Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2010.

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             .

Commission File Number 0-20288

 

 

COLUMBIA BANKING SYSTEM, INC.

(Exact name of issuer as specified in its charter)

 

 

 

Washington   91-1422237

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

 

1301 “A” Street

Tacoma, Washington

  98402-2156
(Address of principal executive offices)   (Zip Code)

(253) 305-1900

(Issuer’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

 

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  ¨    No   x

The number of shares of common stock outstanding at October 29, 2010 was 39,335,365.

 

 

 


Table of Contents

 

TABLE OF CONTENTS

 

     Page  
PART I — FINANCIAL INFORMATION   
Item 1.    Financial Statements (unaudited)   
   Consolidated Condensed Statements of Income - three and nine months ended September 30, 2010 and 2009      1   
   Consolidated Condensed Balance Sheets - September 30, 2010 and December 31, 2009      2   
   Consolidated Condensed Statements of Changes in Shareholders’ Equity - nine months ended September 30, 2010 and 2009      3   
   Consolidated Condensed Statements of Cash Flows - nine months ended September 30, 2010 and 2009      4   
   Notes to Unaudited Consolidated Condensed Financial Statements      5   
Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations      21   
Item 3.    Quantitative and Qualitative Disclosures about Market Risk      38   
Item 4.    Controls and Procedures      39   
PART II — OTHER INFORMATION   
Item 1.    Legal Proceedings      40   
Item 1A.    Risk Factors      40   
Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds      46   
Item 3.    Defaults Upon Senior Securities      46   
Item 4.    [Removed and Reserved]      46   
Item 5.    Other Information      46   
Item 6.    Exhibits      47   
   Signatures      48   

 

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PART I - FINANCIAL INFORMATION

 

Item 1. FINANCIAL STATEMENTS

CONSOLIDATED CONDENSED STATEMENTS OF INCOME

Columbia Banking System, Inc.

(Unaudited)

Consolidated Statements of Income

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 

(in thousands except per share)

   2010     2009 (1)     2010     2009 (1)  

Interest Income

        

Loans

   $ 44,882      $ 29,151      $ 120,769      $ 88,202   

Taxable securities

     4,660        4,327        14,113        12,730   

Tax-exempt securities

     2,252        2,169        6,988        6,258   

Federal funds sold and deposits in banks

     281        53        640        69   
                                

Total interest income

     52,075        35,700        142,510        107,259   

Interest Expense

        

Deposits

     4,007        5,531        13,282        18,297   

Federal Home Loan Bank and Federal Reserve Bank borrowings

     716        651        2,131        2,116   

Long-term obligations

     266        280        769        937   

Other borrowings

     121        120        357        357   
                                

Total interest expense

     5,110        6,582        16,539        21,707   
                                

Net Interest Income

     46,965        29,118        125,971        85,552   

Provision for loan and lease losses

     9,000        16,500        37,500        48,500   

Provision for losses on covered loans

     453        —          453        —     
                                

Net interest income after provision

     37,512        12,618        88,018        37,052   

Noninterest Income

        

Gain on bank acquisitions

     —          —          9,818        —     

Service charges and other fees

     6,518        3,806        18,384        10,982   

Merchant services fees

     2,051        1,957        5,700        5,607   

Redemption of Visa and Mastercard shares

     —          —          58        49   

Bank owned life insurance

     521        515        1,541        1,532   

Change in indemnification asset

     (4,536     —          (1,137     —     

Other

     629        912        2,529        2,994   
                                

Total noninterest income

     5,183        7,190        36,893        21,164   

Noninterest Expense

        

Compensation and employee benefits

     17,574        11,869        52,057        36,017   

Occupancy

     4,278        3,023        12,554        9,005   

Merchant processing

     934        841        2,697        2,442   

Advertising and promotion

     630        296        2,253        1,675   

Data processing and communications

     2,477        1,010        6,923        2,974   

Legal and professional fees

     1,609        793        4,584        2,779   

Taxes, licenses and fees

     803        582        2,055        1,975   

Regulatory premiums

     1,952        1,220        4,910        4,719   

Net cost of operation of other real estate

     (1,442     318        (802     590   

Amortization of intangibles

     1,044        259        2,886        797   

Other

     3,661        2,935        12,045        8,668   
                                

Total noninterest expense

     33,520        23,146        102,162        71,641   
                                

Income (loss) before income taxes

     9,175        (3,338     22,749        (13,425

Income tax provision (benefit)

     3,971        (1,836     4,573        (7,905
                                

Net Income (Loss)

   $ 5,204      $ (1,502   $ 18,176      $ (5,520
                                

Net Income (Loss) Applicable to Common Shareholders

   $ 2,474      $ (2,605   $ 13,229      $ (8,818
                                

Earnings (loss) per common share

        

Basic

   $ 0.06      $ (0.11   $ 0.39      $ (0.45

Diluted

   $ 0.06      $ (0.11   $ 0.38      $ (0.45

Dividends paid per common share

   $ 0.01      $ 0.01      $ 0.03      $ 0.06   

Weighted average number of common shares outstanding

     38,976        23,468        33,938        19,837   

Weighted average number of diluted common shares outstanding

     39,137        23,468        34,142        19,837   

 

(1) Reclassified to conform to the current period’s presentation

See accompanying notes to unaudited consolidated condensed financial statements.

 

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CONSOLIDATED CONDENSED BALANCE SHEETS

Columbia Banking System, Inc.

(Unaudited)

 

(in thousands)

                 September 30,
2010
     December 31,
2009
 
ASSETS            

Cash and due from banks

         $ 77,235       $ 55,802   

Interest-earning deposits with banks

           448,854         249,272   
                       

Total cash and cash equivalents

           526,089         305,074   

Securities available for sale at fair value (amortized cost of $656,986 and $602,675, respectively)

           692,741         620,038   

Federal Home Loan Bank stock at cost

           17,908         11,607   

Loans held for sale

           1,513         —     

Loans, excluding covered loans, net of deferred loan fees of ($3,662) and ($4,616), respectively

           1,934,162         2,008,884   

Less: allowance for loan and lease losses

           62,334         53,478   
                       

Loans, excluding covered loans, net

           1,871,828         1,955,406   

Covered loans

           561,131         —     

Less: allowance for losses on covered loans

           453         —     
                       

Covered loans, net

           560,678         —     

Total loans, net

           2,432,506         1,955,406   

Federal Deposit Insurance Corporation indemnification asset

           166,696         —     

Interest receivable

           11,441         10,335   

Premises and equipment, net

           62,824         62,670   

Other real estate owned ($17,017 and $0 covered by Federal Deposit Insurance Corporation loss share, respectively)

           40,276         19,037   

Goodwill

           109,639         95,519   

Core deposit intangible, net

           19,733         4,863   

Other assets

           163,894         116,381   
                       

Total Assets

         $ 4,245,260       $ 3,200,930   
                       
LIABILITIES AND SHAREHOLDERS’ EQUITY            

Deposits:

           

Non-interest bearing

         $ 864,920       $ 574,687   

Interest-bearing

           2,441,966         1,908,018   
                       

Total deposits

           3,306,886         2,482,705   

Federal Home Loan Bank advances

           119,584         100,000   

Securities sold under agreements to repurchase

           25,000         25,000   

Other borrowings

           1,599         86   

Long-term subordinated debt

           25,719         25,669   

Other liabilities

           61,780         39,331   
                       

Total liabilities

           3,540,568         2,672,791   

Commitments and contingent liabilities

           

Shareholders’ equity:

           
     September 30,
2010
     December 31,
2009
               

Preferred stock (no par value, $76,898 aggregate liquidation preference)

           

Authorized shares

     2,000         2,000         

Issued and outstanding

     —           77         —           74,301   

Common Stock (no par value)

           

Authorized shares

     63,033         63,033         

Issued and outstanding

     39,328         28,129         576,438         348,706   

Retained earnings

           105,478         93,316   

Accumulated other comprehensive income

           22,776         11,816   
                       

Total shareholders’ equity

           704,692         528,139   
                       

Total Liabilities and Shareholders’ Equity

         $ 4,245,260       $ 3,200,930   
                       

See accompanying notes to unaudited consolidated condensed financial statements.

 

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CONSOLIDATED CONDENSED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

Columbia Banking System, Inc.

(Unaudited)

 

     Preferred Stock     Common Stock     Retained
Earnings
    Accumulated
Other
Comprehensive
Income (Loss)
    Total
Shareholders’
Equity
 

(in thousands)

   Number of
Shares
    Amount     Number of
Shares
     Amount        

Balance at January 1, 2009

     77      $ 73,743        18,151       $ 233,192      $ 103,061      $ 5,389      $ 415,385   

Comprehensive income:

               

Net income

     —          —          —           —          (5,520     —          (5,520

Other comprehensive loss, net of tax:

               

Net unrealized gain from securities, net of reclassification adjustments

     —          —          —           —          —          8,717        8,717   

Net change in cash flow hedging instruments

     —          —          —           —          —          (1,264     (1,264

Net pension plan liability adjustment

     —          —          —           —          —          (660     (660
                     

Total comprehensive income

                  1,273   

Accretion of preferred stock discount

     —          414        —           —          (414     —          —     

Issuance of common stock, net of offering costs

         9,775         113,537            113,537   

Issuance of common stock - stock option and other plans

     —            88         928        —          —          928   

Issuance of common stock - restricted stock awards, net of cancelled awards

     —          —          85         —          —          —          —     

Share-based payment

     —          —          —           857        —          —          857   

Tax benefit deficiency associated with share-based compensation

     —          —          —           (83     —          —          (83

Preferred dividends

     —          —          —           —          (2,884     —          (2,884

Cash dividends paid on common stock

     —          —          —           —          (1,093     —          (1,093
                                                         

Balance at September 30, 2009

     77      $ 74,157        28,099       $ 348,431      $ 93,150      $ 12,182      $ 527,920   
                                                         

Balance at January 1, 2010

     77      $ 74,301        28,129       $ 348,706      $ 93,316      $ 11,816      $ 528,139   

Comprehensive income:

               

Net income

     —          —          —           —          18,176        —          18,176   

Other comprehensive income, net of tax:

               

Net unrealized gain from securities, net of reclassification adjustments

     —          —          —           —          —          11,859        11,859   

Net change in cash flow hedging instruments

     —          —          —           —          —          (943     (943

Net pension plan liability adjustment

     —          —          —           —          —          44        44   
                     

Total comprehensive income

                  29,136   

Redemption of preferred stock and common stock warrant

     (77     (76,898        (3,302         (80,200

Accretion of preferred stock discount

     —          2,597        —           —          (2,597     —          —     

Issuance of common stock, net of offering costs

         11,040         229,129            229,129   

Issuance of common stock - stock option and other plans

     —          —          65         864        —          —          864   

Issuance of common stock - restricted stock awards, net of cancelled awards

     —          —          94         —          —          —          —     

Share-based payment

     —          —          —           1,054        —          —          1,054   

Tax benefit deficiency associated with share-based compensation

     —          —          —           (13     —          —          (13

Preferred dividends

     —          —          —           —          (2,349     —          (2,349

Cash dividends paid on common stock

     —          —          —           —          (1,068     —          (1,068
                                                         

Balance at September 30, 2010

     —        $ —          39,328       $ 576,438      $ 105,478      $ 22,776      $ 704,692   
                                                         

See accompanying notes to unaudited consolidated condensed financial statements.

 

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CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

Columbia Banking System, Inc.

(Unaudited)

 

     Nine Months Ended
September 30,
 

(in thousands)

   2010     2009  

Cash Flows From Operating Activities

    

Net Income (Loss)

   $ 18,176      $ (5,520

Adjustments to reconcile net income to net cash provided by operating activities

    

Provision for loan and lease losses

     37,953        48,500   

Stock-based compensation expense

     1,054        857   

Depreciation, amortization and accretion

     10,105        5,384   

Net realized gain on Federal Deposit Insurance Corporation assisted bank acquisitions

     (9,818     —     

Net realized gain on sale of securities

     (58     —     

Net realized (gain) loss on sale of other assets

     (16     145   

Net realized gain on sale of other real estate owned

     (3,527     —     

Gain on termination of cash flow hedging instruments

     (1,463     (1,960

Write-down on other real estate owned

     4,586        120   

Net change in:

    

Loans held for sale

     (1,513     1,964   

Deferred federal income tax

     (394     (4,483

Interest receivable

     4,195        461   

Interest payable

     (625     (2,165

Other assets

     771        (3,919

Other liabilities

     22,053        (2,588
                

Net cash provided by operating activities

     81,479        36,796   

Cash Flows From Investing Activities

    

Purchases of securities available for sale

     (64,054     (154,973

Proceeds from sales of securities available for sale

     69,328        —     

Proceeds from principal repayments and maturities of securities available for sale

     66,118        49,878   

Loans originated and acquired, net of principal collected

     114,618        108,785   

Increase in Small Business Administration secured borrowings

     1,599        —     

Purchases of premises and equipment

     (3,910     (5,469

Proceeds from disposal of premises and equipment

     71        11   

Proceeds from sales of covered other real estate owned

     10,652        —     

Proceeds from sales of other real estate and other personal property owned

     3,943        4,805   

Capital improvements on other real estate properties

     (1,147     (380

Net cash acquired in business combinations

     155,910        —     
                

Net cash provided by investing activities

     353,128        2,657   

Cash Flows From Financing Activities

    

Net (decrease) increase in deposits

     (323,141     61,416   

Proceeds from Federal Home Loan Bank and Federal Reserve Bank borrowings

     —          739,000   

Repayment from Federal Home Loan Bank and Federal Reserve Bank borrowings

     (36,237     (838,000

Net decrease in other borrowings

     (86     (150

Cash dividends paid

     (3,908     (3,913

Repurchase of preferred stock and common stock warrant

     (80,200     —     

Proceeds from issuance of common stock

     229,129        113,537   

Proceeds from exercise of stock options

     851        845   
                

Net cash (used in) provided by financing activities

     (213,592     72,735   

Increase in cash and cash equivalents

     221,015        112,188   

Cash and cash equivalents at beginning of period

     305,074        88,730   
                

Cash and cash equivalents at end of period

   $ 526,089      $ 200,918   
                

Supplemental Information:

    

Cash paid for interest

   $ 17,164      $ 23,872   

Cash paid for income tax

   $ 3,015      $ 500   

Loans transferred to other real estate owned

   $ 27,266      $ 19,998   

See accompanying notes to unaudited consolidated condensed financial statements.

 

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NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

Columbia Banking System, Inc.

1. Basis of Presentation and Significant Accounting Policies

(a) Basis of Presentation

The interim unaudited consolidated condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for condensed interim financial information and with instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain financial information and footnotes have been omitted or condensed. The consolidated condensed financial statements include the accounts of Columbia Banking System, Inc. (“the Company”), and its wholly owned banking subsidiary Columbia State Bank (“the Bank”). All intercompany transactions and accounts have been eliminated in consolidation. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair statement of the results for the interim periods presented have been included. The results of operations for the nine months ended September 30, 2010 are not necessarily indicative of results to be anticipated for the year ending December 31, 2010. The accompanying interim unaudited consolidated condensed financial statements should be read in conjunction with the financial statements and related notes contained in the Company’s 2009 Annual Report on Form 10-K.

Certain reclassifications have been made to the prior-period’s financial statements to conform to the current period’s presentation.

(b) Significant Accounting Policies

The significant accounting policies used in preparation of our consolidated financial statements are disclosed in our 2009 Annual Report on Form 10-K. With the exception of the significant accounting policies listed below, there have not been any other changes in our significant accounting policies compared to those contained in our 2009 10-K disclosure for the year ended December 31, 2009.

Loans

The Company’s accounting methods for loans differ depending on whether the loans were originated or were acquired as a result of a business acquisition.

Originated Loans

Loans are generally carried at principal amounts less net deferred loan fees. Net deferred loan fees include deferred unamortized origination fees less direct incremental origination costs. Net deferred loan fees are amortized into interest income over the contractual life of the related loans. Interest income is accrued as earned. Fees related to lending activities other than the origination or purchase of loans are recognized as noninterest income during the period the related services are performed.

Loans are placed on nonaccrual status when a loan becomes contractually past due 90 days with respect to interest or principal unless the loan is both well secured and in the process of collection, or if full collection of interest or principal becomes uncertain. When a loan is placed on nonaccrual status, the accrued and unpaid interest receivable is reversed and the accretion of net deferred loan fees ceases. Thereafter, interest collected on the loan is accounted for on the cash collection or cost recovery method until qualifying for return to accrual status. Generally, a loan may be returned to accrual status when the delinquent principal and interest are brought current in accordance with the terms of the loan agreement and future payments are reasonably assured.

Loans are considered impaired when based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. The assessment for impairment occurs when and while such loans are designated as criticized/classified per the Company’s internal risk rating system or when and while such loans are on nonaccrual. All nonaccrual loans greater than $250,000 are considered impaired and analyzed individually on a quarterly basis. Criticized/classified loans with an outstanding balance greater than $250,000 are evaluated for potential impairment on a quarterly basis.

When a loan with unique risk characteristics has been identified as being impaired, the amount of impairment will be measured by the Company using discounted cash flows, except when it is determined that the primary (remaining) source of repayment for the loan is the operation or liquidation of the underlying collateral. In these cases, the current fair value of the collateral, reduced by costs to sell, will be used in place of discounted cash flows. As a final alternative, the observable market price of the debt may be used to assess impairment. Predominantly, the Company uses the fair value of collateral approach based upon a reliable valuation.

 

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NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS—(Continued)

Columbia Banking System, Inc.

 

 

When the measurement of the impaired loan is less than the recorded amount of the loan, an impairment is recognized by recording a charge-off to the allowance for loan and lease losses or by designating a specific reserve. The Company’s policy is to record cash receipts received on impaired loans first as reductions to principal and then to interest income.

Unfunded loan commitments are generally related to providing credit facilities to clients of the Bank, and are not actively traded financial instruments.

Acquired Loans

Loans acquired in a business acquisition after December 31, 2008 are recorded at their fair value at acquisition date, factoring in credit losses expected to be incurred over the life of the loan. Accordingly, an allowance for loan losses is not carried over or recorded as of the acquisition date.

Loans purchased with evidence of credit deterioration since origination for which it is probable that all contractually required payments will not be collected are accounted for under Accounting Standards Codification (“ASC”) 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality, formerly SOP 03-3 Accounting for Certain Loans or Debt Securities Acquired in a Transfer. In situations where such loans have similar risk characteristics, loans are aggregated into pools to estimate cash flows. The Company aggregated all of the loans acquired in the Federal Deposit Insurance Corporation (“FDIC”)-assisted acquisitions into pools, based on common risk characteristics. A pool is accounted for as a single asset with a single interest rate, cumulative loss rate and cash flow expectation. Expected cash flows at the acquisition date in excess of the fair value of loans are considered to be accretable yield, which is recognized as interest income over the life of the loan pool using a level yield method if the timing and amount of the future cash flows of the pool is reasonably estimable. Subsequent to the acquisition date, any increases in cash flow over those expected at purchase date in excess of fair value are recorded as interest income prospectively. Any subsequent decreases in cash flow over those expected at purchase date are recognized by recording an allowance for loan losses. Any disposals of loans, including sales of loans, payments in full or foreclosures result in the removal of the loan from the loan pool at the carrying amount. The Company elected to account for all acquired loans under ASC 310-30.

Covered Assets and Related FDIC Indemnification Asset

Assets subject to loss-sharing agreements with the FDIC are labeled “covered” on the Consolidated Condensed Balance Sheet and include certain loans and other real estate owned (“OREO”).

All OREO acquired in FDIC-assisted acquisitions are subject to FDIC loss-sharing agreements and are referred to as covered OREO. Covered OREO is reported exclusive of expected reimbursement cash flows from the FDIC. Upon transferring covered loan collateral to covered OREO status, acquisition date fair value discounts on the related loan are also transferred to covered OREO. Fair value adjustments on covered OREO result in a reduction of the covered OREO carrying amount and a corresponding increase in the expected FDIC reimbursement, with the estimated net loss to the Company, if any, charged against earnings.

The acquisition date fair value of the reimbursement the Company expected to receive from the FDIC under those agreements was recorded in the FDIC indemnification asset on the Consolidated Condensed Balance Sheet. Subsequent to the acquisition the indemnification asset is tied to the loss in the covered loans and covered OREO and is not being accounted for under fair value. The FDIC indemnification asset is accounted for on the same basis as the related covered loans and covered OREO and is the present value of the cash flows the Company expects to collect from the FDIC under the loss-sharing agreements. The difference between the present value and the undiscounted cash flow the Company expects to collect from the FDIC is accreted into noninterest income over the life of the FDIC indemnification asset. The FDIC indemnification asset is adjusted for any changes in expected cash flows based on the loan performance. Any projected increase in cash flows of the loans over those expected will result in a decrease in the accretion for the FDIC indemnification asset recognized in noninterest income. Any projected decrease in cash flows of the loans over those expected will result in an increase in the FDIC indemnification asset with a corresponding benefit recorded to the provision for loan and lease losses.

Core Deposit Intangible

Core Deposit Intangible (“CDI”) is a measure of the value of non-interest checking, savings, NOW and money market deposits that are acquired in a business combination. The fair value of the CDI stemming from any given business combination is based on the present value of the expected cost savings attributable to the core deposit funding, relative to an alternative source of funding. The CDI related to the Columbia River Bank and American Marine Bank acquisitions will be

 

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amortized over an estimated useful life of 10 years to approximate the existing deposit relationships acquired. The Company evaluates such identifiable intangibles for impairment when an indication of impairment exists.

2. Accounting Pronouncements Recently Issued

In July 2010, the Financial Accounting Standards Board (“the FASB”) issued Accounting Standards Update (“ASU”) 2010-20, an amendment of Receivables – Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses (Topic 310). ASU 2010-20 attempts to provide financial statement users with greater transparency about an entity’s allowance for credit losses and the credit quality of its financing receivables. The objective of the amendments in this update is for an entity to provide disclosures that facilitate financial statement users’ evaluation of the following:

 

  1. the nature of credit risk inherent in the entity’s portfolio of financing receivables,

 

  2. how that risk is analyzed and assessed in arriving at the allowance for credit losses and

 

  3. the changes and reasons for those changes in the allowance for credit losses.

In addition to existing requirements, the amendments in this update require an entity to provide the following additional disclosures about its financing receivables:

 

  1. credit quality indicators of financing receivables at the end of the reporting period by class of financing receivables,

 

  2. the aging of past due financing receivables at the end of the reporting period by class of financing receivables,

 

  3. the nature and extent of troubled debt restructurings that occurred during the period by class of financing receivables and their effect on the allowance for credit losses,

 

  4. the nature and extent of financing receivables modified as troubled debt restructurings within the previous 12 months that defaulted during the reporting period by class of financing receivables and their effect on the allowance for credit losses and

 

  5. significant purchases and sales of financing receivables during the reporting period disaggregated by portfolio segment.

The new guidance will become effective in the first interim or annual period ending on or after December 15, 2010. The new guidance will not have a material impact on the Company’s consolidated financial statements.

In April 2010, the FASB issued ASU 2010-18, an amendment of Receivables – Loans and Debt Securities Acquired with Deteriorated Credit Quality (Topic 310-30). ASU 2010-18 attempts to eliminate diversity in practice related to loan modifications. Modifications of loans within a pool of loans accounted for as a single asset do not result in the removal of those loans from the pool even if the modification of those loans would otherwise be considered a troubled debt restructuring. The entity will continue to be required to consider whether the pool of assets in which the loans are included is impaired if expected cash flows for the pool change. The new guidance became effective in the first reporting period ending on or after July 15, 2010 and is to be applied prospectively. The Company was already in compliance with the amendments of this topic prior to the release of ASU 2010-18. The new guidance did not have an impact on the Company’s consolidated financial statements.

In January 2010, the FASB issued ASU 2010-06, Fair Value Measurements and Disclosures (Topic 820), which focuses on Improving Disclosures about Fair Value Measurement. ASU 2010-06 requires new disclosures about transfers in and out of Level 1 and Level 2 fair value measurements and the activity in Level 3 fair value measurements (i.e. purchases, sales, issuances, and settlements). ASU 2010-06 also amended disclosure requirements related to the level of disaggregation of assets and liabilities, as well as disclosures about input and valuation techniques used to measure fair value for both recurring and nonrecurring fair value measurements. The new guidance became effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements and did not have a material impact on the Company’s consolidated financial statements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years.

3. Earnings per Common Share

Basic EPS is computed by dividing income applicable to common shareholders by the weighted average number of common shares outstanding for the period. Common shares outstanding include common stock and vested restricted stock awards where recipients have satisfied the vesting terms. Diluted EPS reflects the assumed conversion of all dilutive securities, applying the treasury stock method. The Company calculates earnings per share using the two-class method as described in the Earnings per Share topic of the FASB ASC.

 

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The following table sets forth the computation of basic and diluted earnings per share for the three and nine months ended September 30, 2010 and 2009:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 

(in thousands except per share)

   2010     2009     2010     2009  

Basic EPS:

        

Net income

   $ 5,204      $ (1,502   $ 18,176      $ (5,520

Less: Preferred dividends and accretion of issuance discount for preferred stock

     (2,730     (1,103     (4,947     (3,298
                                

Net income applicable to common shareholders

   $ 2,474      $ (2,605   $ 13,229      $ (8,818

Less: Earnings allocated to participating securities

     (22     (3     (127     (13
                                

Earnings allocated to common shareholders

   $ 2,452      $ (2,608   $ 13,102      $ (8,831
                                

Weighted average common shares outstanding

     38,976        23,468        33,938        19,837   

Basic earnings per common share

   $ 0.06      $ (0.11   $ 0.39      $ (0.45
                                

Diluted EPS:

        

Earnings allocated to common shareholders

   $ 2,452      $ (2,608   $ 13,102      $ (8,831
                                

Weighted average common shares outstanding

     38,976        23,468        33,938        19,837   

Dilutive effect of equity awards and warrants

     161        —          204        —     
                                

Weighted average diluted common shares outstanding

     39,137        23,468        34,142        19,837   
                                

Diluted earnings per common share

   $ 0.06      $ (0.11   $ 0.38      $ (0.45
                                

Potentially dilutive share options that were not included in the computation of diluted EPS because to do so would be anti-dilutive.

     62        853        54        918   

4. Business Combinations

Columbia River Bank

On January 22, 2010 the Bank acquired certain assets and assumed certain liabilities of Columbia River Bank from the FDIC in an FDIC-assisted transaction. As part of the Purchase and Assumption Agreement, the Bank and the FDIC entered into loss-sharing agreements (each, a “loss-sharing agreement” and collectively, the “loss-sharing agreements”), whereby the FDIC will cover a substantial portion of any future losses on loans (and related unfunded loan commitments), OREO and certain accrued interest on loans. We refer to the acquired loans and OREO subject to the loss-sharing agreements collectively as “covered assets.” Under the terms of the loss-sharing agreements, the FDIC will absorb 80% of losses and share in 80% of loss recoveries on the first $206 million on covered assets and absorb 95% of losses and share in 95% of loss recoveries exceeding $206 million. The loss-sharing agreements for commercial and single family residential mortgage loans are in effect for five years and ten years, respectively, from the January 22, 2010 acquisition date and the loss recovery provisions for such loans are in effect for eight years and ten years, respectively, from the acquisition date.

The Bank acquired tangible assets with an acquisition date fair value of approximately $885.3 million, including $480.3 million of loans, an FDIC indemnification asset of $143.6 million, $100.7 million of investment securities, $98.1 million of cash and cash equivalents and $62.6 million of other assets. The Bank assumed liabilities with an acquisition date fair value of approximately $912.9 million, including $893.4 million of insured and uninsured deposits, $18.4 million of Federal Home Loan Bank (“FHLB”) advances and $1.1 million of other liabilities. Columbia River Bank was a full service commercial bank headquartered in The Dalles, Oregon that operated 21 branch locations, including 14 in the state of Oregon and seven in the State of Washington. We made this acquisition to expand our geographic footprint.

The assets acquired and liabilities assumed have been accounted for under the acquisition method of accounting (formerly the purchase method). The assets and liabilities, both tangible and intangible, were recorded at their estimated fair values as of the January 22, 2010 acquisition date. The application of the acquisition method of accounting resulted in the recognition in $14.1 million of goodwill and a core deposit intangible of $13.4 million. The goodwill represents the excess of the estimated fair value of the liabilities assumed over the estimated fair value of the assets acquired and is influenced significantly by the FDIC-assisted transaction process. All of the goodwill and core deposit intangible assets recognized are deductible for income tax purposes.

The operating results of the Company for the nine months ended September 30, 2010 include the operating results produced by the acquired assets and assumed liabilities for the period January 23, 2010 to September 30, 2010. Due primarily to the Company acquiring only certain assets and liabilities of Columbia River Bank, the significant amount of fair

 

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value adjustments and the FDIC loss-sharing agreements now in place, historical results of Columbia River Bank are not meaningful to the Company’s results and thus no pro forma information is presented.

On April 22, 2010, the Company notified the FDIC of its intent to purchase fourteen branch buildings from the Columbia River Bank Receivership. The fourteen branch buildings have an aggregate appraised value of $15.8 million. Additionally, the Company accepted leases on nine former branch and administrative locations of Columbia River Bank.

The table below displays the amounts recognized as of the acquisition date for each major class of assets acquired and liabilities assumed:

 

     January 22,
2010
 

Assets

  

Cash and due from banks

   $ 33,222   

Interest-earning deposits with banks

     64,921   

Investment securities

     100,650   

Federal Home Loan Bank stock

     3,045   

Loans covered by loss sharing

     480,306   

Accrued interest receivable

     4,021   

FDIC receivable

     46,213   

Other real estate owned covered by loss sharing

     8,714   

Goodwill

     14,120   

Core deposit intangible

     13,442   

FDIC indemnification asset

     143,609   

Other assets

     615   
        

Total assets acquired

   $ 912,878   
        

Liabilities

  

Deposits

   $ 893,356   

Federal Home Loan Bank advances

     18,428   

Accrued interest payable

     524   

Other liabilities

     570   
        

Total liabilities assumed

   $ 912,878   
        

American Marine Bank

On January 29, 2010, the Bank acquired certain assets and assumed certain liabilities of American Marine Bank from the FDIC, which had been appointed receiver of the institution. As part of the Purchase and Assumption Agreement, the Bank and the FDIC entered into loss-sharing agreements whereby the FDIC will cover a substantial portion of any future losses on loans (and related unfunded loan commitments), OREO and certain accrued interest on loans. Under the terms of the loss-sharing agreements, the FDIC will absorb 80% of losses and share in 80% of loss recoveries on the first $66 million on covered assets and absorb 95% of losses and share in 95% of loss recoveries exceeding $66 million. The loss-sharing agreements for commercial and single family residential mortgage loans are in effect for five years and ten years, respectively, from the January 29, 2010 acquisition date and the loss recovery provisions for such loans are in effect for eight years and ten years, respectively, from the acquisition date.

The Bank acquired tangible assets with an acquisition date fair value of approximately $303.5 million, including $176.3 million of loans, an FDIC indemnification asset of $66.8 million, $28.6 million of investment securities, $14.5 million of cash and cash equivalents and $17.3 million of other assets. The Bank assumed liabilities with an acquisition date fair value of approximately $292.6 million, including $254.0 million of insured and uninsured deposits, $37.7 million of FHLB advances and $974 thousand of other liabilities. American Marine Bank was a full service commercial bank headquartered on Bainbridge Island, Washington that operated 11 branch locations in western Washington. In addition, as part of this acquisition, the Bank received regulatory approval to exercise trust powers and intends to continue to operate the Trust and Wealth Management Division of American Marine Bank. We made this acquisition to expand our geographic footprint.

The assets acquired and liabilities assumed have been accounted for under the acquisition method of accounting. The assets and liabilities, both tangible and intangible, were recorded at their estimated fair values as of the January 29, 2010 acquisition date. The application of the acquisition method of accounting resulted in the recognition of a bargain purchase gain of $9.8 million, which is included in the Gain on bank acquisition line item in the Consolidated Condensed Statements

 

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of Income, and a core deposit intangible of $4.3 million. The transaction resulted in a bargain purchase gain as the fair value of assets acquired exceeded the fair value of liabilities assumed.

The operating results of the Company for the nine months ended September 30, 2010 include the operating results produced by the acquired assets and assumed liabilities for the period January 30, 2010 to September 30, 2010. Due primarily to the Company acquiring only certain assets and liabilities of American Marine Bank, the significant amount of fair value adjustments and the FDIC loss-sharing agreements now in place, historical results of American Marine Bank are not meaningful to the Company’s results and thus no pro forma information is presented.

On April 22, 2010, the Company notified the FDIC of its intent to purchase four branch buildings from the American Marine Bank Receivership. The four branch buildings have an aggregate appraised value of $7.4 million. Additionally, the Company accepted leases on six former branch locations of American Marine Bank.

The table below displays the amounts recognized as of the acquisition date for each major class of assets acquired and liabilities assumed:

 

     January 29,
2010
 

Assets

  

Cash and cash equivalents

   $ 14,215   

Federal funds sold

     267   

Investment securities

     28,592   

Federal Home Loan Bank stock

     3,257   

Loans covered by loss sharing

     176,278   

Accrued interest receivable

     1,280   

FDIC receivable

     3,646   

Other real estate owned covered by loss sharing

     8,680   

Core deposit intangible

     4,313   

FDIC indemnification asset

     66,796   

Other assets

     498   
        

Total assets acquired

     307,822   

Liabilities

  

Deposits

     253,965   

Federal Home Loan Bank advances

     37,682   

Accrued interest payable

     337   

Deferred tax liability, net

     5,383   

Other liabilities

     637   
        

Total liabilities assumed

     298,004   
        

Net assets acquired

   $ 9,818   
        

The following is a description of the methods used to determine the fair values of the significant assets and liabilities presented above for both the Columbia River Bank and American Marine Bank acquisitions.

Cash and cash equivalents - Cash and cash equivalents include cash and due from banks, interest-earning deposits with banks and the Federal Reserve Bank (“FRB”) and federal funds sold. Cash and cash equivalents have a maturity of 90 days or less at the time of purchase. The fair value of financial instruments that are short-term or re-price frequently and that have little or no risk are considered to have a fair value equal to carrying value.

Investment securities - The fair value for each purchased security was the quoted market price at the close of the trading day effective on the acquisition dates.

Federal Home Loan Bank stock - The fair value of acquired FHLB stock was estimated to be its redemption value, which is also the par value. The FHLB requires member banks to purchase its stock as a condition of membership and the amount of FHLB stock owned varies based on the level of FHLB advances outstanding. This stock is generally redeemable and is presented at the par value.

        Loans - We refer to certain loans acquired in the Columbia River Bank and American Marine Bank acquisitions as “covered loans” as we will be reimbursed for a substantial portion of any future losses on them under the terms of the FDIC loss-sharing agreements. The estimated fair value of the loan portfolios at the acquisition dates represents the discounted expected cash flows from the portfolio. In estimating such fair value, we (a) calculated the contractual amount and timing of

 

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undiscounted principal and interest payments (the “undiscounted contractual cash flows”) and (b) estimated the amount and timing of undiscounted expected principal and interest payments (the “undiscounted expected cash flows”). The amount by which the undiscounted expected cash flows exceed the estimated fair value (the “accretable yield”) is accreted into interest income over the life of the loans. The difference between the undiscounted contractual cash flows and the undiscounted expected cash flows is the nonaccretable difference. The nonaccretable difference represents an estimate of the credit risk in the Columbia River Bank and American Marine Bank loan portfolios at the acquisition dates.

In calculating expected cash flows, management made several assumptions regarding prepayments, collateral cash flows, the timing of defaults and the loss severity of defaults. Other factors expected by market participants were considered in determining the fair value of acquired loans, including loan pool level estimated cash flows, type of loan and related collateral, risk classification status (i.e. performing or nonperforming), fixed or variable interest rate, term of loan and whether or not the loan was amortizing and current discount rates.

Other real estate owned - OREO is presented at its estimated fair value based on discounted expected cash flows and is also subject to the FDIC shared-loss agreements. Cash flows were estimated using expected selling price and date, less selling and carrying costs and were discounted to present value.

Goodwill - Goodwill represents the excess of the estimated fair value of the liabilities assumed over the estimated fair value of the assets acquired and is influenced significantly by the FDIC-assisted transaction process.

Core deposit intangible - In determining the estimated life and fair value of the core deposit intangible, deposits were analyzed based on factors such as type of deposit, deposit retention, interest rates, and age of the deposit relationships. Based on this valuation, the core deposit intangible asset will be amortized over the projected useful lives of the related deposits on an accelerated basis over 10 years. 

FDIC indemnification asset - The FDIC indemnification asset is measured separately from each of the covered asset categories as it is not contractually embedded in any of the covered asset categories. For example, the FDIC indemnification asset related to estimated future loan losses is not transferable should we sell a loan prior to foreclosure or maturity. The fair value of the FDIC indemnification asset represents the present value of the estimated cash payments (net of amount owed to the FDIC) expected to be received from the FDIC for future losses on covered assets based on the credit adjustment on estimated cash flows for each covered asset pool and the loss-sharing percentages. The ultimate collectability of the FDIC indemnification asset is dependent upon the performance of the underlying covered loans, the passage of time and claims paid by the FDIC.

Deposit liabilities - The fair values used for demand and savings deposits are, by definition, equal to the amount payable on demand at the reporting date. The fair values for time deposits are estimated using a discounted cash flow method that applies interest rates currently being offered on time deposits to a schedule of aggregated contractual maturities of such time deposits.

Borrowings - The fair values for FHLB advances are estimated using a discounted cash flow method based on the current market rates.

 

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5. Securities

The following table summarizes the amortized cost, gross unrealized gains and losses and the resulting fair value of securities available for sale:

Securities Available for Sale

 

(in thousands)

   Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair Value  

September 30, 2010:

          

U.S. government agency and government-sponsored enterprise mortgage-backed securities and collateralized mortgage obligations

   $ 431,727       $ 16,585       $ (71   $ 448,241   

State and municipal securities

     221,978         19,238         (24     241,192   

Other securities

     3,281         48         (21     3,308   
                                  

Total

   $ 656,986       $ 35,871       $ (116   $ 692,741   
                                  

December 31, 2009:

          

U.S. government agency and government-sponsored enterprise mortgage-backed securities and collateralized mortgage obligations

   $ 390,688       $ 10,034       $ (566   $ 400,156   

State and municipal securities

     210,987         8,545         (621     218,911   

Other securities

     1,000         —           (29     971   
                                  

Total

   $ 602,675       $ 18,579       $ (1,216   $ 620,038   
                                  

At September 30, 2010, available for sale securities with a carrying amount of $28.7 million were pledged as collateral for repurchase agreement borrowings. In addition, available for sale securities with a carrying amount of $14.8 million at September 30, 2010 were pledged as collateral for potential obligations under certain interest rate swap agreements.

The following tables show the gross unrealized losses and fair value of the Company’s investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at September 30, 2010 and December 31, 2009:

September 30, 2010

 

     Less than 12 Months     12 Months or More     Total  

(in thousands)

   Fair Value      Unrealized
Losses
    Fair
Value
     Unrealized
Losses
    Fair Value      Unrealized
Losses
 

U.S. government agency and government-sponsored enterprise mortgage-backed securities and collateralized mortgage obligations

   $ 29,197       $ (71   $ 17       $ —        $ 29,214       $ (71

State and municipal securities

     26         (1     3,025         (23     3,051         (24

Other securities

     —           —          979         (21     979         (21
                                                   

Total

   $ 29,223       $ (72   $ 4,021       $ (44   $ 33,244       $ (116
                                                   

December 31, 2009

               
     Less than 12 Months     12 Months or More     Total  

(in thousands)

   Fair Value      Unrealized
Losses
    Fair
Value
     Unrealized
Losses
    Fair Value      Unrealized
Losses
 

U.S. government agency and government-sponsored enterprise mortgage-backed securities and collateralized mortgage obligations

   $ 87,879       $ (566   $ 17       $ —        $ 87,896       $ (566

State and municipal securities

     14,846         (42     16,272         (579     31,118         (621

Other securities

     —           —          971         (29     971         (29
                                                   

Total

   $ 102,725       $ (608   $ 17,260       $ (608   $ 119,985       $ (1,216
                                                   

        The unrealized losses on the above securities are primarily attributable to increases in market interest rates subsequent to their purchase by the Company. Management does not intend to sell any impaired securities nor does available evidence suggest it is more likely than not that management will be required to sell any impaired securities. The Company’s securities portfolio does not include any private label mortgage backed securities or investments in trust preferred securities. Management believes the nature of securities in the Company’s investment portfolio present a very high probability of collecting all contractual amounts due, as the majority of the securities held are backed by government agencies or government-sponsored enterprises. However, this recovery in value may not occur for some time, perhaps greater than the one-year time horizon or perhaps even at maturity.

 

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The scheduled contractual maturities of investment securities available for sale at September 30, 2010 are presented as follows:

 

      September 30, 2010  

(in thousands)

   Amortized Cost      Fair Value  

Due within one year

   $ 2,492       $ 2,551   

Due after one year through five years

     64,617         67,400   

Due after five years through ten years

     102,197         108,232   

Due after ten years

     484,399         511,250   
                 

Total investment securities available-for-sale

   $ 653,705       $ 689,433   
                 

6. Loans

The following is an analysis of the loan portfolio by major types of loans (net of deferred loan fees):

 

(in thousands)

   September 30,
2010
    December 31,
2009
 

Loans, excluding covered loans:

    

Commercial business

   $ 761,113      $ 744,440   

Real Estate:

    

One-to-four family residential

     53,583        63,364   

Commercial and five or more family residential properties

     819,415        856,260   
                

Total real estate

     872,998        919,624   

Real estate construction:

    

One-to-four family residential

     80,289        107,620   

Commercial and five or more family residential properties

     33,929        41,829   
                

Total real estate construction

     114,218        149,449   

Consumer

     189,495        199,987   

Less: deferred loan fees

     (3,662     (4,616
                

Total loans, excluding covered loans

     1,934,162        2,008,884   
                

Covered loans

     561,131        —     

Total loans, net of deferred loan fees

   $ 2,495,293      $ 2,008,884   
                

At September 30, 2010 and December 31, 2009, the Company had no loans to foreign domiciled businesses or foreign countries, or loans related to highly leveraged transactions. The majority of the Company’s loans and loan commitments are geographically concentrated in its service areas within the states of Washington and Oregon. At September 30, 2010, the Company had $1.5 million in Small Business Administration (“SBA”) loans pledged as collateral for SBA-secured borrowings.

As of the acquisition dates, we estimated the fair value of the Columbia River Bank and American Marine Bank loan portfolios at $480.3 million and $176.3 million, respectively, which represents the expected cash flows from the portfolio discounted at market-based rates. In estimating such fair value, we (a) calculated the contractual amount and timing of the undiscounted principal and interest payments (the “undiscounted contractual cash flows”); and (b) estimated the amount and timing of the undiscounted expected principal and interest payments (the “undiscounted expected cash flows”). The amount by which the undiscounted expected cash flows exceed the estimated fair value (the “accretable yield”) is accreted into interest income over the lives of the loans. The difference between the undiscounted contractual cash flows and the undiscounted expected cash flows is referred to as the “non-accretable difference.” The non-accretable difference represents an estimate of credit risk in the covered loan portfolios on the acquisition dates. On the acquisition dates, the preliminary estimate of the undiscounted contractual principal and interest payments for the covered loans acquired in the Columbia River Bank and American Marine Bank acquisitions were $799.8 million and $259.6 million, respectively. The accretable yields were approximately $101.1 million and $21.6 million, respectively, and the non-accretable differences were $217.9 million and $65.5 million, respectively. The expected cash flows at acquisition date, which is the undiscounted contractual principal and interest payments, less the non-accretable differences were $581.9 million and $194.1 million, respectively.

 

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NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS—(Continued)

Columbia Banking System, Inc.

 

 

The following table shows the changes in accretable yield for acquired loans for the nine months ended September 30, 2010:

 

      September 30, 2010  

(in thousands)

   Accretable Yield  

Balance at beginning of period

   $ —     

Established through acquisitions

     122,705   

Accretion

     (39,255

Transfers from nonaccretable difference

     81,399   

Disposals and other

     (22,484
        

Balance at end of period

   $ 142,365   
        

FDIC indemnification asset - As of the acquisition dates, we recorded an FDIC indemnification asset consisting of the present value of the amounts the Company expects to receive from the FDIC under the loss-sharing agreements. The FDIC indemnification asset was $166.7 million at September 30, 2010. The decrease in the indemnification asset since the acquisitions of Columbia River Bank and American Marine Bank included $2.4 million and $6.4 million of accretion into income for the three and nine months, respectively, ended September 30, 2010. Additionally, because of higher cash flows from principal amortization, partial prepayments, and loan payoffs during this timeframe, the Company reduced the indemnification asset by $6.6 million for the three and nine months ended September 30, 2010 and recorded the adjustment as a reduction of noninterest income. The remainder of the change in the indemnification asset was due to charge-offs and losses on covered assets, which are primarily recoverable from the FDIC under the loss-sharing agreements and recorded in other assets.

7. Allowance for Loan and Lease Losses and Unfunded Loan Commitments and Letters of Credit

The following table presents activity in the allowance for noncovered loan and lease losses for the three and nine months ended September 30, 2010 and 2009:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 

(in thousands)

   2010     2009     2010     2009  

Beginning balance

   $ 59,748      $ 48,880      $ 53,478      $ 42,747   

Provision charged to expense

     9,000        16,500        37,500        48,500   

Loans charged off

     (7,540     (13,826     (31,466     (40,330

Recoveries

     1,126        134        2,822        771   
                                

Ending balance

   $ 62,334      $ 51,688      $ 62,334      $ 51,688   
                                

Covered loans acquired in the Columbia River Bank and American Marine Bank acquisitions are also subject to the Bank’s internal and external credit review. Covered loans are accounted for under ASC Topic 310-30, and initially measured at fair value based on expected future cash flows over the lives of the loans. Over the life of the covered loan pools, management continues to monitor and estimate expected future cash flows on a quarterly basis. If expected future cash flows decline, a provision is recorded for estimated covered loan losses. During the quarter ended September 30, 2010, the Company recorded a provision expense of $453 thousand on covered loans accounted for under ASC 310-30 as a result of a decrease in expected future cash flows. If expected cash flows on covered loans increase, subsequent to a loss provision being recorded, the loss provision will be reversed with any additional increases in expected cash flows made as an adjustment from non-accretable difference to accretable yield. No such reversal occurred for the periods presented.

 

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NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS—(Continued)

Columbia Banking System, Inc.

 

 

Changes in the allowance for unfunded loan commitments and letters of credit are summarized as follows:

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 

(in thousands)

   2010      2009      2010      2009  

Beginning balance

   $ 815       $ 575       $ 775       $ 500   

Net changes in the allowance for unfunded commitments and letters of credit

     350         200         390         275   
                                   

Ending balance

   $ 1,165       $ 775       $ 1,165       $ 775   
                                   

At September 30, 2010 and December 31, 2009, the total recorded investment in impaired loans was $106.9 million and $116.4 million, respectively. At September 30, 2010, $22.1 million of impaired loans had a specific valuation allowance of $3.8 million. At December 31, 2009, $18.1 million of impaired loans had a specific valuation allowance of $3.8 million.

8. Changes in Other Real Estate Owned

At September 30, 2010 OREO was $40.3 million, which included $17.0 million of covered OREO acquired in the FDIC-assisted acquisitions of Columbia River Bank and American Marine Bank. The acquired OREO is covered by loss-sharing agreements with the FDIC in which the FDIC will assume 80% of additional write-downs and losses on covered OREO sales, or 95% of additional write-downs and losses on covered OREO sales if the minimum loss share threshold has been met (see note 4 for threshold amounts).

The following table sets forth activity in noncovered OREO for the period:

 

(in thousands)

   Three Months
Ended
September 30, 2010
    Nine Months
Ended
September 30, 2010
 

Noncovered OREO:

    

Balance, beginning of period

   $ 22,814      $ 19,037   

Transfers in, net of write-downs ($14 and $165 thousand, respectively)

     778        8,791   

OREO improvements

     557        1,136   

Additional OREO write-downs

     (183     (1,754

Proceeds from sale of OREO property

     (760     (3,943

Loss (gain) on sale of OREO

     53        (8
                

Total non-covered OREO, end of period

   $ 23,259      $ 23,259   
                

9. Goodwill and Intangible Assets

In accordance with the Intangibles – Goodwill and Other topic of the FASB ASC, goodwill is not amortized but is reviewed for potential impairment at the reporting unit level during the third quarter on an annual basis and between annual tests in certain circumstances such as material adverse changes in legal, business, regulatory and economic factors. An impairment loss is recorded to the extent that the carrying amount of goodwill exceeds its implied fair value. The Company completed its annual goodwill impairment test during the current quarter and determined the fair value of the Company’s single reporting unit exceeded its carrying value.

The core deposit intangible “CDI” is evaluated for impairment if events and circumstances indicate a possible impairment. The CDI is amortized on an accelerated basis over an estimated life of approximately 10 years.

 

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NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS—(Continued)

Columbia Banking System, Inc.

 

 

The following table sets forth activity for goodwill and intangible assets for the period:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 

(in thousands)

   2010     2009     2010     2009  

Total goodwill, beginning of period

   $ 109,639      $ 95,519      $ 95,519      $ 95,519   

Established through acquisitions

     —          —          14,120        —     
                                

Total goodwill, end of period

     109,639        95,519        109,639        95,519   
                                

Gross core deposit intangible balance

     26,651        8,896        8,896        8,896   

Accumulated amortization at beginning of period

     (5,874     (3,528     (4,032     (2,988
                                

Core deposit intangible, net, beginning of period

     20,777        5,368        4,864        5,908   

Established through acquisitions

     —          —          17,755        —     

CDI current period amortization

     (1,044     (256     (2,886     (796
                                

Total core deposit intangible, end of period

     19,733        5,112        19,733        5,112   
                                

Total goodwill and intangible assets, end of period

   $ 129,372      $ 100,631      $ 129,372      $ 100,631   
                                

The following table provides the estimated future amortization expense of core deposit intangibles for the three months ending December 31, 2010 and the succeeding four years:

 

Estimated Future Amortization Expense of Core Deposit Intangibles

   Amount  
     (in thousands)  

Three months ending December 31, 2010

   $ 1,036   

Year ending December 31, 2011

     3,825   

Year ending December 31, 2012

     3,441   

Year ending December 31, 2013

     3,066   

Year ending December 31, 2014

     2,604   

10. Shareholders’ Equity

Preferred Stock. On August 11, 2010, the Company redeemed all 76,898 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A (“Preferred Stock”) originally issued to the U.S. Department of Treasury (“the Treasury”) on November 21, 2008 for approximately $76.9 million in capital under its Capital Purchase Program (“CPP”). The Company paid a total of $77.8 million to the Treasury, consisting of $76.9 million in principal and $919 thousand in accrued and unpaid dividends. Earnings available to the common shareholders were reduced by $2.3 million upon repayment of the Preferred Stock, which represented the remaining unamortized discount on the Preferred Stock. Additionally, on September 1, 2010, the Company repurchased the common stock warrant issued to the Treasury pursuant to the Troubled Asset Relief Program (“TARP”) CPP for $3.3 million. The warrant repurchase, together with the Company’s redemption of its entire Preferred Stock issued to the Treasury, represents full repayment of all TARP obligations and cancellation of all equity interests in the Company held by the Treasury.

Common Stock. On January 28, 2010, the Company declared a quarterly cash dividend of $0.01 per share, payable on February 24, 2010 to shareholders of record as of the close of business February 10, 2010. On April 28, 2010, the Company declared a quarterly cash dividend of $0.01 per share, payable on May 26, 2010, to shareholders of record at the close of business May 12, 2010. On July 29, 2010, the Company declared a quarterly cash dividend of $0.01 per share, payable on August 25, 2010, to shareholders of record at the close of business August 11, 2010. Subsequent to quarter end, on October 28, 2010 the Company declared a quarterly cash dividend of $0.01 per share, payable on November 24, 2010, to shareholders of record at the close of business November 10, 2010.

The payment of cash dividends is subject to Federal regulatory requirements for capital levels and other restrictions. In addition, the cash dividends paid by the Bank to the Company are subject to both Federal and State regulatory requirements.

On May 5, 2010, the Company completed an underwritten public offering of 11,040,000 shares of our common stock at a purchase price to the public of $21.75 per share, resulting in gross proceeds of approximately $240.1 million and net proceeds to us of approximately $229.1 million.

 

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NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS—(Continued)

Columbia Banking System, Inc.

 

 

11. Comprehensive Income

The components of comprehensive income are as follows:

 

     Three Months Ended
September 30,
 

(in thousands)

   2010     2009  

Net income (loss) as reported

   $ 5,204      $ (1,502

Net unrealized holding gain from available for sale securities arising during the period, net of tax of ($2,611) and ($2,655)

     4,739        4,655   

Net change in cash flow hedging instruments, net of tax of $119 and $212

     (216     (384

Pension plan liability adjustment, net of tax ($4) and ($5)

     7        10   
                

Total comprehensive income

   $ 9,734      $ 2,779   
                
     Nine Months Ended
September 30,
 

(in thousands)

   2010     2009  

Net income (loss) as reported

   $ 18,176      $ (5,520

Unrealized gain from securities:

    

Net unrealized holding gain from available for sale securities arising during the period, net of tax of ($6,553) and ($4,802)

     11,897        8,717   

Reclassification adjustment of net gain included in income, net of tax of $20 and $0

     (38     —     
                

Net unrealized gain from securities, net of reclassification adjustment

     11,859        8,717   

Cash flow hedging instruments:

    

Reclassification adjustment of net gain included in income, net of tax of $520 and $696

     (943     (1,264
                

Net change in cash flow hedging instruments

     (943     (1,264

Pension plan liability adjustment:

    

Net unrealized gain (loss) from unfunded defined benefit plan liability arising during the period, net of tax of ($12) and $379

     23        (689

Less: amortization of unrecognized net actuarial loss included in net periodic pension cost, net of tax of ($11) and ($16)

     21        29   
                

Pension plan liability adjustment, net

     44        (660
                

Total comprehensive income

   $ 29,136      $ 1,273   
                

12. Fair Value Accounting and Measurement

The Fair Value Measurements and Disclosures topic of the FASB ASC defines fair value, establishes a consistent framework for measuring fair value and expands disclosure requirements about fair value. We hold fixed and variable rate interest-bearing securities, investments in marketable equity securities and certain other financial instruments, which are carried at fair value. Fair value is determined based upon quoted prices when available or through the use of alternative approaches, such as matrix or model pricing, when market quotes are not readily accessible or available.

The valuation techniques are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our own market assumptions. These two types of inputs create the following fair value hierarchy:

Level 1 – Quoted prices for identical instruments in active markets that are accessible at the measurement date.

Level 2 – Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model derived valuations whose inputs are observable or whose significant value drivers are observable.

 

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NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS—(Continued)

Columbia Banking System, Inc.

 

 

Level 3 – Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable.

Fair values are determined as follows:

Securities at fair value are priced using matrix pricing based on the securities’ relationship to other benchmark quoted prices, and under the provisions of the Fair Value Measurements and Disclosures topic of the FASB ASC are considered a Level 2 input method.

Interest rate contract positions are valued in models, which use as their basis, readily observable market parameters and are classified within level 2 of the valuation hierarchy.

The following table sets forth the Company’s financial assets and liabilities that were accounted for at fair value on a recurring basis at September 30, 2010 by level within the fair value hierarchy. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement:

 

     Fair value at
September 30, 2010
     Fair Value Measurements at Reporting Date Using  

(in thousands)

              Level 1                      Level 2                      Level 3          
Assets            

Securities available for sale

   $ 692,741       $ —         $ 692,741       $ —     

Other assets (Interest rate contracts)

   $ 13,623       $ —         $ 13,623       $ —     
Liabilities            

Other liabilities (Interest rate contracts)

   $ 13,623       $ —         $ 13,623       $ —     

Certain assets and liabilities are measured at fair value on a nonrecurring basis after initial recognition such as loans measured for impairment and OREO. The following methods were used to estimate the fair value of each such class of financial instrument:

Impaired loans - A loan is considered to be impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due (both interest and principal) according to the contractual terms of the loan agreement. Impaired loans are measured by the fair market value of the collateral less estimated costs to sell.

Other real estate owned - OREO is real property that the Bank has taken ownership of in partial or full satisfaction of a loan or loans. OREO is recorded at the lower of the carrying amount of the loan or fair value less estimated costs to sell. This amount becomes the property’s new basis. Any write-downs based on the property fair value less estimated cost to sell at the date of acquisition are charged to the allowance for loan and lease losses. Management periodically reviews OREO in an effort to ensure the property is carried at the lower of its new basis or fair value, net of estimated costs to sell. Any write-downs subsequent to acquisition are charged to earnings.

The following table sets forth the Company’s financial assets that were accounted for at fair value on a nonrecurring basis at September 30, 2010:

 

(in thousands)

   Fair value at
September 30, 2010
     Fair Value Measurements  at
Reporting Date Using
     Losses During  the
Three Months
Ended
September  30, 2010
     Losses During  the
Nine Months Ended
September 30, 2010
 
              Level 1                      Level 2                      Level 3                

Impaired loans

   $ 39,409       $ —         $ —         $ 39,409       $ 4,264       $ 28,376   

Non-covered OREO

     2,313         —           —           2,313         197         1,918   
                                                     
   $ 41,722       $ —         $ —         $ 41,722       $ 4,461       $ 30,294   
                                                     

The losses on impaired loans disclosed above represent the amount of the specific reserve and/or charge-offs during the period applicable to loans held at period end. The amount of the specific reserve is included in the allowance for loan and lease losses. The losses on non-covered OREO disclosed above represent the writedowns taken at foreclosure that were charged to the allowance for loan and lease losses, as well as subsequent writedowns from updated appraisals that were charged to earnings.

 

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NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS—(Continued)

Columbia Banking System, Inc.

 

 

13. Fair Value of Financial Instruments

Because broadly traded markets do not exist for most of the Company’s financial instruments, the fair value calculations attempt to incorporate the effect of current market conditions at a specific time. These determinations are subjective in nature, involve uncertainties and matters of significant judgment and do not include tax ramifications; therefore, the results cannot be determined with precision, substantiated by comparison to independent markets and may not be realized in an actual sale or immediate settlement of the instruments. There may be inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results. For all of these reasons, the aggregation of the fair value calculations presented herein do not represent, and should not be construed to represent, the underlying value of the Company.

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 due from banks and interest-earning deposits with banks - The fair value of financial instruments that are short-term or reprice frequently and that have little or no risk are considered to have a fair value that approximates carrying value.

Securities available for sale - The fair value of all investment securities are based upon the assumptions market participants would use in pricing the security. Such assumptions include observable and unobservable inputs such as quoted market prices, dealer quotes and discounted cash flows.

Federal Home Loan Bank stock - The fair value is based upon the par value of the stock which equates to its carrying value.

Loans - Originated Loans - Loans are not recorded at fair value on a recurring basis. Nonrecurring fair value adjustments are periodically recorded on impaired loans that are measured for impairment based on the fair value of collateral. See Note 12, Fair Value Accounting and Measurement. For most performing loans, fair value is estimated using expected duration and lending rates that would have been offered on September 30, 2010 for loans which mirror the attributes of the loans with similar rate structures and average maturities. Commercial loans and construction loans, which are variable rate and short-term are reflected with fair values equal to carrying value. The fair values resulting from these calculations are reduced by an amount representing the change in estimated fair value attributable to changes in borrowers’ credit quality since the loans were originated. For nonperforming loans, fair value is estimated by applying a valuation discount based upon loan sales data from the Federal Deposit Insurance Corporation. Acquired Loans – Fair value of loans acquired in FDIC-assisted transactions was estimated by applying a valuation discount derived from recent loan sales data and based upon similar loan collateral and performance characteristics.

FDIC indemnification asset - The FDIC indemnification asset is considered to have a fair value that approximates carrying value.

Interest rate contracts - Interest rate swap positions are valued in models, which use as their basis, readily observable market parameters.

Deposits - For deposits with no contractual maturity, the fair value is equal to the carrying value. The fair value of fixed maturity deposits is based on discounted cash flows using the difference between the deposit rate and current market rates for deposits of similar remaining maturities.

FHLB and FRB borrowings - The fair value of FHLB advances and FRB borrowings are estimated based on discounting the future cash flows using the market rate currently offered.

Repurchase Agreements - The fair value of securities sold under agreement to repurchase are estimated based on discounting the future cash flows using the market rate currently offered.

Long-term subordinated debt - The fair value of long-term subordinated debt are estimated based on discounting the future cash flows using an estimated market rate.

Other Financial Instruments - The majority of our commitments to extend credit and standby letters of credit carry current market interest rates if converted to loans, as such, carrying value is assumed to equal fair value.

 

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NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS—(Continued)

Columbia Banking System, Inc.

 

 

The following table summarizes carrying amounts and estimated fair values of selected financial instruments as well as assumptions used by the Company in estimating fair value:

 

     September 30, 2010      December 31, 2009  
     Carrying
Amount
     Fair Value      Carrying
Amount
     Fair Value  
     (in thousands)  
Assets            

Cash and due from banks

   $ 77,235       $ 77,235       $ 55,802       $ 55,802   

Interest-earning deposits with banks

     448,854         448,854         249,272         249,272   

Securities available for sale

     692,741         692,741         620,038         620,038   

Federal Home Loan Bank stock

     17,908         17,908         11,607         11,607   

Loans

     2,432,506         2,192,796         1,955,406         1,808,256   

FDIC indemnification asset

     166,696         166,696         —           —     

Interest rate contracts

     13,623         13,623         9,054         9,054   
Liabilities            

Deposits

   $ 3,306,886       $ 3,473,452       $ 2,482,705       $ 2,486,578   

Federal Home Loan Bank advances

     119,584         122,770         100,000         100,037   

Repurchase agreements

     25,000         28,657         25,000         29,884   

Other borrowings

     1,599         1,599         86         86   

Long-term subordinated debt

     25,719         20,523         25,669         20,296   

Interest rate contracts

     13,623         13,623         9,054         9,054   

14. Derivatives and Hedging Activities

The Company periodically enters into certain commercial loan interest rate swap agreements in order to provide commercial loan customers the ability to convert from variable to fixed interest rates. Under these agreements, the Company enters into a variable-rate loan agreement with a customer in addition to a swap agreement. This swap agreement effectively converts the customer’s variable rate loan into a fixed rate. The Company then enters into a corresponding swap agreement with a third party in order to offset its exposure on the variable and fixed components of the customer agreement. As the interest rate swap agreements with the customers and third parties are not designated as hedges under the Derivatives and Hedging topic of the FASB ASC, the instruments are marked to market in earnings.

The following table presents the fair value of derivative instruments at September 30, 2010 and 2009:

 

    Asset Derivatives     Liability Derivatives  

As of September 30,

  2010     2009           2010     2009  

(in thousands)

  Balance Sheet
Location
    Fair Value     Balance Sheet
Location
    Fair Value     Balance Sheet
Location
    Fair Value     Balance Sheet
Location
    Fair Value  

Derivatives not designated as hedging instruments

               

Interest rate contracts

    Other assets      $ 13,623        Other assets      $ 11,371        Other liabilities      $ 13,623        Other liabilities      $ 11,371   

Termination of Hedging Activities: On January 7, 2008, the Company discontinued its three prime rate floor derivative instruments that were previously utilized to hedge the variable cash flows associated with existing variable-rate loan assets based on the prime rate. The Company received $8.1 million as a result of the termination transaction resulting in a net derivative gain of $6.2 million. The interest rate floors had an original maturity date of April 4, 2011. In accordance with the Derivatives and Hedging topic of the FASB ASC, the net derivative gain related to a discontinued cash flow hedge continues to be reported in accumulated other comprehensive income and is reclassified into earnings in the same periods during which the originally hedged forecasted transactions affect earnings. For the three and nine months ended September 30, 2010, $335 thousand and $1.5 million, respectively of the net derivative gain was reclassified into earnings.

 

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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This discussion should be read in conjunction with the unaudited consolidated condensed financial statements of Columbia Banking System, Inc. (referred to in this report as “we”, “our”, and “the Company”) and notes thereto presented elsewhere in this report and with the December 31, 2009 audited consolidated financial statements and its accompanying notes included in our Annual Report on Form 10-K. In the following discussion, unless otherwise noted, references to increases or decreases in average balances and in items of income and expense for a particular period and balances at a particular date refer to the comparison with corresponding amounts for the period or date one year earlier.

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This quarterly report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, but are not limited to, statements about our plans, objectives, expectations and intentions that are not historical facts, and other statements identified by words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “should,” “projects,” “seeks,” “estimates” or words of similar meaning. These forward-looking statements are based on current beliefs and expectations of management and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. In addition to the factors set forth in the sections “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this report, the following factors, among others, could cause actual results to differ materially from the anticipated results:

 

   

local and national economic conditions could be less favorable than expected or could have a more direct and pronounced effect on us than expected and adversely affect our ability to continue internal growth at historical rates and maintain the quality of our earning assets;

 

   

risks presented by a continued economic downturn, which could adversely affect credit quality, collateral values, investment values, liquidity, loan portfolio delinquency rates and revenue growth;

 

   

integration of our two recent FDIC-assisted acquisitions may present unforeseen challenges;

 

   

efficiencies and enhanced financial and operating performance we expect to realize from investments in personnel, acquisitions and infrastructure could not be realized;

 

   

we may not be able to effectively deploy the net proceeds from our recent capital raise, including but not limited to, as a result of any unavailability of attractive acquisition targets such as FDIC-assisted acquisitions;

 

   

changes in FDIC policy may make the terms of future FDIC-assisted transaction opportunities less favorable to bidders such as the Company;

 

   

interest rate changes could significantly reduce net interest income and negatively affect funding sources;

 

   

projected business increases following strategic expansion or opening of new branches could be lower than expected;

 

   

the ultimate financial and operational burden of the recently enacted financial regulatory reform legislation and related rules;

 

   

changes in the scope and cost of FDIC insurance and other coverage could impose financial and operational burdens;

 

   

changes in accounting principles, policies and guidelines applicable to bank holding companies and banking;

 

   

competition among financial institutions could increase significantly;

 

   

the goodwill we have recorded in connection with acquisitions could become impaired, which may have an adverse impact on our earnings and capital;

 

   

the reputation of the financial services industry could deteriorate, which could adversely affect our ability to access markets for funding and to acquire and retain customers;

 

   

the terms and costs of the numerous actions taken by the Federal Reserve, the U.S. Congress, the Treasury, the FDIC, the SEC and others in response to the liquidity and credit crisis, or the failure of these actions to help stabilize the financial markets, asset prices, market liquidity or worsening of current financial market and economic conditions could materially and adversely affect our business, financial condition, results of operations and the trading price of our common stock; and

 

   

our ability to effectively manage credit risk, interest rate risk, market risk, operational risk, legal risk, liquidity risk and regulatory and compliance risk.

Please take into account that forward-looking statements speak only as of the date of this report. We do not undertake any obligation to publicly correct or update any forward-looking statement whether as a result of new information, future events or otherwise.

 

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CRITICAL ACCOUNTING POLICIES

Management has identified the accounting policies related to the allowance for loan and lease losses and the valuation and recoverability of goodwill as critical to an understanding of our financial statements. These policies and related estimates are discussed in “Item 7. Management Discussion and Analysis of Financial Condition and Results of Operation” under the headings “Allowance for Loan and Lease Losses” and “Valuation and Recoverability of Goodwill” in our 2009 Annual Report on Form 10-K. There have not been any material changes in our critical accounting policies relating to the allowance for loan and lease losses or the valuation and recoverability of goodwill as compared to those disclosed in our 2009 Annual Report on Form 10-K.

SIGNIFICANT INFLUENCES ON THE QUARTER AND NINE MONTHS ENDED SEPTEMBER 30, 2010

Redemption of preferred stock

On August 11, 2010, the Company redeemed all 76,898 shares of Series A preferred stock originally issued to the U.S. Department of Treasury on November 21, 2008 for approximately $76.9 million in capital under its Capital Purchase Program (“CPP”). The Company paid a total of $77.8 million to the Treasury, consisting of $76.9 million in principal and $918,504 in accrued and unpaid dividends.

Repurchase of common stock warrant

On September 1, 2010, the Company repurchased the common stock warrant issued to the U.S. Department of Treasury pursuant to the Troubled Asset Relief Program (“TARP”) CPP for $3.3 million. The warrant repurchase, together with the Company’s redemption of Series A preferred stock represents full repayment of all TARP obligations and cancellation of all equity interests in the Company held by the U.S. Treasury.

Acquisition of Columbia River Bank

On January 22, 2010, the Bank acquired certain assets and assumed certain liabilities of Columbia River Bank from the FDIC, which had been appointed receiver of the institution, including 21 branches located in Oregon and Washington. The Bank acquired tangible assets with a fair value of approximately $885.3 million, including $480.3 million of loans, an FDIC indemnification asset of $143.6 million, $100.7 million of investment securities, $98.1 million of cash and cash equivalents and $62.6 million of other assets. The Bank assumed liabilities with a fair value of approximately $912.9 million, including $893.4 million of insured and uninsured deposits, $18.4 million of FHLB advances and $1.1 million of other liabilities. In connection with this acquisition, The Bank entered into loss-sharing agreements with the FDIC which cover approximately $676.1 million in face value of Columbia River Bank’s loans and $18.7 million of Columbia River Bank’s OREO. The transaction resulted in goodwill of $14.1 million and a core deposit intangible of $13.4 million.

Acquisition of American Marine Bank

On January 29, 2010, The Bank acquired substantially all of the deposits and assets of American Marine Bank from the FDIC, which had been appointed receiver of the institution, including 11 branches located in western Washington. The Bank acquired tangible assets with a fair value of approximately $303.5 million, including $176.3 million of loans, an FDIC indemnification asset of $66.8 million, $28.6 million of investment securities, $14.5 million of cash and cash equivalents and $17.3 million of other assets. The Bank assumed liabilities with a fair value of approximately $292.6 million, including $254.0 million of insured and uninsured deposits, $37.7 million of FHLB advances and $974 thousand of other liabilities. In connection with this acquisition, The Bank entered into loss-sharing agreements with the FDIC which cover approximately $243.8 million in face value of American Marine Bank’s loans and $15.8 million of American Marine Bank’s OREO. In addition, as part of this acquisition, The Bank received regulatory approval to exercise trust powers and intends to continue to operate the Trust and Wealth Management Division of American Marine Bank. The transaction resulted in a bargain purchase gain of $9.8 million, and a core deposit intangible of $4.3 million.

RESULTS OF OPERATIONS

Earnings Summary

The Company reported net income for the third quarter of $5.2 million and $2.5 million in net income applicable to common shareholders or $0.06 per diluted common share, compared to a net loss of $1.5 million and a $2.6 million net loss applicable to common shareholders or $(0.11) per diluted common share for the third quarter of 2009. Net income applicable to common shareholders for the third quarter of 2010 is net of the Preferred Stock dividend of $427 thousand and the redemption of the Preferred Stock resulting in the recognition of the remaining $2.3 million of the Preferred Stock discount. The increase in net income from the prior year period was primarily attributable to the $15.8 million increase in revenue (net interest income plus noninterest income) coupled with the $7.5 million decline in the provision for loan and lease losses partially offset by a $10.4 million increase in noninterest expense. Return on average assets and return on average common

 

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equity were 0.47% and 1.39%, respectively, for the third quarter of 2010, compared with returns of (0.19)% and (2.56)%, respectively for the same period of 2009.

The Company reported net income for the first nine months of $18.2 million and $13.2 million in net income applicable to common shareholders or $0.38 per diluted common share, compared to a net loss of $5.5 million and an $8.8 million net loss applicable to common shareholders or $(0.45) per diluted common share for the first nine months of 2009. Net income applicable to common shareholders for the first nine months of 2010 is net of the Preferred Stock dividend of $2.3 million, the accretion of the Preferred Stock discount totaling $300 thousand and recognizing the remaining $2.3 million of the Preferred Stock discount as a result of redeeming the entire Preferred Stock issued to the Treasury. The increase in net income from the prior year period was primarily attributable to the $9.8 million pre-tax gain on the acquisition of American Marine Bank in the first quarter and a $11.0 million decline in the provision for loan losses for the nine months ended September 30, 2010. Return on average assets and return on average common equity were 0.58% and 2.97%, respectively, for the first nine months of 2010, compared with returns of (0.24)% and (3.23)%, respectively for the same period of 2009.

Revenue (net interest income plus noninterest income) for the three months ended September 30, 2010 was $52.1 million, 44% higher than the same period in 2009. The increase was primarily a result of higher net interest income driven by the accretion of income on acquired loans and noninterest income driven by the acquisitions of Columbia River Bank and American Marine Bank.

Revenue (net interest income plus noninterest income) for the nine months ended September 30, 2010 was $162.9 million, 53% higher than the same period in 2009. The increase was primarily a result of higher net interest income driven by the accretion of income on acquired loans and noninterest income driven by the acquisitions of Columbia River Bank and American Marine Bank, including the $9.8 million pre-tax gain on the acquisition of American Marine Bank.

Total noninterest expense in the quarter ended September 30, 2010 was $33.5 million, a 45% increase from the third quarter of 2009. The increase was primarily due to the addition of operating expenses of Columbia River Bank and American Marine Bank in January 2010.

Total noninterest expense in the nine months ended September 30, 2010 was $102.2 million, a 43% increase from the first nine months of 2009. The increase was primarily due to the addition of operating expenses of Columbia River Bank and American Marine Bank in January 2010.

The provision for loan and lease losses for the third quarter of 2010 was $9.0 million compared with $16.5 million for the third quarter of 2009. The provision reflects management’s continuing evaluation of the loan portfolio’s credit quality, which is affected by a broad range of economic metrics. Additional factors affecting the provision include, but are not limited to, net-loan charge-offs, non-accrual loans, specific reserves and risk-rating migration. The provision increased the Company’s total allowance for loan and lease losses to 3.22% of loans, excluding covered loans at September 30, 2010 from 2.66% at year-end 2009 and 2.50% at the end of the third quarter 2009. Net charge-offs for the current quarter were $6.4 million compared to $13.7 million for the third quarter of 2009.

The provision for loan and lease losses for the first nine months of 2010 was $37.5 million compared with $48.5 million for the first nine months of 2009. Net charge-offs for the first nine months of 2010 were $28.6 million compared to $39.6 million for the first nine months of 2009.

RESULTS OF OPERATIONS

Our results of operations are dependent to a large degree on our net interest income. We also generate noninterest income through service charges and fees, merchant services fees, and bank owned life insurance. Our operating expenses consist primarily of compensation and employee benefits, occupancy, merchant card processing, data processing and legal and professional fees. Like most financial institutions, our interest income and cost of funds are affected significantly by general economic conditions, particularly changes in market interest rates, and by government policies and actions of regulatory authorities.

 

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Net Interest Income

Net interest income is the difference between interest income (which includes yield-related loan fees) and interest expense. Net interest income on a fully taxable-equivalent basis expressed as a percentage of average total interest-earning assets is referred to as the net interest margin. The following tables set forth the components of net interest income on a fully taxable-equivalent basis for the three and nine months ended September 30, 2010 and 2009.

 

     Three months ended September 30,     Three months ended September 30,  
     2010     2009  

(in thousands)

   Average
Balances (1)
     Interest
Earned /
Paid
     Average
Rate
    Average
Balances (1)
     Interest
Earned /
Paid
     Average
Rate
 

ASSETS

                

Loans, net (1)(2)

   $ 2,500,302       $ 44,989         7.14   $ 2,088,478       $ 29,260         5.56

Securities (2)

     715,201         8,151         4.52     593,516         7,701         5.15

Interest-earning deposits with banks and federal funds sold

     439,429         281         0.25     101,126         53         0.21
                                                    

Total interest-earning assets

     3,654,932       $ 53,421         5.80     2,783,120       $ 37,014         5.28

Other earning assets

     51,684              49,696         

Noninterest-earning assets

     654,297              244,271         
                            

Total assets

   $ 4,360,913            $ 3,077,087         
                            

LIABILITIES AND SHAREHOLDERS’ EQUITY

                

Certificates of deposit

   $ 729,053       $ 1,958         1.07   $ 685,621       $ 3,687         2.13

Savings accounts

     202,669         70         0.14     136,132         89         0.26

Interest-bearing demand

     641,070         489         0.30     448,778         515         0.46

Money market accounts

     894,971         1,490         0.66     587,177         1,240         0.84
                                                    

Total interest-bearing deposits

     2,467,763         4,007         0.64     1,857,708         5,531         1.18

Federal Home Loan Bank and Federal Reserve Bank borrowings

     122,250         716         2.32     110,783         651         2.33

Securities sold under agreements to repurchase

     25,000         121         1.92     25,000         120         1.91

Other borrowings

     —           —           0.00     —           —           0.00

Long-term subordinated debt

     25,708         266         4.10     25,642         280         4.33
                                                    

Total interest-bearing liabilities

     2,640,721       $ 5,110         0.77     2,019,133       $ 6,582         1.29

Noninterest-bearing deposits

     829,820              537,603         

Other noninterest-bearing liabilities

     151,217              41,762         

Shareholders’ equity

     739,155              478,589         
                            

Total liabilities & shareholders’ equity

   $ 4,360,913            $ 3,077,087         
                            

Net interest income (2)

      $ 48,311            $ 30,432      
                            

Net interest margin

           5.24           4.34
                            

 

(1) Nonaccrual loans have been included in the tables as loans carrying a zero yield. Amortized net deferred loan fees were included in the interest income calculations. The amortization of net deferred loan fees was $401 thousand and $792 thousand for the three months ended September 30, 2010 and 2009, respectively.
(2) Tax-exempt income is calculated on a tax equivalent basis, based on a marginal tax rate of 35%.

 

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     Nine months ended September 30,     Nine months ended September 30,  
     2010     2009  

(in thousands)

   Average
Balances (1)
     Interest
Earned  /

Paid
     Average
Rate
    Average
Balances (1)
     Interest
Earned  /

Paid
     Average
Rate
 

ASSETS

                

Loans, net (1)(2)

   $ 2,497,396       $ 121,088         6.48   $ 2,154,793       $ 88,528         5.49

Securities (2)

     718,023         24,955         4.65     563,914         22,467         5.33

Interest-earning deposits with banks and federal funds sold

     334,871         640         0.26     35,170         69         0.26
                                                    

Total interest-earning assets

     3,550,290       $ 146,683         5.52     2,753,877       $ 111,064         5.39

Other earning assets

     51,178              49,234         

Noninterest-earning assets

     611,398              250,078         
                            

Total assets

   $ 4,212,866            $ 3,053,189         
                            

LIABILITIES AND SHAREHOLDERS’ EQUITY

                

Certificates of deposit

   $ 799,011       $ 7,042         1.18   $ 718,276       $ 12,707         2.37

Savings accounts

     195,916         237         0.16     132,321         291         0.29

Interest-bearing demand

     631,401         1,730         0.37     460,008         1,744         0.51

Money market accounts

     824,297         4,273         0.69     548,372         3,555         0.87
                                                    

Total interest-bearing deposits

     2,450,625         13,282         0.72     1,858,977         18,297         1.32

Federal Home Loan Bank and Federal Reserve Bank borrowings

     124,234         2,131         2.29     165,813         2,116         1.71

Securities sold under agreements to repurchase

     25,000         357         1.91     25,000         356         1.91

Other borrowings

     —           —           0.00     108         1         0.70

Long-term subordinated debt

     25,692         769         4.00     25,626         937         4.89
                                                    

Total interest-bearing liabilities

     2,625,551       $ 16,539         0.84     2,075,524       $ 21,707         1.40

Noninterest-bearing deposits

     795,698              493,797         

Other noninterest-bearing liabilities

     136,240              44,885         

Shareholders’ equity

     655,377              438,983         
                            

Total liabilities & shareholders’ equity

   $ 4,212,866            $ 3,053,189         
                            

Net interest income (2)

      $ 130,144            $ 89,357      
                            

Net interest margin

           4.90           4.34
                            

 

(1) Nonaccrual loans have been included in the tables as loans carrying a zero yield. Amortized net deferred loan fees were included in the interest income calculations. The amortization of net deferred loan fees was $ 1.7 million and $2.2 million for the nine months ended September 30, 2010 and 2009, respectively.
(2) Tax-exempt income is calculated on a tax equivalent basis, based on a marginal tax rate of 35%.

 

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Net interest income is impacted by the volume (changes in volume multiplied by prior rate), interest rate (changes in rate multiplied by prior volume) and mix of interest-earning assets and interest-bearing liabilities. The following tables set forth the total dollar amount of change in net interest income on a fully taxable-equivalent basis due to volume and rate between the third quarter and first nine months of 2010 and 2009. Changes attributable to the combined effect of volume and interest rates have been allocated proportionately to the changes due to volume and the changes due to interest rates:

 

(in thousands)

   Three Months Ended September 30,
2010 Compared to 2009

Increase (Decrease) Due to
 
         Volume              Rate             Total      

Interest earning assets

       

Loans (1)

   $ 6,442       $ 9,287      $ 15,729   

Securities (2)

     1,387         (937     450   

Interest earning deposits with banks and federal funds sold

     215         13        228   
                         

Interest income (2)

   $ 8,044       $ 8,363      $ 16,407   
                         

Interest bearing liabilities

       

Deposits:

       

Certificates of deposit

   $ 220       $ (1,949   $ (1,729

Savings accounts

     33         (52     (19

Interest-bearing demand

     179         (205     (26

Money market accounts

     552         (302     250   
                         

Total interest on deposits

     984         (2,508     (1,524

FHLB and Federal Reserve Bank borrowings

     67         (2     65   

Other borrowings and interest bearing liabilities

     1         —          1   

Long-term subordinated debt

     1         (15     (14
                         

Interest expense

   $ 1,053       $ (2,525   $ (1,472
                         

 

(1) Nonaccrual loans have been included in the tables as loans carrying a zero yield. Amortized net deferred loan fees were included in the interest income calculations. The amortization of net deferred loan fees was $401 thousand and $792 thousand for the three months ended September 30, 2010 and 2009, respectively.
(2) Tax-exempt income is calculated on a tax equivalent basis, based on a marginal tax rate of 35%.

 

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(in thousands)

   Nine Months Ended September 30,
2010 Compared to 2009
Increase (Decrease) Due to
 
     Volume     Rate     Total  

Interest earning assets

      

Loans (1)

   $ 15,264      $ 17,296      $ 32,560   

Securities (2)

     5,290        (2,802     2,488   

Interest earning deposits with banks and federal funds sold

     573        (2     571   
                        

Interest income (2)

   $ 21,127      $ 14,492      $ 35,619   
                        

Interest bearing liabilities

      

Deposits:

      

Certificates of deposit

   $ 1,297      $ (6,962   $ (5,665

Savings accounts

     107        (161     (54

Interest-bearing demand

     546        (560     (14

Money market accounts

     1,532        (814     718   
                        

Total interest on deposits

     3,482        (8,497     (5,015

FHLB and Federal Reserve Bank borrowings

     (608     623        15   

Other borrowings and interest bearing liabilities

     (1     —          (1

Long-term subordinated debt

     2        (170     (168
                        

Interest expense

   $ 2,875      $ (8,044   $ (5,169
                        

 

 

(1) Nonaccrual loans have been included in the tables as loans carrying a zero yield. Amortized net deferred loan fees were included in the interest income calculations. The amortization of net deferred loan fees was $1.7 million and $2.2 million for the nine months ended September 30, 2010 and 2009, respectively.
(2) Tax-exempt income is calculated on a tax equivalent basis, based on a marginal tax rate of 35%.

The Company’s net interest margin increased to 5.24% in the third quarter of 2010, up from 4.34% for the prior-year period. The net interest margin in the third quarter was positively impacted by the $7.2 million of discount accretion on our acquired loan portfolios. The net interest margin was negatively affected by larger levels of interest-earning cash invested at lower yields. We continue to seek investment opportunities to reduce our level of overnight funds invested at those lower yields.

For the nine months ended September 30, 2010, the Company’s net interest margin increased to 4.90%, up from 4.34% for the prior-year period. As discussed above, the net interest margin was positively impacted by the $8.2 million of discount accretion on our acquired loan portfolios.

Provision for Loan and Lease Losses

During the third quarter of 2010, the Company recorded $9.0 million to its provision for loan and lease losses, compared to $16.5 million for the same period in 2009. The provision increased the Company’s total allowance for loan losses to 3.22% of net loans, excluding covered loans at September 30, 2010.

Provision for Losses on Covered Loans

During the third quarter of 2010, the Company recorded a non-cash net impairment charge of $453 thousand for FDIC-covered loans. The provision expense is primarily a result of a decrease in projected cash flows due to the Company’s revised estimate of the timing of cash flow receipts. The third quarter revision of the cash flow receipts is based on the results of management’s review of the credit quality of the covered loans and the analysis of the loan performance data since the acquisition of the covered loans. The Company will continue updating cash flow projections on the covered loans on a quarterly basis.

Noninterest Income

Noninterest income was $5.2 million for the third quarter of 2010, compared to $7.2 million for the prior-year period. The decrease was primarily due to the $4.5 million net change in the indemnification asset. This reduction was related to higher cash flows received from principal amortization, partial prepayments, and loan payoffs. The decrease in the

 

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indemnification asset was partially offset by an increase in service charges and other fees of $2.7 million primarily resulting from the addition of Columbia River Bank and American Marine Bank operations.

For the nine months ended September 30, 2010, noninterest income increased $15.7 million or 74%, compared to the first nine months of 2009. The increase was primarily due to the $9.8 million pre-tax gain on the American Marine Bank acquisition, and an increase of $7.4 million in service charges and other fees primarily resulting from the impact of the normal operations of Columbia River Bank and American Marine Bank.

Noninterest Expense

Total noninterest expense for the third quarter of 2010 was $33.5 million, an increase of 45% from $23.1 million for the same quarter in 2009. Additionally, total noninterest expense for the first nine months of 2010 was $102.2 million, an increase of 43% from $71.6 million for the first nine months of 2009. The increase was primarily due to the addition of operating expenses of Columbia River Bank and American Marine Bank in January 2010.

The following table presents the significant components of noninterest expense and the related dollar and percentage change from period to period:

 

     Three months ended September 30,      Nine months ended September 30,  
     2010     $ Change     % Change     2009      2010     $ Change     % Change     2009  
     (dollars in thousands)  

Compensation

   $ 14,867      $ 5,397        57   $ 9,470       $ 40,767      $ 11,932        41   $ 28,835   

Employee benefits

     2,532        133        6     2,399         7,820        638        9     7,182   

Contract labor

     175        175        NM        —           3,470        3,470        NM        —     
                                                                 
     17,574        5,705        48     11,869         52,057        16,040        45     36,017   

All other noninterest expense:

                 

Occupancy

     4,278        1,255        42     3,023         12,554        3,549        39     9,005   

Merchant processing

     934        93        11     841         2,697        255        10     2,442   

Advertising and promotion

     630        334        113     296         2,253        578        35     1,675   

Data processing and communications

     2,477        1,467        145     1,010         6,923        3,949        133     2,974   

Legal and professional services

     1,609        816        103     793         4,584        1,805        65     2,779   

Taxes, license and fees

     803        221        38     582         2,055        80        4     1,975   

Regulatory premiums

     1,952        732        60     1,220         4,910        191        4     4,719   

Net cost of operation of other real estate owned

     (1,442     (1,760     -553     318         (802     (1,392     -236     590   

Amortization of intangibles

     1,044        785        303     259         2,886        2,089        262     797   

Other

     3,661        726        25     2,935         12,045        3,377        39     8,668   
                                                                 

Total all other noninterest expense

     15,946        4,669        41     11,277         50,105        14,481        41     35,624   
                                                                 

Total noninterest expense

   $ 33,520      $ 10,374        45   $ 23,146       $ 102,162      $ 30,521        43   $ 71,641   
                                                                 

 

NM – Not Meaningful

 

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The following table presents selected items included in other noninterest expense and the associated change from period to period:

 

     Three months ended
September 30,
     Increase
(Decrease)
Amount
    Nine months ended
September 30,
     Increase
(Decrease)
Amount
 

(in thousands)

   2010      2009        2010      2009     

Software support & maintenance

   $ 267       $ 165       $ 102      $ 793       $ 486       $ 307   

Federal Reserve Bank processing fees

     100         83         17        240         259         (19

Supplies

     438         199         239        1,147         630         517   

Postage

     430         302         128        1,404         932         472   

Investor relations

     35         15         20        117         189         (72

Travel

     296         104         192        709         283         426   

ATM Network

     223         156         67        608         444         164   

Sponsorships and charitable contributions

     145         99         46        584         437         147   

Directors fees

     104         115         (11     328         328         —     

Employee expenses

     100         82         18        353         270         83   

Insurance

     207         125         82        582         357         225   

CRA partnership investment expense

     73         164         (91     219         354         (135

Miscellaneous

     1,243         1,326         (83     4,961         3,699         1,262   
                                                    

Total other noninterest expense

   $ 3,661       $ 2,935       $ 726      $ 12,045       $ 8,668       $ 3,377   
                                                    

In managing our business, we review the efficiency ratio, on a fully taxable-equivalent basis, which is not defined in accounting principles generally accepted in the United States. Our efficiency ratio [noninterest expense, excluding net cost of operation of OREO divided by the sum of net interest income and noninterest income on a tax equivalent basis, excluding gain/loss on sale of investment securities, proceeds from redemption of Visa and Mastercard shares, gain on bank acquisition, incremental income accretion on the acquired loan portfolio and the change in FDIC indemnification asset] was 68.33% for the third quarter 2010 and 68.32% for the first nine months of 2010, compared to 60.85% for the third quarter 2009 and 62.72% for the first nine months of 2009, respectively. The efficiency ratio increased due to increased expenses associated with managing our problem assets, increased regulatory premiums and expenses resulting from our FDIC-assisted transactions.

Income Taxes

We recorded an income tax provision of $4.0 million and $4.6 million for the third quarter and the first nine months of 2010, compared with a benefit of $1.8 million and $7.9 million for the same periods in 2009. Our effective tax rate remains lower than the statutory tax rate due to our nontaxable income generated from tax-exempt municipal bonds, investments in bank owned life insurance, and low income housing credits. For additional information, please refer to the Company’s annual report on Form 10-K for the year ended December 31, 2009.

Credit Risk Management

The extension of credit in the form of loans or other credit products to individuals and businesses is one of our principal business activities. Our policies and applicable laws and regulations require risk analysis as well as ongoing portfolio and credit management. We manage our credit risk through lending limit constraints, credit review, approval policies, and extensive, ongoing internal monitoring. We also manage credit risk through diversification of the loan portfolio by type of loan, type of industry, type of borrower and by limiting the aggregation of debt limits to a single borrower. In analyzing our existing portfolio, we review our consumer and residential loan portfolios by their performance as a pool of loans since no single loan is individually significant or judged by its risk rating, size, or potential risk of loss. In contrast, the monitoring process for the commercial business, private banking, real estate construction, and commercial real estate portfolios includes periodic reviews of individual loans with risk ratings assigned to each loan and performance judged on a loan by loan basis. We review these loans to assess the ability of the borrower to service all of its interest and principal obligations and, as a result, the risk rating may be adjusted accordingly. In the event that full collection of principal and interest is not reasonably assured, the loan is appropriately downgraded and, if warranted, placed on nonaccrual status even though the loan may be current as to principal and interest payments. Additionally, we review these types of loans for impairment in accordance with the Receivables topic of the FASB ASC. Impaired loans are considered for nonaccrual status

 

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and will typically remain as such until all principal and interest payments are brought current and the prospects for future payments in accordance with the loan agreement appear relatively certain.

Loan policies, credit quality criteria, portfolio guidelines and other controls are established under the guidance of our Chief Credit Officer and approved, as appropriate, by the Board. Credit Administration, together with the loan committee, has the responsibility for administering the credit approval process. As another part of its control process, we use an independent internal credit review and examination function to provide assurance that loans and commitments are made and maintained as prescribed by our credit policies. This includes a review of documentation when the loan is initially extended and subsequent monitoring to assess continued performance and proper risk assessment.

We have diversification of loan types within our portfolio. However, we are not immune to either the current instability in the residential real estate markets and mortgage-related industries or the increasing economic stress in the commercial market. Accordingly, we will continue to be diligent in our risk management practices and maintain, what we believe, are adequate reserves for probable loan losses.

Loan Portfolio Analysis

We are a full service commercial bank, originating a wide variety of loans, but concentrating our lending efforts on originating commercial business and commercial real estate loans.

The following table sets forth the Company’s loan portfolio by type of loan for the dates indicated:

 

(in thousands)

   September 30,
2010
    % of
Total
    December 31,
2009
    % of
Total
 

Commercial business

   $ 761,113        30.5   $ 744,440        37.1

Real estate:

        

One-to-four family residential

     53,583        2.2     63,364        3.2

Commercial and five or more family residential properties

     819,415        32.8     856,260        42.6
                                

Total real estate

     872,998        35.0     919,624        45.8

Real estate construction:

        

One-to-four family residential

     80,289        3.2     107,620        5.3

Commercial and five or more family residential properties

     33,929        1.4     41,829        2.1
                                

Total real estate construction

     114,218        4.6     149,449        7.4

Consumer

     189,495        7.6     199,987        9.9
                                

Subtotal

     1,937,824        77.7     2,013,500        100.2

Less: Deferred loan fees

     (3,662     -0.2     (4,616     -0.2
                                

Total loans, excluding covered loans

     1,934,162          2,008,884     
                    

Covered loans

     561,131        22.5     —          0.0
                                

Total loans, net of deferred loan fees

   $ 2,495,293        100.0   $ 2,008,884        100.0
                                

Loans Held for Sale

   $ 1,513        $ —       
                    

Total loans increased $486.4 million, or 24%, from year-end 2009. The increase in total loans was driven primarily by FDIC-assisted acquisitions of Columbia River Bank and American Marine Bank. Although the acquisitions of Columbia River and American Marine Banks increased our loan portfolio by $656.6 million, the credit risk associated with the acquired loans was substantially mitigated by the loss-sharing agreements with the FDIC. Total noncovered loans decreased $74.7 million, or 4%, from December 31, 2009. This decrease was attributable to low loan demand due to current business and economic conditions.

Commercial Loans: We are committed to providing competitive commercial lending in our primary market areas. Management expects a continued focus within its commercial lending products and to emphasize, in particular, relationship banking with businesses, and business owners.

 

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Real Estate Loans: These loans are used to collateralize outstanding advances from the FHLB. Residential loans are secured by properties located within our primary market areas, and typically have loan-to-value ratios of 80% or lower.

Generally, commercial and five-or-more family residential real estate loans are made to borrowers who have existing banking relationships with us. Our underwriting standards generally require that the loan-to-value ratio for these loans not exceed 75% of appraised value, cost, or discounted cash flow value, as appropriate, and that commercial properties maintain debt coverage ratios (net operating income divided by annual debt servicing) of 1.2 or better. However, underwriting standards can be influenced by competition and other factors. We endeavor to maintain the highest practical underwriting standards while balancing the need to remain competitive in our lending practices.

Real Estate Construction Loans: We originate a variety of real estate construction loans. One-to-four family residential construction loans are originated for the construction of custom homes (where the home buyer is the borrower) and to provide financing to builders for the construction of pre-sold homes and speculative residential construction. Underwriting guidelines for these loans vary by loan type but include loan-to-value limits, term limits and loan advance limits, as applicable.

Our underwriting guidelines for commercial and five-or-more family residential real estate construction loans generally require that the loan-to-value ratio not exceed 75% and stabilized debt coverage ratios (net operating income divided by annual debt servicing) of 1.2 or better. As noted above, underwriting standards can be influenced by competition and other factors. However, we endeavor to maintain the highest practical underwriting standards while balancing the need to remain competitive in our lending practices.

Consumer Loans: Consumer loans include automobile loans, boat and recreational vehicle financing, home equity and home improvement loans and miscellaneous personal loans.

Foreign Loans: Our banking subsidiaries are not involved with loans to foreign companies or foreign countries.

Allowance for Loan and Lease Losses

We maintain an allowance for loan and lease losses (“ALLL”) to absorb losses inherent in the loan portfolio. The size of the ALLL is determined through quarterly assessments of the probable estimated losses in the loan portfolio. Our methodology for making such assessments and determining the adequacy of the ALLL includes the following key elements:

 

  1. General valuation allowance consistent with the Contingencies topic of the FASB ASC.

 

  2. Criticized/classified loss reserves on specific relationships. Specific allowances for identified problem loans are determined in accordance with the Receivables topic of the FASB ASC.

 

  3. The unallocated allowance provides for other credit losses inherent in our loan portfolio that may not have been contemplated in the general and specific components of the allowance. This unallocated amount generally comprises less than 1.5% of the allowance. The unallocated amount is reviewed periodically based on trends in credit losses, the results of credit reviews and overall economic trends.

On a quarterly basis our Chief Credit Officer reviews with Executive Management and the Board of Directors the various additional factors that management considers when determining the adequacy of the ALLL, including economic and business condition reviews. Factors which influenced management’s judgment in determining the amount of the additions to the ALLL charged to operating expense include the following as of the applicable balance sheet dates:

 

  1. Existing general economic and business conditions affecting our market place

 

  2. Credit quality trends, including trends in nonperforming loans

 

  3. Collateral values

 

  4. Seasoning of the loan portfolio

 

  5. Bank regulatory examination results

 

  6. Findings of internal credit examiners

 

  7. Duration of current business cycle

The ALLL is increased by provisions for loan and lease losses (“provision”) charged to expense, and is reduced by loans charged off, net of recoveries. While we believe the best information available is used by us to determine the ALLL, changes in market conditions could result in adjustments to the ALLL, affecting net income, if circumstances differ from the assumptions used in determining the ALLL.

 

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In addition to the ALLL, we maintain an allowance for unfunded loan commitments and letters of credit. We report this allowance as a liability on our Consolidated Balance Sheet. We determine this amount using estimates of the probability of the ultimate funding and losses related to those credit exposures. This methodology is similar to the methodology we use for determining the adequacy of our ALLL. For additional information on our allowance for unfunded loan commitments and letters of credit, see Note 7 to the Consolidated Condensed Financial Statements.

At September 30, 2010, our allowance for noncovered loan and lease losses was $62.3 million, or 3.22% of total noncovered loans and 64% of nonperforming, noncovered loans and 51% of nonperforming, noncovered assets. This compares with an allowance of $51.7 million, or 2.50% of the total loan portfolio, 48% of nonperforming loans and 41% of nonperforming assets at December 31, 2009.

At September 30, 2010, our allowance for covered loan losses was $453 thousand, or 0.08% of the total covered loan pools. Covered loans accounted for under ASC 310-30 are generally considered accruing and performing as the loans accrete interest income over the estimated lives of the loans when cash flows are reasonably estimable. Accordingly, covered impaired loans contractually past due are still considered to be accruing and performing loans. The loans acquired in the Columbia River Bank and American Marine Bank acquisitions are also subject to the Bank’s internal and external credit review and are accounted for under ASC Topic 310-30. Covered loans are initially measured at fair value based on expected future cash flows over the lives of the loans, which management continues to monitor and estimate on a quarterly basis. If expected future cash flows decline, a provision is recorded for estimated cash flow losses on covered loans. If expected cash flows on covered loans increase, subsequent to a loss provision being recorded, the loss provision will be reversed with any additional increases in expected cash flows made as an adjustment from non-accretable difference to accretable yield.

 

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The following tables summarize the activity in the allowance for loan and lease losses and unfunded loan commitments and letters of credit for the three and nine month periods ended September 30, 2010 and 2009:

Changes in Allowance for Loan and Lease Losses and

Unfunded Loan Commitments and Letters of Credit

 

     Three Months Ended September 30,     Nine Months Ended September 30,  

(in thousands)

           2010                     2009                     2010                     2009          

Beginning balance

   $ 59,748      $ 48,880      $ 53,478      $ 42,747   

Charge-offs:

        

Commercial business

     (1,760     (4,889     (9,405     (8,200

One-to-four family residential

     —          —          (104     (220

Commercial and five-or-more family residential

     (1,976     (237     (4,958     (956

One-to-four family residential construction

     (1,291     (5,704     (8,955     (21,750

Commercial and five-or-more family residential construction

     —          (2,180     (3,079     (7,542

Consumer

     (2,513     (816     (4,965     (1,662
                                

Total charge-offs

     (7,540     (13,826     (31,466     (40,330

Recoveries

        

Commercial business

     122        127        778        531   

One-to-four family residential

     —          —          15        68   

Commercial and five-or-more family residential

     5