Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

 

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

For the quarterly period ended September 30, 2011

OR

 

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

Commission File Number 0-29480

 

 

HERITAGE FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

Washington   91-1857900

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

201 Fifth Avenue SW,

Olympia, WA

  98501
(Address of principal executive offices)   (Zip Code)

(360) 943-1500

(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 definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes   ¨     No   x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the last practicable date:

As of October 18, 2011 there were 15,583,141 common shares outstanding, with no par value, of the registrant.

 

 

 


Table of Contents

HERITAGE FINANCIAL CORPORATION

FORM 10-Q

INDEX

FORWARD LOOKING STATEMENT

 

          Page  
PART I.    Financial Information   
Item 1.    Condensed Consolidated Financial Statements (Unaudited):   
   Condensed Consolidated Statements of Financial Condition as of September 30, 2011 and December 31, 2010      4   
   Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2011 and 2010      5   
   Condensed Consolidated Statements of Stockholders’ Equity for the Nine Months Ended September 30, 2011 and Comprehensive Income (Loss) for the Three and Nine Months Ended September 30, 2011 and 2010      6   
   Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2011 and 2010      7   
   Notes to Condensed Consolidated Financial Statements      9   
Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations      39   
Item 3.    Quantitative and Qualitative Disclosures About Market Risk      49   
Item 4.    Controls and Procedures      49   
PART II.    Other Information   
Item 1.    Legal Proceedings      49   
Item 1A.    Risk Factors      49   
Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds      49   
Item 3.    Defaults Upon Senior Securities      50   
Item 4.    [Removed and reserved]      50   
Item 5.    Other Information      50   
Item 6.    Exhibits      51   
   Signatures      52   
   Certifications   

 

2


Table of Contents

Forward Looking Statements

“Safe Harbor” statement under the Private Securities Litigation Reform Act of 1995: This Form 10-Q contains forward-looking statements that are subject to risks and uncertainties, including, but not limited to: the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs and changes in our allowance for loan losses and provision for loan losses that may be impacted by deterioration in the housing and commercial real estate markets; changes in general economic conditions, either nationally or in our market areas; changes in the levels of general interest rates, and the relative differences between short and long term interest rates, deposit interest rates, our net interest margin and funding sources; fluctuations in the demand for loans, the number of unsold homes and other properties and fluctuations in real estate values in our market areas; results of examinations of us by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”) and of our bank subsidiaries by the Federal Deposit Insurance Corporation (the “FDIC”), the Washington State Department of Financial Institutions, Division of Banks (the “Washington DFI”) or other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require us to increase our reserve for loan losses, write-down assets, change our regulatory capital position or affect our ability to borrow funds or maintain or increase deposits, which could adversely affect our liquidity and earnings; legislative or regulatory changes that adversely affect our business including changes in regulatory policies and principles, including the interpretation of regulatory capital or other rules including changes from the Dodd-Frank Wall Street Reform and Consumer Protection Act and regulations that have been or will be promulgated thereunder; our ability to control operating costs and expenses; the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation; difficulties in reducing risk associated with the loans on our balance sheet; staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our workforce and potential associated charges; computer systems on which we depend could fail or experience a security breach; our ability to retain key members of our senior management team; costs and effects of litigation, including settlements and judgments; our ability to implement our expansion strategy; our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we have acquired including the Cowlitz Bank and Pierce Commercial Bank transactions or may in the future acquire into our operations and our ability to realize related revenue synergies and cost savings within expected time frames and any goodwill charges related thereto; risks relating to acquiring assets or entering markets in which we have not previously operated and may not be familiar; changes in consumer spending, borrowing and savings habits; the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions; adverse changes in the securities markets; inability of key third-party providers to perform their obligations to us; changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods; other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services; and other risks detailed from time to time in our filings with the Securities and Exchange Commission.

The Company cautions readers not to place undue reliance on any forward-looking statements. Moreover, you should treat these statements as speaking only as of the date they are made and based only on information then actually known to the Company. The Company does not undertake and specifically disclaims any obligation to revise any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. These risks could cause our actual results for 2011 and beyond to differ materially from those expressed in any forward-looking statements by, or on behalf of, us, and could negatively affect the Company’s operating and stock price performance.

As used throughout this report, the terms “we”, “our”, “us”, or the “Company” refer to Heritage Financial Corporation and its consolidated subsidiaries, unless the context otherwise requires.

 

3


Table of Contents
ITEM 1. HERITAGE FINANCIAL CORPORATION

HERITAGE FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(Dollars in thousands, except for per share amounts)

(Unaudited)

 

     September 30,
2011
    December 31,
2010
 
Assets     

Cash on hand and in banks

   $ 30,081      $ 37,179   

Interest earning deposits

     121,921        129,822   

Federal funds sold

     —          1,990   

Investment securities available for sale

     141,747        125,175   

Investment securities held to maturity (market value of $13,358 and $14,290)

     12,446        13,768   

Loans held for sale

     922        764   

Originated loans receivable

     802,941        742,019   

Less: Allowance for loan losses

     (22,387     (22,062
  

 

 

   

 

 

 

Originated loans receivable, net

     780,554        719,957   

Purchased covered loans receivable, net of allowance for loan losses of ($3,682 and $0)

     111,392        128,715   

Purchased non-covered loans receivable, net of allowance for loan losses of ($2,366 and $0)

     92,364        131,049   
  

 

 

   

 

 

 

Total loans receivable, net

     984,310        979,721   

FDIC indemnification asset

     12,079        16,071   

Other real estate owned ($588 & $0 covered by FDIC loss share, respectively)

     2,590        3,030   

Premises and equipment, at cost, net

     22,788        21,750   

Federal Home Loan Bank stock, at cost

     5,594        5,594   

Accrued interest receivable

     5,137        4,626   

Prepaid expenses and other assets

     11,432        8,974   

Deferred income taxes, net

     3,411        4,255   

Intangible assets, net

     1,620        1,953   

Goodwill

     13,012        13,012   
  

 

 

   

 

 

 

Total assets

   $ 1,369,090      $ 1,367,684   
  

 

 

   

 

 

 
Liabilities and Stockholders’ Equity     

Deposits

   $ 1,137,445      $ 1,136,276   

Securities sold under agreement to repurchase

     18,770        19,027   

Accrued expenses and other liabilities

     6,760        10,102   
  

 

 

   

 

 

 

Total liabilities

     1,162,975        1,165,405   

Stockholders’ equity:

    

Common stock, no par, 50,000,000 shares authorized; 15,583,141 and 15,568,471 shares outstanding at September 30, 2011 and December 31, 2010, respectively

     127,780        128,436   

Unearned compensation – ESOP and other

     (116     (182

Retained earnings

     76,681        73,648   

Accumulated other comprehensive income , net

     1,770        377   
  

 

 

   

 

 

 

Total stockholders’ equity

     206,115        202,279   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 1,369,090      $ 1,367,684   
  

 

 

   

 

 

 

See Notes to Condensed Consolidated Financial Statements.

 

4


Table of Contents

HERITAGE FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in thousands, except for per share amounts)

(Unaudited)

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2011     2010      2011     2010  

INTEREST INCOME:

         

Interest and fees on loans

   $ 17,850      $ 14,053       $ 53,252      $ 37,927   

Taxable interest on investment securities

     792        629         2,223        2,049   

Nontaxable interest on investment securities

     214        146         592        297   

Interest on federal funds sold and interest bearing deposits

     65        112         206        232   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total interest income

     18,921        14,940         56,273        40,505   

INTEREST EXPENSE:

         

Deposits

     1,604        2,238         5,161        6,330   

Other borrowings

     18        23         61        64   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total interest expense

     1,622        2,261         5,222        6,394   
  

 

 

   

 

 

    

 

 

   

 

 

 

Net interest income

     17,299        12,679         51,051        34,111   

Provision for loan losses

     395        2,195         4,985        9,095   

Provision for loan losses on purchased loans

     2,821        —           6,128        —     
  

 

 

   

 

 

    

 

 

   

 

 

 

Net interest income after provision for loan losses

     14,083        10,484         39,938        25,016   

NON-INTEREST INCOME:

         

Gains on bank acquisition

     —          438         —          438   

Gains on sales of loans, net

     58        26         245        127   

Service charges on deposits

     1,332        1,212         3,847        3,318   

Merchant Visa income

     754        823         2,184        2,333   

Change in FDIC indemnification asset

     (1,666     —           (2,578     —     

Other income

     383        367         1,495        850   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total non-interest income

     861        2,866         5,193        7,066   

NON-INTEREST EXPENSE:

         

Impairment loss on investment securities

     28        28         93        291   

Less: Portion recorded as other comprehensive income

     —          —           (20     (18
  

 

 

   

 

 

    

 

 

   

 

 

 

Impairment loss on investment securities, net

     28        28         73        273   

Salaries and employee benefits

     6,495        5,191         20,207        13,406   

Occupancy and equipment

     1,749        1,250         5,314        3,268   

Data processing

     553        549         2,011        1,385   

Marketing

     390        261         1,084        895   

Merchant Visa

     622        680         1,793        1,937   

Professional services

     517        598         1,564        1,222   

State and local taxes

     290        295         1,015        668   

Federal deposit insurance premium

     384        423         1,272        1,125   

Other real estate owned

     31        5         596        (33

Other expense

     1,348        1,004         4,305        2,597   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total non-interest expense

     12,407        10,284         39,234        26,743   
  

 

 

   

 

 

    

 

 

   

 

 

 

Income before income taxes

     2,537        3,066         5,897        5,339   

Income tax expense

     701        1,024         1,611        1,746   
  

 

 

   

 

 

    

 

 

   

 

 

 

Net income

   $ 1,836      $ 2,042       $ 4,286      $ 3,593   
  

 

 

   

 

 

    

 

 

   

 

 

 

Dividends accrued and discount accreted on preferred shares

     —          332         —          995   

Net income applicable to common shareholders

   $ 1,836      $ 1,710       $ 4,286      $ 2,598   
  

 

 

   

 

 

    

 

 

   

 

 

 

Earnings per share:

         

Basic

   $ 0.12      $ 0.16       $ 0.28      $ 0.24   

Diluted

   $ 0.12      $ 0.15       $ 0.28      $ 0.23   

Dividends declared per common share:

   $ 0.05      $ —         $ 0.08      $ —     

See Notes to Condensed Consolidated Financial Statements.

 

5


Table of Contents

HERITAGE FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY FOR THE NINE MONTHS ENDED

SEPTEMBER 30, 2011 AND COMPREHENSIVE INCOME FOR THE THREE AND NINE MONTHS ENDED

SEPTEMBER 30, 2011 AND 2010

(Dollars and shares in thousands)

(Unaudited)

 

     Number
of
common
shares
    Common
stock
    Unearned
Compensation-
ESOP and
other
    Retained
earnings
    Accumulated
other
comprehensive
income, net
    Total
stockholders’
equity
 

Balance at December 31, 2010

     15,568      $ 128,436      $ (182   $ 73,648      $ 377      $ 202,279   

Restricted stock awards issued

     81        —          —          —          —          —     

Restricted stock awards canceled

     (3     —          —          —          —          —     

Stock option compensation expense

     —          121        —          —          —          121   

Exercise of stock options (including tax benefits from nonqualified stock options)

     —          1        —          —          —          1   

Share based payment and earned ESOP

     6        615        66        —          —          681   

Tax provision associated with share based payment and unallocated ESOP

     —          (153     —          —          —          (153

Common stock repurchase

     (69     (790     —          —          —          (790

Net income

     —          —          —          4,286        —          4,286   

Change in fair value of securities available for sale, net of reclassification adjustments

     —          —          —          —          1,308        1,308   

Other-than-temporary impairment on securities held to maturity, net of tax

     —          —          —          —          (13     (13

Accretion of other-than-temporary impairment on securities held to maturity, net of tax

     —          —          —          —          98        98   

Repurchase of warrant issued to U.S. Treasury

     —          (450     —          —          —          (450

Cash dividends declared on common stock

     —          —          —          (1,253     —          (1,253
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2011

     15,583      $ 127,780      $ (116   $ 76,681      $ 1,770      $ 206,115   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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

Comprehensive Income

   2011      2010      2011     2010  

Net income

   $ 1,836       $ 2,042       $ 4,286      $ 3,593   

Change in fair value of securities available for sale, net of tax of $520, $131, $695 and $509

     400         244         1,294        945   

Reclassification adjustment of net gain from sale of available for sale securities included in income, net of tax of $0, $0, $8 and $0

     —           —           14        —     

Other-than-temporary impairment on securities held-to-maturity, net of tax of $0, $0, $(7) and $(6)

     —           —           (13     (12

Accretion of other-than-temporary impairment in securities held-to-maturity, net of tax of $18, $18, $53 and $93

     34         34         98        173   
  

 

 

    

 

 

    

 

 

   

 

 

 

Comprehensive income

   $ 2,270       $ 2,320       $ 5,679      $ 4,699   
  

 

 

    

 

 

    

 

 

   

 

 

 

See Notes to Condensed Consolidated Financial Statements.

 

6


Table of Contents

HERITAGE FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

For the nine months ended September 30, 2011 and 2010

(Dollars in thousands)

(Unaudited)

 

     Nine Months Ended
September 30,
 
     2011     2010  

Cash flows from operating activities:

    

Net income

   $ 4,286      $ 3,593   

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

    

Depreciation and amortization

     1,255        1,226   

Deferred loan fees, net of amortization

     249        (94

Provision for loan losses

     11,031        9,095   

Net change in accrued interest receivable, prepaid expenses and other assets, accrued expenses and other liabilities

     (2,470     (19

Recognition of compensation related to ESOP shares and share based payment

     681        383   

Stock option compensation expense

     122        159   

Tax provision realized from stock options exercised, share based payment and dividends on unallocated ESOP shares

     153        6   

Amortization of intangible assets

     333        115   

Deferred income tax

     94        20   

Gain on FDIC assisted bank acquisition, net

     —          (285

(Gain) loss on sale of investment securities

     (23     44   

Impairment loss on investment securities

     73        273   

Origination of loans held for sale

     (11,331     (11,402

Gain on sale of loans

     (244     (101

Proceeds from sale of loans

     11,417        11,201   

Valuation adjustment on other real estate owned

     595        —     

Loss (gain) on sale of other real estate owned

     75        (140

Loss (gain) on sale of premises and equipment

     1        (1
  

 

 

   

 

 

 

Net cash provided by operating activities

     16,297        14,073   
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Loans originated, net of principal payments

     (18,965     14,426   

Maturities of investment securities available for sale

     21,159        13,766   

Maturities of investment securities held to maturity

     1,805        1,711   

Purchase of investment securities available for sale

     (36,144     (8,852

Purchase of investment securities held to maturity

     (271     (2,296

Purchase of premises and equipment

     (2,414     (1,450

Proceeds from sales of other real estate owned

     2,866        1,931   

Proceeds from sales of premises and equipment

     —          445   

Proceeds from sales of securities available for sale

     412        1,105   

Net cash acquired in acquisition

     —          144,862   
  

 

 

   

 

 

 

Net cash (used in) provided by investing activities

     (31,552     165,648   
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Net increase (decrease) in deposits

     1,169        (116,002

Net increase in other borrowed funds

     —          2,188   

Preferred stock cash dividends paid

     —          (900

Common stock cash dividends paid

     (1,253     —     

Net (decrease) increase in securities sold under agreement to repurchase

     (257     5,247   

Proceeds from exercise of stock options

     —          202   

Tax provision realized from stock options exercised, share based payment and dividends on unallocated ESOP shares

     (153     (6

Repurchase of common stock

     (790     —     

Repurchase of common stock warrants

     (450     —     
  

 

 

   

 

 

 

Net cash used in financing activities

     (1,734     (109,271
  

 

 

   

 

 

 

Net (decrease) increase in cash and cash equivalents

     (16,989     70,450   
  

 

 

   

 

 

 

Cash and cash equivalents at beginning of period

     168,991        107,231   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 152,002      $ 177,681   
  

 

 

   

 

 

 

 

7


Table of Contents
     Nine Months Ended
September 30,
 
     2011      2010  

Supplemental disclosures of cash flow information:

     

Cash paid for interest

   $ 5,334       $ 6,363   

Cash paid for income taxes

     5,985         1,283   

Loans transferred to other real estate owned

   $ 3,096       $ 3,007   

Assets acquired (liabilities assumed) in acquisition:

     

Investment securities

   $ —         $ 33,660   

Loans covered by loss sharing

     —           142,974   

Loans not covered by loss sharing

     —           2,334   

Federal Home Loan Bank stock

     —           1,187   

Accrued interest receivable

     —           738   

FDIC indemnification asset

     —           16,084   

Core deposit intangible

     —           1,678   

Other assets

     —           1,237   

Deposits

     —           (343,894

Deferred tax liability

     —           (153

Other liabilities

     —           (422

See Notes to Condensed Consolidated Financial Statements.

 

8


Table of Contents

HERITAGE FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Three and Nine Months Ended September 30, 2011 and 2010

(Unaudited)

NOTE 1. Description of Business and Basis of Presentation

(a) Description of Business

Heritage Financial Corporation (the “Company”) is a bank holding company incorporated in the State of Washington in August 1997. The Company is primarily engaged in the business of planning, directing and coordinating the business activities of its wholly owned subsidiaries: Heritage Bank and Central Valley Bank (the “Banks”). The Banks are Washington-chartered commercial banks and their deposits are insured by the FDIC under the Deposit Insurance Fund (“DIF”). Heritage Bank conducts business from its main office in Olympia, Washington and its twenty-six branch offices located in western Washington and the greater Portland, Oregon area. Central Valley Bank conducts business from its main office in Toppenish, Washington and its five branch offices located in Yakima and Kittitas counties of Washington State.

The Company’s business consists primarily of lending and deposit relationships with small businesses and their owners in its market areas and attracting deposits from the general public. The Company also makes residential and commercial construction, income property, and consumer loans and originates for sale or investment purposes first mortgage loans on residential properties located in western and central Washington State and the greater Portland, Oregon area.

Effective July 30, 2010, Heritage Bank entered into a definitive agreement with the FDIC, pursuant to which Heritage Bank acquired certain assets and assumed certain liabilities of Cowlitz Bank, a Washington state-chartered commercial bank headquartered in Longview, Washington (the “Cowlitz Acquisition”). The Cowlitz Acquisition included nine branches of Cowlitz Bank, including its division Bay Bank, which became branches of Heritage Ban and it also included the Trust Services Division of Cowlitz Bank. Effective November 5, 2010, Heritage Bank entered into a definitive agreement with the FDIC, pursuant to which Heritage Bank acquired certain assets and assumed certain liabilities of Pierce Commercial Bank, a Washington state-chartered bank headquartered in Tacoma, Washington (the “Pierce Commercial Acquisition”). The Pierce Commercial Acquisition included one branch, which became a branch of Heritage Bank. The Cowlitz Acquisition and the Pierce Commercial Acquisition are collectively referred to as the “Cowlitz and Pierce Acquisitions.”

(b) Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with Generally Accepted Accounting Principles, or GAAP, for interim financial information, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information and footnotes required by U.S. Generally Accepted Accounting Principles for complete financial statements. These condensed consolidated financial statements should be read with our December 31, 2010 audited consolidated financial statements and its accompanying notes included in our Annual Report on Form 10-K (“2010 Form 10-K”). In our opinion, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2011 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011. In preparing the condensed consolidated financial statements, we are required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, and expenses. Actual results could differ from those estimates.

Certain prior year amounts have been reclassified to conform to the current year’s presentation.

(c) Significant Accounting Policies

The significant accounting policies used in preparation of our consolidated financial statements are disclosed in our 2010 Annual Form 10-K. There have not been any material changes in our significant accounting policies compared to those contained in our Form 10-K disclosure for the year ended December 31, 2010.

(d) Recently Issued Accounting Pronouncements

Financial Accounting Standards Board (“FASB”) Accounting Standards Updates (“ASU”) 2011-02, A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring, provides an update for factors to be considered when evaluating whether a restructuring constitutes a troubled debt restructuring. ASU 2011-02 provides that a creditor must separately conclude that both of the following exist: (1) the restructuring constitutes a concession; and (2) the debtor is experiencing financial difficulties. In addition, the amendments to Topic 310 clarify that a creditor is precluded from using the effective interest rate test in the debtor’s guidance on restructuring of payables (paragraph 470-60-55-10) when evaluating whether a restructuring constitutes a troubled debt restructuring. The amendments in this Update were effective for the first interim or annual period beginning on or after June 15, 2011 (third quarter of 2011), and was applied retrospectively to the beginning of the year. The Company’s adoption of this guidance changed its disclosures but did not have a significant impact on its consolidated financial statements. See Note 2 for the related disclosures.

 

9


Table of Contents

FASB ASU 2011-03, Reconsideration of Effective Control for Repurchase Agreements, was issued April 2011 addressing the accounting for repurchase agreements and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. The amendments remove from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, and (2) the collateral maintenance implementation guidance related to that criterion. The provisions of this Update are effective for the first interim or annual period beginning on or after December 15, 2011, and should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Management does not expect the adoption of the Update to have a material effect on the Company’s financial statements at the date of adoption.

FASB ASU 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs, was issued May 2011 as a result of the FASB and International Accounting Standards Board’s (IASB) goal to develop common requirements for measuring fair value and for disclosing information about fair value measurements in accordance with U.S. GAAP and International Financial Reporting Standards. The provisions of this Update are effective during the interim or annual periods beginning after December 15, 2011, and are to be applied prospectively. Management does not expect the adoption of the Update to have a material effect on the Company’s financial statements at the date of adoption.

FASB ASU 2011-05, Presentation of Comprehensive Income, was issued June 2011 requiring that all nonowner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. This Update also requires that reclassification adjustments for items that are reclassified from other comprehensive income to net income be presented on the face of the financial statements. The provisions of this Update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, and are to be applied retrospectively. Early adoption is permitted. In October 2011, the FASB announced they are considering deferring certain provisions in ASU 2011-05 related to presentation of reclassification adjustments from other comprehensive income to net income. Management does not expect the adoption of the Update to have a material effect on the Company’s financial statements at the date of adoption.

FASB ASU 2011-08, Goodwill and Other (Topic 350)—Testing Goodwill for Impairment, was issued September 2011 and allows an entity the option to make a qualitative evaluation about the likelihood of goodwill impairment to determine whether it should calculate the fair value of the reporting unit. ASU 2011-08 is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted. Management does not expect the adoption of the Update to have a material effect on the Company’s financial statements at the date of adoption.

NOTE 2. Loans Receivable

(a) Loan Origination/Risk Management

The Company originates loans in one of the four segments of the total loan portfolio: commercial business, real estate construction and land development, one-to-four family residential, and consumer. Within these segments are classes of loans to which management monitors and assesses credit risk in the loan portfolios. The Company has certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk. Management reviews and approves these policies and procedures on a regular basis. A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies, and nonperforming and potential problem loans. The Company also conducts external loan reviews and validates the credit risk assessment on a periodic basis. Results of these reviews are presented to management. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Company’s policies and procedures.

A discussion of the risk characteristics of each portfolio segments is as follows:

Commercial Business

There are three significant classes of loans in the commercial portfolio segment, including commercial and industrial loans, owner-occupied commercial real estate, and non-owner occupied commercial real estate. The owner and non-owner occupied commercial real estate are both considered commercial real estate loans. As each of the classes carries different risk characteristics, management will discuss them separately.

Commercial and industrial. Commercial and industrial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however,

 

10


Table of Contents

some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

Commercial real estate. The Company originates multifamily and commercial real estate loans within its primary market areas. These loans are subject to underwriting standards and processes similar to commercial and industrial loans, in addition to those of real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate involves more risk than other classes in that the lending typically involves higher loan principal amounts, and payments on loans secured by real estate properties are dependent on successful operation and management of the properties. Repayment of these loans may be more adversely affected by conditions in the real estate market or the economy.

One-to-Four Family Residential

The majority of the Company’s one-to four-family residential loans are secured by single-family residences located in its primary market areas. The Company’s underwriting standards require that single-family portfolio loans generally are owner-occupied and do not exceed 80% of the lower of appraised value at origination or cost of the underlying collateral. Terms typically range from 15 to 30 years. The Company generally sells most single-family loans in the secondary market. Management determines to what extent the Company will retain or sell these loans and other fixed rate mortgages in order to control the Bank’s interest rate sensitivity position, growth and liquidity.

Real Estate Construction and Land Development

The Company originates construction loans for one-to-four family residential and for five or more residential properties and commercial properties. The one-to-four family residential construction loans generally include construction of custom homes whereby the home buyer is the borrower. The Company also provides financing to builders for the construction of pre-sold homes and, in selected cases, to builders for the construction of speculative residential property. Substantially all construction loans are short-term in nature and priced with a variable rate of interest. Construction lending can involve a higher level of risk than other types of lending because funds are advanced partially based upon the value of the project, which is uncertain prior to the project’s completion. Because of the uncertainties inherent in estimating construction costs as well as the market value of a completed project and the effects of governmental regulation of real property, the Company’s estimates with regards to the total funds required to complete a project and the related loan-to-value ratio may vary from actual results. As a result, construction loans often involve the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project and the ability of the borrower to sell or lease the property or refinance the indebtedness. If the Company’s estimate of the value of a project at completion proves to be overstated, it may have inadequate security for repayment of the loan and may incur a loss. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.

Consumer

The Company originates consumer loans and lines of credit that are both secured and unsecured. The underwriting process is developed to ensure a qualifying primary and secondary source of repayment. Underwriting standards for home equity loans are heavily influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage of 80%, collection remedies, the number of such loans a borrower can have at one time and documentation requirements. To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed. The majority of the consumer loans are relatively small amounts spread across many individual borrowers which minimizes the credit risk. Additionally, trend reports are reviewed by management on a regular basis.

During the quarter ended June 30, 2011, certain loans were reclassified to better represent the class of loan based on the Bank’s methodology. Therefore, the December 31, 2010 loan balances have been re-classified since being reported in the Annual Report on Form 10-K.

 

11


Table of Contents

Originated loans receivable at September 30, 2011 and December 31, 2010 consisted of the following portfolio segments and classes:

 

     September 30, 2011     December 31, 2010  
     (In thousands)  

Commercial business:

    

Commercial and industrial

   $ 280,692      $ 233,875   

Owner-occupied commercial real estate

     162,088        159,445   

Non-owner occupied commercial real estate

     221,822        221,718   
  

 

 

   

 

 

 

Total commercial business

     664,602        615,038   

One-to-four family residential

     37,783        38,850   

Real estate construction and land development:

    

One-to-four family residential

     23,327        28,989   

Five or more family residential and commercial properties

     47,256        28,411   
  

 

 

   

 

 

 

Total real estate construction and land development

     70,583        57,400   

Consumer

     31,545        32,054   
  

 

 

   

 

 

 

Gross originated loans receivable

     804,513        743,342   

Deferred loan fees

     (1,572     (1,323
  

 

 

   

 

 

 

Total originated loans receivable

   $ 802,941      $ 742,019   
  

 

 

   

 

 

 

Loans acquired in a business acquisition are designated as “purchased” loans. Purchased loans subject to loss-sharing agreements with the FDIC are identified as “covered” loans. Loans purchased with evidence of credit deterioration since origination for which it is probable that all contractually required payments will not be collected are accounted for under FASB Accounting Standards Codification (“FASB ASC”) 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality, formerly AICPA SOP 03-3 Accounting for Certain Loans or Debt Securities Acquired in a Transfer. These loans are identified as “impaired” loans. Loans purchased that are not accounted for under FASB ASC 310-30 are accounted for under FASB ASC 310-20, Receivables—Nonrefundable fees and Other Costs, formerly Statement of Financial Accounting Standards (“SFAS”) 91 Nonrefundable fees and Other Costs. These loans are identified as “other” loans. Funds advanced on the covered loans subsequent to acquisition, identified as “subsequent advances,” are included in the purchased covered loan balances as these subsequent advances are covered under the loss-sharing agreements. These subsequent advances are not accounted for under FASB ASC 310-30. The total balance of subsequent advances on the purchased impaired covered loans was $11.2 million and $6.0 million as of September 30, 2011 and December 31, 2010, respectively.

The recorded investment of purchased covered loans receivable at September 30, 2011 and December 31, 2010 consisted of the following portfolio segments and classes:

 

     September 30, 2011     December 31, 2010  
     (In thousands)  

Commercial business:

    

Commercial and industrial

   $ 41,700      $ 47,046   

Owner-occupied commercial real estate

     39,261        45,219   

Non-owner occupied commercial real estate

     16,325        17,576   
  

 

 

   

 

 

 

Total commercial business

     97,286        109,841   

One-to-four family residential

     5,127        6,224   

Real estate construction and land development:

    

One-to-four family residential

     6,023        5,876   

Five or more family residential and commercial properties

     —          —     
  

 

 

   

 

 

 

Total real estate construction and land development

     6,023        5,876   

Consumer

     6,638        6,774   
  

 

 

   

 

 

 

Total purchased loans receivable

     115,074        128,715   

Allowance for loan losses

     (3,682     —     
  

 

 

   

 

 

 

Purchased loans receivable, net

   $ 111,392      $ 128,715   
  

 

 

   

 

 

 

The September 30, 2011 and December 31, 2010 gross recorded investment balance of impaired purchased covered loans accounted for under FASB ASC 310-30 was $82.8 million and $90.1 million, respectively. The gross recorded investment balance of other purchased covered loans was $32.2 million and $38.6 million at September 30, 2011 and December 31, 2010, respectively.

 

12


Table of Contents

The recorded investment of purchased non-covered loans receivable at September 30, 2011 and December 31, 2010 consisted of the following portfolio segments and classes:

 

     September 30, 2011     December 31, 2010  
     (In thousands)  

Commercial business:

    

Commercial and industrial

   $ 39,536      $ 58,938   

Owner-occupied commercial real estate

     16,997        18,877   

Non-owner occupied commercial real estate

     14,008        18,435   
  

 

 

   

 

 

 

Total commercial business

     70,541        96,250   

One-to-four family residential

     3,145        4,986   

Real estate construction and land development:

    

One-to-four family residential

     1,304        3,816   

Five or more family residential and commercial properties

     965       1,244   
  

 

 

   

 

 

 

Total real estate construction and land development

     2,269        5,060   

Consumer

     18,775        24,753   
  

 

 

   

 

 

 

Total purchased loans receivable

     94,730        131,049   

Allowance for loan losses

     (2,366     —     
  

 

 

   

 

 

 

Purchased loans receivable, net

   $ 92,364      $ 131,049   
  

 

 

   

 

 

 

The September 30, 2011 and December 31, 2010 gross recorded investment balance of impaired purchased non-covered loans accounted for under FASB ASC 310-30 was $59.2 million and $80.2 million, respectively. The recorded investment balance of other purchased non-covered loans was $35.5 million and $50.8 million at September 30, 2011 and December 31, 2010, respectively.

(b) Concentrations of Credit

Most of the Company’s lending activity occurs within the State of Washington, and to a lesser extent the State of Oregon. The primary market areas include Thurston, Pierce, King, Mason, Cowlitz and Clark counties in Washington and Multnomah County in Oregon, as well as other markets. The majority of the Company’s loan portfolio consists of commercial and industrial, non-owner occupied commercial real estate, and owner occupied commercial real estate. As of September 30, 2011 and December 31, 2010, there were no concentrations of loans related to any single industry in excess of 10% of total loans.

(c) Credit Quality Indicators

As part of the on-going monitoring of the credit quality of the Company’s loan portfolio, management tracks certain credit quality indicators including trends related to (i) the risk grade of the loans, (ii) the level of classified loans, (iii) net charge-offs, (iv) nonperforming loans, and (v) the general economic conditions of the United States of America, and specifically the states of Washington and Oregon. The Company utilizes a risk grading matrix to assign a risk grade to each of its loans. Loans are graded on a scale of 0 to 9, and a “W”. A description of the general characteristics of the nine risk grades is as follows:

 

   

Grades 0 to 5—These grades are considered “pass grade” with negligible to above average but acceptable risk. These borrowers generally have strong to acceptable capital levels and consistent earnings and debt service capacity. Loans with the higher grades within the “pass” category may include borrowers who are experiencing unusual operating difficulties, but have acceptable payment performance to date. Increased monitoring of financials and/or collateral may be appropriate. Overall, loans with this grade show no immediate loss exposure.

 

   

Grade “W”—This grade includes loans on management’s “watch list” and is intended to be utilized on a temporary basis for pass grade borrowers where a significant risk-modifying action is anticipated in the near term.

 

   

Grade 6—This grade is for “Other Assets Especially Mentioned” (OAEM) in accordance with regulatory guidelines, and is intended to highlight loans with elevated risks. Loans with this grade show signs of deteriorating profits and capital, and the borrower might not be strong enough to sustain a major setback. The borrower is typically higher than normally leveraged, and outside support might be modest and likely illiquid. The loan is at risk of further decline unless active measures are taken to correct the situation.

 

   

Grade 7—This grade includes “Substandard” loans, in accordance with regulatory guidelines, for which the loan has a high risk. The loan also has defined weaknesses which make payment default or principal exposure likely, but not yet certain. The borrower may have shown serious negative trends in financial ratios and performance. Such loans are apt to be dependent upon collateral liquidation, a secondary source of repayment or an event outside of the normal course of business. Loans with this grade can be accrual or nonaccrual status based on the Company’s accrual policy.

 

13


Table of Contents
   

Grade 8—This grade includes “Doubtful” loans in accordance with regulatory guidelines, and the Company has determined these loans to have excessive risk. Such loans are placed on nonaccrual status and may be dependent upon collateral having a value that is difficult to determine or upon some near-term event which lacks certainty. Additionally, these loans generally have a specific valuation allowance.

 

   

Grade 9—This grade includes “Loss” loans in accordance with regulatory guidelines. These loans are determined to have the highest risk of loss. Such loans are charged-off or charged-down when payment is acknowledged to be uncertain or when the timing or value of payments cannot be determined. “Loss” is not intended to imply that the loan or some portion of it will never be paid, nor does it in any way imply that there has been a forgiveness of debt.

Loan grades for all commercial loans are established at the origination of the loan. Non-commercial loans are not graded as a 0 to 9 at origination date as these loans are determined to be “pass graded” loans. These non-commercial loans may subsequently require a 0-9 risk grade if the credit department has evaluated the credit and determined it necessary to classify the loan. Loan grades are reviewed on a quarterly basis, or more frequently if necessary, by the credit department. Typically, an individual loan grade will not be changed from the prior period unless there is a specific indication of credit deterioration or improvement. Credit deterioration is evidenced by delinquency, direct communications with the borrower, or other borrower information that becomes public. Credit improvements are evidenced by known facts regarding the borrower or the collateral property.

The loan grades relate to the likelihood of losses in that the higher the grade, the greater the loss potential. Loans with a pass grade are believed to have some inherent losses in the portfolios, but at a lesser extent than the other loan grades. These pass graded loans might have a zero percent loss based on historical experience and current market trends. The OAEM loan grade is transitory in that the Company is waiting on additional information to determine the likelihood and extent of the potential loss. However, the likelihood of loss is greater than Watch grade because there has been measurable credit deterioration. Loans with a substandard grade are generally loans for which the Company has individually analyzed for potential impairment. For Doubtful and Loss graded loans, the Company is almost certain of the losses, and the unpaid principal balances are generally charged-off.

The following tables present the balance of the originated loans receivable by credit quality indicator as of September 30, 2011 and December 31, 2010.

 

     September 30, 2011  
     Pass      OAEM      Substandard      Doubtful      Total  
     (in thousands)  

Commercial business:

              

Commercial and industrial

   $ 247,827       $ 3,201       $ 29,225       $ 439       $ 280,692   

Owner-occupied commercial real estate

     157,091         2,081         2,916         —           162,088   

Non-owner occupied commercial real estate

     214,373         2,074         5,375         —           221,822   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial business

     619,291         7,356         37,516         439         664,602   

One-to-four family residential

     37,249         —           534         —           37,783   

Real estate construction and land development:

              

One-to-four family residential

     11,157         2,892         9,278         —           23,327   

Five or more family residential and commercial properties

     33,967         —           13,289         —           47,256   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total real estate construction and land development

     45,124         2,892         22,567         —           70,583   

Consumer

     31,312         —           134         99        31,545   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Gross originated loans

   $ 732,976       $ 10,248       $ 60,751       $ 538       $ 804,513   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 2010  
     Pass      OAEM      Substandard      Doubtful      Total  
     (in thousands)  

Commercial business:

              

Commercial and industrial

   $ 200,583       $ 2,615       $ 29,872       $ 805       $ 233,875   

Owner-occupied commercial real estate

     154,890         913         3,642         —           159,445   

Non-owner occupied commercial real estate

     206,177         12,991         2,550         —           221,718   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial business

     561,650         16,519         36,064         805         615,038   

One-to-four family residential

     38,000         —           848         2         38,850   

Real estate construction and land development:

              

One-to-four family residential

     9,948         2,317         16,724         —           28,989   

Five or more family residential and commercial properties

     18,901         793         8,717         —           28,411   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total real estate construction and land development

     28,849         3,110         25,441         —           57,400   

Consumer

     31,877         —           177         —           32,054   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Gross originated loans

   $ 660,376       $ 19,629       $ 62,530       $ 807       $ 743,342   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

14


Table of Contents

The tables above include impaired loan balances. Potential problem loans are those loans that are currently accruing interest and are not considered impaired, but which management is monitoring because the financial information of the borrower causes concern as to their ability to meet their loan repayment terms. Potential problem originated loans as of September 30, 2011 and December 31, 2010 were $39.0 million and $56.1 million, respectively. The balance of potential problem originated loans guaranteed by a governmental agency was $4.3 million and $5.9 million as of September 30, 2011 and December 31, 2010, respectively. This guarantee reduces the Company’s credit exposure.

The following tables present the recorded balance of the other purchased covered and non-covered loans receivable by credit quality indicator as of September 30, 2011 and December 31, 2010.

 

     September 30, 2011  
     Pass      OAEM      Substandard      Doubtful      Total  
     (in thousands)  

Commercial business:

              

Commercial and industrial

   $ 13,220       $ 120       $ 591       $ —         $ 13,931   

Owner-occupied commercial real estate

     30,943         —           589         —           31,532   

Non-owner occupied commercial real estate

     6,149         501         443         —           7,093   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial business

     50,312         621         1,623         —           52,556   

One-to-four family residential

     1,574         —           —           —           1,574   

Real estate construction and land development:

              

One-to-four family residential

     52         —           —           —           52   

Five or more family residential and commercial properties

     —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total real estate construction and land development

     52         —           —           —           52   

Consumer

     13,283         —           277        —           13,560   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Gross other purchased covered loans

   $ 65,221       $ 621       $ 1,900       $ —         $ 67,742   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 2010  
     Pass      OAEM      Substandard      Doubtful      Total  
     (in thousands)  

Commercial business:

              

Commercial and industrial

   $ 23,833       $ 261       $ 40       $ —         $ 24,134   

Owner-occupied commercial real estate

     34,365         —           398         —           34,763   

Non-owner occupied commercial real estate

     11,186         575         —           —           11,761   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial business

     69,384         836         438         —           70,658   

One-to-four family residential

     1,879         —           —           —           1,879   

Real estate construction and land development:

              

One-to-four family residential

     54         —           —           —           54   

Five or more family residential and commercial properties

     —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total real estate construction and land development

     54         —           —           —           54   

Consumer

     16,795         —           —           —           16,795   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Gross other purchased covered loans

   $ 88,112       $ 836       $ 438       $ —         $ 89,386   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

15


Table of Contents

Originated nonaccrual loans, segregated by segments and classes of loans, were as follows as of September 30, 2011 and December 31, 2010:

 

     September 30,
2011(1)
     December 31,
2010(1)
 
     (In thousands)  

Commercial business:

     

Commercial and industrial

   $ 7,682       $ 8,155   

Owner-occupied commercial real estate

     164         779   

Non-owner occupied commercial real estate

     1,423         1,907   
  

 

 

    

 

 

 

Total commercial business

     9,269         10,841   

One-to-four family residential

     1         —     

Real estate construction and land development:

     

One-to-four family residential

     5,618         10,226   

Five or more family residential and commercial properties

     10,674         5,416   
  

 

 

    

 

 

 

Total real estate construction and land development

     16,292         15,642   

Consumer

     211         —     
  

 

 

    

 

 

 

Gross originated loans

   $ 25,773       $ 26,483   
  

 

 

    

 

 

 

 

(1) $2.1 million and $3.2 million of nonaccrual originated loans were guaranteed by governmental agencies at September 30, 2011 and December 31, 2010, respectively.

There was a recorded investment balance of $277,000 and $86,000 related to nonaccrual consumer and commercial and industrial loans, respectively, recorded in the other purchased loan categories as of September 30, 2011. There were no nonaccrual loans recorded in the other purchased loan categories as of December 31, 2010.

The Company performs aging analysis of past due loans using the categories of 30-89 days past due and 90 or more days past due. This policy is consistent with regulatory reporting requirements. The balances of originated past due loans, segregated by segments and classes of loans, as of September 30, 2011 and December 31, 2010 are as follows.

 

     September 30, 2011  
     30-89 Days      90 Days or
Greater
     Total Past Due      Current      Total      > 90 Days and Still
Accruing
 
     (in thousands)         

Commercial business:

                 

Commercial and industrial

   $ 1,206       $ 6,091       $ 7,297       $ 273,395       $ 280,692       $ 900   

Owner-occupied commercial real estate

     —           399         399         161,689         162,088         235   

Non-owner occupied commercial real estate

     —           778         778         221,044         221,822         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial business

     1,206         7,268         8,474         656,128         664,602         1,135   

One-to-four family residential

     —           —           —           37,783         37,783         —     

Real estate construction and land development:

                 

One-to-four family residential

     184        5,619         5,803         17,524         23,327         —     

Five or more family residential and commercial properties

     —           10,296         10,296         36,960         47,256         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total real estate construction and land development

     184         15,915         16,099         54,484         70,583         —     

Consumer

     447         142         589         30,956         31,545         1  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Gross originated loans

   $ 1,837       $ 23,325       $ 25,162       $ 779,351       $ 804,513       $ 1,136   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

16


Table of Contents
     December 31, 2010  
     30-89 Days      90 Days or
Greater
     Total Past Due      Current      Total      > 90 days and still
accruing
 
     (in thousands)         

Commercial business:

                 

Commercial and industrial

   $ 2,585       $ 3,562       $ 6,147       $ 227,728       $ 233,875       $ 199   

Owner-occupied commercial real estate

     187         1,373         1,560         157,885         159,445         594   

Non-owner occupied commercial real estate

     3,396         1,201         4,597         217,121         221,718         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial business

     6,168         6,136         12,304         602,734         615,038         793   

One-to-four family residential

     624         47         671         38,179         38,850         47   

Real estate construction and land development:

                 

One-to-four family residential

     —           2,844         2,844         26,145         28,989         381  

Five or more family residential and commercial properties

     941         5,416         6,357         22,054         28,411         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total real estate construction and land development

     941         8,260         9,201         48,199         57,400         381   

Consumer

     42         —           42         32,012         32,054         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Gross originated loans

   $ 7,775       $ 14,443       $ 22,218       $ 721,124       $ 743,342       $ 1,221   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

17


Table of Contents

The balances of other purchased past due loans, segregated by segments and classes of loans, as of September 30, 2011 and December 31, 2010 are as follows:

 

     September 30, 2011  
     30-89 Days      90 Days or
Greater
     Total Past Due      Current      Total      > 90 Days and Still
Accruing
 
     (in thousands)         

Commercial business:

                 

Commercial and industrial

   $ 23       $ 86      $ 109       $ 13,822       $ 13,931       $ —     

Owner-occupied commercial real estate

     153         —           153         31,379         31,532         —     

Non-owner occupied commercial real estate

     443         —           443         6,650         7,093         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial business

     619         86        705         51,851         52,556         —     

One-to-four family residential

     —           39        39        1,535         1,574         —     

Real estate construction and land development:

                 

One-to-four family residential

     —           —           —           52         52         —     

Five or more family residential and commercial properties

     —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total real estate construction and land development

     —           —           —           52         52         —     

Consumer

     167         277        444         13,116         13,560         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Gross other purchased covered loans

   $ 786       $ 402      $ 1,188       $ 66,554       $ 67,742       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 2010  
     30-89 Days      90 Days or
Greater
     Total Past Due      Current      Total      > 90 days and still
accruing
 
     (in thousands)         

Commercial business:

                 

Commercial and industrial

   $ 774       $ —         $ 774       $ 23,360       $ 24,134       $ —     

Owner-occupied commercial real estate

     9,898         —           9,898         24,865         34,763         —     

Non-owner occupied commercial real estate

     —           —           —           11,761         11,761         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial business

     10,672         —           10,672         59,986         70,658         —     

One-to-four family residential

     103        —           103        1,776         1,879         —     

Real estate construction and land development:

                 

One-to-four family residential

     —           —           —           54         54         —     

Five or more family residential and commercial properties

     —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total real estate construction and land development

     —           —           —           54         54         —     

Consumer

     81         —           81         16,714         16,795         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Gross other purchased covered loans

   $ 10,856       $ —         $ 10,856       $ 78,530       $ 89,386       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

18


Table of Contents

Impaired originated loans (including restructured loans) at September 30, 2011 and December 31, 2010 are set forth in the following tables.

 

     September 30, 2011  
     Recorded
Investment With
No Specific
Valuation
Allowance
     Recorded
Investment With
Specific
Valuation
Allowance
     Total
Recorded
Investment
     Unpaid
Contractual
Principal
Balance
     Related
Specific
Valuation
Allowance
     Average
Recorded
Investment
 
     (in thousands)  

Commercial business:

                 

Commercial and industrial

   $ 4,731       $ 7,033       $ 11,764       $ 14,227       $ 1,688       $ 10,567   

Owner-occupied commercial real estate

     369         1,380         1,749         2,225         92         1,254   

Non-owner occupied commercial real estate

     1,798         —           1,798         3,533         —           1,814   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial business

     6,898         8,413         15,311         19,985         1,780         13,635   

One-to-four family residential

     1         837         838         1,045         182         419   

Real estate construction and land development:

                 

One-to-four family residential

     1,097         4,886         5,983         7,321         1,170         6,111   

Five or more family residential and commercial properties

     4,709        5,965         10,674         15,074         189         10,685   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total real estate construction and land development

     5,806         10,851         16,657         22,395         1,359         16,796   

Consumer

     76         135        211         460        135         158   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Gross originated loans

   $ 12,781       $ 20,236       $ 33,017       $ 43,885       $ 3,456       $ 31,008   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 2010  
     Recorded
Investment With
No Specific
Valuation
Allowance
     Recorded
Investment With
Specific
Valuation
Allowance
     Total
Recorded
Investment
     Unpaid
Contractual
Principal
Balance
     Related
Specific
Valuation
Allowance
     Average
Recorded
Investment
 
     (in thousands)  

Commercial business:

                 

Commercial and industrial

   $ 2,462       $ 5,691       $ 8,153       $ 9,261       $ 2,569       $ 8,909   

Owner-occupied commercial real estate

     129         650         779         822         163         771   

Non-owner occupied commercial real estate

     2,301         —           2,301         3,972         —           2,175   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial business

     4,892         6,341         11,233         14,055         2,732         11,855   

One-to-four family residential

     —           2         2         2         2         2   

Real estate construction and land development:

                 

One-to-four family residential

     1,804         8,423         10,227         10,183         1,664         11,228   

Five or more family residential and commercial properties

     —           5,416         5,416         6,453         201         5,697   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total real estate construction and land development

     1,804         13,839         15,643         16,636         1,865         16,925   

Consumer

     —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Gross originated loans

   $ 6,696       $ 20,182       $ 26,878       $ 30,693       $ 4,599       $ 28,782   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

For the three and nine months ended September 30, 2011 and September 30, 2010, no interest income was recognized subsequent to a loan’s classification as impaired. For the year ended December 31, 2010, $13,000 of interest income was recognized on impaired loans.

The Company had governmental guarantees of $2.7 million and $3.2 million related to the impaired originated loan balances at September 30, 2011 and December 31, 2010, respectively.

 

19


Table of Contents

(f) Troubled Debt Restructured Loans

A troubled debt restructured loan (“TDR”) is a restructuring in which the Banks, for economic or legal reasons related to a borrower’s financial difficulties, grant a concession to a borrower that it would not otherwise consider. The majority of the Banks’ TDRs are the result of granting extensions to troubled credits which have already been adversely classified. We grant such extensions to reassess the borrower’s financial status and develop a plan for repayment. The remainders of Banks’ TDRs are the result of converting revolving lines of credits to amortizing loans, reducing interest rates for a period of time or for the remainder of the loan, or changing amortizing loans to interest-only loans with balloon payments. These modifications would all be considered a concession for a borrower that could not obtain financing outside of the Banks. We do not forgive principal for a majority of our TDRs, but in those situations where principal is forgiven, the entire amount of such principal forgiveness is immediately charged off to the extent not done so prior to the modification. We sometimes delay the timing on the repayment of a portion of principal (principal forbearance) and charge off the amount of forbearance if that amount is not considered fully collectible. We also consider insignificant delays in payments when determining if a loan should be classified as a TDR.

TDRs are considered impaired and are separately measured for impairment under ASC 310-10-35, whether on accrual or nonaccrual status. At September 30, 2011 and December 31, 2010, the balance of accruing TDRs was $7.2 million and $394,000, respectively. The related allowance for loan losses on the accruing TDRs was $534,000 as of September 31, 2011 and no related allowance for loan losses as of December 31, 2010. At September 30, 2011, non-accruing TDRs were $12.7 million and had a related allowance for loan losses of $1.1 million. At December 31, 2010, non-accruing TDRs of $8.7 million had a related allowance for loan losses of $1.6 million.

A loan may have the TDR classification removed if a) the restructured interest rate was greater than or equal to the interest rate of a new loan with comparable risk at the time of the restructure, and b) the loan is no longer impaired based on the terms of the restructured agreement. The Bank’s policy is that the borrower must demonstrate six consecutive monthly payments in accordance with the modified loan before it can be reviewed for removal of TDR classification under the second criteria. However, the loan must be reported as a TDR in at least one annual Form 10-K.

Troubled debt restructured loans at September 30, 2011 and December 31, 2010 are set forth in the following table.

 

            As of September 30, 2011             As of December 31, 2010  
     Number of
Contracts
     Pre-Modification
Outstanding
Recorded
Investment
     Post-Modification
Outstanding
Recorded
Investment
     Number of
Contracts
     Pre-Modification
Outstanding
Recorded
Investment
     Post-Modification
Outstanding
Recorded
Investment
 
     (in thousands)         

Commercial business:

                 

Commercial and industrial

     21       $ 7,371       $ 7,371         2       $ 892       $ 892   

Owner-occupied commercial real estate

     2         1,585         1,585         —           —           —     

Non-owner occupied commercial real estate

     2         1,021         1,021         1         394         394   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial business

     25         9,977         9,977         3         1,286         1,286   

One-to-four family residential

     2         837         837         —           —           —     

Real estate construction and land development:

                 

One-to-four family residential

     7         4,353         4,353         7         7,763         7,763   

Five or more family residential and commercial properties

     2         4,813         4,813         —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total real estate construction and land development

     9         9,166         9,166         7         7,763         7,763   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Gross originated loans

     36       $ 19,980       $ 19,980         10       $ 9,049       $ 9,049   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The financial effects of each modification will vary based on the specific restructure. For the majority of the Banks’ TDRs, the loans were interest-only with a balloon payment at maturity. If the interest rate is not adjusted and the terms are consistent with market, the Banks might not experience any loss associated with the restructure. If, however, the restructure involves forbearance agreements or principal forgiveness, the Banks might not collect all the principal and interest based on the original contractual terms. The Banks estimate the necessary allowance for loan losses on TDRs using the same guidance as other impaired loans.

 

20


Table of Contents

The balance of troubled-debt restructured loans modified within the three and twelve months ended September 30, 2011 and September 30, 2010 that subsequently defaulted were as follows:

 

    

Twelve-months ended September 30,

2011

     Twelve-months ended September 30,
2010
 
     Number of
Contracts
     Recorded
Investment
     Number of
Contracts
     Recorded
Investment
 

Commercial and industrial

     2         582         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Gross originated loans

     2       $ 582         —         $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

The default on the previously restructured loans in the table above occurred due to additional extensions granted on the credits after they had been classified as TDR. The Banks typically grant shorter extension periods to continually monitor the troubled credits despite the fact that the extended date might not be the date we expect the cash flow.

As a result of adopting the amendments in ASU No. 2011-02, the Banks have reassessed all restructurings that occurred on or after January 1, 2011 for identification as troubled debt restructurings. For the three and nine months ended September 30, 2011, the total recorded investment of identified TDRs as a result of the reassessment was $8.8 million. The Banks identified as troubled debt restructurings certain loans for which the allowance for loan losses had previously been measured under a general allowance for loan losses methodology. Upon identifying those loans as troubled debt restructures, the Banks identified them as impaired under the guidance of ASC 310-10-35. The amendments in ASU No. 2011-02 require prospective application of the impairment measurement guidance in ASC 310-10-35 for those loans newly identified as impaired. At September 30, 2011, the recorded investment in loans for which the allowance for loan losses was previously measured under a general allowance for loan losses methodology and are now impaired under Section 301-10-35 was $7.1 million, and the allowance for loan losses for those loans, on the basis of a current evaluation of loss, was $534,000. At September 30, 2011, the recorded investment in loans for which the allowance for loan losses was previously measured under the guidance of ASC 310-10-35 and are now identified as troubled debt restructures was $1.7 million, and the allowance for loan losses for those loans was $42,000.

(g) Impaired Purchased Loans

As indicated above, the Company purchased impaired loans from the Cowlitz and Pierce Acquisitions which are accounted for under FASB ASC 310-30.

The following tables reflect the outstanding balance at September 30, 2011 and December 31, 2010 of the purchased impaired loans:

 

     Cowlitz Bank  
     September 30,
2011
     December 31,
2010
 
     (In thousands)  

Covered purchased loans:

     

Commercial business:

     

Commercial and industrial

   $ 40,399       $ 44,797   

Owner-occupied commercial real estate

     19,920         23,216   

Non-owner occupied commercial real estate

     16,765         22,063   
  

 

 

    

 

 

 

Total commercial business

     77,084         90,076   

One-to-four family residential

     4,305         5,122   

Real estate construction and land development:

     

One-to-four family residential

     10,332         10,913   

Five or more family residential and commercial properties

     —           —     
  

 

 

    

 

 

 

Total real estate construction and land development

     10,332         10,913   

Consumer

     4,271         4,839   
  

 

 

    

 

 

 

Gross impaired purchased covered loans

     95,992         110,950   

Non-covered purchased loans:

     

Consumer

     469         676   
  

 

 

    

 

 

 

Total impaired purchased loans

   $ 96,461       $ 111,626   
  

 

 

    

 

 

 

 

21


Table of Contents

The total balance of subsequent advances on the purchased impaired covered loans was $11.2 million and $6.0 million as of September 30, 2011 and December 31, 2010, respectively. The Bank has the option to modify certain purchased covered loans which may terminate the FDIC loss-share coverage on those modified loans. As of September 30, 2011 and December 31, 2010, the recorded investment balance of purchased covered loans which are no longer covered under the FDIC loss-sharing agreements was $3.2 million and $841,000, respectively. The Bank continues to report these loans in the covered portfolio as they are in a pool and they continue to be accounted for under ASC 310-30. The FDIC indemnification asset has been properly adjusted to reflect the change in the loan status.

 

22


Table of Contents
     Pierce Commercial Bank  
     September 30,
2011
     December 31,
2010
 
     (In thousands)  

Non-covered purchased loans:

     

Commercial business:

     

Commercial and industrial

   $ 38,247       $ 54,845   

Owner-occupied commercial real estate

     7,078         7,759   

Non-owner occupied commercial real estate

     8,668         8,927   
  

 

 

    

 

 

 

Total commercial business

     53,993         71,531   

One-to-four family residential

     3,367         5,178   

Real estate construction and land development:

     

One-to-four family residential

     7,644         11,925   

Five or more family residential and commercial properties

     3,802         4,333   
  

 

 

    

 

 

 

Total real estate construction and land development

     11,446         16,258   

Consumer

     9,334         11,506   
  

 

 

    

 

 

 

Gross impaired purchased non-covered loans

   $ 78,140       $ 104,473   
  

 

 

    

 

 

 

On the acquisition date, the amount by which the undiscounted expected cash flows of the purchased impaired loans exceed the estimate fair value of the loan is the “accretable yield”. The accretable yield is then measured at each financial reporting date and represents the difference between the remaining undiscounted expected cash flows and the current carrying value of the purchased impaired loan.

The following table summarizes the accretable yield on the Cowlitz Bank and Pierce Commercial Bank impaired purchased loans for the three and nine months ended September 30, 2011:

 

     Three Months Ended
September 30, 2011
    Nine Months Ended
September 30, 2011
 
     Cowlitz Bank     Pierce
Commercial
Bank
    Cowlitz Bank     Pierce
Commercial
Bank
 
           (in thousands)        

Balance at the beginning of period

   $ 22,222      $ 16,275      $ 20,082      $ 10,943   

Accretion

     (1,992     (1,828     (7,430     (4,684

Disposals and other

     (562     (1,138     494        514   

Change in accretable yield

     2,052        1,843        8,574        8,379   
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance at the end of period

   $ 21,720      $ 15,152      $ 21,720      $ 15,152   
  

 

 

   

 

 

   

 

 

   

 

 

 

NOTE 3. Allowance for Loan Losses

The allowance for loan losses is maintained at a level deemed appropriate by management to adequately provide for known and inherent risks in the loan portfolio. A summary of the changes in the originated loans’ allowance for loan losses for the three and nine months ended September 30, 2011 and September 30, 2010 are as follows:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2011     2010     2011     2010  
           (in thousands)        

Balance at the beginning of period

   $ 22,011      $ 26,268      $ 22,062      $ 26,164   

Loans charged off

     (43     (3,361     (5,589     (10,534

Recoveries of loans charged off

     24        102        929        479   

Provision charged to operations

     395        2,195        4,985        9,095   
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance at the end of period

   $ 22,387      $ 25,204      $ 22,387      $ 25,204   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

23


Table of Contents

A summary of the changes in the purchased loans’ allowance for loan losses for the three and nine months ended September 30, 2011 are as follows:

 

     Three Months Ended
September 30, 2011
     Nine Months Ended
September 30, 2011
 
     Purchased
Covered
    Purchased
Non-Covered
     Purchased
Covered
    Purchased
Non-Covered
 
           (in thousands)        

Balance at the beginning of period

   $ 2,516      $ 791       $ —        $ —     

Loans charged off

     (80     —           (80     —     

Provision charged to operations

     1,246        1,575         3,762        2,366   
  

 

 

   

 

 

    

 

 

   

 

 

 

Balance at the end of period

   $ 3,682      $ 2,366       $ 3,682      $ 2,366   
  

 

 

   

 

 

    

 

 

   

 

 

 

 

24


Table of Contents

The following table details activity in the allowance for loan losses disaggregated on the basis of the Company’s impairment method for the three and nine months ended September 30, 2011:

 

    Commercial
and
industrial
    Owner-
occupied
commercial
real estate
    Non-owner
occupied
commercial
real estate
    One-to-four
family
residential
    Real estate
construction
and land
development:
one-to-four
family
residential
    Real estate
construction
and land
development:
five or more
family
residential
and
commercial
real estate
    Consumer     Unallocated     Total  
    (in thousands)  

Allowance for loan losses for the three month ended September 30, 2011:

                 

Beginning balance

  $ 11,037      $ 2,693      $ 3,314      $ 547      $ 4,265      $ 1,696      $ 1,098      $ 668      $ 25,318   

Charge-offs

    (80     —          —          —          —          —          (43     —          (123

Recoveries

    16        —          —          —          —          —          8        —          24   

Provisions

    1,337        151        875        225        (245     438        336        99        3,216   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

    12,310        2,844        4,189        772        4,020        2,134        1,399        767        28,435   

Allowance for loan losses for the nine month ended September 30, 2011:

                 

Beginning balance

  $ 10,487      $ 1,674      $ 2,189      $ 500      $ 4,321      $ 1,114      $ 846      $ 931      $ 22,062   

Charge-offs

    (2,545     —          —          (15     (2,053     (895     (161     —          (5,669

Recoveries

    781        —          25       —          —          103       20        —          929   

Provisions

    3,587        1,170        1,975        287        1,752        1,812        694        (164     11,113   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

    12,310        2,844        4,189        772        4,020        2,134        1,399        767        28,435   

Period-end amount allocated to::

                 

Originated loans individually evaluated for impairment

    1,688        92        —          182        1,170        189        135        —          3,456   

Originated loans collectively evaluated for impairment

    7,926        1,697        3,207       366       2,306        1,945        717       767       18,931   

Purchased other covered loans collectively evaluated for impairment

    67        61        2        9       —          —          15       —          154   

Purchased other non-covered loans collectively evaluated for impairment

    121        75        53       6       —          —          11       —          266   

Purchased impaired covered loans collectively evaluated for impairment

    1,274        759        767        91        521        —          116        —          3,528   

Purchased impaired non-covered loans collectively evaluated for impairment

    1,234        160        160        118        23        —          405        —          2,100   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

  $ 12,310      $ 2,844      $ 4,189      $ 772      $ 4,020      $ 2,134      $ 1,399      $ 767      $ 28,435   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The purchased loans acquired in the Cowlitz and Pierce Acquisitions are subject to the Company’s internal and external credit review. If and when credit deterioration occurs subsequent to the acquisition dates, a provision for loan losses will be charged to earnings for the full amount without regard to the FDIC loss-sharing agreement for the covered loan balances. The portion of the estimated loss reimbursable from the FDIC is recorded in noninterest income and increases the FDIC indemnification asset.

 

25


Table of Contents

The following table details the recorded investment balance of the loan receivables disaggregated on the basis of the Company’s impairment method as of September 30, 2011:

 

     Commercial
and
industrial
     Owner-
occupied
commercial
real estate
     Non-owner
occupied
commercial
real estate
     One-to-four
family
residential
     Real estate
construction
and land
development:
one-to-four
family
residential
     Real estate
construction
and land
development:
five or more
family
residential
and
commercial
real estate
     Consumer      Total  
     (in thousands)  

Originated loans individually evaluated for impairment

   $ 11,764       $ 1,749       $ 1,798       $ 838       $ 5,983       $ 10,674       $ 211      $ 33,017   

Originated loans collectively evaluated for impairment

     268,928         160,339         220,024         36,945         17,344         36,582         31,334         771,496   

Other purchased covered loans collectively evaluated for impairment

     7,482         20,526         324         1,473         52         —           2,393         32,250   

Other purchased non-covered loans collectively evaluated for impairment

     6,449         11,006         6,769         101         —           —           11,167         35,492   

Impaired purchased covered loans collectively evaluated for impairment

     34,218         18,735         16,001         3,654         5,971         —           4,245         82,824   

Impaired purchased non-covered loans collectively evaluated for impairment

   $ 33,087       $ 5,991       $ 7,239       $ 3,044       $ 1,304       $ 965       $ 7,608       $ 59,238   

 

26


Table of Contents

The following table details the balance in the allowance for loan losses disaggregated on the basis of the Company’s impairment method for the year ended December 31, 2010:

 

     Commercial
and
industrial
     Owner-
occupied
commercial
real estate
     Non-owner
occupied
commercial
real estate
     One-to-four
family
residential
     Real estate
construction
and land
development:
one-to-four
family
residential
     Real estate
construction
and land
development:
five or more
family
residential
and
commercial
real estate
     Consumer      Unallocated      Total  
     (in thousands)  

Allowance for loan losses allocated to:

                          

Originated loans individually evaluated for impairment

   $ 2,569       $ 163       $ —         $ 2       $ 1,664       $ 201       $ —         $ —         $ 4,599   

Originated loans collectively evaluated for impairment

     7,918         1,511         2,189         498         2,657         913         846         931         17,463   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Balance of allowance for loan losses at December 31, 2010

   $ 10,487       $ 1,674       $ 2,189       $ 500       $ 4,321       $ 1,114       $ 846       $ 931       $ 22,062   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

There was no allowance for loan losses for purchased loans as of December 31, 2010.

 

27


Table of Contents

The following table details the recorded investment balance of the loan receivables disaggregated on the basis of the Company’s impairment method for the year ended December 31, 2010:

 

     Commercial
and
industrial
     Owner-
occupied
commercial
real estate
     Non-owner
occupied
commercial
real estate
     One-to-four
family
residential
     Real estate
construction
and land
development:
one-to-four
family
residential
     Real estate
construction
and land
development:
five or more
family
residential
and
commercial
real estate
     Consumer      Total  
     (in thousands)  

Originated loans individually evaluated for impairment

   $ 8,153       $ 779       $ 2,301       $ 2       $ 10,227       $ 5,416       $ —         $ 26,878   

Originated loans collectively evaluated for impairment—originated

     225,722         158,666         219,417         38,848         18,762         22,995         32,054         716,464   

Non-impaired purchased covered loans collectively evaluated for impairment

     11,304         22,856         331         1,475         54         —           2,565         38,585   

Non-impaired purchased non-covered loans collectively evaluated for impairment

     12,830         11,907         11,430         404         —           —           14,230         50,801   

Impaired purchased covered loans collectively evaluated for impairment

     35,742         22,363         17,245         4,749         5,822         —           4,209         90,130   

Impaired purchased non-covered loans collectively evaluated for impairment

   $ 46,108       $ 6,970       $ 7,005       $ 4,582       $ 3,816       $ 1,244       $ 10,523       $ 80,248   

NOTE 4. FDIC Indemnification Asset

Changes in the FDIC indemnification asset during the three and nine months ended September 30, 2011 are as follows:

 

     Three  months
ended

September 30, 2011
    Nine months
ended
September 30, 2011
 
     (in thousands)        

Beginning Balance

   $ 14,485      $ 16,071   

Cash payments received from the FDIC

     (740     (1,414

FDIC share of additional estimated losses

     (187     1,123   

Net amortization

     (1,479     (3,701
  

 

 

   

 

 

 

Balance at September 30, 2011

   $ 12,079      $ 12,079   
  

 

 

   

 

 

 

 

28


Table of Contents

NOTE 5. Stockholders’ Equity

(a) Earnings Per Common Share

The following table illustrates the reconciliation of weighted average shares used for earnings per common share computations for the noted periods:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2011     2010     2011     2010  
     (Dollars in thousands)  

Net income:

        

Net income

   $ 1,836      $ 2,042      $ 4,286      $ 3,593   

Dividends accrued and discount accreted on preferred shares

     —          (332     —          (995
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income applicable to common shareholders

     1,836        1,710        4,286        2,598   

Dividends and undistributed earnings allocated to participating securities

     8       —          13        —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings allocated to common shareholders

   $ 1,844      $ 1,710      $ 4,299      $ 2,598   

Basic:

        

Weighted average common shares outstanding

     15,633,792        11,125,007        15,627,573        11,098,640   

Less: Restricted stock awards

     (174,997     (110,463     (170,813     (89,204
  

 

 

   

 

 

   

 

 

   

 

 

 

Total basic weighted average common shares outstanding

     15,458,795        11,014,544        15,456,760        11,009,436   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted:

        

Basic weighted average common shares outstanding

     15,458,795        11,014,544        15,456,760        11,009,436   

Incremental shares from stock options, restricted stock awards and common stock warrant

     52,536       53,696       66,153       48,616   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average common shares outstanding

     15,511,331        11,068,240        15,522,913        11,058,052   
  

 

 

   

 

 

   

 

 

   

 

 

 

Potential dilutive shares are excluded from the computation of earnings per share if their effect is anti-dilutive. For the three and nine months ended September 30, 2011 anti-dilutive shares outstanding related to options and warrants to acquire common stock totaled 415,257 and 486,439, respectively, as the exercise price was in excess of the market value. For the three and nine months ended September 30, 2010 anti-dilutive shares outstanding related to options and warrants to acquire common stock totaled 589,166 and 559,689, respectively, as the exercise price was in excess of the market value.

(b) Dividends

Common Stock. The timing and amount of cash dividends paid on our common stock depends on the Company’s earnings, capital requirements, financial condition and other relevant factors. Dividends on common stock from the Company depend substantially upon receipt of dividends from the Banks, which are the Company’s predominant sources of income. On October 27, 2011, the Company’s Board of Directors declared a dividend of $0.05 per share payable on November 23, 2011, to shareholders of record on November 10, 2011.

The FDIC and the DFI have the authority under their supervisory powers to prohibit the payment of dividends by Heritage Bank and Central Valley Bank to the Company. Additionally, current guidance from the Federal Reserve provides, among other things, that dividends per share on the Company’s common stock generally should not exceed earnings per share, measured over the previous four fiscal quarters. Current regulations allow the Company and its subsidiary banks to pay dividends on their common stock if the Company’s or Banks’ regulatory capital would not be reduced below the statutory capital requirements set by the Federal Reserve and the FDIC.

(c) Preferred Stock and Warrants

On November 21, 2008, the Company completed a sale to the U.S. Department of the Treasury (“Treasury”) of 24,000 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, (“preferred shares”), for an aggregate purchase price of $24.0 million in cash, with a related warrant to purchase 276,074 shares of the Company’s common stock. On December 22, 2010, the Company redeemed the 24,000 preferred shares. The Company paid the Treasury a total of $24.1 million, consisting of $24.0 million of principal and $123,000 of accrued and unpaid dividends.

 

29


Table of Contents

Under the terms of the warrants, because the Company’s September 2009 offering of common stock, described below, was a “qualified equity offering” resulting in aggregate gross proceeds of at least $24.0 million, the number of shares of the Company’s common stock underlying the warrant was reduced by 50% to 138,037 shares. On August 17, 2011, the Company repurchased the warrant from the Treasury for $450,000. The warrant repurchase, together with the Company’s earlier redemption of the entire amount of Fixed Rate Cumulative Perpetual Preferred Stock, Series A, issued to the Treasury, represents full repayment of all TARP obligations and cancellation of all equity interests in the Company held by the Treasury.

NOTE 6. Share Based Payment

Total stock-based compensation expense (excluding ESOP expense) for the nine months ended September 30, 2011 and 2010 were as follows:

 

     Nine Months Ended
September 30,
 
     2011      2010  
     (In thousands)  

Compensation expense recognized

   $ 712       $ 440   

Related tax benefit recognized

     210         110   

As of September 30, 2011, the total unrecognized compensation expense related to non-vested stock awards was $1.4 million and the related weighted average period over which it is expected to be recognized is approximately 2.6 years.

The fair value of options granted during the nine months ended September 30, 2010 was estimated on the date of grant using the Black-Scholes option pricing model based on the assumptions noted in the following table (there were no options granted during the nine months ended September 30, 2011). The expected term of share options was derived from historical data and represents the period of time that share options granted are expected to be outstanding. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant. Expected volatility is based on historical volatility of Company shares. Expected dividend yield is based on dividends expected to be paid during the expected term of the share options.

 

Nine months ended

   Weighted
Average
Risk Free
Interest Rate
    Expected
Term in
Years
     Expected
Volatility
    Expected
Dividend
Yield
    Weighted
Average Fair
Value
 

September 30, 2010

     2.45     6.21         32     2.72   $ 3.84   

NOTE 7. Stock Option and Award Activity

The following table summarizes stock option activity for the nine months ended September 30, 2011.

 

     Shares     Weighted-
Average
Exercise
Price
     Weighted-
Average
Remaining
Contractual
Term
     Aggregate
Intrinsic
Value (In
thousands)
 

Outstanding at December 31, 2010

     550,524      $ 18.70         

Granted

     —          —           

Exercised

     (50     11.35         

Forfeited or expired

     (113,891     19.97         
  

 

 

   

 

 

       

Outstanding at September 30, 2011

     436,583      $ 18.37         3.6       $ —     
  

 

 

   

 

 

    

 

 

    

 

 

 

Exercisable at September 30, 2011

     331,114      $ 19.84         2.4       $ —     
  

 

 

   

 

 

    

 

 

    

 

 

 

The total intrinsic value of options exercised during the nine months ended September 30, 2011 was $0.

 

30


Table of Contents

The following table summarizes restricted stock award activity for the nine months ended September 30, 2011.

 

     Shares     Weighted-
Average
Grant
Date Fair
Value
 

Outstanding at December 31, 2010

     118,304      $ 18.28   

Granted

     80,723        14.79   

Vested

     (27,608     20.86   

Forfeited

     (3,317     15.14   
  

 

 

   

 

 

 

Outstanding at September 30, 2011

     168,102      $ 16.25   
  

 

 

   

 

 

 

 

31


Table of Contents

NOTE 8. Investment Securities

The amortized cost, gross unrealized gains and losses, and fair values of investment securities at the dates indicated were as follows:

 

Securities Available for Sale

   Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair
Value
 
     (In thousands)  

September 30, 2011

          

U.S. Treasury and U.S. Government agencies

   $ 36,083       $ 313       $ —        $ 36,396   

Municipal securities

     25,231         1,177         (3     26,405   

Corporate securities

     10,034         120         —          10,154   

Mortgage backed securities and collateralized mortgage obligations:

          

U.S. Government agencies

     67,067         1,866         (141     68,792   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 138,415       $ 3,476       $ (144   $ 141,747   
  

 

 

    

 

 

    

 

 

   

 

 

 

December 31, 2010

          

U.S. Treasury and U.S. Government agencies

   $ 41,124       $ 367       $ (62   $ 41,429   

Municipal securities

     20,237         169         (193     20,213   

Corporate securities

     10,097         182         (3     10,276   

Mortgage backed securities and collateralized mortgage obligations:

          

U.S. Government agencies

     52,394         1,034         (171     53,257   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 123,852       $ 1,752       $ (429   $ 125,175   
  

 

 

    

 

 

    

 

 

   

 

 

 

Securities Held to Maturity

   Amortized
Cost
     Gross
Unrealized
Gains