s stockholders that are administered by the Board or the Compensation Committee of the Board (the “Compensation Committee”). In April 2008, the stockholders of the Company approved the 2008 Cascade Bancorp Performance Incentive Plan (the “2008 Plan”). The 2008 Plan authorized the Board to issue up to an additional 1,000,000 shares of common stock related to the grant or settlement of stock-based compensation awards, expanded the types of stock-based compensation awards that may be granted, and expanded the parties eligible to receive such awards. In addition, in April 2011, the stockholders approved an increase in the common stock reserved under the 2008 Plan from 1,000,000 shares to 6,000,000 shares. Under the Company’s stock-based compensation plans, the Board (or the Compensation Committee) may grant stock options (including incentive stock options (“ISOs”) as defined in Section 422 of the Internal Revenue Code and non-qualified stock options (“NSOs”)), restricted stock, restricted stock units, stock appreciation rights, and other similar types of equity awards intended to qualify as “performance-based” compensation under applicable tax rules. The stock-based compensation plans were established to allow for the granting of compensation awards to attract, motivate, and retain employees, executive officers, non-employee directors, and other service providers who contribute to the success and profitability of the Company and to give such persons a proprietary interest in the Company, thereby enhancing their personal interest in the Company’s success.
The Board or Compensation Committee may establish and prescribe grant guidelines including various terms and conditions for the granting of stock-based compensation and the total number of shares authorized for this purpose. Under the 2008 Plan, for ISOs and NSOs, the option strike price must be no less than 100% of the stock price at the grant date. Prior to the approval of the 2008 Plan, the option strike price for NSOs could be no less than 85% of the stock price at the grant date. Generally, options become exercisable in varying amounts based on years of employee service and vesting schedules. All options expire after a period of ten years from the date of grant. Other permissible stock awards include restricted stock grants, restricted stock units, stock appreciation rights or other similar stock awards (including awards that do not require the grantee to pay any amount in connection with receiving the shares or that have a purchase price that is less than the grant date fair market value of the Company’s stock).
At December 31, 2015, 269,270 shares reserved under the stock-based compensation plans were available for future grants.
Stock Option Grants
During the year ended December 31, 2015, the Company granted 3,300,000 stock options and incurred stock option compensation expense of $1.0 million. The 2015 grants are the first material stock option grants since 2008. In this time interval, the Company made only de minimis option grants to non-executive officers to facilitate hiring. The 2015 grants, which had an estimated grant date fair value of $1.63 per share and strike price of $4.79 per share, are scheduled to vest over a three to five year period and carry a 10 year life. Using the Black-Scholes model, assumptions related to the fair value of grants include a dividend yield of 0%, expected volatility of 36.59%, a risk free rate of 1.28%, and expected option life of five years.
The Black-Scholes option-pricing model was developed for use in estimating the fair value of publicly-traded options that have no vesting restrictions and are fully transferable. The Black-Scholes model is affected by subjective assumptions including historical volatility of the Company’s common stock price. Assumptions affecting the Black-Scholes option pricing model for the 2015 stock grants include a dividend yield that was based on historical dividend information. The expected volatility was based on the historical volatility of the Company’s common stock price as adjusted for certain historical periods of extraordinary volatility in order to provide a basis for a reasonable estimate of fair value.
In adjusting its methodology for calculating expected volatility, the Company identified certain historical periods during which extraordinary price volatility which was caused by discrete events specific to the Company that are not likely to recur, including recapitalization, the discounted payoff of its junior subordinated debentures, a major bulk sale of its adversely risk rated assets, the write off and recapture of its DTA, and highly uncertain regulatory circumstances. For the identified periods, the Company replaced its common stock price volatility with the average volatility of a peer group of publicly traded banks in the Western U.S. of comparable size and complexity. The Company expects to use this methodology for potential future stock options grants until such a time that the periods of historical volatility containing the events noted above drop off of its historical analysis. The risk-free interest rate assumption was based on the U.S. Treasury yield curve in effect at the date of grant for periods corresponding with the expected lives of the options granted. The expected option lives represent the period of
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
time that options are expected to be outstanding giving consideration to vesting schedules, historical exercise and forfeiture patterns.
During the years ended December 31, 2014 and 2013, the Company granted a de minimis number of stock options, and related stock option compensation expense was immaterial for these periods. As of December 31, 2015, unrecognized compensation cost related to nonvested stock options totaled $4.4 million, which is expected to be recognized in 2016 through 2020.
The following table presents the activity related to options under all plans for the years ended December 31, 2015, 2014, and 2013.
Information regarding the number, weighted-average exercise price, and weighted-average remaining contractual life of options by range of exercise price at December 31, 2015 is as follows:
Restricted Stock Grants
The Company has also granted awards of nonvested restricted stock. During the year ended December 31, 2015, the Company granted 411,037 additional shares of restricted stock with a weighted-average grant date fair value of $5.00 per share, which vest during 2016 through 2020. The following table presents the activity for nonvested restricted stock for the year ended December 31, 2015:
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
Nonvested restricted stock is scheduled to vest over a three to five year period. The unearned compensation on restricted stock is being amortized to expense on a straight-line basis over the estimated applicable service or vesting periods. As of December 31, 2015, unrecognized compensation cost related to nonvested restricted stock totaled approximately $3.7 million, which is expected to be recognized over the next five years. Total expense recognized by the Company for nonvested restricted stock for the years ended December 31, 2015, 2014, and 2013 was $1.5 million, $1.2 million, and $0.8 million, respectively.
The Company has also granted awards of restricted stock units (“RSUs”). A RSU represents the unfunded, unsecured right to require the Company to deliver to the participant one share of common stock for each RSU. Total expense recognized by the Company related to RSUs was insignificant for the years ended December 31, 2015, 2014, and 2013. There was no unrecognized compensation cost related to RSUs at December 31, 2015, 2014, and 2013, as all RSUs were fully-vested. There were no RSUs granted and no RSUs cancelled during the years ended December 31, 2015 and 2014. There were 4,498 RSUs granted during the year ended December 31, 2013 and there were no RSUs cancelled. At December 31, 2015 there were no fully-vested RSUs outstanding. At both December 31, 2014 and December 31, 2013, there were 16,067 fully-vested RSUs outstanding with a weighted-average grant date fair value of $9.22 per share.
19. Fair Value
GAAP establishes a hierarchy for determining fair value measurements which includes three levels and is based upon the valuation techniques used to measure assets and liabilities. The three levels are as follows:
•
Level 1: Inputs that are quoted unadjusted prices in active markets - that the Company has the ability to access at the measurement date - for identical assets or liabilities.
•
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 or liabilities in active markets, quoted prices for identical or similar assets or liabilities in inactive markets, and inputs derived principally from, or corroborated by, observable market data by correlation or other means.
•
Level 3: Inputs that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances.
A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below. These valuation methodologies were applied to all of the Company’s assets and liabilities carried at fair value. Where available, fair value is based upon quoted market prices. Significant balances of the Bank’s financial assets and liabilities do not have quoted market prices. In such circumstances, fair value is based upon internal or third party models that primarily use, as inputs, observable market-based parameters, such as yields and discount rates of comparable instruments of like duration or credit quality. Valuation adjustments may be made to model results with respect to various assets or liabilities. These adjustments may include amounts to reflect counterparty credit quality and the Company’s creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. The Company’s valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes that the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain assets and liabilities could result in a different estimate of fair value at the reporting date. Furthermore, the reported fair value amounts have not been comprehensively revalued since the presentation dates, and, therefore, estimates of fair value after the condensed consolidated balance sheet date may differ significantly from the amounts presented herein.
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
The following is a description of the valuation methodologies used for assets measured at fair value on a recurring or nonrecurring basis, as well as the general classification of such assets pursuant to valuation hierarchy:
Investment securities available-for-sale: Where quoted prices for identical assets are available in an active market, investment securities available-for-sale are classified within level 1 of the hierarchy. If quoted market prices for identical securities are not available, then fair values are estimated by independent sources using pricing models and/or quoted prices of investment securities with similar characteristics or discounted cash flows. The Company has categorized its investment securities available-for-sale as level 2, since a majority of such securities are MBS which are mainly priced in this latter manner.
Impaired loans: In accordance with GAAP, loans are measured for impairment using one of three methods: an observable market price (if available), the present value of expected future cash flows discounted at the loan’s effective interest rate, or at the fair value of the loan’s collateral (if collateral dependent). Estimated fair value of the loan’s collateral is determined by appraisals or independent valuations which are then adjusted for the estimated costs related to liquidation of the collateral. Management’s ongoing review of appraisal information may result in additional discounts or adjustments to valuation based upon more recent market sales activity or more current appraisal information derived from properties of similar type and/or locale. A significant portion of the Bank’s impaired loans are measured using the estimated fair market value of the collateral less the estimated costs to sell. The Company has categorized all its loans impaired during the calendar year utilizing fair value metrics as level 3. Loans that were impaired during the calendar year based on the present value of expected future cash flows discounted at the loans’ effective interest rates are not included in the table below as the loans’ effective interest rates are not based on current market rates.
OREO: The Company’s OREO is measured at estimated fair value less estimated costs to sell. Fair value is generally determined based on third-party appraisals of fair value in an orderly sale. Historically, appraisals have considered comparable sales of like assets in reaching a conclusion as to fair value. Since many recent real estate sales could be termed “distressed sales”, and since a preponderance have been short-sale or foreclosure related, this has directly impacted appraisal valuation estimates. Estimated costs to sell OREO are based on standard market factors. The valuation of OREO is subject to significant external and internal judgment. Management periodically reviews OREO to determine whether the property continues to be carried at the lower of its recorded book value or estimated fair value, net of estimated costs to sell. The Company has categorized its OREO as level 3.
The Company’s only financial assets measured at fair value on a recurring basis at December 31, 2015 and 2014 were as follows (dollars in thousands):
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
Certain assets are measured at fair value on a nonrecurring basis (e.g., the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments when there is evidence of impairment). The following table represents the assets measured at fair value on a nonrecurring basis by the Company at December 31, 2015 and 2014 (dollars in thousands):
The following table presents quantitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at December 31, 2015 and 2014 (dollars in thousands):
The Company did not change the methodology used to determine fair value for any assets or liabilities during 2015 or 2014. In addition, for any given class of assets, the Company did not have any transfers between level 1, level 2, or level 3 during 2015 or 2014.
The following disclosures are made in accordance with the provisions of GAAP, which requires the disclosure of fair value information about financial instruments where it is practicable to estimate that value.
In cases where quoted market values are not available, the Company primarily uses present value techniques to estimate the fair value of its financial instruments. Valuation methods require considerable judgment, and the resulting estimates of fair value can be significantly affected by the assumptions made and methods used. Accordingly, the estimates provided herein do not necessarily indicate amounts which could be realized in a current market exchange.
In addition, as the Company normally intends to hold the majority of its financial instruments until maturity, it does not expect to realize many of the estimated amounts disclosed. The disclosures also do not include estimated fair value amounts for items which are not defined as financial instruments but which may have significant value. The Company does not believe that it would be practicable to estimate a representational fair value for these types of items as of December 31, 2015 and 2014.
Because GAAP excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements, any aggregation of the fair value amounts presented would not represent the underlying value of the Company.
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
The Company uses the following methods and assumptions to estimate the fair value of its financial instruments:
Cash and cash equivalents: The carrying amount approximates the estimated fair value of these instruments.
Investment securities: See above description.
FHLB stock: The carrying amount approximates the estimated fair value of this investment.
Loans: The estimated fair value of non-impaired loans is calculated by discounting the contractual cash flows of the loans using December 31, 2015 and 2014 origination rates. The resulting amounts are adjusted to estimate the effect of changes in the credit quality of borrowers since the loans were originated. Estimated fair values for impaired loans are determined using an observable market price (if available) or the fair value of the loan’s collateral (if collateral dependent) as described above. Observable market prices for community bank loans are not generally available given the non-homogenous characteristics of such loans.
BOLI: The carrying amount of both the separate and general account BOLI approximates the estimated fair value of these instruments. Fair values of insurance policies owned are based on the insurance contracts’ cash surrender values.
MSRs: The estimated fair value of MSRs is calculated by discounting the expected future contractual cash flows. Factors considered in the estimated fair value calculation include prepayment speed forecasts, market discount rates, earning rates, servicing costs, acquisition costs, ancillary income, and borrower rates.
Deposits: The estimated fair value of demand deposits, consisting of checking, interest bearing demand, and savings deposit accounts, is represented by the amounts payable on demand. At the reporting date, the estimated fair value of time deposits is calculated by discounting the scheduled cash flows using the December 31, 2015 and 2014 rates offered on those instruments.
Other borrowings: The fair value of other borrowings (including federal funds purchased, if any) are estimated using discounted cash flow analyses based on the Bank’s December 31, 2015 and 2014 incremental borrowing rates for similar types of borrowing arrangements.
Loan commitments and standby letters of credit: The majority of the Bank’s commitments to extend credit have variable interest rates and “escape” clauses if the customer’s credit quality deteriorates. Therefore, the fair values of these items are not significant and are not included in the following table.
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
The estimated fair values of the Company’s significant on-balance sheet financial instruments at December 31, 2015 and 2014 were approximately as follows (dollars in thousands):
20. Regulatory Matters
Bancorp and the Bank are subject to various regulatory capital requirements administered by the federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. 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 as calculated under regulatory accounting practices. Bancorp’s and the Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require Bancorp and the Bank to maintain minimum amounts and ratios (set forth in the tables below) of Tier 1 capital to average assets and Tier 1 and total capital to risk-weighted assets (all as defined in the regulations).
Federal banking regulators are required to take prompt corrective action if an insured depository institution fails to satisfy certain minimum capital requirements. Such actions could potentially include a leverage capital limit, a risk-based capital requirement, and any other measure of capital deemed appropriate by the federal banking regulator for measuring the capital adequacy of an insured depository institution. In addition, payment of dividends by Bancorp and the Bank are subject to restriction by state and federal regulators and availability of retained earnings.
In July 2013, the Board of Governors of the Federal Reserve System and the FDIC approved the final rules implementing the Basel Committee on Banking Supervision’s capital guidelines for U.S. banks (“Basel III”). Under the final rules, which became effective for the Bancorp and the Bank on January 1, 2015 and are subject to a phase-in period through January 1, 2019, minimum requirements increased for both the quantity and quality of capital held by the Bancorp and the Bank. The rules include a new common equity Tier 1 capital to risk-weighted assets ratio (“CET1” ratio) of 4.5% and a capital conservation buffer of 2.5% above the regulatory minimum risk-based capital requirements, which when fully phased-in, effectively results in a minimum CET1 ratio of 7.0%. Basel III also (i) raises the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0% (which, with the capital conservation buffer, effectively results in a minimum Tier 1 capital ratio of 8.5% when fully phased-in), (ii) effectively results in a minimum total capital to risk-weighted assets ratio of 10.5% (with the capital conservation buffer fully phased-in), and (iii) requires a minimum leverage ratio of 4.0%. Basel III also makes changes to risk weights for certain assets and off-balance-sheet exposures.
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
Bancorp’s and Bank’s actual capital amounts and ratios and the required capital ratios under the prompt corrective action framework as of December 31, 2015 and 2014 are presented in the following table (dollars in thousands):
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
21. Parent company financial information
Condensed financial information for Bancorp (Parent company only) is presented as follows (dollars in thousands):
CONDENSED BALANCE SHEETS
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
21. Parent company financial information - (continued)
CONDENSED STATEMENTS OF COMPREHENSIVE INCOME
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
21. Parent company financial information - (continued)
CONDENSED STATEMENTS OF CASH FLOWS
These consolidated financial statements have not been reviewed or confirmed for accuracy or relevance by the Federal Deposit Insurance Corporation.
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
22. Quarterly Financial Information (Unaudited)
The following tables present the summary results for the eight quarters ending December 31, 2015 (dollars in thousands):
Cascade Bancorp & Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 31, 2015, 2014 and 2013
23. Subsequent Events
Bank of America Branch Acquisition
On October 28, 2015, the Company announced that the Bank had entered into an agreement to purchase 12 Oregon branch locations and three Washington branch locations from Bank of America, National Association. This acquisition allows Cascade the opportunity to enhance and strengthen its footprint in Oregon, while providing entry into the Washington market. In the transaction, Cascade will assume the deposits of the acquired branches, which is currently approximately $480 million. No loans are included in the transaction. The purchase price paid to the seller will be approximately 2% of the balance of deposits at closing. All necessary regulatory approvals have been received. Pending the satisfaction of customary closing conditions, the closing of the acquisition and conversion of these branches to Bank of the Cascade offices is expected to occur in March 2016. Cascade plans on retaining current employees working at the branches.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES.
Evaluation of Disclosure Controls and Procedures
As required by Rule 13a-15(b) under the Exchange Act, management of the Company carried out an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as such is defined in Rules 13a-15(e) or 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports we file or submit under the Exchange Act is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. This evaluation was carried out under the supervision and with the participation of the Company’s Chief Executive Officer and the Company’s Chief Financial Officer. Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this report.
Changes in Internal Control over Financial Reporting
During the quarter ended December 31, 2015, there were no changes in the Company’s internal control over financial reporting that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Management’s Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2015 as required by Rule 13a-15(c) under the Exchange Act. In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework (2013). Based on our evaluation under the framework in Internal Control-Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2015.
There are inherent limitations in the effectiveness of any internal control, including the possibility of human error and the circumvention or overriding of controls. Accordingly, even effective internal control can provide only reasonable assurance with respect to the reliability of financial reporting and financial statement preparation. Further, because of changes in conditions, the effectiveness of internal control may vary over time.
The effectiveness of the Company’s internal control over financial reporting as of December 31, 2015, has been audited by BDO USA, LLP, the independent registered public accounting firm, as stated in their report which is included herein.
REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Cascade Bancorp
Bend, Oregon
We have audited Cascade Bancorp’s internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Cascade Bancorp’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 Item 9A, 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, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included 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 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 its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that 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, Cascade Bancorp maintained, in all material respects, effective internal control over financial reporting as of December 31, 2015, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Cascade Bancorp as of December 31, 2015 and 2014, and the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2015 and our report dated March 4, 2016 expressed an unqualified opinion thereon.
/s/ BDO USA, LLP
Spokane, Washington
March 4, 2016
ITEM 9B.
ITEM 9B. OTHER INFORMATION.
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
The information about our directors, named executive officers and board committees required by this Item 10 is incorporated herein by reference to our Definitive Proxy Statement for the Annual Meeting of Shareholders to be held in 2016, which will be filed with the SEC within 120 days of our most recently completed fiscal year (the “Proxy Statement”).
The information in the Proxy Statement set forth under the caption “Section 16(a) Beneficial Ownership Reporting Compliance” is incorporated herein by reference.
We have adopted a written Code of Conduct and Ethics that applies to all of the Company’s directors, officers and employees, including its principal executive officer, principal financial officer, principal accounting officer and controller. If we make any substantive amendments to the Code of Conduct and Ethics or grant any waiver, including any implicit waiver, from a provision of the Code of Conduct and Ethics to our principal executive officer, principal financial officer, principal accounting officer or controller, we will disclose the nature of the amendment or waiver in a report on Form 8-K. The information in the Proxy Statement set forth under the caption “Code of Conduct and Ethics” is incorporated herein by reference. The Code of Conduct and Ethics is available at www.botc.com.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this Item 11 is incorporated by reference from the Proxy Statement.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
The information required by this Item 12 is incorporated by reference from the Proxy Statement.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.
The information required by this Item 13 is incorporated by reference from the Proxy Statement.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.
The information required by this Item 14 is incorporated by reference from the Proxy Statement.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES.
(a) The following documents are filed as part of this Form 10-K:
(1)
Financial Statements
See the Index to Consolidated Financial Statement contained in Part II, Item 8 of this Form 10-K.
(2)
Financial Statement Schedules
Financial statement schedules are omitted because they are not required or are not applicable, or the required information is provided in the consolidated financial statements or notes described in Item 15 (a)(1) above.
*
Management contract or compensatory plan or arrangement.
†
Filed herewith.
††
Furnished herewith.
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.
CASCADE BANCORP
/s/ Gregory D. Newton
Gregory D. Newton
Executive Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
Date: March 4, 2016
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 and on the dates indicated.