CACB-2013.9.30-10Q


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, 2013
 
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: 000-23322

CASCADE BANCORP
(Exact name of registrant as specified in its charter)
 
Oregon
93-1034484
(State or other jurisdiction of
incorporation)
(IRS Employer Identification No.)
 
1100 N.W. Wall Street
Bend, Oregon 97701
(Address of principal executive offices)
(Zip Code)
 
(877) 617-3400
(Registrant’s telephone number, including area code) 
 

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 x  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   ¨ Non-accelerated filer   x 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
 
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. 47,588,460 shares of no par value Common Stock as of November 8, 2013.




CASCADE BANCORP & SUBSIDIARY
FORM 10-Q
QUARTERLY REPORT
September 30, 2013

 
INDEX
 
 
Page
PART I:  FINANCIAL INFORMATION
 
 
 
 
Item 1.
 
 
 
 
 
 
September 30, 2013 and December 31, 2012
 
 
 
 
 
 
Three and Nine months ended September 30, 2013 and 2012
 
 
 
 
 
 
Three and Nine months ended September 30, 2013 and 2012
 
 
 
 
 
 
Nine months ended September 30, 2013 and 2012
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
PART II:  OTHER INFORMATION
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Item 5
 
 
 
Item 6.
 
 
 

2



PART I – FINANCIAL INFORMATION

ITEM 1.    FINANCIAL STATEMENTS
 Cascade Bancorp & Subsidiary
Condensed Consolidated Balance Sheets
September 30, 2013 and December 31, 2012
(Dollars in thousands)
(unaudited) 
 
September 30, 
 2013
 
December 31,
2012
ASSETS
 

 
 

Cash and cash equivalents:
 

 
 

Cash and due from banks
$
44,405

 
$
31,354

Interest bearing deposits
85,399

 
81,651

Federal funds sold
22

 
23

Total cash and cash equivalents
129,826

 
113,028

Investment securities available-for-sale
200,103

 
257,544

Investment securities held-to-maturity, estimated fair value of $1,364 ($1,863 in 2012)
1,337

 
1,813

Federal Home Loan Bank (FHLB) stock
10,006

 
10,285

Loans held for sale
12,414

 
2,329

Loans, net
916,505

 
829,057

Premises and equipment, net
33,744

 
34,239

Bank-owned life insurance (BOLI)
36,364

 
35,705

Other real estate owned (OREO), net
3,345

 
6,552

Deferred tax asset (DTA), net
51,463

 

Other assets
11,563

 
10,865

Total assets
$
1,406,670

 
$
1,301,417

 
 
 
 
LIABILITIES & STOCKHOLDERS' EQUITY
 

 
 

Liabilities:
 

 
 

Deposits:
 

 
 

Demand
$
459,033

 
$
410,258

Interest bearing demand
541,604

 
496,674

Savings
47,225

 
40,030

Time
147,754

 
129,272

Total deposits
1,195,616

 
1,076,234

FHLB borrowings

 
60,000

Other liabilities
24,178

 
24,408

Total liabilities
1,219,794

 
1,160,642

 
 
 
 
Stockholders' equity:
 

 
 

Preferred stock, no par value; 5,000,000 shares authorized; none issued or outstanding

 

Common stock, no par value; 100,000,000 shares authorized; 47,588,609 issued and outstanding (47,326,306 in 2012)
330,684

 
330,024

Accumulated deficit
(143,320
)
 
(192,933
)
Accumulated other comprehensive income
(488
)
 
3,684

Total stockholders' equity
186,876

 
140,775

Total liabilities and stockholders' equity
$
1,406,670

 
$
1,301,417

  See accompanying notes to condensed consolidated financial statements.

3



Cascade Bancorp & Subsidiary
Condensed Consolidated Statements of Operations
Three and Nine months ended September 30, 2013 and 2012
(Dollars in thousands, except per share amounts)
(unaudited)
 
Three months ended  
 September 30,
 
Nine months ended  
 September 30,
 
2013
 
2012
 
2013
 
2012
Interest income:
 

 
 

 
 
 
 
Interest and fees on loans
$
11,080

 
$
11,893

 
$
33,251

 
$
37,231

Interest on investments
1,356

 
1,533

 
4,059

 
4,462

Other investment income
71

 
36

 
173

 
163

Total interest income
12,507

 
13,462

 
37,483

 
41,856

 
 
 
 
 
 
 
 
Interest expense:
 

 
 

 
 
 
 
Deposits:
 

 
 

 
 
 
 
Interest bearing demand
193

 
224

 
541

 
872

Savings
6

 
5

 
17

 
18

Time
235

 
462

 
829

 
1,612

Other borrowings
16

 
480

 
949

 
1,429

Total interest expense
450

 
1,171

 
2,336

 
3,931

 
 
 
 
 
 
 
 
Net interest income
12,057

 
12,291

 
35,147

 
37,925

Loan loss provision

 

 
1,000

 
1,100

Net interest income after loan loss provision
12,057

 
12,291

 
34,147

 
36,825

 
 
 
 
 
 
 
 
Non-interest income:
 

 
 

 
 
 
 
Service charges on deposit accounts
766

 
791

 
2,245

 
2,471

Card issuer and merchant services fees, net
847

 
694

 
2,473

 
1,970

Earnings on BOLI
224

 
234

 
659

 
751

Mortgage banking income, net
1,284

 
1,104

 
3,504

 
2,948

Other income
516

 
410

 
1,628

 
1,500

Total non-interest income
3,637

 
3,233

 
10,509

 
9,640

 
 
 
 
 
 
 
 
Non-interest expense:
 

 
 

 
 
 
 
Salaries and employee benefits
7,633

 
7,859

 
24,239

 
23,720

Occupancy
1,101

 
1,127

 
3,830

 
3,444

Equipment
457

 
371

 
1,191

 
1,143

Communications
347

 
394

 
1,108

 
1,149

FDIC insurance
454

 
665

 
1,305

 
2,048

OREO
47

 
85

 
322

 
834

Professional services
1,025

 
753

 
2,535

 
2,630

Prepayment penalties on FHLB advances

 

 
3,827

 

Other expenses
2,519

 
2,445

 
7,847

 
6,804

Total non-interest expense
13,583

 
13,699

 
46,204

 
41,772

 
 
 
 
 
 
 
 
Income (loss) before income taxes
2,111

 
1,825

 
(1,548
)
 
4,693

Income tax benefit (provision)
(619
)
 

 
51,159

 
(50
)
Net income
$
1,492


$
1,825


$
49,611


$
4,643

 
 
 
 
 
 
 
 
Basic and diluted income per share:
 

 
 

 
 
 
 
Net income per common share
$
0.03

 
$
0.04

 
$
1.05

 
$
0.10

Net income per common share (diluted)
$
0.03

 
$
0.04

 
$
1.05

 
$
0.10

 
See accompanying notes to condensed consolidated financial statements.

4




Cascade Bancorp & Subsidiary
Condensed Consolidated Statements of Comprehensive Income (Loss)
Three and Nine months ended September 30, 2013 and 2012
(Dollars in thousands)
(unaudited)
 
 
Three months ended  
 September 30,
 
Nine months ended  
 September 30,
 
2013
 
2012
 
2013
 
2012
Net Income
$
1,492

 
$
1,825

 
$
49,611

 
$
4,643

 
 
 
 
 
 
 
 
Other Comprehensive income:
 

 
 

 
 
 
 
Unrealized (losses) gains on investment securities available-for-sale
(4,477
)
 
985

 
(6,729
)
 
1,732

Tax effect of the unrealized (losses) gains on investment securities available-for-sale
1,701

 
(375
)
 
2,557

 
(658
)
Comprehensive (loss) income
$
(1,284
)
 
$
2,435

 
$
45,439

 
$
5,717

 
See accompanying notes to condensed consolidated financial statements.

5




Cascade Bancorp & Subsidiary
Condensed Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2013 and 2012
(Dollars in thousands)
(unaudited)
 
 
Nine months ended  
 September 30,
 
2013
 
2012
Net cash provided by operating activities
$
3,624

 
$
19,500

 
 
 
 
Investing activities:
 

 
 

Purchases of investment securities available-for-sale

 
(398,174
)
Purchases of mutual funds
(11
)
 

Proceeds from maturities, calls, and prepayments of investment securities available-for-sale
49,884

 
333,769

Proceeds from maturities, calls of investment securities held-to-maturity
475

 
310

Proceeds from sale of FHLB stock
279

 
94

Loan (increases) reductions, net
(100,794
)
 
25,803

Purchases of premises and equipment, net
(1,060
)
 
(631
)
Proceeds from sales of OREO
5,091

 
706

Net cash used in investing activities
(46,136
)
 
(38,123
)
 
 
 
 
Financing activities:
 
 
 
Net increase (decrease) in deposits
119,382

 
(16,321
)
Proceeds from stock options exercised
30

 

Tax effect of non-vested restricted stock
(102
)
 
(83
)
Repayment of FHLB advances
(60,000
)
 

Net cash provided by (used in) financing activities
59,310

 
(16,404
)
Net increase (decrease) in cash and cash equivalents
16,798

 
(35,027
)
Cash and cash equivalents at beginning of period
113,028

 
128,439

Cash and cash equivalents at end of period
$
129,826

 
$
93,412

 
 
 
 
Supplemental disclosures of cash flow information:
 

 
 

Interest paid
$
2,573

 
$
4,057

Loans transferred to OREO
$
2,069

 
$
1,267

 
See accompanying notes to condensed consolidated financial statements.

6



Cascade Bancorp & Subsidiary
Notes to Condensed Consolidated Financial Statements
September 30, 2013
(unaudited)
1.    Basis of Presentation
 
The accompanying interim condensed consolidated financial statements include the accounts of Cascade Bancorp (“Bancorp”), an Oregon chartered single bank holding company, and its wholly-owned subsidiary, Bank of the Cascades (the “Bank”) (collectively, the “Company” or “Cascade”). All significant inter-company accounts and transactions have been eliminated in consolidation.
 
The interim condensed consolidated financial statements have been prepared by the Company without audit and in conformity with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information. Accordingly, certain financial information and footnotes have been omitted or condensed. In the opinion of management, the condensed consolidated financial statements include all adjustments (all of which are of a normal and recurring nature) necessary for the fair presentation of the results of the interim periods presented. In preparing the condensed consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the dates of the balance sheets and income and expenses for the reporting periods. Actual results could differ from those estimates. Operating results for the interim periods disclosed herein are not necessarily indicative of the results that may be expected for a full year or any future period.
 
The condensed consolidated financial statements as of and for the year ended December 31, 2012 were derived from audited consolidated financial statements, but do not include all disclosures contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012. The interim condensed consolidated financial statements should be read in conjunction with the December 31, 2012 consolidated financial statements, including the notes thereto, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.
 
Certain amounts in 2012 have been reclassified to conform to the 2013 presentation, however the reclassifications do not have a material impact on the condensed consolidated financial statements.


7



2.    Investment Securities
 
Investment securities at September 30, 2013 and December 31, 2012 consisted of the following (dollars in thousands):
 
Amortized
cost
 
Gross
unrealized
gains
 
Gross
unrealized
losses
 
Estimated
fair value
September 30, 2013
 

 
 

 
 

 
 

Available-for-sale
 

 
 

 
 

 
 

U.S. Agency mortgage-backed securities (MBS) *
$
177,401

 
$
3,140

 
$
4,401

 
$
176,140

Non-agency MBS
14,236

 
99

 
391

 
13,944

U.S. Agency asset-backed securities
8,753

 
869

 
112

 
9,510

Mutual fund
500

 
9

 

 
509

 
$
200,890

 
$
4,117

 
$
4,904

 
$
200,103

Held-to-maturity
 

 
 

 
 

 
 

Tax credit investments
$
630

 
$

 
$

 
$
630

Obligations of state and political subdivisions
707

 
27

 

 
734

 
$
1,337

 
$
27

 
$

 
$
1,364

 
 
 
 
 
 
 
 
December 31, 2012
 

 
 

 
 

 
 

Available-for-sale
 

 
 

 
 

 
 

U.S. Agency MBS *
$
216,141

 
$
5,426

 
$
252

 
$
221,315

Non-agency MBS
20,601

 
253

 

 
20,854

U.S. Agency asset-backed securities
9,374

 
599

 
118

 
9,855

Commercial paper
5,000

 

 

 
5,000

Mutual fund
486

 
34

 

 
520

 
$
251,602

 
$
6,312

 
$
370

 
$
257,544

Held-to-maturity
 

 
 

 
 

 
 

Tax credit investments
$
790

 
$

 
$

 
$
790

Obligations of state and political subdivisions
1,023

 
50

 

 
1,073

 
$
1,813

 
$
50

 
$

 
$
1,863

 
* U.S. Agency MBS include private label MBS of approximately $11.8 million and $14.4 million at September 30, 2013 and December 31, 2012, respectively, which are supported by FHA/VA collateral.
  
The following table presents the contractual maturities of investment securities at September 30, 2013 (dollars in thousands):
 
 
Available-for-sale
 
Held-to-maturity
 
Amortized
cost
 
Estimated
fair value
 
Amortized
cost
 
Estimated
fair value
Due in one year or less
$

 
$

 
$
325

 
$
333

Due after one year through five years
80

 
82

 
382

 
401

Due after five years through ten years
47,516

 
44,331

 

 

Due after ten years
152,794

 
155,181

 

 

Mutual fund
500

 
509

 

 

Tax credit investments

 

 
630

 
630

 
$
200,890

 
$
200,103

 
$
1,337

 
$
1,364

 

8



The following table presents the fair value and gross unrealized losses of the Bank’s investment securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at September 30, 2013 and December 31, 2012 (dollars in thousands):
 
 
Less than 12 months

12 months or more

Total
 
Estimated 
fair value

Unrealized
losses

Estimated 
fair value

Unrealized
losses

Estimated 
fair value

Unrealized
losses
September 30, 2013
 


 


 


 


 


 

U.S. Agency MBS
$
71,106


$
4,382


$
2,908


$
19


$
74,014


$
4,401

Non-Agency MBS
10,832


390


230


1


11,062


391

U.S. Agency asset-backed securities
727


1


2,524


111


3,251


112

 
$
82,665


$
4,773


$
5,662


$
131


$
88,327


$
4,904



















December 31, 2012
 


 


 


 


 


 

U.S. Agency MBS
$
34,114


$
43


$
12,718


$
209


$
46,832


$
252

U.S. Agency asset-backed securities




2,750


118


2,750


118

 
$
34,114


$
43


$
15,468


$
327


$
49,582


$
370

 
The unrealized losses on investments in U.S. Agency and non-agency MBS and U.S Agency asset-backed securities are primarily due to changes in market yield/rate spreads at September 30, 2013 and December 31, 2012 as compared to yield/rate spread relationships prevailing at the time specific investment securities were purchased. Management expects the fair value of these investment securities to recover as securities approach their maturity dates. Management does not believe that the above gross unrealized losses on investment securities are other-than-temporary. Accordingly, no impairment adjustments have been recorded.
 
Management intends to hold the investment securities classified as held-to-maturity until they mature, at which time the Company will receive full amortized cost value for such investment securities. Furthermore, as of September 30, 2013, management did not have the intent to sell any of the securities classified as available-for-sale in the table above and believes that it is more likely than not that the Company will not have to sell any such securities before a recovery of cost.

 3.    Loans and reserve for credit losses

 The composition of the loan portfolio at September 30, 2013 and December 31, 2012 was as follows (dollars in thousands):
 
 
September 30, 2013
 
December 31, 2012
 
Amount
 
Percent
 
Amount
 
Percent
Commercial real estate:
 

 
 

 
 

 
 

Owner occupied
$
209,830

 
22.3
%
 
$
196,821

 
22.9
%
Non-owner occupied
329,566

 
35.1
%
 
328,480

 
38.3
%
Total commercial real estate loans
539,396

 
57.4
%
 
525,301

 
61.2
%
Construction
52,502

 
5.6
%
 
45,650

 
5.3
%
Residential real estate
100,151

 
10.7
%
 
85,494

 
10.0
%
Commercial and industrial
211,246

 
22.5
%
 
162,213

 
18.9
%
Consumer
36,527

 
3.8
%
 
39,506

 
4.6
%
Total loans
939,822

 
100.0
%
 
858,164

 
100.0
%
 
 
 
 
 
 
 
 
Less:
 

 
 

 
 

 
 

Deferred loan fees
(1,664
)
 
 

 
(1,846
)
 
 

Reserve for loan losses
(21,653
)
 
 

 
(27,261
)
 
 

Loans, net
$
916,505

 
 

 
$
829,057

 
 

 

9



For the nine months ended September 30, 2013, total loan balances increased by $81.7 million mainly due to an increased commercial and industrial portfolio, primarily related to the Company's syndicated national credit portfolio. In addition, local owner-occupied commercial real estate ("CRE") was higher and the Company increased its portfolio of originated adjustable rate and 15 year residential real estate loans.
 
Approximately 74% of the Bank’s loan portfolio at September 30, 2013 consisted of real estate-related loans, including construction and development loans, residential mortgage loans, and commercial loans secured by commercial real estate. The Bank's results of operations and financial condition are affected by general economic trends and in particular, the strength of the local residential and commercial real estate markets in Central, Southern and Northwest Oregon and the greater Boise/Treasure Valley, Idaho area. Economic trends can significantly affect the strength of the local real estate market. Real estate values could be affected by, among other things, a worsening of economic conditions, an increase in foreclosures, a decline in home sale volumes, and an increase in interest rates. Furthermore, the Bank may experience an increase in the number of borrowers who become delinquent, file for protection under bankruptcy laws, or default on their loans or other obligations to the Bank given a sustained weakness or a weakening in business and economic conditions generally or specifically in the principal markets in which the Bank does business. An increase in the number of delinquencies, bankruptcies, or defaults could result in a higher level of non-performing assets, net charge-offs, and loan loss provision. Management is targeting to reduce CRE concentration over the long term, but real estate-related loans will remain a significant portfolio component due to the nature of the economies, businesses, and markets we serve.
 
In the normal course of business, the Bank may participate portions of loans to third parties in order to extend the Bank’s lending capability or to mitigate risk. At September 30, 2013 and December 31, 2012, the portion of loans participated to third-parties (which are not included in the accompanying condensed consolidated financial statements) totaled approximately $11.4 million and $12.7 million, respectively.
 
The reserve for loan losses represents management’s estimate of known and inherent losses in the loan portfolio as of the condensed consolidated balance sheet date and is recorded as a reduction to loans. The reserve for loan losses is increased by charges to operating expense through the loan loss provision, and decreased by loans charged-off, net of recoveries. The reserve for loan losses requires complex subjective judgments as a result of the need to make estimates about matters that are uncertain. The reserve for loan losses is maintained at a level currently considered adequate to provide for potential loan losses based on management’s assessment of various factors affecting the loan portfolio.
 
At September 30, 2013 and December 31, 2012, management believes that the Company’s reserve for loan losses is at an appropriate level under current circumstances and prevailing economic conditions. However the reserve for loan losses is based on estimates and actual losses may vary from the current estimates. These estimates are reviewed periodically, and, as adjustments become necessary, they are reported in earnings in the periods in which they become known. Therefore, management cannot provide assurance that, in any particular period, the Company will not have significant losses in relation to the amount reserved. The level of the reserve for loan losses is also determined after consideration of bank regulatory guidance and recommendations and is subject to review by such regulatory authorities who may require increases or decreases to the reserve based on their evaluation of the information available to them at the time of their examinations of the Bank.
 
For purposes of assessing the appropriate level of the reserve for loan losses, the Company analyzes loans and commitments to loan, and the amount of reserves allocated to loans and commitments to loan in each of the following reserve categories: pooled reserves, specifically identified reserves for impaired loans, and the unallocated reserve. Also, for purposes of analyzing loan portfolio credit quality and determining the appropriate level of reserve for loan losses, the Company identifies loan portfolio segments and classes based on the nature of the underlying loan collateral.
 
The decline in the reserve for loan losses from December 31, 2012 to September 30, 2013 was mainly related to charge offs during the period, a significant portion of which relates to the Bank’s ongoing remediation of adversely classified loans.


10



Transactions and allocations in the reserve for loan losses and unfunded loan commitments, by portfolio segment, for the three and nine months ended September 30, 2013 and 2012 were as follows (dollars in thousands):
 
Commercial
real estate
 
Construction
 
Residential
real estate
 
Commercial 
and 
industrial
 
Consumer
 
Unallocated
 
Total
Three months ended September 30, 2013
 

 
 

 
 

 
 

 
 

 
 

 
 

Reserve for loan losses
 

 
 

 
 

 
 

 
 

 
 

 
 

Balance at June 30, 2013
$
10,712

 
$
842

 
$
2,972

 
$
5,348

 
$
1,690

 
$
1,130

 
$
22,694

Loan loss provision (credit)
1,049

 
(201
)
 
(202
)
 
(23
)
 
185

 
(808
)
 

Recoveries
79

 
249

 
28

 
554

 
72

 

 
982

Loans charged off
(656
)
 
(292
)
 
(129
)
 
(534
)
 
(412
)
 

 
(2,023
)
Balance at end of period
$
11,184

 
$
598

 
$
2,669

 
$
5,345

 
$
1,535

 
$
322

 
$
21,653

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Reserve for unfunded lending commitments
 

 
 

 
 

 
 

 
 

 
 

 
 

Balance at June 30, 2013
$
48

 
$
268

 
$
25

 
$
75

 
$
24

 
$

 
$
440

Provision for unfunded loan commitments

 

 

 

 

 

 

Balance at end of period
$
48

 
$
268

 
$
25

 
$
75

 
$
24

 
$

 
$
440

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Reserve for credit losses
 

 
 

 
 

 
 

 
 

 
 

 
 

Reserve for loan losses
$
11,184

 
$
598

 
$
2,669

 
$
5,345

 
$
1,535

 
$
322

 
$
21,653

Reserve for unfunded lending commitments
48

 
268

 
25

 
75

 
24

 

 
440

Total reserve for credit losses
$
11,232

 
$
866

 
$
2,694

 
$
5,420

 
$
1,559

 
$
322

 
$
22,093

 
Commercial
real estate

Construction

Residential
real estate

Commercial 
and 
industrial

Consumer

Unallocated

Total
Nine months ended September 30, 2013
 


 


 


 


 


 


 

Reserve for loan losses
 


 


 


 


 


 


 

Balance at December 31, 2012
$
11,596


$
1,583


$
3,551


$
7,267


$
2,177


$
1,087


$
27,261

Loan loss provision (credit)
1,030


341


(590
)

989


(5
)

(765
)

1,000

Recoveries
294


412


216


1,900


190




3,012

Loans charged off
(1,736
)

(1,738
)

(508
)

(4,811
)

(827
)



(9,620
)
Balance at end of period
$
11,184


$
598


$
2,669


$
5,345


$
1,535


$
322


$
21,653






















Reserve for unfunded lending commitments
 


 


 


 


 


 


 

Balance at December 31, 2012
$
48


$
268


$
25


$
75


$
24


$


$
440

Provision for unfunded loan commitments













Balance at end of period
$
48


$
268


$
25


$
75


$
24


$


$
440






















Reserve for credit losses
 


 


 


 


 


 


 

Reserve for loan losses
$
11,184


$
598


$
2,669


$
5,345


$
1,535


$
322


$
21,653

Reserve for unfunded lending commitments
48


268


25


75


24




440

Total reserve for credit losses
$
11,232


$
866


$
2,694


$
5,420


$
1,559


$
322


$
22,093


11



  
 
Commercial
real estate
 
Construction
 
Residential
real estate
 
Commercial 
and 
industrial
 
Consumer
 
Unallocated
 
Total
Three months ended September 30, 2012
 

 
 

 
 

 
 

 
 

 
 

 
 

Reserve for loan losses
 

 
 

 
 

 
 

 
 

 
 

 
 

Balance at June 30, 2012
$
18,103

 
$
4,529

 
$
3,693

 
$
8,785

 
$
2,508

 
$
601

 
$
38,219

Loan loss provision (credit)
79

 
(1,183
)
 
932

 
580

 
33

 
(441
)
 

Recoveries
171

 
97

 
119

 
348

 
80

 

 
815

Loans charged off
(466
)
 

 
(1,010
)
 
(1,620
)
 
(295
)
 

 
(3,391
)
Balance at end of period
$
17,887

 
$
3,443

 
$
3,734

 
$
8,093

 
$
2,326

 
$
160

 
$
35,643

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Reserve for unfunded lending commitments
 

 
 

 
 

 
 

 
 

 
 

 
 

Balance at June 30, 2012
$
28

 
$
29

 
$
184

 
$
487

 
$
822

 
$

 
$
1,550

Provision for unfunded loan commitments

 

 

 

 

 

 

Balance at end of period
$
28

 
$
29

 
$
184

 
$
487

 
$
822

 
$

 
$
1,550

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Reserve for credit losses
 

 
 

 
 

 
 

 
 

 
 

 
 

Reserve for loan losses
$
17,887

 
$
3,443

 
$
3,734

 
$
8,093

 
$
2,326

 
$
160

 
$
35,643

Reserve for unfunded lending commitments
28

 
29

 
184

 
487

 
822

 

 
1,550

Total reserve for credit losses
$
17,915

 
$
3,472

 
$
3,918

 
$
8,580

 
$
3,148

 
$
160

 
$
37,193


 
Commercial
real estate

Construction

Residential
real estate

Commercial 
and 
industrial

Consumer

Unallocated

Total
Nine months ended September 30, 2012
 


 


 


 


 


 


 

Reserve for loan losses
 


 


 


 


 


 


 

Balance at December 31, 2011
$
21,648

 
$
5,398

 
$
3,259

 
$
11,291

 
$
2,292

 
$
17

 
$
43,905

Loan loss provision (credit)
601

 
(2,375
)
 
2,764

 
(768
)
 
735

 
143

 
1,100

Recoveries
184

 
479

 
238

 
831

 
260

 

 
1,992

Loans charged off
(4,546
)
 
(59
)
 
(2,527
)
 
(3,261
)
 
(961
)
 

 
(11,354
)
Balance at end of period
$
17,887

 
$
3,443

 
$
3,734

 
$
8,093

 
$
2,326

 
$
160

 
$
35,643


 
 
 
 
 
 
 
 
 
 
 
 
 
Reserve for unfunded lending commitments
 

 
 

 
 

 
 

 
 

 
 

 
 

Balance at December 31, 2011
$
28

 
$
29

 
$
184

 
$
487

 
$
822

 
$

 
$
1,550

Provision for unfunded loan commitments

 

 

 

 

 

 

Balance at end of period
$
28

 
$
29

 
$
184

 
$
487

 
$
822

 
$

 
$
1,550


 
 
 
 
 
 
 
 
 
 
 
 
 
Reserve for credit losses
 

 
 

 
 

 
 

 
 

 
 

 
 

Reserve for loan losses
$
17,887

 
$
3,443

 
$
3,734

 
$
8,093

 
$
2,326

 
$
160

 
$
35,643

Reserve for unfunded lending commitments
28

 
29

 
184

 
487

 
822

 

 
1,550

Total reserve for credit losses
$
17,915

 
$
3,472

 
$
3,918

 
$
8,580

 
$
3,148

 
$
160

 
$
37,193


12



 
An individual loan is impaired when, based on current information and events, management believes that it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement. The following table presents the reserve for loan losses and the recorded investment in loans by portfolio segment and impairment evaluation method at September 30, 2013 and December 31, 2012 (dollars in thousands):
 
Reserve for loan losses

Recorded investment in loans
 
Individually
evaluated for
impairment

Collectively
evaluated for
impairment

Total

Individually
evaluated for
impairment

Collectively
evaluated for
impairment

Total
September 30, 2013
 


 


 


 


 


 

Commercial real estate
$
1,996

 
$
9,188

 
$
11,184

 
$
35,543

 
$
503,853

 
$
539,396

Construction
5

 
593

 
598

 
2,189

 
50,313

 
52,502

Residential real estate
62

 
2,607

 
2,669

 
452

 
99,699

 
100,151

Commercial and industrial
102

 
5,243

 
5,345

 
6,248

 
204,998

 
211,246

Consumer

 
1,535

 
1,535

 

 
36,527

 
36,527

 
$
2,165

 
$
19,166

 
21,331

 
$
44,432

 
$
895,390

 
$
939,822

Unallocated
 

 
 

 
322

 
 

 
 

 
 

 
 

 
 

 
$
21,653

 
 

 
 

 
 



















December 31, 2012
 


 


 


 


 


 

Commercial real estate
$
1,088

 
$
10,508

 
$
11,596

 
$
42,859

 
$
482,442

 
$
525,301

Construction
440

 
1,143

 
1,583

 
9,734

 
35,916

 
45,650

Residential real estate
1,141

 
2,410

 
3,551

 
4,840

 
80,654

 
85,494

Commercial and industrial
829

 
6,438

 
7,267

 
9,602

 
152,611

 
162,213

Consumer
301

 
1,876

 
2,177

 
1,636

 
37,870

 
39,506

 
$
3,799

 
$
22,375

 
26,174

 
$
68,671

 
$
789,493

 
$
858,164

Unallocated
 

 
 

 
1,087

 
 

 
 

 
 

 
 

 
 

 
$
27,261

 
 

 
 

 
 


The Company uses credit risk ratings, which reflect the Bank’s assessment of a loan’s risk or loss potential, for purposes of assessing the appropriate level of reserve for loan losses. The Bank’s credit risk rating definitions along with applicable borrower characteristics for each credit risk rating are as follows:
 
Acceptable
 
The borrower is a reasonable credit risk and demonstrates the ability to repay the loan from normal business operations. Loans are generally made to companies operating in an economy and/or industry that is generally sound. The borrower tends to operate in regional or local markets and has achieved sufficient revenues for the business to be financially viable. The borrowers financial performance has been consistent in normal economic times and has been average or better than average for its industry.
 
A loan can also be considered Acceptable even though the borrower may have some vulnerability to downturns in the economy due to marginally satisfactory working capital and debt service cushion. Availability of alternate financing sources may be limited or nonexistent. In some cases, the borrower’s management, may have limited depth or continuity but is still considered capable. An adequate primary source of repayment is identified while secondary sources may be illiquid, more speculative, less readily identified, or reliant upon collateral liquidation. Loan agreements will be well defined, including several financial performance covenants and detailed operating covenants. This category also includes commercial loans to individuals with average or better than average capacity to repay.

Pass-Watch
 
Loans are graded Pass-Watch when temporary situations increase the level of the Bank’s risk associated with the loan, and remain graded Pass-Watch until the situation has been corrected. These situations may involve one or more weaknesses in cash flow, collateral value or indebtedness that could, if not corrected within a reasonable period of time, jeopardize the full repayment of the debt. In general, loans in this category remain adequately protected by the borrower’s net worth and paying capacity, or pledged collateral.
 
Special Mention

13



 
A Special Mention credit has potential weaknesses that may, if not checked or corrected, weaken the loan or leave the Bank inadequately protected at some future date. Loans in this category are deemed by management of the Bank to be currently protected but reflect potential problems that warrant more than the usual management attention but do not justify a Substandard classification.
 
Substandard
 
Substandard loans are those inadequately protected by the net worth and paying capacity of the obligor and/or by the value of the pledged collateral, if any. Substandard loans have a high probability of payment default or they have other well-defined weaknesses. They require more intensive supervision and borrowers are generally characterized by current or expected unprofitable operations, inadequate debt service coverage, inadequate liquidity, or marginal capitalization. Repayment may depend on collateral or other credit risk mitigants.
 
CRE and construction loans are classified Substandard when well-defined weaknesses are present which jeopardize the orderly liquidation of the loan. Well-defined weaknesses include a project’s lack of marketability, inadequate cash flow or collateral support, failure to complete construction on time, and/or the project’s failure to fulfill economic expectations. These loans are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.
 
In addition, Substandard loans also include impaired loans. Impaired loans bear the characteristics of Substandard loans as described above, and the Company has determined it does not expect timely payment of all contractually due interest and principal. Impaired loans may be adequately secured by collateral.
 
During the nine months ended September 30, 2013, the Bank reduced loans classified as special mention and substandard by $72.3 million, with $68.5 million of the reduction occurring in the first half of the year. Remediation was accomplished through credit upgrades mainly owing to improved obligor cash flows as well as payoffs/paydowns, note sales and/or charge offs related to the restructure of adversely risk rated loans.
 

14



The following table presents, by portfolio class, the recorded investment in loans by internally assigned grades at September 30, 2013 and December 31, 2012 (dollars in thousands):
 
 
Loan grades
 
 
 
Acceptable
 
Pass-Watch
 
Special
Mention
 
Substandard
 
Total
September 30, 2013
 

 
 

 
 

 
 

 
 

Commercial real estate:
 

 
 

 
 

 
 

 
 

Owner occupied
$
137,086

 
$
19,168

 
$
28,038

 
$
25,538

 
$
209,830

Non-owner occupied
233,861

 
62,240

 
20,777

 
12,688

 
329,566

Total commercial real estate loans
370,947

 
81,408

 
48,815

 
38,226

 
539,396

Construction
43,244

 
5,575

 
2,288

 
1,395

 
52,502

Residential real estate
96,782

 
953

 

 
2,416

 
100,151

Commercial and industrial
196,677

 
4,388

 
3,606

 
6,575

 
211,246

Consumer
36,499

 

 

 
28

 
36,527

 
$
744,149

 
$
92,324

 
$
54,709

 
$
48,640

 
$
939,822

 
 
 
 
 
 
 
 
 
 
December 31, 2012
 

 
 

 
 

 
 

 
 

Commercial real estate:
 

 
 

 
 

 
 

 
 

Owner occupied
$
122,125

 
$
26,326

 
$
13,622

 
$
34,748

 
$
196,821

Non-owner occupied
214,990

 
39,879

 
24,910

 
48,701

 
328,480

Total commercial real estate loans
337,115

 
66,205

 
38,532

 
83,449

 
525,301

Construction
25,308

 
6,079

 
1,795

 
12,468

 
45,650

Residential real estate
74,576

 
2,207

 
2,086

 
6,625

 
85,494

Commercial and industrial
126,208

 
7,005

 
6,473

 
22,527

 
162,213

Consumer
37,264

 
603

 

 
1,639

 
39,506

 
$
600,471

 
$
82,099

 
$
48,886

 
$
126,708

 
$
858,164




15



The following table presents, by portfolio class, an age analysis of past due loans, including loans placed on non-accrual at September 30, 2013 and December 31, 2012 (dollars in thousands):
 
30-89 days
past due
 
90 days
or more
past due
 
Total
past due
 
Current
 
Total
loans
September 30, 2013
 

 
 

 
 

 
 

 
 

Commercial real estate:
 

 
 

 
 

 
 

 
 

Owner occupied
$
977

 
$
2,838

 
$
3,815

 
$
206,015

 
$
209,830

Non-owner occupied
1,616

 
858

 
2,474

 
327,092

 
329,566

Total commercial real estate loans
2,593

 
3,696

 
6,289

 
533,107

 
539,396

Construction
93

 
162

 
255

 
52,247

 
52,502

Residential real estate
251

 
277

 
528

 
99,623

 
100,151

Commercial and industrial
1,503

 
1,128

 
2,631

 
208,615

 
211,246

Consumer
77

 
27

 
104

 
36,423

 
36,527

 
$
4,517

 
$
5,290

 
$
9,807

 
$
930,015

 
$
939,822

December 31, 2012
 

 
 

 
 

 
 

 
 

Commercial real estate:
 

 
 

 
 

 
 

 
 

Owner occupied
$
1,240

 
$
4,221

 
$
5,461

 
$
191,360

 
$
196,821

Non-owner occupied
8,660

 
7,183

 
15,843

 
312,637

 
328,480

Total commercial real estate loans
9,900

 
11,404

 
21,304

 
503,997

 
525,301

Construction
1,288

 
2,793

 
4,081

 
41,569

 
45,650

Residential real estate
818

 
364

 
1,182

 
84,312

 
85,494

Commercial and industrial
2,825

 
1,858

 
4,683

 
157,530

 
162,213

Consumer
61

 
12

 
73

 
39,433

 
39,506

 
$
14,892

 
$
16,431

 
$
31,323

 
$
826,841

 
$
858,164

 
Loans contractually past due 90 days or more on which the Company continued to accrue interest were $0 and $1.5 million at September 30, 2013 and December 31, 2012, respectively.
 

16



The following table presents information related to impaired loans, by portfolio class, at September 30, 2013 and December 31, 2012 (dollars in thousands):
 
Impaired loans
 
 
 
With a
related
allowance
 
Without a
related
allowance
 
Total
recorded
balance
 
Unpaid
principal
balance
 
Related
allowance
September 30, 2013
 

 
 

 
 

 
 

 
 

Commercial real estate:
 

 
 

 
 

 
 

 
 

Owner occupied
$
7,760

 
$
4,215

 
$
11,975

 
$
14,869

 
$
1,983

Non-owner occupied
1,123

 
22,445

 
23,568

 
23,819

 
13

Total commercial real estate loans
8,883

 
26,660

 
35,543

 
38,688

 
1,996

Construction
784

 
1,405

 
2,189

 
2,189

 
5

Residential real estate
175

 
277

 
452

 
552

 
62

Commercial and industrial
4,319

 
1,929

 
6,248

 
7,070

 
102

Consumer

 

 

 

 

 
$
14,161

 
$
30,271

 
$
44,432

 
$
48,499

 
$
2,165

 
 
 
 
 
 
 
 
 
 
December 31, 2012
 

 
 

 
 

 
 

 
 

Commercial real estate:
 

 
 

 
 

 
 

 
 

Owner occupied
$
8,538

 
$
7,443

 
$
15,981

 
$
21,610

 
$
988

Non-owner occupied
3,712

 
23,166

 
26,878

 
32,630

 
100

Total commercial real estate loans
12,250

 
30,609

 
42,859

 
54,240

 
1,088

Construction
2,348

 
7,386

 
9,734

 
9,867

 
440

Residential real estate
4,530

 
310

 
4,840

 
5,018

 
1,141

Commercial and industrial
6,493

 
3,109

 
9,602

 
10,982

 
829

Consumer
1,636

 

 
1,636

 
1,638

 
301

 
$
27,257

 
$
41,414

 
$
68,671

 
$
81,745

 
$
3,799

 
At September 30, 2013 and December 31, 2012, the total recorded balance of impaired loans in the above table included $34.2 million and $43.6 million, respectively, of Troubled Debt Restructuring (“TDR”) loans which were not on non-accrual status.
 
The following table presents, by portfolio class, the average recorded investment in impaired loans for the three and nine months ended September 30, 2013 and 2012:
 
 
Three Months Ended  
 September 30,
 
Nine Months Ended 
 September 30,
 
2013
 
2012
 
2013
 
2012
Commercial real estate:
 

 
 

 
 

 
 

Owner occupied
$
13,948

 
$
15,532

 
$
14,579

 
$
14,941

Non-owner occupied
25,062

 
33,455

 
26,656

 
31,811

Total commercial real estate loans
39,010

 
48,987

 
41,235

 
46,752

Construction
1,927

 
8,184

 
4,220

 
6,202

Residential real estate
560

 
6,221

 
2,698

 
5,843

Commercial and industrial
6,585

 
10,682

 
7,984

 
10,937

Consumer

 
1,583

 
894

 
1,285

 
$
48,082

 
$
75,657

 
$
57,031

 
$
71,019

 
Interest income recognized for cash payments received on impaired loans for the nine months ended September 30, 2013 was insignificant.


17



Information with respect to the Company’s non-accrual loans, by portfolio class, at September 30, 2013 and December 31, 2012 is as follows (dollars in thousands):
  
 
September 30, 2013
 
December 31, 2012
Commercial real estate:
 

 
 

Owner occupied
$
5,134

 
$
4,836

Non-owner occupied
1,153

 
5,756

Total commercial real estate loans
6,287

 
10,592

Construction
265

 
2,839

Residential real estate
421

 
556

Commercial and industrial
2,011

 
3,233

Total non-accrual loans
$
8,984

 
$
17,220

 
 
 
 
Accruing loans which are contractually past due 90 days or more:
 

 
 

Commercial real estate:
 

 
 

Owner occupied

 

Non-owner occupied

 
1,427

Total commercial real estate loans

 
1,427

Construction

 

Residential real estate

 
94

Commercial and industrial

 

Consumer
27

 
12

Total accruing loans which are contractually past due 90 days or more
$
27

 
$
1,533

 
TDRs
 
A loan is classified as a TDR when a borrower is experiencing financial difficulties and the Company grants a concession to the borrower in the restructuring that the Company would not otherwise consider in the origination of a loan. In some situations a borrower may be experiencing financial distress, but the Company does not provide a concession. These modifications are not considered TDRs. In other cases, the Company might provide a concession, such as a reduction in interest rate, but the borrower is not experiencing financial distress. This could be the case if the Company is matching a competitor’s interest rate. These modifications would also not be considered TDRs. Finally, any renewals at existing terms for borrowers not experiencing financial distress would not be considered TDRs. A TDR loan is considered to be impaired and is individually evaluated for impairment. As with other impaired loans, a reserve for loan loss is estimated for each TDR based on the difference between expected future cash flows discounted at the original contractual rate and the current balance of the loan. For collateral dependent loans, expected future cash flows includes the estimated market value less cost to sell.
 
The Company allocated $1.6 million and $2.7 million of specific reserves to customers whose loan terms have been modified in TDRs as of September 30, 2013 and December 31, 2012, respectively. TDRs involve the restructuring of terms to allow customers to mitigate the risk of foreclosure by meeting a lower loan payment requirement based upon their current cash flow. As indicated above, TDRs may also include loans to borrowers experiencing financial distress that renewed at existing contractual rates, but below market rates for comparable credit quality. The Company has been actively utilizing these programs and working with its customers to improve obligor cash flow and related prospect for repayment. Concessions may include, but are not limited to, interest rate reductions, principal forgiveness, deferral of interest payments, extension of the maturity date, and other actions intended to minimize potential losses to the Company. For each commercial loan restructuring, a comprehensive credit underwriting analysis of the borrower’s financial condition and prospects of repayment under the revised terms is performed to assess whether the new structure can be successful and whether cash flows will be sufficient to support the restructured debt. Generally, if the loan is on accrual at the time of restructuring, it will remain on accrual after the restructuring. After six consecutive payments under the restructured terms, a nonaccrual restructured loan is reviewed for possible upgrade to accruing status.
 
Typically, once a loan is identified as a TDR it will retain that designation until it is paid off, because restructured loans generally are not at market rates following restructuring. Under certain circumstances a TDR may be removed from TDR status if it is

18



determined to no longer be impaired and the loan is at a competitive interest rate. Under such circumstances, allowance allocations for loans removed from TDR status would be based on the historical allocation for the applicable loan grade and loan class.
 
The following table presents, by portfolio segment, information with respect to the Company’s loans that were modified and recorded as TDRs during the three and nine months ended September 30, 2013 and 2012 (dollars in thousands):
 
Three months ended September 30,
 
2013
 
2012
 
Number of
loans
 
TDR outstanding
recorded investment
 
Number of
loans
 
TDR outstanding
recorded investment
Commercial real estate

 
$

 

 
$

Construction
1

 
1,243

 
1

 
72

Residential real estate

 

 
2

 
166

Commercial and industrial
1

 
963

 
17

 
824

Consumer

 

 
6

 
113

 
2

 
$
2,206

 
26

 
$
1,175

 
Nine months ended September 30,
 
2013
 
2012
 
Number of
loans
 
TDR outstanding
recorded investment
 
Number of
loans
 
TDR outstanding
recorded investment
Commercial real estate
5

 
$
27,677

 
4

 
$
1,734

Construction
1

 
1,243

 
2

 
4,497

Residential real estate

 

 
9

 
476

Commercial and industrial
4

 
1,237

 
26

 
1,405

Consumer

 

 
39

 
423

 
10

 
$
30,157

 
80

 
$
8,535


The increase in the outstanding recorded investment of loans modified and recorded as TDRs during the nine months ended September 30, 2013 compared to the same period in 2012 was primarily the result of remediation to bolster cash flow of stressed loans, and includes the restructuring of a large CRE credit in the Bank’s loan portfolio during the first quarter of 2013.

At September 30, 2013 and 2012, the Company had remaining commitments to lend on loans accounted for as TDRs of $0 and $1.2 million, respectively.
 
The following table presents, by portfolio segment, the post modification recorded investment for TDRs restructured during the three and nine months ended September 30, 2013 and 2012 by the primary type of concession granted:
 
Three Months Ended  
 September 30, 2013
Rate
reduction
 
Term
extension
 
Rate reduction
and term
extension
 
Total
Commercial real estate
$

 
$

 
$

 
$

Construction

 
1,243

 

 
1,243

Residential real estate

 

 

 

Commercial and industrial

 
963

 

 
963

Consumer

 

 

 

 
$

 
$
2,206

 
$

 
$
2,206


19



Three Months Ended  
 September 30, 2012
Rate
reduction
 
Term
extension
 
Rate reduction
and term
extension
 
Total
Commercial real estate
$
4

 
$
1

 
$

 
$
5

Construction

 
72

 

 
72

Residential real estate

 
67

 
99

 
166

Commercial and industrial
80

 
409

 
335

 
824

Consumer

 
83

 
30

 
113

 
$
84

 
$
632

 
$
464

 
$
1,180

Nine Months Ended 
 September 30, 2013
Rate
reduction
 
Term
extension
 
Rate reduction
and term
extension
 
Total
Commercial real estate
$
3,809

 
$
2,368

 
$
21,500

 
$
27,677

Construction

 
1,243

 

 
1,243

Residential real estate

 

 

 

Commercial and industrial
174

 
1,063

 

 
1,237

Consumer

 

 

 

 
$
3,983

 
$
4,674

 
$
21,500

 
$
30,157

Nine Months Ended 
 September 30, 2012
Rate
reduction
 
Term
extension
 
Rate reduction
and term
extension
 
Total
Commercial real estate
$
1,299

 
$
435

 
$

 
$
1,734

Construction

 
4,497

 

 
4,497

Residential real estate

 
377

 
99

 
476

Commercial and industrial
169

 
748

 
488

 
1,405

Consumer

 
393

 
30

 
423

 
$
1,468

 
$
6,450

 
$
617

 
$
8,535


The following table presents, by portfolio segment, the TDRs which had payment defaults during the nine months ended September 30, 2013 and 2012 that had been previously restructured within the last twelve months prior to September 30, 2013 and 2012
 
Nine months ended September 30,
 
2013
 
2012
 
Number of
loans
 
TDRs restructured in the
period with a payment
default
 
Number
of loans
 
TDRs restructured in the
period with a payment
default
Commercial real estate
2

 
$
3,500

 

 
$

Construction

 

 

 

Residential real estate

 

 

 

Commercial and industrial loans

 

 
1

 
193

Consumer loans

 

 
1

 
3

 
2

 
$
3,500

 
2

 
$
196




20



4.    Mortgage Servicing Rights (“MSRs”)
 
The Bank sells a predominant share of the mortgage loans it originates into the secondary market while retaining servicing of such loans. MSRs included in other assets in the condensed consolidated financial statements as of September 30, 2013 and December 31, 2012 are accounted for at the lower of origination value less accumulated amortization or current fair value. The net carrying value of MSRs at September 30, 2013 and December 31, 2012 was $2.0 million and $1.3 million, respectively, which includes valuation allowances of $0.2 million.
 
The following table presents activity in MSRs for the periods shown (dollars in thousands):
 
 
Three months ended  
 September 30,
 
Nine months ended  
 September 30,
 
2013
 
2012
 
2013
 
2012
Balance at beginning of period
$
1,786

 
$
774

 
$
1,308

 
$

Additions
369

 
391

 
1,018

 
1,209

Amortization
(111
)
 
(40
)
 
(282
)
 
(84
)
Change in valuation allowance

 
(139
)
 

 
(139
)
Balances at end of period
$
2,044

 
$
986

 
$
2,044

 
$
986

 
Mortgage banking income, net, consisted of the following for the periods shown (dollars in thousands):
 
Three months ended  
 September 30,
 
Nine months ended  
 September 30,
 
2013
 
2012
 
2013
 
2012
Origination and processing fees
$
245

 
$
159

 
$
542

 
$
441

Gain on sales of mortgage loans, net
1,007

 
1,076

 
2,888

 
2,636

MSR valuation allowance

 
(139
)
 

 
(139
)
Servicing fees
143

 
48

 
356

 
94

Amortization
(111
)
 
(40
)
 
(282
)
 
(84
)
Mortgage banking income, net
$
1,284

 
$
1,104

 
$
3,504

 
$
2,948



21



5.    Other Real Estate Owned (“OREO”), net
 
The following table presents activity related to OREO for the periods shown (dollars in thousands):
 
Three months ended  
 September 30,
 
Nine months ended  
 September 30,
 
2013
 
2012
 
2013
 
2012
Balance at beginning of period
$
2,606

 
$
12,251

 
$
6,552

 
$
21,270

Additions
970

 
296

 
2,068

 
1,268

Dispositions
(497
)
 
(8,909
)
 
(13,614
)
 
(26,314
)
Change in valuation allowance
266

 
4,909

 
8,339

 
12,323

Balances at end of period
$
3,345

 
$
8,547

 
$
3,345

 
$
8,547

 
The following table summarizes activity in the OREO valuation allowance for the periods shown (dollars in thousands):
 
 
Three months ended  
 September 30,
 
Nine months ended  
 September 30,
 
2013
 
2012
 
2013
 
2012
Balance at beginning of period
$
2,569

 
$
22,872

 
$
10,642

 
$
30,287

Additions to the valuation allowance
37

 

 
262

 
86

Reductions due to sales
(303
)
 
(4,909
)
 
(8,601
)
 
(12,410
)
Balance at end of period
$
2,303

 
$
17,963

 
$
2,303

 
$
17,963

 
The following table summarizes OREO expenses for the periods shown (dollars in thousands):
 
 
Three months ended  
 September 30,
 
Nine months ended  
 September 30,
 
2013
 
2012
 
2013
 
2012
Operating costs
$
26

 
$
85

 
$
137

 
$
786

Net (gains) losses on dispositions
(16
)
 

 
(77
)
 
(38
)
Increases in valuation allowance
37

 

 
262

 
86

Total
$
47

 
$
85

 
$
322

 
$
834


6.    Basic and Diluted Net Income per Common Share
 
The Company’s basic net income per common share is computed by dividing net income by the weighted-average number of common shares outstanding during the period. The Company’s diluted net income per common share is computed by dividing net income by the weighted-average number of common shares outstanding plus any incremental shares arising from the dilutive effect of stock-based compensation.
 

22



The numerators and denominators used in computing basic and diluted net income per common share for the three and nine months ended September 30, 2013 and 2012 can be reconciled as follows (dollars in thousands, except per share data):
 
 
Three months ended  
 September 30,
 
Nine months ended  
 September 30,
 
2013
 
2012
 
2013
 
2012
Net income
$
1,492

 
$
1,825

 
$
49,611

 
$
4,643

 
 
 
 
 
 
 
 
Weighted-average shares outstanding - basic
47,212,330

 
47,142,441

 
47,175,243

 
47,122,536

Dilutive securities
356,240

 
150,500

 
277,852

 
147,986

Weighted-average shares outstanding - diluted
47,568,570

 
47,292,941

 
47,453,095

 
47,270,522

Common stock equivalent shares excluded due to antidilutive effect
32,399

 
19,412

 
32,399

 
16,283

 
 
 
 
 
 
 
 
Basic and diluted:
 

 
 

 
 

 
 

Net income per common share
$
0.03

 
$
0.04

 
$
1.05

 
$
0.10

Net income per common share (diluted)
$
0.03

 
$
0.04

 
$
1.05

 
$
0.10


7.    Stock-Based Compensation
 
At September 30, 2013, 4,566,192 shares reserved under the stock-based compensation plans were available for future grants.

During the nine months ended September 30, 2013, the Company granted 296,417 additional shares of restricted stock with a weighted-average grant date fair value of $5.81 per share, which vest between 2013 and 2016. During the same period, the Company also granted 5,507 stock options with a weighted-average grant date fair value of approximately $6.80 per option. These stock options vest in 2016. During the nine months ended September 30, 2012, the Company granted 56,223 additional shares of restricted stock with a weighted-average grant date fair value of $5.70 per share, which vest during 2014 and 2015. During the same period, the Company also granted 19,412 stock options with a weighted-average grant date fair value of approximately $4.25 per option. These stock options vest in 2014. The Company used the Black-Scholes option-pricing model with the following weighted-average assumptions to value options granted in 2013 and 2012
 
2013
 
2012
Dividend yield
%
 
%
Expected volatility
77.2
%
 
85.0
%
Risk-free interest rate
1.1
%
 
1.4
%
Expected option lives
6.0 years

 
6.0 years

 
The dividend yield was based on historical dividend information. The Company has not paid dividends since the third quarter of 2008 resulting in the dividend yield of 0.0%. The expected volatility was based on the historical volatility of the Company’s common stock price. The risk-free interest rate was based on the U.S. Treasury yield curve in effect at the date of grant for periods corresponding with the expected lives of the options granted. The expected option lives represent the period of time that options are expected to be outstanding, giving consideration to vesting schedules and historical exercise and forfeiture patterns.
 
The Black-Scholes option-pricing model was developed for use in estimating the fair value of publicly-traded options that have no vesting restrictions and are fully transferable.  The Black-Scholes model is affected by subjective assumptions including historical volatility of the Company’s common stock price.  Because the Company has relatively low average trading volume in its common stock, its estimated volatility may be higher than publicly-traded companies with greater trading volumes. 
 

23



The following table presents the activity related to stock options for the nine months ended September 30, 2013 and 2012:
 
Options
 
Weighted-
average
exercise
price
 
Weighted-
average
remaining
contractual
term (years)
 
Aggregate
intrinsic
value (000)
Options outstanding at January 1, 2013
139,446

 
$
53.39

 
6.2
 
$
79.4

Granted
5,507

 
6.80

 
9.5
 

Exercised
(5,250
)
 
5.70

 
N/A
 
N/A

Canceled / forfeited
(16,193
)
 
128.43

 
N/A
 
N/A

Expired
(10,806
)
 
90.72

 
N/A
 
N/A

Options outstanding at September 30, 2013
112,704

 
$
39.31

 
6.4
 
$
9.9

Options exercisable at September 30, 2013
74,798

 
$
56.16

 
5.3
 
$
6.2

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Options outstanding at January 1, 2012
144,370

 
$
68.90

 
5.9
 
$

Granted
19,412

 
4.25

 
1.9
 
27.8

Canceled / forfeited
(22,928
)
 
68.73

 
N/A
 
N/A

Expired
(8,110
)
 
68.97

 
N/A
 
N/A

Options outstanding at September 30, 2012
132,744

 
$
59.72

 
6.1
 
$
27.8

Options exercisable at September 30, 2012
54,482

 
$
137.22

 
3.4
 
$

 
Stock-based compensation expense related to stock options for the nine months ended September 30, 2013 and 2012 was approximately $0.1 million . As of September 30, 2013, there was approximately $0.1 million unrecognized compensation cost related to nonvested stock options which will be recognized over the remaining vesting periods of the underlying stock options.

The following table presents the activity related to nonvested restricted stock for the nine months ended September 30, 2013:
 
 
Number of
shares
 
Weighted-
average grant
date fair value
per share
Nonvested as of January 1, 2013
157,191

 
$
14.11

Granted
296,417

 
5.81

Vested
(83,508
)
 
5.99

Canceled / forfeited
(13,860
)
 
6.83

Nonvested as of September 30, 2013
356,240

 
$
9.39

 
Restricted stock is generally scheduled to vest over a three year period, with the unearned compensation related to restricted stock amortized to expense on a straight-line basis. As of September 30, 2013, unrecognized compensation cost related to nonvested restricted stock totaled approximately $1.5 million. Total expense recognized by the Company for nonvested restricted stock for the nine months ended September 30, 2013 and 2012 was $0.7 million and $0.6 million, respectively. There was no unrecognized compensation cost related to restricted stock units (“RSUs”) at September 30, 2013 and December 31, 2012, as all RSUs were fully-vested at the date of the grant.

8.    Income Taxes

In assessing the realizability of deferred tax assets (“DTA”), management considers whether it is more likely than not that some portion or all of the DTA will or will not be realized. The Company's ultimate realization of the DTA is dependent upon the generation of future taxable income during the periods in which temporary differences become deductible. Management considers the nature and amount of historical and projected future taxable income, the scheduled reversal of deferred tax assets and liabilities, and available tax planning strategies in making this assessment. The amount of deferred taxes recognized could be impacted by changes to any of these variables.

24




During the three and nine months ended September 30, 2013, the Company recorded a $0.6 million income tax provision and $51.2 million income tax benefit, respectively. The significant income tax benefit recorded in the nine months ended September 30, 2013 resulted primarily from reversing substantially all of the Company's DTA valuation allowance at June 30, 2013 of $51.7 million. During the three and nine months ended September 30, 2012, the Company recorded an income tax provision of $0 and $0.1 million, respectively.

As of September 30, 2013, the net deferred tax asset was $51.5 million. Included in the net deferred taxes are NOL's (tax affected) for are federal taxes of $28.0 million, Oregon state taxes of $4.5 million and Idaho state taxes of $4.0 million. Also included in the net deferred taxes are federal and state tax credits of $0.9 million and $0.3 million, respectively. This is compared with a deferred tax liability as of December 31, 2012 of $2.3 million (pertaining to available-for-sale securities) as the balance of the deferred tax assets was fully reserved. There are a number of tax issues that impact the deferred tax asset balance including changes in temporary differences between the financial statement recognition of revenue and expenses, estimates as to the deductibility of prior losses and potential consequence of Section 382 of the IRC. See also “Critical Accounting Policies and Accounting Estimates - Deferred Income Taxes” included in Part II, Item 7 of the Company's Annual Report on Form 10-K for the year ended December 31, 2012.

25



9.    Fair Value Measurements
 
GAAP establishes a hierarchy for determining fair value measurements which includes three levels and is based upon the valuation techniques used to measure assets and liabilities. The three levels are as follows:
 
Level 1: Inputs that are quoted unadjusted prices in active markets - that the Company has the ability to access at the measurement date - for identical assets or liabilities.

Level 2: Inputs that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the reporting entity including quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in inactive markets, and inputs derived principally from, or corroborated by, observable market data by correlation or other means.

Level 3: Inputs that reflect the reporting entity's own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances.

A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below. These valuation methodologies were applied to all of the Company’s assets and liabilities carried at fair value. In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internal or third party models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that assets or liabilities are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality and the Company’s creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. The Company’s valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes that the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain assets and liabilities could result in a different estimate of fair value at the reporting date. Furthermore, the reported fair value amounts have not been comprehensively revalued since the presentation dates, and, therefore, estimates of fair value after the condensed consolidated balance sheet date may differ significantly from the amounts presented herein.

The following is a description of the valuation methodologies used for assets measured at fair value on a recurring or nonrecurring basis, as well as the general classification of such assets pursuant to valuation hierarchy:
 
Investment securities available-for-sale: Where quoted prices for identical assets are available in an active market, investment securities available-for-sale are classified within level 1 of the hierarchy. If quoted market prices for identical securities are not available, then fair values are estimated by independent sources using pricing models and/or quoted prices of investment securities with similar characteristics or discounted cash flows. The Company has categorized its investment securities available-for-sale as level 2, since a majority of such securities are MBS which are mainly priced in this latter manner.
 
Impaired loans: In accordance with GAAP, loans measured for impairment are reported at estimated fair value, including impaired loans measured at an observable market price (if available), the present value of expected future cash flows discounted at the loan’s effective interest rate, or at the fair value of the loan’s collateral (if collateral dependent). Estimated fair value of the loan’s collateral is determined by appraisals or independent valuations which are then adjusted for the estimated costs related to liquidation of the collateral. Management’s ongoing review of appraisal information may result in additional discounts or adjustments to valuation based upon more recent market sales activity or more current appraisal information derived from properties of similar type and/or locale. A significant portion of the Bank’s impaired loans are measured using the estimated fair market value of the collateral less the estimated costs to sell. The Company has categorized its impaired loans as level 3.
 
OREO: The Company’s OREO is measured at estimated fair value less estimated costs to sell. Fair value is generally determined based on third-party appraisals of fair value in an orderly sale. Historically, appraisals have considered comparable sales of like assets in reaching a conclusion as to fair value. Since many recent real estate sales could be termed “distressed sales”, and since a preponderance have been short-sale or foreclosure related, this has directly impacted appraisal valuation estimates. Estimated costs to sell OREO are based on standard market factors. The valuation of OREO is subject to significant external and internal judgment. Management periodically reviews OREO to determine whether the property continues to be carried at the lower of its recorded book value or estimated fair value, net of estimated costs to sell. The Company has categorized its OREO as level 3.
 

26



MSRs: The estimated fair value of MSRs is calculated by discounting the expected future contractual cash flows. The amount of impairment recognized is the amount, if any, by which the amortized cost of the rights exceeds its estimated fair value. Impairment, if deemed temporary, is recognized through a valuation allowance to the extent that estimated fair value is less than the recorded amount.
 
The Company’s only financial assets measured at fair value on a recurring basis at September 30, 2013 and December 31, 2012 were as follows (dollars in thousands):
 
Level 1
 
Level 2
 
Level 3
September 30, 2013
 

 
 

 
 

Investment securities available-for-sale
$

 
$
200,103

 
$

 
 
 
 
 
 
December 31, 2012
 

 
 

 
 

Investment securities available-for-sale
$

 
$
257,544

 
$

 
Certain assets are measured at fair value on a nonrecurring basis (e.g., the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments when there is evidence of impairment). The following table represents the assets measured at fair value on a nonrecurring basis by the Company at September 30, 2013 and December 31, 2012 (dollars in thousands):
 
Level 1
 
Level 2
 
Level 3
September 30, 2013
 

 
 

 
 

Impaired loans with specific valuation allowances
$

 
$

 
$
14,161

Other real estate owned

 

 
3,345

 
$

 
$

 
$
17,506

 
 
 
 
 
 
December 31, 2012
 

 
 

 
 

Impaired loans with specific valuation allowances
$

 
$

 
$
34,383

Other real estate owned

 

 
6,552

MSRs

 

 
1,308

 
$

 
$

 
$
42,243

 
The following table presents quantitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at September 30, 2013 and December 31, 2012 (dollars in thousands):
 
September 30, 2013
 
Fair Value Estimate
 
Valuation Techniques
 
Unobservable Input
Impaired loans
$
14,161

 
Market approach
 
Appraised value less selling costs of 5% to 10%
Additional discounts of 5% to 50% to appraised value to reflect liquidation value
Other real estate owned
$
3,345

 
Market approach
 
Appraised value less selling costs of 5% to 10%
 
 
December 31, 2012
 
Fair Value Estimate
 
Valuation Techniques
 
Unobservable Input
Impaired loans
$
34,383

 
Market approach
 
Appraised value less selling costs of 5% to 10%
Additional discounts of 5% to 50% to appraised value to reflect liquidation value
Other real estate owned
$
6,552

 
Market approach
 
Appraised value less selling costs of 5% to 10%
MSRs
$
1,308

 
Market approach
 
Weighted average prepayment speed of 10.5%
 

27



The Company did not change the methodology used to determine fair value for any assets or liabilities during 2012, or during the nine months ended September 30, 2013. In addition, for any given class of assets, the Company did not have any transfers between level 1, level 2, or level 3 during 2012 or the nine months ended September 30, 2013.
 
The following disclosures are made in accordance with the provisions of GAAP, which requires the disclosure of fair value information about financial instruments where it is practicable to estimate that value.
 
In cases where quoted market values are not available, the Company primarily uses present value techniques to estimate the fair value of its financial instruments. Valuation methods require considerable judgment, and the resulting estimates of fair value can be significantly affected by the assumptions made and methods used. Accordingly, the estimates provided herein do not necessarily indicate amounts which could be realized in a current market exchange.
 
In addition, as the Company normally intends to hold the majority of its financial instruments until maturity, it does not expect to realize many of the estimated amounts disclosed. The disclosures also do not include estimated fair value amounts for items which are not defined as financial instruments but which may have significant value. The Company does not believe that it would be practicable to estimate a representational fair value for these types of items as of September 30, 2013 and December 31, 2012.
 
Because GAAP excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements, any aggregation of the fair value amounts presented would not represent the underlying value of the Company.
 
The Company uses the following methods and assumptions to estimate the fair value of its financial instruments:
 
Cash and cash equivalents:  The carrying amount approximates the estimated fair value of these instruments.
 
Investment securities: See above description.
 
FHLB stock:  The carrying amount approximates the estimated fair value of this investment.
 
Loans:  The estimated fair value of non-impaired loans is calculated by discounting the contractual cash flows of the loans using September 30, 2013 and December 31, 2012 origination rates. The resulting amounts are adjusted to estimate the effect of changes in the credit quality of borrowers since the loans were originated. Estimated fair values for impaired loans are determined using an observable market price, (if available), the present value of expected future cash flows discounted at the loan’s effective interest rate, or the fair value of the loan’s collateral (if collateral dependent) as described above. Observable market prices for community bank loans are not generally available given the non-homogenous characteristics of such loans.
 
BOLI: The carrying amount approximates the estimated fair value of these instruments.
 
MSRs: See above description.
 
Deposits:  The estimated fair value of demand deposits, consisting of checking, interest bearing demand, and savings deposit accounts, is represented by the amounts payable on demand. At the reporting date, the estimated fair value of time deposits is calculated by discounting the scheduled cash flows using the September 30, 2013 and December 31, 2012 rates offered on those instruments.
 
Other borrowings:   The fair value of other borrowings (including federal funds purchased, if any) are estimated using discounted cash flow analyses based on the Bank’s September 30, 2013 and December 31, 2012 incremental borrowing rates for similar types of borrowing arrangements.
 
Loan commitments and standby letters of credit: The majority of the Bank’s commitments to extend credit have variable interest rates and “escape” clauses if the customer’s credit quality deteriorates. Therefore, the fair values of these items are not significant and are not included in the following table.
 

28



The estimated fair values of the Company’s significant on-balance sheet financial instruments at September 30, 2013 and December 31, 2012 were approximately as follows (dollars in thousands):
 
 
 
 
September 30, 2013
 
December 31, 2012
 
Level in Fair
Value
Hierarchy
 
Carrying
value
 
Estimated
fair value
 
Carrying
value
 
Estimated
fair value
Financial assets:
 
 
 

 
 

 
 

 
 

Cash and cash equivalents
Level 1
 
$
129,826

 
$
129,826

 
$
113,028

 
$
113,028

Investment securities:
 
 
 
 
 

 
 

 
 

Available-for-sale
Level 2
 
200,103

 
200,103

 
257,544

 
257,544

Held-to-maturity
Level 2
 
1,337

 
1,364

 
1,813

 
1,863

FHLB stock
Level 2
 
10,006

 
10,006

 
10,285

 
10,285

Loans held-for-sale
Level 2
 
12,414

 
12,414

 
2,329

 
2,329

Loans, net
Level 3
 
916,505

 
920,256

 
829,057

 
833,399

BOLI
Level 3
 
36,364

 
36,364

 
35,705

 
35,705

MSRs
Level 3
 
2,044

 
2,044

 
1,308

 
1,308

 
 
 
 
 
 
 
 
 
 
Financial liabilities:
 
 
 

 
 

 
 

 
 

Deposits
Level 2
 
1,195,616

 
1,195,289

 
1,076,234

 
1,076,550

FHLB borrowings
Level 2
 

 

 
60,000

 
64,981


10.      Regulatory Matters
 
Bancorp and the Bank are subject to various regulatory capital requirements administered by the federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, Bancorp and the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. Bancorp’s and the Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
 
Quantitative measures established by regulation to ensure capital adequacy require Bancorp and the Bank to maintain minimum amounts and ratios (set forth in the tables below) of Tier 1 capital to average assets and Tier 1 and total capital to risk-weighted assets (all as defined in the regulations).
 
Federal banking regulators are required to take prompt corrective action if an insured depository institution fails to satisfy certain minimum capital requirements. Such actions could potentially include a leverage capital limit, a risk-based capital requirement, and any other measure of capital deemed appropriate by the federal banking regulator for measuring the capital adequacy of an insured depository institution. In addition, payment of dividends by Bancorp and the Bank are subject to restriction by state and federal regulators and availability of retained earnings.
 
On March 7, 2013, the Bank entered into a memorandum of understanding (“MOU”) with the Federal Deposit Insurance Corporation ("FDIC") and the Oregon Division of Finance and Corporate Securities ("DFCS") which terminated cease-and-desist order that had been in effect between the Bank, the FDIC and the DFCS since August 2009. The MOU restricted the Bank from paying dividends without the written consent of the FDIC and DFCS and required that the Bank maintain higher levels of capital than may be required by published capital adequacy requirements.
 
In particular the MOU required the Bank to maintain the minimum capital requirements for a “well-capitalized” bank, including a Tier 1 leverage ratio of at least 10.00%. As of September 30, 2013 and December 31, 2012, the requirement relating to increasing the Bank’s Tier 1 leverage ratio was met.

On September 5, 2013, the MOU was lifted by the FDIC and DFCS.


29



On October 26, 2009, Bancorp entered into a written agreement with the Federal Reserve Bank of San Francisco ("FRB") and DFCS (the “Written Agreement”), which required Bancorp to take certain measures to improve its safety and soundness. Under the Written Agreement, Bancorp was required to develop and submit for approval, a plan to maintain sufficient capital at Bancorp and the Bank within 60 days of the date of the Written Agreement. The Company submitted a strategic plan on October 28, 2009. As of September 30, 2013 and December 31, 2012, Bancorp met the 10% Tier 1 leverage ratio requirement per the Written Agreement. On July 8, 2013, the Bancorp entered into a memorandum of understanding (“FRB-MOU”) with the FRB and the DFCS which terminated the Written Agreement.

On October 23, 2013, the FRB-MOU was lifted by the FRB and DFCS.
 
Bancorp’s actual and required capital amounts and ratios as of September 30, 2013 and December 31, 2012 are presented in the following table (dollars in thousands): 
 
Actual
 
Regulatory minimum to
be "adequately
capitalized"
 
Regulatory minimum
to be "well capitalized"
under prompt
corrective action
provisions
 
 
Capital
Amount
 
Ratio
 
Capital
Amount
 
Ratio
 
Capital
Amount
 
Ratio
 
September 30, 2013
 

 
 

 
 

 
 

 
 

 
 

 
Tier 1 leverage (to average assets)
$
141,410

 
10.4
%
 
$
54,194

 
4.0
%
 
$
135,485

 
10.0
%
(2) 
Tier 1 capital (to risk-weighted assets)
141,410

 
13.4

 
42,175

 
4.0

 
63,263

 
6.0

 
Total capital (to risk-weighted assets)
154,704

 
14.7

 
84,350

 
8.0

 
105,438

 
10.0

 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2012
 

 
 

 
 

 
 

 
 

 
 

 
Tier 1 leverage (to average assets)
$
136,960

 
10.4
%
 
$
52,470

 
4.0
%
 
$
131,174

 
10.0
%
(1) 
Tier 1 capital (to risk-weighted assets)
136,960

 
14.1

 
38,811

 
4.0

 
58,216

 
6.0

 
Total capital (to risk-weighted assets)
149,296

 
15.4

 
77,621

 
8.0

 
97,027

 
10.0

 
 (1) Pursuant to the Written Agreement, which was terminated effective July 8, 2013, Bancorp was required to maintain a Tier 1 leverage ratio of at least 10.00% in order to be deemed "well capitalized".
 (2) Pursuant to the FRB-MOU, which was terminated effective October 23, 2013, Bancorp was required to maintain a Tier 1 leverage ratio of at least 10.00%.
 
The Bank’s actual and required capital amounts and ratios are presented in the following table (dollars in thousands):

30



 
 
Actual
 
Regulatory minimum
to be "adequately
capitalized"
 
Regulatory minimum
to be "well capitalized"
under prompt
corrective action
provisions
 
 
Capital
Amount
 
Ratio
 
Capital
Amount
 
Ratio
 
Capital
Amount
 
Ratio
 
September 30, 2013
 

 
 

 
 

 
 

 
 

 
 

 
Tier 1 leverage (to average assets)
$
141,469

 
10.4
%
 
$
54,204

 
4.0
%
 
$
135,509

 
10.0
%
(1) 
Tier 1 capital (to risk-weighted assets)
141,469

 
13.4

 
42,097

 
4.0

 
63,146

 
6.0

 
Total capital (to risk-weighted assets)
154,739

 
14.7

 
84,194

 
8.0

 
105,243

 
10.0

 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2012
 

 
 

 
 

 
 

 
 

 
 

 
Tier 1 leverage (to average assets)
$
136,658

 
10.4
%
 
$
52,457

 
4.0
%
 
$
131,142

 
10.0
%
(2) 
Tier 1 capital (to risk-weighted assets)
136,658

 
14.1

 
38,803

 
4.0

 
58,205

 
6.0

 
Total capital (to risk-weighted assets)
148,991

 
15.4

 
77,607

 
8.0

 
97,008

 
10.0

 
 (1) Pursuant to the MOU, which was terminated effective September 5, 2013, the Bank was required to maintain a Tier 1 leverage ratio of at least 10.00% in order to be deemed "well-capitalized".
 (2) Pursuant to the Order, which was terminated effective March 7, 2013, the Bank was required to maintain a Tier 1 leverage ratio of at least 10.00% in order to be deemed "well capitalized".

11.      New Authoritative Accounting Guidance

In February 2013, the FASB issued ASU No. 2013-02, “Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income” (“ASU 2013-02”). The provisions of ASU 2013-02 require an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component and to present either on the face of the statement where net income is presented, or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income, but only if the amount reclassified is required to be reclassified to net income in its entirety in the same reporting period. The provisions of ASU 2013-02 are effective for annual and interim reporting periods beginning on or after December 15, 2012. The adoption of ASU 2013-02 did not have a material impact on the Company’s consolidated financial statements.

12.      Commitments and Contingencies
 
The Company is subject to legal proceedings, claims, and litigation arising in the ordinary course of business.  While the outcome of these matters is currently not determinable, management does not expect that the ultimate costs to resolve these matters will have a material adverse effect on the Company’s condensed consolidated financial position, results of operations, or cash flows.


31



13.      Subsequent Event

On October 18, 2013, the Bank received required regulatory approval and completed its previously announced purchase of AmericanWest Bank's Klamath Falls, Oregon branch and the assumption of customer relationships, including deposits and selected loans of AmericanWest's Bend and Redmond, Oregon branch offices. In total, the Bank acquired approximately $25.6 million of deposits, paying a deposit premium of 2.00% of the balance of core in-market deposits assumed, and approximately $1.6 million of performing loans.

On October 23, 2013 the Company, jointly with Home Federal Bancorp, Inc. (NASDAQ: HOME) ("Home Federal"), the holding company for Home Federal Bank announced the signing of a definitive agreement and plan of merger whereby the Company and Home Federal intend to merge in a transaction valued at approximately $265.7 million, payable in a mix of cash and the Company's common stock to Home Federal's stockholders. The combined company is expected to have over $2.0 billion in assets and serve communities across Oregon and Idaho. The transaction, which was unanimously approved by the boards of directors of the Company and Home Federal, however is subject to regulatory approval, approval by the shareholders of the Company and Home Federal and other customary conditions of closing.


32



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

The following discussion should be read in conjunction with the Company’s unaudited condensed consolidated financial statements and the notes thereto, included elsewhere in this Quarterly Report on Form 10-Q. This discussion highlights key information as determined by management but may not contain all of the information that is important to you. For a more complete understanding, the following should be read in conjunction with the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on March 25, 2013, including its audited 2012 consolidated financial statements and the notes thereto as of December 31, 2012 and 2011 and for each of the years in the three-year period ended December 31, 2012.
 
In this documents please note that “we” “our” “us” “Cascade” or the “Company” refer collectively to Cascade Bancorp (“Bancorp”), an Oregon chartered single bank holding company and its wholly-owned subsidiary, Bank of the Cascades (the “Bank”).

Cautionary Information Concerning Forward-Looking Statements
 
This Quarterly Report on Form 10-Q contains forward-looking statements about the Company’s plans and anticipated results of operations and financial condition. These statements include, but are not limited to, our plans, objectives, expectations and intentions and are not statements of historical fact. When used in this report, the words “expects,” “believes,” “anticipates,” “could,” “may,” “will,” “should,” “plan,” “predicts,” “projections,” “continue” and other similar expressions constitute forward-looking statements, as do any other statements that expressly or implicitly predict future events, results or performance, and such statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Certain risks and uncertainties, and the Company’s success in managing such risks and uncertainties could cause actual results to differ materially from those projected, including, among others, the risk factors disclosed in Part II – Item 1A of this Quarterly Report on Form 10-Q and in Part I - Item 1A of the Company’s Annual Report on Form 10-K filed with the SEC on March 25, 2013 for the year ended December 31, 2012.
 
These forward-looking statements speak only as of the date of this Quarterly Report on Form 10-Q. The Company undertakes no obligation to publish revised forward-looking statements to reflect the occurrence of unanticipated events or circumstances after the date hereof. Readers should carefully review all disclosures filed by the Company from time to time with the SEC.

 Critical Accounting Policies and Accounting Estimates
 
Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and could potentially result in materially different results under different assumptions and conditions. We believe that our most critical accounting policies upon which our financial condition depends, and which involve the most complex or subjective decisions or assessments are as follows.
 
Reserve for Credit Losses
 
The Company’s reserve for credit losses provides for estimated losses based upon evaluations of known and inherent risks in the loan portfolio and related loan commitments. Arriving at an estimate of the appropriate level of reserve for credit losses (which consists of our reserve for loan losses and our reserve for loan commitments) involves a high degree of judgment and assessment of multiple variables that result in a methodology with relatively complex calculations and analysis. Management uses historical information to assess the adequacy of the reserve for loan losses and considers qualitative factors including economic conditions and a range of other factors in its determination of the reserve. On an ongoing basis, the Company seeks to enhance and refine its methodology such that the reserve is at an appropriate level and responsive to changing conditions. In this regard, as of June 30, 2013 management implemented a homogeneous pool approach to estimating reserves for consumer and small business loans. This change is not expected to have a material effect on the level of the reserve for loan losses. However, the Company’s methodology may not accurately estimate inherent loss or external factors and changing economic conditions may impact the loan portfolio and the level of reserves in ways currently unforeseen.
 
The reserve for loan losses is increased by provisions for loan losses and by recoveries of loans previously charged-off and reduced by loans charged-off. The reserve for loan commitments is increased and decreased through non-interest expense. For a full discussion of the Company’s methodology of assessing the adequacy of the reserve for credit losses, see "Loan Portfolio and Credit Quality” in Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2012.
 
Deferred Income Taxes
 
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are

33



reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision (credit) for income taxes. A valuation allowance, if needed, reduces deferred tax assets to the expected amount to be realized.

Income tax positions that meet a more-likely-than-not recognition threshold are measured as the largest amount of income tax benefit that is more than 50% likely of being realized upon settlement with the applicable taxing authority.

The Company reversed its DTA valuation allowance as of June 30, 2013 due to management's determination that it was more likely than not that a significant portion of our DTA would be realized. Management's decision was based upon evidence including the Company's positive earnings performance trend, expected continued profitability, and financial condition improvement. As of September 30, 2013, the Company has a deferred tax asset of $51.5 million. This compares to no deferred tax asset as of December 31, 2012 as it was fully reserved against. There are a number of tax issues that impact the deferred tax asset balance including changes in temporary differences between the financial statement and tax recognition of revenue and expenses, estimates as to the deductibility of prior losses and potential consequence of Section 382 of the Internal Revenue Code.

The portion of the benefits associated with income tax positions taken that exceeds the amount measured as described above would be reflected as a liability for unrecognized income tax benefits in the accompanying consolidated balance sheets along with any associated interest and penalties that would be payable to the taxing authorities upon examination. Interest and penalties associated with unrecognized income tax benefits would be classified as additional income taxes in the consolidated statements of operations.

Other Real Estate Owned and Foreclosed Assets

Other real estate owned and other foreclosed assets acquired through loan foreclosure are initially recorded at estimated fair value less costs to sell when acquired, establishing a new cost basis. The adjustment at the time of foreclosure is recorded through the reserve for loan losses. Due to the subjective nature of establishing the asset’s fair value when it is acquired, the actual fair value of the other real estate owned or foreclosed asset could differ from the original estimate. If it is determined that fair value declines subsequent to foreclosure, a valuation allowance is recorded through non-interest expense. Operating costs associated with the assets after acquisition are also recorded as non-interest expense. Gains and losses on the disposition of other real estate owned and foreclosed assets are netted and posted to other non-interest expenses.

Economic Conditions
 
The Company's business is closely tied to the economies of Idaho and Oregon which in turn are influenced by regional and national economic trends and conditions. Idaho and Oregon have recently been experiencing improved economic trends including gains in employment and increased real estate activity. National and regional economies and real estate prices are also stabilizing and in certain cases improved, however lingering effects of the severe economic downturn in 2008 and 2009, including fiscal imbalances, continue to affect employment and business and consumer confidence to some degree and the future direction of the economy remains uncertain. The Company's markets continue to be sensitive to real estate values and unemployment rates continue to be higher than prior to the downturn. An unforeseen economic shock or a return of adverse economic conditions could cause deterioration of local economies and adversely effect the Company's financial condition and results of operations.

Financial Highlights and Summary of the Third Quarter of 2013 (period ended September 30, 2013)

Net Income for the Third Quarter of 2013: $1.5 million or $0.03 per common share after a $0.6 million income tax provision. Net income for the third quarter of 2012 was $1.8 million or $0.04 per common share; there was no income tax provision recorded during this period.
Net Income for the Nine Months Ended September 30, 2013: $49.6 million or $1.05 per share including a $51.2 million income tax benefit, mainly due to the second quarter DTA recapture. This compares to net income for the nine months ended September 30, 2012 of $4.6 million or $0.10 per share after a $0.1 million income tax provision.
Stockholders Equity/Book Value per Share: Equity increased to $186.9 million or $3.93 per share at September 30, 2013 compared to $140.8 million or $2.97 per share at December 31, 2012. The year to date increase was mainly a result of the DTA valuation allowance release in the second quarter of 2013.
Loans: Gross loans are up $81.7 million or 9.52% compared to December 31, 2012.

34



Deposits: Total deposits are up $119.4 million or 11.09% compared to December 31, 2012.
Credit Quality: Reserve for loan losses at $21.7 million or 2.28% of loans compared to $27.3 million or 3.17% of loans at December 31, 2012; no provision was recorded in the third quarter of 2013.
Credit Quality: Net charge-offs for the third quarter of 2013 were $1.0 million, as compared to $2.6 million in the third quarter of 2012, with the decrease mainly related to lower frequency and severity of resolution of special mention and substandard loans.
Credit Quality: Non-performing assets improved to 0.88% of total assets at September 30, 2013 compared to 1.94% at December 31, 2012.
Net Interest Margin ("NIM"): NIM was 3.81% at September 30, 2013 compared to 4.11% at December 31, 2012.
                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
RESULTS OF OPERATIONS –Three and Nine Months Ended September 30, 2013 and 2012
 
Total loans and loans held-for-sale outstanding increased to $950.6 million at September 30, 2013, a year-to-date increase of $91.9 million. The growth was primarily attributable to increased balances of shared national credits in the commercial and industrial portfolio as well as growth in the owner-occupied commercial real estate and residential mortgage portfolios.

Loan quality continued to improve with remediation of special mention and substandard loans. Loans categorized as such totaled $103.3 million at September 30, 2013 as compared to $175.6 million at December 31, 2012. Of the $72.2 million reduction, $68.5 million of special mention and substandard loans were remediated in the first half of 2013. Remediation was accomplished through credit upgrades owing to improved obligor cash flows as well as payoffs/paydowns, note sales and/or charge offs related to the restructure of adversely risk rated loans. Non-performing assets as of September 30, 2013 improved to 0.88% of total assets as compared to 1.94% at December 31, 2012. Charge-offs during the third quarter of 2013 were $1.0 million, however the Company made no provision for loan losses as management believes the reserve for loan losses of $21.7 million at September 30, 2013 is adequate.

Total deposits as of September 30, 2013 were $119.4 million higher than the balance at December 31, 2012, primarily due to an influx of deposits from the Bank's public entities, such a municipalities, as well as an increase in title company funds at the end of the third quarter.

Non-interest income of $3.6 million in the third quarter of 2013 remained relatively consistent to non-interest income of $3.2 million in the third quarter of 2012, while non-interest expense in the third quarter of 2013 was also comparable to the third quarter of 2012.

Income Statement
 
Net Income
 
Net income for the quarter ended September 30, 2013 was $0.03 per share or $1.5 million, compared to $0.04 per share or $1.8 million for the third quarter of 2012. Net income for the quarter ended September 30, 2013 includes a $0.6 million provision for income taxes. No provision was made for the quarter ended September 30, 2012.

Year-to-date net income through September 30, 2013 was $1.05 per share or $49.6 million, compared to $0.10 per share or $4.6 million for the same period in 2012. The increase is primarily due to an income tax benefit of $51.2 million realized through the reversal of the valuation allowance against the Company's deferred tax asset.

Net Interest Income
 
Net interest income was $12.1 million for the third quarter of 2013, comparable to $12.3 million in the third quarter of 2012. Net interest income for the nine months ended September 30, 2013 was $2.8 million lower compared to the nine months ended September 30, 2012. The decline is primarily due to continued reductions in yields on earnings assets mainly resulting from the historically low interest rate environment. Specifically, interest income in the third quarter of 2013 decreased $1.0 million compared to the third quarter of 2012 and decreased $4.4 million in the nine months ended September 30, 2013 compared to the same period in 2012, mainly due to lower loan portfolio yields.
 

35



Interest expense for the third quarter of 2013 decreased $0.7 million compared to the third quarter of 2012. Interest expense decreased $1.6 million in the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012. This improvement was primarily due to lower rates on deposits and reduced borrowing expenses. During the second quarter of 2013, the Company prepaid $60.0 million of FHLB advances bearing a weighted average rate of 3.17%.
 
Components of Net Interest Margin
 
The following tables set forth the components of the Company's net interest margin for the three and nine months ended September 30, 2013 and 2012. The tables present average balance sheet information, interest income and yields on average interest-earning assets, interest expense and rates paid on average interest-bearing liabilities, net interest income, net interest spread and net interest margin for the Company (dollars in thousands):

36



 
Three Months Ended September 30,
 
2013
 
2012
 
Average
Balance
 
Interest
Income/
Expense
 
Average
Yield or
Rates
 
Average
Balance
 
Interest
Income/
Expense
 
Average
Yield or
Rates
Assets
 

 
 

 
 

 
 

 
 

 
 

Investment securities
$
211,652

 
$
1,356

 
2.54
%
 
$
280,244

 
$
1,533

 
2.20
%
Interest bearing balances due from other banks
108,422

 
71

 
0.26
%
 
64,705

 
36

 
0.22
%
Federal funds sold
22

 

 
%
 
23

 

 
%
Federal Home Loan Bank stock
10,083

 

 
%
 
10,464

 

 
%
Loans (1)(2)(3)
924,822

 
11,080

 
4.75
%
 
846,382

 
11,893

 
5.59
%
Total earning assets/interest income
1,255,001

 
12,507

 
3.95
%
 
1,201,818

 
13,462

 
4.46
%
Reserve for loan losses
(22,410
)
 
 

 
 

 
(37,190
)
 
 

 
 

Cash and due from banks
32,307

 
 

 
 

 
29,598

 
 

 
 

Premises and equipment, net
34,085

 
 

 
 

 
33,653

 
 

 
 

Bank-owned life insurance
36,225

 
 

 
 

 
35,294

 
 

 
 

Accrued interest and other assets
65,509

 
 

 
 

 
21,652

 
 

 
 

Total assets
$
1,400,717

 
 

 
 

 
$
1,284,825

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities and Stockholders' Equity
 

 
 

 
 

 
 

 
 

 
 

Interest bearing demand deposits
$
551,667

 
193

 
0.14
%
 
$
479,681

 
224

 
0.19
%
Savings deposits
46,360

 
6

 
0.05
%
 
37,913

 
5

 
0.05
%
Time deposits
141,924

 
235

 
0.66
%
 
139,236

 
462

 
1.32
%
Other borrowings
24,239

 
16

 
0.26
%
 
60,000

 
480

 
3.18
%
Total interest bearing liabilities/interest expense
764,190

 
450

 
0.23
%
 
716,830

 
1,171

 
0.65
%
Demand deposits
423,351

 
 

 
 

 
405,283

 
 

 
 

Other liabilities
24,078

 
 

 
 

 
24,693

 
 

 
 

Total liabilities
1,211,619

 
 

 
 

 
1,146,806

 
 

 
 

Stockholders' equity
189,098

 
 

 
 

 
138,019

 
 

 
 

Total liabilities and stockholders' equity
$
1,400,717

 
 

 
 

 
$
1,284,825

 
 

 
 

Net interest income
 

 
$
12,057

 
 

 
 

 
$
12,291

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Net interest spread
 

 
 

 
3.72
%
 
 

 
 

 
3.81
%
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income to earning assets
 

 
 

 
3.81
%
 
 

 
 

 
4.07
%

(1)
Average non-performing loans included in the computation of average loans for the three months ended September 30, 2013 and 2012 was approximately $12.0 million and $10.3 million, respectively.
(2)
Loan related fees, including prepayment penalties, recognized during the period and included in the yield calculation totaled approximately $0.3 million in 2013 and $0.4 million in 2012.
(3)
Includes loans held for sale.

37



 
Nine Months Ended September 30,
 
2013
 
2012
 
Average
Balance
 
Interest
Income/
Expense
 
Average
Yield or
Rates
 
Average
Balance
 
Interest
Income/
Expense
 
Average
Yield or
Rates
Assets
 
 
 
 
 
 
 
 
 
 
 
Investment securities
$
227,938

 
$
4,059

 
2.38
%
 
$
250,459

 
$
4,462

 
2.38
%
Interest bearing balances due from other banks
93,678

 
173

 
0.25
%
 
87,606

 
163

 
0.25
%
Federal funds sold
22

 

 
%
 
23

 

 
%
Federal Home Loan Bank stock
10,180

 

 
%
 
10,469

 

 
%
Loans (1)(2)(3)
897,803

 
33,251

 
4.95
%
 
861,368

 
37,231

 
5.77
%
Total earning assets/interest income
1,229,621

 
37,483

 
4.08
%
 
1,209,925

 
41,856

 
4.62
%
Reserve for loan losses
(24,578
)
 
 

 
 

 
(40,839
)
 
 

 
 

Cash and due from banks
30,519

 
 

 
 

 
30,277

 
 

 
 

Premises and equipment, net
34,294

 
 

 
 

 
33,853

 
 

 
 

Bank-owned life insurance
36,006

 
 

 
 

 
35,043

 
 

 
 

Accrued interest and other assets
33,194

 
 

 
 

 
25,558

 
 

 
 

Total assets
$
1,339,056

 
 

 
 

 
$
1,293,817

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities and Stockholders' Equity
 

 
 

 
 

 
 

 
 

 
 

Interest bearing demand deposits
$
528,894

 
541

 
0.14
%
 
$
502,744

 
872

 
0.23
%
Savings deposits
44,164

 
17

 
0.05
%
 
36,401

 
18

 
0.07
%
Time deposits
133,087

 
829

 
0.83
%
 
148,409

 
1,612

 
1.45
%
Other borrowings
49,897

 
949

 
2.54
%
 
60,000

 
1,429

 
3.18
%
Total interest bearing liabilities/interest expense
756,042

 
2,336

 
0.41
%
 
747,554

 
3,931

 
0.70
%
Demand deposits
402,249

 
 

 
 

 
386,021

 
 

 
 

Other liabilities
21,944

 
 

 
 

 
24,246

 
 

 
 

Total liabilities
1,180,235

 
 

 
 

 
1,157,821

 
 

 
 

Stockholders' equity
158,821

 
 

 
 

 
135,996

 
 

 
 

Total liabilities and stockholders' equity
$
1,339,056

 
 

 
 

 
$
1,293,817

 
 

 
 

Net interest income
 

 
$
35,147

 
 

 
 

 
$
37,925

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Net interest spread
 

 
 

 
3.67
%
 
 

 
 

 
3.92
%
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income to earning assets
 

 
 

 
3.82
%
 
 

 
 

 
4.20
%
(1)
Average non-performing loans included in the computation of average loans for the nine months ended September 30, 2013 and 2012 was approximately $17.6 million and $9.5 million, respectively.
(2)
Loan related fees, including prepayment penalties, recognized during the period and included in the yield calculation totaled approximately $1.2 million in 2013 and $1.4 million in 2012.
(3)
Includes loans held for sale.

38




Analysis of Changes in Interest Income and Expense
 
The following table shows the dollar amount of increase (decrease) in the Company’s consolidated interest income and expense for the three and nine months ended September 30, 2013, and attributes such variance to “volume” or “rate” changes (dollars in thousands):
 
Three Months Ended September 30,
 
2013 over 2012
 
Total
Increase
 
Amount of Change
Attributed to
 
(Decrease)
 
Volume
 
Rate
Interest income:
 
 
 
 
 
Interest and fees on loans
$
(813
)
 
$
1,105

 
$
(1,918
)
Interest on investment securities
(177
)
 
(376
)
 
199

Other investment income
35

 
25

 
10

Total interest income
(955
)
 
754

 
(1,709
)
 
 
 
 
 
 
Interest expense:
 

 
 

 
 

Interest on deposits:
 

 
 

 
 

Interest bearing demand
(31
)
 
34

 
(65
)
Savings
1

 
1

 

Time deposits
(227
)
 
9

 
(236
)
Other borrowings
(464
)
 
(287
)
 
(177
)
Total interest expense
(721
)
 
(243
)
 
(478
)
 
 
 
 
 
 
Net interest income
$
(234
)
 
$
997

 
$
(1,231
)
  
 
Nine Months Ended September 30,
 
2013 over 2012
 
Total
Increase
 
Amount of Change
Attributed to
 
(Decrease)
 
Volume
 
Rate
Interest income:
 
 
 
 
 
Interest and fees on loans
$
(3,980
)
 
$
1,574

 
$
(5,554
)
Interest on investment securities
(403
)
 
(402
)
 
(1
)
Other investment income
10

 
11

 
(1
)
Total interest income
(4,373
)
 
1,183

 
(5,556
)
 
 
 
 
 
 
Interest expense:
 

 
 

 
 

Interest on deposits:
 

 
 

 
 

Interest bearing demand
(331
)
 
45

 
(376
)
Savings
(1
)
 
4

 
(5
)
Time deposits
(783
)
 
(167
)
 
(616
)
Other borrowings
(480
)
 
(241
)
 
(239
)
Total interest expense
(1,595
)
 
(359
)
 
(1,236
)
 
 
 
 
 
 
Net interest income
$
(2,778
)
 
$
1,542

 
$
(4,320
)


39



Loan Loss Provision
 
The Company did not record a loan loss provision during the third quarter of 2013 or 2012. The year-to-date provision as of September 30, 2013 is $1.0 million while the year-to-date provision for September 30, 2012 was $1.1 million.
 
Net charge-offs in the third quarter of 2013 were $1.0 million compared to $2.6 million in the third quarter of 2012. At September 30, 2013, the reserve for loan losses was $21.7 million or 2.28% of outstanding loans compared to $27.3 million or 3.17% of outstanding loans at December 31, 2012.
 
The reserve for unfunded lending commitments was $0.4 million at September 30, 2013, which remained unchanged from December 31, 2012.
 
Non-Interest Income
 
Non-interest income was as follows for the periods presented below (dollars in thousands):
 
Three Months Ended  
 September 30, 2013
 
Three Months Ended  
 September 30, 2012
 
% Change
 
Nine Months Ended 
 September 30, 2013
 
Nine Months Ended 
 September 30, 2012
 
% Change
Service charges on deposit accounts
$
766

 
$
791

 
(3.2
)%
 
$
2,245

 
$
2,471

 
(9.1
)%
Card issuer and merchant services fees, net
847

 
694

 
22.0
 %
 
2,473

 
1,970

 
25.5
 %
Earnings on BOLI
224

 
234

 
(4.3
)%
 
659

 
751

 
(12.3
)%
Mortgage banking income, net
1,284

 
1,104

 
16.3
 %
 
3,504

 
2,948

 
18.9
 %
Other income
516

 
410

 
25.9
 %
 
1,628

 
1,500

 
8.5
 %
Total non-interest income
$
3,637

 
$
3,233

 
12.5
 %
 
$
10,509

 
$
9,640

 
9.0
 %
Service charges on deposit accounts decreased during both the third quarter and the nine months ended September 30, 2013 compared to the same periods in 2012 mainly as a result of the mix of deposit transactions. Card issuer and merchant service fees increased in the third quarter and first nine months of 2013 compared to the same periods in 2012 primarily due to higher transaction volume.

Net mortgage banking income increased in the three and nine months ended September 30, 2013 compared to the three and nine months ended September 30, 2012, mainly due to stronger residential mortgage origination volumes and related revenues.

Other income for the three months ended September 30, 2013 increased over the three months ended September 30, 2012 mainly as a result of gains on sales of Small Business Administration ("SBA") loans.
 
Non-Interest Expense

Non-interest expense was as follows for the periods presented below (dollars in thousands):


40



 
Three Months Ended  
 September 30, 2013
 
Three Months Ended  
 September 30, 2012
 
% Change
 
Nine Months Ended 
 September 30, 2013
 
Nine Months Ended 
 September 30, 2012
 
% Change
Salaries and employee benefits
$
7,633

 
$
7,859

 
(2.9
)%
 
$
24,239

 
$
23,720

 
2.2
 %
Occupancy
1,101

 
1,127

 
(2.3
)%
 
3,830

 
3,444

 
11.2
 %
Equipment
457

 
371

 
23.2
 %
 
1,191

 
1,143

 
4.2
 %
Communications
347

 
394

 
(11.9
)%
 
1,108

 
1,149

 
(3.6
)%
FDIC insurance
454

 
665

 
(31.7
)%
 
1,305

 
2,048

 
(36.3
)%
OREO
47

 
85

 
(44.7
)%
 
322

 
834

 
(61.4
)%
Professional services
1,025

 
753

 
36.1
 %
 
2,535

 
2,630

 
(3.6
)%
Prepayment penalties on FHLB advances

 

 
 %
 
3,827

 

 
 %
Other expenses
2,519

 
2,445

 
3.0
 %
 
7,847

 
6,804

 
15.3
 %
Total non-interest expense
$
13,583

 
$
13,699

 
(0.8
)%
 
$
46,204

 
$
41,772

 
10.6
 %

Total non-interest expense for the three months ended September 30, 2013 was comparable to the three months ended September 30, 2012. Total non-interest expense for the nine months ended September 30, 2013 was $4.4 million higher than for the nine months ended September 30, 2012, primarily due to prepayment penalties on our FHLB advances in the first half of 2013.

Total salaries and benefits decreased $0.2 million or 2.9% during the three months ended September 30, 2013 compared to the same period in 2012 and increased $0.5 million or 2.2% during the nine months ended September 30, 2013 compared to the same period in 2012 primarily as a result of a $1.3 million expense for human resource related items including incentive and severance obligations incurred in the second quarter of 2013, being partially offset by decreased salaries.

Occupancy, equipment and communications expenses for the three months ended September 30, 2013 were comparable to the same period in 2012, and increased $0.4 million during the nine months ended September 30, 2013 compared to the same period in 2012, primarily due to branch consolidation costs of $0.4 million during the second quarter of 2013.

FDIC insurance has continued to decline for the three and nine months ended September 30, 2013 compared to the same periods in 2012. The decreases are due to reduced monetary assessments by the Federal Deposit Insurance Corporation (“FDIC”) as a result of the Bank's improved financial condition.

OREO expenses decreased 44.7% and 61.4% in the three and nine months ended September 30, 2013, respectively, compared to the same periods in 2012, mainly as a result of significant OREO dispositions during 2012 through the first half of 2013.

Professional services increased 36.1% during the three months ended September 30, 2013 compared to the same period in 2012 and decreased 3.6% for the nine months ended September 30, 2013 compared to the same period in 2012. Increases in the third quarter of 2013 were primarily the result of legal fees related to remediation of classified assets.

Prepayment penalties on FHLB advances of $3.8 million were recorded during the second quarter of 2013. The Company incurred the penalties to prepay $60.0 million of advances to reduce ongoing interest expense.

Other expenses increased in both the third quarter and first nine months of 2013 compared to the same periods in 2012 mainly as a result of marketing expenses and an adjustment of the Company's tax credit investment.

Income Taxes
 
During the nine months ended September 30, 2013, the Company recorded an income tax benefit of $51.2 million. This is the result of the Company releasing a DTA allowance of $51.7 million, recorded as a credit to income taxes, during the second quarter of 2013. As a result of the release of the valuation allowance, the Company is now recording income tax provision based on estimated taxable income. As such, for the three months ended September 30, 2013, the Company recorded a income tax provision of $0.6 million.


41



During the nine months ended September 30, 2012, the Company recorded a $0.1 million income tax provision and no tax provision was recorded during the three months ended September 30, 2012.

The DTA valuation allowance was established during 2009 due to uncertainty regarding the Company's ability to generate sufficient future taxable income to fully realize the benefit of the net DTA. Based on its earnings performance trend, expected continued profitability and improvements in the Company's financial condition, management determined it was more likely than not that a significant portion of our DTA would be realized.

As of September 30, 2013, the net deferred tax asset was $51.5 million. Included in the net deferred taxes are NOL's (tax affected) for federal taxes of $28.0 million, Oregon state taxes of $4.5 million and Idaho state taxes of $4.0 million. Also included in the net deferred taxes are federal and state tax credits of $0.9 million and $0.3 million, respectively. This is compared with a deferred tax liability as of December 31, 2012 of $2.3 million (pertaining to available-for-sale securities) as the balance of the deferred tax assets was fully reserved. There are a number of tax issues that impact the deferred tax asset balance including changes in temporary differences between the financial statement recognition of revenue and expenses, estimates as to the deductibility of prior losses and potential consequence of Section 382 of the IRC. See also “Critical Accounting Policies and Accounting Estimates - Deferred Income Taxes” included in Part II, Item 7 of the Company's Annual Report on Form 10-K for the year ended December 31, 2012.

The Company has evaluated our future taxable earnings projections and as a result, the entire amount of the deferred tax valuation allowance reversal was determined to be a discrete item.

In assessing the Company's ability to utilize its DTA, management considers whether it is more likely than not that some portion or all of the DTA will not be realized. The ultimate realization of DTA is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the nature and amount of historical and projected future taxable income, the scheduled reversal of deferred tax assets and liabilities, and available tax planning strategies in making this assessment. The amount of deferred taxes recognized could be impacted by changes to any of these variables.

Financial Condition
 
Capital Resources
 
Total stockholders’ equity increased to $186.9 million at September 30, 2013, as compared to total stockholders’ equity of $140.8 million at December 31, 2012. The increase in total stockholders' equity was primarily due to the increase in net income recorded in the nine months ended September 30, 2013 of $49.6 million compared to net income of $4.6 million over the same period in 2012. The increased net income during 2013 was mainly the result of a release of $51.7 million DTA valuation allowance during the second quarter of 2013. At September 30, 2013, the total common equity to total assets ratio was 13.3% and the Company’s basic book value per share was $3.93 as compared to the total common equity to total assets ratio of 10.8% and basic book value per share of $2.97 at December 31, 2012.
 
At September 30, 2013, Bancorp’s Tier 1 leverage, Tier 1 risk-based capital and total risk-based capital ratios were 10.44%, 13.41% and 14.67%, respectively, and the Bank’s Tier 1 leverage, Tier 1 risk-based capital and total risk-based capital ratios were 10.44%, 13.44% and 14.70%, respectively, which meet regulatory benchmarks for a “well-capitalized” designation. Regulatory benchmarks for a “well-capitalized” designation are 5.00%, 6.00%, and 10.00% for Tier 1 leverage, Tier 1 risk-based capital and total risk-based capital, respectively. However, in accordance with the Bancorp memorandum of understanding (“FRB-MOU”) with the FDIC and Oregon Division of Finance and Corporate Securities (“DFCS”), Bancorp was required to maintain a Tier 1 leverage ratio of at least 10.00% to be considered “well-capitalized.” The FRB-MOU was lifted effective October 23, 2013. Additional information regarding capital requirements can be found in Note 10 of the notes to the condensed consolidated financial statements included in this Quarterly Report on Form 10-Q.
 
From time to time the Company makes commitments to acquire banking properties or to make equipment or technology related investments of capital. At September 30, 2013, the Company had no material capital expenditure commitments apart from those incurred in the ordinary course of business.
 
Total Assets and Liabilities
 
Total assets were $1.4 billion at September 30, 2013, up $105.3 million from December 31, 2012. The increase in total assets during the period ended September 30, 2013 primarily resulted from the release of the DTA valuation allowance of $51.7 million in the second quarter of 2013, as well as increases in loans held for sale and net loans of $97.5 million and cash and cash equivalents of $16.8 million. These increases were partially offset by a decrease of $57.4 million in investment securities available-for-sale

42



and a decrease of $3.2 million from the disposition of OREO properties. The increase in net loans during the nine months ended September 30, 2013 was primarily the result of an increased shared national credit portfolio included in commercial and industrial loans, augmented by growth in local owner-occupied commercial real estate loans and residential real estate loans in connection with an improved real-estate market in the geographic regions in which we operate. The decline in investment securities available-for-sale during both the third quarter and nine months ended September 30, 2013 was primarily the result of the principal pay downs of our mortgage-backed securities and the payoff of short term commercial paper.
 
Total liabilities were $1.2 billion at September 30, 2013, a $59.2 million increase from December 31, 2012. This was primarily the result of a $119.4 million increase in total deposits, partially offset by $60.0 million in reduced FHLB borrowings. In June 2013, the Company prepaid $60.0 million of FHLB advances bearing a weighted-average rate of 3.17%, as discussed above.
 
Off-Balance Sheet Arrangements
 
The following table summarizes the Bank’s off-balance sheet commitments at September 30, 2013 and December 31, 2012 (dollars in thousands):
 
September 30, 2013
 
December 31, 2012
Commitments to extend credit
$
230,387

 
$
224,531

Commitments under credit card lines of credit
23,646

 
22,847

Standby letters of credit
2,191

 
4,221

 
 
 
 
Total off-balance sheet financial instruments
$
256,224

 
$
251,599

 
 
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the customer contract. Commitments generally have fixed expiration dates or other termination clauses and may require the payment of fees. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

The Bank applies established credit standards and underwriting practices in evaluating the creditworthiness of such obligors and related collateral requirements, if any. Collateral held for commitments varies but may include accounts receivable, inventory, property and equipment, residential real estate and income-producing commercial properties. The Bank typically does not obtain collateral related to credit card commitments.
 
Standby letters of credit are written conditional commitments issued by the Bank to guarantee the performance of a customer to a third-party. These guarantees are primarily issued to support public and private borrowing arrangements. In the event the customer does not perform in accordance with the terms of the agreement with the third-party, the Bank would be required to fund the commitment. The maximum potential amount of future payments the Bank could be required to make is represented by the contractual amount of the commitment. If the commitment were funded, the Bank would be entitled to seek recovery from the customer. The Bank’s policies generally require that standby letter of credit arrangements contain security and debt covenants similar to those involved in extending loans to customers. The credit risk involved in issuing standby letters of credit is essentially the same as that involved in extending loan facilities to customers.
 
Other than those commitments discussed above, there are no other obligations or liabilities of the Company arising from its off-balance sheet arrangements that are or are reasonably likely to become material.  In addition, the Company knows of no event, demand, commitment, trend or uncertainty that will result in or is reasonably likely to result in the termination or material reduction in availability of the off-balance sheet arrangements. The Company had no material off-balance sheet derivative financial instruments as of September 30, 2013 and December 31, 2012.
 
Liquidity
 
The objective of the Bank’s liquidity management is to maintain sufficient cash flows to meet obligations for depositor withdrawals, to fund the borrowing needs of loan customers, and to fund ongoing operations. At September 30, 2013, liquid assets of the Bank were mainly interest bearing balances held at the FRB totaling $77.6 million compared to $78.7 million at December 31, 2012. The decrease was primarily the result of increased loans, discussed above.
 
Core relationship deposits are the Bank’s primary source of funds. As such, the Bank focuses on deposit relationships with local business and consumer clients who maintain multiple accounts and services at the Bank. The Company views such deposits as

43



the foundation of its long-term liquidity because it believes such core deposits are more stable and less sensitive to changing interest rates and other economic factors compared to large time deposits or wholesale purchased funds. The Bank’s customer relationship strategy has resulted in a relatively higher percentage of its deposits being held in checking and money market accounts, and a lesser percentage in time deposits.
 
The Bank augments core deposits with wholesale funds from time to time. Until the cease-and-desist order (the "Order") between the Bank and the FDIC and the DFCS was terminated on March 7, 2013, the Bank was restricted under the terms of the Order from accepting or renewing brokered deposits. Upon termination of the Order, the Bank began to accept local relationship-based reciprocal CDARS and DDM deposits. These deposits are technically classified as brokered deposits. At September 30, 2013, the Company had $27.8 million in reciprocal CDARS and $13.7 million in reciprocal DDM deposits. At December 31, 2012, the Company did not have any brokered deposits.
 
The Bank accepts public fund deposits in Oregon and Idaho and follows rules imposed by state authorities. Current rules imposed by the Oregon State Treasury require that the Bank collateralize 50% of the uninsured public funds of Oregon entities held by the Bank. At September 30, 2013, the Bank was in compliance with this statute. Currently there are no collateral requirements set on Idaho public deposits.
 
The Bank also utilizes borrowings and lines of credit as sources of funds. At September 30, 2013, the FHLB had extended the Bank a secured line of credit of $272.8 million (20.00% of total assets) accessible for short or long-term borrowings given sufficient qualifying collateral. As of September 30, 2013, the Bank had qualifying collateral pledged for FHLB borrowings totaling $274.6 million of which the Bank had nothing at September 30, 2013. At September 30, 2013, the Bank also had undrawn borrowing capacity at FRB of approximately $12.7 million supported by specific qualifying collateral. Borrowing capacity from FHLB or FRB may fluctuate based upon the acceptability and risk rating of loan collateral, and counterparties could adjust discount rates applied to such collateral at their discretion. Also, FRB or FHLB could restrict or limit our access to secured borrowings. Correspondent banks have extended $75.0 million in unsecured or collateralized short-term lines of credit for the purchase of federal funds. At September 30, 2013, the Company had no outstanding borrowings under these federal fund borrowing agreements.
 
Liquidity may be affected by the Bank’s routine commitments to extend credit. At September 30, 2013, the Bank had approximately $256.2 million in total outstanding commitments to extend credit, compared to approximately $251.6 million at year-end 2012. At this time, management believes that the Bank’s available resources will be sufficient to fund its commitments in the normal course of business.
 
The investment portfolio also provides a secondary source of funds as investments may be pledged for borrowings or sold for cash. This liquidity is limited, however, by counterparties’ willingness to accept securities as collateral and the market value of securities at the time of sale could result in a loss to the Bank. As of September 30, 2013, the book value of unpledged investments totaled approximately $25.2 million compared to $134.6 million at December 31, 2012. The decline in unpledged investments was in part due to payoffs in the first quarter of 2013 of securities classified as unpledged at December 31, 2012 as well as reallocating unpledged collateral to secure certain public deposit customers in Idaho. The Bank also pledged additional securities to the State of Oregon as public deposit customers had increased balances in the third quarter of 2013.
 
As of September 30, 2013, the Bank’s primary liquidity ratio (net cash, plus net short-term and marketable assets divided by net deposits and short-term liabilities) was 25.90%.
 
Bancorp is a single bank holding company and its primary ongoing source of liquidity is dividends received from the Bank. Oregon banking laws impose certain limitations on the payment of dividends by Oregon state chartered banks.  The amount of the dividend may not be greater than the Bank’s unreserved retained earnings, deducting from that, to the extent not already charged against earnings or reflected in a reserve, the following: (1) all bad debts, which are debts on which interest is past due and unpaid for at least six months, unless the debt is fully secured and in the process of collection; (2) all other assets charged off as required by the Director of the Department of Consumer and Business Services or a state or federal examiner; and (3) all accrued expenses, interest and taxes of the institution.
 
Inflation
 
The effect of changing prices on financial institutions is typically different than on non-banking companies since virtually all of a bank’s assets and liabilities are monetary in nature. In particular, interest rates are significantly affected by inflation, but neither the timing nor magnitude of the changes are directly related to price level indices; therefore, the Company can best counter inflation over the long term by managing net interest income and controlling net increases in noninterest income and expenses.


44



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
As a smaller reporting company, the Company is not required to provide the information called for by Item 3.

ITEM 4. CONTROLS AND PROCEDURES
 
Evaluation of Disclosure Controls and Procedure
 
As required by Rule 13a-15 under the Securities Exchange Act of 1934 (the “Exchange Act”), the Company carried out an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) or Rule 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. This evaluation was carried out under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and the Company’s Chief Financial Officer. Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this report.
 
Changes in Internal Control over Financial Reporting
 
There were no changes in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS
 
The Company is subject to legal proceedings, claims, and litigation arising in the ordinary course of business.  While the outcome of these matters is currently not determinable, management does not expect that the ultimate costs to resolve these matters will have a material adverse effect on the Company’s condensed consolidated financial position, results of operations or cash flows.

ITEM 1A. RISK FACTORS
 
There have been no material changes to Cascade’s risk factors previously disclosed in Part I – Item 1A Risk Factors of Cascade’s Annual Report on Form 10-K filed with the SEC on March 25, 2013 for the year ended December 31, 2012.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
(a)-(b) Not applicable.
 
(c) During the quarter ended September 30, 2013, the Company did not repurchase any shares.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES
 
Not applicable.

ITEM 4. MINE SAFETY DISCLOSURES
 
Not applicable.

ITEM 5. OTHER INFORMATION
 
(a) Not applicable.
 
(b) There have been no material changes to the procedures by which shareholders may nominate directors to the Company’s board of directors.

ITEM 6. EXHIBITS


45



31.1    Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a)
31.2    Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a)
32    Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

46



SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
  
 
 
 
CASCADE BANCORP
(Registrant)
Date
November 12, 2013
By
/s/ Terry E. Zink
 
 
 
Terry E. Zink, President & Chief Executive Officer
(Principal Executive Officer)
 
 
 
Date
November 12, 2013
By
/s/ Gregory D. Newton
 
 
 
Gregory D. Newton, EVP & Chief Financial Officer
(Principal Financial and Chief Accounting Officer)
 


47