ITEM 1. BUSINESS
General
West Coast Bancorp (“Bancorp” or the “Company”) is a bank holding company headquartered in Lake Oswego, Oregon. Bancorp’s principal business activities are conducted through its full-service, commercial bank subsidiary, West Coast Bank (the “Bank”), an Oregon state-chartered bank with deposits insured by the Federal Deposit Insurance Corporation (“FDIC”). At December 31, 2012, the Bank had facilities in 41 cities and towns in western Oregon and southwestern Washington, operating a total of 55 full-service and three limited-service branches and a Small Business Administration (“SBA”) lending office in Vancouver, Washington. Bancorp also owns West Coast Trust Company, Inc. (“West Coast Trust”), an Oregon trust company that provides agency, fiduciary and other related trust services with offices in Portland and Salem, Oregon.
Bancorp reports two principal operating segments in the notes to its financial statements: West Coast Bank and West Coast Trust and parent company related operations. For more information regarding Bancorp’s operating segments, see Note 20 “Segment and Related Information” to the Company’s audited consolidated financial statements included under the section “Financial Statements and Supplementary Data” in Item 8 of this report.
Historical Information. Bancorp enjoyed a period of sustained growth from 2000 - 2007. However, in late 2007, with the onset of a significant slowdown in economic activity and unprecedented disruptions in the real estate and credit markets, the Company experienced significant net losses for two consecutive years and its balance sheet contracted. Beginning in 2008, Bancorp and the Bank took several steps to preserve capital and sustain or improve regulatory capital ratios, carefully managing its capital position, reducing risk weighted assets, and focusing on limiting operating expenses. During 2009 and 2010, Bancorp also raised a significant amount of new capital.
As part of its capital raising efforts, in October 2009, Bancorp received net proceeds of $139.2 million in a private capital raise (referred to in this report as, the “Private Capital Raise”) in which it issued: 14,288,490 shares of Common Stock; 121,328 shares of mandatorily convertible cumulative participating preferred stock, Series B (“Series B Preferred Stock”) convertible into 1,213,280 shares of Common Stock upon satisfaction of certain conditions; and Class C Warrants exercisable for a total of 240,000 shares of Series B Preferred Stock at a price of $100.00 per share (the “Class C Warrants”) that are, in turn, convertible into 2,400,000 shares of Common Stock, also upon satisfaction of certain conditions.
Following the Private Capital Raise, Bancorp conducted a rights offering of up to 1.0 million shares of Common Stock at a subscription price of $10.00 per share during the first quarter of 2010, raising net proceeds of $9.3 million, and in June 2010, Bancorp sold, through a discretionary equity issuance program, an aggregate of .56 million shares of Common Stock at an average sales price of $14.00 per share, with aggregate gross sales proceeds of $7.9 million.
Regulatory capital ratios at Bancorp and the Bank improved significantly as a result of the Company’s capital raising activities and return to profitability over the two and a half years. For additional information regarding regulatory capital, see the discussion under the subheading “Capital Resources” in Item 7 of this report.
The Pacific Northwest is experiencing a slow economic recovery from the prolonged recession and severe slump in housing and other real estate markets. While values of the property that serves as collateral for many loans appear to have stabilized, the market area continues to experience high unemployment and weak new residential real estate construction activity. Among the effects of the recession, the Bank has experienced a significant reduction in the size of its loan portfolio and a significant increase in its portfolio of investment securities. This shift in earning asset mix has resulted in significant downward pressure on Bancorp’s net interest income and margin, its main source of revenue.
As of December 31, 2012, Bancorp had total assets of $2.49 billion, with total net loans of $1.47 billion and total investment securities of $772.1 million. Bancorp’s total deposits at December 31, 2012, were $1.94 billion and stockholders’ equity was $339.2 million. At December 31, 2011, Bancorp had total assets of $2.43 billion, total net loans of $1.47 billion and total investment securities of $729.8 million. Bancorp’s total deposits at December 31, 2011, were $1.92 billion, with stockholders’ equity of $314.5 million. At December 31, 2012, tangible book value per share was $16.49 up from $15.20 at December 31, 2011.
Net income for the year ending December 31, 2012 was $23.5 million or $1.08 per diluted share, down from net income of $33.8 million or $1.58 per diluted share for the year ending December 31, 2011. The Company reported net income of $3.2 million or $.16 per diluted share for the year ending December 31, 2010.
On September 25, 2012, Bancorp entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Columbia Banking System, Inc., a Washington corporation (“Columbia”), pursuant to which Columbia will acquire Bancorp. Consummation of the transaction remains subject to customary closing conditions, including receipt of requisite shareholder and regulatory approvals. Certain terms of the Merger Agreement and other related agreements are summarized in, and the Merger Agreement has been filed as an exhibit to, the Current Report on Form 8-K filed by Bancorp with the Securities and Exchange Commission on October 1, 2012. For more information regarding the Merger, see the discussion under the subheading “Agreement and Plan of Merger” in this section below.
West Coast Bank
The Bank traces its origins to a bank organized in 1925 under the name The Bank of Newport. The Bank in its current form resulted from the merger on December 31, 1998, of the Bank of Newport of Newport, Oregon, The Commercial Bank of Salem, Oregon, Bank of Vancouver of Vancouver, Washington and Centennial Bank of Olympia, Washington, into a single entity. This entity was renamed West Coast Bank. The Bank’s headquarters is located in Lake Oswego, Oregon.
The Bank’s Oregon branches are located in the following cities and towns: Beaverton, Canby, Clackamas, Dallas, Depoe Bay, Dundee, Eugene (2), Forest Grove, Gresham, Happy Valley, Hillsboro (2), Keizer, King City, Lake Oswego, Lincoln City, McMinnville, Molalla, Monmouth, Mt. Angel, Newberg, Newport (2), North Plains, Oregon City, Portland (5), Salem (5), Silverton, Stayton, Sublimity, Tigard, Tualatin, Waldport, Wilsonville and Woodburn (3). The Bank’s Washington branches are located in Centralia, Chehalis, Hoodsport, Lacey (2), Olympia (2), Shelton, Tukwila and Vancouver (3).
The primary business strategy of the Bank is to provide comprehensive banking and related financial services within its local communities. The Bank emphasizes the diversity and accessibility of its product lines and services and conducts its business consistent with its client value proposition, which is to provide products typically associated with larger financial organizations, while maintaining the local decision making authority, market knowledge and customer service orientation typically associated with a community bank. The Bank focuses on four targeted areas: 1) high value consumers, 2) small businesses that desire streamlined packaged products, 3) commercial businesses that benefit from customized lending, deposit, cash management, and investment solutions and 4) the principals and employees of associated commercial clients who have a commercial relationship with West Coast Bank.
For consumer banking customers, the Bank offers a variety of checking and savings accounts, check cards, and competitive borrowing products. Consumer accounts consist of three streamlined checking account types, each specifically designed to meet the needs of a unique market segment. Because of the straightforward and easy to understand product design, our branch staff are able to quickly and easily help clients identify the account that best fits their needs. Financing products for consumers include residential real estate mortgage loans, home equity lines and loans, personal lines of credit and consumer credit cards. Customers have access to the Bank’s products and services through a variety of convenient channels such as 24 hour 7 day a week automated phone and internet access, a personal customer service center accessed by phone, and ATMs, as well as through our branch locations.
For business banking customers, the Bank offers customized deposit products tailored for specific needs, including a variety of checking accounts; sophisticated internet-based cash management and payment solution products, including iDepositSM - a remote deposit capture product. The Bank also offers a business online suite of products called eBiz Access PLUSSM, which offers commercial clients a customized Treasury Management Online Banking system featuring enhanced security features, real time customizable reports, and expanded treasury management services that are all accessed through a customized dashboard. Customized financing packages provide businesses with a comprehensive suite of credit facilities that include general commercial loans, revolving lines of credit, real estate loans and lines to support construction, owner occupied and investor financing and SBA loans. In addition, the Bank offers business credit cards (VISA), extensive merchant service options, equipment leasing through vendor alliances, and other types of business credit.
West Coast Trust
West Coast Trust provides trust services and life insurance products to individuals, for-profit and not for-profit businesses and institutions. West Coast Trust acts as fiduciary of estates and conservatorships, and as a trustee under various wills, trusts, and pension and profit-sharing plans. The main office of West Coast Trust is located at 1000 SW Broadway, Suite 1100, Portland, Oregon 97205, (503) 279-3911. The market value of assets managed for others at December 31, 2012, was $296.1 million.
West Coast Statutory Trusts III, IV, V, VI, VII and VIII
West Coast Statutory Trusts III, IV, V, VI, VII and VIII are wholly-owned subsidiary trusts of Bancorp formed to facilitate the issuance of trust preferred securities. The trusts were organized in September 2003, March 2004, April 2006, December 2006, March 2007 and June 2007, respectively, in connection with six offerings of trust preferred securities. For more information regarding Bancorp’s trust preferred securities, see Note 9 “Junior Subordinated Debentures” to the Company’s audited financial consolidated statements included under the section “Financial Statements and Supplementary Data” in Item 8 of this report.
Additional Information
Bancorp’s filings with the SEC, including its annual report on Form 10-K, quarterly reports on Form 10-Q, periodic reports on Form 8-K and amendments to these reports, are accessible free of charge at our website at http://www.wcb.com as soon as reasonably practicable after filing with the SEC. By making this reference to our website, we do not intend to incorporate into this report any information contained in the website. The website should not be considered part of this report.
The SEC maintains a website at http://www.sec.gov that contains periodic reports, proxy and information statements, and other information regarding issuers with publicly traded securities, including the Company.
Employees
At December 31, 2012, Bancorp and its subsidiaries had approximately 627 employees. None of these employees are represented by labor unions. Management believes that Bancorp’s relationship with its employees is good. Bancorp emphasizes a positive work environment for its employees and our work environment is measured annually utilizing an anonymous employee survey. Management continually strives to retain top talent as well as provide career development opportunities to enhance skill levels. A number of benefit programs are available to eligible employees.
Competition
Commercial banking in the state of Oregon and southwest Washington is highly competitive with respect to providing banking services, including making loans and attracting deposits. The Bank competes with other banks, as well as with savings and loan associations, savings banks, credit unions, mortgage companies, investment banks, insurance companies, securities brokerages and other financial institutions. Banking in Oregon and Washington is dominated by several large banking institutions, including U.S. Bank, Wells Fargo Bank, Bank of America, and JPMorgan Chase Bank, which together account for a majority of the total commercial and savings bank loans and deposits in Oregon and Washington. These competitors have significantly greater financial resources and offer a greater number of branch locations, higher lending limits, and a variety of services not offered by the Bank. The Bank has attempted to offset some of the advantages of the larger competitors by leveraging technology and third party arrangements to deliver contemporary product solutions and better compete in targeted customer segments. The Bank has positioned itself successfully as a local alternative to banking conglomerates that may be perceived by customers or potential customers to be impersonal, out-of-touch with the community, or simply not interested in providing banking products and services to some of the Bank’s target customers.
In addition to larger institutions, numerous “community” banks and credit unions operate in the Bank’s market areas. As a result of very weak real estate market conditions over the past few years, a number of banks and credit unions have developed a similar focus as the Bank. These institutions have further increased competition, particularly in the Portland metropolitan area. Additionally, a heightened focus by larger institutions on Bancorp’s target market segments, such as small businesses, has led to intensified competition in all aspects of Bancorp’s business.
The financial services industry has experienced widespread consolidation over the last decade. Bancorp anticipates that consolidation among financial institutions in its market areas will continue and perhaps accelerate as a result of financial distress in the industry, intensified competition for the same customer segments, and significantly increased regulatory burdens and rules that are expected to increase expenses and put pressure on revenues.
Supervision and Regulation
Bancorp is an Oregon corporation headquartered in Lake Oswego, Oregon, and is registered with the Federal Reserve Bank of San Francisco (“Federal Reserve”) as a bank holding company. The Bank is an Oregon state bank and is not a member of the Federal Reserve System. The Bank’s primary regulators are the FDIC at the federal level and, at the state level, the Oregon Department of Consumer and Business Services Division of Finance and Corporate Securities (“DFCS”).
The laws and regulations applicable to Bancorp and its subsidiaries are primarily intended to protect borrowers and depositors of the Bank and not stockholders of Bancorp. Various proposals to change the laws and regulations governing the banking industry are made from time to time and presented to Congress, state legislatures and various bank regulatory agencies. As a result of the Dodd-Frank Act (as defined below), the creation of the Consumer Financial Protection Bureau and the current economic climate and regulatory environment, there is a high likelihood of enactment of new banking legislation and promulgation of new banking regulations. The following is a brief description of the significant laws and regulations that govern our activities.
Bank Holding Company Regulation
As a registered bank holding company, Bancorp is subject to the supervision of, and regular inspection by, the Federal Reserve pursuant to the Bank Holding Company Act of 1956, as amended (the “BHCA”). In addition, pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) and subject to certain conditions, the FDIC has backup enforcement authority over bank holding companies, such as Bancorp, if the conduct or threatened conduct of the bank holding company poses a risk to the Deposit Insurance Fund. Bancorp must file reports with the Federal Reserve and must provide it with such additional information as it may require. The BHCA restricts the direct and indirect activities of Bancorp to banking, managing or controlling banks and other subsidiaries authorized under the BHCA, and activities that are closely related to banking or managing or controlling banks. Bank holding companies like Bancorp must, among other things, obtain prior Federal Reserve approval before they: (1) acquire direct or indirect ownership or control of any voting shares of any bank or bank holding company that results in total ownership or control, directly or indirectly, of more than 5% of the outstanding shares of any class of voting securities of such bank or bank holding company; (2) merge or consolidate with another bank holding company; or (3) acquire substantially all of the assets of another bank or bank holding company.
Bank holding companies must also act as a source of financial and managerial strength to subsidiary banks. This means that Bancorp is required to commit, as necessary, resources to support the Bank.
Subsidiary banks of a bank holding company are subject to certain other restrictions under the Federal Reserve Act and Regulation W which restricts transactions with affiliates. These restrictions may limit Bancorp’s ability to obtain funds from the Bank for Bancorp’s cash needs, including funds for payment of interest on its junior subordinated debentures, cash dividends and operational expenses.
Bank Regulation
General. The Bank is an Oregon state bank and is not a member of the Federal Reserve System. The Bank conducts banking business in Oregon and Washington. The Bank is subject to supervision and regulation by the DFCS, the FDIC and to a lesser extent, the Washington Department of Financial Institutions. The Bank's regulators conduct regular examinations of the Bank and have the authority to prohibit the Bank from engaging in unsafe or unsound banking practices.
Deposit Insurance. Generally, eligible deposits maintained at the Bank are insured by the FDIC up to $250,000 per account. The Bank is required to pay quarterly deposit insurance premiums to the FDIC. Premiums are based on an assessment of how much risk a particular institution presents to the Deposit Insurance Fund. Banks with higher levels of capital and a low degree of supervisory concern are assessed lower premiums than banks with lower levels of capital or a higher degree of supervisory concern. The FDIC may terminate deposit insurance if it determines the institution involved has engaged in or is engaging in unsafe or unsound banking practices, is in unsafe or unsound condition, or has violated applicable laws, regulations or orders.
Community Reinvestment Act and Fair Lending and Reporting Requirements. The Bank is subject to the Community Reinvestment Act of 1977, as amended (“CRA”), and to certain fair lending and reporting requirements that relate primarily to home mortgage lending operations. The CRA generally requires the federal banking agencies to evaluate the record of a financial institution in meeting the credit needs of its local communities, including low- and moderate-income neighborhoods, consistent with the safe and sound operation of the institution. The federal banking agencies may take into account compliance with the CRA when regulating and supervising other activities, such as evaluating mergers, acquisitions and applications to open a branch or facility. In connection with its assessment of CRA performance, the FDIC assigns a rating of “outstanding,” “satisfactory,” “needs to improve” or “substantial noncompliance.” The Bank’s most recent CRA rating, based on an examination in August 2012, was satisfactory. There are several rules and regulations governing fair lending and reporting practices by financial institutions. A bank may be subject to substantial damages, penalties and corrective measures for any violation of fair lending and reporting, including credit reporting, laws and regulations.
Consumer Privacy and Information Security. Financial institutions, such as the Bank, are required by statute and regulation to disclose their privacy policies. In addition, we must appropriately safeguard our customers’ nonpublic, personal information.
Consumer Financial Protection Bureau. The Dodd-Frank Act, signed into law by the President on July 21, 2010, among other things, created a new Consumer Financial Protection Bureau (“CFPB”). As required by the Dodd-Frank Act, jurisdiction for all existing consumer protection laws and regulations has been transferred to the CFPB. In addition, the CFPB is granted authority to promulgate new consumer protection regulations for banks and nonbank financial firms offering consumer financial services or products to ensure that consumer are protected from “unfair, deceptive, or abusive” acts or practices. The CFPB has begun conducting studies of existing consumer protection regulations to gauge their effectiveness and to solicit comment on potential new regulations.
Non-Capital Safety and Soundness Standards. The Federal Reserve and the FDIC have prescribed, by regulation, non-capital safety and soundness standards for institutions under their authority. These standards cover internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, and other operational and managerial standards as the agency determines to be appropriate, and standards for asset quality, earnings and stock valuation. An institution that fails to meet these standards must develop a plan acceptable to the agency, specifying the steps it will take to meet the standards. Failure to submit a plan may subject the institution to regulatory sanctions. We believe the Bank is in compliance with these standards.
Capital Adequacy Requirements
Federal bank regulatory agencies use capital adequacy guidelines in the examination and regulation of bank holding companies and banks. If capital falls below minimum levels, the bank holding company or bank may, among other things, be denied approval to acquire or establish additional banks or non-bank businesses or to open new facilities.
The FDIC and Federal Reserve use risk-based capital guidelines for banks and bank holding companies. Risk-based guidelines are designed to make capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off balance sheet exposure and to minimize disincentives for holding liquid low-risk assets. Assets and off balance sheet items are assigned to broad risk categories, each with appropriate weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off balance sheet items.
The guidelines are minimums and the Federal Reserve may require that a banking organization maintain ratios in excess of the minimums, particularly organizations contemplating significant expansion. Current guidelines require all bank holding companies and federally-regulated banks to maintain a minimum risk-based total capital ratio equal to 8%, of which at least 4% must be Tier 1 capital. Tier 1 capital for bank holding companies includes common stockholders’ equity, qualifying preferred stock, and minority interests in equity accounts of consolidated subsidiaries, minus certain deductions, including goodwill, mortgage servicing assets, other identifiable intangible assets, and deferred tax assets subject to a disallowance.
The Federal Reserve also monitors a leverage ratio, which is Tier 1 capital as a percentage of total quarterly average tangible assets. The principal objective of the leverage ratio is to constrain the degree to which a bank holding company may leverage its equity capital base. The Federal Reserve requires a minimum leverage ratio of 3%.
For more information regarding the Bank and Bancorp’s capital and leverage ratios, see the discussion under the section “Capital Resources” in Item 7 of this report. For more information regarding regulatory enforcement actions that increase minimum ratios applicable to Bancorp and the Bank, see the discussion under the subheading “Status of Regulatory Actions” in this section below.
The Federal Deposit Insurance Corporation Improvement Act (“FDICIA”), among other things, created a statutory framework of supervisory actions indexed to the capital level of the individual institution. Under regulations adopted by the FDIC, an institution is assigned to one of five capital categories - well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized - depending on its total risk-based capital ratio, Tier 1 risk-based capital ratio, and leverage ratio, together with certain subjective factors including, but not limited to an overall assessment of profitability, liquidity, interest rate sensitivity, and the level and severity, especially relative to capital, of nonperforming and classified assets. Undercapitalized, significantly undercapitalized, and critically undercapitalized banks are subject to certain mandatory supervisory corrective actions.
Dividends
Substantially all of our activities are conducted through the Bank. Consequently, as the parent company of the Bank, the Company receives substantially all of its revenue as dividends from the Bank. The banking regulators may prohibit banks and bank holding companies from paying dividends that would constitute an unsafe or unsound banking practice. In addition, a bank may not pay cash dividends if doing so would reduce the amount of its capital below that necessary to meet minimum applicable regulatory capital requirements. Oregon law also limits a bank's ability to pay dividends.
As of June 27, 2012, the Written Agreement between Bancorp and the Federal Reserve and the DFCS was terminated. The termination of this agreement ends certain restrictions on Bancorp, including paying interest on its $51 million in trust preferred securities outstanding. At this time, the Reserve Bank requires that we continue to inform and consult with it and seek a non-objection notice ahead of declaring and paying cash dividends to shareholders. For more information regarding regulatory actions, see the discussion under the subheading “Status of Regulatory Actions” in this section below.
Other Laws and Regulations
Interstate Banking and Branching. Subject to certain restrictions, adequately capitalized and managed bank holding companies may purchase banks in any state, and adequately capitalized and managed banks may merge with banks in other states or otherwise expand across state lines. Bank regulators are required to consult with community organizations before permitting an interstate institution to close a branch in a low income area.
Monetary and Fiscal Policy Effects on Interest Rates. Banking is a business which depends on interest rate differentials. In general, the major portion of a bank’s earnings derives from the differences between: (i) interest received by a bank on loans extended to its customers and the yield on securities held in its investment portfolio; and (ii) the interest paid by a bank on its deposits and its other borrowings (the bank’s “cost of funds.”) Thus, our earnings and growth are constantly subject to the influence of economic conditions generally, both domestic and foreign, and also to the monetary, fiscal and related policies of the United States and its agencies, particularly the Federal Reserve and the U.S. Treasury. The nature and timing of changes in such policies and their impact cannot be predicted.
The Volcker Rule. The Dodd-Frank Act implements the "Volcker Rule,” which prohibits “banking entities” such as Bancorp and the Bank from engaging in certain short-term proprietary trading activities and investments. Transactions in certain instruments, including obligations of the U.S. Government or a U.S. Government agency, government-sponsored enterprises, and state and local governments will be exempt from the prohibitions. The Volcker Rule also prohibits Bancorp and the Bank from owning, sponsoring, or having certain relationships with any hedge funds or private equity funds subject to certain exemptions. The prohibitions and restrictions of the Volcker Rule will not take effect until after publication of final interagency rules implementing the Volcker Rule.
Overdraft Programs. The Electronic Funds Transfer Act (the “EFTA”) provides a basic framework for establishing the rights, liabilities, and responsibilities of consumers who use electronic funds transfer (“EFT”) systems. The EFTA is implemented by the Federal Reserve's Regulation E, which governs transfers initiated through ATMs, point-of-sale terminals, payroll cards, automated clearinghouse (“ACH”) transactions, telephone bill-payment plans, or remote banking services. Regulation E requires consumers to opt in (affirmatively consent) to participation in the Bank's overdraft service program for ATM and one-time debit card transactions before overdraft fees may be assessed on the consumer’s account. Notice of the opt-in right must be provided to all new customers who are consumers, and the customer's affirmative consent must be obtained, before charges may be assessed on the consumer's account for paying such overdrafts.
Regulation E also provide bank customers with an ongoing right to revoke consent to participation in an overdraft service program for ATM and one-time debit card transactions and prohibits banks from conditioning the payment of overdrafts for checks, ACH transactions, or other types of transactions that overdraw the consumer's account on the consumer's opting into an overdraft service for ATM and one-time debit card transactions. For customers who do not affirmatively consent to overdraft service for ATM and one-time debit card transactions, a bank must provide those customers with the same account terms, conditions, and features that it provides to consumers who do affirmatively consent, except for the overdraft service for ATM and one-time debit card transactions.
Regulation E may have a substantial negative impact on the Bank's revenue from overdraft service fees and non-sufficient funds (“NSF”) charges if customers elect to not opt-in or subsequently elect to opt-out. For more information regarding risks facing Bancorp and the Bank, see the discussion under the section “Risk Factors” in Item 1A
ITEM 1A. RISK FACTORS
The following are all material risks that management believes are specific to our business, in no particular order of likelihood or significance.
Future loan losses may exceed our allowance for credit losses.
We are subject to credit risk, which is the risk that borrowers will fail to repay loans in accordance with their terms. We maintain an allowance for credit losses that represents management’s best estimate, as of a particular date, of the probable amount of loan receivables and unfunded commitments that the Bank will be unable to collect. The process we use to estimate losses inherent in our loan portfolio involves difficult, subjective, and complex judgments, including forecasts of economic conditions and how these economic forecasts might affect the ability of our borrowers to repay their loans. These matters are inherently uncertain, which may, in turn, impact the reliability of estimates. In addition, if our estimates prove to be inaccurate and economic conditions are significantly less favorable than expected or we experience a rapid change in interest rates, our borrowers’ ability to repay loans could be adversely affected. Developments of this nature could result in losses in excess of our allowance for credit losses. If we determine that it is appropriate to increase the allowance for credit losses to address changing conditions, we will do so through additional provision for credit losses. Any additional provision for credit losses results in a decrease in net income and may have a material adverse effect on our financial condition, results of operations and regulatory capital position. For more information regarding the Company’s allowance for credit losses, see the discussion under the subheading “Allowance for Credit Losses” and “Critical Accounting Policies” included in Item 7 of this report.
A large percentage of our loan portfolio is secured by real estate. As a result, we are particularly vulnerable to continued deterioration in the real estate market in our market areas and other effects.
Approximately 82% of our loan portfolio is secured by real estate. As a result, we are vulnerable to declines in real estate values in the markets in which we operate. We have experienced challenging market conditions over the last four years and high levels of net charge-offs and provision for credit losses as a result. While net charge-offs and provision for credit losses have declined significantly, if we experience increases in delinquencies with respect to commercial real estate or other real estate related loans, or declines in real estate market values, we would expect increased loan charge-offs and additional provision for credit losses, which could have a material adverse effect on our business, financial condition and results of operations. Because of our significant concentration in loans secured by real estate, we are particularly vulnerable to such effects.
The recession has been particularly severe in the market areas we serve and our results of operations may be adversely affected if the local economies do not improve.
Substantially all of our loans and loan opportunities are to businesses and individuals in our markets in Washington and Oregon. As evidenced by the unemployment rate in Oregon, which remained elevated at 8.4% in December 2012, our region has been severely impacted by the same challenges facing the economy nationally and perhaps more so. The region also experienced severe declines in residential and commercial real estate values between 2008 and 2012, before stabilizing recently. If economic conditions deteriorate or economic recovery in our market areas stalls, we could face the following consequences, any of which could materially and adversely affect our business: the value of assets that serve as collateral for our loans, especially real estate, may decline; loan delinquencies, foreclosures and losses on loans and other real estate owned properties (“OREO”) could increase; demand for our products and services may fail to accelerate or even decrease; and access to low cost or non-interest bearing deposits may decrease.
Financial services legislation and regulatory reforms may have a significant impact on our businesses and results of operations.
Many of the provisions of the Dodd-Frank Act have extended implementation periods and delayed effective dates and require extensive rulemaking by regulatory authorities and multiple additional studies. The implementation of Dodd-Frank, including regulatory rules and regulations and related interpretations of those rules, could result in a number of adverse impacts on us. The levels of capital and liquidity that Bancorp and the Bank must maintain to operate may be increased, resulting in decreased leverage and reduced earnings. We may also be subjected to new and/or higher fees to various regulatory entities, including but not limited to deposit insurance premiums to the FDIC. The Bank may also be subject to additional regulations under the newly established CFPB which has been given broad authority to implement new consumer protection regulations. These and other provisions of Dodd-Frank could limit our ability to pursue business opportunities we might otherwise consider, impose additional costs on us, result in significant loss of revenue, impact the value of assets we hold, or otherwise significantly adversely affect our businesses.
Congressional and regulatory initiatives could have an adverse effect on our business.
Federal and state legislators and regulators continue to pursue increased regulation of how loans are originated, purchased, and sold, and properties are foreclosed. These legislative and regulatory responses may impact how the Bank conducts business, makes and underwrites loans, and buys and sells loans in secondary markets, or lead to changes in the banking industry, lending markets and secondary markets for loans generally. We are unable to predict which legislative or regulatory initiatives will be implemented or what form they will take. Any such actions could affect us in substantial and unpredictable ways and could have an adverse effect on our business, financial condition and results of operations. For more information regarding the regulatory environment in which we operate, see the discussion under the subheading “Supervision and Regulation” included in Item 1 of this report.
Significant legal and regulatory actions could subject us to uninsured liabilities, associated reputational risk, and reduced revenues.
From time to time, we are sued for damages or threatened with lawsuits relating to various aspects of our operations. We may also be subject to investigations and possibly substantial civil money penalties assessed by, or other actions of, federal or state regulators in connection with violations or alleged violations of applicable laws, regulations or standards. We may incur substantial attorney fees and expenses in the process of defending against lawsuits or regulatory actions and our insurance policies may not cover, or cover inadequately, the costs of adverse judgments, civil money penalties, and attorney fees and expenses. As a result, we may be exposed to substantial uninsured liabilities, which could adversely affect our results of operations, financial condition, and regulatory capital. We are subject to reputational risk, which is the potential that negative publicity regarding our business practices, whether true or not, could cause a decline in our customer base, stock price, or general reputation in the markets in which we operate. Reputational risk is heightened in the instance of publicity surrounding lawsuits or regulatory actions.
Rapidly changing interest rates or prolonged low market interest rates could reduce our net interest margin, net interest income, and net income.
Interest and fees on loans and investment securities, net of interest paid on deposits and borrowings, are the principal source of our revenues and thus an important driver of net income. Market interest rates and rate changes influence our net interest margin and are subject to many factors beyond our control. As market interest rates change, net interest income is affected. Increasing rates could also lead to decreased demand for loans, deposits, and other products that are priced based on interest rates. For example, rapid increases in interest rates could result in our interest expense increasing faster than interest income because of mismatches in financial instrument maturities. Additionally, extended periods of low market interest rates, such as we have today, may adversely affect our net interest spread and net interest income, because our earning assets yield decreases and stays low during a time that our cost of interest bearing liabilities is already low and cannot be correspondingly reduced further. For more information regarding interest rates, see the discussion under the section “Quantitative and Qualitative Disclosures about Market Risk” in the Item 7A of this report.
We face liquidity risks in the operation of our business.
Liquidity is crucial to the operation of Bancorp and the Bank. Liquidity risk is the potential that Bancorp or the Bank will be unable to fund increases in assets or meet payment obligations, including obligations to the Bank’s depositors, as they become due because of an inability to obtain adequate funding or liquidate assets at a reasonable cost. Funding illiquidity may arise at the Bank if we are unable to, at reasonable terms, attract and retain deposits, secure or renew borrowings from the overnight inter-bank market, the Federal Home Loan Bank of Seattle (the “FHLB”), or the Federal Reserve discount window, or access other sources of liquidity, as described in more detail under the heading “Liquidity and Sources of Funds” in Item 7 of this report. If we fail to monitor and control our liquidity risks, there may be materially adverse effects on our results of operations and financial condition.
We face operational risks that may result in unexpected losses.
We face various operational risks that arise from the potential that inadequate information systems, operational problems, failures in internal controls, breaches of our security systems, fraud, the execution of unauthorized transactions by employees, or any number of other unforeseen events could result in unexpected losses. Additionally, third party vendors provide key components of our business infrastructure such as internet connections, network access, data reporting, and data processing. Any problems caused by third parties could adversely affect our ability to deliver products and services to our customers, with related adverse affects on our revenues, expenses, and earnings. Replacing third party vendors, should that be necessary, may entail significant delay and expense.
Our information systems may experience an interruption or breach in security.
The Bank relies on its computer information systems in the conduct of its business. The Bank has policies and procedures in place to protect against and reduce the occurrences of failures, interruptions, or breaches of security of these systems, however, there can be no assurance that these policies and procedures will eliminate the occurrence of failures, interruptions or breaches of security or that they will adequately restore or minimize any such events. The occurrence of a failure, interruption or breach of security of the Bank's computer information systems could result in a loss of information, business or regulatory scrutiny, or other events, any of which could have a material adverse effect on our financial condition or results of operations.
The financial services industry is very competitive and any failure to develop, implement, and distribute competitive products to generate profitable revenue sources could affect our net income.
We face competition in attracting and retaining deposits, making, and retaining loans and providing other financial services. Our competitors include other community banks, larger banking institutions, and a wide range of other financial institutions, such as credit unions, government-sponsored enterprises, mutual fund companies, insurance companies and other non-bank businesses. Many of these competitors have substantially greater resources than we do. The challenging real estate market conditions and modest loan demand over the past few years have caused intense pricing pressures for loans to qualified borrowers, which impacts the spreads we obtain on loans. For a more complete discussion of our competitive environment, see the discussion under the heading “Competition” included in Item 1 of this report. If we are unable to compete effectively, we will lose market share and income from loans and other products may be reduced.
Inability to hire or retain key professionals, management, and staff could adversely affect our revenues and net income.
We rely on key personnel to manage and operate our business, including, but not limited to, major revenue generating functions such as our loan and deposit portfolios. The loss of key staff may adversely affect our ability to maintain and manage these portfolios effectively, which could negatively affect our revenues and earnings.
Market and other constraints on our loan origination volumes may lead to continued pressure on our interest and fee income.
Due to the continued weak economic conditions in the markets in which we operate and other factors, we expect continued pressure on new loan origination volumes in the near term, particularly with respect to construction loans, relative to such volumes generated in the pre-recession period. If we are unable to increase loan volumes, there will be continued pressure on our interest income and fees generated from our lending operations. Unless we are able to offset the lower interest income and fees with increased activity in other areas of our operations, our total revenues may decline relative to our total noninterest expenses. We expect that it may be difficult to find new revenue sources in the near term.
Our products and services are delivered on a technological platform that is subject to rapid change and transformation.
The financial services industry is undergoing rapid technological change and we face constant evolution of customer demand for technology-driven financial and banking products and services, including mobile banking applications. Many of our competitors have substantially greater resources to invest in technological improvement and product development, marketing, and implementation. Any failure to successfully keep pace with and fund technological innovation in the markets in which we compete could have a material adverse impact on our business and results of operations.
Our Common Stock trades in relatively limited volumes and a significant percentage continues to be owned by investors in the October 2009 Private Capital Raise, which may result in a share price that is volatile and which may be subject to downward pricing pressure in the event significant shareholders decide to dispose of shares of our Common Stock.
Our Common Stock trades on the NASDAQ Global Select Market under the symbol “WCBO" and trading volume is modest. The limited trading market for our Common Stock may lead to exaggerated fluctuations in market prices and possible market inefficiencies, as compared to a more actively traded stock. It may also make it more difficult to dispose of our shares at expected prices, especially for holders seeking to dispose of a large number of our shares. In addition, if a large shareholder or group of investors in our Private Capital Raise elects to sell their shares, such sales or attempted sales could result in significant downward pressure on the market price of our Common Stock and actual price declines.
Natural disasters could affect our ability to operate.
Our market areas are located in earthquake zones and our coastal markets are located in areas that are susceptible to tsunamis. Natural disasters can disrupt our operations, result in damage to our market areas and negatively affect the local economies in which we operate. We cannot predict whether or to what extent damage caused by future earthquakes or tsunamis will affect our operations or the economies in our market areas, but such events could result in an inability to continue business operations or cause a decline in loan originations, a decline in the value or destruction of properties securing our loans and an increase in the risk of delinquencies, foreclosures or loan losses.
The anticipated benefits of the Merger may not be realized.
The success of the Merger will depend, in part, on Columbia’s ability to successfully combine the Columbia and Bancorp organizations. If Columbia is not able to achieve this objective, the anticipated benefits of the Merger may not be realized fully or at all or may take longer than expected to be realized, and in turn may cause the price of Columbia’s common stock to fall. Columbia and Bancorp have operated and, until the completion of the Merger, will continue to operate, independently. It is possible that the integration process or other factors could result in the loss or departure of key employees, the disruption of the ongoing business of Bancorp or inconsistencies in standards, controls, procedures and policies. It is also possible that clients, customers, depositors and counterparties of Bancorp could choose to discontinue their relationships with the combined company pre- or post-Merger because they prefer doing business with an independent company or for any other reason, which would adversely affect the future performance of the combined company. These transition matters could have an adverse effect on Bancorp during the pre-Merger period and on the combined company for an undetermined time after the completion of the Merger.
The Merger Agreement limits Bancorp’s ability to pursue an alternative transaction and requires Bancorp to pay a termination fee of $20,000,000 under certain circumstances relating to alternative acquisition proposals.
The Merger Agreement prohibits Bancorp from soliciting, initiating, encouraging or knowingly facilitating certain alternative acquisition proposals with any third party, subject to exceptions set forth in the Merger Agreement. The Merger Agreement also provides for the payment by Bancorp to Columbia of a termination fee of $20,000,000 in the event that the Merger Agreement is terminated in certain circumstances, including, among others, certain changes in the recommendation of Bancorp’s board of directors, a failure of Bancorp’s shareholders to approve the Merger Agreement or the termination of the Merger Agreement in certain circumstances followed by an acquisition of Bancorp by a third party. These provisions may discourage a potential competing acquiror that might have an interest in acquiring Bancorp from considering or proposing such an acquisition.
The Merger is subject to the receipt of consents and approvals from governmental entities that may impose conditions that could have an adverse effect on Bancorp or the combined company following the Merger.
Before the Merger may be completed, various approvals and consents must be obtained from the Federal Reserve Board, the DFCS and various other securities, antitrust, and other regulatory authorities. These governmental entities may impose conditions on the granting of such approvals and consents. Although Columbia and Bancorp do not currently expect that any such material conditions or changes will be imposed, there can be no assurance that they will not be, and such conditions or changes could have the effect of delaying completion of the Merger or imposing additional costs or limiting the revenues of the combined company following the Merger, any of which might have an adverse effect on Bancorp or the combined company following the Merger. In addition, each of Columbia and Bancorp has agreed to use its reasonable best efforts to avoid or overcome impediments to completing the Merger, including, among other things, making expenditures and incurring costs, raising capital, divesting or otherwise disposing of businesses or assets, and effecting the dissolution, internal merger or consolidation of subsidiaries or enhancing internal controls. Such actions may entail costs and may adversely affect Bancorp, or the combined company following the Merger.
The Merger is subject to certain closing conditions that, if not satisfied or waived, will result in the Merger not being completed, which may cause the price of Bancorp common stock to decline.
The Merger is subject to customary conditions to closing, including the receipt of required regulatory approvals and approvals of the Columbia and Bancorp shareholders. If any condition to the Merger is not satisfied or waived, to the extent permitted by law, the Merger will not be completed. In addition, Columbia and Bancorp may terminate the Merger Agreement under certain circumstances even if the Merger Agreement is approved by Bancorp shareholders and the issuance of Columbia common stock in connection with the Merger is approved by Columbia shareholders. If Columbia and Bancorp do not complete the Merger, the trading price of Bancorp common stock may decline to the extent that the current price reflects a market assumption that the Merger will be completed. In addition, neither Bancorp nor Columbia would realize any of the expected benefits of having completed the Merger. If the Merger is not completed and Bancorp’s board of directors seeks another merger or business combination, Bancorp shareholders cannot be certain that Bancorp will be able to find a party willing to offer equivalent or more attractive consideration than the consideration Columbia has agreed to provide in the Merger. If the Merger is not completed, additional risks could materialize, which could materially and adversely affect the business, financial condition and results of operation of Bancorp.
The combined company expects to incur substantial expenses related to the Merger.
The combined company expects to incur substantial expenses in connection with completing the Merger and combining the business, operations, networks, systems, technologies, policies and procedures of the two companies. Although Columbia and Bancorp have assumed that a certain level of transaction and combination expenses would be incurred, there are a number of factors beyond their control that could affect the total amount or the timing of expenses. Many of the expenses that will be incurred, by their nature, are difficult to estimate accurately at the present time. Due to these factors, the transaction and combination expenses associated with the Merger and integration of the combined operations of Bancorp and Columbia could, particularly in the near term, exceed the savings that the combined company expects to achieve from the elimination of duplicative expenses and the realization of economies of scale and cost savings related to the combination of the businesses following the completion of the Merger. As a result of these expenses, both Columbia and Bancorp expect to take charges against their earnings before and after the completion of the Merger. The charges taken in connection with the Merger are expected to be significant, although the aggregate amount and timing of such charges are uncertain at present.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
The principal properties owned by the Bank include a 40,000-square-foot office and branch facility in downtown Salem, Oregon, a 15,600-square-foot office and branch facility in Newport, Oregon, and a 12,000-square-foot branch and office facility in Lacey, Washington. In total, the Bank owns 26 buildings, primarily to house branch offices. The Bank leases the land under seven buildings and owns the land under 19 buildings. In addition, the Bank leases 39 office spaces and buildings for branch locations.
Other non-branch office facilities are located in leased office space, including our headquarters office in Lake Oswego, Oregon, office and processing space in Salem, Oregon, where the Bank’s data center is located, space in Wilsonville, Oregon, where its loan servicing and operations center is located, space in Vancouver, Washington, and Lake Oswego, Oregon, where we have lending personnel and a branch office, and space in downtown Portland, where we have commercial banking personnel, West Coast Investment Services and West Coast Trust. In addition, we lease two smaller office spaces for lending personnel in Tukwila and Tacoma, Washington.
The aggregate monthly rental on 46 leased properties is approximately $368,000.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
On June 24, 2009, West Coast Trust was served with an Objection to Personal Representative's Petition and Petition for Surcharge of Personal Representative in Linn County Circuit Court. The petition was filed by the beneficiaries of the estate of Archie Q. Adams, for which West Coast Trust acts as the personal representative. The petitioners allege a breach of fiduciary duty with respect to West Coast Trust's prior sale of real property owned by the Adams estate and sought relief in the form of a surcharge to West Coast Trust of $215,573,115.60, the amount of the alleged loss to the estate. West Coast Trust filed a motion to dismiss on July 2, 2009, which was granted in a letter ruling dated September 15, 2009. Petitioners appealed and briefs have been filed. Appeals Court oral arguments were heard on November, 2012, and the Company has not yet received the Appeals Court decision. The Company believes the appeal and underlying petition are without merit.
On October 3, 2012, a class action complaint was filed in the Circuit Court of the State of Oregon for the County of Multnomah against Bancorp, its directors, and Columbia challenging the Merger (as defined above): Gary M. Klein v. West Coast Bancorp, et al., Case No. 1210-12431. The complaint names as defendants Bancorp, all of the current members of Bancorp’s board of directors, and Columbia. The complaint alleges that the Bancorp directors breached their fiduciary duties to Bancorp and Bancorp’s shareholders by agreeing to the proposed Merger at an unfair price. The complaint also alleges that the proposed Merger is being driven by an unfair process, that the directors approved provisions in the Merger Agreement that constitute preclusive deal protection devices, that certain large shareholders of Bancorp are using the merger as an opportunity to sell their illiquid holdings in Bancorp, and that Bancorp directors and officers will obtain personal benefits from the Merger not shared equally by other Bancorp shareholders. The complaint further alleges that Bancorp and Columbia aided and abetted the directors’ alleged breaches of their fiduciary duties. Thereafter, on October 23, 2012, a second lawsuit challenging the Merger was filed in the Circuit Court of the State of Oregon for Clackamas County: Leoni v. West Coast Bancorp et al., Case No. CV12100728. On December 11, 2012, the parties filed a stipulation and proposed order consolidating the two lawsuits for all purposes in the Circuit Court of the State of Oregon for Multnomah County, under the caption In re West Coast Bancorp Shareholder Litigation, Lead Case No. 1210-12431.
While Bancorp believes that the claims in both complaints are without merit, Bancorp agreed, in order to avoid the expense and burden of continued litigation and pursuant to the terms of the proposed settlement, to make in the joint proxy statement/prospectus concerning the proposed Merger certain supplemental disclosures related to the proposed Merger. Accordingly, on December 27, 2012, Bancorp and the other defendants in the two actions entered into a memorandum of understanding to settle both actions. The memorandum of understanding contemplates that the parties will enter into a stipulation of settlement. The stipulation of settlement will be subject to customary conditions, including court approval following notice to Bancorp’s stockholders. In the event that the parties enter into a stipulation of settlement, a hearing will be scheduled at which the Circuit Court of the State of Oregon for Multnomah County will consider the fairness, reasonableness, and adequacy of the settlement. If the settlement is finally approved by the court, it will resolve and release all claims in all actions that were or could have been brought challenging any aspect of the proposed Merger, the Merger Agreement, and any disclosure made in connection therewith, pursuant to terms that will be disclosed to stockholders before final approval of the settlement. There can be no assurance that the parties will ultimately enter into a stipulation of settlement or that the Circuit Court of the State of Oregon for Multnomah County will approve the settlement even if the parties were to enter into such stipulation. In such event, the proposed settlement as contemplated by the memorandum of understanding may be terminated.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
None.
PART II
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Stock Price and Dividends
Bancorp Common Stock trades on the NASDAQ Global Select Market under the symbol “WCBO.” The high and low closing sale prices per share of our Common Stock for each quarter during the last two years are shown in the table below, together with dividend information for each period. The prices below do not include retail mark-ups, mark-downs or commissions, may not represent actual transactions and are not adjusted for dividends. As of December 31, 2012, there were approximately 1,600 holders of record of our Common Stock.
Payment of dividends by Bancorp is limited under federal and Oregon laws and regulations pertaining to Bancorp’s financial condition. Payment of dividends by the Bank is also subject to limitation under state and federal banking laws and by actions of state and federal banking regulators. For more information on this topic, see the discussion under the section “Supervision and Regulation” included in Item 1 of this report and the section “Liquidity and Sources of Funds” included in Item 7 of this report.
Information regarding securities authorized for issuance under equity compensation plans is incorporated by reference from Part III, Item 12 of this report.
Issuer Purchases of Equity Securities
The following table provides information about purchases of Common Stock by the Company during the quarter ended December 31, 2012:
Shares repurchased by Bancorp during the quarter include shares repurchased from employees in connection with cancellation of restricted stock to pay withholding taxes totaling 124 shares, 0 shares, and 0 shares, respectively, for the periods indicated. There were no shares repurchased in the periods indicated pursuant to the Company’s corporate stock repurchase program publicly announced in July 2000 (the “Repurchase Program”) and described in footnote 2 below.
Under the Repurchase Program, the board of directors originally authorized the Company to purchase up to 66,000 common shares, which amount was increased by 110,000 shares in September 2000, by .2 million shares in September 2001, by .2 million shares in September 2002, by .2 million shares in April 2004, and by .2 million shares in September 2007 for a total authorized repurchase amount as of December 31, 2012, of approximately 1.0 million shares. 210,000 shares remain available for repurchase under the plan. The Company is required to advise and consult with the Federal Reserve prior to stock repurchases.
Five Year Stock Performance Graph
The following chart compares the yearly percentage change in the cumulative shareholder return on our Common Stock during the five years ended December 31, 2012, with (1) the Total Return Index for the NASDAQ Stock Market (U.S. Companies) and (2) the Total Return Index for NASDAQ Bank Stocks. This comparison assumes $100.00 was invested on December 31, 2007, in our Common Stock and the comparison groups and assumes the reinvestment of all cash dividends prior to any tax effect and retention of all stock dividends. Bancorp’s total cumulative return was -71.9% over the five year period ended December 31, 2012, compared to -20.3% and 20.4% for the NASDAQ Bank Stocks and NASDAQ composite, respectively.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
Consolidated Five Year Financial Data
The following selected consolidated five year financial data should be read in conjunction with Bancorp’s audited consolidated financial statements and the related notes to those statements presented in Item 8 of this report.
The efficiency ratio has been computed as noninterest expense divided by the sum of net interest income on a tax equivalent basis and noninterest income excluding gains/losses on sales of securities.
Interest earned on nontaxable securities has been computed on a 35% tax equivalent basis.
Consolidated Quarterly Financial Data
The following table presents selected consolidated quarterly financial data for each quarter of 2011 and 2012. The financial information contained in this table reflects all adjustments, which, in the opinion of management, are necessary for a fair presentation of the results of the interim periods.
Due to averaging of shares, quarterly earnings per share may not add up to the totals reported for the full year
Ratios have been annualized.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the audited consolidated financial statements and related notes to those statements during the periods included in the consolidated financial statements of West Coast Bancorp and its subsidiaries that appear in Item 8 “Financial Statements and Supplementary Data” of this report. References to “we,” “our” or “us” refer to West Coast Bancorp and its subsidiaries.
Forward-Looking Statement Disclosure
Statements in this Annual Report of West Coast Bancorp (“Bancorp” or the “Company”) regarding future events or performance are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 (the “PSLRA”) and are made pursuant to the safe harbors of the PSLRA. These forward-looking statements include, but are not limited to, (i) statements about the benefits of the Merger (as defined below), including future financial and operating results, cost savings, enhancements to revenue and accretion to reported earnings that may be realized from the Merger; and (ii) statements about Columbia Banking System, Inc.’s (“Columbia”) and Bancorp’s respective plans, objectives, expectations and intentions and other statements that are not historical facts. The Company’s actual results could be quite different from those expressed or implied by the forward-looking statements. Words such as “could,” “may,” “should,” “plans,” “believes,” “anticipates,” “estimates,” “predicts,” “expects,” “projects,” “potential,” or “continue,” or words of similar meaning, often help identify “forward-looking statements,” which include any statements that expressly or implicitly predict future events, results, or performance. These forward-looking statements are based on current beliefs and expectations of Columbia’s and Bancorp’s managements, and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond Columbia’s and Bancorp’s control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. Factors that could cause events, results or performance to differ from those expressed or implied by our forward-looking statements include, among others, risks discussed in Item 1A, “Risk Factors” of this report, risks discussed elsewhere in the text of this report, as well as the following specific factors:
General economic conditions, whether national or regional, and conditions in real estate markets, that may hinder our ability to increase lending activities or have an adverse effect on the demand for our loans and other products, our credit quality and related levels of nonperforming assets and loan losses, and the value and salability of the real estate that we own or that is the collateral for many of our loans;
Changing bank regulatory conditions, policies, or programs, whether arising as new legislation or regulatory initiatives, that could lead to restrictions on activities of banks, increased costs, price controls on debit card interchange, or prohibition of certain income producing activities, or changes in the secondary market for bank loan and other products;
Competitive factors, including competition with community, regional and national financial institutions, that may lead to pricing pressures that reduce yields the Bank earns on loans and increase rates the Bank pays on deposits, the loss of our most valued customers, defection of key employees or groups of employees, or other losses;
Increasing or decreasing interest rate environments, including changes in the slope and level of the yield curve, which may be caused by the Federal Reserve Bank’s public comments about future direction and level of interest rates, that could lead to decreases in net interest margin, lower net interest and fee income, including lower gains on sales of loans, and changes in the value of our investment securities;
Failure to develop, implement, and distribute competitive and client value added products, that may adversely affect our ability to generate profitable revenue sources;
Changes or failures in technology or third party vendor relationships in important revenue production or service areas or increases in required investments in technology that could reduce our revenues, increase our costs, or lead to disruptions in our business;
The possibility that our proposed Merger with Columbia (the “Merger”) may not close when expected or at all because required regulatory, shareholder or other approvals or conditions to the closing of the Merger are not received or are not satisfied on a timely basis or at all;
Changes in Columbia’s stock price, before closing of the Merger, including those which result from the financial performance of Columbia and/or Bancorp prior to closing, or more generally due to broader stock market movements or the performance of financial companies and peer group companies;
Expected benefits from the Merger may not be fully realized or may take longer to realize than expected, including as a result of changes in general economic and market conditions, interest rates, monetary policy, laws and regulations and their enforcement, and the degree of competition in the geographic and business areas in which Bancorp operates;
Bancorp’s business may not be integrated into Columbia’s successfully, or such integration may take longer to accomplish than expected;
Operating costs, customer relationship losses and business disruptions relating to the Merger, including adverse developments in relationships with employees may be greater than expected;
The anticipated growth opportunities and cost savings from the Merger may not be fully realized or may take longer to realize than expected; and
Management time and effort may be diverted to resolving merger-related issues.
Furthermore, forward-looking statements are subject to risks and uncertainties related to the Company’s ability to, among other things: dispose of properties or other assets obtained through foreclosures at expected prices and within a reasonable period of time; attract and retain key personnel; generate loan and deposit balances at projected spreads; sustain fee generation including gains on sales of loans; maintain asset quality and control risk; limit the amount of net loan charge-offs; adapt to changing customer deposit, investment and borrowing behaviors; control expenses; and monitor and manage its financial reporting, operating and disclosure control environments.
Readers are cautioned not to place undue reliance on our forward-looking statements, which reflect management’s analysis only as of the date of the statements. We do not intend to publicly revise or update forward-looking statements to reflect events or circumstances that arise after the date of this report.
Readers should carefully review all disclosures we file from time to time with the Securities and Exchange Commission (“SEC”).
Overview
Financial Overview
The Company’s operating highlights in 2012 included:
Pre-tax income of $35.8 million, which includes $1.7 million of merger-related expenses, represents an increase of $22.2 million from $13.6 million in 2011;
A provision for income taxes of $12.2 million, compared to a benefit of $20.2 million in 2011 which was largely caused by the reversal of a significant deferred tax asset valuation allowance in the fourth quarter of 2011 that was accumulated in prior years;
Net income of $23.5 million compared to $33.8 million in 2011, which was impacted by the reversal of the deferred tax asset valuation allowance;
A return on average assets of .97%;
An average rate paid on total deposits of .09%, a decline from .26% in 2011;
A benefit for credit losses of $1.0 million, compared to a provision for credit losses of $8.1 million in 2011;
Net loan charge-offs of $4.7 million, a decline from $13.2 million in 2011;
Net other real estate owned (“OREO”) valuation adjustments and gains and losses on sales of $2.8 million, a reduction from $3.2 million in 2011;and
Operating noninterest expense, excluding merger-related charges, of $82.3 million, a 9% reduction from $90.9 million in 2011.
The financial condition of Bancorp and the Bank continued to strengthen in 2012, as evidenced by:
The Bank’s Total and Tier 1 risk-based capital ratios increasing to 21.20% and 19.95%, respectively, at December 31, 2012, up from 19.92% and 18.66% at December 31, 2011;
The Bank’s leverage ratio improving to 15.07% at December 31, 2012, from 14.09% a year ago; and
Total nonperforming assets decreasing by 42% or $30.2 million over the past twelve months to $41.2 million at year end 2012.
The Company’s Board of Directors declared and the Company paid a cash dividend of $.05 per share common share and $.50 per share of Series B Preferred Stock for third and fourth quarters 2012, with the fourth quarter dividend paid in January 2013. Amounts paid to holders of Series B Preferred Stock are equal to amounts that would have been received if such Series B preferred stock had been converted to common stock prior to payment of the dividend. The declaration of the dividends reflected the Company’s strong capital position and continued profitability.
Agreement and Plan of Merger
On September 25, 2012, Bancorp entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Columbia Banking System, Inc., a Washington corporation (“Columbia”). Under the terms of the Merger Agreement a newly formed subsidiary of Columbia will merge with and into Bancorp (the “Merger”), with Bancorp continuing as the surviving corporation (the “Surviving Corporation”). As soon as reasonably practicable following the Merger, and as part of a single integrated transaction, the Surviving Corporation will be merged with and into Columbia (together with the Merger, the “Mergers”).
Subject to the terms and conditions of the Merger Agreement, at the effective time of the Merger, Bancorp shareholders will have the right, with respect to each of their shares of Bancorp common stock, to elect to receive, subject to proration and adjustment, either cash, stock, or a unit consisting of a mix of cash and stock in an amount equal to their pro rata share (taking into account Class C Warrants and in-the-money stock options on an as-exercised basis and shares of common stock issuable upon conversion of Series B Preferred Stock (including shares of Series B Preferred Stock issuable upon exercise of Class C Warrants)) of the total consideration, which consists of $264,468,650 in cash (subject to adjustment in certain circumstances), plus the product of 12,809,525 shares of Columbia common stock multiplied by the volume weighted average price of Columbia common stock for the twenty trading day period beginning on the twenty fifth day before the effective time of the Merger.
The Merger Agreement contains customary representations and warranties from both Bancorp and Columbia. Bancorp has also agreed to various customary covenants and agreements, including, among others, (1) to conduct its business in the ordinary course consistent with past practice in all material respects during the interim period between the execution of the Merger Agreement and the consummation of the Merger, (2) not to engage in certain kinds of transactions or take certain actions during this period without the prior written consent of Columbia (which may not be unreasonably withheld), (3) subject to certain exceptions, to convene and hold a meeting of its shareholders to consider and vote upon the Merger Agreement, (4) to recommend approval of the Merger Agreement to its shareholders and, subject to certain exceptions, not to withdraw or materially and adversely modify such recommendation, (5) not to initiate, solicit, encourage or knowingly facilitate any alternative proposal to acquire Bancorp, and (6) subject to certain exceptions, not to provide any non-public information in connection with any such alternative proposal, or engage in any discussions relating to any such proposal. Columbia has also agreed to various customary covenants and agreements.
The consummation of the Merger is subject to customary conditions, including, among others, (1) approval by Bancorp shareholders of the Merger Agreement, (2) approval by Columbia shareholders of the issuance of Columbia common stock in connection with the Merger, (3) effectiveness of the registration statement on Form S-4 for the Columbia common stock to be issued in the Merger, (4) authorization for listing on the NASDAQ Stock Exchange of the shares of Columbia common stock to be issued in the Merger, (5) the absence of any law, order, injunction or decree prohibiting or making illegal the closing of the Merger or the other transactions contemplated by the Merger Agreement and (6) receipt of required regulatory approvals. Each party’s obligation to consummate the Merger is also subject to certain additional customary conditions, including (i) subject to certain exceptions, the accuracy of the representations and warranties of the other party, (ii) performance in all material respects by the other party of its obligations and (iii) the receipt by such party of an opinion from its counsel to the effect that the Mergers, taken together, will qualify as a reorganization within the meaning of Section 368(a) of the Internal Revenue Code of 1986, as amended.
The Merger Agreement contains certain termination rights in favor of each of Columbia and Bancorp. Upon termination of the Merger Agreement under certain circumstances, Bancorp will be obligated to pay Columbia a termination fee of $20 million. Upon termination of the Merger Agreement in certain other limited circumstances, Columbia will be obligated to pay Bancorp a termination fee of $5 million.
Certain terms of the Merger Agreement and other related agreements are summarized in, and the Merger Agreement has been filed as an exhibit to, the Current Report on Form 8-K filed by Bancorp with the Securities and Exchange Commission on October 1, 2012.
Current Regulatory Matters
As of February 19, 2013, the regulatory order (the “Order”) between the Bank and the FDIC was terminated. On October 18, 2011, the Bank received the Order from the FDIC relating to its overdraft practices. As part of the Order, the Bank agreed to implement certain procedural improvements relating to its compliance function and overdraft program, pay a civil money penalty of $390,000, and make restitution to certain customers in accordance with the formula set out in the Order of approximately $246,000.
As of June 27, 2012, the Written Agreement between Bancorp and the Federal Reserve Bank of San Francisco (“Federal Reserve”) and the Oregon Department of Consumer and Business Services Division of Finance and Corporate Securities (“DFCS”) was terminated. The Federal Reserve continues to require that we inform and consult with it and seek a non-objection notice ahead of declaring and paying cash dividends to shareholders. Bancorp received such non-objection notice in conjunction with the $.05 per share shareholder cash dividends declared by its Board of Directors on September 25, 2012, and December 11, 2012, paid in October 2012 and January 2013.
As of November 29, 2012, the Memorandum of Understanding (“MOU”) between West Coast Bank, the FDIC and DFCS was also terminated. The MOU required that during the life of the MOU the Bank would not pay dividends without the written consent of the FDIC and DFCS and that the Bank maintained higher levels of capital than required by published capital adequacy requirements.
Income Statement Overview
Our net income for the full year 2012 was $23.5 million, compared to $33.8 million in 2011 and $3.2 million in 2010. Earnings per diluted share for the years ended December 31, 2012, 2011, and 2010 were $1.08, $1.58, and $.16, respectively. Return on average assets was .97% in 2012, a decline from 1.37% in 2011 and an increase from .13% in 2010. In 2011, net income, earnings per share, and return on assets benefited materially from the full reversal of the Company’s deferred tax asset valuation allowance. Our full year 2012 pre-tax income was $35.8 million, or $37.5 million excluding merger-related expenses of $1.7 million, and represented an increase of $23.9 million from $13.6 million in 2011. The increase in the 2012 pre-tax income as compared to 2011 pre-tax income was primarily due to an increase in net interest income and reductions in the provision for credit losses and noninterest expense. The improved net income in 2011 when compared to 2010 was primarily due to the reversal of the Company’s deferred tax asset valuation allowance and a reduction in provision for credit losses in 2011 compared to 2010.
Net Interest Income, Average Balances, Yields Earned, and Rates Paid. The following table displays information on net interest income, average yields earned and rates paid, as well as net interest spread and margin information on a tax equivalent basis for the periods indicated. The adjustment to a taxable equivalent basis increases interest income by an estimate of the additional yield that would have been received by the Company if its tax-exempt securities had been taxable at the statutory rate. This information can be used to follow the changes in our yields and rates and the changes in our earning assets and liabilities over the past three years:
Interest earned on nontaxable securities has been computed on a 35% tax equivalent basis.
Net interest income on a tax equivalent basis totaled $88.2 million for the year ended December 31, 2012, an increase of $6.3 million or 7.7% from $81.9 million in 2011. The net interest margin increased 35 basis points to 3.87% in 2012 from 3.52% in 2011. The increase in net interest income and margin from 2011 to 2012 was primarily due to Federal Home Loan Bank of Seattle (the “FHLB”) borrowing prepayment charges of $7.1 million in 2011 and the resulting benefit in 2012 from refinancing the majority of the FHLB borrowings in 2011 at lower rates. Excluding the prepayment charge, the net interest margin in 2011 would have been 3.83%. The 2012 net interest income and margin also benefited from lower rates paid on interest bearing deposits and a continued change in deposit mix to lower cost demand deposits and the lower volume of FHLB borrowings. The combined favorable effect from these factors more than offset the impact from lower loan average balances and lower yields on both loan and investment securities portfolios in 2012 compared to 2011. In 2010, net interest income on a tax equivalent basis was $84.5 million and the net interest margin was 3.48%. The $2.6 million decrease in net interest income from 2010 to 2011 was principally due to FHLB borrowing prepayment charges of $7.1 million in 2011, an increase from $2.3 million in 2010. Additionally, the benefits from lower rates paid on interest bearing deposits, a change in the mix to lower cost demand deposits, as well as lower cash balances at the Federal Reserve, more than offset lower loan balances, a significant shift in the Company’s earning assets mix from loan to investment securities balances, and lower yields on both loan and investment securities portfolios.
Changing interest rate environments, including the slope, level of, and changes in the yield curve, competitive pricing pressure, and changing economic conditions, could lead to higher deposit and borrowing costs, lower loan yields, reduced net interest margin and spread and lower loan fees, all of which could lead to additional pressure on our net interest income. For more information regarding interest rates, see the discussion under the section “Quantitative and Qualitative Disclosures about Market Risk” in the Item 7A
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk
Interest rate, credit and operations risks are the most significant market risks impacting our performance. Other types of market risk, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of our business activities. We rely on loan reviews, prudent loan underwriting standards and an adequate allowance for credit losses to mitigate credit risk. Interest rate risk is reviewed at least quarterly by the Asset Liability Management Committee (“ALCO”) which includes senior management representatives. The ALCO manages our balance sheet to maintain net interest income and present value of equity within acceptable ranges.
Asset/liability management simulation models are used to measure interest rate risk. The models quantify interest rate risk by simulating forecasted net interest income over a 12-month time horizon under various rate scenarios, as well as monitoring the change in the present value of equity under the same rate scenarios. The present value of equity is defined as the difference between the market value of current assets less current liabilities. By measuring the change in the present value of equity under different rate scenarios, management can identify interest rate risk that may not be evident in simulating changes in forecasted net interest income. Readers are referred to the sections, “Forward Looking Statement Disclosure” and “Risk Factors” of this report in connection with this discussion of market risks.
The following table shows the approximate percentage changes in forecasted net interest income over a 12-month period and in the present value of equity under several rate scenarios. For the net interest income analysis, three rate scenarios are compared to a stable (unchanged from December 31, 2012) rate scenario:
As illustrated in the above table, we estimate our balance sheet was slightly asset sensitive over a 12 month horizon at December 31, 2012, meaning that interest earning assets are expected to mature or reprice more quickly than interest-bearing liabilities in a given period. A decrease in market rates of interest could adversely affect net interest income, in part due to cost of our interest bearing liabilities already being very low, while an increase in market rates may increase net interest income slightly. At December 31, 2011, we also estimated that our balance sheet was slightly asset sensitive. We attempt to limit our interest rate risk through managing the repricing characteristics of our assets and liabilities.
For the present value of equity analysis, the results are compared to the net present value of equity using the yield curve as of December 31, 2012. This curve is then shifted up and down and the net present value of equity is computed. The net present value of equity is the difference between the present value of assets and the present value of liabilities. It is useful for assessing longer term interest rate risk. This table does not include flattening or steepening yield curve effects.
It should be noted that the simulation model does not take into account future management actions that could be undertaken should a change occur in actual market interest rates during the year. Also, certain assumptions are required to perform modeling simulations that may have a significant impact on the results. These include important assumptions regarding the level of interest rates and balance changes on deposit products that do not have stated maturities, as well as the relationship between loan yields and deposit rates relative to market interest rates. These assumptions have been developed through a combination of industry standards and future expected pricing behavior but could be significantly influenced by future competitor pricing behavior. The model also includes assumptions about the composition of the balance sheet. The results derived from the simulation model could vary significantly due to external factors such as changes in the prepayment assumptions, early withdrawals of deposits and competition. Any transaction activity will also have an impact on the asset/liability position as new assets are acquired and added.
Interest Rate Sensitivity (Gap) Table
The primary objective of our asset/liability management is to maximize net interest income while maintaining acceptable levels of interest-rate sensitivity. We seek to meet this objective through influencing the maturity and repricing characteristics of our assets and liabilities.
The following table sets forth the estimated maturity and repricing and the resulting interest rate gap between interest earning assets and interest bearing liabilities at December 31, 2012. The amounts in the table are derived from internal Bank data regarding maturities and next repricing dates including contractual repayments.
1 Equity investments have been placed in the 0-3 month category.
Repricing is based on anticipated call dates and may vary from contractual maturities.
3 Repricing is based on estimated average lives.
Certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, savings, interest bearing demand and money market deposit accounts will very likely experience a change in deposit rates more frequently than in their estimated average lives. Additionally, although certain assets and liabilities may have similar maturities and periods of repricing, they may react differently to changes in market interest rates and be impacted by loans that have reached their floor. Also, interest rates on assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other assets and liabilities may follow changes in market interest rates. Given these shortcomings, management believes that rate risk is best measured by simulation modeling as opposed to measuring interest rate risk through interest rate gap measurement.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following audited consolidated financial statements and related documents are set forth in this Annual Report on Form 10-K on the pages indicated:
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
West Coast Bancorp
Lake Oswego, Oregon
We have audited the accompanying consolidated balance sheets of West Coast Bancorp and subsidiaries (the “Company”) as of December 31, 2012 and 2011, 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, 2012. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of West Coast Bancorp and subsidiaries as of December 31, 2012 and 2011, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2012, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2012, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 8, 2013 expressed an unqualified opinion on the Company’s internal control over financial reporting.
/s/ DELOITTE & TOUCHE LLP
Portland, Oregon
March 8, 2013
WEST COAST BANCORP
CONSOLIDATED BALANCE SHEETS
See notes to consolidated financial statements.
WEST COAST BANCORP
CONSOLIDATED STATEMENTS OF INCOME
See notes to consolidated financial statements.
WEST COAST BANCORP
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
See notes to consolidated financial statements.
WEST COAST BANCORP
CONSOLIDATED STATEMENTS OF CASH FLOWS
See notes to consolidated financial statements.
WEST COAST BANCORP
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
See notes to consolidated financial statements.
WEST COAST BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations. West Coast Bancorp (“Bancorp” or “the Company”) provides a full range of financial services including lending and depository services through West Coast Bank and its 58 branch banking offices in Oregon and Washington. West Coast Trust Company, Inc. (“West Coast Trust”) provides fiduciary, agency, trust and related services, and life insurance products.
Principles of Consolidation. The accompanying consolidated financial statements include the accounts of Bancorp, and its wholly-owned subsidiaries, West Coast Bank (the “Bank”), West Coast Trust and Totten, Inc., after elimination of material intercompany transactions and balances. West Coast Statutory Trusts III, IV, V, VI, VII and VIII are considered related parties to Bancorp and their financial results are not consolidated in Bancorp’s financial statements. Junior subordinated debentures issued by the Company to West Coast Statutory Trusts are included on the Company’s consolidated balance sheets as junior subordinated debentures.
Basis of Financial Statement Presentation and the Use of Estimates in the Financial Statements. The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and with prevailing practices within the banking and securities industries. Management is required to make certain estimates and assumptions when preparing the financial statements that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the balance sheet and the amounts of income and expense for the reporting period. Actual results could differ significantly from management’s estimates. Certain material estimates subject to significant change relate to the determination of the allowance for credit losses, the provision or benefit for income taxes, and the fair value of investments and other real estate owned. Immaterial reclassifications related to prior year amounts of Trading Securities in the Balance Sheet have been made to conform to current presentation and Statement of Cash Flows.
Subsequent Events. The Company has evaluated events and transactions for potential recognition or disclosure through the date the financial statements were issued.
Cash and Cash Equivalents. Cash and cash equivalents include cash on hand, interest bearing deposits in other banks, amounts due from banks and federal funds sold. Generally, federal funds are purchased or sold for one-day periods.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Supplemental Cash Flow Information. The following table presents supplemental cash flow information for the years ended December 31, 2012, 2011, and 2010.
Investment Securities Available for Sale. Investment securities classified as available for sale are not trading securities but may be sold before maturity in response to changes in the Company’s interest rate risk profile, funding needs or demand for collateralized deposits by public entities. Available for sale securities are carried at fair value with unrealized gains and losses, net of any tax effect, reported within accumulated other comprehensive income in stockholders’ equity. Premiums and discounts are amortized or accreted over the estimated life of the investment security as an adjustment to the yield. For purposes of computing realized gains and losses, the cost of securities sold is determined using the specific identification method. The Company analyzes investment securities for other-than-temporary impairment (“OTTI”) on a quarterly basis. For equity securities where declines in fair value are deemed other-than-temporary and the Company does not have the ability and intent to hold the securities until recovery, OTTI is recognized in noninterest income. The Company considers whether a debt security will be sold or if it is likely to be required to be sold prior to the recovery of any unrealized loss. Intent to sell or a requirement to sell debt securities prior to recovery would result in recognizing the entire impairment as OTTI in noninterest income. If the Company does not intend to sell impaired debt securities, will not be required to sell them prior to recovery, and the Company does not expect to recover its entire amortized cost basis of the securities, the portion of impairment loss specifically related to credit losses is recognized in noninterest income. The portion of impairment loss related to all other factors is recognized as a separate category in other comprehensive income.
Valuation of Investment Securities Available for Sale. Investment securities are valued utilizing a number of methods including quoted prices in active markets, quoted prices for similar assets, quoted prices for securities in inactive markets and inputs derived principally from or corroborated by observable market data by correlation or other means. In addition, certain investment securities are valued based on the Company’s own assumptions using the best information available using a discounted cash flow model.
Federal Home Loan Bank Stock. Federal Home Loan Bank of Seattle (the “FHLB”) stock is carried at cost which equals its par value because the shares can only be redeemed with the FHLB at par and it lacks a market. The Bank is required to maintain a minimum level of investment in FHLB stock based on specific percentages of its outstanding mortgages and FHLB advances. Stock redemptions are at the discretion of the FHLB or of the Company, upon prior notice to the FHLB of five years for FHLB B stock or six months for FHLB A stock. The Bank considers FHLB stock a restricted security. The Company periodically analyzes FHLB stock for OTTI. The evaluation of OTTI on FHLB stock is based on an assessment of the ultimate recoverability of cost rather than recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of cost is influenced by criteria such as (a) the significance of any decline in net assets of the FHLB as compared to the capital stock amount for the FHLB and the length of time this situation has persisted, (b) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLB, (c) the impact of legislative and regulatory changes on institutions and, accordingly, the customer base of the FHLB, and (d) the liquidity position of the FHLB. The Company analyzed FHLB stock for OTTI and concluded that no impairment exists at December 31, 2012.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Loans Held for Sale. At December 31, 2011, loans held for sale includes mortgage loans that are carried at the lower of cost or market value. During the year ending December 31, 2012, the Company discontinued funding mortgage loans that were sold on the secondary market. The Company changed its business model to act as a direct broker between clients and third party purchasers of mortgage loans. Fees for these services are recognized in income when realized. The Company originates loans to customers under Small Business Administration (“SBA”) programs that generally provide for SBA guarantees of 50% to 85% of each loan. We periodically sell the guaranteed portion of certain SBA loans to investors and retain the unguaranteed portion and servicing rights in our loan portfolio. SBA loans are recorded and held within the loan portfolio until designated to be sold. Gains on these sales are earned through the sale of the guaranteed portion of the loan for an amount in excess of the adjusted carrying value of the portion of the loan sold. We allocate the carrying value of such loans between the portion sold, the portion retained and a value assigned to the right to service the loan. The difference between the adjusted carrying value of the portion retained and the face amount of the portion retained is amortized to interest income over the life of the related loan using a straight-line method over the anticipated lives of the pool of SBA loans. We record a gain on sale of SBA loans at the date of transfer of the loan.
Loans. Loans are reported at the amount of unpaid principal balance outstanding net of unearned income and deferred fees and costs. Loan and commitment fees and certain direct loan origination costs are deferred and recognized over the life of the loan and/or commitment period as yield adjustments. Interest income on loans is accrued daily on the unpaid principal balance outstanding as earned.
Nonaccrual Loans. Loans (including impaired loans) are placed on nonaccrual status when the collection of interest or principal has become 90 days past due or is otherwise considered doubtful. When a loan is placed on nonaccrual status, the Company stops accruing interest and unpaid accrued interest is reversed. In addition, the Company stops amortizing deferred fees and costs. For certain real estate construction loans accrued unpaid interest as well as qualifying capitalized interest is reversed. When management determines that the ultimate collectability of principal is in doubt, cash receipts on nonaccrual loans are applied to reduce the principal balance on a cash-basis method until the loans qualify for return to interest accruing status. Loans are returned to interest accruing status when management expects collection of contractual loan payments and the borrower has demonstrated six months of compliance with the contractual terms of the loan.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Impaired Loans. A loan is considered to be impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due (both interest and principal) according to the contractual terms of the loan agreement. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, as a practical expedient, at the loan’s observable market price or the fair market value of the collateral less selling costs if the loan is collateral dependent. For loans that are collateral dependent the Company charges off the amount of impairment at the time of impairment, rather than placing the impaired loan amount in a specific reserve allowance. Known impairments on non-real estate secured loans are charged off immediately rather than recording a specific reserve allowance in the allowance for loan losses.
Troubled Debt Restructurings. A loan is accounted for as a troubled debt restructuring if the Company, for economic or legal reasons related to the borrower’s financial difficulties, grants a concession to the borrower that it would not otherwise consider. A troubled debt restructuring typically involves a modification of terms such as a reduction of the stated interest rate or face amount of the loan, a reduction of accrued interest, or an extension of the maturity date(s) at a stated interest rate lower than the current market rate for a new loan with similar risk. Troubled debt restructurings are considered impaired loans and as such are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, as a practical expedient, at the loan’s observable market price or the fair market value of the collateral less selling costs if the loan is collateral dependent. Performing troubled debt restructurings not on nonaccrual status are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate based on a current documented evaluation supporting management’s expectation of performance.
Allowance for Credit Losses. The allowance for credit losses is comprised of two components, the allowance for loan losses and the reserve for unfunded commitments. The allowance for loan losses is an estimation of losses incurred for outstanding loan balances, while the reserve for unfunded commitments is based upon an estimation of incurred loss for the portion of total loan commitments not yet funded for the period reported.
The allowance for credit losses is based on management’s estimates. Management determines the adequacy of the allowance for credit losses based on evaluations of the loan portfolio, recent loss experience and other factors, including economic conditions. The Company determines the amount of the allowance for credit losses required for certain sectors based on relative risk characteristics of the loan portfolio. Actual losses may vary from current estimates. These estimates are reviewed periodically and, as adjustments become necessary, are reported in earnings in the periods in which they become known. The allowance for credit losses is increased by provisions for credit losses in earnings. Loan charge-offs reduce the allowance while recoveries are credited to the allowance.
Commitments to Extend Credit. Unfunded loan commitments are generally related to providing credit facilities to customers of the bank and are not actively traded financial instruments. These unfunded commitments are disclosed as commitments to extend credit in Note 18 “Financial Instruments with Off Balance Sheet Risk” in the notes to consolidated financial statements.
Reserve for Unfunded Commitments. As a component of allowance for credit losses, a reserve for unfunded commitments is maintained at a level that, in the opinion of management, is adequate to absorb losses associated with the Bank’s commitment to lend funds under existing agreements such as letters or lines of credit or construction loans. Management determines the adequacy of the reserve for unfunded commitments based upon reviews of individual credit facilities, current economic conditions, the risk characteristics of the various categories of commitments as well as pooled commitments with similar risk characteristics and other relevant factors. The reserve is based on estimates, and ultimate losses may vary from the current estimates. These estimates are evaluated on a regular basis and, as adjustments become necessary, they are reported in the provision for credit losses in the income statement in the periods in which they become known.
Other Real Estate Owned (“OREO”). OREO is real property of which the Bank has taken possession or that has been deeded to the Bank through a deed-in-lieu of foreclosure, non-judicial foreclosure, judicial foreclosure or similar process in partial or full satisfaction of a loan or loans. In addition, the Bank owns a closed branch building that is considered OREO. OREO is initially recorded at the lower of the carrying amount of the loan or fair value of the property less estimated costs to sell. This amount becomes the property’s new basis. Management considers third party appraisals as well as independent fair market value assessments from realtors or persons involved in selling OREO in determining the fair value of particular properties. Accordingly, the valuation of OREO is subject to significant external and internal judgment. Management also reviews OREO at least annually to determine whether the property continues to be carried at the lower of its recorded book value or fair value, net of estimated costs to sell. Any further OREO valuation adjustments or subsequent gains or losses on the final disposition of OREO are charged to other real estate owned valuation adjustments and (loss) gain on sales. Expenses from the maintenance and operations of OREO are included in other noninterest expense in the statements of income.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Premises and Equipment. Premises and equipment are stated at cost, less accumulated depreciation and amortization. Land is carried at cost. Depreciation is computed on the straight-line method over the estimated useful lives of the related assets. In general, furniture and equipment is amortized over a useful life of 3 to 10 years, software and computer related equipment is amortized over 3 to 5 years and buildings are amortized over periods up to 40 years. Leasehold improvements are amortized over the life of the related lease, or the life of the related assets, whichever is shorter. Expenditures for major renovations and betterments of the Company’s premises and equipment are capitalized. Improvements are capitalized and depreciated over their estimated useful lives. Minor repairs, maintenance and improvements are charged to operations as incurred. When property is replaced or otherwise disposed of, the cost of such assets and the related accumulated depreciation are removed from their respective accounts. Related gain or loss, if any, is recorded in current operations.
Income Taxes. Income taxes are accounted for using the asset and liability method. Under this method, a deferred tax asset or liability is determined based on the enacted tax rates that will be in effect when the differences between the financial statement carrying amounts and tax basis of existing assets and liabilities are expected to be reported in Bancorp’s income tax returns. The deferred tax provision (benefit) for the year is equal to the net change in the net deferred tax asset from the beginning to the end of the year, less amounts applicable to the change in value related to investment securities available for sale. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. The Company records net deferred tax assets to the extent these assets will more likely than not be realized. In making such determination, the Company assesses the available positive and negative evidence including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies and recent financial results. A deferred tax asset valuation allowance is established to reduce the net carrying amount of deferred tax assets if it is determined to be more likely than not, that all or some portion of the potential deferred tax asset will not be realized. The Company’s accounting policy is to exclude deferred tax assets related to unrealized losses on its available for sale debt securities as these losses are expected to reverse and realization of the related deferred tax asset is not dependent on future taxable income. The Company determined that no deferred tax asset valuation allowance was required at December 31, 2012. It is the Company’s accounting policy to include interest expense and penalties related to income taxes as a component of provision (benefit) for income taxes. See Note 15 “Income Taxes” of the notes to consolidated financial statements for more detail.
Operating Segments. Public enterprises are required to report certain information about their operating segments in the financial statements. The basis for determining the Company’s operating segments is the way in which management operates the businesses. Bancorp has identified two reportable segments, “banking” and “other” which include West Coast Trust. See Note 20 “Segment and Related Information” of the notes to consolidated financial statements for more detail.
Trust Company Assets. Assets (other than cash deposits) held by West Coast Trust in fiduciary or agency capacities for its trust customers are not included in the accompanying consolidated balance sheets, because such items are not assets of West Coast Trust.
Borrowings. Federal funds purchased and securities sold under agreements to repurchase generally mature within one to four days from the transaction date. Other short-term borrowed funds mature within one year from the date of these financial statements. Long-term borrowed funds extend beyond one year and are reclassed to short-term borrowings when the long term borrowed funds mature within one year and there is no intent to refinance.
Earnings Per Share. Earnings per share is calculated under the two-class method. The two-class method is an earnings allocation formula that determines earnings per share for each class of common stock and participating security according to dividends declared (or accumulated) and participation rights in undistributed earnings. A participating security is an instrument that may participate in undistributed earnings with common stock. The Company has issued restricted stock that qualifies as a participating security. Basic earnings per share is computed by dividing net income available to common shareholders by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is computed in the same manner as basic earnings per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if certain shares issuable upon exercise of options, warrants, conversion of preferred stock, and unvested restricted stock were included unless those additional shares would have been anti-dilutive. For the diluted earnings per share computation, the treasury stock method is applied and compared to the two-class method and whichever method results in a more dilutive impact was utilized to calculate diluted earnings per share.
Service Charges on Deposit Accounts. Service charges on deposit accounts primarily represent monthly fees based on minimum balances or transaction-based fees. These fees are recognized as earned or as transactions occur and services are provided.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Payment Systems Revenue. Payment systems revenue includes interchange income from credit and debit cards, annual fees, and other transaction and account management fees. Interchange income is a fee paid by a merchant bank to the card-issuing bank through the interchange network. Interchange fees are set by the credit card associations and are based on cardholder purchase volumes. The Company records interchange income as transactions occur. Transaction and account management fees are recognized as transactions occur or services are provided, except for annual fees, which are recognized over the applicable period. Volume-related payments to partners and credit card associations and expenses for rewards programs are also recorded within payment systems revenue. Payments to partners and expenses related to rewards programs are recorded when earned by the partner or customer. Merchant processing services revenue consists principally of transaction and account management fees charged to merchants for the electronic processing of transactions, net of interchange fees paid to the credit card issuing bank, card association assessments, and revenue sharing amounts, and are all recognized at the time the merchant’s transactions are processed or other services are performed. The Company may enter into revenue sharing agreements with referral partners or in connection with purchases of merchant contracts from sellers. The revenue sharing amounts are determined primarily on sales volume processed or revenue generated for a particular group of merchants. Merchant processing revenue also includes revenues related to point-of-sale equipment recorded as sales when the equipment is shipped or as earned for equipment rentals.
Trust and Investment Services Revenue. Trust and investment management fees are recognized over the period in which services are performed and are based on a percentage of the fair value of the assets under management or administration, fixed based on account type, or transaction-based fees.
New Accounting Pronouncements. In April 2011, the Financial Accounting Standards Board (“FASB”) issued guidance within the Accounting Standards Update (“ASU”) 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs”. This ASU amends existing guidance regarding the highest and best use and valuation assumption by clarifying these concepts are only applicable to measuring the fair value of nonfinancial assets. The ASU also clarifies that the fair value measurement of financial assets and financial liabilities which have offsetting market risks or counterparty credit risks that are managed on a portfolio basis, when several criteria are met, can be measured at the net risk position. Additional disclosures about Level 3 fair value measurements are required including a quantitative disclosure of the unobservable inputs and assumptions used in the measurement, a description of the valuation process in place, and discussion of the sensitivity of fair value changes in unobservable inputs and interrelationships about those inputs as well disclosure of the level of the fair value of items that are not measured at fair value in the financial statements but disclosure of fair value is required. ASU 2011-04 was effective for the Company’s reporting period beginning after December 15, 2011, and has been applied prospectively.
In February 2013, the FASB issued ASU 2013-02, “Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income”. This ASU requires an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component and to present either on the face of the statement where net income is presented, or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income, but only if the amount reclassified is required to be reclassified to net income in its entirety in the same reporting period. The amendments are effective for annual and interim reporting periods beginning on or after December 15, 2012. The Company is currently in the process of evaluating the ASU but does not expect it will have a material impact on the Company’s consolidated financial statements.
2. INVESTMENT SECURITIES
The following table presents the available for sale investment securities as of December 31, 2012, and 2011:
At December 31, 2012, the estimated fair value of the investment portfolio was $772.1 million, an increase of $42.3 million or 5.8% from $729.8 million at year end 2011. The estimated net unrealized gain on the investment portfolio at December 31, 2012, was $15.6 million, or 2.0% of the total portfolio, compared to $12.3 million and 1.7% respectively, at year end 2011. During 2012, the net unrealized gain on mortgage-backed securities increased $1.7 million to $11.0 million at year end while the net unrealized gain on U.S. Government agency securities increased $1.0 million to $4.4 million. The net unrealized gains in the obligations of state and political subdivisions category remained relatively unchanged from year end 2011. The unrealized loss on the corporate securities portfolio declined $.7 million during 2012.
At December 31, 2012, the corporate securities portfolio included four pooled trust preferred securities with amortized cost of $13.8 million and an estimated fair market value of $8.6 million resulting in an estimated $5.2 million unrealized loss. This unrealized loss was associated with the decline in market value since purchase of our investments in pooled trust preferred securities issued by banks and insurance companies. Continued wide credit and liquidity spreads contributed to the unrealized loss associated with these securities. These pooled trust preferred securities are rated C or better by the rating agencies that cover these securities and they have several features that reduce credit risk, including seniority over certain tranches in the same pool and the benefit of certain collateral coverage tests.
Gross realized gains on the sale of investment securities included in earnings in 2012, 2011, and 2010 were $375,000, $1,022,000, and $1,562,000, respectively. Gross realized losses were $309,000 in 2011 and there were no such losses in 2012 and 2010.
Dividends on equity investments for the years 2012, 2011, and 2010 were $90,000, $100,000, and $105,000, respectively.
2. INVESTMENT SECURITIES
During 2012, in terms of amortized cost, we increased our investment securities balance by $38.9 million principally due to our efforts to maintain relatively low cash balances given the low market interest rates. The purchases over the past year were primarily of U.S. Government agency securities portfolio with 3 to 5 year maturities and municipal securities. The fair value of our U.S. Government agency securities increased by $23.6 million in 2012 as part of our effort to maintain liquidity and portfolio diversification as well as to provide collateral for public funds and borrowing sources such as the FHLB.
Our mortgage-backed securities portfolio had a fair value of $425.1 million, a decrease of $3.6 million from $428.7 million a year ago. This segment of our portfolio primarily consists of U.S. Government agency ten and fifteen year fully amortizing mortgage-backed securities with limited extension risk. This portfolio consisted of U.S. Agency backed mortgages with an amortized cost of $361.7 million and U.S. Government backed mortgage securities with an amortized cost of $52.5 million. Floating or adjustable rate securities represented $9.0 million of this portfolio while the remainder consisted of fixed rate securities. Ten and fifteen year pass-through mortgages with a projected average life of 3.7 years represented the majority of fixed rate securities within this portfolio. Mortgage backed securities are subject to prepayment risk. Rising prepayments reduces the projected average life and accelerates the amortization of premiums and therefore reduces the income from this portfolio. At December 31, 2012, the bank owned no privately issued mortgage backed securities.
Our portfolio of securities representing obligations of state and political subdivisions had a fair value of $82.7 million, with an amortized cost of $77.8 million, indicating a net unrealized gain of $4.9 million. At December 31, 2012, our equity and other investment securities had a fair value of $11.8 million and consisted of three investments in mutual fund shares and three investments in government backed Housing and Urban Development (“HUD”) Bonds. In addition to interest income, these investments provide the Bank with Community Reinvestment Act (“CRA”) benefits. The following tables provide the fair value and gross unrealized losses on securities available for sale, aggregated by category and length of time the individual securities have been in a continuous unrealized loss position:
There were six investment securities with a 12 month or greater continuous unrealized loss in the investment portfolio at December 31, 2012, with an amortized cost of $23.5 million and a total unrealized loss of $5.3 million. In comparison, at December 31, 2011, there were six investment securities with a 12 month or greater continuous unrealized loss in the investment portfolio, with a total unrealized loss of $5.9 million. The unrealized loss on these investment securities was primarily due to continued increased credit and liquidity spreads and an extension of expected cash flow causing a decline in the fair market value of our pooled trust preferred securities (corporate security category). The value of most of our securities fluctuates as market interest rates change.
There were a total of 13 securities in Bancorp’s investment portfolio at December 31, 2012, that have been in a continuous unrealized loss position for less than 12 months, with an amortized cost of $36.2 million and a total unrealized loss of $.2 million. At December 31, 2011, there were a total of eight securities in Bancorp’s investment portfolio that have been in a continuous unrealized loss position for less than 12 months, with an amortized cost of $42.0 million and a total unrealized loss of $.2 million. The fair value of these securities fluctuates as market interest rates change.
2. INVESTMENT SECURITIES
Management reviews and evaluates the Company’s debt securities on an ongoing basis for the presence of other-than-temporary impairment (“OTTI”). Our analysis takes into consideration current market conditions, length and severity of impairment, extent and nature of the change in fair value, issuer ratings, and whether or not the Company intends to, or may be required to, sell debt securities before recovering any unrealized losses.
In the second quarter of 2011, the Company recorded a credit related OTTI charge of $.2 million pretax related to a pooled trust preferred security in our investment portfolio which also was placed on nonaccrual status at the same time. An additional credit related OTTI charge of $49,000 pretax relating to this same security was deemed necessary in the first quarter of 2012. We do not intend to sell this security, and it is not likely that we will be required to sell this security, but we do not expect to recover the entire amortized cost basis of the security. The amount of OTTI related to credit losses recognized in earnings represents the amortized cost of the security that we do not expect to recover and is based on the estimated cash flow expected from the security, discounted by the estimated future coupon rates of the security. We estimate cash flows based on the performance of the underlying collateral for the security and the overall structure of the security. Factors considered in the performance of underlying collateral include current default and deferral rates, estimated future default, deferral and recovery rates, and prepayment rates. Factors considered in the overall structure of the security include the impact of the underlying collateral cash flow on debt coverage tests and subordination levels. The remaining impairment on this security that is related to all other factors is recognized in other comprehensive income. Given regulatory guidelines on expectation of full payment of interest and principal as well as extended principal in kind payments, this pooled trust preferred security was placed on nonaccrual status. In addition, in October 2011 the Company placed another pooled trust preferred security with principal in kind payments on nonaccrual status. While this security had an impairment loss of $1.5 million at December 31, 2012, based on our projections of future interest and principal payments, this security had no credit related OTTI as of December 31, 2012. At year end 2012, these securities were rated C or better by the rating agencies that cover these securities. They have several features that reduce credit risk, including seniority over certain tranches in the same pool and the benefit of certain collateral coverage tests.
The following table presents a summary of the significant inputs utilized to measure the other-than-temporary impairment related to credit losses associated with the above pooled trust preferred security at December 31, 2012, and 2011:
The following table presents information about the securities with OTTI losses for the years ended December 31, 2012, 2011, and 2010:
2. INVESTMENT SECURITIES
The following table presents a tabular roll forward of the amount of credit related OTTI recognized in earnings for years ended December 31, 2012, and 2011:
At December 31, 2012, and 2011, the Company had $287.1 million and $291.0 million, respectively, in investment securities being provided as collateral to the FHLB, the Federal Reserve Bank of San Francisco (the “Federal Reserve”), the State of Oregon and the State of Washington, and others for our borrowings and certain public fund deposits. At December 31, 2012, and December 31, 2011, Bancorp had no reverse repurchase agreements.
The follow table presents the maturities of the investment portfolio at December 31, 2012:
Mortgage-backed securities, including collateralized mortgage obligations and asset-backed securities, have maturities that will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
3. LOANS AND ALLOWANCE FOR CREDIT LOSSES
The following table presents the loan portfolio as of December 31, 2012, and 2011:
At December 31, 2012, total loans decreased $6.4 million from the balance at December 31, 2011. The declines within the loan portfolio principally occurred in the commercial and real estate mortgage loan categories. The growth in the commercial real estate portfolio nearly offset these declines. At December 31, 2012, and 2011, Bancorp had $1.7 million and $.8 million, respectively, of overdrafts classified as loans in the installment and other consumer loan category.
The Company has lending policies and underwriting processes in place that are designed to make loans within an acceptable level of risk for the estimated return. Management reviews and approves these policies and processes on a regular basis. Management frequently reviews reports related to loan production, loan quality, loan delinquencies and nonperforming and potential problem loans. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions.
Commercial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and prudently execute its business. Underwriting standards are designed to promote relationship banking rather than transactional banking. The Company’s lending officers examine current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Management monitors and evaluates commercial loans based on collateral, geography and risk rating criteria. Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and typically incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.
Commercial real estate loans are subject to underwriting standards and processes similar to commercial loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful lease-up of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. Management monitors and evaluates commercial real estate loans based on collateral, geography, and risk rating criteria. As a general rule, the Company avoids financing single purpose projects unless other underwriting factors are present to help mitigate risk. The Company also utilizes third parties to provide insight and guidance about economic conditions and trends affecting market areas it serves.
Our residential and commercial construction portfolios are portfolios we consider to have higher risk. Construction loans are underwritten utilizing independent appraisal reviews, sensitivity analysis of absorption and lease rates financial analysis of the developers, property owners, and investors as well as on a selective basis, feasibility studies. Construction loans are generally based upon estimates of costs and value associated with the complete project. Significant judgments and estimates are made in the preparation of the financial statements and actual results could differ from these estimates as future events occur. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from the Company or other approved third party long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, pre-leasing that does not materialize, general economic conditions, the availability of long-term financing, and completion of construction within timelines and costs originally set forth.
3. LOANS AND ALLOWANCE FOR CREDIT LOSSES
The Bank originates home equity loans and lines through an online application system in which all applications are centrally reviewed with underwriting and verifications completed by an experienced underwriter. Monthly loan portfolio reports provide home equity loan performance monitoring. Credit risk is minimized by accepting borrowers with a proven credit history, verified income sources for repayment and owner occupied properties as acceptable collateral. Portfolio balances, performance and underwriting standards can be influenced by regional economic cycles related to unemployment levels, de-leveraging by borrowers, and market values for residential properties.
The Company originates consumer loans utilizing a computer-based credit scoring analysis to supplement the underwriting process. To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed, jointly by line and staff personnel. This activity, coupled with relatively small loan amounts that are spread across many individual borrowers, minimizes risk. Additionally, trend and outlook reports are reviewed by management on a regular basis.
The Company maintains credit administration and credit review functions that are designed to help confirm our credit standards are being followed. Significant findings and periodic reports are communicated to the Chief Credit Officer and Chief Executive Officer and, in certain cases, to the Loan, Investment & Asset/Liability Committee, which is comprised of certain directors. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Company’s policies and procedures.
Loans greater than 90 days past due are classified into nonaccrual status. The following table presents an age analysis of the loan portfolio as of December 31, 2012, and 2011:
3. LOANS AND ALLOWANCE FOR CREDIT LOSSES
The following table presents an analysis of impaired loans as of December 31, 2012, and 2011:
The unpaid principal balance on impaired loans represents the amount owed by the borrower. The carrying value of impaired loans is lower than the unpaid principal balance due to charge-offs.
At December 31, 2012, and 2011, Bancorp’s recorded investment in loans that were considered to be impaired was $42.5 million and $56.4 million, respectively. A loan is considered to be impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due including both interest and principal according to the contractual terms of the loan agreement. For loans that are collateral dependent, the Company charges off the amount of impairment at the time of impairment. At December 31, 2012, a specific reserve allowance in the amount of $.8 million was established related to $17.4 million of impaired loans which were considered to be troubled debt restructurings (“TDR”) that were on interest accruing status, compared to a specific reserve allowance in the amount of $.5 million established related to $15.8 million of impaired loans which were considered to be troubled debt restructurings and were on an interest accruing status at December 31, 2011. Troubled debt restructuring nonaccrual loan balances were $11.4 million and $21.8 million at December 31, 2012, and 2011, respectively, which are included in total nonaccrual loans.
The average recorded investment in impaired loans for the years ended December 31, 2012, 2011, and 2010, was approximately, $49.9 million, $65.8 million and $78.0 million, respectively. For the years ended December 31, 2012, 2011, and 2010, interest income recognized on impaired loans totaled $999,000, $1,035,000, and $568,000, respectively.
3. LOANS AND ALLOWANCE FOR CREDIT LOSSES
A loan is accounted for as a TDR if the Company, for economic or legal reasons related to the borrower’s financial difficulties, grants a concession to the borrower that it would not otherwise consider granting. A TDR typically involves a modification of terms such as a reduction of the stated interest rate or face amount of the loan, a reduction of accrued interest, or an extension of the maturity date(s) at a stated interest rate lower than the current market rate for a new loan with similar risk.
The following table presents an analysis of TDRs for the periods ended December 31, 2012, and 2011:
For TDRs that are collateral dependent, the Company charges off the amount of impairment at the time of impairment, rather than creating a specific reserve allowance for the impaired amount. TDRs that are performing and on an interest accruing status are measured for impairment based on the present value of expected future cash flows discounted at the loan’s effective interest rate. Impairment resulting from this measurement is recorded as a specific reserve allowance in the allowance for credit losses.
The following table presents nonaccrual loans by category as of December 31, 2012, and 2011:
Loans on which the accrual of interest has been discontinued were approximately $25.1 million, $40.6 million and $61.2 million at December 31, 2012, 2011, and 2010, respectively. Interest income foregone on nonaccrual loans was approximately $3.4 million, $4.1 million and $6.5 million in 2012, 2011, and 2010, respectively.
3. LOANS AND ALLOWANCE FOR CREDIT LOSSES
The Company uses a risk rating matrix to assign a risk rating to loans not evaluated on a homogenous pool level. At December 31, 2012, $1.13 billion of loans were risk rated and $362.1 million were evaluated on a homogeneous pool basis. Individually risk rated loans are rated on a scale of 1 to 10. A description of the general characteristics of the 10 risk ratings is as follows:
Ratings 1, 2 and 3 - These ratings include loans to very high credit quality borrowers of investment or near investment grade. These borrowers have significant capital strength, moderate leverage, stable earnings and growth, and readily available financing alternatives. Smaller entities, regardless of strength, would generally not fit in these ratings. These ratings also include loans that are collateralized by U. S. Government securities and certificates of deposits.
Rating 4 - These ratings include loans to borrowers of solid credit quality with moderate risk. Borrowers in these ratings are differentiated from higher ratings on the basis of size (capital and/or revenue), leverage, asset quality and the stability of the industry or market area.
Ratings 5 and 6 - These ratings include “pass rating” loans to borrowers of acceptable credit quality and risk. Such borrowers are differentiated from Rating 4 in terms of size, secondary sources of repayment or they are of lesser stature in other key credit metrics in that they may be over-leveraged, undercapitalized, inconsistent in performance or in an industry or an economic area that is known to have a higher level of risk, volatility, or susceptibility to weaknesses in the economy. However, no material adverse trends are evident with borrowers in these pass ratings.
Rating 7 - This rating includes loans on management’s “watch list” and is intended to be utilized on a temporary basis for pass rating borrowers where a significant risk-modifying action is anticipated in the near term.
Rating 8 - This rating includes “Substandard” loans, in accordance with regulatory guidelines, for which the accrual of interest may or may not be discontinued. By definition under regulatory guidelines, a “Substandard” loan has defined weaknesses which make payment default or principal exposure likely, but not yet certain. Such loans are apt to be dependent upon collateral liquidation, a secondary source of repayment, or an event outside of the normal course of business.
Rating 9 - This rating includes “Doubtful” loans in accordance with regulatory guidelines. Such loans are placed on nonaccrual status and may be dependent upon collateral having a value that is difficult to determine or upon some near-term event which lacks certainty.
Rating 10 - This rating includes “Loss” loans in accordance with regulatory guidelines. Such loans are to be charged-off or charged-down when payment is acknowledged to be uncertain or when the timing or value of payments cannot be determined. “Loss” is not intended to imply that the loan or some portion of it will never be paid, nor does it in any way imply that there has been a forgiveness of debt.
The Company considers loans assigned a risk rating 8 through 10 to be classified loans. The weighted average risk ratings declined from December 31, 2011, to December 31, 2012. Overall classified loan balances have decreased, however, both in total and as a percentage of the total loan portfolio. The following table presents weighted average risk ratings of the loan portfolio and classified loans by category:
Installment and other consumer loans are primarily evaluated on a homogenous pool level and generally not individually risk rated unless certain factors are met.
3. LOANS AND ALLOWANCE FOR CREDIT LOSSES
Important credit quality metrics for the homogenous pool basis include nonaccrual and past due status. Total loans evaluated on a homogeneous pool basis were $362.1 million and $397.6 million at December 31, 2012, and 2011, respectively. The following table presents loans by category that the credit risk is evaluated on a homogenous pool basis. The real estate mortgage category includes home equity lines of credit and home equity loans and certain small business loans.
The allowance for credit losses is a reserve established through a provision for credit losses charged to expense, which represents management’s best estimate as of the balance sheet date, of probable losses that have been incurred within the existing loan portfolio. The allowance for credit losses is based on historical loss experience by type of credit and internal risk rating, specific homogeneous risk pools and specific loss allocations, with adjustments for current events and conditions. The Company’s process for determining the appropriate amount of the allowance for credit losses is designed to account for credit deterioration as it occurs. The provision for credit losses is reflective of loan quality trends, and considers trends related to nonaccrual loans, past due loans, potential problem loans, criticized loans and net charge-offs or recoveries, among other factors. The provision for credit losses also reflects the totality of actions taken on all loans for a particular period.
The allowance for credit losses reflects management’s continuing evaluation of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. Portions of the allowance may be allocated for specific loans; however, the entire allowance is available for any loan that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond the Company’s control, including, among other things, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications.
The Company’s allowance for loan losses consists of three key elements: specific reserve allowances, formula allowance, and an unallocated allowance that represents an amount to capture risk associated with qualitative factors and uncertainty that is inherent in estimates used to determine the allowance.
Specific reserve allowances may be established when management can estimate the amount of an impairment of a loan, typically on a non real estate collateralized loan or to address the unique risks associated with a group of loans or particular type of credit exposure. The Company does not establish specific reserve allowances on collateral dependent impaired loans. Impairment on these loans is charged off to the allowance for credit losses when impairment is established.
The formula allowance is calculated by applying loss factors to individual loans based on the assignment of risk ratings, or through the assignment of loss factors to homogenous pools of loans. Changes in risk ratings of both performing and nonperforming loans affect the amount of the formula allowance. Loss factors are based on our historical loss experience and such other data as management believes to be pertinent, and may be adjusted for significant factors that, in management’s judgment, affect the collectability of the portfolio as of the evaluation date. At December 31, 2012, and 2011, the allowance for loan losses was $29.4 million and $35.2 million, respectively, while the reserve for unfunded commitments was $.9 and $.8 million, respectively, at December 31, 2012, and 2011.
The unallocated loan loss allowance represents an amount for imprecision or uncertainty that is inherent in estimates used to determine the allowance. In determining whether to carry an unallocated allowance and, if so, the amount of the allowance, management considers a variety of qualitative factors, including regional economic and business conditions that impact important categories of our portfolio, loan growth rates, the depth and skill of lending staff, the interest rate environment, and the results of bank regulatory examinations and findings of our internal credit examiners. Currently, we have an unallocated allowance for loan losses that is the result of our judgment about risks inherent in the loan portfolio due to economic uncertainties, as well as our evaluation of historical loss experience relative to current trends, and other subjective factors.
3. LOANS AND ALLOWANCE FOR CREDIT LOSSES
The following is an analysis of the changes in the allowance for credit losses:
The following table presents summary account activity of the allowance for credit losses by loan category as of December 31, 2012, and 2011:
4. PREMISES AND EQUIPMENT
Premises and equipment consists of the following:
Depreciation included in occupancy and equipment expense amounted to $3.1 million, $3.4 million, and $3.8 million for the years ended December 31, 2012, 2011, and 2010, respectively. Depreciation for all premises and equipment is calculated using the straight-line method. The Company periodically reviews the recorded value of its long-lived assets, specifically premises and equipment, to determine whether impairment exists. In 2011, the Company recorded impairment of $.1 million in conjunction with a Bank branch that was closed and $.5 million of leasehold improvement charge-offs associated with Bank branch closures. No material impairments associated with premises and equipment were recorded during 2012 or 2010.
5. OTHER REAL ESTATE OWNED, NET
The following table summarizes Bancorp’s OREO for the years ended December 31, 2012, and 2011:
The following table summarizes Bancorp’s OREO valuation allowance for the years ended December 31, 2012, 2011, and 2010:
6. OTHER ASSETS
The following table summarizes Bancorp’s other assets for the years ended December 31, 2012, and 2011:
Bancorp has invested in two limited partnerships that operate qualified affordable housing properties. Tax credits and tax deductions from operating losses are passed through the partnerships to Bancorp. The Company accounts for these investments using the equity method.
7. BALANCES WITH THE FEDERAL RESERVE BANK
The Bank is required to maintain cash reserves or deposits with the Federal Reserve Bank equal to a percentage of reservable deposits. The average required cash reserve for the Bank was $6.8 million and $6.5 million during the years ended December 31, 2012, and 2011, respectively.
8. BORROWINGS
The following table summarizes Bancorp’s borrowings as of December 31, 2012, and 2011:
At December 31, 2012, Bancorp’s long-term borrowings consisted of seven fixed rate, fixed maturity notes with rates ranging from 1.03% to 1.74%. Principal payments due at the scheduled maturities of Bancorp’s long-term borrowings at December 31, 2012, were $30.0 million in 2014, $29.3 million in 2015, $10.7 million in 2016, and $7.9 million in 2019.
Long-term borrowings at December 31, 2011, consisted of notes with fixed maturities and putable advances with the FHLB totaling $120.0 million at interest rates ranging from 0.81% to 1.43%. Total long-term borrowings with fixed maturities were $120.0 million at December 31, 2011.
During 2011, the Company prepaid $168.6 million in long-term FHLB borrowings, offset in part by $120.0 million in new long-term FHLB borrowings in the same period. As a result of the long-term borrowing prepayments, the Company incurred a prepayment charge of $7.1 million for the year ended December 31, 2011.
FHLB advances are collateralized, as provided for in an “Advances, Security and Deposit Agreement” with the FHLB, by investment securities and qualifying loans. At December 31, 2012, the Company had additional borrowing capacity available at the FHLB of $383.5 million based on pledged collateral. Bancorp had no outstanding Federal Funds purchased from correspondent banks, borrowings from the discount window, or reverse repurchase agreements at December 31, 2012, and 2011.
9. JUNIOR SUBORDINATED DEBENTURES
At December 31, 2012, six wholly-owned subsidiary grantor trusts established by Bancorp had issued and sold $51.0 million of trust preferred securities. Trust preferred securities accrue and pay distributions periodically at specified annual rates as provided in each indenture. The trusts used all of the net proceeds from each sale of trust preferred securities to purchase a like amount of junior subordinated debentures of the Company. The junior subordinated debentures are the sole assets of the trusts. The Company’s obligations under the junior subordinated debentures and related documents, taken together, constitute a full and unconditional guarantee by the Company of the obligations of the trusts. The trust preferred securities are mandatorily redeemable upon the maturity of the junior subordinated debentures and may be subject to earlier redemption by the Company as provided in the indentures. The Company has the right to redeem the junior subordinated debentures in whole (but not in part) on or after specific dates, at a redemption price specified in the indentures plus any accrued but unpaid interest to the redemption date. Bancorp has no deferred interest on its outstanding debentures.
The following table is a summary of outstanding trust preferred securities at December 31, 2012:
The variable rate preferred securities reprice quarterly.
The weighted average interest rate on the trust preferred securities was 2.17% at December 31, 2012. The interest rate on each security resets quarterly and is tied to the London Interbank Offered Rate (“LIBOR”) rate. The junior subordinated debentures issued by Bancorp to the grantor trust are reflected in our consolidated balance sheet in the liabilities section at December 31, 2012, and 2011, as junior subordinated debentures. Bancorp records interest expense on the corresponding junior subordinated debentures in the consolidated statements of income. The common capital securities issued by the trusts are recorded within other assets in the consolidated balance sheets, and totaled $1.6 million at December 31, 2012, and 2011.
10. EMPLOYEE BENEFIT PLANS
Bancorp employee benefits include a plan established under section 401(k) of the Internal Revenue Code for certain qualified employees (the “401(k) plan”). Employee contributions up to 100 percent of salaries under the Internal Revenue Code guidelines can be made under the 401(k) plan, of which Bancorp may match 50 percent of the employees’ contributions up to a maximum of three percent of the employees’ eligible compensation. Bancorp may also elect to make discretionary contributions to the plan. In 2011 and 2010, Bancorp made qualified, non-elective, discretionary contributions into employee 401(k) plans; no such contributions were made in 2012. Bancorp’s 401(k) related discretionary contributions expenses for 2012, 2011, and 2010 were zero, $.3 million, and $.1 million, respectively. Employees vest immediately in their own contributions and earnings, and vest in Bancorp’s matching contributions over five years of eligible service. Bancorp had 401(k) plan related matching expenses of $.6 million in 2012, while no such expenses were recorded in 2011 and 2010 related to the Company’s 401(k) plan match.
Bancorp provides separate non-qualified deferred compensation plans for directors and executive officers (collectively, “Deferred Compensation Plans”) as supplemental benefit plans which permit directors and selected officers to elect to defer receipt of all or any portion of their future salary, bonus or directors’ fees, including with respect to officers, amounts they otherwise might not be able to defer under the 401(k) plan due to specified Internal Revenue Code restrictions on the maximum deferral that may be allowed under that plan. Under the Deferred Compensation Plans, an amount equal to compensation being deferred by participants is placed in a rabbi trust, the assets of which is available to Bancorp’s creditors and invested consistent with the participants’ direction among a variety of investment alternatives. A deferred compensation liability of $1.9 million was included in other liabilities as of December 31, 2012, up $.3 million or 16% from $1.6 million at December 31, 2011.
Bancorp has multiple supplemental executive retirement agreements with former and current executives. The following table reconciles the accumulated liability for the benefit obligation of these agreements:
Bancorp’s obligations under supplemental executive retirement agreements are unfunded plans and have no plan assets. The benefit obligation represents the vested net present value of future payments to individuals under the agreements. Bancorp’s benefit expense, as specified in the agreements for the entire year 2013, is expected to be $.2 million. The benefits expected to be paid are presented in the following table:
11. COMMITMENTS AND CONTINGENT LIABILITIES
The Company leases land and office space under 46 leases, of which 45 are long-term operating leases that expire between 2013 and 2024. At the end of most of the respective lease terms, Bancorp has the option to renew the leases at fair market value. At December 31, 2012, minimum future lease payments under these leases and other operating leases were:
Rental expense for all operating leases was $4.4 million, $4.5 million, and $4.2 million for the years ended December 31, 2012, 2011, and 2010, respectively.
Bancorp is periodically party to litigation arising in the ordinary course of business. Based on information currently known to management, although there are uncertainties inherent in litigation, we do not believe there is any legal action to which Bancorp or any of its subsidiaries is a party that, individually or in the aggregate, will have a materially adverse effect on Bancorp’s financial condition and results of operations, cash flows, or liquidity.
12. STOCKHOLDERS’ EQUITY AND REGULATORY CAPITAL
Authorized capital stock of Bancorp at December 31, 2012, included 50,000,000 shares of Common Stock, no par value, and 10,000,000 shares of Preferred Stock, no par value, of which 2,000,000 shares had been designated as Mandatorily Convertible Cumulative Participating Preferred Stock, Series A (“Series A Preferred Stock”) and 600,000 shares had been designated as Mandatorily Convertible Cumulative Participating Preferred Stock, Series B (“Series B Preferred Stock”).
Preferred Stock. Following the receipt of shareholder approvals on January 20, 2010, 1,428,849 shares of Series A Preferred Stock issued in connection with Bancorp's Private Capital Raise and outstanding at December 31, 2009, automatically converted into an aggregate of 14,288,490 shares of Common Stock. As of December 31, 2012, and 2011, there were no shares of Series A Preferred Stock currently outstanding.
Bancorp also issued an aggregate of 121,328 shares of Series B Preferred Stock in the Private Capital Raise all of which remains outstanding. These shares will automatically convert into an aggregate of 1,213,280 shares of Common Stock upon transfer of the Series B Preferred Stock to third parties in a widely dispersed offering.
The Series B Preferred Stock is not subject to the operation of a sinking fund. The Series B Preferred Stock is not redeemable by the Company and is perpetual with no maturity. The holders of Series B Preferred Stock have no general voting rights. Bancorp had accrued dividends on Series B Preferred Stock of $.1 million and $0, respectively, at December 31, 2012, and 2011, and no dividends in arrears for those same years.
Warrants to Purchase Series B Preferred Stock. In October 2009, as part of a Private Capital Raise, Bancorp issued Class C Warrants to purchase an aggregate of 240,000 shares of Series B Preferred Stock at an exercise price of $100.00 per share or $24 million in aggregate. The Warrants were immediately exercisable and will expire on October 23, 2016. Shares of Series B Preferred Stock issuable upon exercise of the Warrants will automatically convert into an aggregate of 2.4 million shares of Common Stock upon transfer of the Series B Preferred Stock to third parties in a widely dispersed offering.
The Company allocated the proceeds of $21.1 million from the issuance of the Series B Preferred Stock and Warrants between the two based on their relative fair values. The fair value allocated to the warrants was $11.1 million.
The Company maintains a stock repurchase plan. Under the Company’s stock repurchase plan, the Company can purchase up to 980,000 shares of the Company’s Common Stock. The Company did not repurchase any shares under this plan in 2012 nor does it anticipate repurchasing any shares in the foreseeable future. Total shares available for repurchase under this plan are 210,400 at December 31, 2012.
12. STOCKHOLDERS’ EQUITY AND REGULATORY CAPITAL
Regulatory Capital. The Federal Reserve and Federal Deposit Insurance Corporation (“FDIC”) have established minimum requirements for capital adequacy for bank holding companies and nonmember banks. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, Bancorp and the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities and certain off balance sheet items. The Federal Reserve and FDIC risk based capital guidelines require banks and bank holding companies to have a ratio of Tier 1 capital to total risk weighted assets of at least 4%, and a ratio of total capital to total risk weighted assets of 8% or greater. In addition, the leverage ratio of Tier 1 capital to total average assets less intangibles is required to be at least 4%. Bancorp and its bank subsidiary’s capital components, classification, risk weightings and other factors are also subject to qualitative judgments by regulators. Failure to meet minimum capital requirements can initiate certain action by regulators that, if undertaken, could have a material effect on Bancorp’s financial statements.
Bancorp’s total risk-based capital ratio improved to 21.83% at December 31, 2012, up from 20.62% at December 31, 2011, while Bancorp's Tier 1 risk-based capital ratio increased to 20.66% at December 31, 2012, from 19.36% at December 31, 2011. Bancorp’s capital ratios improved over year end 2011 principally as a result of the consistent improvement in the core operating performance of the Company over the past two years and a reduction in the Company’s risk weighted assets over the past 12 months also contributed to improved capital ratios at Bancorp.
The following table presents the capital measures of Bancorp and the Bank as of December 31, 2012, and 2011:
13. STOCK PLANS
On April 24, 2012, shareholders approved Bancorp’s 2012 Omnibus Incentive Plan (the “2012 Incentive Plan”). Bancorp's 2002 Stock Incentive Plan (the “2002 Plan”) was terminated on March 8, 2012, and no additional awards will be granted under the 2002 Plan. The 2012 Incentive Plan authorizes the issuance of up to 400,000 shares to participants in connection with grants of stock options, restricted stock, restricted stock units, stock appreciation rights, and other stock-based awards. The 2012 Incentive Plan has 372,166 shares available for grant at December 31, 2012. The number of shares that may be issued under the 2012 Incentive Plan is subject to adjustment in certain circumstances.
It is Bancorp’s policy to issue new shares for stock option exercises and restricted stock awards. Bancorp expenses stock options and restricted stock on a straight line basis over the applicable vesting term. Restricted stock granted generally vests over a two to four year vesting period; however, certain grants have been made that vested immediately or over a one year period, including grants to directors.
All outstanding stock options have an exercise price that was equal to the closing market value of Bancorp’s stock on the date the options were granted. Options granted generally vest over a two to four year vesting period; however, certain grants have been made that vested immediately, including grants to directors. Stock options have a 10 year maximum term. The following table presents information on stock options outstanding for the periods shown:
The average fair value of stock options granted is estimated on the date of grant using the Black-Scholes option-pricing model. There were no stock options granted in 2012 and 2011. The following table presents the assumptions used in the fair value calculation for 2010:
As of December 31, 2012, outstanding stock options consist of the following:
13. STOCK PLANS
The following table presents information on stock options outstanding for the periods shown, less estimated forfeitures:
Restricted stock grants are made at the discretion of the Board of Directors, except with regard to grants to certain Company officers, which are made at the discretion of the Board’s Compensation & Personnel Committee. Compensation expense for restricted stock is based on the market price of the Company stock at the date of the grant and amortized on a straight-line basis over the vesting period which is currently one, three or four years for all grants. Recipients of restricted stock do not pay any cash consideration to the Company for the shares, have the right to vote all shares subject to such grant and receive all dividends with respect to such shares, whether or not the shares have vested.
Restricted stock consists of the following for the years ended December 31, 2012, 2011, and 2010:
The following table presents stock-based compensation expense for employees and directors related to restricted stock and stock options for the periods shown:
The balance of unearned compensation related to unvested restricted stock granted as of December 31, 2012, and 2011, was $2.0 million and $3.3 million, respectively. The unearned compensation balance at December 31, 2012, is expected to be recognized over a weighted average period of 1.6 years, or immediately upon a change in control event. The Company received cash in the amount of $151,132 and $79,891 from stock option exercises for the twelve months ended December 31, 2012, and 2011, respectively. The Company recorded $11,000 of tax expense and $69,350 of tax benefits from disqualifying dispositions involving incentive stock options, the exercise of non-qualified stock options, and the vesting and release of restricted stock for the twelve months ended December 31, 2012, and 2011.
14. EARNINGS PER SHARE
Earnings per share is calculated under the two-class method. The two-class method is an earnings allocation formula that determines earnings per share for each class of common stock and participating security according to dividends declared (or accumulated) and participation rights in undistributed earnings. A participating security is an instrument that may participate in undistributed earnings with common stock. The Company has issued restricted stock and preferred stock that qualifies as a participating security. Basic earnings per share is computed by dividing net income available to common shareholders by the weighted average number of shares of common stock outstanding during the period.
Diluted earnings per share is computed in the same manner as basic earnings per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if certain shares issuable upon exercise of options and warrants, conversion of preferred stock, and unvested restricted stock were included, unless those additional shares would have been anti-dilutive. For the diluted earnings per share computation, the treasury stock method is applied and compared to the two-class method and whichever method results in a more dilutive impact is utilized to calculate diluted earnings per share. The two-class method was utilized to calculate diluted earnings per share for the year ended December 31, 2012.
The following table reconciles the numerator and denominator of the basic and diluted earnings per share computations for the year ended December 31, 2012, 2011, and 2010:
15. INCOME TAXES
The components of the provision (benefit) for income taxes for the last three years were:
The deferred Federal and State tax expense includes a benefit from the full reversal of the deferred tax asset valuation allowance of $23.5 million for the year ended December 31, 2011.
The reconciliation between the Company’s effective tax rate on income and the statutory rate is as follows:
15. INCOME TAXES
Net deferred taxes are included in other assets on the Company’s balance sheet. The tax effect of temporary differences that give rise to significant components of deferred tax assets and deferred tax liabilities as of December 31, 2012, and 2011, are presented below:
At December 31, 2012, the Company has state tax net operating loss carryforwards of $1.9 million and state tax credit carryforwards of $1.1 million. The following table summarizes the expiration dates of state net operating loss and tax credit carryforwards:
Bancorp is subject to U.S. federal income taxes and State of Oregon income taxes. The years 2009 through 2012 remain open to examination for federal income taxes and for State examination. As of December 31, 2012, and 2011, Bancorp had no unrecognized tax benefits or uncertain tax positions. Bancorp had no accrued interest or penalties as of December 31, 2012.
16. TIME DEPOSITS
Included in time deposits are deposits in denominations of $100,000 or greater, totaling $41.6 million and $54.5 million at December 31, 2012, and 2011, respectively. Interest expense relating to time deposits in denominations of $100,000 or greater was $.4 million, $1.0 million, and $2.7 million for the years ended December 31, 2012, 2011, and 2010, respectively. Maturity amounts on Bancorp’s time deposits include $95.2 million in 2013, $23.4 million in 2014, $5.3 million in 2015, $3.7 million in 2016, and $3.0 million in 2017. Included in the maturity amounts are $1.6 million in variable rate time deposits that reprice monthly with maturities in the first quarter of 2013.
17. FAIR VALUE MEASUREMENT AND FAIR VALUES OF FINANCIAL INSTRUMENTS
Bancorp measures or discloses certain financial assets and liabilities at fair value in accordance with GAAP, which defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
Bancorp has estimated fair value based on quoted market prices where available. In cases where quoted market prices were not available, fair values were based on the quoted market price of a financial instrument with similar characteristics, the present value of expected future cash flows or other valuation techniques that utilize assumptions which are subjective and judgmental in nature. Subjective factors include, among other things, estimates of cash flows, the timing of cash flows, risk and credit quality characteristics, interest rates and liquidity premiums or discounts. Accordingly, the results may not be precise, and modifying the assumptions may significantly affect the values derived. Further, fair values may or may not be realized if a significant portion of the financial instruments were sold in a bulk transaction or a forced liquidation. Therefore, any aggregate unrealized gains or losses should not be interpreted as a forecast of future earnings or cash flows. Furthermore, the fair values disclosed should not be interpreted as the aggregate current value of Bancorp.
GAAP established a fair value hierarchy which prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the instrument’s fair value measurement. The three levels within the fair value hierarchy are described as follows:
Level 1 - Quoted prices in active markets for identical assets utilizing inputs that the Company has the ability to access at the measurement date. An active market for the asset is a market in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis.
Level 2 - Other observable inputs that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the reporting entity including quoted prices for similar assets, quoted prices for securities in inactive markets and inputs derived principally from or corroborated by observable market data by correlation or other means.
Level 3 - Significant unobservable inputs that reflect the reporting entity’s own estimates about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances.
The estimated fair values of financial instruments and respective level classifications at December 31, 2012, are as follows:
17. FAIR VALUE MEASUREMENT AND FAIR VALUES OF FINANCIAL INSTRUMENTS
The fair values of financial instruments at December 31, 2011, are as follows:
The Company’s Asset/Liability Management Committee (“ALCO”) oversees the bank’s valuation process and reports such valuations to the Loan, Investment & ALCO Committee of the Board of Directors. The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:
Cash and cash equivalents - The carrying amount is a reasonable estimate of fair value.
Investment securities - For substantially all available for sale investment securities within the categories U.S. Treasuries, U.S Government agencies, mortgage-backed, obligations of state and political subdivisions, and equity investments and other securities held for investment purposes, fair values are based on unadjusted, quoted market prices or dealer quotes if available. When quoted market prices are not readily accessible or available, alternative approaches, such as matrix or model pricing or indicators from market makers, are used. If a quoted market price is not available due to illiquidity, fair value is estimated using quoted market prices for similar securities or other pricing models. Securities measured with these valuation techniques are generally classified as Level 2 of the hierarchy.
Level 3 investment securities measured on a recurring basis consist of pooled trust preferred securities. The fair values of these securities were estimated using discounted expected cash flows. The fair value for these securities used inputs for base case default, recovery and prepayment rates to estimate the probable cash flows for the security. The estimated cash flows were discounted using a rate for comparably rated securities and adjusted for an additional liquidity premium.
Trading securities held at December 31, 2012, are recorded at fair value on a recurring basis and related solely to bonds, equity securities and mutual funds held in a Rabbi Trust for benefit of the Company’s deferred compensation plans. Fair values for trading securities are based on quoted market prices for identical assets. Trading securities were recorded in other assets within The Balance Sheet. Trading securities were approximately $.8 million and $.7 million at December 31, 2012 and 2011, respectively.
Federal Home Loan Bank stock - FHLB stock is carried at cost which approximates fair value and equals its par value because the shares can only be redeemed with the FHLB at par.
17. FAIR VALUE MEASUREMENT AND FAIR VALUES OF FINANCIAL INSTRUMENTS
Loans held for sale - Loans held for sale includes mortgage loans that are carried at the lower of cost or market value. The fair value of loans held for sale is based on prices from current offerings in secondary markets. Fair value generally approximates cost because of the short duration of these assets on the Company’s balance sheet.
Loans - The fair value of loans disclosed and not measured on a recurring or nonrecurring basis is estimated by discounting the future cash flows using the current rate at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. These estimates differentiate loans based on their financial characteristics such as loan category, pricing features, and remaining maturity. Prepayment and credit loss estimates are also incorporated into loan fair value estimates as well as an additional liquidity discount to more closely align the fair value with observed market prices.
Loans that are deemed impaired are measured on a nonrecurring basis and based on the present value of expected future cash flows discounted at the loan’s effective interest rate. Loans may also, as a practical expedient, be measured at the loan’s observable market price or the fair market value of the collateral less selling costs if the loan is collateral dependent.
Bank owned life insurance - Bank owned life insurance is carried at the cash surrender value of all policies, which approximates fair value.
Other real estate owned - Management obtains third party appraisals as well as independent fair market value assessments from realtors or persons involved in selling OREO in determining the fair value of particular properties. Accordingly, the valuation of OREO is subject to significant external and internal judgment. Management reviews OREO at least annually and obtains periodic appraisals to determine whether the property continues to be carried at the lower of its recorded book value or fair value less estimated selling costs.
Deposit liabilities - The fair value of demand deposits, savings accounts and other deposits is the amount payable on demand at the reporting date. The fair value of time deposits is estimated using the rates currently offered for deposits of similar remaining maturities.
Long-term borrowings - The fair value of the long-term borrowings is estimated by discounting the future cash flows using the current rate at which similar borrowings with similar remaining maturities could be made.
Junior subordinated debentures - The fair value of the variable rate junior subordinated debentures and trust preferred securities approximates the pricing of a preferred security at current market prices.
Commitments to extend credit, standby letters of credit and financial guarantees - The majority of commitments to extend credit carry current market interest rates if converted to loans.
17. FAIR VALUE MEASUREMENT AND FAIR VALUES OF FINANCIAL INSTRUMENTS
The tables below present fair value information on certain assets broken down by recurring or nonrecurring measurement status for the periods shown. Recurring assets are initially measured at fair value and are required to be reflected at fair value in the financial statements at each reporting date. Assets measured on a nonrecurring basis are assets that due to an event or circumstance were required to be re-measured at fair value after initial recognition in the financial statements at some time during the reporting period.
Certain assets and liabilities are measured at fair value on a nonrecurring basis after initial recognition such as loans held for sale, loans measured for impairment and OREO. The Company did not have any loans held for sale for the twelve months ended December 31, 2012. For the twelve months ended December 31, 2011, loans held for sale were subject to the lower of cost or market method of accounting. There was no impairment recognized on loans held for sale at December 31, 2011. For the twelve months ended December 31, 2012, loans amounting to $42.5 million in Bancorp’s loan portfolio were deemed impaired. OREO that was taken into possession during 2012 was measured at fair value less sales expense. In addition, during 2012, certain properties were written down $3.0 million to reflect additional decreases in their fair market value after initial recognition at the time the property was placed into OREO.
1 Fair value amounts exclude the estimated selling costs of impaired loan collateral and OREO properties.
17. FAIR VALUE MEASUREMENT AND FAIR VALUES OF FINANCIAL INSTRUMENTS
The Company made no transfers between hierarchy levels in 2012. During second quarter 2011, the Company transferred $2.0 million in equity investments and other securities from a level 2 instrument to a level 1 instrument. In addition, the Company had no material changes in valuation techniques for recurring and nonrecurring assets measured at fair value during the year ended December 31, 2012. There were no nonrecurring level 1 or 2 fair value measurements in 2012.
The following table represents a reconciliation of level 3 instruments for assets that are measured at fair value on a recurring basis for the full year 2012 and 2011:
The losses from adjustments for OTTI of securities were recognized in noninterest income in the consolidated income statement.
The following table presents quantitative information about Level 3 fair value measurements for the twelve months ended December 31, 2012:
The Company estimates the fair value of its Level 3 securities quarterly based on both observable and unobservable inputs. Observable inputs include discount rates derived from current rates on traded corporate bonds. Unobservable inputs are primarily estimates of future cash flows from the Level 3 securities. The Level 3 fair value measurements of the Company’s corporate securities are highly sensitive to its estimate of the cash flow from these securities. Higher default or deferral rates and lower recovery rates reduce the overall estimated cash flows and would reduce the estimated fair value of these securities. Prepayment assumptions, recovery lag assumptions and discount rates have a reduced relative effect on the fair value estimates.
ALCO assesses the methodology and validates the model inputs for the Level 3 pricing models quarterly. The ALCO and management review the reasonableness of third-party cash flow estimates as well as market-based discount factors and estimated liquidity spreads. The resulting fair value estimates are compared to third party model estimates to confirm the model is producing reasonable fair value estimates.
18. FINANCIAL INSTRUMENTS WITH OFF BALANCE SHEET RISK
The Bank has financial instruments with off balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets.
The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as for on-balance sheet instruments. As of December 31, 2012, and 2011, outstanding commitments consist of the following:
The category “other” represents commitments extended to clients or borrowers that have been extended but not yet fully executed. These extended commitments are not yet classified nor have they been placed into our loan system.
Commitments to extend credit are agreements to lend to a customer, as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Many of the commitments may expire without being drawn upon; therefore total commitment amounts do not necessarily represent future cash requirements. Each customer’s creditworthiness is evaluated on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon extension of credit, is based on the Bank’s credit evaluation of the customer. Collateral held varies, but may include real property, accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.
Total outstanding commitments of $575.8 million at December 31, 2012, increased $1.5 million from December 31, 2011. During 2012, outstanding commitments for commercial loans and real estate construction increased by $21.8 million and $18.5 million, respectively, while outstanding commitments for home equity lines of credit and account overdraft protection instruments decreased by $11.0 million and $27.9 million, respectively.
Standby letters of credit are conditional commitments issued to support a customer’s performance or payment obligation to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.
Interest rates on residential 1-4 family mortgage loan applications are typically rate locked during the application stage for periods ranging from 15 to 45 days, the most typical period being 30 days. These loans are locked with various qualified investors under a best-efforts delivery program. The Company makes every effort to deliver these loans before their rate locks expire. This arrangement generally requires the Bank to deliver the loans prior to the expiration of the rate lock. Delays in funding the loans may require a lock extension. The cost of a lock extension at times is borne by the borrower and at times by the Bank. These lock extension costs paid by the Bank are not expected to have a material impact on operations. This activity is managed daily.
19. PARENT COMPANY ONLY FINANCIAL DATA
The following sets forth the condensed financial information of West Coast Bancorp on a stand-alone basis:
WEST COAST BANCORP
UNCONSOLIDATED BALANCE SHEETS
WEST COAST BANCORP
UNCONSOLIDATED STATEMENTS OF INCOME
There were no items of other comprehensive income for the parent company.
19. PARENT COMPANY ONLY FINANCIAL DATA
WEST COAST BANCORP
UNCONSOLIDATED STATEMENTS OF CASH FLOWS
During the year ended December 31, 2010, the Parent Company made non-cash capital contributions of $.53 million to the Bank in the form of an intercompany tax settlement. No such contributions were made during the year ended December 31, 2011, and 2012.
20. SEGMENT AND RELATED INFORMATION
Bancorp accounts for intercompany fees and services at a fair value according to regulatory requirements for the service provided. Intercompany items relate primarily to the use of accounting, human resources, data processing and marketing services provided by the Bank, West Coast Trust, and the holding company. All other accounting policies are the same as those described in the summary of significant accounting policies.
Summarized financial information concerning Bancorp’s reportable segments and the reconciliation to Bancorp’s consolidated results is shown in the following table. The “Other” column includes West Coast Trust’s operations and holding company related items including activity relating to trust preferred securities. Investment in subsidiaries is netted out of the presentations below. The “Intercompany” column identifies the intercompany activities of revenues, expenses and other assets, between the “Banking” and “Other” segment.
20. SEGMENT AND RELATED INFORMATION
21. RELATED PARTY TRANSACTIONS
As of December 31, 2012, the Bank had loan commitments to directors, senior officers, principal stockholders and their related interests totaling $.2 million, a decrease of $5.3 million from December 31, 2011. These commitments and the loan balances below were made substantially on the same terms in the course of ordinary banking business, including interest rates, maturities and collateral as those made to other customers of the Bank.
The following table presents a summary of outstanding balances for loans made to directors, senior officers, and principal stockholders of the Company and their related interests:
22. QUARTERLY FINANCIAL INFORMATION (unaudited)
Due to averaging of shares, quarterly earnings per share may not add up to the totals reported for the full year
23. PROPOSED MERGER WITH COLUMBIA BANKING SYSTEM, INC.
On September 25, 2012, Bancorp entered into an Agreement and Plan of Merger with Columbia Banking System, Inc., a Washington corporation (“Columbia”), pursuant to which Columbia will acquire Bancorp. Consummation of the transaction remains subject to customary closing conditions, including receipt of requisite shareholder and regulatory approvals
In connection with the proposed merger, Bancorp has incurred merger-related expenses of approximately $1.7 million, principally legal and professional services, for the twelve months ended December 31, 2012.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
Our disclosure controls and procedures are designed to ensure that information the Company must disclose in its reports filed or submitted under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. Our management has evaluated, with the participation and under the supervision of our chief executive officer (“CEO”) and chief financial officer (“CFO”), the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) as of the end of the period covered by this report. Based on this evaluation, our CEO and CFO have concluded that, as of such date, the Company’s disclosure controls and procedures are effective in ensuring that information relating to the Company, including its consolidated subsidiaries, required to be disclosed in reports that it files under the Exchange Act is (1) recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and (2) accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.
Material Changes in Internal Control over Financial Reporting
There was no change in our internal controls over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
Management’s Report on Internal Control Over Financial Reporting
The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control system is designed to provide reasonable assurance regarding the preparation, reliability and fair presentation of published financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. Management is also responsible for ensuring compliance with the federal laws and regulations concerning loans to insiders and the federal and state laws and regulations concerning dividend restrictions, both of which are designated by the Federal Deposit Insurance Corporation (“FDIC”) as safety and soundness laws and regulations. Nonetheless, all internal control systems, no matter how well designed, have inherent limitations. Even systems determined to be effective as of a particular date can provide only reasonable assurance with respect to financial statement preparation and presentation and may not eliminate the need for restatements.
The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2012. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework. Based on our assessment, we believe that, as of December 31, 2012, the Company’s internal control over financial reporting is effective based on those criteria.
The Company’s management has assessed its compliance with the designated safety and soundness laws and regulations and has maintained records of its determinations and assessments as required by the FDIC. Based on this assessment, management believes that West Coast Bancorp has complied, in all material respects, with the designated safety and soundness laws and regulations for the year ended December 31, 2012.
The Company’s independent registered public accounting firm has audited the Company’s internal control over financial reporting as of December 31, 2012, as stated in their report appearing below.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
West Coast Bancorp
Lake Oswego, Oregon
We have audited the internal control over financial reporting of West Coast Bancorp and subsidiaries (the “Company”) as of December 31, 2012, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Because management’s assessment and our audit were conducted to meet the reporting requirements of Section 112 of the Federal Deposit Insurance Corporation Improvement Act (FDICIA), management’s assessment and our audit of the Company’s internal control over financial reporting included controls over the preparation of the schedules equivalent to the basic financial statements in accordance with the instructions for the Consolidated Financial Statements for Bank Holding Companies (Form FR Y-9C). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying management’s report on internal control over financial reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have not examined and, accordingly, we do not express an opinion or any other form of assurance on management’s statement referring to compliance with laws and regulations.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended December 31, 2012 of the Company and our report dated March 8, 2013 expressed an unqualified opinion on those consolidated financial statements.
/s/ DELOITTE & TOUCHE LLP
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Information with Respect to Directors
The directors of Bancorp are listed below, together with certain biographical information. All current directors of Bancorp also serve as Directors of the Bank.
Lloyd D. Ankeny,
Director since 1995
Mr. Ankeny is Chair of our Board of Directors. He has been a private real estate investor for more than five years. Prior to entering the real estate field, Mr. Ankeny held management positions with IBM and Xerox Corporations. Mr. Ankeny has been a Bank Director since 1986. Mr. Ankeny was selected for his leadership skills, prior management experience, lengthy history and familiarity with the Company, the Bank, their respective operations, the banking business generally, and his knowledge of real estate.
David A Dietzler, 69
Director since 2012
Mr. Dietzler is a certified public accountant. He built his career at one of the world’s largest audit, tax and advisory services firms, KPMG LLP in Portland, and retired in 2005 after 37 years of service. His responsibilities at KPMG LLP included the role of managing partner of the Portland office for twenty years and holding various leadership roles for the Pacific Northwest offices for eleven years. Mr. Dietzler has extensive experience auditing public companies and working with audit committees. He has gained significant expertise in SEC reporting, financial statement preparation, and internal control and compliance requirements. Mr. Dietzler has been a Director of Portland General Electric Company since 2006 where he chairs the audit committee.
Henchy R. Enden, 40
Director since 2012
Ms. Enden has been employed for more than five years by MFP Investors, LLC, the investment advisor to MFP Partners, L.P. Ms. Enden was nominated at the recommendation of MFP Partners, L.P., an investor in the Company’s October 2009 capital raise. Ms. Enden is an Equity Analyst with a background in investments and finance and has an MBA from Columbia Business School.
Shmuel (Sam) Levinson, 39
Director since 2011
Mr. Levinson is currently the managing Director of Levinson Capital Management, LLC, a private equity investment advisor. Since 1996, he has also been the principal of Trapeze, Inc., a commercial and residential development company. Mr. Levinson has been a Director of Coleman Cable, Inc. since 2005. He is also a Director of Optician Medical, Inc., a medical device manufacturer; Canary Wharf Group, PLC, a real estate development and investment group; and Song Bird Estates, PLC, a real estate investment company. Mr. Levinson was nominated at the request of GF Financial, LLC. Mr. Levinson has an extensive background in investment management and real estate.
Steven J. Oliva, 72
Director since 2003
Mr. Oliva has served as President and Chief Executive Officer of Hi-School Pharmacy, Inc., for more than five years. Hi-School Pharmacy & Affiliates is a retail drug and hardware store with 25 locations in two western states and over 425 employees. Mr. Oliva is a board member of the National Association of Chain Drug Stores and Oregon State University Advisory Board-School of Pharmacy, Emeritus. He is also a real estate investor. Mr. Oliva was selected for his familiarity with the Company and his knowledge of the pharmaceutical industry and real estate markets. He is also well-regarded and active within our community.
John T. Pietrzak, 40
Director since
Mr. Pietrzak has been a principal of Castle Creek Capital LLC, a merchant banking organization that specializes in bank investments and operations, since 2008 and a Director from 2005 to 2008. Prior to joining Castle Creek, he was a Director of Demand Planning for Levi Strauss & Co. Mr. Pietrzak is also a Director of Square 1 Financial Inc. and Panhandle State Bank. Mr. Pietrzak was nominated at the recommendation of Castle Creek Partners IV, LP. Mr. Pietrzak has a background in investments, retail planning, and a current focus on investments in community banks.
Steven N. Spence, 65
Director since
Mr. Spence has been a Senior Vice President of RBC Wealth Management, Inc. since 2009. Previously, he was Senior Vice President of UBS Financial Services Inc., a securities brokerage firm, and its predecessors in Portland, Oregon, for more than thirty eight years. His duties at RBC include advising private clients under the Investment Advisor Act of 1940 on a discretionary basis. Mr. Spence was selected for his leadership skills, his familiarity with the Company and the banking business, and his background and high profile within the investment management community.
Robert D. Sznewajs, 66
Director since 2000
Mr. Sznewajs has been President and Chief Executive Officer of Bancorp and the Bank for more than five years. Mr. Sznewajs has also been a Director of Coinstar Inc. for more than five years. Mr. Sznewajs was selected for his leadership skills, his position as President & CEO of the Company, and his knowledge of the Company and the banking business.
Dr. Nancy A. Wilgenbusch, 65
Director since 2003
Dr. Wilgenbusch has been President Emerita of and advisor to Marylhurst University since 2008. Previously she was President of Marylhurst University for more than five years. Dr. Wilgenbusch has served as a Director of Cascade Corporation and as a trustee of Tax-Free Trust of Oregon and has done so for more than five years. She previously served as a Director of Scottish Power from 2004 to 2007. Dr. Wilgenbusch was selected for her knowledge of the Company, her background in education and auditing, and high profile within our community.
Information with Respect to Executive Management Team
Information with respect to our executive management team, other than Mr. Sznewajs, appears below. Information relating to Mr. Sznewajs, who is also a Director, can be found above under "Information with Respect to Directors." Each of the executive officers listed below serves in the position listed at both Bancorp and the Bank.
James D. Bygland,
Mr. Bygland has served as Executive Vice President and Chief Information Officer for more than five years.
Anders Giltvedt, 53
Mr. Giltvedt has served as Executive Vice President and Chief Financial Officer for more than five years.
Kevin McClung, 43
Mr. McClung has served as Senior Vice President., Controller and Principal Accounting Officer for more than five years.
Xandra McKeown, 54
Ms. McKeown has served as Executive Vice President and Manager of the Commercial Banking Group for more than five years.
Hadley S. Robbins, 55
Mr. Robbins has served as Executive Vice President and Chief Credit Officer for more than five years.
Cynthia J. Sparacio, 60
Ms. Sparacio has served as Executive Vice President and Director of Human Resources for more than five years.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934, as amended ("Section 16(a)"), requires that all of our executive officers and directors and all persons who beneficially own more than 10% of our common stock ("reporting persons") file reports with the SEC with respect to beneficial ownership of Bancorp common stock. We have adopted procedures to assist our directors and executive officers in complying with the Section 16(a) filing requirements.
Based solely upon our review of the copies of filings that we received with respect to the year ended December 31, 2012, and written representations from reporting persons, we believe that all executive officers and directors made all filings required by Section 16(a) on a timely basis during 2012, except that: (i) Ms. Enden filed a late Form 3 on January 25, 2012; and (ii) Messrs. Sznewajs, Giltvedt and McClung and Mses. McKeown and Sparacio, each filed a late Form 4 in May 2012, reporting dispositions of shares that occurred in 2011 and 2012 to satisfy withholding tax obligations arising out of the vesting of restricted stock. The number of prior transactions reported varied based on whether the officer in each instance elected to satisfy his or her tax obligations in shares.
In addition, (i) during fiscal year 2011, each of the Company's directors and executive officers filed, during the period between June 6 and June 17, 2011, one late Form 4 reporting restricted stock grants made on May 27 and 28, 2011, and (ii) in March 2013, each of the Company’s executive officers reported the forfeiture of certain performance-based restricted stock that occurred in September 2011.
Code of Ethics
We have adopted a code of ethics (the "Code of Ethics"), for our CEO, CFO, principal accounting officer, and persons performing similar functions, entitled the West Coast Bancorp Code of Ethics for Senior Financial Officers. The Code of Ethics is available on our website at www.wcb.com under the tab for investor relations. Stockholders may request a free copy of the Code of Ethics from:
West Coast Bancorp
Attention: Assistant Secretary
5335 Meadows Road, Suite 201
Lake Oswego, Oregon
(503) 598-3248
Audit and Compliance Committee
Bancorp has a separately-designated standing Audit and Compliance Committee established in accordance with Section 3(a)(58)(A) of the Exchange Act. The members of the Audit and Compliance Committee are David Dietzler (Chair), Henchy Enden, Nancy Wilgenbusch, and Lloyd Ankeny, each of whom is independent as independence for audit committee members is defined under NASDAQ listing standards applicable and SEC rules to the Company.
Audit Committee Financial Expert
Bancorp's Board of Directors has determined that David Dietzler is an audit committee financial expert as defined in Item 407(d)(5) of Regulation S-K of the Exchange Act and is independent as independence for audit committee members is defined under NASDAQ listing standards and SEC rules applicable to the Company.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Compensation Discussion & Analysis
As part of our discussion of executive compensation in this report, we provide summaries of and derive examples from various plans and agreements, such as employment agreements, change in control agreements, equity incentive plans, and supplemental executive retirement agreements, which are complicated legal documents. For additional information regarding these legal documents, we refer you to the complete documents as they have been incorporated into this report. The Exhibit Index in this annual report directs you to where each of the exhibits incorporated into this annual report, including all compensatory agreements with our named executive officers, can be found. All of these documents can be obtained on the SEC website. All summaries or examples derived from these documents that are included in this report are qualified in their entirety by reference to the actual legal documents.
Company Performance. Our corporate goals in recent years have been to return the Company to profitability on a consistent basis at levels equal to our peers, reduce the level of non-performing loans, maintain a stable net interest margin, increase our levels of capital, control operating expenses consistent with levels of operating income, maintain a high degree of customer satisfaction, and retain and reward our employees.
During 2012, the Company returned to a consistent level of profitability, reporting net income of $23.5 million and a Return on Assets (“ROA”) of .97% for the full year. The Company also continued to significantly reduce the level of non-performing assets, reducing such assets by an additional 42% to $41 million at December 31, 2012, or less than 2% of total assets.
Summary of Key Compensation Decisions.
Chief Executive Officer Compensation: On February 1, 2012, Mr. Sznewajs salary was increased to $450,000. Mr. Sznewajs did not receive any stock grants in 2012. Mr. Sznewajs was awarded a cash bonus equal to $325,000, representing 72% of salary or 144% of his target bonus in 2012. There is no salary change for 2013 for Mr. Sznewajs.
Other Named Executive Officer Compensation: On February 1, 2012, all four other named executive officers received salary increases bringing salary to $235,000 for Mr. Giltvedt, $216,000 for Ms. McKeown and Mr. Robbins, and $200,000 for Ms. Sparacio. Each named officer (other than Mr. Sznewajs) received a cash bonus ranging from 21% to 35% of salary, vested (based on continued employment) and were paid cash retention awards that were granted in 2010, and received restricted stock grants in 2012. There is no salary change for 2013 for the named executive officers.
Say-on-Pay. At the Company’s 2011 Annual Meeting, the Company presented a proposal on how frequently the Company should hold an advisory vote on the compensation of the Company’s named executive officers. A majority of the shareholders voted in favor of a three-year frequency. Accordingly, the Company’s shareholders did not take an advisory vote on the compensation of the Company’s named executive officers at the 2012 Annual Meeting. The most recent advisory say-on-pay for the Company was at the 2011 Annual Meeting, at which 85.72% of the votes cast on the advisory vote on executive compensation approved the compensation of the Company's named executive officers. The vote results demonstrate support for our current executive compensation program.
Objectives and Basis for Compensation. The objectives of our compensation program for named executive officers are to attract, retain, motivate and reward highly qualified executives. As a general practice, the Compensation Committee targets total compensation of each named executive officer at the 50th to 65th percentile of the total compensation of executives holding similar positions at similarly situated bank holding companies, as modified upward or downward by the following factors:
length of time in the position,
scope of job responsibilities,
current and long term job performance and potential for advancement,
competitive market conditions for individuals holding similar positions, and
the annual and longer term performance of our company.
Total executive compensation may also be affected by decisions to pay higher levels of compensation in order to attract superior executive talent in critical functions or to provide additional compensation outside of the normal annual review cycle to address retention issues.
To assist the Compensation Committee in achieving the objectives of our compensation programs for executive officers, the Compensation Committee has on a periodic basis retained the services of an independent consultant to conduct surveys and provide reports, updates and related advice to the Compensation Committee regarding compensation paid to executive officers at similarly situated bank holding companies that hold positions similar to those of our named executive officers. In 2012, the Compensation Committee reviewed its relationship with McLagan, an Aon Hewitt company, (the "Consultant"). The Compensation Committee considered all relevant factors, including those set forth in Rule 10C01(b)(4)(i) through (vi) under the Securities Exchange Act of 1934. The Committee determined that McLagan and Aon Hewitt’s work does not raise a conflict of interest and retained McLagan to perform consulting services. The Consultant provided the Compensation Committee with a report regarding executive compensation based on information derived from a banking and financial industry compensation survey and a customized survey of a peer group ("the peer group") composed of the bank holding companies listed under the subsection "Bank Holding Company Peer Group" below.
The Compensation Committee periodically compares the total annual compensation of each named executive officer to the total annual compensation of executives holding comparable positions at similarly situated bank holding companies. For the purpose of such comparisons, the Compensation Committee considers base salary, annual bonus, and the value of stock options and restricted stock grants. The Compensation Committee focuses primarily on total annual compensation rather than the various individual elements of compensation because total annual compensation is generally most important to executives. Further, focusing on total annual compensation allows us more flexibility to provide forms of compensation that are tailored to meet our goals and the particular executive's needs and wishes, either at the time of hire or later in the employment relationship. The Compensation Committee does not focus on supplemental executive retirement plans, life insurance, change in control agreements, and other compensation elements in its comparisons because it does not believe such comparisons are particularly meaningful, it is difficult to assign a value to certain elements, and it is not believed to be industry practice to do so.
According to updated information provided by our Consultant, the 2012 total direct compensation of each of our named executive officers is at the following percentile of the peer group: Mr. Sznewajs: 66th percentile; Mr. Giltvedt: 64th percentile; Ms. McKeown: 67th percentile; Mr. Robbins: 89th percentile; Ms. Sparacio: 5% above the median. Data used in the 2011 study was aged 6% (3% per year) to provide updated comparisons.
Based on the Compensation Committee’s review of the compensation arrangements discussed below, and our assessments of individual and corporate performance, the Compensation Committee believes the Company’s executive compensation levels and the design of the executive compensation programs are effective.
Goals. The compensation program and its various elements are designed to reward a combination of individual, department and/or corporate performance. How the various elements of the compensation program are designed to reward such performance is explained more fully below.
Elements of Compensation. The primary elements of our compensation program for named executive officers are base salary, annual bonus, stock options and restricted stock. In addition, although not a normal part of our compensation program, in May 2010, we made certain retention awards to named executive officers other than our Chief Executive Officer (“CEO”), which vested and were paid out in 2012. We also provide executives certain life insurance, change in control and supplemental retirement benefits, and we offer executive officers an opportunity to participate in non-qualified deferred compensation plans. We have an employment contract with our President & CEO. In addition, named executive officers are eligible to receive other benefits that are generally available to all employees on a non-discriminatory basis, such as participation in and matching contributions under our 401(k) plan, vacations, and medical, dental, life, disability, and long term care insurance.
Base Salaries. Effective February 1, 2012, base salaries for Messrs. Sznewajs, Giltvedt, Robbins, Ms. McKeown and Ms. Sparacio were increased as follows:
These base salaries for 2012 represent an increase for the CEO of $30,000 and for the other named executive officers an aggregate increase of $84,000 from 2011 levels, and was awarded for the reasons described above. For 2012, base salaries were at the following percentiles of the peer group: Mr. Sznewajs 41st percentile, Mr. Giltvedt 29th percentile, Ms. McKeown 41st percentile, Mr. Robbins 48th percentile, and Ms. Sparacio 5% below the median of survey data.
Annual Bonuses. Annual bonuses were paid to all named executive officers for 2012 achievements.
Annual bonuses allow named executive officers to earn additional annual cash compensation if performance goals and certain objective and subjective criteria are satisfied. The bonus paid each named executive officer is a function of the executive's bonus opportunity, the achievement of individual, department and/or corporate performance goals, and the Compensation Committee's discretion.
The bonus opportunity of each named executive officer is a percentage of his or her base salary and, except in the case of our CEO, is proposed by the President and CEO and reviewed and approved annually by the Compensation Committee. For example, an executive with a base salary of $200,000 and a bonus opportunity of 50% has an opportunity to earn a bonus of $100,000, subject to achievement of individual, department and Company performance goals and to the discretion of the Compensation Committee. The bonus paid may be more or less than the amount of the bonus opportunity. This structure gives the Compensation Committee latitude to weigh factors it considers important when considering executive bonuses, including subjective factors.
The bonus opportunity and the percentage of that opportunity that is allocated between individual, department and corporate goals for each named executive officer is as follows:
The individual and department performance goals for each of our named executive officers were as follows:
Officer Performance Goal Areas
Robert D. Sznewajs
Provide leadership relative to the Company's future strategic planning, set short and long term goals for profitability, interact with the Board and regulatory agencies, achieve the annual budget and long term financial plan, and attract and retain an effective management team, oversee the merger integration.
Anders Giltvedt
Oversee financial reporting, corporate risk management, and audit, asset/liability and capital management, manage corporate projects and quality of reporting to the Board and its Audit & Compliance and Loan Committees, including merger integration planning.
Xandra McKeown
Oversee the origination and sale of certain commercial, industrial and real estate loans, cross-sell deposit and related products, achieve reduction in non-performing assets, and facilitate commercial customer retention and satisfaction.
Hadley S. Robbins
Responsible for the Company’s credit policies, credit quality, loan losses, reduction in non-performing assets, enhancement of credit administration practices, and quality of reporting to the Board and its Loan Committee, including merger integration planning.
Cynthia Sparacio
Responsible for planning, organizing and directing the human resource functions and activities of the Company, including compensation, employment, employee relations, employee development and organizational development.
In 2012, the Company's achievements included a ROA of .97%, net income of $23.5 million, improved capital ratios, and a $30 million decrease in non-performing assets to 1.66% of total assets. The results relating to earnings and capital ratios were very favorable to the Company's peer group as shown in the Bank Holding Company Peer Group table.
As a result the Company's 2012 performance executive officers were awarded bonus payments ranging from 21% to 72% of salary. These bonus payments were determined by the Compensation Committee after evaluating the overall performance of the Company relative to peers, individual and corporate performance relative to goals and the need to retain talented executives.
With respect to Mr. Sznewajs, it should be noted in accordance with his most recent employment agreement, effective January 1, 2011, and discussed under the subheading within this section "Employment Contract with the CEO," he is not entitled to any additional equity grants during the term of the Employment Agreement. Accordingly, Mr. Sznewajs received no equity grants in 2012 and will not receive any in 2013. As part of the negotiation of the new employment agreement, the Company agreed to certain changes to Mr. Sznewajs Supplemental Executive Retirement Plan (“SERP”) agreement, as described under the subheading within this section "Supplemental Executive Retirement Plans." The Compensation Committee believes that given Mr. Sznewajs’ substantial stock holdings, his interests are closely aligned with those of shareholders and future incentive compensation would generally be awarded as part of his annual performance evaluation rather than through any additional equity grants.
Restricted Stock and Stock Options. Restricted stock and stock options provide the Compensation Committee with important tools to attract, retain, motivate and reward named executive officers and to further align the interests of management with those of our shareholders. Restricted stock and stock option awards are designed to strengthen the mutuality of interests between Bancorp's shareholders and named executive officers by providing a portion of annual compensation in a form that gives the executive a proprietary interest in pursuing the long-term growth, profitability, and financial success of Bancorp. Stock option grants provide an additional incentive for named executive officers to build shareholder value since recipients only receive value from the grants if the price of our stock appreciates. The Company has only issued restricted stock awards to its executive officers during the past two years.
In 2012, restricted stock was granted to Mr. Giltvedt, Ms. McKeown, Mr. Robbins that vests 25% each year for four years, and to Ms. Sparacio that vests 33-1/3% each year for three years (due to retirement eligibility). The vesting period helps retain named executive officers and is generally consistent with industry practice. We chose to grant restricted stock to encourage long-term shareholder value as opposed to solely motivating based on stock price increases.
The number of shares granted to each named executive officer was determined based on individual performance, the executive's potential, and a formula that takes into account the total number of shares being granted to all employees (as determined by total dollars available for all such grants), the executive's salary, and a multiplier based on the executive's job grade.
2010 Retention Awards. In May 2010, in consideration of the challenges confronting the Company, retention awards were granted to retain key employees to reward them for their efforts in raising capital, reducing non-performing assets, controlling operating expenses and retaining customers and employees during 2010. To earn the full award, each employee was required to remain employed by the Company through May 1, 2012.
Mr. Sznewajs did not receive a retention award in 2010.
Supplemental Executive Retirement Plans. The Compensation Committee approved entry into supplemental executive retirement agreements ("SERPs") with Mr. Sznewajs (restated January 2011), Mr. Giltvedt and Ms. McKeown in 2003 and with Mr. Robbins in 2007. In connection with the restatement of Mr. Sznewajs’ SERP in January 2011, the Company increased the percentage of annual base salary upon which Mr. Sznewajs’ SERP benefit is based to 45%, effective on January 1, 2011 and as part of the negotiation of his new employment contract. The SERPs were implemented to help retain key executives and provide compensation that is competitive with others in our peer group.
The SERPs, as amended in 2005 and again in 2009, tie the benefit provided to a percentage of final base salary. All named executive officers have elected to receive their SERP benefits in a lump sum payment rather than in installments over 15 years, except that Mr. Giltvedt has elected a lump sum only in the event of benefits triggered by death (and Mr. Giltvedt otherwise receives payments in installments over 15 years). Each SERP includes non-compete and non-solicitation provisions. For more detailed discussion of the SERPs, see the discussion in this section below under the subheading "Pension Benefits for 2012."
Life Insurance. In 2003, we purchased bank-owned life insurance for Mr. Sznewajs, Mr. Giltvedt, Ms. McKeown and Ms. Sparacio and other officers of the Company to help recover the costs of projected employee benefits, provide key executives with another element of a comprehensive and competitive compensation package, reward those persons for past and future services, and encourage them to continue employment with us. In 2007, we purchased a term life insurance policy for Mr. Robbins. Life insurance benefits under the policies are $300,000 for Mr. Sznewajs and $200,000 for each of Ms. McKeown and Ms. Sparacio and Messrs. Giltvedt and Robbins. Additional life insurance coverage is provided under policies available to all employees.
Change in Control Agreements. The Compensation Committee approved entry into change in control agreements ("CIC's") for Mr. Sznewajs, Mr. Giltvedt, Ms. McKeown and Ms. Sparacio in 2003 and Mr. Robbins in 2007. All CIC’s were updated to comply with section 409A of the Internal Revenue Code (the “Code”). The CICs were implemented to help us retain the executives (particularly after a change in control has been proposed) and remain competitive with others in our peer group and in our market. The CICs with Ms. McKeown and Mr. Robbins will be superseded by the employment agreements that each of them entered into with Columbia in connection with Bancorp entering into the definitive merger agreement that will become effective upon the consummation of the merger with Columbia.
Benefits under the CICs are payable to each named executive officer upon the occurrence of events described in the CICs. Those events require both a change in control (as defined in the CIC and, except in limited circumstances, requires the acquisition of more than 30% of the Company's outstanding shares of common stock) and a termination of the employment of the named executive officer (i.e., a double trigger) as opposed to change in control arrangements that provide for payment solely upon the consummation of a change in control (i.e., a single trigger). We believe our approach is more reasonable and reflective of our intent to compensate the executive only in the event that the named executive’s employment is also terminated.
For a more detailed discussion of the terms and conditions of the CICs, see the discussion in this section under the subheading "Potential Payments Upon Termination or Change in Control."
Deferred Compensation Plan. We maintain an executive officers' deferred compensation plan which permits each named executive officer and others to defer all or part of his or her base salary, annual incentive bonuses, and commissions under the plan on a tax-deferred basis. We do not make contributions to the plan or pay or guarantee earnings to participants.
An amount equal to participant deferrals is placed in a "rabbi" trust that is subject to the claims of our creditors. Plan participants have a number of investment options, including Bancorp stock. The return on contributions enjoyed by each participant depends on the return on the investments which the participant selects. Participants are fully vested in their plan benefits at all times. For more detailed discussion of the deferred compensation plan, see the discussion below under the subheading "Nonqualified Deferred Compensation for 2012."
Employment Contract with the CEO. We entered into an employment agreement with Mr. Sznewajs that became effective on January 1, 2011 (the "2011 Employment Agreement") and continues for a three-year term that ends December 31, 2013. This agreement became effective immediately following the end of the term of our previous three-year agreement with Mr. Sznewajs, which expired on December 31, 2010. Both agreements are consistent with the objectives of our compensation program to attract, retain, motivate and reward highly qualified executives. For more detailed discussion of the terms and conditions of the 2011 Employment Agreement, see the tables and related discussion below under the subheading "Potential Payments Upon Termination or Change in Control."
Under Mr. Sznewajs’ employment agreement, Mr. Sznewajs is entitled to receive an annual base salary of $420,000, subject to upward adjustment only based on reviews to occur annually and an annual cash bonus opportunity of 50% of his annual base salary. Mr. Sznewajs’ annual base salary was increased to $450,000 effective as of February 1, 2012. Mr. Sznewajs will not receive any stock option or restricted stock awards during the term of his employment agreement. Mr. Sznewajs is also entitled to participate in all pension, welfare and insurance benefit plans or programs, and such fringe benefits as are available to other senior executives.
Employment Agreements with Mr. Robbins and Ms. McKeown. In connection with the execution of the merger agreement, Mr. Robbins and Ms. McKeown entered into substantially similar employment agreements with Columbia that, effective upon the completion of the merger, supersede their respective CICs that were previously entered into with West Coast Bancorp and West Coast Bank (as described above).
The employment agreements provide that Mr. Robbins will serve as Senior Vice President, Oregon and Southwest Washington Group Manager, and Ms. McKeown will serve as Senior Vice President, Oregon and Southwest Washington Commercial Banking Manager, and each will be employed in West Coast’s corporate offices as of immediately prior to the completion of the merger. Each of the named executive officers will have an initial annual base salary of $216,000 and be eligible for an annual bonus with a target opportunity of 25% of annual base salary, with the actual annual bonus to be determined based on the attainment of performance objectives established by Columbia’s board of directors or the compensation committee of Columbia’s board of directors.
The employment agreements provide for a grant of restricted stock to each of the executives (3,000 shares of restricted stock for Mr. Robbins and 2,000 shares of restricted stock for Ms. McKeown) that vests over a four year period, with 20% vesting on the second anniversary of the completion of the merger, 30% vesting on the third anniversary of the completion of the merger and the remaining 50% vesting on the fourth anniversary of the completion of the merger. Each of Mr. Robbins and Ms. McKeown were also granted a retention bonus equal to $554,365 (the amount that each would have been entitled to had their employment been terminated under certain circumstances in connection with the completion of the merger) that vests in two equal annual installments, subject to continued employment (subject to accelerated vesting and payment upon certain terminations of employment) and pays out on a termination of employment for any reason after the second anniversary of the completion of the merger.
The employment agreements also provide that Columbia will maintain the Supplemental Executive Retirement Plans, or SERPs, for both Mr. Robbins and Ms. McKeown, with the benefit to never be less than the benefit provided pursuant to the SERP in the event of a qualifying termination of employment within 24 months of a change in control. The employment agreement also provides that, upon a termination of employment without “cause” or a resignation for “good reason” (as each is defined in the employment agreement), Mr. Robbins and Ms. McKeown will each be entitled to all earned but unpaid amounts, the accelerated vesting of the retention bonus and all outstanding equity awards, 18 months of COBRA continuation (fully paid by Columbia) and $5,000 in outplacement and/or tax planning services. Mr. Robbins and Ms. McKeown will also be entitled to a “gross-up” for any excise taxes as a result of “excess parachute payments” within the meaning of Section 280G of the Code and will be subject to a 12 month non-solicit of employees and customers and a 12 month non-compete following the termination of their respective employment.
Role of Executive Officers. The base salaries, bonus payments, and restricted shares granted to Mr. Giltvedt, Ms. McKeown and Mr. Robbins were recommended to the Compensation Committee by our CEO and Executive Vice President of Human Resources, with the compensation for Ms. Sparacio recommended to the Compensation Committee by the CEO and approved by the Compensation Committee. The recommendations were reviewed with the Compensation Committee chair in advance of deliberations and action by the Compensation Committee as a whole. Our CEO and Executive Vice President of Human Resources were present during the Compensation Committee's deliberations and approval process (except when decisions were made for our Executive Vice President of Human Resources, in which case our CEO was the only member of management present). The base salary and bonus payment granted to Mr. Sznewajs were approved by the Compensation Committee in executive session.
Compensation Recovery and Forfeiture Policies. We maintain the following provisions regarding the recovery, adjustment and forfeiture of compensation paid or due to named executive officers:
Forfeiture of Equity Awards. The 2002 Plan and the 2012 Omnibus Incentive Plan provide that, in the event the employment of any holder of an option is terminated for cause, stock options of such holder, whether vested or unvested, will terminate. Termination "for cause" is defined as either conviction for committing a felony or willful and deliberate failure to perform job duties. Restricted stock that has not yet vested will also be forfeited upon any "for cause" termination. These provisions serve to protect our intellectual and human capital and help ensure that our executives act in the best interest of our company and its stockholders.
Forfeiture and Recoupment Benefits. Each SERP applicable to our named executive officers provides that the executive will forfeit any benefits upon any termination of employment "for cause." An explanation of what constitutes "for cause" may be found in the discussion in this section below under the subheading "Potential Payments Upon Termination or Change in Control." Each SERP also provides that, if the non-competition or non-solicitation provisions of the SERP agreement are violated, any payments made after the date of breach must be repaid and any remaining unpaid benefits will be forfeited.
Recoupment of Annual Bonuses and Stock Gains. The Sarbanes-Oxley Act of 2002 provides that if a company is required to restate its financials due to material non-compliance with reporting requirements, the chief executive officer and chief financial officer must reimburse the company for (1) any bonus or other incentive- or equity-based compensation received during the 12 months following the first public release of later-restated financials, and (2) any profits from the sale of securities during those 12 months.
Stock Ownership Policy Guidelines. We established the following policy and recommended guidelines regarding minimum ownership of Bancorp stock by our named executive officers:
Named executive officers are expected to achieve the indicated share ownership within three to five years of becoming an executive. Shares subject to stock options, whether vested or unvested, are considered owned for purposes of our stock ownership policy. During 2012 all named officers were in compliance with the policy.
Accounting and Tax Treatments. Provisions of the Code limit the deductibility of compensation in excess of $1 million, unless the compensation is "performance-based compensation" or qualifies under certain other exceptions. The Compensation Committee strives to qualify executive compensation for deductibility to the extent consistent with the best interests of our company, but deductibility is not the sole factor used by the Compensation Committee in ascertaining appropriate levels or modes of compensation.
Bank Holding Company Peer Group. The Consultant's 2011 report provided compensation-related information regarding the bank holding companies listed below (the "peer group"). Data is updated as of or for the period ending September 30, 2012. Nara Bancorp, Inc. (NARA) completed a merger and is no longer available for comparison.
The Consultant's 2011 report included information regarding base salary, bonus, value of awarded stock options, value of restricted stock awards, and certain other compensation derived from various sources, including the reports, of members of the peer group. The peer group used in the Consultant's 2011 report was jointly selected by the Compensation Committee, management and the Consultant.
Risk Review of Compensation Plans. The Compensation Committee completed a review of all incentive plans (defined broadly as cash plans, equity plans, employment agreements and executive benefits plans) in place during fiscal year 2011. The assessment of the incentive plans was performed by key members of the Company's human resources team in coordination with the Consultant, and included a rigorous review of each plan's design and operation. The assessment followed the parameters of the FDIC's Guidance on Sound Incentive Compensation Policies finalized in 2010 that apply to all banking organizations. The findings were reviewed by both senior management and the Compensation Committee.
The purpose of this review was to determine whether the risks related to the design and operation of these plans, if present, are reasonably likely to have a material adverse effect on the Company. The Company utilized a 27 factor evaluation list provided by the Consultant to evaluate its incentive plans. Major categories included compensation program administration, overall compensation structure, general incentive plan design and payout curves, performance metrics, equity compensation, and termination provisions. We believe that our compensation policies and practices do not encourage excessive risk-taking and are not reasonably likely to have a material adverse effect on the Company. Mitigating factors which support this conclusion include but are not limited to:
Oversight of the executive incentive plan and long-term incentive plan by the Compensation Committee;
Management oversight of key plans and programs, including approving target level payouts, setting financial and operating goals, and approving payouts;
Vesting and stock ownership requirements which encourage a long-term perspective among participants;
A preference for performance measures which result in payments only upon achievement of ultimate financial results; and
Centralized administration and oversight of plans and programs.
Summary Compensation Table.
The following table summarizes the various elements of compensation paid to or earned by our chief executive officer, chief financial officer and other three most highly compensated executive officers during 2010, 2011, and 2012.
(1)
The dollar amounts in column (e) reflect the grant date fair value using the closing price of the stock on the grant date. Additional details regarding restricted stock awards under the 2012 Plan are described in the tables below under the headings "Grants of Plan-Based Awards for 2012" and "Outstanding Equity Awards at Fiscal Year-End 2012."
(2)
The dollar amounts in column (h) reflect increases in the actuarial present value of each executive's SERP using assumptions consistent with those used in our financial statements, as discussed in the table and related discussion under the subheading "Pension Benefits for 2012" below.
(3)
The dollar amounts in column (i) reflect 401 (k) Plan matching contributions, dividends on restricted stock paid for 2012 and a nonelective employer contribution to the 401 (k) Plan in 2011 equal to 1% of base salary.
Grants of Plan-Based Awards for 2012.
The following table sets forth certain information concerning individual grants of equity and non-equity awards to the named executive officers during the year ended December 31, 2012. No previously issued stock options were repriced or otherwise modified in 2012.
(1)
Reflects restricted stock grants in 2012 under the 2012 Plan. Shares vest 25% per year over a four-year vesting schedule for Anders Giltvedt, Xandra McKeown, and Hadley S. Robbins and 33-1/3% per year over a three year vesting schedule due to retirement provisions for Cynthia Sparacio, and vest immediately in the event of retirement, death, disability, or termination of employment within 24 months of a change in control affecting our company. Shares held by employees terminated for cause terminate immediately.
(2)
Reflects a grant date price of $19.05.
Outstanding Equity Awards at Fiscal Year-End 2012
The following table sets forth certain information concerning outstanding equity awards held by named executive officers at December 31, 2012.
Year of Vesting
Option Exercises and Stock Vesting for 2012
The following table sets forth certain information concerning exercises of stock options and vesting of restricted stock by the named executive officers during the year ended December 31, 2012.
Pension Benefits for 2012
The following table sets forth certain information concerning Bancorp's supplemental executive retirement agreements ("SERPs") with named executive officers as of December 31, 2012.
(1)
Messrs. Sznewajs and Giltvedt and Ms. McKeown are fully vested with respect to voluntary termination benefits under their SERPs.
(2)
SERPs are individual contracts with each of our named executive officers that originally provided for specified benefit payments over a fixed 15-year term. The valuation method used to determine the present value of accumulated benefit in column (d) above and the increase in the present value of the benefit disclosed in column (h) of the Summary Compensation Table is consistent with Accounting Principles Board Opinion No. 12, as amended, and based on the actual terms of each SERP and a discount rate of 6% as specified in the SERPs. The same methods and assumptions were used to derive amounts included in our financial statements.
We entered into a SERP with Mr. Robbins in April 2007. We entered into SERPs with each of the other listed named executive officers other than Ms. Sparacio in August 2003, which SERPs were amended effective July 1, 2005. Ms. Sparacio does not have a SERP with the Company. All SERPs were amended in 2009 to comply with section 409A of the Internal Revenue Code and to give each named executive officer a one-time opportunity, to be exercised on or before December 31, 2008, to elect to receive some or all SERP payments in a lump sum payment upon reaching retirement or normal retirement age, as the case may be. Mr. Giltvedt elected to receive a lump sum payment in the event of his death prior to normal retirement age. The other executive officers each elected to receive lump sum payments in all payment circumstances. Mr. Sznewajs’ SERP was restated effective January 2011. Each SERP is a non-qualified, unfunded plan that is designed to provide retirement benefits for the participant. Each SERP is further intended to assist in assuring each participant's continued service to our company.
Benefit amounts payable under each SERP vary based on whether (1) a participant retired at normal retirement age or terminated employment in connection with a termination event under his or her CIC, or (2) terminated employment due to early voluntary termination, early involuntary termination, or disability.
All SERP benefits are equal to, or the lump sum payment is calculated based on the value of, a 15-year stream of monthly payments equal to 35% of the participant's final base salary, except that, in the event a participant terminates employment in connection with a termination event under his or her CIC, monthly payments or lump sum amounts are based on 35% of base salary as of the participant's normal retirement date. Effective January 1, 2011, Mr. Sznewajs' benefit was increased to 45% of his annual base salary as part of the negotiation of his new employment agreement. In the event a participant terminates employment as a result of an early voluntary termination, early involuntary termination, or disability, his or her monthly payments or lump sum amounts will be based on annual benefit levels determined in accordance with a formula set forth in each participant's SERP that results in benefit amounts that increase over the participant's period of continued service, but not above the normal retirement benefit. No benefits are payable if a participant is terminated for cause (as defined in each participant's CIC).
Each SERP also includes non-competition and non-solicitation provisions that provide for a loss of future benefits and forfeiture of benefits received after a breach but before discovery if an executive competes with us in the states of Oregon or Washington or solicits our customers or employees (i) in the case of Mr. Sznewajs, within 36 months of any termination which triggers change in control benefits or 24 months of any other termination; and (ii) in the case of other named executives, within 24 months of any termination which triggers change in control benefits or 12 months of any other termination.
Retirement, change in control, involuntary termination, and disability benefits of each participant are fully vested immediately. Voluntary termination benefits are presently vested as follows: Mr. Sznewajs, 100%; Mr. Giltvedt, 100%; Ms. McKeown, 100%; and Mr. Robbins, 40%. Mr. Robbins' voluntary termination benefits will continue to vest at a rate of 10% for each additional year of completed service. Each SERP may be amended only by mutual agreement, except that we may amend or terminate each SERP if laws or regulations change in a way that would result in benefits being taxable to the executive before receipt or in material financial penalties or other materially detrimental ramifications to our company, provided in any case vested benefits would be preserved.
Nonqualified Deferred Compensation for 2012
The following table sets forth certain information regarding the accounts of named executive officers under Bancorp's executives' deferred compensation plan.
(1)
No earnings in the current year are reported as compensation in the year's Summary Compensation Table.
Our executive officers' deferred compensation plan permits each named executive officer (and other senior executives) to defer all or part of his or her base salary, annual incentive bonuses, and commissions on a tax-deferred basis. We have not and do not make contributions to the plan or pay preferential earnings or guaranty interest to participants in the plan.
Under the plan, an amount equal to deferrals under the plan is placed in a "rabbi" trust that is subject to the claims of our creditors. Participants have a number of investment options upon which to base earnings on deferred amounts, including our stock. The return on contributions enjoyed by each participant depends on the return on the investments that the participant selects.
The following table shows currently available investment choices and annualized returns earned by those choices in 2012:
Potential Payments Upon Termination or Change in Control
The following five tables set forth certain information concerning payments and other benefits that would have been payable to our named executive officers in the event of a termination of employment on December 31, 2012, under various circumstances described in the tables. The tables assume no changes in benefits or vesting are made by our Board. We have not entered into any agreements or plans that provide benefits to our named executive officers solely as a result of a change in control. All change of control benefits require both a qualifying termination event and a change of control event to occur. Except as noted in the footnotes to the tables, all amounts are payable by Bancorp.
Robert D. Sznewajs, President and Chief Executive Officer
(1)
Dollar amounts in columns (a) and (d) are comprised of amounts that would be due to Mr. Sznewajs under his Employment Agreement as in effect on December 31, 2012, under which, in the event he terminates his employment with us for "good reason" or we terminate his employment without "cause," each as described in his employment agreement and summarized in the discussion that follows these tables, he is entitled to receive a lump sum payment equal to the sum of:
The product of his base salary in effect on the date of termination multiplied by the number of days from the date of termination through December 31, 2013, divided by 365;
Annualized bonus earned through the date termination occurs (in this case $325,000 for 2012);
The product of the average of the bonus paid for the year before the year in which termination occurs and the annualized bonus multiplied by the number of days from January 1 of the year following the year in which termination occurred, through December 31, 2013, divided by 365; and
His deemed matching and profit sharing contributions under our 401(k) plan.
All payments must be made within six months of termination. Mr. Sznewajs has no obligation to mitigate or offset amounts we pay him if he takes another position following termination.
Dollar amounts in columns (b) and (e) represent amounts that would be due to Mr. Sznewajs under his CIC agreement, under which, if he terminates his employment for "good reason," or if we or our successor terminate his employment other than for "cause," "disability," or death within three years of a change in control (or prior to a change of control but on or after the date a transaction is announced or should have been announced under applicable law), he is entitled to a lump sum payment equal to the sum of:
Three times his adjusted salary and average bonus; and
Three times his deemed matching contribution under our 401(k) plan.
Cash payments due under Mr. Sznewajs' CIC agreement must be paid the first day of the seventh month following the date of a termination event, unless applicable regulations permit earlier payments, in which case payment must be made within 30 days of the date of termination.
(2)
All dollar amounts represent the value of the vesting in full of shares of restricted stock that were not vested as of December 31, 2012, calculated by multiplying the number of shares that would vest by the closing price of our stock on December 31, 2012, $22.15 per share (the "Year-End Price"). Mr. Sznewajs is entitled to vesting of all restricted stock and options with respect to various termination events described in the column headings as follows: (i) columns (a) and (d), under the terms of his employment agreement, (ii) columns (b) and (e), under the terms of his CIC agreement and the 2002 Plan, (iii) columns (c) and (f), under the terms of the 2002 Plan and related award agreements that provide for full vesting upon retirement, unless terminated for cause, and (iv) columns (g) and (h), under the terms of both the 2002 Plan and his employment agreement.
(3)
Represents the incremental value of benefits that would become due to Mr. Sznewajs under his SERP upon certain termination events described in the table.
(4)
Dollar amounts in columns (a) and (d) represent total COBRA payments for 12 months that we would be obligated to pay under Mr. Sznewajs' employment agreement, provided that our obligation to make these payments terminates if he qualifies for group health coverage from a subsequent employer. Dollar amounts in columns (b) and (e) represent total COBRA payments for 18 months that we would be obligated to pay under Mr. Sznewajs' CIC agreement, except that our obligation to make these payments will not exceed the maximum period for which COBRA coverage is provided by law.
(5)
The dollar amount in column (g) represents amounts that would be due to Mr. Sznewajs' heirs under our bank-owned life insurance program ($300,000) that provides a benefit to certain executives.
(6)
Represents amounts available for outplacement services under his CIC agreement.
(7)
If severance benefits due to Mr. Sznewajs under his CIC agreement subject him to the federal excise tax imposed on benefits that constitute excess parachute payments under the Internal Revenue Code (the "Code"), he is entitled to be reimbursed for taxes on an after-tax basis.
Anders Giltvedt, Executive Vice President and Chief Financial Officer
(1)
Dollar amounts in columns (b) and (e) represent amounts that would be due to Mr. Giltvedt under his CIC agreement, under which, if he terminates his employment for "good reason," or if we or our successor terminate his employment other than for "cause," "disability," or death within two years of a change in control (or prior to a change of control but on or after the date a transaction is announced or should have been announced under applicable law), he is entitled to a lump sum payment equal to the sum of:
Two times his adjusted salary and average bonus; and
Two times his deemed matching contribution under our 401(k) plan.
For purposes of calculating Mr. Giltvedt's severance payment under his CIC agreement, we have used the average of bonuses paid to him in 2012 and 2013 for services to our company in 2011 and 2012. Cash payments due under Mr. Giltvedt's CIC agreement must be paid within 30 days of the date of a termination event.
(2)
All dollar amounts represent the value of the vesting in full of restricted stock that was not vested as of December 31, 2012, calculated by multiplying the number of shares that would vest by the Year-End Price. Mr. Giltvedt is entitled to vesting of all restricted stock and options, (i) with respect to termination events described in columns (b) and (e), under the terms of his CIC agreement and the 2002 and 2012 Plan and (ii) with respect to termination events described in columns (g) and (h), under the terms of the 2002 and 2012 Plan.
(3)
Represents the incremental value of benefits that would become due to Mr. Giltvedt under his SERP upon certain termination events described in the table.
(4)
Dollar amounts in columns (b) and (e) represent total COBRA payments for 18 months that would be due to Mr. Giltvedt under his CIC agreement, except that our obligation to make these payments will end at the maximum period for which COBRA coverage is provided by law.
(5)
The dollar amount in column (g) represents amounts due to Mr. Giltvedt's heirs under our bank-owned life insurance program ($200,000) that provides a benefit to certain executives.
(6)
Represents the amount available to cover outplacement services under his CIC agreement.
(7)
If severance benefits due to Mr. Giltvedt under his CIC agreement subject him to the federal excise tax imposed on benefits that constitute excess parachute payments under the Code, he is also entitled to be reimbursed for taxes on an after-tax basis. Mr. Giltvedt's severance benefits as of December 31, 2012, would not trigger an excise tax under the Code, so no gross-up payment is shown in this illustration.
Xandra McKeown, Executive Vice President of Commercial Banking.
(1)
The employment agreement entered into by Columbia with Ms. McKeown will become effective upon completion of the Merger and provides for a lump sum cash retention payment equal to $554,365. The retention bonus will vest in two equal installments and the vested amount will be payable upon termination of employment. The vesting of the retention bonus accelerates upon a qualifying termination of employment as described in Part III, Item 11 “Executive Compensations” above under the subheading “Compensation Discussion and Analysis.” The disclosures in the table assume that the agreement with Columbia was in effect as of the termination date used for purposes of this illustration, December 31, 2012.
(2)
All dollar amounts represent the value of the vesting in full of restricted stock and stock options that were not vested as of December 31, 2012, calculated by multiplying the number of shares that would vest by the Year-End Price. Ms. McKeown is entitled to vesting of all restricted stock and options, (i) with respect to termination events described in columns (a) and (d), under the terms of her employment agreement with Columbia, (ii) with respect to termination events described in columns (b) and (e), under the terms of her employment agreement and the 2002 and 2012 Plan and (iii) with respect to termination events described in columns (g) and (h), under the terms of the 2002 and 2012 Plan.
(3)
Represents the incremental value of benefits that would become due to Ms. McKeown under her employment agreement and modified SERP upon certain termination events described in the table.
(4)
Dollar amounts represent total COBRA payments for 18 months that would be due to Ms. McKeown under her employment agreement, except that our obligation to make these payments will end at the maximum period for which COBRA coverage is provided by law.
(5)
The dollar amount in column (g) represents amounts due to Ms. McKeown's heirs under our bank-owned life insurance program ($200,000) that provides a benefit to certain executives.
(6)
Represents the amount available to cover outplacement services under her employment agreement.
(7)
If severance benefits due to Ms. McKeown under her employment agreement subject her to the federal excise tax imposed on benefits that constitute excess parachute payments under the Code, she is also entitled to be reimbursed for taxes on an after-tax basis. Ms. McKeown's severance benefits as of December 31, 2012, would not trigger an excise tax under the Code, so no gross-up payment is shown in this illustration.
Hadley S. Robbins, Executive Vice President and Chief Credit Officer
(1)
The employment agreement entered into by Columbia with Mr. Robbins will become effective upon completion of the Merger and provides for a lump sum cash retention payment equal to $554,365. The retention bonus will vest in two equal installments and the vested amount will be payable upon termination of employment. The vesting of the retention bonus accelerates upon a qualifying termination of employment as described in Part III, Item 11 “Executive Compensations” above under the subheading “Compensation Discussion and Analysis.” The disclosures in the table assume that the agreement with Columbia was in effect as of the termination date used for purposes of this illustration, December 31, 2012.
(2)
All dollar amounts represent the value of the vesting in full of restricted stock that were not vested as of December 31, 2012, calculated by multiplying the number of shares that would vest by the Year-End Price. Mr. Robbins is entitled to vesting of all restricted stock and options, (i) with respect to termination events described in columns (a) and (d), under the terms of his employment agreement with Columbia, (ii) with respect to termination events described in columns (b) and (e), under the terms of his employment agreement and the 2002 and 2012 Plan, and (ii) with respect to termination events described in columns (g) and (h), under the terms of the 2002 and 2012 Plan.
(3)
Represents the incremental value of benefits that would become due to Mr. Robbins under his employment agreement and modified SERP upon certain termination events described in the table.
(4)
Dollar amounts represent total COBRA payments for 18 months that would be due to Mr. Robbins under his employment agreement, except that our obligation to make these payments will end at the maximum period for which COBRA coverage is provided by law.
(5)
The dollar amount in column (g) represents amounts due to Mr. Robbins's heirs under our bank-owned life insurance program ($200,000) that provides a benefit to certain executives.
(6)
Represents the amount available to cover outplacement services under his CIC agreement.
(7)
If severance benefits due to Mr. Robbins subject him to the federal excise tax imposed on benefits that constitute excess parachute payments under the Code, he is also entitled to be reimbursed for taxes on an after-tax basis. Amount shown represents the estimated gross-up payment that would be due to Mr. Robbins under the terms of his employment agreement to cover excise taxes arising out of severance benefits shown in the table.
Cynthia Sparacio, Executive Vice President
(1)
Dollar amounts in columns (b) and (e) represent amounts that would be due to Ms. Sparacio under her CIC agreement with us, under which, if she terminates her employment for "good reason," or if we or our successor terminate her employment other than for "cause," "disability," or death within two years of a change in control (or prior to a change of control but on or after the date a transaction is announced or should have been announced under applicable law), she is entitled to a lump sum payment equal to the sum of:
Two times her adjusted salary and average bonus; and
Two times her deemed matching contribution under our 401(k) plan.
(2)
All dollar amounts represent the value of the vesting in full of restricted stock that were not vested as of December 31, 2012, calculated by multiplying the number of shares that would vest by the Year-End Price. Ms. Sparacio is entitled to vesting of all restricted stock and options, (i) with respect to termination events described in columns (b) and (e), under the terms of her CIC agreement and the 2002 and 2012 Plan and (ii) with respect to termination events described in columns (g) and (h), under the terms of the 2002 and 2012 Plan.
(3)
Dollar amounts in columns (b) and (e) represent total COBRA payments for 18 months that would be due to Ms. Sparacio under her employment agreement, except that our obligation to make these payments will end at the maximum period for which COBRA coverage is provided by law.
(4)
The dollar amount in column (g) represents amounts due to Ms. Sparacio's heirs under our bank-owned life insurance program ($200,000) that provides a benefit to certain executives.
(5)
Represents the amount available to cover outplacement services under her CIC agreement.
(6)
If severance benefits due to Ms. Sparacio subject her to the federal excise tax imposed on benefits that constitute excess parachute payments under the Code, she is also entitled to be reimbursed for taxes on an after-tax basis. Ms. Sparacio’s severance benefits as of December 31, 2012, would not trigger an excise tax under the Code, so no gross-up payment is shown in this illustration.
Non-Employee Director Compensation for
The following table summarizes compensation paid to non-employee directors for services during the year ended December 31, 2012.
(3)
Non-employee directors are entitled to participate in Bancorp's Directors' Deferred Compensation Plan (the "Directors' DCP"), under which directors may elect to defer payment of some or all of their directors fees. Earnings on contributions by each participant are dependent on the return on investments that the director selects from a list of publicly available mutual funds or Bancorp stock. See "Executive Compensation-Nonqualified Deferred Compensation for 2012" for a list of available investment options, which are the same as those available to our executives under the executives' plan. We do not make additional contributions or provide above-market or preferential earnings on fees deferred by directors under the Directors' DCP.
In establishing non-employee director compensation, the Compensation Committee and the Board of Directors considered information regarding the compensation paid to directors of the peer group companies listed under the heading "Executive Compensation-Discussion and Analysis of Executive Compensation Programs" below that was provided by McLagan, an Aon Hewitt company, a compensation consultant engaged by the Compensation Committee in 2011, along with director compensation information derived from other sources. Non-employee directors serving on the Board are paid an annual retainer and additional fees for attendance at certain Board and Board committee meetings.
During 2012, the Board chair received an annual retainer of $64,000, while the Audit Committee, Compensation Committee and Loan Committee chairs received $44,000. The Governance Committee chair, who also serves as the Board chair, waived for 2012 the additional retainer of $6,000 normally received by the Governance Committee chair. All other directors received annual retainers of $32,000. Non-employee directors also received $300 for each regular board meeting attended. In addition, non-employee directors received $600 for each Board committee meeting attended (whether as a member of a committee or at the request of a committee) on the same day as a regular Board meeting. Non-employee directors also received $600 for attending meetings with the Company's independent registered public accountants to analyze, review, and discuss the Company's quarterly earnings releases and Forms 10-Q, Form 10-K, and related matters. Non-employee directors also received $200 per day (or partial day) for attendance at education programs and are reimbursed for travel expenses to attend regular board meetings and education programs. Bancorp directors who also serve on the board of West Coast Trust received $300 for each regular meeting of the West Coast Trust board that they attended. The West Coast Trust board chair received an additional $1,000 for the year.
Recent practice has been to grant restricted stock awards and/or stock options to non-employee directors on an annual basis. In 2012, the directors were granted a restricted stock award at the May 29, 2012, board meeting as reflected in the preceding table.
Compensation Committee Interlocks and Insider Participation
Messrs. Ankeny, Oliva, Pietrzak and Levinson, Ms. Enden, and Dr. Wilgenbusch served on the Compensation Committee during 2012. During 2012, none of our executive officers served on the Board of Directors of any entities whose directors or officers serve on our Compensation Committee.
Compensation Committee Report
The Compensation & Personnel Committee ("Compensation Committee") discharges the responsibilities assigned to it by the Board of Directors with respect to compensation and personnel matters, including those relating to Bancorp's executive officers.
In discharging its responsibilities, the Compensation Committee:
Reviewed and discussed with management the Compensation Discussion and Analysis included in this report; and
Based on the review and discussions, the Compensation Committee recommended to the Board of Directors that the Compensation Discussion and Analysis be included in the report and furnished in the Company's annual report on Form 10-K for the year ended December 31, 2012, through its incorporation by reference from the report.
Compensation Committee Members
Dr. Wilgenbusch (Chair), Mr. Ankeny, Ms. Enden, Mr. Levinson,
Mr. Oliva, and Mr. Pietrzak.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCK HOLDER MATTERS
Stock Ownership Table
The following table shows beneficial ownership as of February 1, 2013, of Bancorp common stock beneficially owned by our current directors and nominees for director, the executive officers named in the summary compensation table, shareholders known to us to beneficially own more than 5% of our common stock, and all executive officers and directors of Bancorp as a group. No officer or director beneficially owns any shares of Series B Preferred Stock. Beneficial ownership includes shares currently owned, shares that a person has a right to vote or transfer, and any shares that a person has a right to acquire within 60 days. To our knowledge, none of the listed shares have been pledged as collateral for loans or other indebtedness. Except as noted below, each holder has sole voting and investment power with respect to listed shares. At February 1, 2013, Bancorp had 19,316,843 shares outstanding.
*Represents less than 1% of our outstanding common stock.
(10)
Based on information contained in the Schedule 13G filed February 13, 2013, by AQR Capital Management LLC (“AQR”). The Schedule 13G indicates that AQR has shared voting and dispositive power over the listed shares. The Schedule 13G indicates that AQR is a beneficial owner of the listed shares as a result of its serving as an investment adviser.
(11)
Share amounts include 1,054 shares owned by Mr. Spence's spouse. Mr. Spence disclaims any beneficial ownership of these shares.
(12)
Share amounts include 4 shares owned by Mr. Sznewajs' spouse. Mr. Sznewajs disclaims any beneficial ownership of these shares.
Equity Compensation Plan Information
The following table summarizes information regarding shares of Bancorp stock that may be issued upon exercise of options, warrants and rights under Bancorp's existing equity compensation plans and arrangements as of December 31, 2012. All of our plans or arrangements under which equity compensation may be awarded have been approved by shareholders. The information includes the number of shares covered by and the weighted average exercise price of, outstanding options, warrants, and other rights and the number of shares remaining available for future grants, excluding the shares to be issued upon exercise of outstanding options, warrants, and other rights.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Transactions with Related Persons
Many of our directors and officers, members of their immediate families, and firms in which they have or had an interest were customers of and had transactions with the Bank or West Coast Trust during 2012 in the ordinary course of business. Similar transactions may be expected to take place in the ordinary course of business in the future. All outstanding loans and commitments were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons and did not, in the opinion of management, involve more than the normal risk of collectability or present other unfavorable features.
Bancorp has adopted written policies and procedures for the review, approval and ratification of transactions with related persons. Related persons include our directors and named executive officers. The policies require that all transactions with related persons that are required to be publicly disclosed under Item 404 of Regulation S-K of the Securities and Exchange Commission ("SEC") be either approved or ratified by a designated Board committee and reported to the Board of Directors.
The policies require that all material facts of all transactions that require approval be reviewed and either approved or disapproved:
Loan Committee Approval. With respect to loans and other extensions of credit, by the Loan Committee, with any members of the committee who are not independent abstaining from discussion and voting; and
Governance Committee Approval. With respect to other transactions, by the Governance Committee.
In determining whether to approve or ratify a transaction, the appropriate Board committee will take into account, among other factors determined to be appropriate, whether the transaction is on terms no less favorable than terms generally available to an unaffiliated third-person under the same or similar circumstances and the extent of the related person's interest in the transaction. If advance approval of a transaction is not feasible, the transaction is considered and, if determined to be appropriate, ratified by the committee as soon as practicable after its occurrence.
No director may participate in any discussion or approval of a transaction for which he or she is involved, except that the director is required to provide all material information concerning the transaction to the committee. If a transaction will be ongoing, the appropriate committee responsible for approval of the transaction may establish guidelines for management to follow in its ongoing dealings with the related person. The policy does not require pre-approval or ratification of any transaction with another entity in which the related person's only relationship is as an employee (other than an executive officer) of the entity.
We will provide a complete written copy of the policy upon written request addressed to the Assistant Corporate Secretary at 5335 Meadows Road, Suite 201, Lake Oswego, Oregon 97035.
Director Independence
The Board of Directors has determined that each of the current directors standing for election, other than Mr. Sznewajs, is an "independent director" under Rule 5605(a)(2) of NASDAQ listing standards applicable to the Company. All members of the Board's compensation, nominating and audit committees are "independent directors" under this standard.
In the course of determining that each director is an "independent director" under the NASDAQ listing standards, the Board considered various loan transactions and deposit relationships between the Bank and certain directors (or their family members or business interests). These transactions and relationships were entered into on the same terms prevailing at the time for comparable transactions or relationships with other persons, as described further under the heading "Transactions With Related Persons" above.
The independence of the Audit Committee members is described in Item 10 under the heading "Audit and Compliance Committee" above.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Fees Paid to Independent Registered Public Accountants
The following table sets forth the aggregate fees paid to Deloitte & Touche LLP, the member firms of Deloitte Touche Tohmatsu, and their respective affiliates (collectively, "Deloitte & Touche"), for the years ended December 31, 2012, and December 31, 2011:
(1)
Fees for audit services consist of:
Audit of the Company's annual financial statements;
Reviews related to obligations under the Federal Deposit Insurance Corporation Improvement Act;
Reviews in connection with quarterly reports filed with the SEC; and
Other SEC-related work such as consents and other services.
(2)
Fees for audit-related services consist of benefit plan audits.
(3)
Fees for tax services consist of tax compliance services, including federal, state, and local tax preparation services and advice, and tax planning.
(4)
Fees related to merger with Columbia.
The Audit Committee has adopted pre-approval policies and procedures for pre-approving work to be performed by Deloitte & Touche. Under Bancorp's pre-approval policy, the Audit Committee must pre-approve all audits and permitted non-audit services to be performed by our independent auditors. All services performed by Deloitte & Touche during 2012 were pre-approved by the Audit Committee.
The Audit Committee has pre-approved the use of Deloitte & Touche for certain audit services and specific types of services characterized as audit-related and tax services. These categories include with respect to audit services, attestation services, services associated with SEC registration statements, and consultations with management relating to accounting disclosure of transactions or events. With respect to audit-related and tax services, these categories include due diligence and audit services relating to potential mergers and acquisitions, benefit plan audits, internal control reviews, consultations relating to disclosure treatment of transactions, tax preparation services, and tax planning and advice. For each category of services, the Audit Committee has set dollar limits on the amount of services that may be provided and has required that management or the auditor’s report back to the committee from time to time to inform members of services actually provided and costs therefor. The Audit Committee has delegated to the chair of the Audit Committee the authority to consider and pre-approve any management or other request for additional services to be performed by Deloitte & Touche.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) (1)
Financial Statements:
The financial statements and related documents listed in the Index set forth in Item 8 of this report are filed as part of this report.
(2)
Financial Statements Schedules:
None.
(3)
Exhibits:
The response to this portion of Item 15 is submitted as a separate section of this report appearing immediately following the signature page and entitled “Index to Exhibits.”
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 8, 2013.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 8, 2013.
*By /s/ Robert D. Sznewajs
Robert D. Sznewajs
Attorney-in-Fact
INDEX TO EXHIBITS
INDEX TO EXHIBITS
* Indicates a management contract or compensatory plan, contract or arrangement.