ITEM 1. BUSINESS
GENERAL
West Coast Bancorp ("Bancorp," "Company," or the "registrant,") an Oregon corporation and a bank holding company, was organized in August of 1981 under the name "Commercial Bancorp." Commercial Bancorp acquired West Coast Bancorp, a one-bank holding company based in Newport, Oregon, on February 28, 1995. The combined corporation retained the name "West Coast Bancorp," and moved its headquarter office to Lake Oswego, Oregon.
Bancorp remains headquartered in Lake Oswego, and its principal business activities are conducted through its full-service, commercial bank subsidiary West Coast Bank ("Bank"), an Oregon State-chartered bank with deposits insured by the Federal Deposit Insurance Corporation ("FDIC"). At December 31, 1998, the Bank had facilities in 31 cities and towns in western Oregon and western Washington, operating a total of 37 full-service and three limited-service branches. Bancorp also operates West Coast Trust Company, Inc., an Oregon trust company that provides agency, fiduciary, and other related trust services. The market value of assets managed for others at December 31, 1998 totaled $260.4 million.
Bancorp's four former commercial bank subsidiaries were merged together under the name West Coast Bank, effective December 31, 1998 (the "Consolidation"). For more information regarding the Consolidation, see below under "Recent Developments."
RECENT DEVELOPMENTS
RESULTS
For the year ended December 31, 1998, the operations of the registrant on a combined basis earned net income of $14.1 million, or $0.96 per diluted share. The combined equity of the registrant at December 31, 1998, was $117.2 million, with 14.2 million common shares outstanding and a book value of $8.23 per share. Net loans of $849.6 million at December 31, 1998, represented approximately 67.67 percent of total assets. Deposits total $1.1 billion at year-end 1998. For more information regarding Bancorp's results, see "Management's Discussion and Analysis of Financial Condition and Results of Operation" and "Financial Statements and Supplementary Data," contained in this report.
THE CONSOLIDATION
During 1998, Bancorp was the parent bank holding company of four wholly owned, full-service commercial Bank subsidiaries: (1) The Bank of Newport, Newport, Oregon, (2) The Commercial Bank, Salem, Oregon, (3) Bank of Vancouver, Vancouver, Washington, and (4) Centennial Bank, Olympia, Washington. On December 31, 1998, The Commercial Bank, Bank of Vancouver, and Centennial Bank were merged into The Bank of Newport, which changed its name to West Coast Bank. Each Bank branch now operates under the name West Coast Bank, although some signage changes are still underway. Each former bank subsidiary operated under the advisement of its own local board of directors. These boards were disbanded upon closing of the Consolidation. The board of directors of the Bank currently consists of the same members as the Bancorp board of directors. In exchange for their agreement not to compete with the Bank, certain members of the former bank boards were appointed as Directors Emeritus of the Bank board to serve until June 30, 1999.
MANAGEMENT DEVELOPMENTS
Lee S. Stenseth, former President and Chief Executive Officer ("CEO") of Bank of Vancouver, retired in May of 1998. Ronald T. DeLude was hired to replace Mr. Stenseth as President and CEO of Bank of Vancouver. As part of the Consolidation, Mr. DeLude was promoted to Chief Operating Officer of Bancorp and the Bank.
Also, as part of the Consolidation: (1) Victor L. Bartruff was appointed President and CEO of the Bank; (2) Timothy P. Dowling, former President and CEO of The Bank of Newport was appointed to Regional Vice-President of the Bank, serving the Bank's Coast/Willamette region, (2) Daniel Yerrington, former President of Centennial Bank, was appointed to Regional Vice-President, serving the Bank's South Puget Sound region, and (3) Edgar B. Martin, former President and CEO of The Commercial Bank, retired in December of 1998.
ACQUISITION OF CENTENNIAL HOLDINGS, LTD. ("CHL")
On February 28, 1998, Bancorp acquired CHL of Olympia, Washington, the parent bank holding company of Centennial Bank, a full-service commercial bank organized in 1974. CHL's principal business activities were conducted through Centennial Bank, which operated eight branches and two real estate offices in southwestern Washington. As part of Bancorp's acquisition of CHL, Centennial Bank became a wholly owned subsidiary of Bancorp. The transaction was accounted for as a pooling of interests
under generally accepted accounting principles. As discussed above, Centennial Bank was consolidated into West Coast Bank on December 31, 1998.
FUTURE EXPANSION STRATEGY
Bancorp remains committed to community banking and intends West Coast Bank to remain community-focused. Bancorp's strategic vision continues to include expansion throughout the west. Bancorp will continue to seek acquisition opportunities with community banks that share its business philosophies. Bancorp also intends to grow through development of new branch locations. Consistent with this strategy, Bancorp opened a new branch in McMinnville, Oregon on January 25, 1999.
SUBSIDIARIES
THE BANK
West Coast Bank was originally organized in 1925 under the name "The Bank of Newport," and its head office is currently located in Lake Oswego, Oregon. The Bank conducts business through 40 branches located in western Oregon and southwestern Washington. The Oregon branches are located in the following cities and towns: Salem--four branches, Keizer--three branches, Newberg--two branches, Newport-two branches, Clackamas, Dallas, Depoe Bay, Forest Grove, Hillsboro, King City, Lake Oswego, Lincoln City, Molalla, Monmouth, North Plains, Portland, Silverton, Stayton, Sublimity, Tigard, Toledo, Waldport, Wilsonville, and Woodburn. The Bank's Washington branches are located in the following cities and towns: Vancouver-two branches, Olympia-two branches, Centralia, Chehalis, Hoodsport, Lacey, and Shelton. At December 31, 1998, the Bank had deposits totaling $1.108 billion and net loans totaling $849.6 million.
The primary business strategy of the Bank is to provide community banking and related services to individuals, professionals, and small to medium-sized businesses. The Bank emphasizes customer relationships, high quality service, and individual attention to customer needs. Small to medium-sized business, the mature market consumer, real estate construction, and commercial customers are a significant focus. The Bank offers deposit accounts, safe-deposit boxes, consumer loans, commercial and residential real estate loans, commercial loans, including operating lines secured by accounts receivable and inventory, and other traditional bank products. The Bank's portfolio has some concentration in real estate-secured loans, construction loans, and agricultural and light manufacturing-related businesses.
Deposit products include regular and interest or package checking accounts, savings accounts, certificates of deposit, and money market accounts. Consumer credit products include residential first and second mortgages, automobile loans, credit cards, lines of credit, and other products. Lending services include short to intermediate-term loans, inventory financing, equipment leasing, revolving lines of credit, and other types of credit. The Bank also offers a VISA credit card program as part of its retail banking services.
The Bank emphasizes the importance of establishing high quality, long-term relationships with customers and seeks to implement new products and services to meet their banking needs and to exceed their banking expectations. For example, the Bank offers (1) trust services through its affiliate West Coast Trust, (2) courier services to our small business customers, (3) a Progressive Banking Program (which uses designated customer deposits exclusively for loans to and short-term investments in small businesses, affordable housing, and community development), (4) 24-hour telephone banking, and (5) ExecuBanc (24-hour access to electronic banking for business customers). Automated teller machines are available in 38 branch and other locations offering 24-hour transaction services, including cash withdrawals, deposits, account transfers, and balance inquiries. The Bank offers electronic banking services through telephone and personal computers. The Bank also offers securities and insurance products through an arrangement with a third party broker/dealer. These products include tax-deferred annuities, single premium whole life insurance, and other insurance investment products and securities products.
Bancorp also operates a commercial real estate loan brokerage division, which originates and brokers commercial real estate loans to other banks, insurance companies pension funds, and other sophisticated investors.
BANK LOCATION
The principal office of the Bank is located at 5335 Meadows Road, Suite 201, Lake Oswego, OR 97035 (503) 684-0884.
WEST COAST TRUST COMPANY
West Coast Trust provides trust services to individuals, partnerships, corporations, and institutions. West Coast Trust acts as fiduciary of estates and conservatorships, and as a trustee under various wills, trust, and pension and profit-sharing plans.
These trust and annuity services are available and offered through a third party broker-dealer with offices at branches of West Coast Bancorp affiliates. The main office of West Coast Trust is located at 301 Church Street, Salem, OR 97301 (503) 399-2993.
TOTTEN, INC.
Totten, Inc. ("Totten"), a Washington corporation, is a subsidiary of Bancorp that serves as trustee under deeds of trust and holds certain real estate licenses. Totten was formerly a subsidiary of CHL and became a wholly owned subsidiary of the Bancorp following Bancorp's acquisition of CHL.
BV CORPORATION
In 1996, Bank of Vancouver incorporated BV Corporation ("BV"), a Washington Corporation, to serve as trustee under deeds of trust. Since BV and Totten served duplicative functions, BV was merged into Totten on December 31, 1998. Totten was the surviving corporation in this merger, and BV no longer exists as a separate entity.
CENTENNIAL FUNDING CORPORATION
In September of 1995, CHL acquired all of the outstanding stock of Centennial Funding Corporation, a Washington corporation and an FHA-approved mortgage lender that makes home loans and residential development loans. Following Bancorp's acquisition of CHL, Centennial Funding Corporation became a wholly owned subsidiary of Bancorp.
ELD, INC.
ELD, Inc, a Washington corporation, is a wholly owned subsidiary of West Coast Bank. ELD, Inc. was incorporated by Centennial Bank in October, 1990 to conduct real estate reconveyances and to hold certain other property classified as other real estate owned. Following the Consolidation, ELD became West Coast Bank's subsidiary.
EMPLOYEES
At December 31, 1998, Bancorp and its subsidiaries had approximately 652 full-time equivalent employees. None of these employees are represented by labor unions. A number of benefit programs are available to eligible employees, including group medical plans, paid sick leave, paid vacation, group life insurance, 401(k) plans, deferred compensation plans, stock option plans, and an optional employee stock purchase plan.
COMPETITION
The Bank competes with other banks, as well as with savings and loan associations, savings banks, credit unions, mortgage companies, investment banks, insurance companies, securities brokerages, and other financial institutions. Banking in Oregon and Washington is dominated by several significant banking institutions, including U.S. Bank, Wells Fargo Bank, Bank of America, and Washington Mutual Savings Bank, which together account for a majority of the total commercial and savings bank deposits in Oregon and Washington. These competitors offer a greater number of branch locations (with statewide branch networks in the case of the two largest competitors), the ability to offer higher lending limits, and a variety of services not offered by the Bank. Bancorp has attempted to offset some of the advantages of the larger competitors by arranging participations with other banks for loans above its legal lending limits. Emphasis is placed on local banking featuring quality service, local responsive decision making, money reinvested into the community, and participation in nationwide services such as VISA, The Exchange, Interlink, Plus, and Accel.
Bancorp anticipates that the level of consolidation among financial institutions in its market area will continue. Other financial institutions, many with substantially greater resources than Bancorp, compete in the acquisition market against Bancorp. Some of these institutions, among other items, have greater access to capital markets, larger cash reserves and a more liquid currency than Bancorp.
Although Bancorp has been able to compete effectively in the financial services business in its markets to date, there can be no assurance that it will be able to continue to do so in the future.
GOVERNMENTAL POLICIES
The earnings and growth of Bancorp, the Bank and Bancorp's other subsidiaries, as well as their existing and future business activities, are affected not only by general economic conditions, but also by the fiscal and monetary policies of the Federal government and its agencies, particularly the Board of Governors of the Federal Reserve System ("FRB"). The FRB
implements national monetary policies (intended to curb inflation and combat recession) by its open-market operations in United States Government securities, by adjusting the required level of reserves for financial institutions subject to its reserve requirements, and by varying the discount rates applicable to borrowings by the banks from the Federal Reserve Bank. The actions of the FRB in these areas influence the growth of bank loans, investments and deposits, and also affect interest rates charged on loans and deposits. As banking is a business which depends largely on interest rate differentials (in general, the difference between the interest rates paid by the Bank on their deposits and their other borrowings and the interest rates received by the Bank on loans extended to their customers and on securities held in the Bank investment portfolios), the influence of economic conditions and monetary policies on interest rates will directly affect earnings. The nature and impact of any future changes in monetary policies cannot be predicted.
SUPERVISION AND REGULATION
GENERAL
INTRODUCTION
Bancorp is extensively regulated under federal and state law. These laws and regulations are primarily intended to protect depositors, not shareholders. The discussion below describes and summarizes certain statutes and regulations. These descriptions and summaries are qualified in their entirety by reference to the particular statute or regulation. Changes in applicable laws or regulations may have a material effect on the business and prospects of Bancorp. The operations of Bancorp may also be affected by changes in the policies of banking and other government regulators. Bancorp cannot accurately predict the nature or extent of the effects on its business and earnings that fiscal or monetary policies, or new federal or state laws, may have in the future.
FEDERAL BANK HOLDING COMPANY REGULATION
General. Bancorp is a bank holding company as defined in the Bank Holding Company Act of 1956, as amended (the "BHCA"), and is therefore subject to regulation, supervision and examination by the FRB. In general, the BHCA limits the business of bank holding companies to owning or controlling banks and engaging in other activities closely related to banking. Bancorp must file reports with the FRB and must provide it with such additional information as it may require.
Holding Company Bank Ownership. The BHCA requires every bank holding company to obtain the prior approval of the FRB before (1) acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after such acquisition, it would own or control more than 5% of such shares, (2) acquiring all or substantially all of the assets of another bank or bank holding company, or (3) merging or consolidating with another bank holding company.
Holding Company Control of Nonbanks. With some exceptions, the BHCA also prohibits a bank holding company from acquiring or retaining direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank or bank holding company, or from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries. The principal exceptions to these prohibitions involve certain non-bank activities which, by statute or by FRB regulation or order, have been identified as activities closely related to the business of banking or of managing or controlling banks. In making this determination, the FRB considers whether the performance of such activities by a bank holding company can be expected to produce benefits to the public, such as greater convenience, increased competition or gains in the efficient use of resources, which can be expected to outweigh the risks of possible adverse effects, such as decreased or unfair competition, conflicts of interest or unsound banking practices. The Economic Growth and Regulatory Reduction Act of 1996 amended the BHCA to eliminate the requirement that a bank holding company seek prior FRB approval before engaging in certain permissible nonbanking activities, if the holding company is well-capitalized and meets certain other specified criteria.
Transactions with Affiliates. Subsidiary banks of a bank holding company are subject to restrictions imposed by the Federal Reserve Act on extensions of credit to the holding company or its subsidiaries, on investments in their securities and on the use of their securities as collateral for loans to any borrower. These regulations and restrictions may limit Bancorp's ability to obtain funds from the Bank for its cash needs, including, funds for payment of dividends, interest and operational expenses.
Tying Arrangements. Bancorp and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, sale or lease of property or furnishing of services. For example, with certain exceptions, neither Bancorp nor its subsidiaries may condition an extension of credit to a customer on either (1) a requirement that the customer obtain additional services provided by it or (2) an agreement by the customer to refrain from obtaining other services from a competitor. Effective April 21, 1997, the FRB also adopted significant amendments to its anti-tying rules that: (1) remove FRB-imposed anti-tying restrictions on bank holding companies and their non-bank subsidiaries; (2) allow banks greater flexibility
to package products with their affiliates; and (3) establish a safe harbor from the tying restrictions for certain foreign transactions. These amendments are designed to enhance competition in banking and nonbanking products and allow banks and their affiliates to provide more efficient, lower cost service to their customers.
Support of Subsidiary Banks. Under FRB policy, a bank holding company is expected to act as a source of financial and managerial strength to, and commit resources to support, each of its subsidiary banks. Any capital loans a bank holding company makes to its subsidiary banks are subordinate to deposits and to certain other indebtedness of those subsidiary banks. The Crime Control Act of 1990 provides that, in the event of a bank holding company's bankruptcy, the bankruptcy trustee will assume any commitment the bank holding company has made to a federal bank regulatory agency to maintain the capital of a subsidiary bank and this obligation will be entitled to a priority of payment.
State Law Restrictions. As an Oregon corporation, Bancorp is subject to certain limitations and restrictions under applicable Oregon corporate law. For example, state law restrictions in Oregon include limitations and restrictions relating to: indemnification of directors, distributions to shareholders, transactions involving directors, officers or interested shareholders, maintenance of books, records, and minutes, and observance of certain corporate formalities.
CONTROL TRANSACTIONS
The Change in Bank Control Act of 1978, as amended, prohibits a person or group of persons from acquiring "control" of a bank holding company unless the FRB has been given 60 days' prior written notice of the proposed acquisition, and within that time period, the FRB has not issued a notice disapproving the proposed acquisition or extending for up to another 30 days the period during which such a disapproval may be issued. An acquisition may be made before the expiration of the disapproval period if the FRB issues written notice of its intent not to disapprove the action. Under a rebuttable presumption established by the FRB, the acquisition of 10% or more of a class of voting stock of a bank holding company with a class of securities registered under Section 12 of the Exchange Act would, under the circumstances set forth in the presumption, constitute the acquisition of control.
In addition, any company would be required to obtain the approval of the FRB under the BHCA before acquiring 25% (5% if the company is a bank holding company) or more of the outstanding shares of Bancorp or to otherwise obtain control over the Bancorp.
FEDERAL AND STATE REGULATION OF THE BANK
General. The Bank is an Oregon commercial bank with deposits insured by the FDIC and is subject to the supervision and regulation of the Oregon Department of Consumer and Business Services, the Washington Department of Financial Institutions, and the FDIC. These agencies have the authority to prohibit banks from engaging in what they believe constitute unsafe or unsound banking practices.
CRA. The Community Reinvestment Act ("CRA") requires that, in connection with examinations of financial institutions within their jurisdiction, the FRB or the FDIC evaluate the record of the financial institution in meeting the credit needs of its local communities, including low and moderate income neighborhoods, consistent with the safe and sound operation of the institution. These factors are also considered in evaluating mergers, acquisitions and applications to open a branch or facility.
Insider Credit Transactions. Banks are also subject to certain restrictions imposed by the Federal Reserve Act on extensions of credit to executive officers, directors, principal shareholders or any related interests of such persons. Extensions of credit (1) must be made on substantially the same terms, including interest rates and collateral as, and follow credit underwriting procedures that are not less stringent than, those prevailing at the time for comparable transactions with persons not covered above and who are not employees, and (2) must not involve more than the normal risk of repayment or present other unfavorable features. Banks are also subject to certain lending limits and restrictions on overdrafts to such persons. A violation of these restrictions may result in the assessment of substantial civil monetary penalties on the affected bank or any officer, director, employee, agent or other person participating in the conduct of the affairs of that bank, the imposition of a cease and desist order, and other regulatory sanctions.
Regulation of Management. Federal law (1) sets forth circumstances under which officers or directors of a bank may be removed by the institution's federal supervisory agency; (2) places restraints on lending by a bank to its executive officers, directors, principal shareholders, and their related interests; and (3) prohibits management personnel of a bank from serving as a director or in other management positions of another financial institution whose assets exceed a specified amount or which has an office within a specified geographic area.
FDICIA. Under the Federal Deposit Insurance Corporation Improvement Act ("FDICIA"), each federal banking agency has prescribed, by regulation, non-capital safety and soundness standards for institutions under its authority. These standards cover internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, such other operational and managerial standards as the agency determines to be appropriate, and standards for asset quality, earnings and stock valuation. An institution which fails to meet these standards must develop a plan acceptable to the agency, specifying the steps that the institution will take to meet the standards. Failure to submit or implement such a plan may subject the institution to regulatory sanctions. Management believes that the Bank meets all such standards.
INTERSTATE BANKING AND BRANCHING
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 ("Interstate Act") permits nationwide interstate banking and branching under certain circumstances. This legislation generally authorizes interstate branching and relaxes federal law restrictions on interstate banking. Currently, bank holding companies may purchase banks in any state, and states may not prohibit these purchases. Additionally, banks are permitted to merge with banks in other states, as long as the home state of neither merging bank has opted out under the legislation. The Interstate Act requires regulators to consult with community organizations before permitting an interstate institution to close a branch in a low-income area.
Under recent FDIC regulations, banks are prohibited from using their interstate branches primarily for deposit production. The FDIC has accordingly implemented a loan-to-deposit ratio screen to ensure compliance with this prohibition.
Oregon and Washington each enacted "opting in" legislation in accordance with the Interstate Act provisions allowing banks to engage in interstate merger transactions, subject to certain "aging" requirements. Both states restrict an out-of-state bank from opening de novo branches. However, once an out-of-state bank has acquired a bank within the state, either through merger or acquisition of all or substantially all of the bank's assets, the out-of-state bank may open additional branches within the state.
DEPOSIT INSURANCE
The deposits of The Bank are currently insured to a maximum of $100,000 per depositor through the Bank Insurance Fund ("BIF") administered by the FDIC. The Bank is required to pay semiannual deposit insurance premium assessments to the FDIC.
FDICIA included provisions to reform the Federal deposit insurance system, including the implementation of risk-based deposit insurance premiums. FDICIA also permits the FDIC to make special assessments on insured depository institutions in amounts determined by the FDIC to be necessary to give it adequate assessment income to repay amounts borrowed from the U.S. Treasury and other sources or for any other purpose the FDIC deems necessary. The FDIC has implemented a risk-based insurance premium system under which banks are assessed insurance premiums based on how much risk they present to the BIF. Banks with higher levels of capital and a low degree of supervisory concern are assessed lower premiums than banks with lower levels of capital or a higher degree of supervisory concern.
DIVIDENDS
The principal source of Bancorp's cash reserves are dividends received from the Bank. The payment of dividends is subject to government regulation, in that regulatory authorities may prohibit banks and bank holding companies from paying dividends in a manner that would constitute an unsafe or unsound banking practice. In addition, a bank may not pay cash dividends if doing so would reduce the amount of its capital below that necessary to meet minimum applicable regulatory capital requirements. Oregon Laws also limit a bank's ability to pay dividends. Under these restrictions, as of December 31, 1998, the Bank could have declared dividends of approximately $24 million in the aggregate, without obtaining prior regulatory approval.
CAPITAL ADEQUACY
Federal bank regulatory agencies use capital adequacy guidelines in the examination and regulation of bank holding companies and banks. If capital falls below minimum guideline levels, the holding company or bank may be denied approval to acquire or establish additional banks or nonbank businesses or to open new facilities.
The FDIC and FRB use risk-based capital guidelines for banks and bank holding companies. These are designed to make such capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance sheet exposure and to minimize disincentives for holding liquid assets. Assets and off-balance sheet items are assigned to broad risk categories, each with appropriate weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items. The guidelines are minimums, and the FRB has noted that bank holding companies contemplating significant expansion programs should not allow expansion to diminish their capital ratios and should maintain ratios well in excess of the minimum. The current guidelines require all bank holding companies and federally-regulated banks to maintain a minimum risk-based total capital ratio equal to 8%, of which at least 4% must be Tier I capital. Tier I capital for bank holding companies includes common shareholders' equity, certain qualifying perpetual preferred stock and minority interests in equity accounts of consolidated subsidiaries, less intangibles.
The FRB also employs a leverage ratio, which is Tier I capital as a percentage of total assets less intangibles, to be used as a supplement to risk-based guidelines. The principal objective of the leverage ratio is to constrain the maximum degree to which a bank holding company may leverage its equity capital base. The FRB requires a minimum leverage ratio of 3%. However, for all but the most highly rated bank holding companies and for bank holding companies seeking to expand, the FRB expects an additional cushion of at least 1% to 2%.
FDICIA created a statutory framework of supervisory actions indexed to the capital level of the individual institution. Under regulations adopted by the FDIC, an institution is assigned to one of five capital categories depending on its total risk-based capital ratio, Tier I risk-based capital ratio, and leverage ratio, together with certain subjective factors. Institutions which are deemed to be "undercapitalized," depending on the category to which they are assigned, are subject to certain mandatory supervisory corrective actions.
EFFECTS OF GOVERNMENT MONETARY POLICY
The earnings and growth of Bancorp are affected not only by general economic conditions, but also by the fiscal and monetary policies of the federal government, particularly the FRB. The FRB can and does implement national monetary policy for such purposes as curbing inflation and combating recession, but its open market operations in U.S. government securities, control of the discount rate applicable to borrowings from the FRB, and establishment of reserve requirements against certain deposits, influence the growth of bank loans, investments and deposits, and also affect interest rates charged on loans or paid on deposits. The nature and impact of future changes in monetary policies and their impact on Bancorp cannot be predicted with certainty.
CHANGES IN BANKING LAWS AND REGULATIONS
The laws and regulations that affect banks and bank holding companies are currently undergoing significant changes. This year, legislation was proposed in Congress which contained proposals to alter the structure, regulation, and competitive relationships of the nation's financial institutions. Although the legislation was not passed in the 1998 general session of Congress, similar legislation may be proposed in the coming years and, if enacted into law, such bills could have the effect of increasing or decreasing the cost of doing business, limiting or expanding permissible activities (including activities in the insurance and securities fields), or affecting the competitive balance among banks, savings associations, and other financial institutions. Some of these bills may reduce the extent of federal deposit insurance, broaden the powers or the geographical range of operations of bank holding companies, alter the extent to which banks could engage in securities activities, and change the structure and jurisdiction of various financial institution regulatory agencies. Whether or in what form such legislation may be adopted, or the extent to which the business of Bancorp might be affected thereby, cannot be predicted with certainty.
ITEM 2.
ITEM 2. PROPERTIES
The principal properties of the registrant are comprised of the banking facilities owned by the Bank. The Bank owns a total of 24 buildings hosting its branch offices and owns the land under 21 of those buildings. Some significant properties owned by the Bank are as follows:
(1) Land, administrative offices and drive-up teller facilities in Salem, Oregon with approximately 40,000 square feet of space;
(2) A building with approximately 8,000 square feet of space and the land under it in Salem, Oregon, containing administrative offices for the Bank's human resources, security, and risk management and compliance personnel;
(3) Land and the building housing a branch and administrative offices in Newport, Oregon, consisting of approximately 15,640 square feet of space;
(4) A building in Vancouver, Washington that is leased to another party under a ground lease at a monthly rental of $6,771;
(5) A building and the land under it in Lacey, Washington that is home to the Bank's Lacey branch and contains some administrative offices in approximately 12,000 square feet of space; and
(6) A building and land in Shelton, Washington with approximately 7,500 square feet that contains data processing and communications equipment.
The Bank leases office space in Lake Oswego, Oregon, for its headquarter offices. The Bank also leases a building and land in Salem, Oregon, where the Bank's data center is located. In addition, the Bank leases space at approximately 19 other locations for branch and other offices. The aggregate monthly rental on all properties leased by Bancorp and the Bank is approximately $101,500.
West Coast Trust's main office is in Salem where it leases space from the Bank. West Coast Trust also has offices in Portland, Oregon, Newport, Oregon, Vancouver, Washington, and Olympia, Washington where it leases space from the Bank.
ELD, Inc. holds a one-third partnership interest in a building and land in Sequim, Washington. This interest was acquired before Bancorp purchased ELD's former parent Centennial Bank. Bancorp is currently seeking to divest of its interest in this property.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company received a letter in March of 1999 asserting a potential claim with respect to an alleged loan commitment. No lawsuit related to the matter has yet been filed against the Bank. Counsel for the Bank has advised us that if this matter is eventually litigated, it is unlikely that any liability, if any, imposed on the Bank would exceed the Bank's applicable insurance coverage limits. Management is currently in contact with its insurance carrier to confirm coverage, and management does not consider this asserted claim material at this time.
This section contains certain "forward looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 ("PSLRA"). This statement is included for the express purpose of availing Bancorp of the protections of the safe harbor provisions of the PSLRA. The forward looking statements contained in this section are subject to factors, risks, and uncertainties that may cause actual results to differ materially from those projected. Important factors that might cause such a material difference include, but are not limited to, (1) facts and events currently unknown to management that may surface as the subject matters discussed are further investigated, (2) common law, rights, and legal and equitable remedies that may be uncovered when the issues raised above are further researched, and (3) uncertainties inherent in the legal process. Readers are cautioned not to place undue reliance on these forward looking statements, which reflect Management's analysis only as of the date of the statement. Bancorp undertakes no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances that arise after the date of this report. Readers should carefully review the risk factors described in this and other documents Bancorp files from time to time with the Securities and Exchange Commission.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
NONE.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
STOCK PRICE AND DIVIDENDS
West Coast Bancorp common stock trades on The Nasdaq Stock Market under the symbol "WCBO" and its primary market makers are: Black & Company; Dain Rauscher, Inc.; Herzog, Heine, Geduld, Inc.; Hoefer & Arnett, Inc.; Keefe, Bruyette & Woods, Inc.; Pacific Crest Securities; Piper Jaffray Companies, Inc., and Spear, Leeds & Kellogg. The respective high and low sale prices of West Coast Bancorp's common stock for the periods indicated are shown below. The prices below do not include retail mark-ups, mark-downs or commissions, and may not represent actual transactions. The per share information has been adjusted retroactively for all stock dividends and splits previously issued. As of December 31, 1998, there were approximately 4,800 shareholders of record of Bancorp common stock.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data should be read in conjunction with West Coast Bancorp's (Bancorp or the Company) consolidated financial statements and the accompanying notes presented in this report. The per share information has been adjusted retroactively for all stock dividends and splits previously issued.
(1) Interest earned in nontaxable securities has been computed on a 34% tax equivalent basis.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
FORWARD LOOKING STATEMENT DISCLOSURE
In addition to historical information, this annual report contains certain "forward looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 (PSLRA) This statement is included for the express purpose of availing Bancorp of the protections of the safe harbor provisions of the PSLRA. The forward looking statements contained in this report are subject to factors, risks, and uncertainties that may cause actual results to differ materially from those projected. Important factors that might cause such a material difference include, but are not limited to, those discussed in this section of the report. In addition, the following items are among the factors that could cause actual results to differ materially from the forward looking statements in this report: general economic conditions, including their impact on capital expenditures; business conditions in the banking industry; the regulatory environment; new legislation; rapidly changing technology and evolving banking industry standards; competitive standards; competitive factors, including increased competition with community, regional, and national financial institutions; fluctuating interest rate environments; and similar matters. Readers are cautioned not to place undue reliance on these forward looking statements, which reflect Management's analysis only as of the date of the statement. Bancorp undertakes no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances that arise after the date of this report. Readers should carefully review the risk factors described in this and other documents Bancorp files from time to time with the Securities and Exchange Commission.
RESULTS OF OPERATIONS
Years Ended December 31, 1998, 1997 and 1996.
OVERVIEW. In both 1998 and 1996, Bancorp completed an acquisition transaction that extended its market into Washington and increased its market positioning. Bancorp's assets increased nearly 150 percent in the past three years from $517 million, (before these pooling transactions) at December 31, 1995, to $1.255 billion in assets at December 31, 1998. This rapid growth is attributable in nearly equal parts to these acquisitions and the Company's strong internal growth. During the past three years, net income has been impacted by certain nonrecurring costs associated with these acquisition transactions. In addition, in 1998, Bancorp began the process of consolidating its four banking companies into a single entity called West Coast Bank. The Company's 1998 financial results have been impacted by the related nonrecurring restructuring costs.
Bancorp's net income for 1998 was $14.1 million, compared with $14.4 million in 1997 and $11.7 million in 1996. The Company's net income during 1998 was reduced by $1.1 million for charges associated with its acquisition of Centennial Holdings, Ltd. (CHL), WA. These charges were for conversion costs of $569,000 (pretax), and an increase in the provision for loan losses of $1.0 million (pretax) to bring the CHL's allowance for loan loss methodology in line with Bancorp practices. In addition, nonrecurring restructuring charges of $2.4 million ($3.8 million pretax) were incurred in 1998. The 1997 results were favorably impacted by a $1.095 million gain on sale of servicing rights offset by merger expenditures of $905,000. Net income in 1996 was impacted by $280,000 in merger-related expenditures from the acquisition of Vancouver Bancorp, WA.
Bancorp's diluted earnings per share for the three years ended 1998 were $0.96, $1.01, and $0.85.
Net interest income on a tax equivalent basis totaled $62.7 million for the year ended December 31, 1998, a 7.92% increase over $58.1 million for the same period in 1997, which was a 15.37% increase over 1996. Growth of noninterest income was due to increased customer bases and transaction volumes. Noninterest expenses increased primarily due to bank branch expansion, merger-related expenditures and reorganization and consolidation costs.
NET INTEREST INCOME. During the years ended December 31, 1998, 1997 and 1996, average interest earning assets grew to $1.082 billion, from $931.6 million and $769.9 million, respectively. For the same periods, average interest bearing liabilities were $875.4 million, $758.6 million and $630.3 million, respectively. The percentage of interest earning assets to interest bearing liabilities increased to 123.61% in 1998 from 122.8% in 1997 and 122.16% in 1996. During the same periods Bancorp's net interest margins were 5.79%, 6.23% and 6.54%, respectively; the decreases in Bancorp's net interest margin and related yields or spreads are due mainly to a changing interest rate environment, increased pricing competition, a shift in some of its asset mix, and an increase of long-term funding sources. Given these factors, Bancorp expects there to be continued pressure on its net interest margins and spreads. Net interest income on a tax-equivalent basis increased $4.6 million, or 7.92%, to $62.7 million in 1998 from $58.1 million in 1997 and $50.3 million in 1996. The increased net interest income was caused mainly by earning assets growth. Average interest earning assets increased 16.15% in 1998 from 1997 and 20.99% in 1997 over 1996.
Bancorp experienced a decrease in the net interest spread of 45 basis points in 1998 to 5.00% from 5.45% in 1997 which was down 32 basis points from 5.77% in 1996. The average yield earned on interest earning assets was 9.16% in 1998, 9.70% in 1997 and 9.99% in 1996. Average interest bearing liabilities increased $116.8 million, or 15.39%, to $875.4 million for the period ended December 31, 1998, from $758.6 million in 1997 and $630.3 million in 1996, while the average rates paid were 4.16%, 4.25%, and 4.22%, respectively. Bancorp's loan portfolio experienced growth in 1998 ending the year at $862.1 million, up $85.2 million from $776.9 million at December 31, 1997. Bancorp's deposit base grew to $1.108 billion at December 31, 1998, up $149.5 million or 15.6% from $958.5 million at the end of 1997. Bancorp also had a shift in its asset mix from the loan portfolio to investment securities during 1998; in general, Bancorp's investment securities have shorter maturities and yield lower interest rate returns than those associated with the loan portfolio.
ANALYSIS OF NET INTEREST INCOME. The following table presents information regarding yields on interest-earning assets, expense on interest-bearing liabilities, and net yields on interest-earning assets for the periods indicated on a tax equivalent basis:
(1) Interest earned on nontaxable securities has been computed on a 34% tax equivalent basis.
Average Balances and Average Rates Earned and Paid. The following table sets forth, for the periods indicated, information with regard to (1) average balances of assets and liabilities, (2) the total dollar amounts of interest income on interest earning assets and interest expense on interest bearing liabilities, (3) resulting yields or costs, (4) net interest income, and (5) net interest spread. Nonaccrual loans have been included in the tables as loans carrying a zero yield. Loan fees are recognized as income using the interest method over the life of the loan.
(1) Yield/rate calculations have been based on more detailed information than presented and therefore may not recompute exactly due to rounding.
(2) Interest earned on nontaxable securities has been computed on a 34 percent tax equivalent basis.
(3) Includes balances for loans held for sale.
Analysis of Change in Interest Differential. The following table sets forth the amounts of the changes in consolidated net interest income attributable to changes in volume and to changes in interest rates. Changes not due solely to volume or rate are allocated to rate and changes due to new product lines are allocated to volume.
(1) Tax-exempt income has been adjusted to a tax-equivalent basis at a 34 percent rate.
PROVISION FOR LOAN LOSSES. Bancorp recorded provisions for loan losses of $2,900,415, $3,936,000 and $2,570,987 for the years ended December 31, 1998, 1997 and 1996 respectively. Bancorp's provision was impacted during 1998 by a $1.0 million provision related to the CHL acquisition to bring the allowance for loan loss methodology in-line with Bancorp practices. During 1997 the provision was impacted by subsequent portfolio activity related to an acquisition previously made by CHL. CHL increased its provision in 1997 by $675,000, directly related to the loans acquired and recorded net charge-offs in 1997 including those related to the acquired loans of $1.3 million. The 1997 CHL net charge-offs were substantially higher than those experienced in 1996 of $487,000, prior to this acquisition. In total, Bancorp incurred net charge-offs of $898,000, $1,976,000, and $1,194,000, in 1998, 1997 and 1996 respectively. The allowance for loan loss as a percentage of loan totals at December 31, 1998 and 1997 was 1.44% and 1.35% of total loans, respectively and Bancorp's allowance for loan losses represented 217.41% of its non-performing assets as of December 31, 1998, compared to 218.50% at December 31, 1997.
NONINTEREST INCOME. Noninterest income for the year ended December 31, 1998 was $19 million up from $14.1 million in 1997 and $9.9 million in 1996. In 1998, gains on sales of loans increased $4 million to $6,362,308 from $2,383,000 in 1997, which was an increase from $1,220,769 reported in 1996. In 1998, Bancorp benefited from the low interest rate environment that increased significantly the refinance activity on loans sold into the secondary market. Service charges on deposit accounts, other service charges, commissions and fees, and trust revenues increased over the last three years, due to an increased customer base and transaction volumes serviced. Loan servicing fees have declined in recent years as the Bank has chosen not to add to this portfolio, but rather recognize added revenue on the initial sale of the loans. Other noninterest income fluctuated over the three year period with some non-recurring activity, and the growth of the company. During 1997 and 1996, Bancorp recognized gains on the sale of servicing rights of $1,659,420 and $269,107, respectively. During 1998 no such sale of servicing rights occurred. Net securities gains were $347,797 in 1998, with net losses in 1997 of $85,446 and net gains of $8,555 in 1996. Overall increases in noninterest income were due to increased market presence in existing and expanding markets.
NONINTEREST EXPENSE. Noninterest expenses have increased during the last three years to $56.1 million in 1998 from $45.4 million in 1997 and $38.9 million in 1996. Increases in salaries, equipment, occupancy, communications, marketing, printing and office supplies, and other noninterest expenses have been caused mainly by Bancorp's expansion of its branch system and services and the costs associated with entering new markets. Bancorp's branch system grew to 40 office locations at the end of 1998 from 34 at the end of 1995. Bancorp intends to continue to grow through strategically placed offices in 1999 and beyond. In general, the opening of new branches results in higher costs for Bancorp, which are not offset until a certain level of growth in deposits and loans is achieved. Thus, at least initially, new branches tend to have an adverse effect on results of operations, until earnings grow to cover overhead. Bancorp opened one new branch during 1998 and substantially completed the work on a second branch, which opened in January, 1999. At the end of 1998, Bancorp employed 652 full-time equivalent employees, compared to 645 in 1997 and 611 in 1996. Other increases in noninterest expense generally were caused by higher operating
activity levels associated with Bancorp's internal growth. During 1998, Bancorp expensed $3.8 million related to the consolidation of its four separate commercial banks into one bank, see restructuring charge disclosure that follows. Readers are referred to management's "Forward Looking Statements Disclosure" in connection with this section.
RESTRUCTURING CHARGES
The 1998 results have been impacted by one-time costs resulting from the consolidation of the company's affiliate banks into one entity, called West Coast Bank. The consolidation was completed on December 31, 1998, and new signs on the branch facilities are being installed in the first two months of 1999. Bancorp anticipates incurring approximately $5 million in aggregate costs for the consolidation, including costs related to a severance plan, signage, data conversions, marketing, regulatory and administrative costs. As of December 31, 1998, the company has expended $3.8 million related to the consolidation efforts and anticipates the remaining costs to be expensed as incurred in the first two quarters of 1999. Approximately 50% of the costs incurred to date are employee program and severance related, which were accrued for in the third quarter of 1998. The accruals are being charged as payments are made. As part of the restructure, the company has invested in new network computer systems and has therefore recorded a write-down during the fourth quarter of approximately $1.1 million related to the replaced equipment no longer in use. In addition, the company prepaid $20 million of its existing long-term debt that was required to meet certain liquidity requirements under its previous structure, but is not needed under the current single banking organization. The prepayment penalty of approximately $517,000 was incurred in the fourth quarter as part of the restructure charges.
Bancorp accrued $1.92 million in restructuring charges to cover anticipated costs of $1.73 million for the severance program and personnel related expenditures, with the remaining $188,000 for marketing and professional fees related to the restructuring. These amounts were incurred but not paid at the time the accrual was made. During 1998, $13,000 of the severance related program costs and $145,000 of the marketing and professional fees have been paid and charged against the accrual. As of December 31, 1998, Bancorp has an accrual for the restructuring charges of $1.76 million, of which $1.73 million is for severance and employee related costs and the remaining amount is for unpaid professional fees for work incurred.
The company expects that the consolidation will save approximately $6 million annually, related to reductions in overhead. The cost savings will come from reductions in staff and related overhead, a simplified corporate structure, a reduced regulatory burden, and pricing and other synergies created by unified marketing efforts and name branding. As of year-end 1998, the company is on track with its plan and approximately 25% of the anticipated 100 staff related reductions have occurred. Plans are in place to continue to reduce staff levels to reach the desired goals. Certain of the companies operations are being consolidated into centralized locations during 1999 and additional staffing reductions will be realized following these changes. The company estimates that it has in place approximately 25% of the cost savings anticipated from the plan. The plan calls for two-thirds of the cost savings to be substantially achieved by the third quarter of 1999, with the remaining savings to be achieved early in the year 2000.
Bancorp's liquidity has not been materially affected by cash outlays related to one-time restructuring charges. Bancorp does not anticipate that future restructuring charges will have a material effect on Bancorp's liquidity. Readers are referred to management's "Forward Looking Statements Disclosure" in connection with this section.
INCOME TAXES
Income tax expense for 1998 was $6,724,375 or 32 percent of income before income taxes, 1997 was $7,183,673 or 33 percent of income before income taxes and 1996 was $5,803,407 or 33 percent of income before income taxes. Income tax expense has fluctuated over time due to state income tax credits and capitalization of certain merger related expenditures for income tax purposes, as well as changes in the income before income taxes of the company. It is anticipated that Bancorp's tax expense will increase in future years, both due to increased income before income taxes and a smaller percentage of Bancorp's income being generated from tax exempt items. Any future merger-related capitalized costs may also increase Bancorp's tax provisions. Readers are referred to management's "Forward Looking Statements Disclosure" in connection with this section.
LENDING AND CREDIT MANAGEMENT
Interest earned on the loan portfolio is the primary source of income for Bancorp. Net loans represented 67.67% of total assets as of December 31, 1998.
Although the Bank strives to serve the credit needs of the service areas, the primary focus is on real estate related and commercial credits. The Bank makes substantially all its loans to customers located within its service areas. The Bank has no loans defined as highly leveraged transactions by the FRB.
Although a risk of nonpayment exists with respect to all loans, certain specific types of risks are associated with different types of loans. Owing to the nature of the Bank's customer base and the growth experienced in the market areas served, real estate is frequently a material component of collateral for the Bank's loans. The expected source of repayment of these loans is generally the cash flow of the project, operations of the borrower's business or personal income. Risks associated with real estate loans include fluctuating land values, local economic conditions, changes in tax policies, and a concentration of loans within any one area.
The Bank manages the general risks inherent in the loan portfolio by following loan policies and underwriting practices designed to result in prudent lending activities.
The maturity distribution of selected categories of Bancorp's loan portfolio at December 31, 1998, and the interest sensitivity are estimated in the following table.
(1) Some loans contain provisions which place maximum or minimum limits on interest rate charges.
The following table presents information with respect to nonperforming assets.
Interest income on loans is accrued daily on the principal balance outstanding. Generally, no interest is accrued on loans when factors indicate collection of interest is doubtful or when the principal or interest payment becomes 90 days past due. Increases in nonaccrual loans in recent years are due substantially from growth in Bancorp's loan portfolio. The nonaccrual loans consist of a number of loans in different categories and are largely secured. For such loans previously accrued but uncollected interest is charged against current earnings, and income is only recognized to the extent payments are subsequently received. Interest income foregone on nonaccrual loans was approximately $434,000 at December 31, 1998.
At December 31, 1998, there was no concentration of loans exceeding 10 percent of the total loans to a multiple number of borrowers engaged in a similar business. At December 31, 1998 and 1997 Bancorp had $4,628,000 and $0 of bankers acceptances, respectively.
As of December 31, 1998, the Band had loans to persons serving as directors, officers, principal shareholders and their related interests. These loans were made substantially on the same terms, including interest rates, maturities and collateral as those made to other customers of the Banks.
(1) Included in new loans and advances and principal payments and payoffs is $7.1 million of consolidated and refinanced loans.
LOAN LOSS ALLOWANCE AND PROVISION
Bancorp maintains a loan loss allowance to absorb losses inherent in the loan portfolio. The allowance is based on ongoing, quarterly assessments of the probable estimated losses inherent in the loan portfolio, and to a lesser extent, unused commitments to provide financing. Our methodology for assessing the appropriateness of the allowance consists of several key elements, which include:
-- The formula allowance
-- Specific allowances for identified problem loans and portfolio segments and
-- The unallocated allowance.
Bancorp's allowance incorporates the results of measuring impaired loans as provided in: - Statement of financial Accounting Standards ("SFAS") No. 114, "Accounting by Creditors for Impairment of a Loan," and - SFAS No 118, "Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures." These accounting standards prescribe the measurement methods, income recognition and disclosures concerning impaired loans.
The formula allowance is calculated by applying loss factors to outstanding loans and certain unused commitments, in each case based on the internal risk grade of those loans, pools of loans, or commitments. Changes in risk grades of both performing and nonperforming loans affect the amount of the formula allowance. Loss factors are based on our historical loss experience and other such pertinent data and may be adjusted for significant factors that, in management's judgement, affect the collectibility of the portfolio as of the evaluation date. Loss factors are described as follows:
-- Problem graded loan loss factors are obtained from four years of historical loss experience. Bancorp is exploring the utilization of a migration model to track historical loss experience.
-- Pooled loan loss factors, not individually graded loans, are based on expected net charge-offs for one year. Pooled loans are loans and leases that are homogeneous in nature, such as consumer installment and residential mortgage loans.
Specific allowances are established where management has identified significant conditions or circumstances related to a credit that management believes indicate the probability that a loss may be incurred in excess of the amount determined by the application of the formula allowance.
The unallocated allowance uses a more subjective method and considers such factors as the following:
-- Existing general economic and business conditions affecting our key lending areas, -- Credit quality trends, including trends in nonperforming loans expected to result from existing conditions, -- Collateral values, -- Loan volumes and concentrations, -- Seasoning of the loan portfolio, -- Specific industry conditions within portfolio segments, -- Recent loss experience in particular segments of the portfolio, -- Duration of the current business cycle, -- Bank regulatory examination results and -- Findings of our internal credit examiners.
Executive credit management reviews these conditions quarterly in discussion with our senior credit officers. If any of these conditions is evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management's estimate of the effect of this condition may be reflected as a specific allowance applicable to this credit or portfolio segment. Where any of these conditions is not evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management's evaluation of the probable loss concerning this condition is reflected in the unallocated allowance.
The allowance for credit losses is based upon estimates of probable losses inherent in the loan portfolio. The amount actually observed for these losses can vary significantly from the estimated amounts. Our methodology includes several features that are intended to reduce the differences between estimated and actual losses. By assessing the probable estimated losses inherent in the loan portfolio on a quarterly basis, we are able to adjust specific and inherent loss estimates based upon any more recent information that has become available.
Recently acquired loan portfolios are reviewed and an overall assessment is made using Bancorp's methodology as to the adequacy of the loan portfolios and any necessary adjustments to the allowance are made as they are identified. A detailed review of the acquired loan portfolio follows and Bancorp's loan grading system is then applied to the portfolio, any further adjustments to the allowance are recorded in the period they are identified.
At December 31, 1998, our allowance for loan loss was $12.4 million, or 1.44 percent of total loans, and 217.41 percent of total nonperforming assets, compared with an allowance for credit losses at December 31, 1997 or $10.5 million, or 1.35 percent of total loans, and 218.50 percent of total nonperforming assets.
Bancorp, during its normal loan review procedures considers a loan to be impaired when it is probable that Bancorp will be unable to collect all amounts due according to the contractual terms of the loan agreement. A loan is not considered to be impaired during a period of minimal delay (less than 90 days). Bancorp measures impaired loans 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. Loans that are currently measured at fair value or at lower of cost or fair value, leases and certain large groups of smaller balance homogeneous loans that are 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.
At December 31, 1998 and 1997, Bancorp's recorded investment in certain loans that were considered to be impaired were $4,423,000 and $4,091,000, respectively, all of which was classified as non-performing. Of these impaired loans, $555,000 and $702,000 had a related valuation allowance of $150,000 and $352,000, respectively, while $3,868,000 and $3,389,000 did not require a valuation allowance. The balance of the allowance for loan loss in excess of these specific reserves is available to absorb losses from all loans. The average recorded investment in certain impaired loans for the years ended December 31, 1998 and 1997 was approximately, $3,633,000 and $1,207,000, respectively. For the years ended December 31, 1998 and 1997, interest income recognized on impaired loans totaled $384,000 and $161,000, respectively, all of which was recognized on a cash basis.
During the first quarter of 1998 Bancorp recorded a $1.0 million provision related to the CHL acquisition to bring the allowance for loan loss methodology in-line with Bancorp practices.
At December 31, 1998, our allowance for credit losses was $12.4 million, consisting of a $11.3 million formula allowance, a $117,000 specific allowance and a $1.0 million unallocated allowance.
During 1998, net loans charged off were $898,000, compared to $1,976,000 during 1997. During 1997, charge-offs were impacted by subsequent portfolio activity related to an acquisition by CHL. CHL increased its provision in 1997 by $675,000, directly related to the loans acquired and recorded net charge-offs in 1997 including those related to the acquired loans of $1.3 million.
The percentage of net loans charged off to average loans outstanding was 0.11 percent at December 31, 1998 which was down from 0.26 percent and 0.19 percent for the years ended December 31, 1997 and 1996, respectively. Charges of loans reflect the realization of losses in the portfolio that were recognized previously through provisions for credit losses.
At December 31, 1998, the provision for loans loss exceeded the net loans charged off during the year, reflecting management's belief, based on the foregoing analysis, that there are additional losses inherent in the portfolio.
There can be no assurance that the averse impact of any of these conditions on us will not be in excess of the range set forth above. Readers are referred to management's "Forward Looking Statement Disclosure" in connection with this section.
MARKET RISK
Interest rate, credit and operations credit risks are the most significant market risks impacting Bancorp's performance. Other types of market risk, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of Bancorp's business activities. Bancorp relies on loan reviews, prudent loan underwriting standards and an adequate allowance of loan loss to mitigate credit risk.
Bancorp uses an asset/liability management simulation model to measure interest rate risk. The model quantifies interest rate risk through simulating forecasted net interest income over a 12-month time period under various rate scenarios as well as monitoring the change in the present value of equity under the same rate scenarios. The present value of equity is defined as the difference between the market value of current assets less current liabilities. By measuring the change in the present value of equity under different rate scenarios, management is able to identify interest rate risk that may not be evident in simulating changes in forecasted net interest income.
Forecasting Bancorp's net interest income over the next 12 months using historical growth trends and the current interest rate environment, Bancorp would expect that continuation of the current flat interest rate yield curve would continue to exert pressure on Bancorp's net interest margin. A flat yield curve environment exists when there is a historically small difference between the short maturity end of the yield curve and the long maturity end of the yield curve. The average 3-month treasury bill yield in December 1998 was 4.50% compared to 5.06% on the 30-year treasury bill. The relatively small difference, in this case 56 basis points, constitutes a flat yield curve environment. This type of environment offers fewer opportunities to improve Bancorp's margin than when the yield curve is steeper, with a larger difference between the short and long ends of the yield curve.
The following table presents an analysis of the approximate percent change in projected net interest income over a 12-month period along with the approximate change in the present value of equity relative to earnings in the current interest rate environment. All percent changes are compared to the current interest rate yield curve. The change in interest rates assumes an immediate, parallel and sustained shift in the interest rate yield curve. This table does not consider flattening or steepening yield curve effects.
Readers are referred to management's "Forward Looking Statement Disclosure" in connection with this section.
As illustrated in the above table, Bancorp is currently slightly liability sensitive, meaning that interest bearing liabilities mature or reprice more quickly than interest-earning assets in a given period, therefore, a significant increase in market rates of interest or a flattening interest rate yield curve could adversely affect net interest income. In contrast, a decreasing rate environment or a steepening interest rate curve may slightly improve Bancorp's margin. Further, the effects of a flattening yield curve could more adversely affect Bancorp's margin than any benefits received from a decreasing rate environment. Bancorp's attempts to limit its loss exposure through managing the repricing characteristics of its assets and liabilities. Bancorp has also placed increased emphasis on its non-interest revenue products to additionally stabilize earnings strength.
It should be noted that the simulation model does not take into account future management actions that could be undertaken, if there were a change in actual market interest rates during the year. Also, certain assumptions are required to perform modeling simulations that may have significant impact on the results. These include assumptions regarding the level of interest rates and balance changes on deposit products that do not have stated maturities. These assumptions have been developed through a combination of industry standards and future expected pricing behavior. The model also includes assumptions about changes in the composition or mix of the balance sheet. The results derived from the simulation model could vary significantly due to external factors such as changes in the prepayment assumptions, early withdrawals of deposits and competition. Any merger activity will also have an impact on Bancorp's asset/liability position as new assets are acquired and added. The acquisition of Centennial Holdings, Ltd., during 1998, decreased Bancorp's liability sensitivity.
INTEREST RATE SENSITIVITY (GAP) TABLE
The primary objective of Bancorp's asset/liability management is to maximize net interest income while maintaining acceptable levels of interest-rate sensitivity. The Company seeks to meet this objective through influencing the maturity and repricing characteristics of its assets and liabilities.
The following table sets forth the estimated maturity and repricing and the resulting interest rate gap between interest earning assets and interest bearing liabilities at December 31, 1998. The amounts in the table are derived from internal data from the Bank based on maturities and next repricing dates including contractual repayments.
(1) Equity investments have been placed in the 0-3 month category.
(2) Repricing is based on anticipated call dates, and may vary from contractual maturities.
(3) Repricing is based on historical average lives.
Certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities and periods of repricing, they may react differently to changes in market interest rates. Also, interest rates on assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other assets and liabilities may follow changes in market interest rates. Given these shortcomings, management believes that rate risk is best measured by simulation modeling as opposed to measuring interest rate risk through interest rate gap measurement.
LIQUIDITY AND SOURCES OF FUNDS
Bancorp's primary sources of funds are customer deposits, maturities of investment securities, sales of "Available for sale" securities, loan sales, loan repayments, net income, advances from the Federal Home Loan Bank of Seattle ("FHLB"), and the use of Federal Funds markets. Scheduled loan repayments are relatively stable sources of funds, while deposit inflows and unscheduled loan prepayments are not. Deposit inflows and unscheduled loan prepayments are influenced by general interest rate levels, interest rates available on other investments, competition, economic conditions, and other factors.
Deposits are Bancorp's primary source of new funds. Total deposits were $1.108 billion at December 31, 1998, up from $958.5 million at December 31, 1997. Bancorp does not generally accept brokered deposits. A concerted effort has been made to attract deposits in the market area it serves through competitive pricing and delivery of a quality product. Increases over the period are due to marketing efforts, expansion, and new business development programs initiated by Bancorp.
Management anticipates that Bancorp will continue relying on customer deposits, maturity of investment securities, sales of "Available for Sale" securities, loan sales, loan repayments, net income, Federal Funds markets, FHLB, and other borrowings to provide liquidity. Although deposit balances have shown historical growth, such balances may be influenced by changes in the banking industry, interest rates available on other investments, general economic conditions, competition, customer management of cash resources due to the year 2000 and other factors. Borrowings may be used on a short-term basis to compensate for reductions in other sources of funds. Borrowings may also be used on a long-term basis to support expanded lending activities and to match maturities or repricing intervals of assets. The sources of such funds will include Federal Funds purchased and borrowings from the FHLB.
CAPITAL RESOURCES
The Federal Reserve Bank (FRB) and Federal Deposit Insurance Corporation (FDIC) have established minimum requirements for capital adequacy for bank holding companies and member banks. The requirements address both risk-based capital and leveraged capital. The regulatory agencies may establish higher minimum requirements if, for example, a corporation has previously received special attention or has a high susceptibility to interest rate risk. The FRB and FDIC risk-based capital guidelines require banks and bank holding companies to have a ratio of tier one capital to total risk-weighted assets of at least 4 percent and a ratio of total capital to total risk-weighted assets of 8 percent or greater. In addition, the leverage ratio of tier one capital to total assets less intangibles is required to be at least 3 percent. As of December 31, 1998, Bancorp and all of its subsidiary banks are considered "Well Capitalized" per the regulatory risk based capital guidelines.
Shareholders' equity increased to $117.2 million at December 31, 1998 from $101.1 million at December 31, 1997 an increase of $16.1 million, or 15.90%, over that period of time. At December 31, 1998, Bancorp's shareholders' equity, as a percentage of total assets, was 9.34%, compared to 9.05% at December 31, 1997. The change was primarily a result of income recognition plus cash from the exercise of stock options and the change in net value of Bancorp's available for sale investment portfolio which in aggregate outpaced the growth of assets. In a rising interest rate environment, the value of Bancorp's available for sale portfolio will decline, thus negatively impacting equity. The opposite would occur in a falling rate environment. Equity grew at 15.90% over the period from December 31, 1997 to December 31, 1998, while assets grew by 12.31% over the same period.
As the following table indicates, Bancorp currently exceeds the regulatory minimum capital ratio requirements.
INVESTMENT PORTFOLIO
The following table shows the amortized cost and fair value of Bancorp's investments.
At December 31, 1998 the net unrealized gains on the investment portfolio was $5,966,000 representing 2.33% of the total portfolio. Management has no current plans to sell any of these securities that would result in a material impact on the results of operation.
The following table summarized the contractual maturities and weighted average yields of investment securities.
(1) Yields are stated on a federal tax-equivalent basis at 34 percent.
(2) Does not reflect anticipated maturity from prepayments on mortgage-based and asset-based securities. Anticipated lives are shorter than contractual maturities.
DEPOSITS AND BORROWINGS
The following table summarizes the average amount of, and the average rate paid on, each of the deposit and borrowing categories for the periods shown.
As of December 31, 1998 time deposit liabilities are presented below at the earlier of the next repricing date or maturity.
(1) Time deposits of $100,000 or more represent 8.42% of total deposits as of December 31, 1998.
(2) All other time deposits represent 22.60% of total deposits as of December 31, 1998.
As of December 31, 1998 other borrowings had the following times remaining to maturity.
(1) Based on contractual maturities, and may vary based on possible call dates.
YEAR 2000 ISSUES
INTRODUCTION. The year 2000 creates challenges with respect to the automated systems used by financial institutions and other companies. Many software programs are not able to recognize the year 2000, since most programs and systems were designed to store calendar years in the 1900s by assuming the "19" and storing only the last two digits of the year. For example, these automated systems would recognize a year stored as "00" as the year "1900," rather than as the year 2000. If these automated systems are not appropriately re-coded, updated, or replaced before the year 2000, they will likely confuse data, crash, or fail in some manner. In addition, many software programs and automated systems will fail to recognize the year 2000 as a leap year. The problem is not limited to computer systems. Year 2000 issues will potentially affect every system that has an embedded microchip, such as automated teller machines, elevators, and vaults.
These challenges are especially problematic for financial institutions, since many transactions, such as interest accruals and payments, are date sensitive. The operations of third parties with whom Bancorp does business, including the Company's vendors, suppliers, utility companies, and customers, may also be affected.
THE COMPANY'S STATE OF READINESS. The Company is committed to addressing these year 2000 challenges in a prompt and responsible manner and has dedicated resources to do so. Management has completed an assessment of its automated systems and has implemented a plan to resolve these issues, including purchasing appropriate computer technology. The Company's year 2000 compliance plan ("Y2K Plan") has five phases. These phases are (1) project management, (2) awareness, (3) assessment, (4) testing, and (5) renovation and implementation. The Company has substantially completed phases one through four, although appropriate follow-up activities are continuing to occur, and the Company is currently focusing on the fifth phase of the Y2K Plan.
PROJECT MANAGEMENT. The Company's Chief Information Officer has primary responsibility for year 2000 project management. The Company has also formed a year 2000 compliance committee, consisting of appropriate representatives from its critical operational areas, to assist the Chief Information Officer in implementing the Y2K Plan. In addition, the Company's board of directors is provided with quarterly reports, in order to assist them in overseeing the Company's year 2000 readiness.
AWARENESS. The Company has completed several projects designed to promote awareness of year 2000 issues throughout our organization and our customer base. These projects include mailing information brochures to deposit and loan customers, providing training for lending officers and other staff, assigning a compliance officer to answer customer questions, responding to vendor, customer, and shareholder inquiries, and providing year 2000 information and progress updates on the Company's web site.
ASSESSMENT. Assessment is the process of identifying all mission-critical applications, including information technology and non-information technology systems, that could potentially be negatively affected by dates in the year 2000 and beyond. The Company's assessment phase is substantially complete. Systems examined during this phase included telecommunications systems, account-processing applications, and other software and hardware used in connection with customer accounts.
The Company's operations, like those of many other companies, are intertwined with the operations of certain of its business partners. Accordingly, the Company's operations could be materially affected, if the operations of those companies who provide the Company with mission critical applications, systems, and services are materially affected. For example, the Company depends upon vendors who provide equipment, technology, and software to it in connection with its business operations. Failure of these software vendors to achieve year 2000 readiness could substantially affect the operations of the Company. In addition, lawsuits and other financial challenges materially affecting the financial viability of these vendors could materially affect the Company. In response to this concern, the Company has identified and contacted those vendors who provide our mission-critical applications. The Company is assessing their year 2000 compliance efforts and will continue to monitor their progress as the year 2000 approaches.
The Company's lending personnel have examined its current loan portfolios and identified our key business customers. The Company has contacted these customers and requested information regarding their preparation for the year 2000. The Company then assessed the responses received to identify the risk of loan defaults due to the effects of the year 2000 on the businesses of key business customers. The Company is continuing to follow-up as appropriate in order to identify events that may increase the assessed risk. For example, the Company is monitoring on a quarterly basis those business borrowers who appear to have higher risk than others with respect to year 2000 issues. In addition, the Company will continue to assess new loan applicants for year 2000 risks. For more information see below, under "The Risks of the Company's Year 2000 Issues."
TESTING. Updating and testing of the Company's mission-critical automated systems continues. During the first round of testing, all mission-critical systems were tested to verify that dates in the year 2000 are being appropriately recognized and processed, and the Company found no material year 2000 compliance issues that could not be remedied before the year 2000. In order to verify results, a second round of testing is currently underway using an alternative testing methodology. This second round of testing is expected to be substantially complete by mid-April of 1999. The Company plans to conduct a final round of testing on its mission-critical automated systems during the fourth quarter of 1999.
RENOVATION AND IMPLEMENTATION. This phase involves obtaining and implementing renovated software applications provided by our vendors. As these applications are received and implemented, the Company will test them for year 2000 compliance. This phase also involves upgrading and replacing mission-critical automated systems where appropriate and will continue throughout 1999. Although the Company expects this phase to be substantially complete by early in the fourth quarter of 1999, with a final round of testing to follow in 1999, additional follow-up activities may take place in the year 2000 and beyond.
ESTIMATED COSTS TO ADDRESS THE COMPANY'S YEAR 2000 ISSUES. The total financial effect of these year 2000 challenges on the Company cannot be predicted with certainty at this time. In fact, in spite of all efforts being made to rectify these problems, the success of these efforts cannot be predicted until the year 2000 actually arrives. The Company will upgrade or replace certain automated systems before the year 2000; although some of these systems would have been replaced without regard to year 2000 issues, due to technology updates and Company expansion. The Company's estimated budget under its Y2K Plan is set forth in the table below(1). The costs below represented approximately 9% of the Company's information technology budget for 1998 and will represent about 10% of the 1999 information technology budget. The Company currently plans to continue to use normal operating funds for payment of its year 2000 expenses.
Bancorp's estimated budget for year 2000 costs and expenses is as follows:
(1) The Company may incur additional costs complying with requirements of its regulatory agencies related to year 2000 issues. Management cannot predict these costs at this time, so they have not been included in the table above, other than with respect to anticipated personnel costs.
(2) This represents the replacement cost of certain equipment the Company has identified to date as requiring replacement. The majority of this equipment was scheduled for replacement regardless of year 2000 issues, due to age, operability, and changing Company requirements.
(3) Bancorp engaged a consulting firm to write a comprehensive testing plan for the Company in 1998. Expenses for 1999 relate to costs associated with proxy testing of certain systems and consulting Bancorp may seek to review and audit the Company's year 2000 compliance progress.
Based on the estimates set forth above and the information the Company has received to date from its critical system providers and vendors, Management does not believe that expenses related to meeting the Company's year 2000 challenges will have a material effect on the operations or financial performance of the Company. However, factors beyond the control of management, such as the effects on vendors of our mission-critical software and systems, the effects of year 2000 issues on the economy, and the development of the risks identified below under "The Risks of the Company's Year 2000 Issues," among other things, could have a material effect on the operations or financial performance of the Company.
THE RISKS OF THE COMPANY'S YEAR 2000 ISSUES. The year 2000 presents certain risks to the Company and its operations. Some of these risks are present because the Company purchases technology applications from other parties who face year 2000 challenges. Other of these risks are inherent in the business of banking or are risks faced by many companies with stock traded on a national stock exchange. Although it is impossible to identify every possible risk that the Company may face moving into the millennium, Management has to date identified the following potential risks:
1. Commercial banks, such as the Bank, may experience a contraction in their deposit base, if a significant amount of deposited funds are withdrawn by customers prior to the year 2000, and interest rates may increase in the latter part of 1999. This potential deposit contraction could make it necessary for the Bank to change its sources of funding and could materially impact future earnings. The Company has incorporated a contingency plan for addressing this situation, should it occur, into its asset and liability management strategies. This plan includes maintaining the ability to borrow funds in an amount at least equal to 50% of the Company's allowed borrowing from the Federal Home Loan Bank of Seattle. Significant demand for funds by other banks could reduce the amount of funds available for the Company to borrow. If insufficient funds are available from a Federal Home Loan Bank or other correspondents, the Company may also sell investment securities or other liquid assets to meet liquidity needs. Despite these efforts, a significant deposit contraction could materially impact the Company's earnings or future operations, particularly if funds availability at the Federal Home Loan Bank is impaired or higher interest rates for the Bank's funding sources lead to a decrease in the Company's net interest margin.
2. The Bank lends significant amounts to businesses in its market areas. If these businesses are adversely affected by year 2000 issues, their ability to repay loans could be impaired. This increased credit risk could affect the Company's financial performance. Management is currently monitoring the year 2000 compliance efforts of its significant business loan customers as described above under the "Assessment" segment of the "Introduction." In 1998, management found the Company's loan loss reserves adequate to absorb potential losses from loan defaults due to year 2000 risks. However, as the Company continues to monitor risk in this area, it may increase loan loss reserves as appropriate in the future.
3. The Company's operations, like those of many other companies, can be affected by the year-2000-triggered failures of other companies upon whom the Company depends for the functioning of its automated systems. Accordingly, the Company's operations could be materially affected, if the operations of those companies who provide the Company with mission critical applications, systems, and services are materially affected. As described above, the Company has identified its mission-critical vendors and is monitoring their year 2000 compliance progress. For more information, see "The Company's Year 2000 Readiness," above.
4. All companies with stock traded on a national stock exchange, including Bancorp, could experience a drop in stock price as investors change their investment portfolios or sell stock prior to the millennium. At this time, it is impossible to predict whether or not this will in fact be the case with respect to the stock of Bancorp or any other company.
5. Bancorp's subsidiary West Coast Trust provides investment advisory services to certain customers, including an open-end mutual fund administered by an investment company registered under the Investment Advisors Act of 1940. Management is currently assessing the material risks of the activities of West Coast Trust and is monitoring the year 2000 compliance activities of the investment company administering the open-end mutual fund.
6. The Company's ability to operate effectively in the year 2000 could be affected by communications abilities and access to utilities, such as electricity, water, telephone, and others, to the extent access is interrupted due to the effects of year 2000 issues on these and other utilities.
THE COMPANY'S CONTINGENCY PLANS. In addition to the contingency plans described above under "The Risks of the Company's Year 2000 Issues," the Company is developing a Business Interruption Contingency Plan ("BIC Plan"). This BIC Plan is currently being finalized, and the Company expects to complete it by the end of the first quarter of 1999. The BIC Plan will contain information pertinent to maintaining the successful operation of each major business line of the Company as we transition from 1999 to 2000. Based on the Company's current assessment, it is anticipated that the BIC Plan will address such matters as (1) Company policies and procedures relating to staffing and employee resources during the critical time periods before and after the year 2000, (2) maintenance of external and internal communications, (3) plans for maintaining critical business operations, (4) steps for contingency plan implementation, (5) timelines or timing guidelines for contingency plan implementation, and (6) guidelines or procedures to be followed if it becomes necessary to implement a contingency plan with respect to a major business line. In addition, if the Company identifies a material problem with a mission-critical system, the Company will develop an appropriate contingency plan for operation or recovery, as possible and appropriate, should that system fail in the year 2000. Certain circumstances may occur for which there are no satisfactory contingency plans. For more information see above under "The Risks of the Company's Year 2000 Issues."
FORWARD LOOKING STATEMENTS
The discussion above, entitled "Year 2000 Issues," including without limitation the section entitled "Risks of the Company's Year 2000 Issues," includes certain "forward looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 ("PSLRA"). This statement is included for the express purpose of availing Bancorp of the protections of the safe harbor provisions of the PSLRA. Management's ability to predict results or effects of issues related to the year 2000 is inherently uncertain, and is subject to factors that may cause actual results to differ materially from those projected. Factors that could affect the actual results include, without limitation, (1) the possibility that protection procedures, contingency plans, and remediation efforts will not operate as intended, (2) the possibility that the Company may fail to timely or completely identify all software or hardware applications requiring remediation or other risks or issues related to the year 2000, (3) unexpected costs or events, (4) failures of communications abilities or utility companies serving the Company, (5) fluctuating interest rates, and (6) the uncertainty associated with the impact of year 2000 issues on the banking industry and on the Company's customers, vendors, and others with whom it does business. Readers are cautioned not to place undue reliance on these forward looking statements.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following audited consolidated financial statements and related documents are set forth in this Annual Report on Form 10-K on the pages indicated:
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders and Board of Directors of West Coast Bancorp:
We have audited the accompanying consolidated balance sheets of West Coast Bancorp (an Oregon corporation) as of December 31, 1998 and 1997, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of West Coast Bancorp's management. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the 1997 and 1996 financial statements of Centennial Holdings, Ltd., a company acquired during 1998 in a transaction accounted for as a pooling of interests, as discussed in Note 2. Such statements are included in West Coast Bancorp's consolidated balance sheet as of December 31, 1997, and consolidated statements of income, changes in stockholders' equity and cash flows for the years ended December 31, 1997 and 1996 and reflect 24% of consolidated assets as of December 31, 1997, and 25% of consolidated interest revenues in both 1997 and 1996. These statements were audited by other auditors whose report has been furnished to us and our opinion, insofar as it relates to the amounts included for Centennial Holdings, Ltd., is based solely upon the report of the other auditors.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the report of other auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of the other auditors, the financial statements referred to above present fairly, in all material respects, the financial position of West Coast Bancorp as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Portland, Oregon January 26, 1999
WEST COAST BANCORP CONSOLIDATED BALANCE SHEETS
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED STATEMENTS
WEST COAST BANCORP CONSOLIDATED STATEMENTS OF INCOME
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED STATEMENTS
WEST COAST BANCORP CONSOLIDATED STATEMENTS OF CASH FLOWS
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED STATEMENTS
WEST COAST BANCORP CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED STATEMENTS
WEST COAST BANCORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION. The accompanying consolidated financial statements include the accounts of West Coast Bancorp (Bancorp or the Company) which operates its wholly-owned subsidiaries, West Coast Bank, West Coast Trust, Centennial Funding Corporation and Totten, Inc. after elimination of intercompany transactions and balances.
NATURE OF OPERATIONS. Bancorp operates 40 offices in western Oregon and Washington. The Bank's activities include the usual lending and deposit functions of commercial banks. West Coast Trust provides agency, trust and related services.
INVESTMENT SECURITIES. Investment securities are classified as either available for sale or held to maturity. Available for sale securities are carried at fair value with unrealized gains and losses, net of any tax effect, added to or deducted directly from stockholders' equity. Held to maturity securities are carried at amortized cost.
LOANS HELD FOR SALE. Loans held for sale are carried at the lower of cost or market. Market value is determined in the aggregate.
LOANS. Interest income on loans is accrued daily on the principal balance outstanding. Generally, no interest is accrued on loans when factors indicate collection of interest is doubtful or when the principal or interest payment becomes 90 days past due. For such loans, previously accrued but uncollected interest is charged against current earnings, and income is only recognized to the extent payments are subsequently received. Loan fees are offset against operating expense to the extent these fees cover the direct expense of originating loans. Fees in excess of origination costs are deferred and amortized to income over the related loan period.
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. Loans that are currently measured at fair value or at lower of cost or fair value, leases and certain large groups of smaller balance homogeneous loans that are collectively measured for impairment are excluded.
ALLOWANCE FOR LOAN LOSS. The allowance for loan loss is based on management's estimates. Actual losses may vary from current estimates. These estimates are reviewed periodically and, as adjustments become necessary, are reported in earnings in the periods in which they become known. Losses are charged and recoveries are credited to the allowance.
ACCOUNTING CHANGES. In 1995, Bancorp adopted Statement of Financial Accounting Standard (SFAS) No. 122, "Accounting to Mortgage Servicing Rights," which requires recognition as separate assets rights to service mortgage loans for others, however those rights are acquired. It further requires the assessment of its capitalized mortgage servicing rights for impairment based on the fair value of those rights. Impairment should be recognized through a valuation allowance. This statement applies to financial statements for fiscal years beginning after December 15, 1995. The implementation of this statement did not have a material effect on Bancorp's reported financial position or net income in 1996.
In 1995, Bancorp adopted SFAS No. 123, "Accounting for Stock-Based Compensation," which requires disclosures about stock-based compensation arrangements regardless of the method used to account for them. Bancorp has opted to continue to apply the accounting provisions of Opinion No. 25, and therefore discloses the difference between compensation cost included in net income and the related cost measured by the fair value based method defined by SFAS No. 123, including tax effects, that would have been recognized in the income statement if the fair value method had been used.
In 1997, Bancorp adopted SFAS No. 128, "Earnings Per Share," which establishes standards for computing and presenting earnings per share (EPS). It replaces the presentation of primary EPS with a presentation of basic EPS. It also requires dual presentation of basic and diluted EPS on the face of the income statement for all entities with complex capital structures and requires reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. The implementation of this statement did not have a material effect on Bancorp's reported financial position or net income in 1997. EPS for 1996 was restated to conform with this statement.
In 1998, Bancorp adopted SFAS No. 130, "Reporting Comprehensive Income." This statement established standards for reporting and display of comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general purpose financial statements. This display is presented in the consolidated statement of equity and related notes.
In 1998, Financial Accounting Standards Board issued SFAS NO. 133, "Accounting for Derivative Instruments and Hedging Activities," which Bancorp is required to adopt for years beginning after June 15, 1999. The statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statements of financial position and measure those instruments at fair value. Bancorp does not anticipate that the implementation of this statement will have a material effect on Bancorp's reported financial position or net income.
PREMISES AND EQUIPMENT. Premises and equipment are stated at cost, less accumulated depreciation. The provision for depreciation is computed on the straight-line method over the estimated useful lives of the related assets, which range from 3 to 40 years. Improvements are capitalized and depreciated over their estimated useful lives. Minor repairs, maintenance, and improvements are charged to operations as incurred. When property is replaced or otherwise disposed of, the cost of such assets and the related accumulated depreciation are removed from their respective accounts. Related profit or loss, if any, is recorded in the Consolidated Statement of Income.
OTHER BORROWINGS. Federal funds purchased and securities sold under agreements to repurchase generally mature within one to four days from the transaction date. Other short-term borrowed funds mature within one year from the transaction date. Other long-term borrowed funds extend beyond one year.
INCOME TAXES. Income taxes are accounted for using the asset and liability method. Under this method, a deferred tax asset or liability is determined based on the enacted tax rates that will be in effect when the differences between the financial statement carrying amounts and tax bases of existing assets and liabilities are expected to be reported in Bancorp income tax returns. The deferred tax provision for the year is equal to the net change in the deferred tax asset from the beginning to the end of the year, less amounts applicable to the change in value related to investments available for sale. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date.
TRUST DEPARTMENT ASSETS. Assets (other than cash deposits) held by West Coast Trust in fiduciary or agency capacities for its trust customers are not included in the accompanying Consolidated Balance Sheets, since such items are not assets of West Coast Trust.
SUPPLEMENTAL CASH FLOW INFORMATION. For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, and federal funds sold. Generally, federal funds are purchased and sold for one-day periods. Bancorp paid $36,648,000, $32,257,000, and $26,337,000, for interest in 1998, 1997, and 1996, respectively. Income taxes paid were $4,650,000, $7,987,000, and $5,218,000 in 1998, 1997, and 1996, respectively.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS. The preparation of financial statements, in conformity with generally accepted accounting principles, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
RECLASSIFICATIONS. Certain reclassifications of prior year amounts have been made to conform to current classifications.
2. BUSINESS COMBINATIONS
On July 1, 1996, Bancorp acquired Vancouver Bancorp parent of Bank of Vancouver, headquartered in Vancouver, Washington. Shareholders of Vancouver Bancorp were issued 1,049,000 new shares of Bancorp common stock, and an additional 234,000 shares were reserved for options previously granted, providing for a total stock transaction valued at closing at $11.6 million. The transaction was accounted for as a pooling-of-interest under generally accepted accounting principles.
On February 28, 1998, Bancorp acquired Centennial Holdings, Ltd., (CEB) of Olympia, Washington. Shareholders of Centennial Holdings were issued 2,657,000 new shares of Bancorp common stock, and an additional 148,000 shares were made available for options previously granted, providing for a total stock transaction valued at closing at $66 million. The transaction was accounted for as a pooling of interest under generally accepted accounting principles.
The following data summarizes the results of operations of the previously separate companies for the periods 1997 and 1996 before the acquisition. Certain reclassifications of prior period components have been made to conform to current classifications and consistent presentations. Intercompany transactions have been eliminated from the data provided.
On June 6, 1996 CEB acquired First American State Bank in a business combination accounted for as a purchase. First American was a full-service bank with two branches in Lewis County, and at the date of acquisition, had approximately $33 million of assets, $22 million of loans, $29 million of deposits, and stockholders' equity of $3.4 million. The results of operations of First American are included in the accompanying financial statements since the date of acquisition. The cost of the acquisition was $5.4 million, which exceeded the fair value of the net assets acquired by $1.8 million. The excess is being amortized on the straight-line basis over the estimated remaining lives of the underlying assets.
3. CONSOLIDATION AND RESTRUCTURING CHARGES
As of December 31, 1998, Bancorp completed its consolidation of its four separate banking affiliates into a single banking organization. During 1998, Bancorp accrued $1.92 million in restructuring charges to cover anticipated costs of $1.73 million for the severance program and personnel related expenditures, with the remaining $188,000 for marketing and professional fees related to the restructuring. These amounts were incurred but not paid at the time the accrual was made. During 1998, $13,000 of the severance related program costs and $145,000 of the marketing and professional fees have been paid and charged against the accrual. As of December 31, 1998, Bancorp has an accrual for the restructuring charges of $1.76 million, of which $1.73 million is for severance and employee related costs and the remaining amount is for unpaid professional fees for work incurred. The consolidation is expected to reduce employment by approximately 100 positions or 13% of Bancorp's total work force. The reductions are primarily comprised of administrative and back office positions. As of December 31, 1998, approximately 25% of the anticipated staff related reductions have occurred. Additionally, in connection with its restructuring plan, the company has invested in new network computer systems and has therefore recorded a write-down related to the replaced equipment no longer in use. The write-down of $1.1 million was incurred during 1998 and is included in the restructuring charge. During the year, the company also prepaid $20 million of its long-term debt that was required to meet certain liquidity needs of the individual banks under its previous structure, but was no longer required under the reorganized single bank structure. The prepayment penalty of $517,000 was incurred during 1998 and is included in the restructuring charge. Other costs related to the restructuring of approximately $300,000, primarily data conversion, marketing, regulatory and administrative, were paid during 1998 and included in restructuring costs. Total restructuring costs charged to expense during 1998 totaled $3.8 million.
4. INVESTMENT SECURITIES
Gross gains of $357,226, $52,010, and $87,748 and gross losses of $9,429, $137,456, and $79,193, were realized on sales of investment securities in 1998, 1997, and 1996, respectively. Securities with a fair value of approximately $28,788,000 at December 31, 1998, were pledged to secure public deposits. No outstanding mortgage-backed securities were classified as high-risk at December 31, 1998.
5. MATURITIES OF INVESTMENTS
6. LOANS AND ALLOWANCE FOR LOAN LOSS
The loan portfolio consists of the following:
The following is an analysis of the changes in the allowance for loan loss:
Loans on which the accrual of interest has been discontinued, amounted to approximately $4,565,000, $4,245,000, and $2,228,000, at December 31, 1998, 1997, and 1996, respectively. Interest income foregone on non-accrual loans was approximately $434,000, $432,000, and $333,000, in 1998, 1997, and 1996, respectively.
At December 31, 1998 and 1997, Bancorp's recorded investment in certain loans that were considered to be impaired was $4,423,000 and $4,091,000, respectively, all of which was classified as non-performing. Of these impaired loans, $555,000 and $702,000 had a related valuation allowance of $150,000 and $352,000, respectively, while $3,868,000 and $3,389,000 did not require a valuation allowance. The balance of the allowance for loan loss in excess of these specific reserves is available to absorb losses from all loans. The average recorded investment in certain impaired loans for the years ended December 31, 1998 and 1997 was approximately, $3,633,000 and $1,207,000, respectively. For the years ended December 31, 1998 and 1997, interest income recognized on impaired loans totaled $384,000 and $161,000, respectively, all of which was recognized on a cash basis.
As of December 31, 1998, 1997 and 1996, the Bank had loans to persons serving as directors, officers, principle shareholders and their related interests totaling $19,873,000, $12,678,000 and $8,799,000, respectively. These loans were made substantially on the same terms, including interest rates, maturities and collateral as those made to other customers of the Banks.
The Bank grants commercial and residential loans to customers primarily throughout Oregon and Washington. Although the Bank has a diversified loan portfolio, a substantial portion of the portfolio belongs to debtors whose ability to honor their contracts is dependent upon the economics of Oregon and/or Washington.
7. PREMISES AND EQUIPMENT
Premises and equipment consists of the following:
Depreciation included in net occupancy and equipment expense amounted to $3,179,000, and $2,705,000 and $2,460,000 for the years ended December 31, 1998, 1997, and 1996, respectively.
8. CERTIFICATES OF DEPOSIT
Included in certificates of deposit are certificates in denominations of $100,000 or greater, totaling $93,371,000 and $75,155,000 at December 31, 1998 and 1997, respectively. Interest expense relating to certificates of deposits in denominations of $100,000 or greater was $3,731,000, 3,808,000, and $3,076,000 for the years ended December 31, 1998, 1997 and 1996, respectively.
9. BORROWINGS
Short-term borrowings generally consist of a Cash Management Account (CMA) line of credit for overnight funding with the Federal Home Loan Bank (FHLB), and Federal Funds Purchased overnight from correspondent banks. No short-term borrowings were outstanding at December 31, 1998.
Long-term borrowings, as of December 31, 1998, consist of amortizing notes and putable advances with the FHLB totaling $20,259,985. Bancorp has two amortizing notes totaling $2,259,985, that have original terms of seven years and mature between April of 2000, and January of 2001. Rates on the amortizing notes range from 4.98% to 5.42%. Bancorp also has $18 million in putable advances from the FHLB. The putable advances have terms of five years with quarterly put options starting September 1999 with a final maturity in December 2003; rates on these advances range from 4.53% to 5.68%. Principal payments due on Bancorp's borrowings in 1999 are $1.6 million, in 2000 are $667,000, in 2001 are $22,000, and in 2002 are $18 million with no balances due thereafter.
10. BALANCES WITH THE FEDERAL RESERVE BANK
The Bank is required to maintain cash reserves or deposits with the Federal Reserve Bank equal to a percentage of reservable deposits. The average required reserves for the Bank was $2,676,000 during 1998.
11. COMMITMENTS AND CONTINGENT LIABILITIES
The Company leases land and office space under thirty leases, of which twenty-seven are long-term noncancellable operating leases that expire between 1999 and 2011. At the end of the respective lease terms, Bancorp may renew the leases at fair rental value. At December 31, 1998, minimum future lease payments under these leases and other operating leases were:
Rental expense for all operating leases was $1,201,000, 1,221,000, and $1,164,000, for the years ended December 31, 1998, 1997, and 1996, respectively.
12. INCOME TAXES
The provision for income taxes attributable to income for the last three years consisted of the following:
The tax effect of temporary differences that give rise to significant portions of deferred tax assets and deferred tax liabilities for the last three years are presented below:
The financial tax rate of the provision for income taxes varies from the federal income tax statutory rate. The reasons for the variance are as follows:
13. STOCKHOLDERS' EQUITY AND REGULATORY REQUIREMENTS
Authorized capital of West Coast Bancorp includes 10,000,000 shares of Preferred Stock no par value, none of which were issued at December 31, 1998. During 1998, Bancorp increased its no par value common stock authorized shares from 15,000,000 shares to 50,000,000 shares. On September 25, 1998, the Board of Directors declared a 10 percent dividend payable to shareholders of record October 6, 1998. All share and per share amounts have been restated to retroactively reflect the stock dividend as well as all previous stock dividends and splits.
In December 1998, Bancorp announced a stock repurchase program. Under the plan the company will buy up to 1.5 million shares of the company's common stock. The plan repurchases will be limited by the anticipated timing of stock option exercises as well as other parameters. The company intends to use existing funds and/or long-term borrowings to finance the repurchases. The repurchased common shares will be available for use under the company's existing stock option plans. As of December 31, 1998, 50,000 common shares had been repurchased for $1,029,000, an average purchase price of $20.58 per share.
The Federal Reserve Board (FRB) and Federal Deposit Insurance Corporation (FDIC) have established minimum requirements for capital adequacy for bank holding companies and member banks. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, Bancorp and its significant bank subsidiaries must meet specific capital guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items. The FRB and FDIC risk based capital guidelines require banks and bank holding companies to have a ratio of tier one capital to total risk weighted assets of at least 4%, and a ratio of total capital to total risk weighted assets of 8% or greater. In addition, the leverage ratio of tier one capital to total average assets less intangibles is required to be at least 3%. Well capitalized guidelines require banks and bank holding companies to maintain tier one capital of at least 6%, total risk based capital of at least 10% and a leverage ratio of at least 5%. Bancorp and its significant bank subsidiaries' capital components, classification, risk weightings and other factors are also subject to qualitative judgements by regulators. Failure to meet minimum capital requirements can initiate certain action by regulators that, if undertaken, could have a material effect on Bancorp's financial statements. As of December 31, 1998, Bancorp and its subsidiary bank are considered "Well Capitalized" under current risk based capital regulatory guidelines. Management believes that no events or changes in conditions have occurred which would significantly change Bancorp's capital position.
The following table presents selected risk adjusted capital information as of December 31, 1998 and 1997:
14. EARNINGS PER SHARE
The following table reconciles the numerator and denominator of the Basic and Diluted earnings per share computations:
Bancorp for the periods reported had no reconciling items between net income and income available to common shareholders.
15. COMPREHENSIVE INCOME
Bancorp adopted SFAS No. 130 "Reporting Comprehensive Income," in 1998 which established standards for reporting and displaying comprehensive income and its components. The following table displays the components of other comprehensive for the last three years:
16. EMPLOYEE BENEFIT PLANS
During 1998, West Coast Bancorp employee benefits included a plan established under section 401(k) of the Internal Revenue Code for certain qualified employees (the 401(k) plan). Employee contributions up to 15 percent of salaries under the Internal Revenue Code guidelines, can be made under the 401(k) plan, of which Bancorp matches 50 percent of the employees' contributions up to a maximum of 6 percent of the employee's salary. Bancorp may also elect to make discretionary contributions to the plan. Employees vest immediately in their own contributions and earnings thereon and vest in Bancorp's contributions over five years of eligible service. As of December 31, 1998, Bancorp has merged acquired companies' plans into its own plan. Bancorp's expenses totaled $398,000, $603,000 and $331,000 for 1998, 1997, and 1996 respectively, of which $0, $200,000, and $0, respectively, were discretionary.
In 1996, Bancorp adopted a non-qualified Deferred Compensation Plan for Directors and a non-qualified Deferred Compensation Plan for Executive Officers (Deferred Compensation Plans) as supplemental benefit plans which permit directors and selected officers to elect to defer receipt of all or any portion of their future salary, bonus or directors' fees. In addition, the Deferred Compensation Plans restore benefits lost by employees under the 401(k) plan due to specified Internal Revenue Code restrictions on the maximum benefits that may be paid under those plans. All contributions are invested at the employees' direction among a variety of investment alternatives. Amounts contributed to these plans to restore benefits otherwise limited by the Code restrictions have been included in the 401(k) plan contribution expense reported in the previous paragraph.
Bancorp's expenses related to retirement benefits with certain present and former employees, were $153,000, $206,000 and $207,000 for 1998, 1997 and 1996, respectively. Certain of these retirement benefits are directly or indirectly funded through the purchase of corporate owned life insurance policies. The recorded cash surrender value of these policies was $1,626,000 and $2,173,000 at December 31, 1998 and 1997, respectively.
Prior to its acquisition, Centennial Holdings, LTD sponsored a non-contributory employee stock ownership plan (ESOP) that covered certain employees meeting eligibility requirements. The contributions to the ESOP were discretionary and were charged against compensation expense amounts were $176,000 and $50,000 in 1997 and 1996. Contributions were used to acquire Centennial Holdings, LTD common stock. The ESOP owned 194,292 and 189,895 shares at December 31, 1997 and 1996 respectively. During 1998 the ESOP assets were merged into Bancorp's 401(k) plan.
17. STOCK OPTION PLANS
Bancorp's stock option plans include the Combined 1991 Employee Stock Option Plan and Non-Qualified Stock Option Plan (1991 Plan), the 1995 Directors Stock Option Plan (1995 Plan), the 1989 and 1985 Non-Qualified Stock Option Plans and the 1989 and 1985 Qualified Stock Option Plans (1985 and 1989 Plans). The 1991 Plan allows for a maximum number of shares available for grant not to exceed 2 percent of the shares of Bancorp's outstanding common stock on January 1st of each such year. The 1995 Plan authorizes the issuance of 660,000 shares of common stock. No additional grants may be made under the 1985 and 1989 Plans.
Substantially all stock options have an exercise price that is not less than the fair market value of Bancorp's stock on the date the option were granted. The majority of the options previously granted under the 1991 and 1989 Plans are exercisable immediately following the effective date of the grant with certain options granted under the 1991 plan exercisable in one year. Certain options previously granted under the 1995 Plan are exercisable over 1 to 4 year periods. Substantially all options previously granted under the 1985 Plans become exercisable at a rate of 2 percent a month for 50 months, or equally over a four year period; all options previously issued under the 1985 plan were fully vested as of December 31, 1998.
17. STOCK OPTION PLANS (Continued)
As of December 31, 1998, outstanding stock options consist of the following:
Bancorp accounts for these plans under APB Opinion No. 25, under which no compensation cost has been recognized. Had compensation cost for these plans been determined consistent with SFAS Statement No. 123, Bancorp's net income and earnings per share would have been reduced to the following proforma amounts:
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model. The following table presents the assumptions used in the fair value calculation:
Due to the discretionary nature of stock option grants, the compensation cost included in the 1998, 1997 and 1996 proforma net income per SFAS No. 123, may not be representative of that expected in future years.
18. FAIR VALUES OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments," requires the disclosure of the fair value of financial instruments. A financial instrument is defined as cash, evidence of an ownership interest in an entity, or a contract that conveys or imposes the contractual right or obligation to either receive or deliver cash or another financial instrument. Examples of financial instruments included in Bancorp's balance sheet are cash, federal funds sold or purchased, debt and equity securities, loans, demand, savings and other interest-bearing deposits, notes and debentures. Examples of financial instruments which are not included in the Bancorp balance sheet are commitments to extend credit and standby letters of credit.
Fair value is defined as the amount at which a financial instrument could be exchanged in a current transaction between willing parties, other than in a forced sale or liquidation, and is best evidenced by a quoted market price if one exists.
The statement requires the fair value of deposit liabilities with no stated maturity, such as demand deposits, NOW and money market accounts, to equal the carrying value of these financial instruments and does not allow for the recognition of the inherent value of core deposit relationships when determining fair value. While the statement does not require disclosure of the fair value of nonfinancial instruments, such as Bancorp's premises and equipment, its banking and trust franchises and its core deposit relationships, Bancorp believes these nonfinancial instruments have significant fair value.
Bancorp has estimated fair value based on quoted market prices where available. In cases where quoted market prices were not available, fair values were based on the quoted market price of a financial instrument with similar characteristics, the present value of expected future cash flows or other valuation techniques that utilize assumptions which are highly subjective and judgmental in nature. Subjective factors include, among other things, estimates of cash flows, the timing of cash flows, risk and credit quality characteristics and interest rates. Accordingly, the results may not be precise and modifying the assumptions may significantly affect the values derived. In addition, fair values established utilizing alternative valuation techniques may or may not be substantiated by comparison with independent markets. Further, fair values may or may not be realized if a significant portion of the financial instruments were sold in a bulk transaction or a forced liquidation. Therefore any aggregate unrealized gains or losses should not be interpreted as a forecast of future earnings or cash flows. Furthermore, the fair values disclosed should not be interpreted as the aggregate current value of Bancorp.
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:
Cash and Cash Equivalents - The carrying amount is a reasonable estimate of fair value.
Investment Securities - For securities held for investment purposes, fair values are based on quoted market prices or dealer quotes. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.
Loans - The fair value of loans is estimated by discounting the future cash flows using the current rate at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.
Deposit Liabilities - The fair value of demand deposits, savings accounts and other deposits is the amount payable on demand at the reporting date. The fair value of certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities.
Short-term borrowings - The carrying amount is a reasonable estimate of fair value given the short-term nature of these financial instruments.
Long-term borrowings - The fair value of the long-term borrowings is estimated by discounting the future cash flows using the current rate at which similar borrowings with similar remaining maturities could be made.
Commitments to Extend Credit, Standby Letters of Credit and Financial Guarantees - The fair value of commitments, standby letters of credit and financial guarantees is not significant.
18. FAIR VALUES OF FINANCIAL INSTRUMENTS (Continued)
The estimated fair values of financial instruments at December 31, 1998 are as follows:
The estimated fair value of financial instruments at December 31, 1997 are as follows:
19. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Bank has financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the Consolidated Balance Sheets.
The Bank's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as for on-balance sheet instruments. Management does not anticipate any material loss as a result of these transactions.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Many of the commitments may expire without being drawn upon, therefore the total commitment amounts do not necessarily represent future cash requirements. Each customer's creditworthiness is evaluated on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon extension of credit, is based on management's credit evaluation of the customer. Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.
Standby letters of credit are conditional commitments issued to guarantee a customer's performance or payment to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.
20. PARENT COMPANY ONLY FINANCIAL DATA
The following sets forth the condensed financial information of West Coast Bancorp on a stand-alone basis:
20. PARENT COMPANY ONLY FINANCIAL DATA (Continued)
Statement of Condition (Unconsolidated)
Statement of Cash Flows (Unconsolidated)
21. SEGMENT AND RELATED INFORMATION
Bancorp adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," in 1998 which established standards for the way enterprises report information about operating segments.
During 1998, Bancorp operated four community banks, until December 1998 when these banks were consolidated into one banking entity. Until late in 1998 separate management teams managed the four banks, relying on common support services offered though the parent company. The four banks operated in Oregon and Washington, where the economic and regulatory factors were similar for the banks, three of the four banks shared the Portland, Oregon market. The banks used similar means of branch networks, marketing and technology to deliver similar loan and deposit products and services. Following the consolidation to a single banking entity the bank operated 40 branch offices, and has realigned management resources into a single team. Due to the similarities in the nature of the four banks and the consolidation to a single banking company Bancorp has aggregated its banking operations into a single segment presented below.
Bancorp accounts for intercompany fees and services at an estimated fair value according to regulatory requirements for the service provided. Intercompany items relate primarily to the use of accounting, human resources, data processing and marketing services provided by the parent company. All other accounting policies are the same as those described in the summary of significant accounting policies.
Summarized financial information concerning Bancorp's reportable segments and the reconciliation to Bancorp's consolidated results is shown in the following table. The "Other" column includes Bancorp's trust operations and corporate related items including support services such as accounting, human resources, data processing and marketing. Investment in subsidiaries is netted out of the presentations below. The "Intersegment" column identifies the intersegment activities of revenues, expenses and other assets, between the "Banking" and "Other" segment.
21. SEGMENT AND RELATED INFORMATION (Continued)
22. QUARTERLY FINANCIAL INFORMATION (unaudited)
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
NONE
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
For information concerning directors and certain executive officers of Bancorp, see INFORMATION WITH RESPECT TO NOMINEES AND DIRECTORS WHOSE TERMS EXPIRE" and "SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT" and "COMPLIANCE WITH SECTION 16(a) FILING REQUIREMENTS" in Bancorp's 1999 Annual Meeting Proxy Statement ("Proxy Statement"), which is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
For information concerning executive compensation, see "INFORMATION WITH RESPECT TO NOMINEES AND DIRECTORS WHOSE TERMS CONTINUE - COMPENSATION OF DIRECTORS" and "EXECUTIVE COMPENSATION" in the Proxy Statement, which is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
For information concerning the security ownership of certain beneficial owners and management, see "INFORMATION WITH RESPECT TO NOMINEES AND DIRECTORS WHOSE TERMS EXPIRE and "SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT" in the Proxy Statement, which is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
For information concerning certain relationships and related transactions, see "INFORMATION WITH RESPECT TO NOMINEES AND DIRECTORS WHOSE TERMS CONTINUE" and "TRANSACTIONS WITH MANAGEMENT" in the Proxy Statement, which is incorporated herein by reference.
PART IV ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
List of Financial Statements and Financial Statement Schedules
(a)(1) and (2) Financial Statements:
The financial statements and related documents listed in the index set forth in Item 8 of this report are filed as part of this report.
All other schedules to the consolidated financial statements required by Regulation S-X are omitted because they are not applicable, not material or because the information is included in the consolidated financial statements or related notes.
(3) Exhibits:
Exhibits are listed in the Exhibit Index beginning on page 56 of this report.
(b) During the three months ended December 31, 1998 Bancorp filed the following current report on Form 8-K: Form 8-K filed December 9, 1998, relating the adoption of a Stock Repurchase Plan.
(c) Exhibits:
The response to this portion of Item 14 is submitted as a separate section of this report entitled, "Index to Exhibits."
(d) Financial Statement Schedules:
None
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 25th day of March, 1999.
WEST COAST BANCORP
(Registrant)
By: /s/ Victor L. Bartruff ----------------------------------- President and CEO
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on the 25th day of March, 1999.
INDEX TO EXHIBITS
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(1) Incorporated by reference to Exhibit 3.1 of Registrant's Quarterly Report on Form 10Q for the quarter ended June 30, 1998.
(2) Incorporated by reference to Exhibits 10.1, 10.2, and 10.3 of Registrant's Annual Report on Form 10-K for the year ended December 31, 1996.
(3) Incorporated by reference to Exhibits 99.1, 99.2 and 99.3 of Registrant's S-8 Registration Statement--Registration No. 333-01651.
(4) Incorporated by reference to Exhibits 99.1 and 99.2 of Registrant's S-8 Registration Statement--Registration No. 333-01651.
(5) Incorporated by reference to Exhibits 99.1, 99.2, 99.3 and 99.5 of Registrant's S-8 Registration Statement -- Registration No. 33-60259.
(6) Incorporated by reference to Exhibits 99.1, 99.3, and 99.4 of Registrant's S-8 Registration Statement - Registration No. 333-09721.
(7) Incorporated by reference to Exhibits 10.23 and 10.24 of Registrant's Annual Report on Form 10-K for the year ended December 31, 1997.