ITEM 1. BUSINESS The disclosures in this Item are qualified by the Risk Factors set forth in Item 1A
ITEM 1A. RISK FACTORS There are a number of risks and uncertainties, many of which are beyond the Company’s control that could have a material adverse impact on the Company’s financial condition or results of operations. The Company describes below the most significant of these risks and uncertainties. These should not be viewed as an all inclusive list or in any particular order. Additional risks that are not currently considered material may also have an adverse effect on the Company. This report is qualified in its entirety by these risk factors.
Before making an investment decision investors should carefully consider the specific risks detailed in this section and other risks facing the Company including, among others, those certain risks, uncertainties and assumptions identified herein by management that are difficult to predict and that could materially affect the Company’s financial condition and results of operations and other risks described in this Form 10-K, the information in Part I, Item 1 “Business,” Part II, Item 6 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Company’s cautionary statements as to “Forward-Looking Statements” contained therein.
Risks Related to Our Business The Bank was issued a regulatory order from the FDIC and the DCFS which prohibits the Bank from paying dividends to the Company without the consent of the FDIC and the DCFS and places other limitations and obligations on the Bank. On August 27, 2009, the Bank entered into an agreement with the FDIC, its principal federal banking regulator, and the DFCS which requires the Bank to take certain measures to improve its safety and soundness.
In connection with this agreement, the Bank stipulated to the issuance by the FDIC and the DFCS of a regulatory order against the Bank based on certain findings from an examination of the Bank conducted in February 2009 based upon financial and lending data measured as of December 31, 2008 (the “Order”). In entering into the stipulation and consenting to entry of the order, the Bank did not concede the findings or admit to any of the assertions therein.
Under the Order, the Bank is required to take certain measures to improve its capital position, maintain liquidity ratios, reduce its level of non-performing assets, reduce its loan concentrations in certain portfolios, improve management practices and board supervision and to assure that its Reserve for Loan Losses is maintained at an appropriate level. While the Bank successfully completed several of the measures under the Order as of December 31, 2009, it was unable to implement certain measures in the time frame provided, particularly those related to raising capital levels.
Among the corrective actions required are for the Bank to develop and adopt a plan to maintain the minimum capital requirements for a “well-capitalized” bank, including a Tier 1 leverage ratio of at least 10% at the Bank level beginning 150 days from the issuance of the Order. As of December 31, 2009 and through the date of this report, the requirement relating to increasing the Bank’s Tier 1 leverage ratio has not been met.
In addition, pursuant to the Order, the Bank must retain qualified management and must notify the FDIC and the DFCS in writing when it proposes to add any individual to its board of directors or to employ any new senior executive officer. Under the Order the Bank’s board of directors must also increase its participation in the affairs of the Bank, assuming full responsibility for the approval of sound policies and objectives and for the supervision of all the Bank’s activities.
The Order further requires the Bank to ensure the level of the reserve for loan losses is maintained at appropriate levels to safeguard the book value of the Bank’s loans and leases, and to reduce the amount of classified loans as of the date of the Order to no more than 75% of capital. As of December 31, 2009 and through the date of this report, the requirement that the amount of classified loans as of the date of the Order be reduced to no more than 75% of capital has not been met. However, as required by the Order, all assets classified as “Loss” in the Bank’s report of examination from February 2009 (the “ROE”) have been charged-off. The Bank has also developed and implemented a process for the review and approval of all applicable asset disposition plans.
The Order restricts the Bank from taking certain actions without the consent of the FDIC and the DFCS, including paying cash dividends, and from extending additional credit to certain types of borrowers.
The Order further requires the Bank to maintain a primary liquidity ratio (net cash, net short-term and marketable assets divided by net deposits and short-term liabilities) of at least 15%.
The Bank was required to implement these measures under various time frames, all of which have expired. While the Bank successfully completed several of the measures, it was unable to implement certain measures in the time frame provided, particularly those related to raising capital levels. In order for the Bank to meet the 10% capital requirement of the Order, as of December 31, 2009, the Bank is targeting a minimum of approximately $150 million of additional equity capital. The economic environment in our market areas and the duration of the downturn in the real estate market will continue to have a significant impact on the implementation of the Bank’s business plans. While the Company plans to continue its efforts to aggressively pursue and evaluate opportunities to raise capital, there can be no assurance that such efforts will be successful or that the Bank’s plans to achieve objectives set forth in the Order will successfully improve the Bank’s results of operation or financial condition or result in the termination of the Order from the FDIC and the DFCS. In addition, failure to increase capital levels consistent with the requirements of the Order could result in further enforcement actions by the FDIC and/or DFCS or the placing of the Bank into conservatorship or receivership.
On October 26, 2009, the Company entered into a written agreement with the FRB and DFCS (the “Written Agreement”), which requires the Company to take certain measures to improve its safety and soundness. Under the Written Agreement, the Company is required to develop and submit for approval, a plan to maintain sufficient capital at the Company and the Bank within 60 days of the date of the Written Agreement. The Company submitted a strategic plan on October 28, 2009 and as of December 31, 2009 and through the date of this report the Company is in compliance with the terms of the Written Agreement with the exception of requirements tied to or dependent upon execution of a capital raise.
We have failed to comply with certain provisions of our regulatory order. The Order to which the Bank is subject requires, among other obligations described elsewhere in this report, that we increase our regulatory capital and reduce our troubled assets. Our obligation to increase regulatory capital was subject to a deadline of January 26, 2010. As of the date of this report, we have been unable to raise capital or achieve this goal by other means.
At December 31, 2009, the Company’s Tier 1 leverage, Tier 1 risk-based capital and total risk-based capital ratios were 2.40%, 3.18% and 6.35%, respectively, and the Bank’s Tier 1 leverage, Tier 1 risk-based capital and total risk-based capital ratios were 4.69%, 6.20% and 7.46%, respectively, which do not meet regulatory benchmarks for “adequately-capitalized”. Regulatory benchmarks for an “adequately-capitalized” designation are 4%, 4% and 8% for Tier 1 leverage, Tier 1 risk-based capital and total risk-based capital, respectively; “well-capitalized” benchmarks are 5%, 6%, and 10% for Tier 1 leverage, Tier 1 risk-based capital and total risk-based capital, respectively. However, as mentioned above, pursuant to the Order, the Bank is required to maintain a Tier 1 leverage ratio of at least 10% to be considered “well-capitalized.” We can provide no assurances that we will be able to raise additional capital in the foreseeable future given the present condition of financial markets. If we fail to raise additional capital or take other measures that will cause our regulatory capital levels to increase, regulators may take additional measures that could include receivership or a forced divestiture of our assets and deposits. Any such measures, if taken, may have a material adverse effect upon the value of our common stock.
Because of our condition and uncertainties as to the implementation of management plans there is doubt about our ability to continue as a going concern. The consolidated financial statements have been prepared based upon the Company’s judgment that the Company will continue as a going concern, which contemplates the realization of assets and the discharge of liabilities in the normal course of business. Accordingly, the consolidated financial statements do not include any adjustments to reflect the possible future effects that may result from the outcome of various uncertainties as discussed below.
The effects of the severe economic contraction caused the Company to incur net losses for the years ended December 31, 2009 and 2008. The Company and the Bank do not currently meet the definition of an “adequately capitalized institution” and are thus operating under significant regulatory restrictions including a requirement to achieve certain capital requirements, enhance liquidity and improve the credit quality of the Bank’s assets (see Note 21). In response, the Company has implemented plans to meet the requirements of the August 27, 2009 agreement with the FDIC, its principal federal banking regulator, and the DFCS which requires the Bank to take certain measures to improve its safety and soundness (the Order) including an ongoing effort to raise capital. Additional plans and actions to preserve existing capital and to conserve liquidity include (1) improve asset quality and reduce non performing asset totals; (2) reduce loan portfolio totals and thereby reduce required capital; (3) retain core deposits while reducing brokered deposits; and (4) continued reduction of discretionary expenses.
Based upon its plans and expectations management believes the Company has sufficient capital and liquidity to achieve realization of assets and the discharge of liabilities in the normal course of business. However, uncertainties exist as to future economic conditions and regulatory actions, and the successful implementation of plans to improve the Company’s financial condition and meet the requirements of the Order. These uncertainties raise doubt about the Company’s ability to continue as a going concern. The consolidated financial statements do not include any adjustments that might result from the lack of success in implementing its plans or the occurrence of other events that could adversely affect its condition or operations.
The Company expects to continue to be adversely affected by current economic and market conditions. The Company’s business is closely tied to the economies of Idaho and Oregon in general and is particularly affected by the economies of Central, Southern and Northwest Oregon, as well as the Greater Boise, Idaho area. Since mid-2007 the country has experienced a significant economic downturn. Business activity across a wide range of industries and regions has been negatively impacted and local governments and many businesses are being challenged due to the lack of consumer spending and the lack of liquidity in the credit markets. Unemployment has increased significantly in Idaho and Oregon, and may remain elevated for some time.
The Company’s financial performance generally, and in particular the ability of borrowers to pay interest on and repay principal of outstanding loans and the value of collateral securing those loans, is highly dependent upon the business environment in the markets where the Company operates. The current downturn in the economy and declining real estate values have had a direct and adverse effect on the financial condition and results of operations for the Company. This is particularly evident in the residential land development and residential construction segments of the Bank’s loan portfolio. Developers or home builders whose cash flows are dependent on sale of lots or completed residences have experienced reduced ability to service their loan obligations and the market value of underlying collateral has decreased dramatically. The impact on the Company has been an elevated level of impaired loans, an associated increase in provisioning expense and charge-offs for the Company, leading to a net loss for 2008 and 2009. It is expected that the level of provisioning expense and charge-offs will significantly decrease in 2010 as compared to 2009.
In order to reduce our exposure in the residential land development and residential construction development category of loans the Company has formalized collateral valuation practices to ensure timely recognition of asset collateral support, redefined the roles and responsibility of key credit risk officers to focus on problem portfolios, designed and executed multiple stress test scenarios to identify problem assets and potential problem assets and initiated weekly asset review on residential land development and residential construction development problem assets. The Company has also improved documentation standards to verify borrower’s financial condition and collateral values, improved management information systems and internal controls to track performance and value of such portfolios, created a Special Assets Group to manage and monitor the residential land development and residential construction development portfolio and created an oversight committee to review resolution and sales of the construction/lot/land development portfolio. In addition, the Company has significantly reduced loan limits in the portfolio.
On August 25, 2009, the Company replaced its Chief Credit Officer, and we have hired an Other Real Estate Owned specialist. The Company continues to re-evaluate and re-appraise the properties in the
residential land development and residential construction development portfolio on a frequent basis, and to track sales for contingent properties to monitor sales values.
In addition, the Company has aggressively collected on guarantees and improved overall collection procedures. The Company has also aggressively pursued portfolio exposure reduction through active curtailment of additional advances on existing facilities when able and proactively recognized and resolved problem exposures through, among other things, write-offs, write-downs, and note sales.
The Company also established clear guidance on asset concentration targets as a percentage of capital for the residential land development and residential construction development category of loans which we expect will result in much lower exposure in the future.
In 2009 deposits stabilized and together with loan reductions enabled the Company to build a substantial contingent liquidity reserve. However, the Company’s condition, regulatory restrictions and ongoing economic uncertainty may affect deposit resources and access to borrowings in the future. These conditions may also increase the Company’s need for additional capital which may not be available on terms acceptable to the Company, if at all.
The banking industry and the Company operate under certain regulatory requirements that are expected to further impair our revenues, operating income and financial condition. The Company operates in a highly regulated industry and are subject to examination, supervision, and comprehensive regulation by the DFCS, the FDIC, and the Federal Reserve. Our compliance with these laws and regulations is costly and restricts certain of our activities, including payment of dividends, mergers and acquisitions, investments, loans and interest rates charged, interest rates paid on deposits, access to capital and brokered deposits and locations of banking offices. If we are unable to meet these regulatory requirements, our financial condition, liquidity and results of operations would be materially and adversely affected.
The Company has a significant concentration in real estate lending. The sustained downturn in real estate within the Company’s markets has had and is expected to continue to have a negative impact on the Company. Approximately 70% of the Bank’s loan portfolio at December 31, 2009 consisted of loans secured by real estate located in Oregon and Idaho. Declining real estate values and a severe constriction in the availability of mortgage financing have negatively impacted real estate sales, which has resulted in customers’ inability to repay loans. In addition, the value of collateral underlying such loans has decreased materially. During 2008 and 2009, we experienced significant increases in non-performing assets relating to our real estate lending, primarily in our residential real estate portfolio. We will see a further increase in non-performing assets if more borrowers fail to perform according to loan terms and if we take possession of real estate properties. Additionally, if real estate values continue to further decline, the value of real estate collateral securing our loans could be significantly reduced. If any of these effects continue or become more pronounced, loan losses will increase more than we expect and our financial condition and results of operations would be adversely impacted.
In addition, the Bank’s loans in other real estate portfolios including commercial construction and commercial real estate have experienced and are expected to continue to experience reduced cash flow and reduced collateral value. Approximately 44% of the Bank’s loan portfolio at December 31, 2009 consisted of loans secured by commercial real estate. Nationally, delinquencies in these types of portfolios are increasing significantly. While our portfolios of these types of loans have not been as adversely impacted as residential loans, there can be no assurance that the credit quality in these portfolios will not decrease significantly and may result in losses that exceed the estimates that are currently included in the reserve for credit losses, which could adversely affect the Company’s financial conditions and results of operations. See also “Financial Condition - Loan Portfolio and Credit Quality” in Item 6 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this report for further information.
The Company may be required to make further increases to its reserve for credit losses and to charge off additional loans in the future, which could adversely affect our results of operations. The Company maintains a reserve for credit losses, which is a reserve established through a provision for loan losses charged to expense, that represents management’s best estimate of probable incurred losses within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The level of the allowance reflects management’s continuing evaluation of specific credit risks; loan loss experience; current loan portfolio quality; present economic, political and regulatory conditions; industry concentrations and other unidentified losses inherent in the current loan portfolio. The determination of the appropriate level of the reserve for credit losses inherently involves a high degree of subjectivity and judgment and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the allowance for loan losses. Increases in nonperforming loans have a significant impact on our allowance for loan losses. Generally, our non-performing loans and assets reflect operating difficulties of individual borrowers resulting from weakness in the economy of the markets we serve. Our reserve for loan losses was 23.2% and 29.6% of NPAs at December 31, 2009 and 2008, respectively. If real estate markets deteriorate further, we expect that we may continue to experience increased delinquencies and credit losses. While economic conditions have stabilized on a national level, conditions could worsen, potentially resulting in higher delinquencies and credit losses. There can be no assurance that the reserve for credit losses will be sufficient to cover actual loan related losses.
Representatives of the Federal Reserve Board, the FDIC, and the DFCS, our principal regulators, have publicly expressed concerns about the banking industry’s lending practices and have particularly noted concerns about real estate-secured lending. Further, state and federal regulatory agencies, as an integral part of their examination process, review our loans and our allowance for loan losses. Additional provision for loan losses or charge-off of loans could adversely impact our results of operations and financial condition. See also “Financial Condition - Loan Portfolio and Credit Quality” in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this report.
The Company’s reserve for credit losses may not be adequate to cover future loan losses, which could adversely affect our earnings. The Company maintains a reserve for credit losses in an amount that we believe is adequate to provide for losses inherent in our portfolio. While we strive to carefully monitor credit quality and to identify loans that may become non-performing, at any time there are loans in the portfolio that could result in losses that have not been identified as non-performing or potential problem loans. Estimation of the allowance requires us to make various assumptions and judgments about the collectability of loans in our portfolio. These assumptions and judgments include historical loan loss experience, current credit profiles of our borrowers, adverse situations that have occurred that may affect a borrower’s ability to meet its financial obligations, the estimated value of underlying collateral and general economic conditions. Determining the appropriateness of the reserve is complex and requires judgment by management about the effect of matters that are inherently uncertain. We cannot be certain that we will be able to identify deteriorating loans before they become non-performing assets, or that we will be able to limit losses on those loans that have been identified. As a result, future significant increases to the reserve for credit losses may be necessary. Additionally, future increases to the reserve for credit losses may be required based on changes in the composition of the loans comprising our loan portfolio, deteriorating values in underlying collateral (most of which consists of real estate in the markets we serve) and changes in the financial condition of borrowers, such as may result from changes in economic conditions, or as a result of incorrect assumptions by management in determining the reserve for credit loss. Additionally, banking regulators, as an integral part of their supervisory function, periodically review our reserve for credit losses. These regulatory agencies may require us to increase the reserve for credit losses which could have a negative effect on our financial condition and results of operations.
Liquidity risk could impair our ability to fund operations and jeopardize our financial condition. Liquidity is essential to our business. Our primary funding source is commercial and retail deposits of our customers, brokered deposits, advances from the FHLB, FRB discount window and other borrowings to fund our operations. Although we have historically been able to replace maturing deposits and advances as necessary, we might not be able to replace such funds in the future depending on adverse results of operations, financial condition or capital ratings or regulatory restrictions. An inability to raise funds through traditional deposits, brokered deposits, borrowings, the sale of securities or loans and other sources could have a substantial negative effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities on terms which are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or economy in general. At the onset of the economic downturn in 2007 and through 2008 and early 2009 core deposits declined because customers in general experienced reduced funds available for core deposits. As a result, the amount of our wholesale funding increased. Core deposits stabilized in late 2009, and the Company has established a significant liquidity reserve as of December 31, 2009. However our ability to borrow or attract and retain deposits in the future could be adversely affected by our financial condition, regulatory restrictions, or impaired by factors that are not specific to us, such as FDIC insurance changes including the expiration of TAG program, or further disruption in the financial markets or negative views and expectations about the prospects for the banking industry. We are presently restricted from accepting additional brokered deposits, including the Bank’s reciprocal Certificate of Deposit Account Registry Service (CDARs) program. As of December 31, 2009, we had outstanding brokered deposits totaling $116.5 million, 100% of which will mature in 2010.
The Bank’s primary counterparty for borrowing purposes is the FHLB, and liquid assets are mainly balances held at the FRB. Available borrowing capacity has been reduced as we drew on our available sources. Borrowing capacity from the FHLB of Seattle or FRB may fluctuate based upon the condition of the bank or the acceptability and risk rating of loan collateral, and counterparties could adjust discount rates applied to such collateral at their discretion, and the FRB or FHLB of Seattle could restrict or limit our access to secured borrowings. As with many community banks, correspondent banks have withdrawn unsecured lines of credit or now require collateralization for the purchase of fed funds on a short-term basis due to the present adverse economic environment. In addition, collateral pledged against public deposits held at the Bank has been increased under Oregon law to more than 110% of such balances. The Bank is a public depository and, accordingly, accepts deposit funds that belong to, or are held for the benefit of, the State of Oregon, political subdivisions thereof, municipal corporations and other public funds. In accordance with applicable state law, in the event of default of one bank, all participating banks in the state collectively assure that no loss of funds is suffered by any public depositor. Generally in the event of default by a public depository, the assessment attributable to all public depositories is allocated on a pro rata basis in proportion to the maximum liability of each public depository as it existed on the date of loss. The maximum liability is dependent upon potential changes in regulations, bank failures and the level of public fund deposits, all of which cannot be presently determined. Liquidity also may be affected by the Bank’s routine commitments to extend credit. These circumstances have the effect of reducing secured borrowing capacity.
There can be no assurance that our sources of funds will remain adequate for our liquidity needs and we may be compelled to seek additional sources of financing in the future. There can be no assurance additional borrowings, if sought, would be available to us or, if available, would be on favorable terms. The Company’s stock price has been negatively affected by the recent adverse economic trend, as has the ability of banks and holding companies to raise capital or borrow in the debt markets compared to recent years. If additional financing sources are unavailable or not available on reasonable terms to provide necessary liquidity, our financial condition, results of operations and future prospects could be materially adversely affected.
The Company is seeking additional capital to improve capital ratios, but capital may not be available when it is needed. The Company is required by federal and state regulatory authorities, including under the obligations placed on the Bank by the Order, to maintain adequate levels of capital to support our operations. In addition, we may elect to raise additional capital to offset elevated risks arising from adverse economic conditions, support our business, finance acquisitions, if any, or we may otherwise elect to raise additional capital. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets, economic
conditions and a number of other factors, many of which are outside our control, and on our financial performance. In that regard, current market conditions and investor uncertainty have made it very challenging for financial institutions in general to raise capital. Market conditions and investor sentiment prevented the Company from raising capital through public and private offerings in the fourth quarter of 2009. If we cannot raise additional capital when needed, it may have a material adverse effect on our financial condition, results of operations and prospects, in addition to any possible action discussed above, that the FDIC or DFCS could take in connection with a failure to comply with or a violation of the Order.
The Company may not be able to obtain such financing or it may be only available on terms that are unfavorable to the Company and its shareholders. In the case of equity financings, dilution to the Company’s shareholders could result and securities issued in such financings may have rights, preferences and privileges that are senior to those of the Company’s current shareholders. Under the Company’s articles of incorporation, the Company may issue preferred equity without first obtaining shareholder approval. In addition, debt financing may include covenants that restrict our operations, and interest charges would detract from future earnings Further, in the event additional capital is not available on acceptable terms through available financing sources, the Company may instead take additional steps to preserve capital, including reducing loans outstanding, selling certain assets and increasing loan participations. The Company reduced its dividend to $.01 in the third quarter of 2008, and eliminated its cash dividend at year end 2008 as part of its effort to preserve capital under current adverse economic conditions. There can be no assurance that dividends on our common stock will be paid in the future, and if paid, at what amount.
Real estate values may continue to decrease leading to additional and greater than anticipated loan charge-offs and valuation write downs on our other real estate owned (“OREO”) properties. Real estate owned by the Bank and not used in the ordinary course of its operations is referred to as “other real estate owned” or “OREO” property. We foreclose on and take title to the real estate serving as collateral for many of our loans as part of our business. At December 31, 2009, we had OREO with a carrying value of $29.6 million relating to loans originated in the raw land and land development portfolio and to a lesser extent, other loan portfolios. Increased OREO balances lead to greater expenses as we incur costs to manage and dispose of the properties. We expect that our earnings in 2010 will continue to be negatively affected by various expenses associated with OREO, including personnel costs, insurance and taxes, completion and repair costs, and other costs associated with property ownership, as well as by the funding costs associated with assets that are tied up in OREO. Moreover, our ability to sell OREO properties is affected by public perception that banks are inclined to accept large discounts from market value in order to quickly liquidate properties. Any decrease in market prices may lead to OREO write downs, with a corresponding expense in our statement of operations. We evaluate OREO property values periodically and write down the carrying value of the properties if the results of our evaluations require it. Further write-downs on OREO or an inability to sell OREO properties could have a material adverse effect on our results of operations and financial condition.
The Company is not in compliance with certain continued listing requirements of the NASDAQ Stock Market. On December 17, 2009, the Company received a notice letter from The NASDAQ Stock Market regarding its non-compliance with Rule 5550(a)(2) of the NASDAQ Marketplace Rules with respect to the minimum bid price requirement of $1.00 per share. The Company’s common stock has failed to meet the $1.00 minimum bid price for 30 consecutive business days. In accordance with Rule 5810(b) of the NASDAQ Marketplace Rules, the Company has a 180 calendar day grace period, or until June 15, 2010, to comply with the minimum bid price requirement. To regain compliance, the bid price must meet or exceed $1.00 per share for at least ten consecutive business days prior to June 15, 2010. The Company will continue to evaluate its options with respect to meeting this listing qualification within the time period required. If the Company does not regain compliance with the minimum bid price rule by June 15, 2010, NASDAQ will again provide written notification that the Company’s securities are subject to potential delisting. At that time, the Company may appeal the delisting determination to a NASDAQ listing qualifications hearings panel. A delisting of the Company’s common stock from the NASDAQ Stock Market would have a material adverse effect on its financial condition.
The Bank’s deposit insurance premium could be substantially higher in the future, which could have a material adverse effect on our future earnings. The FDIC insures deposits at FDIC insured financial institutions, including the Bank. The FDIC charges the insured financial institutions premiums to maintain the Deposit Insurance Fund at a certain level. Current economic conditions have increased bank failures and expectations for further failures, in which case the FDIC ensures payments of deposits up to insured limits from the Deposit Insurance Fund. Either an increase in the risk category of the Bank or adjustments to the base assessment rates, and/or a significant special assessment could have a material adverse effect on our earnings. In addition, the deposit insurance limit on FDIC deposit insurance coverage generally has increased to $250,000 through December 31, 2013. These developments will cause the premiums assessed on us by the FDIC to increase and will materially increase our noninterest expense.
On February 27, 2009, the FDIC issued a final rule that revises the way the FDIC calculates federal deposit insurance assessment rates beginning in the second quarter of 2009. Under the new rule, the FDIC first establishes an institution’s initial base assessment rate. This initial base assessment rate will range, depending on the risk category of the institution, from 12 to 45 basis points. The FDIC will then adjust the initial base assessment (higher or lower) to obtain the total base assessment rate. The adjustments to the initial base assessment rate will be based upon an institution’s levels of unsecured debt, secured liabilities, and certain brokered deposits. The total base assessment rate will range from 7 to 77.5 basis points of the institution’s deposits.
Additionally, on May 22, 2009, the FDIC announced a final rule imposing a special emergency assessment as of June 30, 2009, payable September 30, 2009, of 5 basis points on each FDIC insured deposit any institution’s assets, less Tier 1 capital, as of June 30, 2009, but the amount of the assessment is capped at 10 basis points of domestic deposits. The final rule also allows the FDIC to impose additional special emergency assessments on or after September 30, 2009, of up to 5 basis points per quarter, if necessary to maintain public confidence in FDIC insurance. These higher FDIC assessment rates and special assessments will have an adverse impact on our results of operations. We are unable to predict the impact in future periods; including whether and when additional special assessments will occur, in the event the economic crisis continues. However, the FDIC has indicated that for now it will not impose additional special assessments but instead is requiring institutions to prepay certain assessments.
On November 12, 2009, the FDIC issued a final rule pursuant to which all insured depository institutions were required to prepay on December 31, 2009 their estimated assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012. Under the rule, however, the FDIC has the authority to exempt an institution from the prepayment requirements if the FDIC determines that the prepayment would adversely affect the safety and soundness of the institution. The Bank has received an exemption from the prepayment requirements. The Bank will continue to pay its insurance assessments on a quarterly basis.
We also participate in the FDIC’s Temporary Liquidity Guarantee Program, or TLGP, for noninterest-bearing transaction deposit accounts. Banks that participate in the TLGP’s noninterest-bearing transaction account guarantee program in 2009 generally paid the FDIC an annual assessment of 10 basis points on the amounts in such accounts above the amounts covered by FDIC deposit insurance. The guarantee program has been extended through December 31, 2013. Beginning in 2010, participants will be assessed at an annual rate of between 15 and 25 basis points on the amounts in the guaranteed accounts in excess of the amounts covered by the FDIC deposit insurance. To the extent that these TLGP assessments are insufficient to cover any loss or expenses arising from the TLGP program, the FDIC is authorized to impose an emergency special assessment on all FDIC-insured depository institutions. The FDIC has authority to impose charges for the TLGP program upon depository institution holding companies as well. These charges, along with the full utilization of our FDIC deposit insurance assessment credit in early 2009, will cause the premiums and TLGP assessments charged by the FDIC to increase. These actions have significantly increased our noninterest expense in 2009 and will likely do so for the foreseeable future.
Changes in interest rates could adversely impact the Company. The Company’s earnings are highly dependent on the difference between the interest earned on loans and investments and the interest paid on deposits and borrowings. Changes in market interest rates impact the rates earned on loans and investment securities and the rates paid on deposits and borrowings. In addition, changes to the market interest rates may impact the level of loans, deposits and investments, and the credit quality of existing loans. These rates may be affected by many factors beyond the Company’s control, including general and economic conditions and the monetary and fiscal policies of various governmental and regulatory authorities. Changes in interest rates may negatively impact the Company’s ability to attract deposits, make loans and achieve satisfactory interest rate spreads, which could adversely affect the Company’s financial condition or results of operations.
The Company is subject to extensive regulation which undergoes frequent and often significant changes. The Company’s operations are subject to extensive regulation by federal and state banking authorities which impose requirements and restrictions on the Company’s operations. The regulations affect the Company’s and the Bank’s investment practices, lending activities, and dividend policy, among other things. Moreover, federal and state banking laws and regulations undergo frequent and often significant changes and have been subject to significant change in recent years, sometimes retroactively applied, and may change significantly in the future. Changes to these laws and regulations or other actions by regulatory agencies could, among other things, make regulatory compliance more difficult or expensive for the Company, could limit the products the Company and the Bank can offer or increase the ability of non-banks to compete and could adversely affect the Company in significant but unpredictable ways which in turn could have a material adverse effect on the Company’s financial condition or results of operations. Failure to comply with the laws or regulations could result in fines, penalties, sanctions and damage to the Company’s reputation which could have an adverse effect on the Company’s business and financial results.
The financial services business is intensely competitive and our success will depend on our ability to compete effectively. The Company faces competition for its services from a variety of competitors. The Company’s future growth and success depends on its ability to compete effectively. The Company competes for deposits, loans and other financial services with numerous financial service providers including banks, thrifts, credit unions, mortgage companies, broker dealers, and insurance companies. To the extent these competitors have less regulatory constraints, lower cost structures, or increased economies of scale they may be able to offer a greater variety of products and services or more favorable pricing for such products and services. Improvements in technology, communications and the internet have intensified competition. As a result, the Company’s competitive position could be weakened, which could adversely affect the Company’s financial condition and results of operations.
Our information systems may experience an interruption or breach in security. The Company relies on its computer information systems in the conduct of its business. The Company 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 Company’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 the Company’s financial condition or results of operations.
We continually encounter technological change. Frequent introductions of new technology-driven products and services in the financial services industry result in the need for rapid technological change. In addition, the effective use of technology may result in improved customer service and reduced costs. The Company’s future success depends, to a certain extent, on its ability to identify the needs of our customers and address those needs by using technology to provide the
desired products and services and to create additional efficiencies in its operations. Certain competitors may have substantially greater resources to invest in technological improvements. We may not be able to successfully implement new technology-driven products and services or to effectively market these products and services to our customers. Failure to implement the necessary technological changes could have a material adverse impact on our business and, in turn, our financial condition and results of operations.
The Company’s controls and procedures may fail or be circumvented. Management regularly reviews and updates the Company’s internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of the Company’s controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on the Company’s business, results of operations and financial condition. See “Item 9A Controls and Procedures” of this report for a more detailed discussion of our controls and procedures.
Cascade Bancorp relies on dividends from the Bank. Cascade Bancorp is a separate legal entity from the Bank and substantially all of our revenues are derived from Bank dividends. These dividends may be limited by certain federal and state laws and regulations. In addition, any distribution of assets of the Bank upon a liquidation or reorganization would be subject to the prior liens of the Bank’s creditors. Because of the elevated credit risk and associated loss incurred in 2008 and 2009, regulators have required the Company to seek permission prior to payment of dividends on common stock or on Trust Preferred Securities. In addition, pursuant to the Order, the Bank is required to seek permission prior to payment of cash dividends on its common stock. The Company cut its dividend to zero in the fourth quarter of 2008 and deferred payments on its Trust Preferred Securities beginning in the second quarter of 2009. We do not expect the Bank to pay dividends to Cascade Bancorp for the foreseeable future. Cascade Bancorp does not expect to pay any dividends for the foreseeable future. Cascade Bancorp is unable to pay dividends on its common stock until it pays all accrued payments on its Trust Preferred Securities. As of October 31, 2009, we had $66.5 million of TPS outstanding with a weighted average interest rate of 2.83%. The Company elected to defer payments on its TPS beginning in the second quarter of 2009 and as of October 31, 2009, accrued dividends were $1.38 million. If the Bank is unable to pay dividends to Cascade Bancorp in the future, Cascade Bancorp may not be able to pay dividends on its stock or pay interest on its debt, which could have a material adverse effect on the Company’s financial condition and results of operations.
The Company may not be able to attract or retain key banking employees. We expect our future success to be driven in large part by the relationships maintained with our clients by our executives and senior lending officers. We have entered into employment agreements with several members of senior management. The existence of such agreements, however, does not necessarily ensure that we will be able to continue to retain their services. The unexpected loss of key employees could have a material adverse effect on our business and possibly result in reduced revenues and earnings.
The Company strives to attract and retain key banking professionals, management and staff. Competition to attract the best professionals in the industry can be intense which will limit the Company’s ability to hire new professionals. Banking related revenues and net income could be adversely affected in the event of the unexpected loss of key personnel.
The value of certain securities in our investment securities portfolio may be negatively affected by disruptions in the market for these securities. The Company’s investment portfolio securities are mainly mortgage backed securities guaranteed by government sponsored enterprises such as FNMA, GNMA, FHLMC and FHLB, or otherwise backed by FHA/VA guaranteed loans; however, volatility or illiquidity in financial markets may cause certain investment securities held within our investment portfolio to become less liquid. This coupled with the uncertainty surrounding the credit risk associated with the underlying collateral or guarantors may cause material
discrepancies in valuation estimates obtained from third parties. Volatile market conditions may affect the value of securities through reduced valuations due to the perception of heightened credit and liquidity risks in addition to interest rate risk typically associated with these securities. There can be no assurance that the declines in market value associated with these disruptions will not result in impairments of these assets, which would lead to accounting charges that could have a material adverse effect on our results of operations, equity, and capital ratios.
We are exposed to risk of environmental liabilities with respect to properties to which we take title. In the course of our business, we may foreclose and take title to real estate, and could be subject to environmental liabilities with respect to these properties. We may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clean-up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. In addition, if we are the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. If we become subject to significant environmental liabilities, our business, financial condition, results of operations and prospects could be adversely affected.
FNMA is no longer allowing the Bank to sell its mortgages to FNMA and may potentially force the sale of our MSR’s On November 13, 2009, FNMA informed the Bank that as a result of the Bank’s capital ratios falling below contractual requirements the Bank no longer qualified as a FNMA designated mortgage loan seller or servicer and the Bank had until December 31, 2009 to improve its capital ratios to meet FNMA’s requirements. As of December 31, 2009, the Bank had not met such requirements, and, accordingly, FNMA has terminated the Bank’s rights to originate and sell mortgage loans directly to FNMA. In addition, FNMA now has the option to terminate its mortgage servicing agreement with the Bank, upon which occurrence the Bank would no longer be allowed to service FNMA loans in the future. Management is in the process of discussing such issues with FNMA and has been evaluating the prospective impact of this development. Possible outcomes include a reduction of the Company’s mortgage banking and mortgage servicing revenues in the future and sale or forced transfer of its mortgage servicing business to a third-party by FNMA. As a result of the actions by FNMA, the Company anticipates that the majority of mortgage loans originated in future periods will be sold to other third-parties and that the Bank will not retain servicing rights. The Company expects that this may result in a significant decrease to future net mortgage servicing income. Management believes that under the circumstances, FNMA will provide the Company with sufficient time to accomplish an orderly disposition of its MSRs. However, there can be no assurance that FNMA will provide for an orderly process nor that a reduction of mortgage banking revenues or possible impairment of MSRs will not occur. Because the estimated fair value of the Company’s MSRs exceeds book value at December 31, 2009, and because management believes it is unlikely FNMA will preemptively transfer the Company’s MSRs to a third-party, no impairment adjustment has been made in connection with this issue as of December 31, 2009. In addition, no valuation allowance for MSRs was recorded as of December 31, 2008 and 2007.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS None
ITEM 2.
ITEM 2. PROPERTIES At December 31, 2009, the Company conducted full-service community banking through 32 branches, including eleven in Central Oregon, three in the Salem/Keizer area, five in Southern Oregon, one office in Portland, and 12 branches serving the greater Boise area.
In Oregon, three branch buildings are owned and are situated on leased land. The Bank owns the land and buildings at six branch locations. The Bank leases the land and buildings at eleven branch locations. In addition, the Bank leases space for the Operations and Information Systems departments located in Bend. All leases include multiple renewal options.
In Idaho, the Company owns the land and buildings at nine branch locations and leases the land and building at three branch locations.
The Company’s main office is located at 1100 NW Wall Street, Bend, Oregon, and consists of approximately 15,000 square feet. The building is owned by the Bank and is situated on leased land. The ground lease term is for 30 years and commenced June 1, 1989. There are ten renewal options of five years each. The current rent is $6,084 per month with adjustments every five years by mutual agreement of landlord and tenant. The main bank branch occupies the ground floor. A separate drive-up facility is also located on this site.
In 2004, the Bank purchased the Boyd Building with 26,035 square feet in downtown Bend. This building is occupied by Credit Services, Mortgage Division, Deposit Services and Administrative/Executive offices.
In December 2008, the Bank opened a new Salem regional office, which houses branch banking services, a mortgage center, commercial lending, professional banking advisors and a trust department. In addition, during 2008 the Bank closed its West Salem branch.
In the opinion of management, all of the Bank’s properties are adequately insured, its facilities are in good condition and together with any anticipated improvements and additions, are adequate to meet it operating needs for the foreseeable future.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is from time to time a party to various legal actions arising in the normal course of business. Management does not expect the ultimate disposition of these matters to have a material adverse effect on the business or financial position of the Company.
PART II ITEM 4.
ITEM 4. (Removed and Reserved.) ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Cascade Bancorp common stock trades on the NASDAQ Capital Market under the symbol “CACB.” The following table sets forth, for the quarters shown, the range of high and low sales prices of our common stock on the NASDAQ Capital Market and the cash dividends declared on the common stock.
On December 17, 2009, the Company received a notice letter from The NASDAQ Stock Market regarding its non-compliance with Rule 5550(a)(2) of the NASDAQ Marketplace Rules with respect to the minimum bid price requirement of $1.00 per share. The Company’s common stock has failed to meet the $1.00 minimum bid price for 30 consecutive business days. The notice letter has no immediate effect on the listing of the Company’s common stock on The NASDAQ Capital Market. In accordance with Rule 5810(b) of the NASDAQ Marketplace Rules, the Company has a 180 calendar day grace period, or until June 15, 2010, to comply with the minimum bid price requirement. To regain compliance, the bid price must meet or exceed $1.00 per share for at least ten consecutive business days prior to June 15, 2010. If the Company does not regain compliance with the minimum bid price rule by June 15, 2010, NASDAQ will again provide written notification that the Company’s securities are subject to potential delisting. At that time, the Company may appeal the delisting determination to a NASDAQ listing qualifications hearings panel.
The sales price and cash dividends shown below are retroactively adjusted for stock dividends and splits and are based on actual trade statistical information provided by the NASDAQ Capital Market for the periods indicated. Prices do not include retail mark-ups, mark-downs or commissions. As of December 31, 2009 we had approximately 28,174,163 shares of common stock outstanding, held of record by approximately 479 holders of record. The last reported sales price of our common stock on the NASDAQ Capital Market on March 5, 2010 was $0.57 per share.
Dividend Policy The amount of future dividends will depend upon our earnings, financial conditions, capital requirements and other factors and will be determined by our board of directors. The appropriate regulatory authorities are authorized to prohibit banks and bank holding companies from paying dividends, which would constitute an unsafe or unsound banking practice. Because of the elevated credit risk and associated loss incurred in 2008, the Company cut its dividend to zero in the fourth quarter of 2008 and deferred payments on its Trust Preferred Securities in the second quarter of 2009. Cascade Bancorp is unable to pay dividends on its common stock until it makes all accrued payments on its Trust Preferred Securities. Pursuant to the Order, the Bank cannot pay dividends on its common stock without the permission of its regulators. There can be no assurance as to future dividends because they are dependent on the Company’s future earnings, including dividends from the Bank, capital requirements and financial conditions.
The following table sets forth Information regarding securities authorized for issuance under the Company’s equity plans as of December 31, 2009. Additional information regarding the Company’s equity plans is presented in Note 19 of the Notes to Consolidated Financial Statements included in Item 7 of this report.
Five-Year Stock Performance Graph The graph below compares the yearly percentage change in the cumulative shareholder return on the Company’s common stock during the five years ended December 31, 2009 with: (i) the Total Return Index for the NASDAQ Stock Market (U.S. Companies) as reported by the Center for Research in Securities Prices; (ii) the Total Return Index for NASDAQ Bank Stocks as reported by the Center for Research in Securities Prices; and (iii) a peer-group of publicly traded commercial banks. This comparison assumes $100.00 was invested on December 31, 2004, in the Company’s common stock and the comparison groups and assumes the reinvestment of all cash dividends prior to any tax effect and adjusted to give retroactive effect to material changes resulting from stock dividends and splits.
Total Return Performance
* Cascade Bancorp 2009 Peer Group consists of publicly traded commercial banks, excluding Cascade Bancorp, headquartered in Oregon and Washington with total assets between $700 million and $3 billion in 2009, including AmericanWest Bancorporation, Cascade Financial Corporation, Cashmere Valley Financial Corporation, City Bank, Columbia Bancorp, Heritage Financial Corporation, Pacific Continental Corporation, PremierWest Bancorp, Washington Banking Company, and West Coast Bancorp.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA The following consolidated selected financial data is derived from the Company’s audited consolidated financial statements as of and for the five years ended December 31, 2009. The following consolidated financial data should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and related notes included elsewhere in this report. All of the Company’s acquisitions during the five years ended December 31, 2009 were accounted for using the purchase method. Accordingly, the operating results of the acquired companies are included with the Company’s results of operations since their respective dates of acquisition.
Notes:
(1) Adjusted to reflect a 25% (5:4) stock split declared in October 2006.
(2) Excludes goodwill, core deposit intangible and other identifiable intangible assets, related to the acquisitions of Community Bank of Grants Pass and F&M Holding Company.
(3) 2008 noninterest expense includes $105,047 of goodwill impairment.
Notes:
(4) Computed in accordance with FRB and FDIC guidelines.
The following table sets forth the Company’s unaudited data regarding operations for each quarter of 2009 and 2008. This information, in the opinion of management, includes all normal recurring adjustments necessary to fairly state the information set forth:
(1) Increase in fourth quarter provision to increase level of credit reserves primarily related to deterioration within the Company’s residential land development loan portfolio.
(2) Increase in fourth quarter noninterest expenses primarily due to $105,047 impairment of goodwill.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This discussion highlights key information as determined by management but may not contain all of the information that is important to you. For a more complete understanding, the following should be read in conjunction with the Company’s audited consolidated financial statements and the notes thereto as of December 31, 2009 and 2008 and for each of the years in the three-year period ended December 31, 2009 included in Item 7 of this report.
Cautionary Information Concerning Forward-Looking Statements This annual report on Form 10-K contains forward-looking statements, which are not historical facts and pertain to our future operating results. These statements include, but are not limited to, our plans, objectives, expectations and intentions and are not statements of historical fact. When used in this report, the word “expects,” “believes,” “anticipates,” “could,” “may,” “will,” “should,” “plan,” “predicts,” “projections,” “continue” and other similar expressions constitute forward-looking statements, as do any other statements that expressly or implicitly predict future events, results or performance, and such statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Certain risks and uncertainties and the Company’s success in managing such risks and uncertainties may cause actual results to differ materially from those projected, including among others, the risk factors described in this as well as the following factors: our inability to comply in a timely manner with the Order with the FDIC and the DFCS, under which we are currently operating, could lead to further regulatory sanctions or orders, which could further restrict our operations and negatively affect our results of operations and financial condition; local and national economic conditions could be less favorable than expected or could have a more direct and pronounced effect on us than expected and adversely affect our results of operations and financial condition; the local housing/real estate market could continue to decline for a longer period than we anticipate; the risks presented by a continued economic recession, which could continue to adversely affect credit quality, collateral values, including real estate collateral and OREO properties, investment values, liquidity and loan originations, reserves for loan losses and charge offs of loans and loan portfolio delinquency rates and may be exacerbated by our concentration of operations in the States of Oregon and Idaho generally, and the Oregon communities of Central Oregon, Northwest Oregon, Southern Oregon and the greater Boise area, specifically; we will be seeking additional capital in the future to improve capital ratios, but capital may not be available when needed or on acceptable terms; interest rate changes could significantly reduce net interest income and negatively affect funding sources; competition among financial institutions could increase significantly; competition or changes in interest rates could negatively affect net interest margin, as could other factors listed from time to time in the Company’s SEC reports; the reputation of the financial services industry could further deteriorate, which could adversely affect our ability to access markets for funding and to acquire and retain customers; and existing regulatory requirements, changes in regulatory requirements and legislation and our inability to meet those requirements, including capital requirements and increases in our deposit insurance premium, could adversely affect the businesses in which we are engaged, our results of operations and financial condition.
These forward-looking statements speak only as of the date of this annual report on Form 10-K. The Company undertakes no obligation to publish revised forward-looking statements to reflect the occurrence of unanticipated events or circumstances after the date hereof. Readers should carefully review all disclosures filed by the Company from time to time with the SEC.
Recent Developments In October 2009, the Company filed a registration statement on Form S-1 with the SEC pursuant to which it intended to offer up to $108 million of its Common Stock in a public offering, subject to market and other conditions including consummation of the previously announced private offerings with Mr. David F. Bolger (“Bolger”) and an affiliate of Lightyear Fund II, L.P. (“Lightyear”). On December 23, 2009, the Company announced the withdrawal of the registration statement due to market and other conditions. On February 16, 2010, the Company entered into amendments to the stock purchase agreements with each of Bolger and Lightyear which, among other things, extended the stock purchase agreements to
May 31, 2010 in order to provide the Company additional time to implement a capital raise. Because capital raising in the current economic environment is very limited, it is uncertain whether the Bank will be able to increase its capital to required levels.
On November 13, 2009, FNMA informed the Bank that - as a result of the Bank’s capital ratios falling below contractual requirements - the Bank no longer qualified as a FNMA designated mortgage loan seller or servicer and the Bank had until December 31, 2009 to improve its capital ratios to meet FNMA’s requirements. As of December 31, 2009, the Bank had not met such requirements, and, accordingly, FNMA has terminated the Bank’s rights to originate and sell mortgage loans directly to FNMA. In addition, FNMA now has the option to terminate its mortgage servicing agreement with the Bank, upon which occurrence the Bank would no longer be allowed to service FNMA loans in the future. Management is in the process of discussing such issues with FNMA and has been evaluating the prospective impact of this development. Possible outcomes include a reduction of the Company’s mortgage banking and mortgage servicing revenues in the future and sale or forced transfer of its mortgage servicing business to a third-party by FNMA. As a result of the actions by FNMA, the Company anticipates that the majority of mortgage loans originated in future periods will be sold to other third-parties and that the Bank will not retain servicing rights. The Company expects that this may result in a significant decrease to future net mortgage servicing income. Management believes that under the circumstances, FNMA will provide the Company with sufficient time to accomplish an orderly disposition of its MSRs. However, there can be no assurance that FNMA will provide for an orderly process nor that a reduction of mortgage banking revenues or possible impairment of MSRs will not occur. Because the estimated fair value of the Company’s MSRs exceeds book value at December 31, 2009, and because management believes it is unlikely FNMA will preemptively transfer the Company’s MSRs to a third-party, no impairment adjustment has been made in connection with this issue as of December 31, 2009. In addition, no valuation allowance for MSRs was recorded as of December 31, 2008 and 2007.
On December 17, 2009, the Company received a notice letter from The NASDAQ Stock Market regarding its non-compliance with Rule 5550(a)(2) of the NASDAQ Marketplace Rules with respect to the minimum bid price requirement of $1.00 per share. The Company’s common stock has failed to meet the $1.00 minimum bid price for 30 consecutive business days. The notice letter has no immediate effect on the listing of the Company’s common stock on The NASDAQ Capital Market. The Company has a 180 calendar day grace period, or until June 15, 2010, to comply with the minimum bid price requirement. To regain compliance, the bid price must meet or exceed $1.00 per share for at least ten consecutive business days prior to June 15, 2010. The Company will continue to evaluate its options with respect to meeting this listing qualification within the time period required.
Critical Accounting Policies and Accounting Estimates Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and could potentially result in materially different results under different assumptions and conditions. We believe that our most critical accounting policies upon which our financial condition depends, and which involve the most complex or subjective decisions or assessments are as follows:
Reserve for Credit Losses: The Company’s reserve for credit losses provides for possible losses based upon evaluations of known and inherent risks in the loan portfolio and related loan commitments. Arriving at an estimate of the appropriate level of reserve for credit losses (reserve for loan losses and loan commitments) involves a high degree of judgment and assessment of multiple variables that result in a methodology with relatively complex calculations and analysis. Management uses historical information to assess the adequacy of the reserve for loan losses as well as consideration of the prevailing business environment. On an ongoing basis the Company seeks to refine its methodology such that the reserve is responsive to the effect that qualitative and environmental factors have upon the loan portfolio. However, external factors and changing economic conditions may impact the portfolio and the level of reserves in ways currently unforeseen. The reserve for loan losses is increased by provisions for loan losses and by recoveries of loans previously charged-off and reduced by loans charged-off. The reserve for loan commitments is increased and decreased through non-interest expense. For a full discussion of the Company’s methodology of assessing the adequacy of the reserve for credit losses, see “Reserve for Credit Losses” later in this report.
Other Real Estate Owned and Foreclosed Assets: Other real estate owned or other foreclosed assets acquired through loan foreclosure are initially recorded at estimated fair value less costs to sell when acquired, establishing a new cost basis. The adjustment at the time of foreclosure is recorded through the reserve for loans losses. Due to the subjective nature of establishing the fair value when the asset is acquired, the actual fair value of the other real estate owned or foreclosed asset could differ from the original estimate. If it is determined that fair value declines subsequent to foreclosure, a valuation allowance is recorded through noninterest expense. Operating costs associated with the assets after acquisition are also recorded as noninterest expense. Gains and losses on the disposition of other real estate owned and foreclosed assets are netted and posted to other noninterest expenses.
Mortgage Servicing Rights (MSRs): Determination of the fair value of MSRs requires the estimation of multiple interdependent variables, the most impactful of which is mortgage prepayment speeds. Prepayment speeds are estimates of the pace and magnitude of future mortgage payoff or refinance behavior of customers whose loans are serviced by the Company. Errors in estimation of prepayment speeds or other key servicing variables could subject MSRs to impairment risk. On a quarterly basis, the Company engages a qualified third party to provide an estimate of the fair value of MSRs using a discounted cash flow model with assumptions and estimates based upon observable market-based data and methodology common to the mortgage servicing market. Management believes it applies reasonable assumptions under the circumstances, however, because of possible volatility in the market price of MSRs, and the vagaries of any relatively illiquid market, there can be no assurance that risk management and existing accounting practices will result in the avoidance of possible impairment charges in future periods. Please see “Recent Developments” above for additional information related to FNMA and the Bank’s designation as a seller/servicer. See also “Non-Interest Income” below and Note 7 of the Company’s Condensed Consolidated Financial Statements included in Item 7 of this report.
Deferred Income Taxes: The Company evaluates deferred income tax assets for recoverability based on all available evidence. This process involves significant management judgment about assumptions that are subject to change from period to period based on changes in tax laws, our ability to successfully implement tax planning strategies, or variances between our future projected operating performance and our actual results. The Company is required to establish a valuation allowance for deferred income tax assets if we determine, based on available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred income tax assets will not be realized. In determining the more-likely-than-not criterion, we evaluate all positive and negative available evidence as of the end of each reporting period. Future adjustments to the deferred income tax asset valuation allowance, if any, will be determined based upon changes in the expected realization of the net deferred income tax assets. The realization of the deferred income tax assets ultimately depends on the existence of sufficient taxable income in either the carry back or carry forward periods under the tax law. Due to the Company’s cumulative tax losses in 2008 and 2009 it was determined that as of December 31, 2009, the Company was not able to meet the ‘more likely than not” standard as to realization of the Deferred Tax asset and accordingly established an allowance against such asset.
Economic Conditions The Company’s business is closely tied to the economies of Idaho and Oregon in general and is particularly affected by the economies of Central, Southern and Northwest Oregon, as well as the Greater Boise, Idaho area. The uncertain depth and duration of the present economic downturn could continue to cause further deterioration of these local economies, resulting in an adverse effect on the Company’s financial condition and results of operations. Real estate values in these areas have declined and may continue to fall. Unemployment rates in these areas have increased significantly and could increase further. Business activity across a wide range of industries and regions has been impacted and local governments and many businesses are facing serious challenges due to the lack of consumer spending driven by elevated unemployment and uncertainty.
The Company’s financial performance generally, and in particular the ability of borrowers to pay interest on and repay principal of outstanding loans and the declining value of collateral securing those loans, is reflective of the business environment in the markets where the Company operates. The present significant downturn in economic activity and declining real estate values has had a direct and adverse effect on the condition and results of operations of the Company. This is particularly evident in the residential land
development and residential construction segments of the Company’s loan portfolio. Developers or home builders whose cash flows are dependent on the sale of lots or completed residences have reduced ability to service their loan obligations and the market value of underlying collateral has been and continues to be adversely affected. The impact on the Company has been an elevated level of impaired loans, an associated increase in provisioning expense and charge-offs for the Company leading to a net loss in 2009 and 2008 of $93.1 million and $134.6 million, respectively. The local and regional economy also has a direct impact on the volume of bank deposits. Core deposits have declined since mid-2006 because business and retail customers have realized a reduction in cash available to deposit in the Bank. However, core deposits showed signs of stabilization in the latter part of 2009.
Financial Highlights and Summary of Q4 and Full Year 2009 2010 Plan
Given the economic environment and its affect on the financial condition of the Company, the following objectives and plans have been implemented and are expected to be continued in 2010: 1) the Company continues its efforts to raise additional capital through the sale of its common stock in one or more private offerings; 2) the Company has implemented strategies and plans to stabilize and reduce its the level of problem loans and minimizing the severity of associated credit losses to the extent possible; 3) the Company has reduced the size of the loan portfolio to lower credit risk and conserve capital and liquidity; 4) the Company has worked to stabilize its core deposits and has funded a significant contingent liquidity reserve; and 5) the Company has implemented plans to reduce controllable non- interest expense.
Fourth Quarter 2009:
The Company recorded a net loss of ($1.73) per share or ($48.5) million in the fourth quarter of 2009 as compared to a net loss of ($137.6) million or ($4.92) per share for the year ago quarter. The quarterly loss was mainly attributable to a $28.0 million provision for loan losses, a $26.8 million charge to create a full allowance against the deferred tax assets at December 31, 2009, $7.5 million in OREO disposition costs and expenses, and a $2.1 million prepayment penalty to extinguish certain higher rate FHLB borrowings. Additionally, net interest income was $1.4 million lower than in the linked-quarter due to reduced average loans outstanding and $0.4 million interest reversed on non performing loans. During the quarter the Company took significant steps to maximize the benefit of recent legislation that extended (for 2009 losses only) net operating loss tax carryback to 5 years. These actions resulted in the Company recording a $43.3 million tax receivable at year-end, which is expected to be realized upon filing of our 2009 tax return. Tax optimization related endeavors included proactive sales of OREO properties, charge-offs and note sales on troubled loans, and prepayment of certain FHLB advances. Linked-quarter credit metrics improved with NPA’s including OREO down 18% along with reduced levels of classified and criticized assets. The net interest margin for the quarter was up at 3.25% compared to 3.13% in the linked-quarter primarily resulting from lower average NPA’s and lower levels of interest reversals on non performing loans compared to the prior quarter.
In October 2009, the Company filed a registration statement on Form S-1 with the SEC pursuant to which it intended to offer up to $108 million of its Common Stock in a public offering, subject to market and other conditions including consummation of the previously announced private offerings with Bolger and Lightyear. On December 23, 2009, the Company announced the withdrawal of the registration statement due to market and other conditions. On February 16, 2010, the Company entered into amendments to the stock purchase agreements with each of Bolger and Lightyear which, among other things, extended the stock purchase agreements to May 31, 2010 in order to provide the Company additional time to implement a capital raise. Because of the Company’s financial condition and challenging capital market conditions it is uncertain whether the Bank will be able to increase its capital to required levels.
Full Year 2009:
The Company recorded a net loss of ($93.1) million or ($3.32) per share compared to a net loss of ($134.6) million or ($4.82) per share for 2008. The annual loss was mainly attributable to 1) elevated credit quality related expenses; 2) a substantial charge against existing deferred tax assets; and 3) lower net interest income primarily because of lower average loan yields and a decline in loans outstanding coupled with a higher volume of non-performing assets. For the year, the Company recorded $113.0 million provision for
loan losses and $24.1 million in OREO valuation and disposition costs and related expenses reflecting adverse economic conditions effect on borrower’s ability to repay loan obligations. This compares with $99.6 million in provision for loan losses expense and $8.4 million OREO costs in 2008. In addition, the Company recorded a $26.8 million charge to create a full allowance against the Company’s deferred tax assets at December 31, 2009. In order to mitigate credit risk and conserve capital and liquidity, the Bank reduced its loan balances by $408.5 million for the year, but as a consequence net interest income for the year was down $22.7 million due to lower earning asset volumes and the effect of interest reversals and interest foregone on non performing loans. Core deposits appeared to stabilize in the latter half of 2009 and balances were near levels from the prior year end. Non-interest income was up $1.6 million in 2009 compared to 2008 largely because of our gain on sale of merchant services business. Meanwhile human resource costs and controllable/discretionary non-interest expenses were decreased in 2009 compared to the prior year. However, total non-interest expense increased year over year because of a $24.1 million in OREO related expenses including valuation charges and loss on sale compared to $8.4 million in the prior year.
Results of Operations - Years ended December 31, 2009, 2008 and 2007 Net Income/Loss The Company recorded a net loss of ($93.1) million (or $3.32) per share in 2009 compared to a net loss of ($134.6) million or ($4.82) per share for 2008 and net income of $30.0 million in 2007 or $1.05 per share. The loss in 2009 primarily resulted from a decrease in net interest income of $22.7 million, $113.0 million loan loss provision, a valuation allowance against our deferred tax assets of $26.8 million, and OREO expenses of $24.1 million. The loss in 2008 mainly resulted from the Company’s non-cash impairment of goodwill in the amount of $105.0 million, a $99.6 million loan loss provision as well as a decrease in net interest income of $13.1 million.
Net Interest Income/Net Interest Margin For most financial institutions, including the Company, the primary component of earnings is net interest income. Net interest income is the difference between interest income earned, principally from loans and investment securities portfolio, and interest paid, principally on customer deposits and borrowings. Changes in net interest income typically result from changes in volume, spread and margin. Volume refers to the dollar level of interest-earning assets and interest-bearing liabilities. Spread refers to the difference between the yield on interest-earning assets and the cost of interest-bearing liabilities. Margin refers to net interest income divided by interest-earning assets and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities.
Total interest income decreased approximately $31.0 million (or 22.5%) for 2009 due mainly to lower average earning assets and interest reversals and interest foregone on non-performing loans. In 2008 interest income was down by $33.5 million (or 19.5%) as compared to 2007 primarily because of lower average yields, including interest reversed, and interest foregone on non-performing loans. Total interest expense declined by approximately $8.2 million (or 19.4%) for 2009 primarily due to lower rates. Interest expense dropped $20.4 million (or 32.4%) for 2008 as compared to 2007 as a result of lower rates and reduced volumes of interest bearing deposits and borrowings. Accordingly, net interest income decreased to $72.7 million or 23.8% in 2009 over 2008. Net interest income decreased $13.1 million or 12.1% in 2008 over 2007. Yields earned on assets decreased to 5.03% for 2009 as compared to 6.40% in 2008 and 8.21% in 2007. Meanwhile, the average rates paid on interest bearing liabilities for 2009 decreased to 1.93% compared to 2.49% in 2008 and 4.01% in 2007.
The Company’s net interest margin (NIM) decreased to 3.43% for 2009 as compared to 4.44% for 2008. Three factors contributed to the lower NIM for the year ended December 31, 2009, including interest forgone and reversed on NPA’s, an elevated level of assets held at the FRB for contingent liquidity purposes, lower average customer balances in non-interest bearing deposit accounts, and the effect of lower market interest rates on the Company’s asset and liability mix. The margin can also be affected by factors beyond market interest rates, including loan or deposit volume shifts and/or aggressive rate offerings by competitor institutions. The Company’s financial model indicates a relatively stable interest rate risk profile within a reasonable range of rate movements around the forward rates currently predicted by financial markets.
Components of Net Interest Margin The following table presents further analysis of the components of Cascade’s net interest margin and sets forth for 2009, 2008, and 2007 information with regard to average balances of assets and liabilities, as well as total dollar amounts of interest income from interest-earning assets and interest expense on interest-bearing liabilities, resultant average yields or rates, net interest income, net interest spread, net interest margin and the ratio of average interest-earning assets to average interest-bearing liabilities for the Company:
(1) Tax-exempt income has been adjusted to a tax-equivalent basis at a rate of 35%.
(2) Average non-accrual loans included in the computation of average loans for 2009 was $156.9 million, $86.3 million for 2008 and $5.8 million in 2007.
(3) Loan related fees recognized during the period and included in the yield calculation were $3.2 million in 2009, $4.6 million in 2008 and $5.8 million in 2007.
(4) Includes mortgage loans held for sale.
Changes in Interest Income and Expense The following table shows the dollar amount of the increase (decrease) in the Company’s consolidated interest income and expense, and attributes such variance to “volume” or “rate” changes. Variances that were immaterial have been allocated equally between rate and volume categories:
Loan Loss Provision At December 31, 2009, the reserve for credit losses (reserve for loan losses and reserve for unfunded commitments) was 2.47% of outstanding loans, as compared to 2.46% for 2008 and 1.81% in 2007. The loan loss provision was $113.0 million in 2009, $99.6 million in 2008 and $19.4 million in 2007. Provision expense is determined by the Company’s ongoing analytical and evaluative assessment of the adequacy of the reserve for credit losses. At December 31, 2009, management believes that its reserve for credit losses is at an appropriate level under current circumstances and prevailing economic conditions. For further discussion, see “Reserve for Credit Losses” below. There can be no assurance that the reserve for credit losses will be sufficient to cover actual loan related losses or that additional provision expense will not be required should economic conditions remain adverse. See Item 1A “Risk Factors” and “Highlights - Loan Growth and Credit Quality” earlier in this report.
Non-interest Income Total non-interest income decreased 8.1% in 2009 compared to 2008 after excluding the one-time gain of $3.2 million on the sale of the merchant card processing business. Service charges on deposit accounts were down $1.3 million, card issuer and merchant service fees were down $0.7 million and earnings on bank-owned life insurance was down $0.2 million. These decreases were partially offset by increases in mortgage banking income, gains on sales of investment securities available-for-sale and other income. Non-interest income decreased 5.8% in 2008 compared to 2007 mainly due to earnings on bank-owned life insurance resulting from lowered investment returns in the volatile securities markets that persisted in 2008.
Mortgage Banking Income - Home Mortgage Originations and Mortgage Related Revenue The Company provides residential mortgage services on a direct to customer basis and does no business through third party (brokerage) channels. The Company has focused its originations in conventional mortgage products while avoiding sub-prime/option-ARM type products. The low delinquency rate within the Company’s loan servicing portfolio underscores this long-held discipline in mortgage origination. At December 31, 2009, the portfolio contained about 3,750 mortgage loans totaling $543 million with a delinquency rate of loans past due >30 days of only 2.58%, notably below the Mortgage Bankers Association (MBA) national mortgage delinquency rate of 14.41% at September 30, 2009.
Residential mortgage originations totaled $177.2 million in 2009, up 45.4% when compared to $121.7 million in 2008. Related net mortgage revenue was $2.8 million, an increase of 34.6% compared to $2.1 million for the previous year. Non-Interest income arising from mortgage servicing totaled approximately $2.7 million in 2007. The general level and direction of interest rates directly influence the volume and profitability of the yield curve in mortgage banking. A lower interest rate climate continued in 2009 and 2008 which had the affect of decreasing the profitability of mortgage banking due to a lower interest rate yield curve.
Historically, the Company sold a predominant portion of its residential mortgage loans to Fannie Mae, a U.S. Government sponsored enterprise and other secondary market investors. The Company services such loans for Fannie Mae and is paid approximately .25% per annum on the outstanding balances for providing this service. Such revenues are included in the above mortgage banking results. Mortgages serviced for Fannie Mae totaled $542.9 million at December 31, 2009, an increase over $512.2 million at December 31, 2008 and an increase over $494.0 million at December 31, 2007. The related Mortgage Servicing Rights (MSRs) were approximately $3.9 million in 2009 and $3.6 million in 2008.
As described under “Recent Developments”, the Bank received a letter from FNMA advising that the Bank failed to meet FNMA’s minimum required Total Risk Based Capital ratio of 10% as of September 30, 2009. The letter stated that the Bank was being suspended as a Fannie Mae Seller/Servicer effective immediately. It was noted that failure to meet applicable standards would result in termination of the Bank’s Selling and Servicing Contract. As of December 31, 2009, and through the date of this report, the Bank does not meet FNMA’s minimum financial standards. As a result, the Company may not sell mortgage loans to FNMA and FNMA may terminate its agreement to allow the Company to service FNMA loans in the future. Mortgage loans not sold to the Federal National Mortgage Association (“Fannie Mae” or “FNMA”), are generally sold servicing released to other secondary market investors. Loans sold on this basis generate no future servicing fees for the Company.
The estimated fair value of mortgage servicing rights (“MSR”) portfolio is estimated to exceed book value by amounts ranging from $0.8 million to $1.9 million. The Company capitalizes the estimated market value of MSRs into income upon the sale of each originated mortgage loan. The Company amortizes MSRs in proportion to the servicing income it receives from Fannie Mae over the estimated life of the underlying mortgages, considering prepayment expectations and refinancing patterns. In addition, the Company amortizes, in full, any remaining MSRs balance that is specifically associated with a serviced loan that is refinanced or paid-off. At December 31, 2009, expressed as a percentage of loans serviced, the book value of MSR was .73% of serviced mortgage loans, while fair value was approximately .97% of serviced mortgages. Fair value as a percentage of loans serviced was estimated at .89% a year earlier.
Non-interest Expenses Non-interest expense for 2009 decreased 45.9% to $94.0 million as compared to 2008. After adjusting for the non-cash goodwill impairment charge recorded in 2008, non-interest expense for 2009 increased $25.3 million or 36.9%. The increases in 2009 are attributable to increases in OREO related costs, FDIC insurance, and other professional services, partially offset by a reduction in salaries and employee benefits expense.
OREO expenses were $24.1 million in 2009 compared to $8.4 million in 2008 and were only $0.1 million in 2007. OREO costs and valuation adjustments increased $15.7 million for 2009 compared to 2008, primarily due to depressed real estate values on foreclosed land development properties. In addition, FDIC deposit insurance assessments increased $5.2 million or 305.7% in 2009 when compared to 2008, reflecting
the FDIC’s higher base assessment rate for 2009 and expenses related to the FDIC’s industry-wide emergency special assessment in the second quarter. FDIC premiums have increased due to the rise in financial institution failures in 2008 and 2009, the Company’s voluntary participation in the Temporary Liquidity Guarantee Program and the FDIC’s rates applicable to banks in the Company’s regulatory classification. Professional fees increased $4.5 million or 175.3% which includes legal, accounting and other professional services in connection with the Company’s efforts to raise capital in the fourth quarter of 2009. Meanwhile, the Company continued to see a reduction in salary expenses, and employee benefits expenses declined as staffing continues to be trimmed in response to the slowing economy, no executive bonuses were paid in 2008, or 2009. Total non-interest expense for 2008 increased 177.5% to $173.7 million as compared to 2007 primarily due to the noncash after-tax goodwill impairment charge and expenses related to the Company’s OREO properties. Human resource costs were down in 2008 compared to 2007 as executive bonuses were foregone in both 2007 and 2008.The Company’s efficiency ratio was 99.9% in 2009 compared to 150.6% in 2008.
Income Taxes
As of December 31, 2009, the Company had recorded refundable income taxes receivable of approximately $43.3 million related to the carryback of operating losses to prior years and had provided a $26.8 million charge to create a full valuation allowance against its deferred tax assets. For discussion of the Company’s deferred income tax assets see “Critical Accounting Policies - Deferred Income Taxes” above.
Financial Condition Balance Sheet Overview At December 31, 2009 total assets were down 3.7% to $2.19 billion compared to year-end 2008. Cash and cash equivalents increased $310.4 million or 16.4% of total assets at December 31, 2009 compared to a negligible percentage at year-end 2008. Total loans have been reduced by $408.5 million to $1.5 billion at December 31, 2009 compared to $1.9 billion at year-end 2008, primarily due to initiative to reduce loans to customers where deposit relationships are not a meaningful part of the overall banking relationship. A portion of the reduction in loan balances was the result of net loan charge-offs of $122.6 million for 2009. The reduction in loan balances has resulted in lower credit risk exposure and has helped to support the Bank’s regulatory capital ratios.
Funding sources have increased in 2009, including TLGP debt issuance and internet listing service deposits. These increases also offset reduced core deposits that have trended down due to the ongoing effects of an adverse economy on local markets. Deposits have also been impacted due to provisions of the Order limiting the use of brokered deposits with deposits showing an increase of only 1.2% in 2009 over 2008.
The following sections provide detailed analysis of the Company’s financial condition, describing its investment securities, loan portfolio composition and credit risk management practices (including those related to the loan loss reserve), as well as its deposits, and capital position.
Investment Securities The following table shows the carrying value of the Company’s portfolio of investments at December 31, 2009, 2008, and 2007:
MBS are mainly adjustable rate (ARM) MBS. Prepayment speeds on mortgages underlying MBS may cause the average life of such securities to be shorter (or longer) than expected.
The Company’s investment portfolio increased by $26.1 million, or 23.8% from December 31, 2008 to December 31, 2009 as a result of increased purchase activity during the year. The following is a summary of the contractual maturities and weighted average yields of investment securities at December 31, 2009:
(1) Yields on tax-exempt securities have been stated on a tax equivalent basis.
The average years to maturity of the Company’s investment portfolio was 7.9 years at December 31, 2009 compared to 6.5 years at December 31, 2008. Duration of the portfolio is lower than average life since many of the securities are adjustable rate mortgage securities (ARM’s) with annual interest rate adjustments.
Investments are mainly classified as “available for sale” and consist mainly of MBS and Agency notes backed by government sponsored enterprises, such as the Government National Mortgage Association (“Ginnie Mae”), FNMA and FHLB. The Company regularly reviews its investment portfolio to determine whether any securities are other than temporarily impaired. The Company did not invest in securities backed by sub-prime mortgages and believes its investment portfolio has negligible exposure to such risk at this date. At December 31, 2009, the investment portfolio had gross unrealized losses on available-for-sale securities of approximately $1.4 million and management does not believe that these unrealized losses are other-than-temporary.
Loan Portfolio and Credit Quality Loan Portfolio Composition. Net loans represented 69% of total assets as of December 31, 2009. The Company makes substantially all of its loans to customers located within the Company’s service areas. As a result of the economic conditions and characteristics of the Company’s primary markets, including among others, the historical rapid growth in population and the nature of the tourism and service industry found in much of its market areas, Cascade’s loan portfolio has historically been concentrated in real estate related loans. The Company is presently working to reduce its construction/lot portfolio in response to the challenging real estate economy. However achieving significant reduction could prove problematic without some
improvement in economic conditions and market liquidity as well as in pricing of related real estate assets. Because of the nature of its markets, real estate lending is expected to continue as a major concentration within the loan portfolio. The Company has no significant agricultural loans.
The following table presents the composition of the Company’s loan portfolio, at the dates indicated:
The following table provides the geographic distribution of the Company’s loan portfolio by region as a percent of total company-wide loans at December 31, 2009:
At December 31, 2009, the contractual maturities of all loans by category were as follows:
At December 31, 2009, variable and adjustable rate loans contractually due after one year totaled $991.7 million and loans with predetermined or fixed rates due after one year totaled $110.8 million.
Real Estate Loan Concentration Risk. Real estate loans have historically represented a significant portion of the Company’s overall loan portfolio and real estate is frequently a material component of collateral for the Company’s loans. Approximately two-thirds of total loans have exposure to real estate, including construction and lot loans (comprised of land development plus residential and commercial construction loan types), commercial real estate loans, residential mortgage loans, and consumer real estate. Risks associated
with real estate loans include fluctuating land values, demand and prices for housing or commercial properties, national, regional and local economic conditions, changes in tax policies, and concentration within the Bank’s market area.
The following paragraphs provide information on portions of the Company’s real estate loan portfolio, specifically Construction/lot and Commercial Real Estate. All such lending activities are subject to the varied risks of real estate lending. The Company’s loan origination process requires specialized underwriting, collateral and approval procedures, which mitigates, but does not eliminate the risk that loans may not be repaid. Note that the minor balance differences between the preceding and following tables are a result of the inclusion of net deferred loan fees in the above tables.
(a) Residential land development category. This category is included in the construction/lot portfolio balances above, and represents loans made to developers for the purpose of acquiring raw land and/or for the subsequent development and sale of residential lots. Such loans typically finance land purchase and infrastructure development of properties (i.e. roads, utilities, etc.) with the aim of making improved lots ready for subsequent sale to consumers or builders for ultimate construction of residential units. The primary source of repayment of such loans is generally the cash flow from developer sale of lots or improved parcels of land while real estate collateral, secondary sources and personal guarantees may provide an additional measure of security for such loans. The nationwide downturn in real estate has continued to slow down lot and home sales within the Company’s markets. This has adversely impacted certain developers by lengthening the marketing period of their projects and negatively affecting borrower liquidity and collateral values. Weakness in this category of loans has contributed significantly to the elevated level of provision for loan losses in 2009 and 2008. The situation continues to be closely monitored and an elevated level of provisioning may be required should deterioration continue.
(b) Residential construction category. This category is included in the construction/lot portfolio balances above, and represents financing of homeowner or builder construction of new residences and condominiums where the obligor generally intends to own the home upon construction (pre-sold), or builder construction of homes for resale (speculative construction).
Pre-sold construction loans are underwritten to facilitate permanent mortgage (take-out) financing at the end of the construction phase. Especially with the turmoil in mortgage markets of the last year, no assurance can be made that committed take-out financing will be available at conclusion of construction.
Speculative construction lending finances builders/contractors who rely on the sale of completed homes to repay loans. The Bank may finance construction costs within residential subdivisions or on a custom site basis. Speculative construction loans decreased in 2009 as a result of the nationwide downturn in residential real estate. This may impact certain builders by lengthening the marketing period for constructed homes and negatively affecting borrower liquidity and collateral values.
(c) Commercial construction category. This category is included in the construction/lot portfolio balances above, and represents lending to finance the construction or development of commercial properties. Obligors may be the business owner/occupier of the building who intends to operate its business from the property upon construction, or non owner (speculative) developers. The expected source of repayment of these loans is typically the sale or refinancing of the project upon completion of the construction phase. In certain circumstances, the Company may provide or commit to take-out financing upon construction. Take-out financing is subject to the project meeting specific underwriting guidelines.
The overall decline in 2009 in our commercial construction portfolio is mainly related to project completions. While our portfolios of these types of loans have not experienced the severe credit quality challenges experienced in residential construction projects, there can be no assurance that the credit quality in these portfolios will not be impacted should present challenging economic conditions persist. No assurance can be given that losses will not exceed the estimates that are currently included in the reserve for credit losses, which could adversely affect the Company’s financial conditions and results of operations.
(d) Commercial real estate (CRE) portfolio. This $675.7 million portfolio generally represents loans to finance retail, office and industrial commercial properties. The expected source of repayment of CRE loans is generally the operations of the borrower’s business, rents or the obligor’s personal income. CRE loans represent approximately 44% of total loans outstanding as of December 31, 2009. Approximately 52% of CRE loans are made to owner-occupied users of the commercial property, while 48% of CRE loans are to obligors
who do not directly occupy the property. Management believes that lending to owner-occupied businesses may mitigate, but not eliminate, commercial real estate risk. The average loan in the CRE portfolio is only about $0.6 million and 86% of balances are represented in loans under $5 million. This granular and well diversified portfolio has maintained low delinquency and only modest deterioration in the present downturn. However no assurance can be given that residential real estate or other economic factors will not adversely impact the CRE portfolio.
The following table provides the geographic distribution of the Company’s CRE loan portfolio by region as a percent of total company-wide CRE loans at December 31, 2009:
Lending and Credit Management. The Company has a comprehensive risk management process to control, underwrite, monitor and manage credit risk in lending. The underwriting of loans relies principally on an analysis of an obligor’s historical and prospective cash flow augmented by collateral assessment, credit bureau information, as well as business plan assessment. Ongoing loan portfolio monitoring is performed by a centralized credit administration function including review and testing of compliance to loan policies and procedures. Internal and external auditors and bank regulatory examiners periodically sample and test certain credit files as well. Risk of nonpayment exists with respect to all loans, which could result in the classification of such loans as non-performing. Certain specific types of risks are associated with different types of loans.
Reserve for Credit Losses. The reserve for credit losses (reserve for loan losses and reserve for unfunded commitments) represents management’s recognition of the assumed and present risks of extending credit and the possible inability or failure of the obligors to make repayment. The reserve is maintained at a level considered adequate to provide for losses on loans and unfunded commitments based on management’s current assessment of a variety of current factors affecting the loan portfolio. Such factors include loss experience, review of problem loans, current economic conditions, and an overall evaluation of the quality, risk characteristics and concentration of loans in the portfolio. The level of reserve for credit losses is also subject to review by the bank regulatory authorities who may require increases to the reserve based on their evaluation of the information available to it at the time of its examination of the Bank. The reserve is based on estimates, and ultimate losses may vary from the current estimates. These estimates are reviewed periodically, and, as adjustments become necessary, they are reported in earnings in the periods in which they become known. The reserve is increased by provisions charged to operations and reduced by loans charged-off, net of recoveries. See “Income Statement Overview - Loan Loss Provision” above.
The following describes the Company’s methodology for assessing the appropriate level of the reserve for loan losses. For this purpose, loans and related commitments to loan are analyzed and reserves categorized into the allocated reserve, specifically identified reserves for impaired loans, the unallocated reserve, or the reserve for unfunded loan commitments.
The allocated portion of the reserve and the reserve for unfunded loan commitments is calculated by applying loss factors to outstanding loan balances and commitments to loan, segregated by differing risk categories. Loss factors are based on historical loss experience, adjusted for current economic trends, portfolio concentrations and other conditions affecting the portfolio. In certain circumstances with respect to adversely risk rated loans, loss factors may utilize information as to estimated collateral values, secondary sources of
repayment, guarantees and other relevant factors. The allocated portion of the consumer loan reserve is estimated based mainly upon a quarterly credit scoring analysis.
Impaired loans are either specifically allocated for in the reserve for loan losses or reflected as a partial charge-off of the loan balance. The Bank considers loans to be impaired when management believes that it is probable that either principal and/or interest amounts due will not be collected according to the contractual terms. Impairment is measured on a loan-by-loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price or the estimated fair value of the loan’s underlying collateral or related guaranty. Since a significant portion of the Bank’s loans are collateralized by real estate, the Bank primarily measures impairment based on the estimated fair value of the underlying collateral or related guaranty. In certain other cases, impairment is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate. Smaller balance homogeneous loans (typically installment loans) are collectively evaluated for impairment. Accordingly, the Bank does not separately identify individual installment loans for impairment disclosures. Generally, the Bank evaluates a loan for impairment when a loan is determined to be adversely risk rated.
The unallocated portion of the reserve is based upon management’s evaluation of various factors that are not directly measured in the determination of the allocated and specific reserves. Such factors include uncertainties in economic conditions, uncertainties in identifying triggering events that directly correlate to subsequent loss rates, risk factors that have not yet manifested themselves in loss allocation factors, regulatory examinations, and historical loss experience data that may not precisely correspond to the current portfolio. In addition, the unallocated reserve may be further adjusted based upon the direction of various risk indicators. Examples of such factors include the risk as to current and prospective economic conditions, the level and trend of charge offs or recoveries, levels and trends in delinquencies or non-accrual loans, risks in originating loans in new or unfamiliar markets, risk of heightened imprecision of appraisals used in estimating real estate values, or initiating specialty lending to industry sectors that may be new to the Company. Although this allocation process may not accurately predict credit losses by loan type or in aggregate, the total reserve for credit losses is available to absorb losses that may arise from any loan type or category. Due to the subjectivity involved in the determination of the unallocated portion of the reserve for loan losses, the relationship of the unallocated component to the total reserve for loan losses may fluctuate from period to period. As of year-end 2009 the Company’s unallocated reserve balance was approximately 16% of its calculated reserve based upon the management’s assessment of elevated risk factors mainly relating to uncertain and adverse economic conditions and the level and trend of delinquencies, nonaccrual loans and charge-offs.
The Bank’s ratio of reserve for credit losses to total loans was 2.47% at December 31, 2009 compared to 2.46% at December 31, 2008 and 1.81% at December 31, 2007. At this date, management believes that the Company’s reserve is at an appropriate level under current circumstances and prevailing economic conditions. The total amount of actual loan losses may vary significantly from the estimated amount. No assurance can be given that in any particular period, the reserve for credit losses will be sufficient, or that loan losses will not be sustained that are sizable in relation to the amount reserved, or that changing economic factors or other environmental conditions could cause increases in the loan loss provision.
The Company classifies reserves for unfunded commitments as a liability on the consolidated balance sheet. Such reserves are included as part of the overall reserve for credit losses. Reserves for unfunded commitments totaled approximately $704 and $1,039 at December 31, 2009 and 2008, respectively.
Allocation of Reserve for Credit Losses. The higher reserve for loan losses in recent years is attributable to the affect the adverse economy has had on obligor’s ability to repay loans. The unallocated portion of the reserve reflects the level of uncertainty as to the future direction and severity of the economic environment. While a combination of evidence demonstrating greater clarity on construction/lot exposure and reduced exposure levels has lessened concern in this loan portfolio, risk in other asset categories continues. Typical factors leading to changes in reserve allocation include changes in debt service coverage ratios, guarantor and/or collateral valuation as well as economic conditions that may have a specific or generalized impact on the relative risks inherent in various
loan portfolios. Although this allocation process may not accurately predict credit losses by loan type or in aggregate, the total reserve for loan losses is available to absorb losses that may arise from any loan type or category.
The following table allocates the reserve for credit losses among major loan types.
The following table summarizes the Company’s reserve for credit losses and charge-off and recovery activity for each of the last five years:
The following table presents information with respect to non-performing assets (NPAs): As of December 31, 2009 residential land development and construction represented about 59% of NPAs; Commercial construction 7%; commercial real estate 15% and Commercial and Industrial loans & other 19%.
The following table presents the composition of NPAs for the years presented:
The increase in NPAs at year-end is a result of the nationwide downturn in real estate which has slowed lot and home sales within the Company’s markets. This has impacted certain developers by lengthening the marketing period of their projects and negatively affecting borrower liquidity and collateral values (for further discussion, see “Real Estate Loan Concentration Risk” above).
The accrual of interest on a loan is discontinued when, in management’s judgment, the future collectibility of principal or interest is in doubt. Loans placed on nonaccrual status may or may not be contractually past due at the time of such determination, and may or may not be secured. When a loan is placed on nonaccrual status, it is the Bank’s policy to reverse, and charge against current income, interest previously accrued but uncollected. Interest subsequently collected on such loans is credited to loan principal if, in the opinion of management, full collectibility of principal is doubtful. Interest income that was reversed and charged against income for 2009 was $2.4 million, $2.7 million in 2008 and $1.2 in 2007.
During our normal loan review procedures, a loan is considered to be impaired when it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans are measured based on the present value of expected future cash flows, discounted at the loan’s effective interest rate or, as a practical expedient, at the loan’s observable market price or the fair market value of the collateral if the loan is collateral dependent. Impaired loans are currently measured at lower of cost or fair value. Certain large groups of smaller balance homogeneous loans, collectively measured for impairment, are excluded. Impaired loans are charged to the allowance when management believes, after considering economic and business conditions, collection efforts and collateral position that the borrower’s financial condition is such that collection of principal is not probable. In addition, net overdraft losses are included in the calculation of the allowance for loan losses per the guidance provided by regulatory authorities early in 2005, in “Joint Guidance on Overdraft Protection Programs.” At December 31, 2009, the Company’s recorded investment in certain loans that were considered to be impaired was $147.6 million and specific valuation allowances were $0.1 million. Impaired loans were $120.5 million with specific valuation allowances of $2.7 at year-end 2008.
At December 31, 2009, the Company had three borrowers with loans accounted for as troubled debt restructurings (“TDRs”) totaling $27.3 million, or 1.24% of total assets. The Company had no TDRs at December 31, 2008. The TDRs at December 31, 2009 are classified as impaired loans and, in the opinion of management, are reserved appropriately. At December 31, 2009, the Company had remaining commitments to lend of $328 related to the TDRs.
Bank-Owned Life Insurance (BOLI) The Company has purchased BOLI to protect itself against the loss of certain key employees and directors due to death and to offset the Bank’s future obligations to its employees under its retirement and benefit plans. See Note 1 of the Company’s notes to consolidated financial statements located under item 8 of this report. During 2009 and 2008 the Bank did not purchase any new BOLI. The cash surrender value of the Bank’s total life insurance policies was $33.6 at December 31, 2009 and 2008. The Bank recorded income from the BOLI policies of $0.1 million in 2009, $0.3 million in 2008 and $1.6 million in 2007.
The Company owns both general account and separate account BOLI. The separate account BOLI was purchased the fourth quarter of 2006 as an investment expected to provide a long-term source of earnings to support existing employee benefit plans. The fair value of the general account BOLI is based on the insurance contract cash surrender value. The cash surrender value of the separate account BOLI is the quoted market
price of the underlying securities, further supported by a stable value wrap, which mitigates, but may not fully insulate investment against changes in the fair market value depending on severity and duration of possible market price disruption.
Liabilities Deposit Liabilities and Time Deposit Maturities. At December 31, 2009, total deposits were $1.82 billion, up 1.2% from year-end 2008. Average deposits totaled $1.87 billion for the full year 2009, up 11.3% or $189.0 million on average from the prior year. Average non-interest-bearing demand deposits in 2009 were $407.3 million, basically unchanged from the 2008 average of $408.0 million. Consistent efforts to retain and serve customers have proven successful with the number of total customer relationships consistent in 2009. In order to augment aggregate deposits the Company utilized brokered, internet listing service deposits and Certificate of Deposit Registry Program (CDARSTM) deposits.
At December 31, 2009 wholesale brokered deposits totaled $116.5 million compared to $147.9 million at December 31, 2008. The internet listing service deposits at December 31, 2009 were approximately $195.1 million compared to a de minimus balance at year-end 2008. Such deposits are sourced by posting time deposit rates on an internet site where institutions seeking to deploy funds contact the Bank directly to open a deposit account. In addition, local relationship based reciprocal CDARS deposits totaled $47.3 million at December 31, 2009 and $168.3 million at December 31, 2008. However, banks that fail to be “well-capitalized” are restricted from accessing wholesale brokered deposits. Further, the Order restricts the Bank’s ability to accept additional brokered deposits, including the Bank’s reciprocal CDAR’s program, for which it previously had a temporary waiver from the FDIC.
To provide customer assurances, the Bank is participating in the FDIC’s Transaction Account Guarantee (TAG) program which provides temporary 100% guarantee of non-interest bearing checking accounts, including NOW accounts paying up to 0.50%. The Company did not opt out of the six-month extension of the transaction account guarantee program which will continue through June 30, 2010. Additionally, under recent changes from the FDIC, all interest bearing deposit accounts are insured up to $250,000 through December 31, 2013.
The following table summarizes the average amount of, and the average rate paid on, each of the deposit categories for the periods shown:
As of December 31, 2009, the Company’s time deposit liabilities had the following times remaining to maturity:
(1) Time deposits of $100,000 or more represents 15.4% of total deposits as of December 31, 2009.
(2) All other time deposits represent 17.3% of total deposits as of December 31, 2009.
Junior Subordinated Debentures. The purpose of the Company’s $68.6 million of trust preferred securities was to fund the cash portion of the F&M Holding Company acquisition in 2006, to support general corporate purposes and to augment regulatory capital. Management believes that at December 31, 2009, the TPS meet applicable regulatory guidelines to qualify as Tier I capital in the amount of $14.5 million and Tier 2 capital in the amount of $32.3 million. At December 31, 2008, the TPS met applicable regulatory guidelines to qualify as Tier I capital and Tier 2 capital in the amounts of $43.5 million and $23.0 million, respectively. The Company’s obligations under the Junior Subordinated Debentures (the “Debentures”) and related agreements, taken together, constitute a full and irrevocable guarantee by the Company of the obligations of the trusts. The trust preferred securities are subject to mandatory redemption upon the maturity of the Debentures, or upon earlier redemption as provided in the Indenture related to the Debentures. The trust preferred securities may be called by the Company at par at varying times subsequent to September 15, 2011, and may be redeemed earlier upon the occurrence of certain events that impact the income tax or the regulatory capital treatment of the trust preferred securities. In October 2009, the Company entered into a binding letter agreement with Cohen & Company Financial Management, LLC for the restructuring of the Company’s TPS. Pursuant to the Letter Agreement, at such time that a capital raise transaction is agreed, the Company will exchange the TPS for senior notes in the aggregate principal amount of $13.3 million representing 20% of the original balance of the TPS. Subsequent to the capital raise the notes will be extinguished for cash and liability for TPS debt will be fully extinguished, resulting in an after tax gain of approximately $31 million for the Company. The agreements with Bolger and Lightyear - including their respective contributions of capital - are contingent upon the execution of this transaction. The exchange of the TPS for the Notes will have no effect on capital at the Bank and does not impact the amount of capital needed by the Bank to comply with the Order.
See Note 12 and Note 21 of the consolidated financial statements included in Item 7 of this report for additional details.
Other Borrowings. At December 31, 2009 the Bank had a total of $195.0 million in long-term borrowings from FHLB of Seattle with maturities ranging from 2011 to 2017, bearing a weighted-average rate of 1.92% and short-term borrowings with FRB of approximately $0.2 million Also, the Bank had $41.0 million of senior unsecured debt issued in connection with the FDIC’s Temporary Liquidity Guarantee Program (TLGP) maturing February 12, 2012 bearing a weighted average rate of 2.00%, exclusive of net issuance costs and 1% per annum FDIC insurance assessment applicable to TLGP debt which are being amortized straight line over the term of the debt. At year-end 2008, the Bank had a total of $128.5 million in long-term borrowings from FHLB of Seattle with maturities from 2009 to 2025. In addition, at December 31, 2008, the Bank had short-term borrowings with FRB of approximately $120.5 million. The FHLB has also issued $138.0 million in letters of credit on behalf of the Company which are pledged to collateralize Oregon public deposits held at the Bank. (See the discussion under “Liquidity and Sources of Funds” in this Item 6 for further discussion).
Contractual Obligations. As of December 31, 2009, the Company has entered into the contractual obligations to make future payments as listed below:
Off-Balance Sheet Arrangements. A schedule of significant off-balance sheet commitments at December 31, 2009 is included in the following table (dollars in thousands):
See Note 14 of the Notes to Consolidated Financial Statements included in Item 8 hereof for a discussion of the nature, business purpose, and importance of off-balance sheet arrangements.
Stockholder’s Equity The Company’s total stockholders’ equity at December 31, 2009 was $45.1 million, a decrease of $90.2 million from December 31, 2008. The decrease primarily resulted from the net loss for the year ended December 31, 2009 of $93.1 million, which was partially offset by an increase other comprehensive income of approximately $1.8 million.
Capital Resources At December 31, 2009, the Company’s Tier 1 leverage, Tier 1 risk-based capital and total risk-based capital ratios were 2.40%, 3.18% and 6.35%, respectively, and the Bank’s Tier 1 leverage, Tier 1 risk-based capital and total risk-based capital ratios were 4.69%, 6.20% and 7.46%, respectively, which do not meet regulatory benchmarks for “adequately-capitalized”. Regulatory benchmarks for an “adequately-capitalized” designation are 4%, 4% and 8% for Tier 1 leverage, Tier 1 risk-based capital and total risk-based capital, respectively; “well-capitalized” benchmarks are 5%, 6%, and 10% for Tier 1 leverage, Tier 1 risk-based capital and total risk-based capital, respectively. However, as mentioned elsewhere in this report, pursuant to the Order, the Bank is required to maintain a Tier 1 leverage ratio of at least 10% to be considered “well-capitalized.” Additional information regarding capital resources are located in Note 21 of the Notes to the Consolidated Financial Statements included in item 7 this report.
Federal banking regulators are required to take prompt corrective action if an insured depository institution fails to satisfy certain minimum capital requirements, including a leverage limit, a risk-based capital requirement, and any other measure of capital deemed appropriate by the federal banking regulator for measuring the capital adequacy of an insured depository institution. At December 31, 2009, the Company does not meet the regulatory benchmarks for “adequately-capitalized” institutions. As mentioned earlier in this report the Bank is under a regulatory Order.
Under the Order, the Bank is required to take certain measures to improve its capital position, maintain liquidity ratios, reduce its level of non-performing assets, reduce its loan concentrations in certain portfolios, improve management practices and board supervision and to assure that its reserve for loan losses is maintained at an appropriate level. While the Bank successfully completed several of the measures under the Order, it was unable to implement certain measures in the time frame provided, particularly those related to raising capital levels.
Among the corrective actions required are for the Bank to develop and adopt a plan to maintain the minimum capital requirements for a “well-capitalized” bank, including a Tier 1 leverage ratio of at least 10% at the Bank level beginning 150 days from the issuance of the Order. As of December 31, 2009 and through the date of this report, the requirement relating to increasing the Bank’s Tier 1 leverage ratio has not been met. Bank level capital ratios set forth below are substantially higher than the capital ratios at the Company level. This is mainly because regulatory calculations give different treatment to the $66.5 million in Trust Preferred debt proceeds. At the Company level substantial percentage of Trust Preferred debt is excluded from regulatory capital; while it is fully included at Bank level. At December 31, 2009, the Company’s Tier 1 leverage, Tier 1 risk-based capital and total risk-based capital ratios were 2.40%, 3.18% and 6.35%, respectively, and the Bank’s Tier 1 leverage, Tier 1 risk-based capital and total risk-based capital ratios were 4.69%, 6.20% and 7.46%, respectively, which do not meet regulatory benchmarks for “adequately-capitalized”. Regulatory benchmarks for an “adequately-capitalized” designation are 4%, 4% and 8% for Tier 1 leverage, Tier 1 risk-based capital and total risk-based capital, respectively; “well-capitalized”
benchmarks are 5%, 6%, and 10% for Tier 1 leverage, Tier 1 risk-based capital and total risk-based capital, respectively. However, as mentioned above, pursuant to the Order, the Bank is required to maintain a Tier 1 leverage ratio of at least 10% to be considered “well-capitalized.”
From time to time the Company makes commitments to acquire banking properties or to make equipment or technology related investments of capital. At December 31, 2009, the Company had no material capital expenditure commitments apart from those incurred in the ordinary course of business.
Liquidity and Sources of Funds The objective of the Bank’s liquidity management is to maintain ample cash flows to meet obligations for depositor withdrawals, fund the borrowing needs of loan customers, and to fund ongoing operations. Core relationship deposits are the primary source of the Bank’s liquidity. As such, the Bank focuses on deposit relationships with local business and consumer clients who maintain multiple accounts and services at the Bank. The Company views such deposits as the foundation of its long-term liquidity because it believes such core deposits are more stable and less sensitive to changing interest rates and other economic factors compared to large time deposits or wholesale purchased funds. The Bank’s customer relationship strategy has resulted in a relatively higher percentage of its deposits being held in checking and money market accounts, and a lesser percentage in time deposits.
Bancorp is a single bank holding company and its primary ongoing source of liquidity is from dividends received from the Bank. Such dividends arise from the cash flow and earnings of the bank. Banking regulations and authorities may limit the amount or require certain approvals of the dividend that the Bank may pay to Bancorp. Pursuant to the Order, the Bank is required to seek permission from its regulators prior to payment of cash dividends on its common stock. The Company cut its dividend to zero in the fourth quarter of 2008 and deferred payments on its Trust Preferred Securities beginning in the second quarter of 2009. We do not expect the Bank to pay dividends to Cascade Bancorp for the foreseeable future. Cascade Bancorp does not expect to pay any dividends for the foreseeable future. Cascade Bancorp is unable to pay dividends on its common stock until it pays all accrued payments on its Trust Preferred Securities. As of October 31, 2009, we had $66.5 million of TPS outstanding with a weighted average interest rate of 2.83%. The Company elected to defer payments on its TPS beginning in the second quarter of 2009 and as of October 31, 2009, accrued dividends were $1.38 million.
To build contingent liquidity in response to challenging deposit market conditions including restrictions on acceptance or renewal of brokered deposits, the Bank has worked to stabilize and retain local deposits, by accessing internet listing service deposits, and by reducing its loan balances. At December 31, 2009, liquid assets of the Bank are mainly balances held at FRB totaling $314.6 million compared to $294.3 million at prior quarter end and a negligible amount at December 31, 2008. Because of the economic situation, the condition of the bank and other uncertainties no assurance can be given as to the Company’s ability to maintain sufficient liquidity.
At December 31, 2009 the internet sourced deposits were approximately $195.1 million compared to a de minimus balance at year-end 2008. Such deposits are sourced by posting time deposit rates on an internet site where institutions seeking to deploy funds contact the Bank directly to open a deposit account. At December 31, 2009 wholesale brokered deposits totaled $116.5 million down from $147.9 million at December 31, 2008andlocal relationship based reciprocal CDARS deposits totaled $47.3 million at December 31, 2009 and $168.3 million at December 31, 2008 which are also technically classified as brokered deposits. The Bank is currently restricted from accepting or renewing brokered deposits.
Available borrowing capacity has been reduced as the Company drew on its available sources. At December 31, 2009, the FHLB had extended the Bank a secured line of credit of $767.1 million that may be accessed for short or long-term borrowings given sufficient qualifying collateral. As of December 31, 2009, the Bank had qualifying collateral pledged for FHLB borrowings totaling $341.9 million which was largely utilized by approximately $195.0 million in secured borrowings and $138.0 million FHLB letter of credit used for collateralization of Oregon public deposits held by the Bank. In addition, at December 31, 2009, the Bank had short-term borrowings from the FRB of approximately $0.2 million and the Bank also had undrawn borrowing capacity at FRB of approximately $83.2 million at December 31, 2009 that is currently supported by specific qualifying collateral. Borrowing capacity from FHLB or FRB may fluctuate based upon the
acceptability and risk rating of loan collateral, and counterparties could adjust discount rates applied to such collateral at their discretion. Also, FRB or FHLB could restrict or limit our access to secured borrowings. As with many community banks, correspondent banks have withdrawn unsecured lines of credit or now require collateralization for the purchase of fed funds on a short-term basis due to the present adverse economic environment.
In 2008, the U.S. TLGP under which the FDIC would temporarily provide a guarantee of the senior debt of FDIC-insured institutions and their holding companies. On February 12, 2009 the Bank issued $41 million of notes under the TLGP. The issuance included $16 million floating rate and $25 million fixed rate notes maturing February 12, 2012.
Liquidity may be affected by the Bank’s routine commitments to extend credit. Historically a significant portion of such commitments (such as lines of credit) have expired or terminated without funding. In addition, more than one-third of total commitments pertain to various construction projects. Under the terms of such construction commitments, completion of specified project benchmarks must be certified before funds may be drawn. At December 31, 2009, the Bank had approximately $288.7 million in outstanding commitments to extend credit, compared to approximately $514.6 million at year-end 2008. At this time, management believes that the Bank’s available resources will be sufficient to fund its commitments in the normal course of business.
Inflation The effect of changing prices on financial institutions is typically different than on non-banking companies since virtually all of a bank’s assets and liabilities are monetary in nature. In particular, interest rates are significantly affected by inflation, but neither the timing nor magnitude of the changes are directly related to price level indices; therefore, the Company can best counter inflation over the long term by managing net interest income and controlling net increases in noninterest income and expenses.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The disclosures in this item are qualified by the Risk Factors set forth in Item 1A and the Section entitled “Cautionary Information Concerning Forward-Looking Statements” included in Item 6. Management’s Discussion and Analysis of Financial Condition and Results of Operations in this report and any other cautionary statements contained herein.
Interest Rate Risk and Asset and Liability Management The goal of the Company’s asset and liability management policy is to maximize long-term profitability under the range of likely interest rate scenarios. Interest rate risk management requires estimating the probability and impact of changes in interest rates on assets and liabilities. The Board of Directors oversees implementation of strategies to control interest rate risk. Management hires and engages a qualified independent service provider to assist in modeling, monthly reporting and assessing interest rate risk. The Company’s methodology for analyzing interest rate risk includes simulation modeling as well as traditional interest rate gap analysis. While both methods provide an indication of risk for a given change in interest rates, it is management’s opinion that simulation is the more effective tool for asset and liability management. The Bank has historically adjusted its sensitivity to changing interest rates by strategically managing its loan and deposit portfolios with respect to pricing, maturity or contractual characteristics. The Bank may also target the expansion or contraction of specific investment portfolio or borrowing structures to further affect its risk profile. In addition, the Bank is authorized to enter into interest rate swap or other hedging contracts with re-pricing characteristics that tend to moderate interest rate risk. However, there are no material structured hedging instruments in use at this time. Because of the volatility of market rates, event risk and other uncertainties described below, there can be no assurance of the effectiveness of management programs to achieve its interest rate risk objectives.
To assess and estimate the degree of interest rate risk, the Company utilizes a sophisticated simulation model that estimates the possible volatility of Company earnings resulting from changes in interest rates. Management first establishes a wide range of possible interest rate scenarios over a two-year forecast period. Such scenarios routinely include a “stable” or unchanged scenario and an “estimated” or most likely scenario
given current and forecast economic conditions. In addition, scenarios titled “rising rates”, “declining rates”, and “alternate rising rates” are established to stress-test the impact of more dramatic rate movements that are perceived as less likely, but may still possibly occur. Next, net interest income and net income are simulated in each scenario. Note that earnings projections include the effect of estimated loan and deposit growth that management deems reasonable; however, such volume projections are not varied by rate scenario. Note also that the downturn in real estate has caused elevated levels of non-performing loans which lower reported NIM depending on the absolute volume of such assets. Simulated earnings are compared over a two-year time horizon. The following table defines the market interest rates projected in various interest rate scenarios. Generally, projected market rates are reached gradually over the 2-year simulation horizon.
The following table presents percentage changes in simulated future earnings under the above-described scenarios as compared to earnings under the “Estimated” rate scenario calculated as of this year end. The effect on earnings assumes no changes in non-interest income or expense between scenarios.
Management’s assessment of interest rate risk and scenario analysis must be considered in the context of market interest rates and overall economic conditions. The Federal Reserve is holding short term rates low in an effort to stimulate economic growth. The yield curve is unusually steep as a result. Rates are expected to rise toward the end of 2010 as the Fed reduces the excess liquidity in the monetary system.
In management’s judgment and at this date, the interest rate risk profile of the Bank is reasonably balanced within the most likely range of possible outcomes. The model indicates that should future interest rates actually follow the path indicated in the “estimated” rate scenario, the net interest margin would range between 3.40% and 3.66% all else being equal. However, with the more dramatic changes reflected in the “rising” or “declining” scenarios, the model suggests the margin would likely fall outside of this range should such interest rates actually occur. This is mainly because the Bank has a large portion of non-interest bearing funds (approximately 21% of total deposits) that are assumed to be relatively insensitive to changes in interest rates. Thus in the event of rising rates, yields on earning assets would tend to increase at a faster pace than overall cost of funds, leading to an improving margin. Conversely, should rates fall to the low levels assumed in the declining scenario, yields on loans and securities would compress against an already low cost of funds. Also in this declining rate scenario, the model assumes an annualized 35% prepayment rate on loans currently outstanding that would refinance to lower rates, contributing to margin compression. Thus in the declining rate scenario where the federal fund rates fall to just 0.063%, the model indicates that the net interest margin could be 3.48% or less during the first 12 months of the forecast horizon, and 3.22% below during the second twelve months. Management has concluded that the degree of margin and earnings volatility under the above scenarios is acceptable because of the cost of mitigating such risk and because the model suggests that the Bank would still generate satisfactory returns under such circumstances.
Please carefully review and consider the following information regarding the risk of placing undue reliance on simulation models, interest rate projections and scenario results. In all scenarios discussed above, results are modeled using management’s estimates as to growth in loans, deposits and other balance sheet items, as well as the expected mix and pricing thereof. These volume estimates are static in the various scenarios. Such estimates may be inaccurate as to future periods. Model results are only indicative of interest rate risk exposure under various scenarios. The results do not encompass all possible paths of future market rates, in terms of absolute change or rate of change, or changes in the shape of the yield curve. Nor does the simulation anticipate changes in credit conditions that could affect results. Likewise, scenarios do not include possible changes in volumes, pricing or portfolio management tactics that may enable management to moderate the effect of such interest rate changes.
Simulations are dependent on assumptions and estimations that management believes are reasonable, although the actual results may vary substantially, and there can be no assurance that simulation results are reliable indicators of future earnings under such conditions. This is, in part, because of the nature and uncertainties inherent in simulating future events including: (1) no presumption of changes in asset and liability strategies in response to changing circumstances; (2) model assumptions may differ from actual outcomes; (3) uncertainties as to customer behavior in response to changing circumstances; (4) unexpected absolute and relative loan and deposit volume changes; (5) unexpected absolute and relative loan and deposit pricing levels; (6) unexpected behavior by competitors; and (7) other unanticipated credit conditions or other events impacting volatility in market conditions and interest rates.
Interest Rate Gap Table In the opinion of management, the use of interest rate gap analysis is less valuable than the simulation method discussed above as a means to measure and manage interest rate risk. This is because it is a static measure of rate sensitivity and does not capture the possible magnitude or pace of rate changes. At year-end 2009, the Company’s one-year cumulative interest rate gap analysis indicates that rate sensitive liabilities maturing or available for re-pricing within one-year exceeded rate sensitive assets by approximately $277.7 million.
The Company considers its rate-sensitive assets to be those that either contains a provision to adjust the interest rate periodically or matures within one year. These assets include certain loans and leases and investment securities and interest bearing balances with FHLB. Rate-sensitive liabilities are those liabilities that are considered sensitive to periodic interest rate changes within one year, including maturing time certificates, savings deposits, interest-bearing demand deposits and junior subordinated debentures.
Set forth below is a table showing the interest rate sensitivity gap of the Company’s assets and liabilities over various re-pricing periods and maturities, as of December 31, 2009:
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The following reports, audited consolidated financial statements and the notes thereto 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 Cascade Bancorp
We have audited the accompanying consolidated balance sheet of Cascade Bancorp and its subsidiary, Bank of the Cascades (collectively, “the Company”), as of December 31, 2009, and the related consolidated statements of operations, changes in stockholders’ equity, and cash flows for the year then ended. The Company’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. The consolidated financial statements as of December 31, 2008, and for the years ended December 31, 2008 and 2007, were audited by Symonds, Evans & Company, P.C., who merged with Delap LLP as of June 1, 2009, and whose report dated March 10, 2009, expressed an unqualified opinion on those consolidated financial statements with an explanatory paragraph that emphasized the Company’s current operating environment and financial condition.
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 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 audit provides a reasonable basis for our opinion.
In our opinion, the 2009 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Cascade Bancorp and its subsidiary as of December 31, 2009, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Company incurred net losses in 2009 and 2008, has a significant level of nonperforming assets, and is currently operating under written agreements with its principal banking regulators which require management to take a number of actions, including, among other things, restoring and maintaining capital levels to amounts that are in excess of the Company’s current capital levels. These conditions raise substantial doubt about the Company’s ability to continue as a going concern as of December 31, 2009. Management’s plans to address these matters are described in Notes 2 and 21. The accompanying consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
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, 2009, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 12, 2010 expressed an unqualified opinion.
/s/ Delap LLP
Lake Oswego, Oregon
March 12, 2010
CASCADE BANCORP AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2009 AND 2008
(Dollars in thousands)
See accompanying notes.
CASCADE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2009, 2008 AND 2007
(Dollars in thousands, except per share amounts)
See accompanying notes.
CASCADE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
YEARS ENDED DECEMBER 31, 2009, 2008 AND 2007
(Dollars in thousands, except per share amounts)
See accompanying notes.
CASCADE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
YEARS ENDED DECEMBER 31, 2009, 2008 AND 2007
(Dollars in thousands, except per share amounts)
See accompanying notes.
CASCADE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
YEARS ENDED DECEMBER 31, 2009, 2008 AND 2007
(Dollars in thousands, except per share amounts)
See accompanying notes.
CASCADE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2009, 2008 AND 2007
(Dollars in thousands)
See accompanying notes.
CASCADE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 1. Basis of presentation and summary of significant accounting policies Basis of presentation The accompanying consolidated financial statements include the accounts of Cascade Bancorp (Bancorp), an Oregon chartered single bank holding company, and its wholly-owned subsidiary, Bank of the Cascades (the Bank) (collectively, “the Company”). All significant intercompany accounts and transactions have been eliminated in consolidation.
Bancorp has also established four subsidiary grantor trusts in connection with the issuance of trust preferred securities (see Note 12). In accordance with accounting principles generally accepted in the United States (GAAP), the accounts and transactions of these trusts are not included in the accompanying consolidated financial statements.
Effective July 1, 2009, the Financial Accounting Standards Board’s (FASB’s) Accounting Standards Codification (the ASC) became the FASB’s single source of authoritative GAAP for all public and non-public non-governmental entities. While the ASC does not change GAAP, all existing FASB and American Institute of Certified Public Accountants (AICPA) accounting literature, with certain exceptions, was superseded by and incorporated into the ASC. Rules and interpretive releases of the Securities and Exchange Commission (SEC) under the authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. All other accounting literature is considered non-authoritative. The switch to the ASC affects the way companies refer to GAAP in financial statements and accounting policies. Accordingly, all references to specific GAAP literature in these consolidated financial statements have been modified to reflect this change. Subsequent changes to GAAP will be incorporated into the ASC through the issuance of Accounting Standards Updates (ASUs). The adoption of the ASC did not impact the Company’s consolidated financial condition, results of operations or cash flows.
Certain amounts in 2008 and 2007 have been reclassified to conform with the 2009 presentation.
Description of business The Bank conducts a general banking business, operating branches in Central, Southern and Northwest Oregon, as well as the Boise, Idaho area. Its activities include the usual lending and deposit functions of a commercial bank: commercial, construction, real estate, installment, credit card and mortgage loans; checking, money market, time deposit and savings accounts; Internet banking and bill payment; automated teller machines and safe deposit facilities. Additionally, the Bank originates and sells mortgage loans into the secondary market and offers trust and investment services.
During 2009, the Company sold its merchant card processing business and certain miscellaneous assets utilized in connection with that business. Accordingly, the Company recognized a pre-tax net gain resulting from the sale of the merchant card processing business of approximately $3,247 during 2009.
Method of accounting The Company prepares its consolidated financial statements in conformity with GAAP and prevailing practices within the banking industry. The Company utilizes the accrual method of accounting which recognizes income and gains when earned and expenses and losses when incurred. The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of income, gains, expenses and losses during the reporting periods. Actual results could differ from those estimates.
CASCADE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 1. Basis of presentation and summary of significant accounting policies - (continued) Segment reporting The Company is managed by legal entity and not by lines of business. The Company has determined that its operations are solely in the community banking industry and consist of traditional community banking services, including lending activities; acceptance of demand, savings, and time deposits; business services; and trust services. These products and services have similar distribution methods, types of customers and regulatory responsibilities. The performance of the Company and the Bank is reviewed by the executive management team and the Company’s Board of Directors (the Board) on a monthly basis. All of the executive officers of the Company are members of the Bank’s executive management team, and operating decisions are made based on the performance of the Company as a whole. Accordingly, disaggregated segment information is not required to be presented in the accompanying consolidated financial statements, and the Company will continue to present one segment for financial reporting purposes.
Cash and cash equivalents For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks (including cash items in process of collection), interest bearing deposits with Federal Reserve Bank of San Francisco (FRB) and Federal Home Loan Bank of Seattle (FHLB), and federal funds sold. Generally, any interest bearing deposits are invested for a maximum of 90 days. Federal funds are generally sold for one-day periods.
The Bank maintains balances in correspondent bank accounts which, at times, may exceed federally insured limits. In addition, federal funds sold are essentially uncollateralized loans to other financial institutions. Management believes that its risk of loss associated with such balances is minimal due to the financial strength of the correspondent banks and counterparty financial institutions. The Bank has not experienced any losses in such accounts.
Supplemental disclosures of cash flow information Noncash transactions resulted from unrealized gains and losses on investment securities available-for-sale, net of income taxes, issuance of nonvested restricted stock and stock-based compensation expense, all as disclosed in the accompanying consolidated statements of changes in stockholders’ equity; the net capitalization of originated mortgage-servicing rights, as disclosed in Note 7; the transfer of approximately $26,059, $55,760 and $11,651 of loans to other real estate owned (OREO) in 2009, 2008 and 2007, respectively, and a $105,047 impairment of goodwill in 2008.
During 2009, 2008 and 2007, the Company paid approximately $32,279, $42,521 and $62,902, respectively, in interest expense.
During 2009, the Company did not make any income tax payments, and received income tax refunds of approximately $19,951. During 2008 and 2007, the Company made income tax payments of approximately $7,338 and $24,940, respectively.
Investment securities Investment securities that management has the positive intent and ability to hold to maturity are classified as held-to-maturity securities and reported at cost, adjusted for premiums and discounts that are recognized in interest income using the interest method over the period to maturity.
Investment securities that are purchased and held principally for the purpose of selling them in the near term are classified as trading securities and are reported at fair value, with unrealized gains and losses included in noninterest income. The Company had no trading securities during 2009, 2008 or 2007.
CASCADE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 1. Basis of presentation and summary of significant accounting policies - (continued) Investment securities that are not classified as either held-to-maturity securities or trading securities are classified as available-for-sale securities and are reported at fair value, with unrealized gains and losses excluded from earnings and reported as other comprehensive income or loss, net of income taxes. 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.
Management determines the appropriate classification of securities at the time of purchase.
Gains and losses on the sales of available-for-sale securities are determined using the specific-identification method. Premiums and discounts on available-for-sale securities are recognized in interest income using the interest method generally over the period to maturity.
Declines in the fair value of individual held-to-maturity and available-for-sale securities below their cost that are deemed to be other-than-temporary impairment (OTTI) would result in write-downs of the individual securities to their fair value. In estimating other-than-temporary impairment losses, management considers, among other things, (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near term prospects of the issuer, and (iii) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery of fair value. The related write-downs would be included in earnings as realized losses. Management believes that all unrealized losses on investment securities at December 31, 2009 and 2008 are temporary (see Note 4).
FHLB stock As a member of the FHLB system, the Bank is required to maintain a minimum level of investment in FHLB stock based on specific percentages of its outstanding mortgages, total assets or FHLB advances. At December 31, 2009 and 2008, the Bank met its minimum required investment. The Bank may request redemption at par value of any FHLB stock in excess of the minimum required investment; however, stock redemptions are at the discretion of the FHLB.
The Bank’s investment in FHLB stock - which has limited marketability - is carried at cost, which approximates fair value. GAAP provides that, for impairment testing purposes, the value of long-term investments such as FHLB stock is based on the “ultimate recoverability” of the par value of the security without regard to temporary declines in value. The determination of whether a decline affects the ultimate recovery is influenced by criteria such as: 1) the significance of the decline in net assets of the FHLB as compared to the capital stock amount and length of time a decline has persisted; 2) the impact of legislative and regulatory changes on the FHLB and 3) the liquidity position of the FHLB. As of December 31, 2009, the FHLB reported that it had met all of its regulatory capital requirements, but remained classified as “undercapitalized” by its regulator. The FHLB will not repurchase capital stock or pay a dividend while it is classified as undercapitalized. The FHLB has noted that its primary concern with meeting its risk-based capital requirements relates to the potential impact of OTTI charges that they may be required to record on their private label mortgage-backed securities. While the FHLB was undercapitalized as of December 31, 2009, the Company does not believe that its investment in FHLB stock is impaired. However, this estimate could change if: 1) significant OTTI losses are incurred on the FHLB’s mortgage-backed securities causing a significant decline in its regulatory capital status; 2) the economic losses resulting from credit deterioration on the FHLB’s mortgage-backed securities increases significantly or 3) capital preservation strategies being utilized by the FHLB become ineffective.
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DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 1. Basis of presentation and summary of significant accounting policies - (continued) Loans
Loans are stated at the amount of unpaid principal, reduced by the reserve for loan losses, the undisbursed portion of loans in process and deferred loan fees.
Interest income on loans is accrued daily based on the principal amounts outstanding. Allowances are established for uncollected interest on loans for which the interest is determined to be uncollectible. Generally, all loans past due (based on contractual terms) 90 days or more are placed on non-accrual status and internally classified as substandard. Any interest income accrued at that time is reversed. Subsequent collections are applied proportionately to past due principal and interest, unless collectibility of principal is in doubt, in which case all payments are applied to principal. Loans are removed from non-accrual status only when the loan is deemed current, and the collectibility of principal and interest is no longer doubtful, or, on one-to-four family loans, when the loan is less than 90 days delinquent.
The Bank charges fees for originating loans. These fees, net of certain loan origination costs, are deferred and amortized to interest income, on the level-yield basis, over the loan term. If the loan is repaid prior to maturity, the remaining unamortized deferred loan origination fee is recognized in interest income at the time of repayment.
Reserve for loan losses
The reserve for loan losses represents management’s recognition of the assumed risks of extending credit. The reserve is established to absorb management’s best estimate of known and inherent losses in the loan portfolio as of the consolidated balance sheet date. The reserve requires complex subjective judgments as a result of the need to make estimates about matters that are uncertain. The reserve is maintained at a level currently considered adequate to provide for potential loan losses based on management’s assessment of various factors affecting the portfolio.
The reserve is based on estimates, and ultimate losses may vary from the current estimates. These estimates are reviewed periodically, and, as adjustments become necessary, they are reported in earnings in the periods in which they become known. Therefore, management cannot provide assurance that, in any particular period, the Company will not have significant losses in relation to the amount reserved. The level of reserve for loan losses is also subject to review by the bank regulatory authorities who may require increases or decreases to the reserve based on their evaluation of the information available to them at the time of their examinations of the Bank. The reserve is increased by provisions charged to operations and reduced by loans charged-off, net of recoveries.
The following describes the Company’s methodology for assessing the appropriate level of the reserve for loan losses. For this purpose, loans and related commitments to loan are analyzed - and reserves are categorized - into the allocated reserve, specifically identified reserves for impaired loans, the unallocated reserve, or the reserve for unfunded loan commitments.
The allocated portions of the reserve and the reserve for unfunded loan commitments are calculated by applying loss factors to outstanding loan balances and commitments to loan, segregated by differing risk categories. Loss factors are based on historical loss experience, adjusted for current economic trends, portfolio concentrations and other conditions affecting the portfolio. In certain circumstances with respect to adversely risk rated loans, loss factors may utilize information as to estimated collateral values, secondary sources of repayment, guarantees and other relevant factors. The allocated portion of the consumer loan reserve is estimated based mainly upon a quarterly credit scoring analysis.
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DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 1. Basis of presentation and summary of significant accounting policies - (continued) Impaired loans are either specifically allocated for in the reserve for loan losses or reflected as a partial charge-off of the loan balance. The Bank considers loans to be impaired when management believes that it is probable that either principal and/or interest amounts due will not be collected according to the contractual terms. Impairment is measured on a loan-by-loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price or the estimated fair value of the loan’s underlying collateral or related guaranty. Since a significant portion of the Bank’s loans are collateralized by real estate, the Bank primarily measures impairment based on the estimated fair value of the underlying collateral or related guaranty. In certain other cases, impairment is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate. Smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Bank does not separately identify individual installment loans for impairment disclosures. Generally, the Bank evaluates a loan for impairment when a loan is determined to be adversely risk rated.
The unallocated portion of the reserve is based upon management’s evaluation of various factors that are not directly measured in the determination of the allocated and specific reserves. Such factors include uncertainties in economic conditions, uncertainties in identifying triggering events that directly correlate to subsequent loss rates, internal and external risk factors that have not yet manifested themselves in loss allocation factors and historical loss experience data that may not precisely correspond to the current portfolio. The unallocated reserve may also be affected by review by the bank regulatory authorities who may require increases or decreases to the unallocated reserve based on their evaluation of the information available to them at the time of their examinations. Also, loss data representing a complete economic cycle is not available for all sections of the loan portfolio. Accordingly, the unallocated reserve helps to minimize the risk related to the margin of imprecision inherent in the estimation of allocated loan losses. Due to the subjectivity involved in the determination of the unallocated portion of the reserve for loan losses, the relationship of the unallocated component to the total reserve for loan losses may fluctuate from period to period.
Reserve for unfunded loan commitments The Company maintains a separate reserve for losses related to unfunded loan commitments. Management estimates the amount of probable losses related to unfunded loan commitments by applying the loss factors used in the reserve for loan loss methodology to an estimate of the expected amount of funding and applies this adjusted factor to the unused portion of unfunded loan commitments. The reserve for unfunded loan commitments totaled $704 and $1,039 at December 31, 2009 and 2008, respectively, and these amounts are included in accrued interest and other liabilities in the accompanying consolidated balance sheets. Increases (decreases) in the reserve for unfunded loan commitments are recorded in noninterest expenses in the accompanying consolidated statements of operations.
Mortgage servicing rights (MSRs) MSRs are measured by allocating the carrying value of loans between the assets sold and interest retained, based upon the relative estimated fair value at date of sale. MSRs are capitalized at their allocated carrying value and amortized in proportion to, and over the period of, estimated future net servicing revenue. Impairment of MSRs is assessed based on the estimated fair value of servicing rights. Fair value is estimated using discounted cash flows of servicing revenue less servicing costs taking into consideration market estimates of prepayments as applied to underlying loan type, note rate and term (see also Note 7). Impairment adjustments, if any, are recorded through a valuation allowance.
Fees earned for servicing mortgage loans are reported as income when the related mortgage loan payments are received. The Company classifies MSRs as accrued interest and other assets in the accompanying consolidated balance sheets.
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DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 1. Basis of presentation and summary of significant accounting policies - (continued) Premises and equipment Premises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization are computed on the straight-line method over the shorter of the estimated useful lives of the assets or terms of the leases. Amortization of leasehold improvements is included in depreciation and amortization expense in the accompanying consolidated financial statements.
Goodwill and other intangible assets Goodwill and other intangible assets represent the excess of the purchase price and related costs over the fair value of net assets acquired in business combinations under the purchase method of accounting.
Based on the results of an interim goodwill impairment test performed at December 31, 2008, the Company concluded that the estimated fair value of the Company’s reporting unit was less than its book value and the carrying amount of the Company’s reporting unit goodwill exceeded its implied fair value. Accordingly, this resulted in a noncash after-tax impairment charge of $105,047 during 2008, eliminating all previously recorded goodwill. Goodwill impairment was a noncash accounting adjustment that did not affect the Company’s reported cash flows, and the Company’s Tier 1 and total regulatory capital ratios were unaffected by this adjustment. The Company did not experience any goodwill impairment during 2009 or 2007.
Other intangible assets include core deposit intangibles (CDI) and other identifiable finite-life intangible assets which are being amortized over their estimated useful lives primarily under the straight-line method. The CDI arose from the acquisitions of F&M Holding Company (F&M) and Community Bank of Grants Pass (CBGP), and totaled approximately $6,388 and $7,921 at December 31, 2009 and 2008, respectively. The CDI is included in accrued interest and other assets in the accompanying consolidated balance sheets and is being amortized over an eight-year period for F&M and over a seven-year period for CBGP. Other intangible assets, exclusive of CDI, are not significant at December 31, 2009 and 2008.
Bank-owned life insurance (BOLI) The Company has purchased BOLI to protect itself against the loss of certain key employees and directors due to death and as a source of long-term earnings to support certain employee benefit plans. At December 31, 2009 and 2008, the Company had $26,105 and $26,315, respectively, of separate account BOLI and $7,530 and $7,253, respectively, of general account BOLI.
The cash surrender value of the separate account BOLI is the quoted market price of the underlying securities, further supported by a stable value wrap, which mitigates, but does not fully protect the investment against changes in the fair market value depending on the severity and duration of market price disruption. The fair value of the general account BOLI is based on the insurance contract cash surrender value. During 2009 and 2007, the fair value of the underlying investments plus the stable value wrap protection supported the cash surrender value of the separate account BOLI. During 2008, losses on the underlying investments in the separate account BOLI exceeded the support of the stable value wrap. As a result, the Company incurred losses of approximately $648 on the separate account BOLI in 2008, which is included in other noninterest expenses in the accompanying 2008 consolidated statement of operations. There can be no assurance that additional losses in excess of the stable value wrap protection will not occur on separate account BOLI in the future.
OREO OREO, acquired through foreclosure or deeds in lieu of foreclosure, is carried at the lower of cost or estimated net realizable value. When the property is acquired, any excess of the loan balance over the estimated net realizable value is charged to the reserve for loan losses. Holding costs; subsequent write-downs to net realizable value, if any; or any disposition gains or losses are included in noninterest expenses. The
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DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 1. Basis of presentation and summary of significant accounting policies - (continued) valuation of OREO is subjective in nature and may be adjusted in the future because of changes in economic conditions. Management considers third- party appraisals, as well as independent fair market value assessments from realtors or persons involved in selling OREO, in determining the estimated fair value of particular properties. Net OREO was approximately $29,609 and $52,727 at December 31, 2009 and 2008, respectively, which is net of an allowance for losses in OREO of $5,481 and $5,340 as of December 31, 2009 and 2008.
Customer repurchase agreements Prior to December 31, 2009, the Bank entered into repurchase agreements with customers who wished to deposit amounts in excess of the Federal Insurance Deposit Corporation (FDIC) insured limits. The Bank no longer offers this service and, therefore, there were no customer repurchase agreements outstanding as of December 31, 2009. At December 31, 2008, the Bank had $9,871 in customer repurchase agreements outstanding.
Advertising Advertising costs are generally charged to expense during the year in which they are incurred.
Income taxes The provision (credit) for income taxes is based on income and expenses as reported for financial statement purposes using the “asset and liability method” for accounting for deferred taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision (credit) for income taxes. A valuation allowance, if needed, reduces deferred tax assets to the expected amount to be realized. At December 31, 2009 the Company established a valuation allowance against its deferred tax assets (see Note 15).
Trust assets Assets of the Bank’s trust department, other than cash on deposit at the Bank, are not included in the accompanying consolidated financial statements, because they are not assets of the Bank. Assets (unaudited) totaling approximately $121,000 and $130,000 were held in trust as of December 31, 2009 and 2008, respectively.
Transfers of financial assets Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (i) the assets have been isolated from the Company, (ii) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (iii) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Cash dividend restriction Payment of dividends by the Company and the Bank is subject to restriction by state and federal regulators and the availability of retained earnings (see Note 21).
Preferred stock Beginning in 2008, the Company may issue preferred stock in one or more series, up to a maximum of 5,000,000 shares. Each series shall include the number of shares issued, preferences, special rights and limitations, as determined by the Board. Preferred stock may be issued with or without voting rights, not to
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DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 1. Basis of presentation and summary of significant accounting policies - (continued) exceed one vote per share, and the shares of preferred stock will not vote as a separate class or series except as required by state law. At December 31, 2009 and 2008, there were no shares of preferred stock issued and outstanding.
Comprehensive income (loss) Comprehensive income (loss) includes all changes in stockholders’ equity during a period, except those resulting from transactions with stockholders. The Company’s comprehensive income (loss) consists of net income (loss) and the change in net unrealized appreciation or depreciation in the fair value of investment securities available-for-sale, net of taxes.
New authoritative accounting guidance As previously discussed, on July 1, 2009, the ASC became FASB’s officially recognized source of authoritative GAAP applicable to all public and non-public non-governmental entities, superseding existing FASB, AICPA and related literature. Rules and interpretive releases of the SEC under the authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. All other accounting literature is considered non-authoritative. The switch to the ASC affects the way companies refer to GAAP in financial statements and accounting policies. Citing particular content in the ASC involves specifying the unique numeric path to the content through the Topic, Subtopic, Section and Paragraph structure.
In December 2007, the FASB issued new authoritative guidance under ASC Topic 805, “Business Combinations”. The new authoritative guidance under ASC Topic 805 applies to all transactions and other events in which one entity obtains control over one or more other businesses. ASC Topic 805 requires an acquirer to recognize the assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of the acquisition date. ASC Topic 805 also requires an acquirer to recognize assets acquired and liabilities assumed arising from contractual contingencies as of the acquisition date, measured at their acquisition-date fair values. ASC Topic 805 requires acquirers to expense acquisition-related costs as incurred rather than require allocation of such costs to the assets acquired and liabilities assumed. The new authoritative guidance in ASC Topic 805 was effective for business combination reporting for fiscal years beginning on or after December 15, 2008. The adoption of the new authoritative guidance in ASC Topic 805 as of January 1, 2009 did not have a significant effect on the Company’s consolidated financial statements.
In December 2007, the FASB issued new authoritative guidance under ASC Topic 810, “Consolidation”. ASC Topic 810 establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. ASC Topic 810 also clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. ASC Topic 810 requires consolidated net income (loss) to be reported at amounts that include the amounts attributable to both the parent and the noncontrolling interest. Under prior guidance in ASC Topic 810, net income (loss) attributable to the noncontrolling interest generally was reported as expense (income) in arriving at consolidated net income (loss). Additional disclosures are required as a result of the new authoritative guidance in ASC Topic 810 to clearly identify and distinguish between the interests of the parent’s owners and the interests of the noncontrolling owners of a subsidiary. The new authoritative guidance in ASC Topic 810 was effective for fiscal year’s beginning on or after December 15, 2008. The adoption of the new authoritative guidance in ASC Topic 810 as of January 1, 2009 did not have a significant effect on the Company’s consolidated financial statements.
Further new authoritative accounting guidance under ASC Topic 810 amends prior guidance to change how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The determination of whether a company is required to consolidate an entity is based on, among other things, an entity’s purpose and design and a company’s ability to direct the
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DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 1. Basis of presentation and summary of significant accounting policies - (continued) activities of the entity that most significantly impact the entity’s economic performance. The new authoritative accounting guidance requires additional disclosures about the reporting entity’s involvement with variable-interest entities and any significant changes in risk exposure due to that involvement as well as its effect on the entity’s financial statements. The new authoritative accounting guidance under ASC Topic 810 will be effective January 1, 2010 and is not expected to have a significant impact on the Company’s consolidated financial statements.
In March 2008, the FASB issued new authoritative guidance under ASC Topic 815, “Derivatives and Hedging”. ASC Topic 815 requires disclosure regarding an entity’s derivative instruments and hedging activities. Expanded qualitative disclosure that is required under ASC Topic 815 includes: (1) how and why an entity uses derivative instruments; (2) how derivative instruments and related hedged items are accounted for under ASC Topic 815, and (3) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. The new authoritative guidance in ASC Topic 815 also requires several added quantitative disclosures in financial statements. The new authoritative guidance in ASC Topic 815 became effective for the Company on January 1, 2009 and did not have a significant effect on the Company’s consolidated financial statements.
In April 2009, the FASB issued new authoritative guidance under the following three ASC’s intended to provide additional guidance and enhance disclosures regarding fair value measurements and impairment of securities:
ASC Topic 320, “Investments - Debt and Equity Securities”, includes new authoritative accounting guidance which (i) changes existing guidance for determining whether an impairment is other-than-temporary to debt securities and (ii) replaces the existing requirement that the entity’s management assert that it has both the intent and ability to hold an impaired security until recovery with a requirement that management assert: (a) it does not have the intent to sell the security; and (b) it is more likely than not that it will not have to sell the security before recovery of its cost basis. Under ASC Topic 320, declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other-than-temporary are reflected in earnings as realized losses to the extent the impairment is related to credit losses. The amount of the impairment related to other factors is recognized in other comprehensive income or loss. The Company adopted the provisions of the new authoritative accounting guidance under ASC Topic 320 during the interim period ended March 31, 2009. Adoption of the new guidance did not significantly impact the Company’s consolidated financial statements.
ASC Topic 820, “Fair Value Measurements and Disclosures,” provides additional guidance for estimating fair value when the volume and level of activity for the asset or liability have decreased significantly. ASC Topic 820 also provides guidance on identifying circumstances that indicate a transaction is not orderly. The revised provisions of ASC Topic 820 were effective for the period ended March 31, 2009 and did not have a significant effect on the Company’s consolidated financial statements.
Further new authoritative accounting guidance (ASU No. 2009-5) under ASC Topic 820 provides guidance for measuring the fair value of a liability in circumstances in which a quoted price in an active market for the identical liability is not available. In such instances, a reporting entity is required to measure fair value utilizing a valuation technique that uses (i) the quoted price of the identical liability when traded as an asset, (ii) quoted prices for similar liabilities or similar liabilities when traded as assets, or (iii) another valuation technique that is consistent with the existing principles of ASC Topic 820, such as an income approach or market approach. The new authoritative accounting guidance also clarifies that when estimating the fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents the transfer of the liability. The forgoing new authoritative accounting guidance under ASC Topic 820
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(Dollars in thousands, except per share amounts) 1. Basis of presentation and summary of significant accounting policies - (continued) became effective for the Company’s financial statements for periods ending after October 1, 2009 and did not have a significant impact on the Company’s consolidated financial statements.
ASC Topic 825, “Financial Instruments,” requires disclosures about fair value of financial instruments in interim reporting periods of publicly traded companies that were previously only required to be disclosed in annual financial statements. The provisions of the new authoritative guidance in ASC Topic 825 were effective for the Company’s interim period ended on June 30, 2009, and did not have a significant effect on the Company’s consolidated financial statements.
In May 2009, the FASB issued new authoritative guidance under ASC Topic 855 (formerly Statement No. 165) “Subsequent Events.” ASC Topic 855 was effective June 30, 2009 and established general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. In particular, this guidance sets forth (i) the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements; (ii) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements; and (iii) the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. This topic does not apply to subsequent events or transactions that are within the scope of other applicable GAAP that provide different guidance on the accounting treatment for subsequent events or transactions. This Topic applies to both interim financial statements and annual financial statements. The adoption of the new authoritative guidance in ASC Topic 855 as of June 30, 2009 did not have a significant effect on the Company’s consolidated financial statements.
In June 2009, the FASB issued new authoritative guidance under ASC Topic 860, “Transfers and Servicing,” to enhance reporting about transfers of financial assets, including securitizations, and where companies have continuing exposure to the risks related to transferred financial assets. ASC Topic 860 eliminates the concept of a “qualifying special-purpose entity” and changes the requirements for derecognizing financial assets. ASC Topic 860 also requires additional disclosures about all continuing involvements with transferred financial assets including information about gains and losses resulting from transfers during the period. The new authoritative guidance in ASC Topic 860 became effective January 1, 2010 and is not expected to have a significant impact on the Company’s future consolidated financial statements.
2. Going concern The going concern assumption is a fundamental principle in the preparation of financial statements. It is the responsibility of management to assess the Company’s ability to continue as a going concern. In assessing this assumption, management has taken into account all available information about the future, which is at least, but is not limited to, twelve months from the balance sheet date of December 31, 2009. The consolidated financial statements have been prepared based upon management’s judgment that the Company will continue as a going concern, which contemplates the realization of assets and the discharge of liabilities in the normal course of business. Accordingly, the consolidated financial statements do not include any adjustments to reflect the possible future effects that may result from the outcome of various uncertainties as discussed below.
The effects of the severe economic contraction caused the Company to incur net losses of $93,080 and $134,566, for the years ended December 31, 2009 and 2008, respectively. The 2008 net loss included a non-cash goodwill impairment charge of $105,047. The Company and the Bank do not currently meet the definition of an “adequately capitalized institution” and are thus operating under significant regulatory restrictions including a requirement to achieve certain capital requirements, enhance liquidity and improve the credit quality of the Bank’s assets (see Note 21). In response, the Company has implemented plans to meet
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DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 2. Going concern - (continued) the requirements of the August 27, 2009 agreement with the FDIC, its principal federal banking regulator, and the DFCS (the Order) which requires the Bank to take certain measures to improve its safety and soundness including an ongoing effort to raise capital. Additional plans and actions to preserve existing capital and to conserve liquidity include (1) improve asset quality and reduce non performing asset totals; (2) reduce loan portfolio totals and thereby reduce required capital; (3) retain core deposits while reducing brokered deposits; and (4) continued reduction of discretionary expenses.
With respect to its efforts to raise capital, in October 2009, the Company entered into agreements with private investors who committed to invest $65,000 into the Company on certain conditions. One condition was that the Company raise an additional $93,000 such that the net aggregate capital raised (after costs) would be at least $150,000. In early December 2009, the Company launched a public offering to meet this condition. However, the public offering was withdrawn in late December 2009 due to the inability to fill the minimums required in the offering. Despite the offering setback, the $65,000 million private equity commitments were extended through May 31, 2010 to allow the Company time to pursue additional private or public capital. The Company is presently in the process of discussions with several qualified private investors regarding the additional capital. Although management is aggressively pursuing additional capital, it is presently uncertain whether the Company will be successful in these efforts.
During 2009, the Company has reduced its level of nonperforming assets. This has been accomplished through sale, disposition, resolution and/or charge-off of such assets. Management believes it has taken appropriate action to charge-off or reserve estimated losses on loans on a timely basis, and expects that the 2010 level of loan loss provision and net charge-offs should be significantly lower as compared to 2009. The Company intends to continue the actions that have led to improved credit quality but it is presently uncertain whether the Company will be successful in these efforts.
Under the Order, the Bank may not generate or renew brokered deposits. Accordingly, it has focused on maintaining its core deposit base to help assure sufficient liquidity. Core deposits as of December 31, 2009 totaled $1,535 as compared to $1,446 as of December 31, 2008. This stabilization was achieved by attracting and retaining business, public and retail customers while minimizing uninsured deposit amounts. Brokered deposits have been decreasing as they mature in compliance with the Order. While the deposit environment remains challenging, the Company intends to continue actions to manage its core deposits but it is presently uncertain whether the Company will be successful in these efforts.
As discussed above, based upon its plans and expectations management believes the Company has sufficient capital and liquidity to achieve realization of assets and the discharge of liabilities in the normal course of business. However, uncertainties exist as to future economic conditions and regulatory actions, and the successful implementation of plans to improve the Company’s financial condition and meet the requirements of the Order. These uncertainties raise doubt about the Company’s ability to continue as a going concern. The consolidated financial statements do not include any adjustments that might result from the lack of success in implementing the Company’s plans or the occurrence of other events that could adversely affect the Company’s condition or operations.
3. Cash and due from banks By regulation, the Bank must meet reserve requirements as established by the FRB (approximately $5,066 and $9,993 at December 31, 2009 and 2008, respectively). Accordingly, the Bank complies with such requirements by holding cash and maintaining average reserve balances with the FRB in accordance with such regulations.
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DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 4. Investment securities Investment securities at December 31, 2009 and 2008 consisted of the following:
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(Dollars in thousands, except per share amounts) 4. Investment securities - (continued) The following table presents the fair value and gross unrealized losses of the Bank’s investment securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2009 and 2008:
The unrealized losses on U.S. Agency and non-agency MBS investments are primarily due to widening of interest rate spreads at December 31, 2009 and 2008 as compared to yields/spread relationships prevailing at the time specific investment securities were purchased. Management expects the fair value of these investment securities to recover as market volatility lessens, and/or as securities approach their maturity dates. Accordingly, management does not believe that the above gross unrealized losses on investment securities are other-than-temporary. Accordingly, no impairment adjustments have been recorded for the years ended December 31, 2009 and 2008.
Management of the Company has the intent and ability to hold the investment securities classified as held-to-maturity until they mature, at which time the Company will receive full amortized cost value for such investment securities. Furthermore, as of December 31, 2009, management does not have the intent to sell any of the securities classified as available-for-sale in the table above and believes that it is more likely than not that the Company will not have to sell any such securities before a recovery of cost.
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(Dollars in thousands, except per share amounts) 4. Investment securities - (continued) The amortized cost and estimated fair value of investment securities at December 31, 2009, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities, because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Investment securities with a carrying value of approximately $85,457 and $109,293 at December 31, 2009 and 2008, respectively, were pledged to secure public deposits, customer repurchase agreements (at December 31, 2008 only) and for other purposes as required or permitted by law.
The Company had no gross realized losses on sales of investment securities during the years ended December 31, 2009, 2008 and 2007. Gross realized gains on sales of investment securities during the years ended December 31, 2009, 2008 and 2007 are as disclosed in the accompanying consolidated statements of operations.
5. Loans Loans at December 31, 2009 and 2008 consisted of the following:
Included in mortgage loans at December 31, 2009 and 2008 were approximately $411 and $1,416, respectively, in mortgage loans held for sale. In addition, the above loans are net of deferred loan fees of approximately $3,281 and $4,697 at December 31, 2009 and 2008, respectively.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 5. Loans - (continued) A substantial portion of the Bank’s loans are collateralized by real estate in four major markets (Central, Southern and Northwest Oregon, as well as the Boise, Idaho area), and, accordingly, the ultimate collectability of a substantial portion of the Bank’s loan portfolio is susceptible to changes in the local economic conditions in such markets.
In the normal course of business, the Bank participates portions of loans to third-parties in order to extend the Bank’s lending capability or to mitigate risk. At December 31, 2009 and 2008, the portion of these loans participated to third-parties (which are not included in the accompanying consolidated financial statements) totaled approximately $61,327 and $46,432, respectively.
6. Reserve for credit losses Transactions in the reserve for loan losses and unfunded loan commitments for the years ended December 31, 2009, 2008 and 2007 were as follows:
At December 31, 2009, the Bank had approximately $288,749 in outstanding commitments to extend credit, compared to approximately $514,605 at December 31, 2008. During 2009 and 2008, the Company reduced its estimated reserves for unfunded commitments by $335 and $2,124, respectively, as a result of declining outstanding commitments and lower estimated funding rates.
The Bank’s operations, like those of other financial institutions operating in the Bank’s market, are significantly influenced by various economic conditions including local economies, the strength of the real estate market and the fiscal and regulatory policies of the federal and state government and the regulatory authorities that govern financial institutions. Approximately 70% of the Bank’s loan portfolio at December 31, 2009 consisted of real estate-related loans, including construction and development loans, commercial real estate mortgage loans and commercial loans secured by commercial real estate. There has been a significant slow-down in the real estate markets due to negative economic trends and credit market disruption, the impacts of which are not yet completely known or quantified. Recently, there have been tighter credit underwriting and higher premiums on liquidity, both of which may continue to place downward pressure on real estate values. Any further downturn in the real estate markets could materially and adversely affect the Bank’s business because a significant portion of the Bank’s loans are secured by real estate. The Bank’s ability to recover on defaulted loans by selling the real estate collateral would then be diminished and the
CASCADE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 6. Reserve for credit losses - (continued) Bank would be more likely to suffer losses on defaulted loans. Consequently, the Bank’s results of operations and financial condition are dependent upon the general trends in the economy, and in particular, the residential and commercial real estate markets. If there is a further decline in real estate values, the collateral for the Bank’s loans would provide less security. Real estate values could be affected by, among other things, a worsening of economic conditions, an increase in foreclosures, a decline in home sale volumes, and an increase in interest rates. Further, the Bank may experience an increase in the number of borrowers who become delinquent, file for protection under bankruptcy laws or default on their loans or other obligations to the Bank given a sustained weakness or a weakening in business and economic conditions generally or specifically in the principal markets in which the Bank does business. An increase in the number of delinquencies, bankruptcies or defaults could result in a higher level of nonperforming assets, net charge-offs and loan loss provision.
Loans on nonaccrual status at December 31, 2009 and 2008 were approximately $132,110 and $120,468, respectively. Interest income which would have been realized on such nonaccrual loans outstanding at year-end, if they had remained current, was approximately $9,177, $4,953, and $1,307 for the years ended December 31, 2009, 2008, and 2007, respectively.
Loans contractually past due 90 days or more on which the Company continued to accrue interest were insignificant at December 31, 2009 and 2008.
Total impaired loans as of December 31, 2009 and 2008 were as follows:
The average recorded investment in impaired loans was approximately $156,748 and $86,332 for the years ended December 31, 2009 and 2008, respectively. Interest income recognized for cash payments received on impaired loans for the years ended December 31, 2009, 2008, and 2007 was insignificant.
At December 31, 2009, the Company had remaining commitments to lend of $328 related to loans accounted for as troubled debt restructurings (TDRs). The Company had no TDRs at December 31, 2008.
The following tables present information with respect to non-performing assets at December 31, 2009 and 2008:
CASCADE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 7. Mortgage banking activities The Bank sells a predominant share of the mortgage loans it originates into the secondary market. However, it retained the right to service loans sold to the Federal National Mortgage Association (FNMA) with principal balances totaling approximately $543,000, $512,000 and $494,000 as of December 31, 2009, 2008 and 2007, respectively. These balances are not included in the accompanying consolidated balance sheets. The sales of these mortgage loans are subject to technical underwriting requirements and related repurchase risks. However, as of December 31, 2009 and 2008, management is not aware of any mortgage loans which will have to be repurchased.
Mortgage loans held for sale are carried at the lower of cost or estimated market value. Market value is determined on an aggregate loan basis. At December 31, 2009 and 2008, mortgage loans held for sale were carried at cost, which was less than the estimated market value.
On November 13, 2009, FNMA informed the Bank that - as a result of the Bank’s capital ratios falling below contractual requirements - the Bank no longer qualified as a FNMA designated mortgage loan seller or servicer and the Bank had until December 31, 2009 to improve its capital ratios to meet FNMA’s requirements. As of December 31, 2009, the Bank had not met such requirements, and, accordingly, FNMA has terminated the Bank’s rights to originate and sell mortgage loans directly to FNMA. In addition, FNMA now is in the process of terminating its mortgage servicing agreement with the Bank, upon which occurrence the Bank would no longer be allowed to service FNMA loans. Management is in the process of discussing such issues with FNMA and has been evaluating the prospective impact of this development. Possible outcomes include a reduction of the Company’s mortgage banking and mortgage servicing revenues in the future and sale or forced transfer of its mortgage servicing business to a third-party by FNMA. As a result of the actions by FNMA, the Company anticipates that the majority of mortgage loans originated in future periods will be sold to other third-parties and that the Bank will not retain servicing rights. The Company expects that this may result in a significant decrease to future net mortgage servicing income. Management believes that under the circumstances, FNMA will provide the Company with sufficient time to accomplish an orderly disposition of its MSRs. However, there can be no assurance that FNMA will provide for an orderly process nor that a reduction of mortgage banking revenues or possible impairment of MSRs will not occur. Because the estimated fair value of the Company’s MSRs exceeds book value at December 31, 2009, and because management believes it is unlikely FNMA will preemptively transfer the Company’s MSRs to a third-party, no impairment adjustment has been made in connection with this issue as of December 31, 2009. In addition, no valuation allowance for MSRs was recorded as of December 31, 2008 and 2007.
Transactions in the Company’s MSRs for the years ended December 31, 2009, 2008 and 2007 were as follows:
The Company analyzes its MSRs by underlying loan type and interest rate (primarily fixed and adjustable). The estimated fair values are obtained through a independent third-party valuations, utilizing future cash flows which incorporate numerous assumptions including servicing income, servicing costs, market discount rates, prepayment speeds, default rates and other market-driven data. Additional adjustments may be made for other factors not directly related to the underlying cash flows of the mortgage servicing portfolio, as described below, Accordingly, changes in such assumptions could significantly affect the estimated fair values of the Company’s MSRs.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 7. Mortgage banking activities - (continued) At December 31, 2009 and 2008, the estimated fair value of the Company’s MSRs was approximately $4,229 and $4,572, respectively. As previously estimated, the Bank is in the process of attempting to sell its MSRs. Accordingly, at December 31, 2009, the fair value of MSRs was estimated using the average of two discounted cash flow analyses calculated by 3rd-party valuation experts, less estimated broker fees and other estimated costs of disposition. The key assumptions used in estimating the fair value of MSRs at December 31, 2008 included weighted-average mortgage prepayment rates of approximately 318% for the first year, 258% for the second year and 219% thereafter. A discount rate of 10% was applied in 2008.
Mortgage banking income, net, consisted of the following for the years ended December 31, 2009, 2008 and 2007:
8. Premises and equipment Premises and equipment at December 31, 2009 and 2008 consisted of the following:
9. Core deposit intangibles (CDI) Net unamortized CDI totaled $6,388 and $7,921 at December 31, 2009 and 2008, respectively. Amortization expense related to the CDI during the years ended December 31, 2009, 2008 and 2007 totaled $1,533, $1,581 and $1,580, respectively.
At December 31, 2009, the forecasted CDI annual amortization expense for each of the next five years is as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 10. OREO Transactions in the Company’s OREO for the years ended December 31, 2009, 2008 and 2007 were as follows:
OREO valuation adjustments have been recorded on certain OREO properties in 2009 and 2008. These expenses are included in OREO expense in the accompanying 2009 and 2008 consolidated statements of operations.
The following table summarizes activity in the OREO valuation allowance for the years ended December 31, 2009 and 2008:
OREO expenses for the year ended December 31, 2009 consisted of $1,655 of OREO operating costs, $3,504 of losses on dispositions of OREO, and $17,232 of valuation allowances. OREO expenses for the year ended December 31, 2008 primarily consisted of $2,742 of OREO operating costs and $5,460 of valuation allowances. OREO expenses for the year ended December 31, 2007 were insignificant.
11. Time deposits Time deposits in amounts of $100,000 or more aggregated approximately $280,000 and $349,000 at December 31, 2009 and 2008, respectively.
At December 31, 2009, the scheduled annual maturities of all time deposits were approximately as follows:
Included in the total time deposits are national market brokered time deposits that were part of the Company’s wholesale funding strategies in 2008. Also, the Bank utilizes the Certificate of Deposit Registry Program (CDARSTM)to meet the needs of certain customers whose investment policies may necessitate or require FDIC insurance. At December 31, 2009 and 2008, brokered time deposits were $116,476 and $147,900, respectively, and CDARS deposits totaled $47,287 and $168,246, respectively. The Company is restricted from renewing any brokered deposits under terms of the Order (see Note 21).
CASCADE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 11. Time deposits - (continued) In addition, the Bank’s internet listing service deposits at December 31, 2009 and 2008 totaled $195,077 and $740, respectively, and are included in the above total time deposits. Such deposits are generated by posting time deposit rates on an internet site where institutions seeking to deploy funds contact the Bank directly to open a deposit account.
12. Junior subordinated debentures The Company has established four subsidiary grantor trusts for the purpose of issuing trust preferred securities (TPS) and common securities. The common securities were purchased by the Company, and the Company’s investment in the common securities of $2,058 at both December 31, 2009 and 2008, is included in accrued interest and other assets in the accompanying consolidated balance sheets.
The interest on TPS may be deferred at the sole determination of the issuer. Under such circumstances, the Company would continue to accrue interest but not make payments on the TPS. On April 27, 2009, the Company’s Board of Directors (the Board) elected to defer payment of interest on TPS until such time as resumption is deemed appropriate. Accrued interest on the TPS at December 31, 2009 was $1,704, and is included in accrued interest and other liabilities in the accompanying 2009 consolidated balance sheet.
The TPS are subordinated to any other borrowings of the Company, and no principal payments are required until the related maturity dates (unless conditions are met as described below). The significant terms of each individual trust are as follows:
(A) The Junior Subordinated Debentures (Debentures) were issued with substantially the same terms as the TPS and are the sole assets of the related trusts. The Company’s obligations under the Debentures and related agreements, taken together, constitute a full and irrevocable guarantee by the Company of the obligations of the trusts.
(B) The Debentures bear a fixed quarterly interest rate for 20 quarters, at which time the rate begins to float on a quarterly basis based on the three-month London Inter-Bank Offered Rate (LIBOR) plus 1.33% thereafter until maturity.
(C) The three-month LIBOR in effect as of December 31, 2009 was 0.25363%.
CASCADE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 12. Junior subordinated debentures - (continued)
(D) The TPS may be called by the Company at par at any time subsequent to March 15, 2010 and may be redeemed earlier upon the occurrence of certain events that impact the income tax or the regulatory capital treatment of the TPS.
(E) The TPS may be called by the Company at par at any time subsequent to June 15, 2011 and may be redeemed earlier upon the occurrence of certain events that impact the income tax or the regulatory capital treatment of the TPS.
(F) The TPS may be called by the Company at par at any time subsequent to September 15, 2011 and may be redeemed earlier upon the occurrence of certain events that impact the income tax or the regulatory capital treatment of the TPS.
In accordance with industry practice, the Company’s liability for the common securities has been included with the Debentures in the accompanying consolidated balance sheets. Management believes that at December 31, 2009, the TPS meet applicable regulatory guidelines to qualify as Tier I capital in the amount of $14.5 million and Tier 2 capital in the amount of $32.5 million. At December 31, 2008, the TPS met applicable regulatory guidelines to qualify as Tier I capital and Tier 2 capital in the amounts of $43.5 million and $23.0 million, respectively (see Note 21).
13. Other borrowings The Bank is a member of the FHLB. As a member, the Bank has a committed line of credit up to 35% of total assets, subject to the Bank pledging sufficient collateral and maintaining the required investment in FHLB stock. At December 31, 2009, the Bank had outstanding borrowings under the committed lines of credit totaling $195,000 ($128,457 at December 31, 2008) of which $90,000 was at fixed interest at rates ranging from 2.29% to 3.71% and of which $105,000 was at variable interest rates ranging from 0.56% to 1.16%. In addition, at December 31, 2009, the Bank has a total of $138,000 in letters of credit issued by FHLB which are pledged to collateralize Oregon public deposits held by the Bank. All outstanding borrowings and letters of credit with the FHLB are collateralized by a blanket pledge agreement on the Bank’s FHLB stock, any funds on deposit with the FHLB, certain investment securities and loans. At December 31, 2009, the Bank had remaining available maximum borrowings from the FHLB of approximately $418,578, given availability and sufficiency of eligible collateral. At December 31, 2009, the Bank had $8,868 in available borrowings from the FHLB based on existing collateral that had been pledged to the FHLB, and had additional collateral with which to pledge for borrowings totaling approximately $341,868. There can be no assurance that future advances will be allowed by the FHLB based upon the condition of the Bank (see Notes 2 and 21).
At December 31, 2009, the contractual maturities of the Bank’s FHLB borrowings outstanding were approximately as follows:
CASCADE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 13. Other borrowings - (continued) In December 2009, the Company elected to repay FHLB advances totaling approximately $48,500 (with maturities ranging from September 2010 to May 2025, and rates ranging from 1.87% to 6.62%) and receive two advances from the FHLB totaling $20,000 each. These advances mature in December 2011 and June 2012 at interest rates of one-month LIBOR plus a margin of 0.33% and prime minus a margin of 2.45%, respectively. In connection with the early repayment of the advances, the Company incurred prepayment penalties totaling $2,081.
At December 31, 2009, the Bank had approximately $83,383 in available short-term borrowings from the FRB, collateralized by certain of the Bank’s loans and securities. Such available borrowings include participation in the Treasury Tax and Loan (TT&L) program of the federal government, with access to this funding source limited to $300 and fully at the discretion of the U.S. Treasury. Of the total available FRB borrowings, at December 31, 2009, the Bank had approximately $207 ($120,518 at December 31, 2008) in total borrowings outstanding from the FRB. FRB borrowings at December 31, 2009 consisted of TT&L overnight borrowings at an interest rate of 0.25%.
At December 31, 2009, the Bank had $41,000 of senior unsecured debt issued in connection with the FDIC’s Temporary Liquidity Guarantee Program (TLGP) maturing February 12, 2012 bearing a weighted-average rate of 2.00%, exclusive of net issuance costs and 1% per annum FDIC insurance assessment applicable to TLGP debt which are being amortized on a straight line basis over the term of the debt.
14. Commitments, guarantees and contingencies Off-balance sheet financial instruments
In the ordinary course of business, the Bank is a party to financial instruments with off-balance sheet risk to meet the financing needs of its customers. These financial instruments include commitments to extend credit, commitments under credit card lines of credit and standby letters of credit. These financial instruments involve, to varying degrees, elements of credit and interest-rate risk in excess of amounts recognized in the accompanying consolidated balance sheets. The contractual amounts of these financial instruments reflect the extent of the Bank’s involvement in these particular classes of financial instruments. As of December 31, 2009 and 2008, the Bank had no material commitments to extend credit at below-market interest rates and held no significant derivative financial instruments.
The Bank’s exposure to credit loss for commitments to extend credit, commitments under credit card lines of credit and standby letters of credit is represented by the contractual amount of these instruments. The Company follows the same credit policies in underwriting and offering commitments and conditional obligations as it does for on-balance sheet financial instruments.
A summary of the Bank’s off-balance sheet financial instruments at December 31, 2009 and 2008 is approximately as follows:
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require the payment of fees. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash
CASCADE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 14. Commitments, guarantees and contingencies - (continued) requirements. The Bank applies established credit related standards and underwriting practices in evaluating the creditworthiness of such obligors. The amount of collateral obtained, if it is deemed necessary by the Bank upon the extension of credit, is based on management’s credit evaluation of the counterparty.
The Bank typically does not obtain collateral related to credit card commitments. Collateral held for other commitments varies but may include accounts receivable, inventory, property and equipment, residential real estate and income-producing commercial properties.
Standby letters of credit are written conditional commitments issued by the Bank to guarantee the performance of a customer to a third-party. These guarantees are primarily issued to support public and private borrowing arrangements. In the event that the customer does not perform in accordance with the terms of the agreement with the third-party, the Bank would be required to fund the commitment. The maximum potential amount of future payments the Bank could be required to make is represented by the contractual amount of the commitment. If the commitment was funded, the Bank would be entitled to seek recovery from the customer. The Bank’s policies generally require that standby letter of credit arrangements contain security and debt covenants similar to those involved in extending loans to customers. The credit risk involved in issuing standby letters of credit is essentially the same as that involved in extending loan facilities to customers.
The Bank considers the fees collected in connection with the issuance of standby letters of credit to be representative of the fair value of its obligations undertaken in issuing the guarantees. In accordance with GAAP related to guarantees, the Bank defers fees collected in connection with the issuance of standby letters of credit. The fees are then recognized in income proportionately over the life of the related standby letter of credit agreement. At December 31, 2009 and 2008, the Bank’s deferred standby letter of credit fees, which represent the fair value of the Bank’s potential obligations under the standby letter of credit guarantees, were insignificant to the accompanying consolidated financial statements. The Bank also has certain lending commitments for conforming residential mortgage loans to be sold into the secondary market which are considered derivative instruments under GAAP. However, in the opinion of management, such derivative amounts are not significant, and, therefore, no derivative assets or liabilities are recorded in the accompanying consolidated financial statements.
Lease commitments The Bank leases certain land and facilities under operating leases, some of which include renewal options and escalation clauses. At December 31, 2009, the aggregate minimum rental commitments under operating leases that have initial or remaining non-cancelable lease terms in excess of one year were approximately as follows:
Total rental expense was approximately $2,395, $2,528 and $2,309 in 2009, 2008 and 2007, respectively.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 14. Commitments, guarantees and contingencies - (continued) Litigation In the ordinary course of business, the Bank becomes involved in various litigation arising from normal banking activities, including numerous matters related to loan collections and foreclosures. In the opinion of management, the ultimate disposition of these legal actions will not have a material adverse effect on the Company’s consolidated financial statements as of and for the year ended December 31, 2009.
Other
The Bank is a public depository and, accordingly, accepts deposit funds belonging to, or held for the benefit of, the state of Oregon, political subdivisions thereof, municipal corporations, and other public funds. In accordance with applicable state law, in the event of default of one bank, all participating banks in the state collectively assure that no loss of funds is suffered by any public depositor. Generally, in the event of default by a public depository, the assessment attributable to all public depositories is allocated on a pro rata basis in proportion to the maximum liability of each public depository as it existed on the date of loss. The Bank has pledged a letter of credit issued by FHLB which collateralizes public deposits not otherwise insured by FDIC. At December 31, 2009 there was no liability associated with the Bank’s participation in this pool because all participating banks are presently required to fully collateralize uninsured Oregon public deposits, and there were no occurrences of an actual loss on Oregon public deposits at such participating banks. The maximum future contingent liability is dependent upon the occurrence of an actual loss, the amount of such loss, the failure of collateral to cover such a loss and the resulting share of loss to be assessed to the Company.
The Company has entered into employment contracts and benefit plans with certain executive officers and members of the Board that allow for payments (or accelerated payments) contingent upon a change in control of the Company.
15. Income taxes The provision (credit) for income taxes for the years ended December 31, 2009, 2008 and 2007 was approximately as follows:
CASCADE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 15. Income taxes - (continued) The provision (credit) for income taxes results in effective tax rates which are different than the federal income tax statutory rate. The nature of the differences for the years ended December 31, 2009, 2008, and 2007 were approximately as follows:
The components of the net deferred tax assets and liabilities at December 31, 2009 and 2008 were approximately as follows:
Due to recent tax law changes enacted in 2009, the Company can carry back its federal net operating losses from 2009 to offset federal taxes paid in the previous five years as opposed to the two-year carry back permitted under the prior tax laws. At December 31, 2009 and 2008, the Company has recorded income taxes
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 15. Income taxes - (continued) receivable of approximately $43,256 and $21,230, respectively, which are recorded in other assets in the accompanying consolidated balance sheets.
State net operating losses may only be carried forward to future years. At December 31, 2009, the Company had state net operating loss carryforwards of approximately $171,070, which expire at various dates from 2014 to 2030.
The valuation allowance for deferred tax assets as of December 31, 2009 was $26,757. There was no valuation allowance as of December 31, 2008. Management determined that a valuation allowance was required at December 31, 2009 by evaluating the nature and amount of historical and projected future taxable income, the scheduled reversal of deferred tax assets and liabilities, and available tax planning strategies.
The Company has evaluated its income tax positions as of December 31, 2009 and 2008. Based on this evaluation, the Company has determined that it does not have any uncertain income tax positions for which an unrecognized tax liability should be recorded. The Company recognizes interest in penalties related to income tax matters as interest expense and other noninterest expense, respectively, in the consolidated statements of operations. The Company had no significant interest and penalties related to income tax matters during the years ended December 31, 2009, 2008 or 2007.
16. Basic and diluted earnings (loss) per common share The Company’s basic earnings (loss) per common share is computed by dividing net income (loss) by the weighted-average number of common shares outstanding during the period. The Company’s diluted earnings per common share is computed by dividing net income by the weighted-average number of common shares outstanding plus dilutive common shares related to stock options and nonvested restricted stock. The Company’s diluted loss per common share is the same as the basic loss per common share due to the anti-dilutive effect of common stock equivalents.
The numerators and denominators used in computing basic and diluted earnings (loss) per common share for the years ended December 31, 2009, 2008 and 2007 can be reconciled as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 16. Basic and diluted earnings (loss) per common share - (continued)
17. Transactions with related parties Certain officers and directors (and the companies with which they are associated) are customers of, and have had banking transactions with, the Bank in the ordinary course of the Bank’s business. In addition, the Bank expects to continue to have such banking transactions in the future. All loans, and commitments to loan, to such parties are generally made on the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons. In the opinion of management, these transactions do not involve more than the normal risk of collectibility or present any other unfavorable features.
An analysis of activity with respect to loans to officers and directors of the Bank for the years ended December 31, 2009 and 2008 was approximately as follows:
In addition, during the years ended December 31, 2009, 2008 and 2007, the Company incurred legal fees of approximately $446, $47 and $243 to firms in which certain directors were partners.
18. Benefit plans 401(k) profit sharing plan
The Company maintains a 401(k) profit sharing plan (the Plan) that covers substantially all full-time employees. Employees may make voluntary tax-deferred contributions to the Plan, and the Company’s contributions related to the Plan are at the discretion of the Board, not to exceed the amount deductible for federal income tax purposes.
Employees vest in the Company’s contributions to the Plan over a period of five years. The total amounts charged to operations under the Plan were approximately $197, $1,078 and $1,977 for the years ended December 31, 2009, 2008 and 2007, respectively. In 2009 and 2008 the Company’s contributions to the Plan consisted solely of employer matching contributions. The Company’s contributions to the Plan for the year ended December 31, 2007 consisted of employer matching contributions of $1,120 and profit sharing contributions of $857.
CASCADE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 18. Benefit plans - (continued) Other benefit plans The Bank has deferred compensation plans for the Board and certain key executives and managers, and a salary continuation plan and a supplemental executive retirement (SERP) plan for certain key executives. In accordance with the provisions of the deferred compensation plans, participants can elect to defer portions of their annual compensation or fees. The deferred amounts generally vest as deferred. The deferred compensation plus interest is generally payable upon termination in either a lump-sum or monthly installments.
The salary continuation and SERP plans for certain key executives provide specified benefits to the participants upon termination or change of control. The benefits are subject to certain vesting requirements, and vested amounts are generally payable upon termination or change of control in either a lump-sum or monthly installments. The Bank annually expenses amounts sufficient to accrue for the present value of the benefits payable to the participants under these plans. These plans also include death benefit provisions for certain participants.
To assist in the funding of these plans, the Bank has purchased BOLI policies on the majority of the participants. The cash surrender value of the general account policies at December 31, 2009 and 2008 was approximately $7,530 and $7,253, respectively. The cash surrender value of the separate account policies, including the value of the stable value wraps, was approximately $26,105 and $26,315 at December 31, 2009 and 2008, respectively. At December 31, 2009 and 2008, the liabilities related to the deferred compensation plans included in accrued interest and other liabilities in the accompanying consolidated balance sheets totaled approximately $4,481 and $4,744, respectively. During 2009, two Board members received withdrawals from their deferred compensation accounts aggregating a total of approximately $400. In addition, during January 2010, the same two Board members withdrew an aggregate of approximately $386 from their deferred compensation accounts. All such withdrawals were pre-approved by the FDIC. The amount of expense charged to operations in 2009, 2008 and 2007 related to the deferred compensation plans was approximately $1,385, $1,495 and $1,744, respectively. As of December 31, 2009 and 2008, the liabilities related to the salary continuation and SERP plans included in accrued interest and other liabilities in the accompanying consolidated balance sheets totaled approximately $8,827 and $7,760, respectively. The amount of expense charged to operations in 2009, 2008 and 2007 for the salary continuation, SERP and fee continuation plans was approximately $1,257, $1,356 and $1,560, respectively. For financial reporting purposes, such expense amounts have not been adjusted for income earned on the BOLI policies.
19. Stock-based compensation plans The Company has historically maintained certain stock-based compensation plans, approved by the Company’s shareholders that are administered by the Board or the Compensation Committee of the Board (the Compensation Committee). In addition, on April 28, 2008, the shareholders of the Company approved the 2008 Cascade Bancorp Performance Incentive Plan (the 2008 Plan). The 2008 Plan authorized the Board to issue up to an additional one million shares of common stock related to the grant or settlement of stock-based compensation awards, expanded the types of stock-based compensation awards that may be granted, and expanded the parties eligible to receive such awards. Under the Company’s stock-based compensation plans, the Board (or the Compensation Committee) may grant stock options (including incentive stock options (ISOs) as defined in Section 422 of the Internal Revenue Code and non-qualified stock options (NSOs)), restricted stock, restricted stock units, stock appreciation rights and other similar types of equity awards intended to qualify as “performance-based” compensation under applicable tax rules. The stock-based compensation plans were established to allow for the granting of compensation awards to attract, motivate and retain employees, executive officers, non-employee directors and other service providers who contribute to the success and
CASCADE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 19. Stock-based compensation plans - (continued) profitability of the Company and to give such persons a proprietary interest in the Company, thereby enhancing their personal interest in the Company’s success.
The Board or Compensation Committee may establish and prescribe grant guidelines including various terms and conditions for the granting of stock-based compensation and the total number of shares authorized for this purpose. Under the 2008 Plan, for ISOs and NSOs, the option strike price must be no less than 100% of the stock price at the grant date. Prior to the approval of the 2008 Plan, the option strike price for NSOs could be no less than 85% of the stock price at the grant date. Generally, options become exercisable in varying amounts based on years of employee service and vesting schedules. All options expire after a period of ten years from the date of grant. Other permissible stock awards include restricted stock grants, restricted stock units, stock appreciation rights or other similar stock awards (including awards that do not require the grantee to pay any amount in connection with receiving the shares or that have a purchase price that is less than the grant date fair market value of the Company’s stock.)
At December 31, 2009, 1,353,217 shares reserved under the stock-based compensation plans were available for future grants.
During 2009, the Company did not grant any stock options. During 2008 and 2007, the Company granted 400,130 and 139,962 stock options with a weighted-average fair value of $2.36 and $9.14 per option, respectively. The Company used the Black-Scholes option-pricing model with the following weighted-average assumptions to value options granted in 2008 and 2007:
The dividend yield was based on historical dividend information. The expected volatility was based on historical volatility of the Company’s common stock price. The risk-free interest rate was based on the U.S. Treasury yield curve in effect at the date of grant for periods corresponding with the expected lives of the options granted. The expected option lives represent the period of time that options are expected to be outstanding giving consideration to vesting schedules and historical exercise and forfeiture patterns.
The Black-Scholes option-pricing model was developed for use in estimating the fair value of publicly-traded options that have no vesting restrictions and are fully transferable. Additionally, the model requires the input of highly subjective assumptions. Because the Company’s stock options have characteristics significantly different from those of publicly-traded options, and because changes in the subjective input assumptions can materially affect the fair value estimates, in the opinion of the Company’s management, the Black-Scholes option-pricing model does not necessarily provide a reliable single measure of the fair value of the Company’s stock options.
CASCADE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 19. Stock-based compensation plans - (continued) The following table presents the activity related to options under all plans for the years ended December 31, 2009, 2008, and 2007.
Stock-based compensation expense related to stock options for the years ended December 31, 2009, 2008 and 2007 was approximately $593, $676 and $769, respectively. As of December 31, 2009 and 2008, unrecognized compensation cost related to nonvested stock options totaled $336and $1,159, respectively, which is expected to be recognized over a weighted-average life of less than two years.
Information regarding the number, weighted-average exercise price and weighted-average remaining contractual life of options by range of exercise price at December 31, 2009 is as follows:
CASCADE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 19. Stock-based compensation plans - (continued) As of December 31, 2009, unrecognized compensation cost related to nonvested restricted stock totaled approximately $388, which is expected to be recognized over a weighted-average life of two years. Total expense recognized by the Company for nonvested restricted stock for the years ended December 31, 2009, 2008 and 2007 was $665, $890 and $904, respectively. The following table presents the activity for nonvested restricted stock for the year ended December 31, 2009:
Nonvested restricted stock is scheduled to vest over periods ranging from one to five years from the grant dates, with a weighted-average remaining vesting term of 1.9 years. The unearned compensation on restricted stock is being amortized to expense on a straight-line basis over the applicable vesting periods.
The Company has also granted awards of restricted stock units (RSUs). A RSU represents the unfunded, unsecured right to require the Company to deliver to the participant one share of common stock for each RSU. Total expense recognized by the Company related to RSUs was insignificant for the years ended December 31, 2009, 2008 and 2007. There was no unrecognized compensation cost related to RSUs at December 31, 2009 and 2008, as all RSUs were fully-vested. The following table presents the activity for RSUs for the year ended December 31, 2009:
20. Fair value measurements ASC Topic 820 establishes a hierarchy for determining fair value measurements, includes three levels and is based upon the valuation techniques used to measure assets and liabilities. The three levels are as follow:
• Quoted prices in active markets for identical assets (Level 1): Inputs that are quoted unadjusted prices in active markets for identical assets that the Company has the ability to access at the measurement date. An active market for the asset is a market in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis.
• Significant other observable inputs (Level 2): Inputs that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from
CASCADE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 20. Fair value measurements - (continued)
sources independent of the reporting entity including quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in inactive markets, and inputs derived principally from, or corroborated by, observable market data by correlation or other means.
• Significant unobservable inputs (Level 3): Inputs that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances.
A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below. These valuation methodologies were applied to all of the Company’s financial assets and financial liabilities carried at fair value. In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally-developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality and the Company’s creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. The Company’s valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes that the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. Furthermore, the reported fair value amounts have not been comprehensively revalued since the presentation dates, and therefore, estimates of fair value after the consolidated balance sheet date may differ significantly from the amounts presented herein.
The following is a description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to valuation hierarchy:
Investment securities: Where quoted prices for identical assets are available in an active market, investment securities available-for-sale are classified within level 1 of the hierarchy. If quoted market prices for identical securities are not available then fair values are estimated by independent sources using pricing models and/or quoted prices of investment securities with similar characteristics or discounted cash flows. The Company has categorized its investment securities available-for-sale as level 2, since a majority of such securities are MBS which are mainly priced in this latter manner.
Impaired loans: In accordance with GAAP, loans measured for impairment are reported at estimated fair value, including impaired loans measured at an observable market price (if available) or at the fair value of the loan’s collateral (if collateral dependent). Estimated fair value of the loan’s collateral is determined by appraisals or independent valuation which is then adjusted for the estimated costs related to liquidation of the collateral. Management’s ongoing review of appraisal information may result in additional discounts or adjustments to valuation based upon more recent market sales activity or more current appraisal information derived from properties of similar type and/or locale. A significant portion of the Bank’s impaired loans are measured using the estimated fair market value of the collateral less the estimated costs to sell. During 2009, impaired loans with a carrying value of $197,283 were reduced by specific valuation allowance allocations totaling $49,701 to a total reported value of $147,582 based on collateral valuations utilizing level 3 valuation inputs. During 2008, impaired loans with a carrying value of $169,729 were reduced by specific valuation allowance allocations totaling $49,261to a total reported value of $120,468 based on collateral valuations utilizing level 3 inputs.
CASCADE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 20. Fair value measurements - (continued) OREO: The Company’s OREO is measured at estimated fair value less estimated costs to sell. Fair value was generally determined based on third-party appraisals of fair value in an orderly sale. Historically, appraisals have considered comparable sales of like assets in reaching a conclusion as to fair value. Since many recent real estate sales could be termed “distressed sales”, since a preponderance have been short-sale or foreclosure related, this has directly impacted appraisal valuation estimates. Estimated costs to sell OREO were based on standard market factors. The valuation of OREO is subject to significant external and internal judgment. Management periodically reviews OREO to determine whether the property continues to be carried at the lower of its recorded book value or estimated fair value, net of estimated costs to sell. During 2009, OREO with a carrying value of $35,090 was reduced by specific valuation allowance allocations totaling $5,481 to a total reported value of $29,609 based on collateral valuations utilizing level 3 valuation inputs. During 2008, OREO with a carrying value of $58,067 was reduced by specific valuation allowance allocations totaling $5,340 to a total reported value of $52,727 based on collateral valuations utilizing level 3 inputs.
At December 31, 2009 and 2008, the Company had no financial liabilities measured at fair value on a recurring basis. The Company’s financial assets measured at fair value on a recurring basis at December 31, 2009 and 2008 are as follows:
Certain non-financial assets are also measured at fair value on a non-recurring basis. These assets primarily consist of intangible assets and other non-financial long-lived assets which are measured at fair value for periodic impairment assessments. The Company has no non-financial liabilities measured at fair value on a non-recurring basis.
Certain assets are measured at fair value on a nonrecurring basis (e.g., the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments when there is evidence of impairment). The following table represents the assets measured at fair value on a nonrecurring basis by the Company at December 31, 2009 and 2008:
CASCADE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 20. Fair value measurements - (continued)
The Company did not change the methodology used to determine fair value for any financial instruments during the years ended December 31, 2009 and 2008. Accordingly, for any given class of financial instruments, the Company did not have any transfers between level 1, level 2, or level 3 during these periods.
The following disclosures are made in accordance with the provisions of FASB ASC Topic 825, “Financial Instruments,” which requires the disclosure of fair value information about financial instruments where it is practicable to estimate that value.
In cases where quoted market values are not available, the Company primarily uses present value techniques to estimate the fair value of its financial instruments. Valuation methods require considerable judgment, and the resulting estimates of fair value can be significantly affected by the assumptions made and methods used. Accordingly, the estimates provided herein do not necessarily indicate amounts which could be realized in a current market exchange.
In addition, as the Company normally intends to hold the majority of its financial instruments until maturity, it does not expect to realize many of the estimated amounts disclosed. The disclosures also do not include estimated fair value amounts for items which are not defined as financial instruments but which may have significant value. The Company does not believe that it would be practicable to estimate a representational fair value for these types of items as of December 31, 2009 and 2008.
Because ASC Topic 825 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements, any aggregation of the fair value amounts presented would not represent the underlying value of the Company.
The Company uses the following methods and assumptions to estimate the fair value of its financial instruments:
Cash and cash equivalents: The carrying amount approximates the estimated fair value of these instruments.
Investment securities: See above description.
FHLB stock: The carrying amount approximates the estimated fair value.
Loans: The estimated fair value of loans is calculated by discounting the contractual cash flows of the loans using December 31, 2009 and 2008 origination rates. The resulting amounts are adjusted to estimate the effect of changes in the credit quality of borrowers since the loans were originated. Fair values for impaired loans are estimated using a discounted cash flow analysis or the underlying collateral values.
BOLI: The carrying amount approximates the estimated fair value of these instruments.
OREO: See above description.
CASCADE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 20. Fair value measurements - (continued) Deposits: The estimated fair value of demand deposits, consisting of checking, interest bearing demand and savings deposit accounts, is represented by the amounts payable on demand. At the reporting date, the estimated fair value of time deposits is calculated by discounting the scheduled cash flows using the December 31, 2009 and 2008 rates offered on those instruments.
Junior subordinated debentures, other borrowings and TLGP senior unsecured debt: The fair value of the Bank’s junior subordinated debentures, other borrowings (including federal funds purchased) and TLGP senior unsecured debt are estimated using discounted cash flow analyses based on the Bank’s December 31, 2009 and 2008 incremental borrowing rates for similar types of borrowing arrangements. However, as of December 31, 2009, the estimated fair value of the Bank’s junior subordinated debentures has been adjusted to reflect the possible negotiated exchange of such debentures for cash.
Customer repurchase agreements: The carrying value approximates the estimated fair value.
Loan commitments and standby letters of credit: The majority of the Bank’s commitments to extend credit have variable interest rates and “escape” clauses if the customer’s credit quality deteriorates. Therefore, the fair values of these items are not significant and are not included in the following table.
The estimated fair values of the Company’s significant on-balance sheet financial instruments at December 31, 2009 and 2008 were approximately as follows:
21. Regulatory matters The Company and the Bank are subject to various regulatory capital requirements administered by the federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific
CASCADE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 21. Regulatory matters - (continued) capital guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Company’s and the Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the tables below) of Tier 1 capital to average assets and Tier 1 and total capital to risk-weighted assets (all as defined in the regulations).
Federal banking regulators are required to take prompt corrective action if an insured depository institution fails to satisfy certain minimum capital requirements. Such actions could potentially include a leverage limit, a risk-based capital requirement, and any other measure of capital deemed appropriate by the federal banking regulator for measuring the capital adequacy of an insured depository institution. In addition, payment of dividends by the Company and the Bank are subject to restriction by state and federal regulators and availability of retained earnings. At December 31, 2009, the Company and the Bank do not meet the regulatory benchmarks to be “adequately capitalized” under the applicable regulations.
On August 27, 2009, the Bank entered into an agreement with the FDIC, its principal federal banking regulator, and the DFCS which requires the Bank to take certain measures to improve its safety and soundness.
In connection with this agreement, the Bank stipulated to the issuance by the FDIC and the DFCS of the Order based on certain findings from an examination of the Bank conducted in February 2009 based upon financial and lending data measured as of December 31, 2008 (the “ROE”). In entering into the stipulation and consenting to entry of the Order, the Bank did not concede the findings or admit to any of the assertions therein.
Under the Order, the Bank is required to take certain measures to improve its capital position, maintain liquidity ratios, reduce its level of non-performing assets, reduce its loan concentrations in certain portfolios, improve management practices and board supervision and to assure that its reserve for loan losses is maintained at an appropriate level. Management generally believes that at December 31, 2009 the Company is in substantial compliance with the requirements of the Order with the exception of requirements tied to or dependent upon execution of a capital raise as described below.
Among the corrective actions required are for the Bank to develop and adopt a plan to maintain the minimum capital requirements for a “well-capitalized” bank, including a Tier 1 leverage ratio of at least 10% at the Bank level beginning 150 days from the issuance of the Order. As of December 31, 2009 and through the date of this report the requirement relating to increasing the Bank’s Tier 1 leverage ratio has not been met.
In addition, pursuant to the Order, the Bank must retain qualified management and must notify the FDIC and the DFCS in writing when it proposes to add any individual to its Board or to employ any new senior executive officer. Under the Order the Bank’s Board must also increase its participation in the affairs of the Bank, assuming full responsibility for the approval of sound policies and objectives and for the supervision of all the Bank’s activities.
The Order further requires the Bank to ensure the level of the reserve for loan losses is maintained at appropriate levels to safeguard the book value of the Bank’s loans and leases, and to reduce the amount of classified loans as of the date of the Order to no more than 75% of capital. As of December 31, 2009 and through the date of this report, the requirement that the amount of classified loans as of the date of the Order be reduced to no more than 75% of capital has not been met. However, as required by the Order, all assets classified as “Loss” in the ROE have been charged-off. The Bank has also developed and implemented a process for the review and approval of all applicable asset disposition plans.
CASCADE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 21. Regulatory matters - (continued) The Order restricts the Bank from taking certain actions without the consent of the FDIC and the DFCS, including paying cash dividends, and from extending additional credit to certain types of borrowers.
The Order further requires the Bank to maintain a primary liquidity ratio (net cash, net short-term and marketable assets divided by net deposits and short-term liabilities) of at least 15%.
The Bank was required to implement these measures under various time frames, all of which have expired. While the Bank successfully completed several of the measures, it was unable to implement certain measures in the time frame provided, particularly those related to raising capital levels. In order for the Bank to meet the capital requirements of the Order, as of December 31, 2009, the Bank is targeting a minimum of approximately $150 million of additional equity capital. The economic environment in our market areas and the duration of the downturn in the real estate market will continue to have a significant impact on the implementation of the Bank’s business plans. While the Company plans to continue its efforts to aggressively pursue and evaluate opportunities to raise capital, there can be no assurance that such efforts will be successful or that the Bank’s plans to achieve the objectives set forth in the Order will successfully improve the Bank’s results of operations or financial condition or result in the termination of the Order from the FDIC and the DFCS. In addition, failure to increase capital levels consistent with the requirements of the Order could result in further enforcement actions by the FDIC and/or DFCS or the placing of the Bank into conservatorship or receivership.
On October 26, 2009, the Company entered into a written agreement with the FRB and DFCS (the “Written Agreement”), which requires the Company to take certain measures to improve its safety and soundness. Under the Written Agreement, the Company is required to develop and submit for approval, a plan to maintain sufficient capital at the Company and the Bank within 60 days of the date of the Written Agreement. The Company submitted a strategic plan on October 28, 2009 and as of December 31, 2009 and through the date of this report, management believes that the Company is in compliance with the terms of the Written Agreement with the exception of requirements tied to or dependent upon execution of a capital raise.
As outlined in the table below, as of December 31, 2009 the Company and the Bank had not complied with terms of the Order and Agreement to bring its capital ratios to the targeted levels.
The Company’s and Bank’s actual and required capital amounts and ratios are presented in the following tables. Note that the Company’s ratios are substantially below those of the Bank because regulatory calculations disallow portions of TPS from inclusion of capital at the Company level, but it is included as Tier 1 capital at the Bank level:
CASCADE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 21. Regulatory matters - (continued) The Company’s actual and required capital amounts and ratios are presented in the following table:
CASCADE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 21. Regulatory matters - (continued) The Bank’s actual and required capital amounts and ratios (exclusive of the 10% Tier 1 leverage ratio required under the Order) are presented in the following table:
CASCADE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 22. Parent company financial information Condensed financial information for Bancorp (Parent company only) is presented as follows:
CONDENSED BALANCE SHEETS
CASCADE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 22. Parent company financial information - (continued) CONDENSED STATEMENTS OF OPERATIONS
CASCADE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(Dollars in thousands, except per share amounts) 22. Parent company financial information - (continued) CONDENSED STATEMENTS OF CASH FLOWS
The consolidated financial statements have not been reviewed or confirmed for accuracy
or relevance by the Federal Deposit Insurance Corporation.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedure
As required by Rule 13a-15 under the Exchange Act of 1934, the Company carried out an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of the end of the period covered by this report. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. This evaluation was carried out under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and the Company’s Chief Financial Officer. Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective as of the end of the period covered by this report.
Changes in Internal Controls
During 2009, the Company had no changes to identified internal controls that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Management’s Report on Internal Control Over Financial Reporting
Management of Cascade Bancorp and its subsidiary, Bank of the Cascades (collectively, “the Company”), is responsible for preparing the Company’s annual consolidated financial statements. Management is also responsible for establishing and maintaining internal control over financial reporting presented in conformity with both accounting principles generally accepted in the United States and regulatory reporting in conformity with the Federal Financial Institutions Examination Council Instructions for Consolidated Reports of Condition and Income (call report instructions). The Company’s internal control contains monitoring mechanisms, and actions are taken to correct deficiencies identified.
There are inherent limitations in the effectiveness of any internal control, including the possibility of human error and the circumvention or overriding of controls. Accordingly, even effective internal control can provide only reasonable assurance with respect to financial statement preparation. Further, because of changes in conditions, the effectiveness of internal control may vary over time.
The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2009. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework. Based on our assessment, we believe that, as of December 31, 2009, the Company’s internal control over financial reporting is effective.
The effectiveness of the Company’s internal control over financial reporting as of December 31, 2009, has been audited by Delap LLP, the independent registered public accounting firm who has also audited the Company’s consolidated financial statements included in this Annual Report on Form 10-K. Delap LLP’s report on the Company’s internal control over financial reporting appears on page 111 of this Annual Report on Form 10-K.
ITEM 9B.
ITEM 9B. OTHER INFORMATION Submission of Matters to a Vote of Security Holders
The Company held a special meeting of shareholders on December 7, 2009. The record date for the meeting was October 26, 2009, at which time there were 28,156,483 shares of common stock outstanding. Holders of 24,737,657 shares (87.9%) were present at the meeting in person or by proxy. At the meeting, shareholders were asked to act upon, and ultimately voted to approve, the following three proposals:
Proposal 1. To approve an amendment to our Articles of Incorporation, as amended, to increase the number of authorized shares of the Company’s Common Stock from 45,000,000 to 300,000,000:
Proposal 2. To approve the issuance of up to $65 million of the Company’s Common Stock to investors in Private Offerings, which will result in such investors owning greater than 20% of the outstanding voting securities of the Company:
Proposal 3. To approve an amendment to our Articles of Incorporation, as amended, to effect a one for ten reverse stock split of our Common Stock and payment of cash for resulting fractional shares:
Although all of the above proposals passed at the special shareholders meeting, as a result of the Company’s unsuccessful efforts to raise capital and the previously announced withdrawal of the registration statement due to market and other conditions, none of the proposals have been implemented as of the date of this report.
REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM To the Board of Directors and
Stockholders of Cascade Bancorp
We have audited the internal control over financial reporting of Cascade Bancorp and its subsidiary, Bank of the Cascades (collectively, “the Company”) as of December 31, 2009, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). 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 of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit the preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on the COSO criteria.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s consolidated balance sheet as of December 31, 2009, and the related consolidated statements of operations, changes in stockholders’ equity, and cash flows for the year then ended, and our report dated March 12, 2010 expressed an unqualified opinion on those consolidated financial statements, and such report included an explanatory paragraph related to the Company’s ability to continue as a going concern.
/s/ Delap LLP
Lake Oswego, Oregon
March 12, 2010
PART III ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE Certain information regarding executive officers is included in the section captioned “Executive Officers of the Registrant” in Part 1, Item 1, elsewhere in this report. Information concerning directors of Bancorp required to be included in this item is set forth under the headings “Election of Directors,” and “Compliance with Section 16(a),” in the Company’s Proxy Statement for its 2010 Annual Meeting of Shareholders to be filed within 120 days of the Company’s fiscal year end of December 31, 2009 (the “Proxy Statement”), and is incorporated into this report by reference and under the heading Business-Executive Officers of the Registry in this report.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION Information concerning executive and director compensation and certain matters regarding participation in the Company’s compensation committee required by this item is set forth under the heading “Compensation Discussion & Analysis” in the Proxy Statement and is incorporated into this report by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCK HOLDER MATTERS Information concerning the security ownership of certain beneficial owners and management required by this item is set forth under the heading “Security Ownership of Management and Others” in the Proxy Statement and is incorporated into this report by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE Information concerning certain relationships and related transactions required by this item is set forth under the heading “Certain Relationships and Related Transactions” and the information concerning director independence is set forth under the heading of “Committees of the Board of Directors” each in the Proxy Statement and incorporated into this report by reference.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES Information concerning fees paid to our independent auditors required by this item is included under the heading “Audit and Non-Audit Fees” in the Proxy Statement and is incorporated into this report by reference.
PART IV ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) The following documents are filed as part of this Annual Report on Form 10-K:
(1) The consolidated financial statements required in this Annual Report are listed in the accompanying Index to Consolidated Financial Statements on page 59.
(2) All consolidated financial statement schedules are omitted because they are not applicable or not required, or because the required information is included in the consolidated financial statements or the notes thereto
(3) Exhibits. Exhibits filed with this Annual Report on Form 10-K or incorporated by reference from other filing are as follows:
Exhibits related to our Trust Preferred Securities have been intentionally omitted. Upon written request, we will provide to you, without charge, a copy of those exhibits. Written requests to obtain a list of exhibits or any exhibit should be sent to Cascade Bancorp, 1100 NW Wall Street, Bend, Oregon 97701, attention: Investor Relations.
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.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.