b10q.htm

 
 
 
 
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, 2008.
 
¨
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, and (2) has been subject to such filing requirements for the past 90 days. Yes  x    No  ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer  ¨                Accelerated filer  x                Non-accelerated filer  ¨
 
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 31, 2008 was 18,150,965


TABLE OF CONTENTS
     
 
Page
 
     
Item 1.
 
     
 
        1
     
 
        2
     
 
        3
     
 
        4
     
 
        5
     
Item 2.
        14
     
Item 3.
        22
     
Item 4.
        23
   
 
     
Item 1.
        24
     
Item 1A.
        24
     
Item 2.
        26
     
Item 3.
        26
     
Item 4.
        26
     
Item 5.
        26
     
Item 6.
        27
     
 
        28
 

i


PART I - FINANCIAL INFORMATION
Item 1.                      FINANCIAL STATEMENTS

CONSOLIDATED CONDENSED STATEMENTS OF INCOME (LOSS)
 
Columbia Banking System, Inc.
(Unaudited)

   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
(in thousands except per share)
 
2008
   
2007
   
2008
   
2007
 
Interest Income
                       
Loans
  $ 35,590     $ 42,353     $ 114,227     $ 112,607  
Taxable securities
    4,615       4,625       14,490       14,067  
Tax-exempt securities
    1,997       2,005       5,997       5,925  
Federal funds sold and deposits in banks
    135       395       379       1,180  
Total interest income
    42,337       49,378       135,093       133,779  
Interest Expense
                               
Deposits
    10,148       16,841       36,444       42,617  
Federal Home Loan Bank advances
    1,887       2,454       6,464       8,117  
Long-term obligations
    423       584       1,339       1,604  
Other borrowings
    286       639       652       2,183  
Total interest expense
    12,744       20,518       44,899       54,521  
Net Interest Income
    29,593       28,860       90,194       79,258  
Provision for loan and lease losses
    10,500       1,231       27,926       2,198  
Net interest income after provision for loan and lease losses
    19,093       27,629       62,268       77,060  
Noninterest Income
                               
Service charges and other fees
    3,823       3,561       11,129       9,813  
Merchant services fees
    2,081       2,251       6,159       6,344  
Redemption of Visa and Mastercard shares
    -       -       3,028       -  
Gain on sale of investment securities, net
    -       -       882       -  
Loss on impairment of equity securities
    (18,517 )     -       (18,517 )     -  
Bank owned life insurance ("BOLI")
    533       502       1,587       1,379  
Other
    1,134       1,317       4,248       3,013  
Total noninterest income
    (10,946 )     7,631       8,516       20,549  
Noninterest Expense
                               
Compensation and employee benefits
    12,173       12,159       37,917       34,365  
Occupancy
    3,248       3,241       9,706       9,023  
Merchant processing
    961       880       2,731       2,587  
Advertising and promotion
    579       575       1,797       1,779  
Data processing
    909       743       2,507       1,863  
Legal and professional fees
    765       695       1,479       2,205  
Taxes, licenses and fees
    720       773       2,267       2,089  
Net loss (gain) on sale of other real estate owned
    4       -       (19 )     -  
Other
    4,032       3,359       11,927       9,182  
Total noninterest expense
    23,391       22,425       70,312       63,093  
Income (loss) before income taxes
    (15,244 )     12,835       472       34,516  
Provision (benefit) for income taxes
    (6,485 )     3,579       (3,682 )     9,433  
Net Income (Loss)
  $ (8,759 )   $ 9,256     $ 4,154     $ 25,083  
Net income (loss) per common share
                               
Basic
  $ (0.49 )   $ 0.53     $ 0.23     $ 1.52  
Diluted
  $ (0.49 )   $ 0.53     $ 0.23     $ 1.51  
Dividends paid per common share
  $ 0.17     $ 0.17     $ 0.51     $ 0.49  
Weighted average number of common shares outstanding
    17,948       17,339       17,898       16,472  
Weighted average number of diluted common shares outstanding
    17,948       17,533       17,994       16,636  
 
See accompanying notes to unaudited consolidated condensed financial statements.

1


CONSOLIDATED CONDENSED BALANCE SHEETS
 
Columbia Banking System, Inc.
(Unaudited)
 
         
September 30,
   
December 31,
 
(in thousands)
       
2008
   
2007
 
ASSETS
                 
Cash and due from banks
        $ 81,555     $ 82,735  
Interest-earning deposits with banks
          21,849       11,240  
Total cash and cash equivalents
          103,404       93,975  
Securities available for sale at fair value (amortized cost of $535,620 and $558,685, respectively)
          536,277       561,366  
Federal Home Loan Bank stock at cost
          14,785       11,607  
Loans held for sale
          2,890       4,482  
Loans, net of deferred loan fees of ($3,852) and ($3,931), respectively
        2,216,133       2,282,728  
Less: allowance for loan and lease losses
          35,814       26,599  
Loans, net
          2,180,319       2,256,129  
Interest receivable
          12,980       14,622  
Premises and equipment, net
          61,153       56,122  
Other real estate owned
          1,288       181  
Goodwill
          95,519       96,011  
Core deposit intangible, net
          6,179       7,050  
Other assets
          90,186       77,168  
Total Assets
        $ 3,104,980     $ 3,178,713  
LIABILITIES AND SHAREHOLDERS' EQUITY
                     
Deposits:
                     
Non-interest bearing
        $ 498,815     $ 468,237  
Interest-bearing
          1,857,006       2,029,824  
Total deposits
          2,355,821       2,498,061  
Short-term borrowings:
                     
Federal Home Loan Bank advances
          301,000       257,670  
Securities sold under agreements to repurchase
          25,000       -  
Other borrowings
          20,097       5,061  
Total short-term borrowings
          346,097       262,731  
Long-term subordinated debt
          25,582       25,519  
Other liabilities
          41,045       50,671  
Total liabilities
          2,768,545       2,836,982  
Commitments and contingent liabilities (note 11)
                     
Shareholders' equity:
                     
Preferred stock (no par value)
          -       -  
Authorized, 2 million shares; none outstanding
                     
 
September 30,
 
December 31,
               
 
2008
 
2007
               
Common Stock (no par value)
                     
Authorized shares
 63,034
 
 63,034
               
Issued and outstanding
 18,147
 
 17,953
    229,680       226,550  
Retained earnings
          102,965       110,169  
Accumulated other comprehensive income
          3,790       5,012  
Total shareholders' equity
          336,435       341,731  
Total Liabilities and Shareholders' Equity
        $ 3,104,980     $ 3,178,713  
 
See accompanying notes to unaudited consolidated condensed financial statements.
 
2


CONSOLIDATED CONDENSED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
 
Columbia Banking System, Inc.
(Unaudited)

   
Common Stock
         
Accumulated
       
                     
Other
   
Total
 
   
Number of
         
Retained
   
Comprehensive
   
Shareholders'
 
(in thousands)
 
Shares
   
Amount
   
Earnings
   
Income (Loss)
   
Equity
 
Balance at January 1, 2007
    16,060     $ 166,763     $ 89,037     $ (3,453 )   $ 252,347  
Comprehensive income:
                                       
Net income
    -       -       25,083       -       25,083  
Other comprehensive income, net of tax:
                                       
Net unrealized gain from securities, net of reclassification adjustments
    -       -       -       1,911       1,911  
Net unrealized gain from cash flow hedging instruments
    -       -       -       794       794  
Total comprehensive income
                                    27,788  
Purchase and retirement of common stock
    (65 )     (2,121 )     -       -       (2,121 )
Acquisitions:
                                       
Shares issued to the shareholders of Mountain Bank Holding Company
    993       30,327       -       -       30,327  
Converted Mountain Bank Holding Company stock options
    -       1,325       -       -       1,325  
Shares issued to the shareholders of Town Center Bancorp
    705       23,869       -       -       23,869  
Converted Town Center Bancorp stock options
    -       1,598       -       -       1,598  
Issuance of stock under stock option and other plans
    139       2,098       -       -       2,098  
Stock award compensation expense
    50       573       -       -       573  
Stock option compensation expense
    -       137       -       -       137  
Tax benefit associated with stock-based compensation
    -       235       -       -       235  
Cash dividends paid on common stock
    -       -       (8,207 )     -       (8,207 )
Balance at September 30, 2007
    17,882     $ 224,804     $ 105,913     $ (748 )   $ 329,969  
Balance at January 1, 2008
    17,953     $ 226,550     $ 110,169     $ 5,012     $ 341,731  
Cumulative effect of change in accounting principle (note 2)
    -       -       (2,137 )     -       (2,137 )
Comprehensive income:
                                       
Net income
    -       -       4,154       -       4,154  
Other comprehensive loss, net of tax:
                                       
Net unrealized loss from securities, net of reclassification adjustments
    -       -       -       (1,302 )     (1,302 )
Net unrealized gain from cash flow hedging instruments
    -       -       -       80       80  
Total comprehensive income
                                    2,932  
Issuance of stock under stock option and other plans
    132       1,860       -       -       1,860  
Stock award compensation expense
    62       1,040       -       -       1,040  
Tax benefit associated with stock-based compensation
    -       230       -       -       230  
Cash dividends paid on common stock
    -       -       (9,221 )     -       (9,221 )
Balance at September 30, 2008
    18,147     $ 229,680     $ 102,965     $ 3,790     $ 336,435  
 
See accompanying notes to unaudited consolidated condensed financial statements.
 
3


CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
 
Columbia Banking System, Inc.
(Unaudited)

   
Nine Months Ended September 30,
 
(in thousands)
 
2008
   
2007
 
Cash Flows From Operating Activities
           
Net Income
  $ 4,154     $ 25,083  
Adjustments to reconcile net income to net cash provided by operating activities
               
Provision for loan and lease losses
    27,926       2,198  
Deferred income tax benefit
    (12,318 )     (1,194 )
Excess tax benefit from stock-based compensation
    (230 )     (235 )
Stock-based compensation expense
    1,040       710  
Depreciation, amortization and accretion
    5,389       4,607  
Net realized gain on sale of securities
    (882 )     -  
Net realized gain on sale of other assets
    (798 )     (8 )
Impairment charge on investment securities
    18,517       -  
Net change in:
               
Loans held for sale
    1,592       (875 )
Interest receivable
    1,642       (2,074 )
Interest payable
    (4,591 )     4,606  
Other assets
    (6,841 )     3,109  
Other liabilities
    (5,951 )     (6,994 )
Net cash provided by operating activities
    28,649       28,933  
Cash Flows From Investing Activities
               
Purchases of securities available for sale
    (86,902 )     (2,888 )
Proceeds from sales of securities available for sale
    51,358       28,467  
Proceeds from principal repayments and maturities of securities available for sale
    40,328       39,033  
Proceeds from maturities of securities held to maturity
    -       578  
Loans originated and acquired, net of principal collected
    45,605       (218,350 )
Purchases of premises and equipment
    (8,838 )     (4,003 )
Proceeds from disposal of premises and equipment
    115       212  
Acquisition of Mt. Rainier and Town Center, net of cash acquired
    -       (32,429 )
Proceeds from sales of Federal Reserve Bank stock
    -       310  
Purchase of FHLB stock
    (3,178 )     -  
Proceeds from termination of cash flow hedging instruments
    8,093       -  
Proceeds from sales of other real estate and other personal property owned
    204       -  
Net cash provided by(used in) investing activities
    46,785       (189,070 )
Cash Flows From Financing Activities
               
Net increase(decrease) in deposits
    (142,240 )     149,758  
Proceeds from Federal Home Loan Bank advances
    1,784,268       2,353,626  
Repayment from Federal Home Loan Bank advances
    (1,740,938 )     (2,315,151 )
Proceeds from repurchase agreement borrowings
    25,000        -  
Repayment of repurchase agreement borrowings
    -       (20,000 )
Net increase in other borrowings
    15,036       10  
Cash dividends paid on common stock
    (9,221 )     (8,207 )
Proceeds from issuance of common stock
    1,860       2,098  
Repurchase of common stock
    -       (2,121 )
Excess tax benefit from stock-based compensation
    230       235  
Net cash provided by(used in) financing activities
    (66,005 )     160,248  
Increase in cash and cash equivalents
    9,429       111  
Cash and cash equivalents at beginning of period
    93,975       104,344  
Cash and cash equivalents at end of period
  $ 103,404     $ 104,455  
Supplemental Information:
               
Cash paid for interest
  $ 49,490     $ 49,915  
Cash paid for income tax
  $ 9,916     $ 10,490  
Share-based consideration issued for acquisitions
  $ -     $ 57,119  
Loans transferred to other real estate owned
  $ 1,288     $ -  
 
See accompanying notes to unaudited consolidated condensed financial statements.

4

 
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 the Company, and its wholly owned banking subsidiary Columbia 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 consolidated financial statements and results of operations presented in this report on Form 10-Q include financial information for Mountain Bank Holding Company and Town Center Bancorp, which were merged into Columbia Bank in the third quarter of 2007.  The results of operations for the nine months ended September 30, 2008 are not necessarily indicative of results to be anticipated for the year ending December 31, 2008. 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 2007 Annual Report on Form 10-K.
 
(b)
Significant Accounting Policies
 
The significant accounting policies used in preparation of our consolidated financial statements are disclosed in our 2007 Annual Report on Form 10-K. There have not been any other changes in our significant accounting policies compared to those contained in our 2007 10-K disclosure for the year ended December 31, 2007.
 
2. Accounting Pronouncements Recently Issued or Adopted
 
In May 2008, the FASB issued Statement of Financial Accounting Standards No. 162, The Hierarchy of Generally Accepted Accounting Principles (“SFAS 162”).  This statement identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (“GAAP”) in the United States (the GAAP hierarchy).  This Statement is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles.  Adoption of SFAS 162 is not expected to have any effect on the Company’s financial condition or results of operations.
 
 
In March 2008, the FASB issued Statement of Financial Accounting Standards No. 161, Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133 (“SFAS 161”).  This Statement requires enhanced disclosures about an entity’s derivative and hedging activities and is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008.  The Company plans to apply the enhanced disclosure provisions of SFAS 161 to all derivative and hedging activities.
 
 
On January 1, 2008, the Company adopted Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS 157”).   SFAS 157 defines fair value, establishes a framework for measuring fair value under accounting principles generally accepted in the United States of America, and expands disclosures about fair value measurement.  For further information, see Note 6 of the Notes to Unaudited Consolidated Condensed Financial Statements.
 
On January 1, 2008, the Company began applying the consensus reached by the Emerging Issues Task Force in Issue No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements (“EITF 06-4”).  EITF 06-4 provides recognition guidance regarding liabilities and related compensation costs for endorsement split-dollar life insurance arrangements that provide a benefit to an employee that extends to postretirement periods.  The Company recognized the effects of applying the consensus through a change in accounting principle with a cumulative-effect charge to retained earnings of $2.1 million, net of income taxes of $1.2 million.  During the second quarter of 2008 the Company entered into transactions whereby certain current and former officers of the Company agreed to terminate the split-dollar portion of their bank owned life insurance policies in exchange for individual life insurance policies.  In the second quarter of 2008 the Company recognized the net effect of those transactions as a reduction of compensation expense totaling $107,000.

5

 
3. Earnings per share
 
The following table sets forth the computation of basic and diluted earnings (loss) per share for the three and nine months ended September 30, 2008 and 2007 (in thousands, except for per share data):  
 

   
For The Three Months Ended
   
For The Nine Months Ended
 
(in thousands except per share)
 
9/30/2008
   
9/30/2007
   
9/30/2008
   
9/30/2007
 
Net Income (Loss)
  $ (8,759 )   $ 9,256     $ 4,154     $ 25,083  
Weighted average common shares outstanding (for basic calculation)
    17,948       17,339       17,898       16,472  
Dilutive effect of outstanding common stock options and nonvested restricted shares
    -       194       96       164  
Weighted average common stock and common equivalent shares outstanding (for
diluted calculation)
    17,948       17,533       17,994       16,636  
Earnings (loss) per common share - basic
  $ (0.49 )   $ 0.53     $ 0.23     $ 1.52  
Earnings (loss) per common share - diluted
  $ (0.49 )   $ 0.53     $ 0.23     $ 1.51  
 
Potential dilutive shares are excluded from the computation of earnings per share if their effect is anti-dilutive. Anti-dilutive shares outstanding related to options to acquire common stock for the three and nine month periods ended September 30, 2008 totaled 92,258 and 59,292, respectively.  There were no anti-dilutive shares outstanding related to options to acquire common stock for the same periods last year.
 
4. Dividends
 
Subsequent to quarter end, on October 23, 2008, the Company declared a quarterly cash dividend of $0.07 per share, payable on November 19, 2008, to shareholders of record at the close of business November 5, 2008.  The decision to reduce the quarterly dividend as compared to recent quarters was based upon the Board of Directors’ review of the Company’s dividend payout ratio and dividend yield balanced with the Company’s desire to retain capital.  On July 24, 2008, the Company declared a quarterly cash dividend of $.17 per share, payable on August 20, 2008, to shareholders of record at the close of business on August 6, 2008.  On April 24, 2008, the Company declared a quarterly cash dividend of $0.17 per share, payable on May 21, 2008, to shareholders of record at the close of business May 7, 2008.  On January 24, 2008, the Company declared a quarterly cash dividend of $0.17 per share, payable on February 20, 2008 to shareholders of record as of the close of business on February 6, 2008.  The payment of cash dividends is subject to Federal regulatory requirements for capital levels and other restrictions. In addition, the cash dividends paid by Columbia Bank to the Company are subject to both Federal and State regulatory requirements.
 
Subsequent to quarter-end, the Company received preliminary approval from the U.S. Department of Treasury to receive additional capital by participating in the Treasury Department’s Capital Purchase Program.  As a participant in the program, Columbia could issue to the U.S. Treasury up to $76.9 million in senior preferred shares and related warrants.  Receipt of the funding is subject to Columbia’s acceptance of the terms of the agreement, satisfaction of closing conditions and registration with the Securities and Exchange Commission.  Certain terms of the senior preferred shares restrict the ability of the Company to repurchase and/or pay dividends on common stock.
 
5. Business Segment Information
 
The Company is managed along two major lines of business: commercial banking and retail banking. The treasury function of the Company, included in the “Other” category, although not considered a line of business, is responsible for the management of investments and interest rate risk. In addition, the provision for loan and lease losses is included in the “Other” category.  On April 1, 2008, the Bank of Astoria banking subsidiary was merged into the Columbia Bank banking subsidiary.  This change in internal organizational structure also changes the composition of the Company’s reportable segments.  Accordingly, segment results for the Bank of Astoria are now included in the Retail Banking segment.  Prior period segment reporting has been restated to reflect this change.
 
The Company generates segment results that include balances directly attributable to business line activities. The financial results of each segment are derived from the Company’s general ledger system. Overhead, including sales and back office support functions and other indirect expenses are not allocated to the major lines of business. Goodwill resulting from business combinations is included in the Retail Banking segment. Since the Company is not specifically organized around lines of business, most reportable segments comprise more than one operating activity.

6

 
The principal activities conducted by commercial banking are the origination of commercial business relationships, private banking services and real estate lending. Retail banking includes all deposit products, with their related fee income, and all consumer loan products as well as commercial loan products offered in the Company’s branch offices.
 
Effective January 1, 2008 the Company implemented a more robust internal funds transfer pricing methodology.  Internal funds transfer pricing refers to the process we utilize to give an earnings credit to a branch or revenue center for the deposit funds they generate while providing an earnings charge to the centers that use deposit funds to make loans.  The implementation of this methodology changed the basis of measurement for segment net interest income as presented in the tables below.  Generally, this methodology had the effect of increasing net interest income for the commercial banking segment with a corresponding decrease in net interest income for the retail banking segment.  The increase in net interest income for the commercial banking segment is driven primarily by the earnings credit for deposit funds generated within that segment.  In prior years, the retail banking segment benefited from the earnings credit for deposit funds generated by the commercial banking segment.  Segment net interest income after provision for loan and lease losses for the current quarter and year-to-date periods is not directly comparable to the same line item for the same periods of last year as those prior periods cannot practicably be restated.
 
The organizational structure of the Company and its business line financial results are not necessarily comparable with information from other financial institutions. Financial highlights by lines of business are as follows:

   
Three Months Ended September 30, 2008
 
(in thousands)
 
Commercial Banking
   
Retail Banking
   
Other
   
Total
 
Net interest income
  $ 10,563     $ 13,198     $ 5,832     $ 29,593  
Provision for loan and lease losses
    -       -       (10,500 )     (10,500 )
Net interest income after provision for loan and lease losses
    10,563       13,198       (4,668 )     19,093  
Noninterest income
    846       2,171       (13,963 )     (10,946 )
Noninterest expense
    (10,610 )     (14,866 )     2,085       (23,391 )
Income (loss) before income taxes
    799       503       (16,546 )     (15,244 )
Income tax benefit
                            6,485  
Net loss
                          $ (8,759 )
Total assets
  $ 1,423,184     $ 1,015,412     $ 666,384     $ 3,104,980  
                                 
   
Three Months Ended September 30, 2007
 
(in thousands)
 
Commercial Banking
   
Retail Banking
   
Other
   
Total
 
Net interest income
  $ 11,893     $ 17,464     $ (497 )   $ 28,860  
Provision for loan and lease losses
     -        -       (1,231 )     (1,231 )
Net interest income after provision for loan and lease losses
    11,893       17,464       (1,728 )     27,629  
Noninterest income
    1,067       2,353       4,211       7,631  
Noninterest expense
    (3,341 )     (7,362 )     (11,722 )     (22,425 )
Income (loss) before income taxes
    9,619       12,455       (9,239 )     12,835  
Income tax provision
                            (3,579 )
Net income
                          $ 9,256  
Total assets
  $ 1,399,262     $ 1,003,947     $ 719,535     $ 3,122,744  
 
7

 
   
Nine Months Ended September 30, 2008
 
(in thousands)
 
Commercial Banking
   
Retail Banking
   
Other
   
Total
 
Net interest income
  $ 37,283     $ 43,805     $ 9,106     $ 90,194  
Provision for loan and lease losses
    -       -       (27,926 )     (27,926 )
Net interest income after provision for loan and lease losses
    37,283       43,805       (18,820 )     62,268  
Noninterest income
    2,848       6,736       (1,068 )     8,516  
Noninterest expense
    (16,577 )     (31,965 )     (21,770 )     (70,312 )
Income (loss) before income taxes
    23,554       18,576       (41,658 )     472  
Income tax benefit
                            3,682  
Net income
                          $ 4,154  
Total assets
  $ 1,423,184     $ 1,015,412     $ 666,384     $ 3,104,980  
                                 
   
Nine Months Ended September 30, 2007
 
(in thousands)
 
Commercial Banking
   
Retail Banking
   
Other
   
Total
 
Net interest income
  $ 21,055     $ 59,537     $ (1,334 )   $ 79,258  
Provision for loan and lease losses
     -        -       (2,198 )     (2,198 )
Net interest income after provision for loan and lease losses
    21,055       59,537       (3,532 )     77,060  
Noninterest income
    2,427       6,249       11,873       20,549  
Noninterest expense
    (8,719 )     (20,058 )     (34,316 )     (63,093 )
Income (loss) before income taxes
    14,763       45,728       (25,975 )     34,516  
Income tax provision
                            (9,433 )
Net income
                          $ 25,083  
Total assets
  $ 1,399,262     $ 1,003,947     $ 719,535     $ 3,122,744  
 

 
6. Fair Value Accounting and Measurement
 
SFAS 157 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.
 
Level 3 – Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable.

8

 
Fair values are determined as follows:

Certain preferred stock securities at fair value are priced using quoted prices for identical instruments in active markets and are classified within level 1 of the valuation hierarchy.

Other securities at fair value are priced using matrix pricing based on the securities’ relationship to other benchmark quoted prices, and under the provisions of SFAS 157 are considered a Level 2 input method.

Interest rate swap 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, 2008 by level within the fair value hierarchy.  As required by SFAS 157, 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
   
Fair Value Measurements at Reporting Date Using
 
(in thousands)
 
September 30, 2008
   
Level 1
   
Level 2
   
Level 3
 
Assets
                       
Securities available for sale
  $ 536,277     $ 1,512     $ 534,765     $ -  
Interest rate swap agreements
  $ 3,703     $ -     $ 3,703     $ -  
Liabilities
                               
Interest rate swap agreements
  $ 3,703     $ -     $ 3,703     $ -  
 
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.
 
 
     The following table sets forth the Company’s financial assets that were accounted for at fair value on a nonrecurring basis at September 30, 2008:
 
   
Fair value at
   
Fair Value Measurements at Reporting Date Using
 
(in thousands)
 
September 30, 2008
   
Level 1
   
Level 2
   
Level 3
 
Impaired loans
  $ 14,453     $ -     $ -     $ 14,453  
Other real estate owned
    1,449       -       -       1,449  
    $ 15,902     $ -     $ -     $ 15,902  

In accordance with Statement of Financial Accounting Standards No. 114, Accounting by Creditors for Impairment of a Loan, impaired loans, with carrying amounts of $16,701 had specific valuation allowances totaling $2,248, which were included in the allowance for loan and lease losses.

9


Other real estate owned with a carrying amount of $1.6 million was acquired during the quarter.  In accordance with Statement of Financial Accounting Standards No.144, Accounting for the Impairment or Disposal of Long-Lived Assets, these long-lived assets held for sale were written down to their fair value of $1.4 million, less cost to sell of $161,000 (or $1.3 million), resulting in a loss of $266,000, which was charged to the allowance for loan and lease losses during the period.

7. Securities

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

         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
       
(in thousands)
 
Cost
   
Gains
   
Losses
   
Fair Value
 
September 30, 2008:
                       
U.S. government-sponsored enterprise preferred stock
  $ 1,512     $ -     $ -     $ 1,512  
U.S. government agency and government-sponsored enterprise mortgage-backed securities and collateralized mortgage obligations
    344,123       3,803       (1,268 )     346,658  
State and municipal securities
    188,985       2,635       (4,453 )     187,167  
Other securities
    1,000       -       (60 )     940  
Total
  $ 535,620     $ 6,438     $ (5,781 )   $ 536,277  
December 31, 2007:
                               
U.S. government-sponsored enterprise
  $ 61,137     $ 216     $ (53 )   $ 61,300  
U.S. government agency and government-sponsored enterprise mortgage-backed securities and collateralized mortgage obligations
    304,475       1,132       (1,865 )     303,742  
State and municipal securities
    190,673       3,782       (490 )     193,965  
Other securities
    2,400       -       (41 )     2,359  
Total
  $ 558,685     $ 5,130     $ (2,449 )   $ 561,366  

During the quarter, the Federal Home Loan Mortgage Corporation (“Freddie Mac”) and the Federal National Mortgage Association (“Fannie Mae”) were placed into conservatorship in a plan announced by the U.S. Treasury Department (“Treasury”) and the Federal Housing Finance Agency (“FHFA”).   The Company holds 400,000 shares of Series Z preferred stock issued by Freddie Mac and 400,000 shares of Series S preferred stock issued by Fannie Mae.  Such securities are held in the Company’s available-for-sale investment securities portfolio and, as such, declines in fair value below cost are subject to a potential other than temporary impairment charge to earnings under Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities.  The Company’s cost for these securities was $20 million.  The estimated fair market value of these securities declined from $20 million at June 30, 2008 to $1.5 million at September 30, 2008.  In light of the actions taken by Treasury and FHFA and the accompanying significant decline in the fair value of these securities below cost, the Company has deemed the impairment to be other than temporary and, accordingly, recognized a pre-tax charge to earnings in the third quarter totaling $18.5 million.

At September 30, 2008, 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 $6.1 million at September 30, 2008 were pledged as collateral for certain interest rate swap agreements.

10


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, 2008 and December 31, 2007:

September 30, 2008
                                   
   
Less than 12 Months
   
12 Months or More
   
Total
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
(in thousands)
 
Value
   
Losses
   
Value
   
Losses
   
Value
   
Losses
 
U.S. government agency and government-sponsored enterprise mortgage-backed securities and collateralized mortgage obligations
  $ 11,679     $ (78 )   $ 53,728     $ (1,190 )   $ 65,407     $ (1,268 )
State and municipal securities
    95,609       (4,037 )     6,158       (416 )     101,767       (4,453 )
Other securities
    -       -       940       (60 )     940       (60 )
Total
  $ 107,288     $ (4,115 )   $ 60,826     $ (1,666 )   $ 168,114     $ (5,781 )

December 31, 2007
                                   
   
Less than 12 Months
   
12 Months or More
   
Total
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
(in thousands)
 
Value
   
Losses
   
Value
   
Losses
   
Value
   
Losses
 
U.S. government-sponsored enterprise
  $ -     $ -     $ 17,678     $ (53 )   $ 17,678     $ (53 )
U.S. government agency and government-sponsored enterprise mortgage-backed securities and collateralized mortgage obligations
    16,897       (28 )     170,932       (1,837 )     187,829       (1,865 )
State and municipal securities
    19,725       (112 )     24,549       (378 )     44,274       (490 )
Other securities
    -       -       959       (41 )     959       (41 )
Total
  $ 36,622     $ (140 )   $ 214,118     $ (2,309 )   $ 250,740     $ (2,449 )


U.S. Government Agency and Government-Sponsored Enterprise Mortgage-Backed Securities and Collateralized Mortgage Obligations.   At September 30, 2008, there were 21 U.S. government agency and government-sponsered enterprise mortgage-backed securities & collateralized mortgage obligations securities in an unrealized loss position, of which 15 were in a continuous loss position for 12 months or more. The unrealized losses on U.S. Government agency mortgage-backed securities & collateralized mortgage obligations were caused by interest rate increases subsequent to the purchase of the securities. It is expected that the securities would not be settled at a price less than the amortized cost of the investment. Because the decline in fair value is attributable to changes in interest rates rather than credit quality, and because the Company has the ability and intent to hold these investments until a recovery of market value, which may be maturity, the Company does not consider these investments to be other-than-temporarily impaired at September 30, 2008.

State and Municipal Securities.  At September 30, 2008 there were 126 state and municipal government securities in an unrealized loss position, of which 8 were in a continuous loss position for 12 months or more. The unrealized losses on state and municipal securities were caused by interest rate increases subsequent to the purchase of the individual securities. Management monitors published credit ratings of these securities for adverse changes. As of September 30, 2008 none of the obligations of state and local government entities held by the Company had an adverse credit rating. Because the decline in fair value is attributable to changes in interest rates rather than credit quality, and because the Company has the ability and intent to hold these investments until a recovery of market value, which may be maturity, the Company does not consider these investments to be other-than-temporarily impaired at September 30, 2008.

Other Securities.  At September 30, 2008, there was one other security, a mortgage-backed securities fund, which was in a continuous loss position for 12 months or more. The unrealized loss on this security was caused by interest rate increases subsequent to the purchase of the security. It is expected that this security would not be settled at a price less than the amortized cost of the investment. Because the decline in fair value is attributable to changes in interest rates rather than credit quality, and because the Company has the ability and intent to hold this investment until a recovery of market value, the Company does not consider this investment to be other-than-temporarily impaired at September 30, 2008.

11


8. Comprehensive Income (Loss)
 
The components of comprehensive income are as follows:

   
Three Months Ended
 
   
September 30,
 
(in thousands)
 
2008
   
2007
 
Net income(loss) as reported
  $ (8,759 )   $ 9,256  
Unrealized gain from securities:
               
Net unrealized holding gain from available for sale securities arising during the period, net of tax of ($1,935) and $(3,259)
    3,513       5,974  
Reclassification adjustment of net (gain)loss from sale of available for sale securities included in income, net of tax of $0 and $0
    -       -  
Net unrealized gain from securities, net of reclassification adjustment
    3,513       5,974  
Unrealized gain(loss) from cash flow hedging instruments:
               
Net unrealized gain from cash flow hedging instruments arising during the period, net of tax of $0 and $(863)
    -       1,583  
Reclassification adjustment of net (gain)loss included in income, net of tax of $197 and $(13)
    (357 )     24  
Net unrealized gain(loss) from cash flow hedging instruments
    (357 )     1,607  
Total comprehensive income (loss)
  $ (5,603 )   $ 16,837  
   
Nine Months Ended
 
   
September 30,
 
(in thousands)
 
2008
   
2007
 
Net income as reported
  $ 4,154     $ 25,083  
Unrealized gain(loss) from securities:
               
Net unrealized holding gain(loss) from available for sale securities arising during the period, net of tax of $410 and $(992)
    (731 )     1,911  
Reclassification adjustment of net gain from sale of available for sale securities included in income, net of tax of $311 and $0
    (571 )     -  
Net unrealized gain (loss) from securities, net of reclassification adjustment
    (1,302 )     1,911  
Unrealized gain from cash flow hedging instruments:
               
Net unrealized gain from cash flow hedging instruments arising during the period, net of tax of $(425) and ($413)
    739       756  
Reclassification adjustment of net (gain)loss included in income, net of tax of $363 and $(20)
    (659 )     38  
Net unrealized gain from cash flow hedging instruments
    80       794  
Total comprehensive income
  $ 2,932     $ 27,788  
 

12

 
9. Allowance for Loan and Lease Losses and Unfunded Loan Commitments and Letters of Credit
 
The following table presents activity in the allowance for loan and lease losses for the three and nine months ended September 30, 2008 and 2007:
 

   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
(in thousands)
 
2008
   
2007
   
2008
   
2007
 
Beginning balance
  $ 41,724     $ 21,339     $ 26,599     $ 20,182  
Balance established through acquisition
    -       3,192       -       3,192  
Provision charged to expense
    10,500       1,231       27,926       2,198  
Loans charged off
    (16,481 )     (528 )     (19,384 )     (854 )
Recoveries
    71       146       673       662  
Ending balance
  $ 35,814     $ 25,380     $ 35,814     $ 25,380  
 
Changes in the allowance for unfunded loan commitments and letters of credit are summarized as follows:
 
   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
(in thousands)
 
2008
   
2007
   
2008
   
2007
 
Beginning balance
  $ 459     $ 339     $ 349     $ 339  
Net changes in the allowance for unfunded commitments and letters of credit
    -       10       110       10  
Ending balance
  $ 459     $ 349     $ 459     $ 349  
 
10. Goodwill and Intangible Assets
 
At September 30, 2008 and December 31, 2007, the Company had $95.5 million and $96.0 million in goodwill, respectively.  The change in goodwill from year-end is due to income tax adjustments related to the 2007 acquisitions resulting from the preparation of final income tax returns.  At September 30, 2008 and December 31, 2007, the Company had a core deposit intangible (“CDI”) asset of $6.2 million and $7.1 million, respectively. In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets”, 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 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. Amortization expense related to the CDI was $279,000 and $96,000 for the three months ended September 30, 2008 and September 30, 2007 and $871,000 and $287,000 for the nine months ended September 30, 2008 and September 30, 2007, respectively. The Company estimates that aggregate amortization expense on the CDI will be $271,000 during the fourth quarter of 2008, $1.0 million for 2009, $963,000 for 2010, $893,000 for 2011 and $832,000 for 2012.  The CDI amortization expense is included in other noninterest expense on the consolidated condensed statements of income.
 
 
11. Commitments and Contingent Liabilities
 
On March 18, 2008 Visa, Inc. (“Visa”) completed its initial public offering (“IPO”). On March 31, 2008 Visa funded a litigation escrow account with $3.0 billion from the IPO proceeds. Based on the Company’s Visa USA membership percentage, the expected economic benefit to the Company from this escrow account is $889,200. Accordingly, the Company recognized a recapture of previously accrued legal expense of $889,200. This recapture is included in the legal and professional services line item of the consolidated condensed statements of income and is a reduction of the $1.8 million Visa litigation liability the Company accrued during the fourth quarter of 2007. Subsequent to quarter-end, on October 27, 2008, Visa announced that it had reached a settlement in principle in certain covered litigation with Discover Financial Services.  The settlement totals $1.9 billion, which includes $1.7 billion from the litigation escrow account, $80 million from Visa to obtain releases from MasterCard and an additional $65 million which will be refunded by Morgan Stanley under a separate agreement related to the settlement.  On November 5, 2008, Visa announced that the settlement was approval by Visa’s former U.S. member financial institutions.

13

 
 Item 2.                      MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS
 
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, 2007 audited consolidated financial statements and its accompanying notes included in our recent Annual Report on Form 10-K. In the following discussion, unless otherwise noted, references to increases or decreases in average balances 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.
 
NOTE REGARDING FORWARD LOOKING STATEMENTS
 
This Quarterly Report on Form 10-Q may be deemed to include forward looking statements, which management believes to be a benefit to shareholders.  These forward looking statements describe management’s expectations regarding future events and developments such as future operating results, growth in loans and deposits, continued success of our style of banking and the strength of the local economy. The words “will,” “believe,” “expect,” “should,” and “anticipate” and words of similar construction are intended in part to help identify forward looking statements. Future events are difficult to predict, and the expectations described above are necessarily subject to risk and uncertainty that may cause actual results to differ materially and adversely. In addition to discussions about risks and uncertainties set forth from time to time in our filings with the SEC, factors that may cause actual results to differ materially from those contemplated by such forward looking statements include, among others, the following possibilities: (1) local and national economic conditions are less favorable than expected or 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; (2) a continued decline in the housing/real estate market; (3) changes in interest rates significantly reduce interest margins and negatively affect funding sources; (4) deterioration of credit quality that could, among other things, increase defaults and delinquency risks in the Company’s loan portfolios (5) projected business increases following strategic expansion activities are lower than expected; (6) competitive pressure among financial institutions increases significantly; (7) legislation or regulatory requirements or changes adversely affect the businesses in which we are engaged; and (8) our ability to realize the efficiencies we expect to receive from our investments in personnel, acquisitions and infrastructure.
 
CRITICAL ACCOUNTING POLICIES
 
Management has identified the accounting policies related to the allowance for loan and lease losses 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 heading “Allowance for Loan and Lease Losses and Unfunded Loan Commitments and Letters of Credit” in our 2007 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 as compared to those disclosed in our 2007 Annual Report on Form 10-K.
 
OVERVIEW
 
Note:  The first nine months of 2007 financial information does not include the results of operations of Mountain Bank Holding Company and Town Center Bancorp prior to the acquisition date of July 23, 2007.
 
Earnings Summary
 
The Company reported a net loss for the third quarter of $8.8 million or ($0.49) per diluted share, compared to net income of $9.3 million or $0.53 per diluted share for the third quarter of 2007.  Return on average assets and return on average equity were (1.12%) and (10.10%), respectively, for the third quarter of 2008, compared with returns of 1.24% and 12.18%, respectively for the same period of 2007.  The Company’s results for the third quarter of 2008 declined from the same period in 2007, as a result of an other than temporary impairment charge of $18.5 million, before tax, on preferred stock issued by Federal National Mortgage Association (“Fannie Mae”) and Federal Home Loan Mortgage Corporation (“Freddie Mac”) and a provision for loan and lease losses of $10.5 million as discussed below.  The results of the third quarter of 2008 reflect the financial consolidation of Mountain Bank Holding Company and Town Center Bancorp, which were both acquired on July 23, 2007; accordingly, the financial information for the third quarter of 2007 only includes partial results of the two organizations.

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The Company reported net income of $4.2 million for the first nine months of 2008 or $0.23 per diluted share, compared with $25.1 million or $1.51 per diluted share for the first nine months of 2007.  Return on average assets and return on average equity were 0.18% and 1.59%, respectively, for the first nine months of 2008, compared with returns of 1.22% and 12.92%, respectively for the first nine months of 2007.  As stated above, the Company’s results for the first nine months of 2008 declined from the same period in 2007, as a result of the other than temporary impairment charge of $18.5 million and a provision for loan and lease losses of $27.9 million as discussed below.  The results of the first nine months reflect the financial consolidation of Mountain Bank Holding Company and Town Center Bancorp, which were both acquired on July 23, 2007; accordingly, the financial information for the first nine months of 2007 does not include the results of the two organizations for the entire period.
 
Revenue (net interest income plus noninterest income) for the three months ended September 30, 2008 was $18.6 million, 49% lower than the same period in 2007.  The decrease was primarily driven by the reduction in noninterest income resulting from the $18.5 million impairment loss on preferred stock discussed above.
 
Revenue (net interest income plus noninterest income) for the first nine months of 2008 was $98.7 million, 1%, lower than the first nine months of 2007.  The reduction in noninterest income for the period stemming from the $18.5 million impairment loss was partially offset by gains on the sale of investment securities, proceeds from the redemption of Visa and MasterCard shares and increased service charges and other fees.  In addition, net interest income increased 14% from the prior year driven primarily by growth in earning assets due, in part, to the third quarter 2007 acquisitions.
 
Total noninterest expense in the quarter ended September 30, 2008 was $23.4 million, a 4% increase from the third quarter of 2007.  Regulatory premiums, data processing expenses and core deposit intangible expenses increased in the third quarter 2008 primarily due to the third quarter 2007 acquisitions.
 
Total noninterest expense in the first nine months of 2008 was $70.3 million, or 11%, higher than in the first nine months of 2007.  The increase was due to compensation and occupancy costs related to the third quarter 2007 acquisitions.  In addition, regulatory premiums were $1.2 million higher for the first nine months of 2008 over the same period in 2007, resulting from a credit received in 2007 which offset the majority of the FDIC premiums due. These increases were offset by a partial reversal of legal expenses in the first quarter of 2008, totaling $889,000, related to certain Visa litigation.  Legal expenses related to this litigation were accrued by the Company in the fourth quarter of 2007.
 
The provision for loan and lease losses for the third quarter of 2008 was $10.5 million compared with $1.2 million for the third quarter of 2007.  The additional provision is due to the continued weakness in the for-sale housing industry resulting from the slowing economic environment and non-accrual loans of $76.2 million at September 30, 2008 compared to $10 million at September 30, 2007.  The provision increased the Company’s total allowance for loan and lease losses to 1.62% of net loans at September 30, 2008 from 1.17% at year-end.  Net charge-offs for the current quarter were $16.4 million compared to $382,000 for the third quarter of 2007.
 
The provision for loan and lease losses for the first nine months of 2008 was $27.9 million compared with $2.2 million for the first nine months of 2007.  Net charge-offs for the first nine months of 2008 were $18.7 million as compared to $192,000 for the first nine months of 2007.
 
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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Note:  The first nine months of 2007 financial information does not include the results of operations of Mountain Bank Holding Company and Town Center Bancorp prior to the acquisition date of July 23, 2007.
 
Net Interest Income
 
For the three months ended September 30, 2008 we experienced a slight decrease in our net interest margin when compared to the same period in 2007.  This decrease resulted primarily from a decline in the yield on earning assets.  For the third quarter of 2008 interest income decreased 14% while interest expense decreased 38%, when compared to the same period in 2007.  The decrease in interest income and interest expense for the period is primarily due to rate decreases on both interest-earning assets and interest-bearing liabilities.  For the nine months ended September 30, 2008 interest income increased 1% over the same period in 2007 whereas interest expense decreased 18%.  The increase in interest income in the first nine months of the year was driven primarily by loan growth and the decrease in interest expense driven by rate decreases on interest bearing deposits and borrowed funds.   Finally, like most financial institutions, changes in the target Federal Funds rate may affect our net interest margin.

The following tables set forth the average balances of all major categories of interest-earning assets and interest-bearing liabilities, the total dollar amounts of interest income on interest-earning assets and interest expense on interest-bearing liabilities, the average yield earned on interest-earning assets and average rate paid on interest-bearing liabilities by category and in total, net interest income and net interest margin.  
 
   
Three months ending September 30,
   
Three months ending September 30,
 
   
2008
   
2007
 
   
Average
   
Interest
   
Average
   
Average
   
Interest
   
Average
 
(in thousands)
 
Balances (1)
   
Earned / Paid
   
Rate
   
Balances (1)
   
Earned / Paid
   
Rate
 
ASSETS
                                   
Loans, net (2)
  $ 2,241,574     $ 35,696       6.34 %   $ 2,102,281     $ 42,353       7.99 %
Securities (2)
    558,990       7,806       5.56 %     572,124       7,727       5.36 %
Interest-earning deposits with banks and federal funds sold
    30,330       135       1.78 %     28,082       395       5.58 %
Total interest-earning assets
    2,830,894     $ 43,637       6.13 %     2,702,487     $ 50,475       7.41 %
Other earning assets
    47,795                       44,595                  
Noninterest-earning assets
    227,867                       222,115                  
     Total assets
  $ 3,106,556                     $ 2,969,197                  
LIABILITIES AND SHAREHOLDERS' EQUITY
                                               
Certificates of deposit
  $ 741,101     $ 6,048       3.25 %   $ 772,358     $ 8,976       4.61 %
Savings accounts
    120,025       109       0.36 %     116,640       131       0.45 %
Interest-bearing demand and money market accounts
    1,035,641       3,991       1.53 %     1,038,571       7,734       2.95 %
Total interest-bearing deposits
    1,896,767       10,148       2.13 %     1,927,569       16,841       3.47 %
Federal Home Loan Bank advances
    293,685       1,887       2.56 %     178,303       2,454       5.46 %
Securities sold under agreements to repurchase
    25,000       121       1.93 %     44,457       637       5.68 %
Other borrowings and interest-bearing liabilities
    18,634       165       3.52 %     370       2       2.14 %
Long-term subordinated debt
    25,569       423       6.59 %     24,771       584