Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This report contains certain financial information determined by methods other than in accordance with GAAP. These measures include net interest income on a fully tax equivalent basis and net interest margin on a fully tax equivalent basis. Management uses these non-GAAP measures in its analysis of the Company’s performance. The tax equivalent adjustment to net interest income recognizes the income tax savings when comparing taxable and tax-exempt assets and assumes a 34% tax rate. Management believes that it is a standard practice in the banking industry to present net interest income and net interest margin on a fully tax equivalent basis, and accordingly believes that providing these measures may be useful for peer comparison purposes. These disclosures should not be viewed as substitutes for the results determined to be in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies.
Critical Accounting Policies
Critical accounting policies and estimates are discussed in our 2014 Form 10-K under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operation – Critical Accounting Policies.” That discussion highlights estimates the Company makes that involve uncertainty or potential for substantial change. There have not been any material changes in the Company’s critical accounting policies and estimates as compared to the disclosure contained in the Company’s 2014 Form 10-K.
Regulatory Developments and Significant Events
In January 2012, the Bank agreed to the Office of the Comptroller of the Currency (“OCC”) establishing higher minimum capital ratios for the Bank, specifically that the Bank maintain a Tier 1 capital (leverage) ratio of not less than 9.00% and a total risk-based capital ratio of not less than 12.00%. As of June 30, 2014, the Bank’s Tier 1 capital (leverage) ratio was 10.93% and its total risk-based capital ratio was 16.58%.
In October 2009, the Company entered into a Memorandum of Understanding (“MOU”) agreement with the Office of Thrift Supervision, at the time the Company’s primary regulator. In May 2013, the Company entered into a written agreement with the Federal Reserve which superseded the MOU. This written agreement requires the Company to: (a) provide notice to and obtain written approval from the Federal Reserve prior to the Company declaring a dividend or redeeming any capital stock or receiving dividends or other payments from the Bank; (b) provide notice to and obtain written approval from the Federal Reserve prior to the Company incurring, issuing, renewing or repurchasing any new debt; (c) provide notice to and obtain written approval from the Federal Reserve prior to the Company making payments on its Debentures; (d) submit a written statement of its planned sources and uses of cash for debt service, operating expenses, and other purposes (“Cash Flow Projection”) beginning for calendar year 2013 and submit progress reports related to its Cash Flow Projections and financial results.
The Company believes it is currently in compliance with all of the requirements of the written agreement with the Federal Reserve through its normal business operations. The written agreement will remain in effect until modified or terminated by the Federal Reserve.
Executive Overview
As a progressive, community-oriented financial services company, the Company emphasizes local, personal service to residents of its primary market area. The Company considers Clark, Cowlitz, Klickitat and Skamania counties of Washington and Multnomah and Marion counties of Oregon as its primary market area. The counties of Multnomah, Clark and Skamania are part of the Portland metropolitan area as defined by the U.S. Census Bureau. The Company is engaged predominantly in the business of attracting deposits from the general public and using such funds in its primary market area to originate commercial business, commercial real estate, multi-family real estate, real estate construction, residential real estate and other consumer loans. The Company’s strategy over the past several years has been to control balance sheet growth, including the targeted reduction of residential construction related loans, in order to improve its regulatory capital ratios. The Company’s loan portfolio totaled $534.7 million at June 30, 2014 compared to $520.9 million at March 31, 2014.
Most recently, the Company’s primary focus has been on increasing commercial business loans and owner occupied commercial real estate loans with a specific focus on medical professionals and the medical industry. The Company also purchased two separate pools of automobile loans during fiscal 2014 and one additional pool in the first fiscal quarter of 2015 totaling $8.7 million from another financial institution as a way to further diversify its loan portfolio and to earn a higher yield than earned on its cash or short-term investments. These indirect automobile loans were originated through a single dealership group located outside the Company’s primary market area. The collateral for these loans is comprised of a mix of used automobiles. These loans are purchased with servicing retained by the seller. The Company does not have any immediate plans to purchase additional pools of auto loans. At June 30, 2014, one of the purchased automobile loans totaling $27,000 was on non-accrual status.
Through the Bank’s subsidiary, RAMCorp, the trust and financial services company which is located in downtown Vancouver, Washington, RAMCorp provides full-service brokerage activities, trust and asset management services. The Bank’s Business and Professional Banking Division, with two lending offices in Vancouver and one in Portland, offers commercial and business banking services.
Vancouver is located in Clark County, Washington, which is just north of Portland, Oregon. Many businesses are located in the Vancouver area because of the favorable tax structure and lower energy costs in Washington as compared to Oregon. Companies located in the Vancouver area include Sharp Microelectronics, Hewlett Packard, Georgia Pacific, Underwriters Laboratory, Wafer Tech, Nautilus, Barrett Business Services, PeaceHealth and Fisher Investments, as well as several support industries. In addition to this industry base, the Columbia River Gorge Scenic Area is a source of tourism, which has helped to transform the area from its past dependence on the timber industry.
The Company’s strategic plan includes targeting the commercial banking customer base in its primary market area for loan originations and deposit growth, specifically small and medium size businesses, professionals and wealth building individuals. In pursuit of these goals, the Company will seek to increase the loan portfolio consistent with its strategic plan and asset/liability and regulatory capital objectives, which includes maintaining a significant amount of commercial and commercial real estate loans in its loan portfolio. Significant portions of our new loan originations carry adjustable rates, higher yields or shorter terms and higher credit risk than traditional fixed-rate mortgages.
At June 30, 2014, checking accounts totaled $236.0 million, or 34.4% of our total deposit mix, compared to $210.6 million or 31.9% a year ago. Our strategic plan also stresses increased emphasis on non-interest income, including increased fees for asset management through RAMCorp and deposit service charges. The strategic plan is designed to enhance earnings, reduce interest rate risk and provide a more complete range of financial services to customers and the local communities the Company serves. We believe we are well positioned to attract new customers and to increase our market share through our 18 branches, including ten in Clark County, three in the Portland metropolitan area and three lending centers, including our most recently opened full-service branch in Gresham, Oregon.
Economic conditions in the Company’s market areas have continued to improve from the recent recessionary downturn; however, the pace of recovery has been modest and uneven and ongoing stress in the economy will likely continue to be challenging going forward. According to the Washington State Employment Security Department, unemployment in Clark County decreased to 6.6% at May 31, 2014 compared to 8.2% at March 31, 2014 and 10.0% at June 30, 2013. According to the Oregon Employment Department, unemployment in Portland slightly increased to 6.3% at May 31, 2014 compared to 6.2% at March 31, 2014 and decreased compared to 6.9% at June 30, 2013. According to the Regional Multiple Listing Services (“RMLS”), residential home inventory levels in Portland, Oregon have slightly decreased to 2.8 months at June 30, 2014 compared to 3.1 months at March 31, 2014 and 2.9 months at June 30, 2013. Residential home inventory levels in Clark County have decreased to 3.9 months at June 30, 2014 compared to 4.6 months at March 31, 2014 and slightly increased compared to 3.7 months at June 30, 2013. According to the RMLS, closed home sales in Clark County increased 2.4% in June 2014 compared to June 2013. Closed home sales at June 2014 in Portland increased 4.2% compared to June 2013. Commercial real estate leasing activity in the Portland/Vancouver area has performed better than the residential real estate market; however, it is generally affected by a slow economy later than other indicators. According to Norris Beggs Simpson (a firm specializing in Pacific Northwest commercial real estate sales and management) commercial vacancy rates in Clark County, Washington and Portland, Oregon were approximately 11.32% and 14.62%, respectively, as of June 30, 2014 compared to 11.19% and 15.97%, respectively, at June 30, 2013. The Company has also seen an increase in sales activity for building lots during the past twelve months
Operating Strategy
The Company’s goal is to deliver returns to shareholders by managing problem assets, increasing higher-yielding assets (in particular commercial real estate and commercial business loans), increasing core deposit balances, reducing expenses, hiring experienced employees with a commercial lending focus and exploring expansion opportunities. The Company seeks to achieve these results by focusing on the following objectives:
Focusing on Asset Quality
. The Company is focused on monitoring existing performing loans, resolving nonperforming loans and selling foreclosed assets. The Company has aggressively sought to reduce its level of nonperforming assets through write-downs, collections, modifications and sales of nonperforming loans and real estate owned. The Company has taken proactive steps to resolve its nonperforming loans, including negotiating repayment plans, forbearances, loan modifications and loan extensions with borrowers when appropriate, and accepting short payoffs on delinquent loans, particularly when such payoffs result in a smaller loss than foreclosure. In connection with the downturn in real estate markets, the Company applied more conservative and stringent underwriting practices to new loans, including, among other things, increasing the amount of required collateral or equity requirements, reducing loan-to-value ratios and increasing debt service coverage ratios. The Company has continued to reduce its exposure to land development and speculative construction loans. The total land development and speculative construction loan portfolios declined to $19.3 million at June 30, 2014 compared to $19.9 million at March 31, 2014. Nonperforming assets decreased $2.8 million to $19.0 million
at June 30, 2014 compared to $21.8 million at March 31, 2014. However, there can be no assurance that the ongoing economic conditions affecting our borrowers will not result in future increases in nonperforming and classified loans.
Improving Earnings by Expanding Product Offerings
. The Company intends to prudently increase the percentage of its assets consisting of higher-yielding commercial real estate and commercial loans, which offer higher risk-adjusted returns, shorter maturities and more sensitivity to interest rate fluctuations, while maintaining compliance with its heightened regulatory capital requirements. The Company also intends to selectively add additional products to further diversify revenue sources and to capture more of each customer’s banking relationship by cross selling loan and deposit products and additional services to Bank customers, including services provided through RAMCorp to increase its fee income. Assets under management by RAMCorp totaled $374.9 million and $354.4 million at June 30, 2014 and 2013, respectively.
The Company continuously reviews new products and services to provide its customers more financial options. All new technology and services are generally reviewed for business development and cost saving purposes. The Bank has implemented remote check capture at all of its branches and for selected customers of the Bank. The Company continues to experience growth in customer use of its online banking services, which allows customers to conduct a full range of services on a real-time basis, including balance inquiries, transfers and electronic bill paying. The Company also upgraded its online banking product for consumer customers, providing consumer customers greater flexibility and convenience in conducting their online banking. The Company’s online service has also enhanced the delivery of cash management services to business customers. The Company introduced its mobile banking application during the second fiscal quarter of 2013 to further allow flexibility and convenience to its customers related to their banking needs. During June 2013, the Company also implemented a new core banking platform that will enable the Company to better serve its customer base. The Company also participates in an internet deposit listing service which allows the Company to post time deposit rates on an internet site where institutional investors have the ability to deposit funds with the Company. The Company does not currently have any internet based deposits during fiscal year 2015; however, the Company will continue to have accessibility to these funds in the future. Furthermore, the Company may utilize the internet deposit listing service to purchase certificates of deposit at other financial institutions. The Company also offers Insured Cash Sweep (ICS™), a reciprocal money market product, to its customers along with the Certificate of Deposit Account Registry Service (CDARS™) program which allows customers access to FDIC insurance on deposits exceeding the $250,000 FDIC insurance limit.
Attracting Core Deposits and Other Deposit Products
. The Company’s strategic focus is to emphasize total relationship banking with its customers to internally fund its loan growth. The Company has reduced its reliance on other wholesale funding sources, including FHLB and FRB advances, by focusing on the continued growth of core customer deposits. The Company believes that a continued focus on customer relationships will help to increase the level of core deposits and locally-based retail certificates of deposit. In addition to its retail branches, the Company maintains technology-based products, such as personal financial management, business cash management, and business remote deposit products, that enable it to compete effectively with banks of all sizes. Core branch deposits (comprised of all demand, savings, interest checking accounts and all time deposits but excludes wholesale-brokered deposits, trust account deposits, Interest on Lawyer Trust Accounts (“IOLTA”), public funds and Internet based deposits) decreased $380,000 during the quarter-ended June 30, 2014. The Company had no outstanding advances from the FHLB or the FRB at June 30, 2014.
Continued Expense Control
. Management has undertaken several initiatives to reduce non-interest expense and continues to make it a priority to identify cost savings opportunities throughout all aspects of the Company’s operations, including forming a cost saving committee whose mission is to find additional cost saving opportunities at the Company. The Company has instituted expense control measures such as cancelling certain projects and capital purchases, and reducing travel and entertainment expenditures. In July 2014, the Company announced its intention to close one of its branches as a result of its failure to meet the Company’s required growth and profitability standards. This was an in-store branch located in Portland Oregon. The Company expects minimal impact to its customers and deposit totals due to this branch’s proximity to its new Gresham, Oregon branch opened in the summer of 2012.
Recruiting and Retaining Highly Competent Personnel With a Focus on Commercial Lending
. The Company’s ability to continue to attract and retain banking professionals with strong community relationships and significant knowledge of its markets will be a key to its success. The Company believes that it enhances its market position and adds profitable growth opportunities by focusing on hiring and retaining experienced bankers focused on owner occupied commercial real estate and commercial lending, and the deposit balances that accompany these relationships. The Company emphasizes to its employees the importance of delivering exemplary customer service and seeking opportunities to build further relationships with its customers. The goal is to compete with other financial service providers by relying on the strength of the Company’s customer service and relationship banking approach. The Company believes that one of its strengths is that its employees are also significant shareholders through the Company’s employee stock ownership (“ESOP”) and 401(k) plans.
Disciplined Franchise Expansion
. The Company believes opportunities currently exist within its market area to grow its franchise. The Company anticipates organic growth as the local economy and loan demand strengthens, through its marketing efforts and as a result of the opportunities being created as a result of the consolidation of financial institutions occurring in its market area. The Company may also seek to expand its franchise through the selective acquisition of individual branches, loan purchases and whole bank transactions that meet its investment and market objectives. The Company expects to gradually expand its operations further in the Portland, Oregon metropolitan area which has a population of approximately two million people. The Company will continue to be disciplined as it pertains to future expansion focusing on the Pacific Northwest markets it knows and understands.
Loan Composition
The following table sets forth the composition of the Company’s commercial and construction loan portfolio based on loan purpose at the dates indicated (in thousands).
|
|
Commercial
Business
|
|
|
Other Real
Estate
Mortgage
|
|
|
Real Estate
Construction
|
|
|
Commercial &
Construction
Total
|
|
June 30, 2014
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial business
|
|
$
|
75,702
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
75,702
|
|
Commercial construction
|
|
|
-
|
|
|
|
-
|
|
|
|
14,272
|
|
|
|
14,272
|
|
Office buildings
|
|
|
-
|
|
|
|
80,944
|
|
|
|
-
|
|
|
|
80,944
|
|
Warehouse/industrial
|
|
|
-
|
|
|
|
45,578
|
|
|
|
-
|
|
|
|
45,578
|
|
Retail/shopping centers/strip malls
|
|
|
-
|
|
|
|
61,170
|
|
|
|
-
|
|
|
|
61,170
|
|
Assisted living facilities
|
|
|
-
|
|
|
|
7,556
|
|
|
|
-
|
|
|
|
7,556
|
|
Single purpose facilities
|
|
|
-
|
|
|
|
94,287
|
|
|
|
-
|
|
|
|
94,287
|
|
Land
|
|
|
-
|
|
|
|
15,251
|
|
|
|
-
|
|
|
|
15,251
|
|
Multi-family
|
|
|
-
|
|
|
|
22,501
|
|
|
|
-
|
|
|
|
22,501
|
|
One-to-four family construction
|
|
|
-
|
|
|
|
-
|
|
|
|
4,075
|
|
|
|
4,075
|
|
Total
|
|
$
|
75,702
|
|
|
$
|
327,287
|
|
|
$
|
18,347
|
|
|
$
|
421,336
|
|
March 31, 2014
|
|
Commercial
Business
|
|
|
Other Real
Estate
Mortgage
|
|
|
Real Estate
Construction
|
|
|
Commercial &
Construction
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial business
|
|
$
|
71,632
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
71,632
|
|
Commercial construction
|
|
|
-
|
|
|
|
-
|
|
|
|
15,618
|
|
|
|
15,618
|
|
Office buildings
|
|
|
-
|
|
|
|
77,476
|
|
|
|
-
|
|
|
|
77,476
|
|
Warehouse/industrial
|
|
|
-
|
|
|
|
45,632
|
|
|
|
-
|
|
|
|
45,632
|
|
Retail/shopping centers/strip malls
|
|
|
-
|
|
|
|
63,049
|
|
|
|
-
|
|
|
|
63,049
|
|
Assisted living facilities
|
|
|
-
|
|
|
|
7,585
|
|
|
|
-
|
|
|
|
7,585
|
|
Single purpose facilities
|
|
|
-
|
|
|
|
93,766
|
|
|
|
-
|
|
|
|
93,766
|
|
Land
|
|
|
-
|
|
|
|
16,245
|
|
|
|
-
|
|
|
|
16,245
|
|
Multi-family
|
|
|
-
|
|
|
|
21,128
|
|
|
|
-
|
|
|
|
21,128
|
|
One-to-four family construction
|
|
|
-
|
|
|
|
-
|
|
|
|
3,864
|
|
|
|
3,864
|
|
Total
|
|
$
|
71,632
|
|
|
$
|
324,881
|
|
|
$
|
19,482
|
|
|
$
|
415,995
|
|
Comparison of Financial Condition at June 30, 2014 and March 31, 2014
Cash, including interest-earning accounts, totaled $41.6 million at June 30, 2014 compared to $68.6 million at March 31, 2014. The Company made the decision to invest a portion of its excess cash balances into investment and mortgage-backed securities to earn higher yields than cash held in interest-earning accounts based on its asset/liability program objectives in order to maximize earnings. As a part of the Company’s liquidity strategy, the Company also invests a portion of its excess cash in short-term certificates of deposit. All of the certificates of deposit held for investment are fully insured by the FDIC. At June 30, 2014, certificates of deposits held for investment totaled $34.4 million compared to $36.9 million at March 31, 2014.
Investment securities available for sale totaled $21.5 million and $23.4 million at June 30, 2014 and at March 31, 2014, respectively. The Company primarily purchases agency securities with maturities of five years or less. For the quarter ended June 30, 2014, the Company determined that none of its investment securities required an OTTI charge. For additional information, see Note 11 of the Notes to Consolidated Financial Statements contained in Item 1 of this Form 10-Q.
Mortgage-backed securities available-for-sale totaled $98.4 million at June 30, 2014, compared to $78.6 million at March 31, 2014. The increase was due to a decision by the Company to invest additional excess cash into higher yielding mortgage-backed securities. The Company primarily purchases a combination of mortgage-backed securities backed by government agencies (FHLMC, FNMA, SBA or GNMA). The Company does not believe that it has any exposure to sub-prime mortgage backed securities.
Loans receivable, net, totaled $534.7 million at June 30, 2014, compared to $520.9 million at March 31, 2014. The increase in loans included $6.1 million in net organic loan growth as well as a $7.7 million net increase in purchased automobile loan pools. The Company does not have any immediate plans to purchase additional pools of automobile loans. The Company has seen an increase in loan demand in its market areas and anticipates organic loan growth will increase during fiscal year 2015. A substantial portion of the loan portfolio is secured by real estate, either as primary or secondary collateral, located in the Company’s primary market areas. Risks associated with loans secured by real estate include decreasing land and property values, increases in interest rates, deterioration in local economic conditions, tightening credit or refinancing markets, and a concentration of loans within any one area. The Company has no option adjustable-rate mortgage (ARM), or teaser residential real estate loans in its portfolio.
Deposit accounts decreased $3.4 million to $686.6 million at June 30, 2014, compared to $690.1 million at March 31, 2014. The Company had no wholesale-brokered deposits as of June 30, 2014 or March 31, 2014. Core branch deposits accounted for 96.1% of total deposits at June 30, 2014, compared to 95.7% at March 31, 2014. The Company plans to continue its focus on core deposits and on building customer relationships as opposed to obtaining deposits through the wholesale markets.
Shareholders’ Equity and Capital Resources
Shareholders' equity increased $1.4 million to $99.4 million at June 30, 2014 from $98.0 million at March 31, 2014. The increase was mainly attributable to net income of $740,000 and other comprehensive income related to unrealized holding gain on securities available for sale of $599,000 for the three months ended June 30, 2014.
The Bank is subject to various regulatory capital requirements administered by the OCC.
Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on
the Bank’s
financial statements. As of June 30, 2014, the Bank was “well capitalized” as defined under the regulatory framework for prompt corrective action. To be categorized as “well capitalized,” the Bank must maintain the minimum capital ratios set forth in the table below.
The Bank’s actual and required minimum capital amounts and ratios are as follows (dollars in thousands):
|
|
Actual
|
|
|
“Adequately Capitalized”
|
|
|
“Well Capitalized”
|
|
|
|
Amount
|
|
Ratio
|
|
|
Amount
|
|
Ratio
|
|
|
Amount
|
|
Ratio
|
|
June 30, 2014
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Capital:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(To Risk-Weighted Assets)
|
$
|
92,771
|
|
16.58
|
%
|
$
|
44,770
|
|
8.0
|
%
|
$
|
67,155
|
|
12.0
|
%
(1)
|
Tier 1 Capital:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(To Risk-Weighted Assets)
|
|
85,707
|
|
15.31
|
|
|
22,385
|
|
4.0
|
|
|
33,578
|
|
6.0
|
|
Tier 1 Capital (Leverage):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(To Adjusted Tangible Assets)
|
|
85,707
|
|
10.93
|
|
|
31,362
|
|
4.0
|
|
|
70,565
|
|
9.0
|
(1)
|
Tangible Capital:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(To Tangible Assets)
|
|
85,707
|
|
10.93
|
|
|
11,761
|
|
1.5
|
|
|
N/A
|
|
N/A
|
|
March 31, 2014
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Capital:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(To Risk-Weighted Assets)
|
$
|
90,733
|
|
16.66
|
%
|
$
|
43,572
|
|
8.0
|
%
|
$
|
65,359
|
|
12.0
|
%
(1)
|
Tier 1 Capital:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(To Risk-Weighted Assets)
|
|
83,850
|
|
15.40
|
|
|
21,786
|
|
4.0
|
|
|
32,679
|
|
6.0
|
|
Tier 1 Capital (Leverage):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(To Adjusted Tangible Assets)
|
|
83,850
|
|
10.71
|
|
|
31,320
|
|
4.0
|
|
|
70,469
|
|
9.0
|
(1)
|
Tangible Capital:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(To Tangible Assets)
|
|
83,850
|
|
10.71
|
|
|
11,745
|
|
1.5
|
|
|
N/A
|
|
N/A
|
|
|
(1)
The Bank agreed with the OCC to establish higher minimum capital ratios and to maintain a Tier 1 capital (leverage) ratio of not less than 9.0% and a total risked-based capital ratio of not less than 12.0% in order to be deemed “well capitalized”.
|
Liquidity
Liquidity is essential to our business. The objective of the Bank’s liquidity management is to maintain ample cash flows to meet obligations for depositor withdrawals, to fund the borrowing needs of loan customers, and to fund ongoing operations. Core relationship deposits are the primary source of the Bank’s liquidity. As such, the Bank focuses on deposit relationships with local consumer and business clients who maintain multiple accounts and services at the Bank.
In response to the recent adverse economic conditions, the Company has been, and will continue to work toward reducing the amount of nonperforming assets, managing balance sheet growth, reducing controllable operating costs, and augmenting deposits while striving to maximize secured borrowing facilities to manage liquidity and capital levels over the coming fiscal year. However, the Company’s inability to successfully implement its plans or further deterioration in economic conditions and real estate prices could have a material adverse effect on the Company’s liquidity.
Liquidity management is both a short- and long-term responsibility of the Company's management. The Company adjusts its investments in liquid assets based upon management's assessment of (i) expected loan demand, (ii) projected loan sales, (iii) expected deposit flows, (iv) yields available on interest-bearing deposits and (v) its asset/liability management program objectives. Excess liquidity is invested generally in interest-bearing overnight deposits and other short-term government and agency obligations. If the Company requires funds beyond its ability to generate them internally, it has additional diversified and reliable sources of funds with the FHLB, the FRB and other wholesale facilities. These sources of funds may be used on a long or short-term basis to compensate for reduction in other sources of funds or on a long-term basis to support lending activities. Beginning in the first quarter of fiscal 2011, the Company elected to defer regularly scheduled interest payments on its outstanding $22.7 million aggregate principal amount of junior subordinated debentures issued in connection with the sale of trust preferred securities through statutory business trusts. The Company continued with the interest deferral at June 30, 2014. As of June 30, 2014, the Company had deferred a total of $3.8 million of interest payments. The accrual for these payments is included in accrued expenses and other liabilities on the Consolidated Balance Sheets and interest expense on the Consolidated Statements of Income. This deferral may adversely affect our ability to access wholesale funding facilities or obtain debt financing on commercially reasonable terms, or at all.
The Company's primary sources of funds are customer deposits, proceeds from principal and interest payments on loans, proceeds from the sale of loans, maturing securities, FHLB advances and FRB borrowings. While maturities and scheduled amortization of loans and securities are a predictable source of funds, deposit flows and prepayment of mortgage loans and mortgage-backed securities are greatly influenced by general interest rates, economic conditions and competition. Management believes that its focus on core relationship deposits coupled with access to borrowing through reliable counterparties provides reasonable and prudent assurance that ample liquidity is available. However, depositor or counterparty behavior could change in response to competition, economic or market situations or other unforeseen circumstances, which could have liquidity implications that may require different strategic or operational actions.
The Company must maintain an adequate level of liquidity to ensure the availability of sufficient funds for loan originations, deposit withdrawals and continuing operations, satisfy other financial commitments and take advantage of investment opportunities. During the three months ended June 30, 2014, the Company used its sources of funds primarily to fund loan commitments, purchase investment securities and to fund deposit withdrawals. At June 30, 2014, cash and available for sale investments totaled $196.0 million, or 23.8% of total assets. The Bank generally maintains sufficient cash and short-term investments to meet short-term liquidity needs; however, its primary liquidity management practice is to increase or decrease short-term borrowings, including FRB borrowings and FHLB advances. At June 30, 2014, the Company had no advances from the FRB and a borrowing capacity of $54.4 million from the FRB. At June 30, 2014, there were no borrowings from the FHLB of Seattle and the Company had an available credit facility of $173.8 million. At June 30, 2014, the Company had sufficient unpledged collateral to allow it to utilize its available borrowing capacity from the FRB and the FHLB. Borrowing capacity may, however, fluctuate based on acceptability and risk rating of loan collateral and counterparties could adjust discount rates applied to such collateral at their discretion.
An additional source of wholesale funding includes brokered certificate of deposits. While the Company has utilized brokered deposits from time to time, the Company historically has not relied on brokered deposits to fund its operations. At June 30, 2014, the Company had no wholesale-brokered deposits. The Company also participates in the CDARS and ICS deposit products, which allows the Company to accept deposits in excess of the FDIC insurance limit for that depositor and obtain “pass-through” insurance for the total deposit. The Bank’s CDARS and ICS balances were $35.9 million, or 5.2% of total deposits, and $38.3 million, or 5.6% of total deposits, at June 30, 2014 and March 31, 2014, respectively. Although the FDIC permanently raised the insurance limit to $250,000, demand for CDARS deposits remains strong with continued renewals of existing CDARS deposits and the opening of new accounts. In addition, the Bank is enrolled in an internet deposit listing service. Under this listing service, the Bank may post time deposit rates on an internet site where institutional investors have the ability to deposit funds with the Bank. The Company does not currently have any internet based deposits; however, the Company will continue to have accessibility to these funds in the future. The combination of all the Company’s funding sources, gives the Company available liquidity of $512.9 million, or 62.2% of total assets at June 30, 2014.
The Bank's deposits are insured up to applicable limits by the Deposit Insurance Fund of the FDIC. The Dodd-Frank Act permanently increased the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor. The Dodd-Frank Act also broadens the base for FDIC insurance assessments. Assessments are now based on the average consolidated total assets less tangible equity capital of a financial institution.
At June 30, 2014, the Company had total commitments of $96.6 million, which includes commitments to extend credit of $14.3 million, unused lines of credit and undisbursed balances of $81.4 million and standby letters of credit totaling $791,000. The Company anticipates that it will have sufficient funds available to meet current loan commitments. Certificates of deposits that are scheduled to mature in less than one year totaled $105.7 million. Historically, the Company has been able to retain a significant amount of its deposits as they mature. Offsetting these cash outflows are scheduled loan maturities of less than one year totaling $72.8 million.
Sources of capital and liquidity for the Company include distributions from the Bank and the issuance of debt or equity securities. Dividends and other capital distributions from the Bank are subject to regulatory restrictions and approval. The Company elected to defer regularly scheduled interest payments on its junior subordinated debentures during the first quarter of fiscal 2011, which in turn, restricts the Company’s ability to pay dividends on its common stock.
Asset Quality
Nonperforming assets, consisting of nonperforming loans and REO, totaled $19.0 million or 2.30% of total assets at June 30, 2014 compared to $21.8 million or 2.64% of total assets at March 31, 2014.
The following table sets forth information regarding the Company’s nonperforming loans (dollars in thousands).
|
June 30, 2014
|
|
|
March 31, 2014
|
|
|
Number
of Loans
|
|
|
Balance
|
|
|
|
Number
of Loans
|
|
|
Balance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial business
|
|
2
|
|
$
|
187
|
|
|
|
4
|
|
$
|
452
|
Commercial real estate
|
|
6
|
|
|
7,038
|
|
|
|
8
|
|
|
8,067
|
Land
|
|
1
|
|
|
800
|
|
|
|
1
|
|
|
800
|
Multi-family
|
|
2
|
|
|
2,345
|
|
|
|
1
|
|
|
2,014
|
Consumer
|
|
9
|
|
|
2,682
|
|
|
|
9
|
|
|
2,729
|
Total
|
|
20
|
|
$
|
13,052
|
|
|
|
23
|
|
$
|
14,062
|
The Company has continued to focus on managing the residential construction and land acquisition and development portfolios. At June 30, 2014, the Company’s residential construction and land acquisition and development loan portfolios were $4.1 million and $15.3 million, respectively as compared to $3.9 million and $19.2 million at June 30, 2013. The percentage of nonperforming loans in the residential construction and land acquisition and development portfolios at June 30, 2014 was 0.00% and 5.25%, respectively as compared to 4.30% and 7.63%, respectively, a year ago. For the three months ended June 30, 2014, there were no charge-offs or recoveries in the residential construction portfolio. Net recoveries in the land development portfolio totaled $62,000 for the three months ended June 30, 2014.
REO totaled $5.9 million at June 30, 2014 compared to $7.7 million at March 31, 2014. During the quarter, REO sales totaled $1.3 million, valuation write-downs totaled $513,000 and transfers to REO totaled $52,000. The $5.9 million balance of REO is comprised of single-family homes totaling $635,000, residential building lots totaling $878,000, land development property totaling $3.5 million and commercial real estate property totaling $914,000. All of these properties are located in Washington and Oregon.
The allowance for loan losses was $12.3 million or 2.25% of total loans at June 30, 2014 compared to $12.6 million or 2.35% of total loans at March 31, 2014. The decrease in the balance of the allowance for loan losses at June 30, 2014 reflects the continuing trend of lower levels of delinquent and classified loans, decreased charge-offs and increased recoveries, as well as stabilizing real estate values which began in fiscal 2014, which resulted in the Company recording a recapture of loan losses of $300,000 for the three months ended June 30, 2014.
The coverage ratio of allowance for loan losses to nonperforming loans was 94.09% at June 30, 2014 compared to 89.25% at March 31, 2014. At June 30, 2014, the Company identified $12.5 million, or 96.14% of its nonperforming loans, as impaired and performed a specific valuation analysis on each loan resulting in no specific reserves being required for these impaired loans. Management considers the allowance for loan losses to be adequate at June 30, 2014 to cover probable losses inherent in the loan portfolio based on the assessment of various factors affecting the loan portfolio and the Company believes it has established its existing allowance for loan losses in accordance with GAAP. However, a further decline in local economic conditions, results of examinations by the Company’s regulators, or other factors could result in a material increase in the allowance for loan losses and may adversely affect the Company’s financial condition and results of operations. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses will be adequate or that substantial increases will not be necessary should the quality of any loans deteriorate or should collateral values further decline as a result of the factors discussed elsewhere in this document. For further information regarding the Company’s impaired loans and allowance for loan losses, see Note 8 of the Notes to Consolidated Financial Statements contained in Item 1 of this Form 10-Q.
Troubled debt restructurings (“TDRs”) are loans where the Company, for economic or legal reasons related to the borrower's financial condition, has granted a concession to the borrower that it would otherwise not consider. A TDR typically involves a modification of terms such as a reduction of the stated interest rate or face amount of the loan, a reduction of accrued interest, or an extension of the maturity date(s) at a stated interest rate lower than the current market rate for a new loan with similar risk.
TDRs are considered impaired loans and as such, when a loan is deemed to be impaired, the amount of the impairment is measured using discounted cash flows using the original note rate, except when the loan is collateral dependent. In these cases, the estimated fair value of the collateral and when applicable, less selling costs, are used. Impairment is recognized
as a specific component within the allowance for loan losses if the value of the impaired loan is less than the recorded investment in the loan. When the amount of the impairment represents a confirmed loss, it is charged off against the allowance for loan losses. At June 30, 2014, the Company had TDRs totaling $22.4 million of which $13.0 million were on accrual status. However, all of the Company’s TDRs are paying as agreed except for two of the Company’s TDRs that defaulted since the loan was modified. The related amount of interest income recognized on these TDRs was $142,000 and $123,000 for the three months ended June 30, 2014 and 2013, respectively.
The Company has determined that, in certain circumstances, it is appropriate to split a loan into multiple notes. This typically includes a nonperforming charged-off loan that is not supported by the cash flow of the relationship and a performing loan that is supported by the cash flow. These may also be split into multiple notes to align portions of the loan balance with the various sources of repayment when more than one exists. Generally the new loans are restructured based on customary underwriting standards. In situations where they were not, the policy exception qualifies as a concession, and the borrower is experiencing financial difficulties, the loans are accounted for as TDRs.
The Company’s general policy related to TDRs is to perform a credit evaluation of the borrower’s financial condition and prospects for repayment under the revised terms. This evaluation includes consideration of the borrower’s sustained historical repayment performance for a reasonable period of time. A sustained period of repayment performance generally would be a minimum of six months, and may include repayments made prior to the restructuring date. If repayment of principal and interest appears doubtful, it is placed on non-accrual status.
The following table sets forth information regarding the Company’s nonperforming assets.
|
|
June 30,
2014
|
|
|
March 31,
2014
|
|
|
|
(dollars in thousands)
|
|
Loans accounted for on a non-accrual basis:
|
|
|
|
|
|
|
Commercial business
|
$
|
187
|
|
$
|
452
|
|
Other real estate mortgage
|
|
10,183
|
|
|
10,881
|
|
Real estate one-to-four family
|
|
2,682
|
|
|
2,729
|
|
Total
|
|
13,052
|
|
|
14,062
|
|
Accruing loans which are contractually
past due 90 days or more
|
|
-
|
|
|
-
|
|
Total nonperforming loans
|
|
13,052
|
|
|
14,062
|
|
REO
|
|
5,926
|
|
|
7,703
|
|
Total nonperforming assets
|
$
|
18,978
|
|
$
|
21,765
|
|
|
|
|
|
|
|
|
Foregone interest on non-accrual loans
(1)
|
$
|
144
|
|
$
|
949
|
|
Total nonperforming loans to total loans
|
|
2.39
|
%
|
|
2.64
|
%
|
Total nonperforming loans to total assets
|
|
1.58
|
|
|
1.71
|
|
Total nonperforming assets to total assets
|
|
2.30
|
|
|
2.64
|
|
|
|
|
|
|
|
|
(1)
Three months ended June 30, 2014 and twelve months ended March 31, 2014
|
The composition of the Company’s nonperforming assets by loan type and geographical area is as follows:
|
|
Northwest
Oregon
|
|
|
Other
Oregon
|
|
|
Southwest
Washington
|
|
|
Other
Washington
|
|
|
Other
|
|
|
Total
|
June 30, 2014
|
(Dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial business
|
$
|
-
|
|
$
|
-
|
|
$
|
187
|
|
$
|
-
|
|
$
|
-
|
|
$
|
187
|
Commercial real estate
|
|
1,780
|
|
|
-
|
|
|
5,258
|
|
|
-
|
|
|
-
|
|
|
7,038
|
Land
|
|
-
|
|
|
800
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
800
|
Multi-family
|
|
1,988
|
|
|
-
|
|
|
357
|
|
|
-
|
|
|
-
|
|
|
2,345
|
Real estate one-to-four family
|
|
335
|
|
|
-
|
|
|
2,050
|
|
|
270
|
|
|
-
|
|
|
2,655
|
Other installment
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
27
|
|
|
27
|
Total nonperforming loans
|
|
4,103
|
|
|
800
|
|
|
7,852
|
|
|
270
|
|
|
27
|
|
|
13,052
|
REO
|
|
426
|
|
|
45
|
|
|
4,781
|
|
|
674
|
|
|
-
|
|
|
5,926
|
Total nonperforming assets
|
$
|
4,529
|
|
$
|
845
|
|
$
|
12,633
|
|
$
|
944
|
|
$
|
27
|
|
$
|
18,978
|
|
|
Northwest
Oregon
|
|
|
Other
Oregon
|
|
|
Southwest
Washington
|
|
|
Other
Washington
|
|
|
Other
|
|
|
Total
|
March 31, 2014
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial business
|
$
|
-
|
|
$
|
-
|
|
$
|
452
|
|
$
|
-
|
|
$
|
-
|
|
$
|
452
|
Commercial real estate
|
|
2,194
|
|
|
-
|
|
|
5,873
|
|
|
-
|
|
|
-
|
|
|
8,067
|
Multi-family
|
|
2,014
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
2,014
|
Land
|
|
-
|
|
|
800
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
800
|
Real estate one-to-four family
|
|
395
|
|
|
-
|
|
|
2,065
|
|
|
269
|
|
|
-
|
|
|
2,729
|
Total nonperforming loans
|
|
4,603
|
|
|
800
|
|
|
8,390
|
|
|
269
|
|
|
-
|
|
|
14,062
|
REO
|
$
|
374
|
|
$
|
542
|
|
$
|
5,966
|
|
$
|
821
|
|
|
-
|
|
|
7,703
|
Total nonperforming assets
|
$
|
4,977
|
|
$
|
1,342
|
|
$
|
14,356
|
|
$
|
1,090
|
|
$
|
-
|
|
$
|
21,765
|
The composition of the land development and speculative construction loan portfolios by geographical area is as follows:
|
|
Northwest
Oregon
|
|
|
Other
Oregon
|
|
|
Southwest
Washington
|
|
|
Other
|
|
|
Total
|
|
June 30, 2014
|
|
|
|
|
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Land development
|
$
|
1,963
|
|
$
|
1,176
|
|
$
|
12,112
|
|
$
|
-
|
|
$
|
15,251
|
|
Speculative construction
|
|
-
|
|
|
-
|
|
|
3,877
|
|
|
145
|
|
|
4,022
|
|
Total land development and speculative construction
|
$
|
1,963
|
|
$
|
1,176
|
|
$
|
15,989
|
|
$
|
145
|
|
$
|
19,273
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2014
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Land development
|
$
|
2,676
|
|
$
|
1,184
|
|
$
|
12,385
|
|
$
|
-
|
|
$
|
16,245
|
|
Speculative construction
|
|
-
|
|
|
-
|
|
|
3,617
|
|
|
30
|
|
|
3,647
|
|
Total land development and speculative construction
|
$
|
2,676
|
|
$
|
1,184
|
|
$
|
16,002
|
|
$
|
30
|
|
$
|
19,892
|
|
Other loans of concern consist of loans where the borrowers have cash flow problems, or the collateral securing the respective loans may be inadequate. In either or both of these situations, the borrowers may be unable to comply with the present loan repayment terms, and the loans may subsequently be included in the non-accrual category. Management considers the allowance for loan losses to be adequate to cover the probable losses inherent in these and other loans.
The following table sets forth information regarding the Company’s other loans of concern (dollars in thousands).
|
|
June 30, 2014
|
|
|
March 31, 2014
|
|
|
|
Number
of Loans
|
|
|
Balance
|
|
|
Number
of Loans
|
|
|
Balance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial business
|
|
|
11
|
|
|
$
|
996
|
|
|
|
15
|
|
|
$
|
7,967
|
|
Commercial real estate
|
|
|
11
|
|
|
|
11,772
|
|
|
|
11
|
|
|
|
11,771
|
|
Multi-family
|
|
|
1
|
|
|
|
13
|
|
|
|
1
|
|
|
|
14
|
|
Total
|
|
|
23
|
|
|
$
|
12,781
|
|
|
|
27
|
|
|
$
|
19,752
|
|
At June 30, 2014 and March 31, 2014, loans delinquent 30 - 89 days were 0.44% and 0.42%, respectively, of total loans. At June 30, 2014, the 30 - 89 days delinquency rate in the commercial business portfolio was 0.12% while the delinquency rate in the commercial real estate loan portfolio was 0.66%, comprised of two loans totaling $1.9 million. At that date, commercial real estate loans represented the largest portion of the loan portfolio at 52.93% of total loans and commercial business loans represented 13.84% of total loans. At June 30, 2014, the 30-89 days delinquency rate in the real estate one-to-four family loan portfolio was 0.35%.
Off-Balance Sheet Arrangements and Other Contractual Obligations
Through the normal course of operations, the Company enters into certain contractual obligations and other commitments. Obligations generally relate to funding of operations through deposits and borrowings as well as leases for premises. Commitments generally relate to lending operations.
The Company has obligations under long-term operating leases, principally for building space and land. Lease terms generally cover a five-year period, with options to extend, and are not subject to cancellation.
The Company has commitments to originate fixed and variable rate mortgage loans to customers. Because some commitments expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Undisbursed loan funds and unused lines of credit include funds not disbursed, but committed to construction projects and home equity and commercial lines of credit. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party.
For further information regarding the Company’s off-balance sheet arrangements and other contractual obligations, see Note 14 of the Notes to Consolidated Financial Statements contained in Item 1 of this Form 10-Q.
Goodwill Valuation
Goodwill is initially recorded when the purchase price paid for an acquisition exceeds the estimated fair value of the net identified tangible and intangible assets acquired. Goodwill is presumed to have an indefinite useful life and is tested, at least annually, for impairment at the reporting unit level. The Company has one reporting unit, the Bank, for purposes of computing goodwill. All of the Company’s goodwill has been allocated to this single reporting unit. The Company performs an annual review in the third quarter of each year, or more frequently if indications of potential impairment exist, to determine if the recorded goodwill is impaired. If the fair value exceeds the carrying value, goodwill at the reporting unit level is not considered impaired and no additional analysis is necessary. If the carrying value of the reporting unit is higher than its fair value, there is an indication that impairment may exist and additional analysis must be performed to measure the amount of impairment loss, if any. The amount of impairment is determined by comparing the implied fair value of the reporting unit’s goodwill to the carrying value of the goodwill in the same manner as if the reporting unit was being acquired in a business combination. Specifically, the Company would allocate the fair value to all of the assets and liabilities of the reporting unit, including unrecognized intangible assets, in a hypothetical analysis that would calculate the implied fair value of goodwill. If the implied fair value of goodwill is less than the recorded goodwill, the Company would record an impairment charge for the difference.
A significant amount of judgment is involved in determining if an indicator of impairment has occurred. Such indicators may include, among others: a significant decline in our expected future cash flows; a sustained, significant decline in our stock price and market capitalization; a significant adverse change in legal factors or in the business climate; adverse action or assessment by a regulator; and unanticipated competition. Any adverse change in these factors could have a significant impact on the recoverability of these assets and could have a material impact on the Company’s Consolidated Financial Statements.
The Company performed its annual goodwill impairment test as of October 31, 2013. An interim impairment test was not deemed necessary as of June 30, 2014, due to there not being a significant change in the reporting unit’s assets and liabilities, the amount that the fair value of the reporting unit exceeded the carrying value as of the most recent valuation, and because the Company determined that, based on an analysis of events that have occurred and circumstances that have changed since the most recent valuation date, the likelihood that a current fair value determination would be less than the current carrying amount of the reporting unit is remote.
The goodwill impairment test involves a two-step process. Step one of the goodwill impairment test estimates the fair value of the reporting unit utilizing the allocation of corporate value approach, the income approach and the market approach in order to derive an enterprise value of the Company. The allocation of corporate value approach applies the aggregate market value of the Company and divides it among the reporting units. A key assumption in this approach is the control premium applied to the aggregate market value. A control premium is utilized as the value of a company from the perspective of a controlling interest and is generally higher than the widely quoted market price per share. The Company used an expected control premium of 35%, which was based on comparable transactional history. The income approach uses a reporting unit’s projection of estimated operating results and cash flows that is discounted using a rate that reflects current market conditions. The projection uses management’s best estimates of economic and market conditions over the projected period including growth rates in loans and deposits, estimates of future expected changes in net interest margins and cash expenditures. Assumptions used by the Company in its discounted cash flow model (income approach) included an annual revenue growth rate that approximated 7.5%, a net interest margin that approximated 4.0% and a return on assets that ranged from 0.68% to 0.99% (average of 0.80%). In addition to utilizing the above projections of estimated operating results, key assumptions used to determine the fair value estimate under the income approach was the discount rate of 16.7% utilized for our cash flow estimates and a terminal value estimated at 1.49 times the ending book value of the reporting unit. The Company used a build-up approach in developing the discount rate that included an assessment of the risk free interest rate, the rate of return expected from publicly traded stocks, the industry the Company operates in and the size of the Company. The market approach estimates fair value by applying tangible book value multiples to the reporting unit’s operating performance. The multiples are derived from comparable publicly traded companies with similar operating and investment characteristics of the reporting unit. In applying the market approach method, the Company selected eight publicly traded comparable institutions based on a variety of financial metrics (tangible equity, leverage ratio, return on assets, return on equity, net interest margin, nonperforming assets, net charge-offs, and reserves for loan losses) and other relevant qualitative factors (geographical location, lines of business, business model, risk profile, availability of financial information, etc.). After selecting comparable institutions, the Company derived the fair value of the reporting unit by completing a comparative analysis of the relationship between their financial metrics listed above and their market values utilizing a market multiple of 1.22 times tangible book value. The Company calculated a fair value of its reporting unit of $91 million using the corporate value approach, $87 million using the income approach and $97 million using the market approach, with a final concluded value of $93 million, with primary weight given to the market approach. The results of the Company’s step one test indicated that the reporting unit’s fair value was less than its carrying value and therefore the Company performed a step two analysis.
The Company calculated the implied fair value of its reporting unit under step two of the goodwill impairment test. Under this approach, the Company calculated the fair value for its unrecognized deposit intangible, as well as the remaining assets and liabilities of the reporting unit. The calculated implied fair value of the Company’s goodwill exceeded the carrying value by $19.3 million. Significant adjustments were made to the fair value of the Company’s loans receivable compared to its recorded value. The Company utilized a discounted cash flow approach to determine the fair value of its loans receivable. A key assumption was determining an appropriate discount rate. In determining the discount rate, the Company started with its contractual cash flows and its current lending rate for comparable loans and adjusted these for both credit and liquidity premiums. Based on results of the step two impairment test, the Company determined no impairment charge of goodwill was required.
Even though the Company determined that there was no goodwill impairment, a decline in the value of its stock price as well as values of other financial institutions, declines in revenue for the Company beyond our current forecasts, significant adverse changes in the operating environment for the financial industry or an increase in the value of our assets without an increase in the value of the reporting unit may result in a future impairment charge.
It is possible that changes in circumstances existing at the measurement date or at other times in the future, or in the numerous estimates associated with management’s judgments, assumptions and estimates made in assessing the fair value of our goodwill, could result in an impairment charge of a portion or all of our goodwill. If the Company recorded an impairment charge, its financial position and results of operations would be adversely affected; however, such an impairment charge would have no impact on our liquidity, operations or regulatory capital.
Comparison of Operating Results for the Three Months Ended June 30, 2014 and 2013
Net Income.
Net income was $740,000, or $0.03 per diluted share for the fiscal first quarter ended June 30, 2014, compared to $1.6 million, or $0.07 per diluted share for same prior year period. The Company’s earnings reflect the current stabilization of the economic environment and improvement in asset quality at the Company, which resulted in a $300,000 and $2.5 million recapture for loan losses for the three months ended June 30, 2014 and 2013, respectively.
Net Interest Income.
The Company’s profitability depends primarily on its net interest income, which is the difference between the income it receives on interest-earning assets and the interest paid on deposits and borrowings. When the rate earned on interest-earning assets equal or exceed the rate paid on interest-bearing liabilities, any positive interest rate spread will generate net interest income. The Company’s results of operations are also significantly affected by general economic and competitive conditions, particularly changes in market interest rates, government legislation and regulation, and monetary and fiscal policies.
Net interest income for the three months ended June 30, 2014 was $6.4 million, representing an increase of $205,000, or 3.3%, from $6.2 million during the same prior year period. The net interest margin for the three months ended June 30, 2014 was 3.46% compared to 3.51% for the three months ended June 30, 2013. This decrease was primarily the result of the downward repricing of loans within the loan portfolio as well as the increase in the average balance of lower yielding cash and short term investments.
The Company achieves better net interest margins in a stable or increasing interest rate environment as a result of the balance sheet being slightly asset interest rate sensitive. At June 30, 2014, 7.22% of our loan portfolio had adjustable (floating) interest rates. At June 30, 2014, $25.3 million, or 64.07% of our adjustable (floating) loan portfolio contained interest rate floors, below which the loans’ contractual interest rate may not adjust. The inability of these loans to adjust downward has contributed to increased income in the currently low interest rate environment; however, net interest income will be reduced in a rising interest rate environment until such time as the current rate exceeds these interest rate floors. At June 30, 2014, $24.9 million or 4.56% of the loans in the Company’s loan portfolio were at the floor interest rate of which $21.1 million or 84.64% had yields that would begin floating again once the Wall Street Journal Prime Rate increases at least 150 basis points. While the Company does not anticipate further significant reductions in market interest rates, further modest reductions in its deposit costs are expected due to decreases in its deposit rate offerings and as existing long-term deposits renew upon maturity and reprice at a lower rate. The amount and timing of these reductions is dependent on competitive pricing pressures, yield curve shape and changes in interest rate spread
Interest Income.
Interest income for the three months ended June 30, 2014 increased $35,000 to $6.9 million compared to $6.8 million for the same period in prior year. The increase was due primarily to the increase in the average balance of investment securities and mortgage-backed securities which resulted in an increase in interest income of $45,000 and $464,000, respectively. This increase was offset by a decrease of interest income on loans of $434,000 due to the impact of loans repricing down to the current low interest rates.
The average balance of net loans increased $6.7 million to $538.1 million for the three months ended June 30, 2014 from $531.4 million for the same prior year period. The increase in average loan balances was due to the Company recently purchasing three separate automobile loan pools with outstanding loan balances totaling $30.3 million at June 30, 2014. The average yield on net loans was 4.60% for the three months ended June 30, 2014 compared to 4.99% for the same three months in the prior year. The decrease in the average yield on net loans was primarily due to the impact of loans repricing
downward in the current low interest rate environment and the lower yields on the automobile loan pools. During the three months ended June 30, 2014, the Company also reversed $7,000 of interest income on nonperforming loans compared to $110,000 for the same three months in the prior year.
Interest Expense.
Interest expense decreased $170,000 to $507,000 for the three months ended June 30, 2014 compared to $677,000 for the three months ended June 30, 2013. The decrease in interest expense was primarily the result of declining deposit costs, due to the Company’s decision to reduce its deposit rate offerings in light of the continued low interest rate environment. The Company has continued to lower its deposit costs throughout the year on many of its deposit products. The weighted average interest rate on interest-bearing deposits decreased to 0.26% for the three months ended June 30, 2014 from 0.39% for the same period in the prior year.
The following table sets forth, for the periods indicated, information regarding average balances of assets and liabilities as well as the total dollar amounts of interest earned on average interest-earning assets and interest paid on average interest-bearing liabilities, resultant yields, interest rate spread, ratio of interest-earning assets to interest-bearing liabilities and net interest margin.
|
Three Months Ended June 30,
|
|
|
2014
|
|
|
2013
|
|
|
Average
Balance
|
|
Interest and
Dividends
|
|
Yield/Cost
|
|
|
Average
Balance
|
|
Interest and
Dividends
|
|
Yield/Cost
|
|
|
|
|
|
|
(Dollars in thousands)
|
|
|
|
|
|
Interest-earning assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mortgage loans
|
$
|
418,343
|
|
$
|
4,789
|
|
|
4.59
|
%
|
|
$
|
457,796
|
|
$
|
5,401
|
|
|
4.73
|
%
|
Non-mortgage loans
|
|
119,753
|
|
|
1,382
|
|
|
4.63
|
|
|
|
73,631
|
|
|
1,204
|
|
|
6.56
|
|
Total net loans
(1)
|
|
538,096
|
|
|
6,171
|
|
|
4.60
|
|
|
|
531,427
|
|
|
6,605
|
|
|
4.99
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mortgage-backed securities
(2)
|
|
94,640
|
|
|
480
|
|
|
2.03
|
|
|
|
3,460
|
|
|
16
|
|
|
1.85
|
|
Investment securities
(2)(3)
|
|
22,218
|
|
|
84
|
|
|
1.52
|
|
|
|
11,911
|
|
|
39
|
|
|
1.31
|
|
Daily interest-bearing assets
|
|
1,116
|
|
|
-
|
|
|
-
|
|
|
|
1,258
|
|
|
-
|
|
|
-
|
|
Other earning assets
|
|
81,647
|
|
|
131
|
|
|
0.64
|
|
|
|
154,870
|
|
|
171
|
|
|
0.44
|
|
Total interest-earning assets
|
|
737,717
|
|
|
6,866
|
|
|
3.73
|
|
|
|
702,926
|
|
|
6,831
|
|
|
3.90
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest-earning assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Office properties and equipment, net
|
|
16,325
|
|
|
|
|
|
|
|
|
|
17,645
|
|
|
|
|
|
|
|
Other non-interest-earning assets
|
|
62,521
|
|
|
|
|
|
|
|
|
|
50,405
|
|
|
|
|
|
|
|
Total assets
|
$
|
816,563
|
|
|
|
|
|
|
|
|
$
|
770,976
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Regular savings accounts
|
$
|
67,034
|
|
|
17
|
|
|
0.10
|
|
|
$
|
54,683
|
|
|
20
|
|
|
0.15
|
|
Interest checking accounts
|
|
100,715
|
|
|
19
|
|
|
0.08
|
|
|
|
89,809
|
|
|
26
|
|
|
0.12
|
|
Money market deposit accounts
|
|
228,017
|
|
|
69
|
|
|
0.12
|
|
|
|
216,090
|
|
|
119
|
|
|
0.22
|
|
Certificates of deposit
|
|
158,159
|
|
|
255
|
|
|
0.65
|
|
|
|
182,550
|
|
|
362
|
|
|
0.80
|
|
Total interest-bearing deposits
|
|
553,925
|
|
|
360
|
|
|
0.26
|
|
|
|
543,132
|
|
|
527
|
|
|
0.39
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other interest-bearing liabilities
|
|
25,034
|
|
|
147
|
|
|
2.36
|
|
|
|
25,114
|
|
|
150
|
|
|
2.40
|
|
Total interest-bearing liabilities
|
|
578,959
|
|
|
507
|
|
|
0.35
|
|
|
|
568,246
|
|
|
677
|
|
|
0.48
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest-bearing liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest-bearing deposits
|
|
128,188
|
|
|
|
|
|
|
|
|
|
114,004
|
|
|
|
|
|
|
|
Other liabilities
|
|
9,721
|
|
|
|
|
|
|
|
|
|
8,729
|
|
|
|
|
|
|
|
Total liabilities
|
|
716,868
|
|
|
|
|
|
|
|
|
|
690,979
|
|
|
|
|
|
|
|
Shareholders’ equity
|
|
99,695
|
|
|
|
|
|
|
|
|
|
79,997
|
|
|
|
|
|
|
|
Total liabilities and shareholders’ equity
|
$
|
816,563
|
|
|
|
|
|
|
|
|
$
|
770,976
|
|
|
|
|
|
|
|
Net interest income
|
|
|
|
$
|
6,359
|
|
|
|
|
|
|
|
|
$
|
6,154
|
|
|
|
|
Interest rate spread
|
|
|
|
|
|
|
|
3.38
|
%
|
|
|
|
|
|
|
|
|
3.42
|
%
|
Net interest margin
|
|
|
|
|
|
|
|
3.46
|
%
|
|
|
|
|
|
|
|
|
3.51
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ratio of average interest-earning assets to average interest-bearing liabilities
|
|
|
|
|
|
|
|
127.42
|
%
|
|
|
|
|
|
|
|
|
123.70
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tax equivalent adjustment
(3)
|
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
Includes non-accrual loans.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(2)
For purposes of the computation of average yield on investments available for sale, historical cost balances were utilized;
therefore, the yield information does not give effect to changes in fair value that are reflected as a component of shareholders’ equity.
|
|
(3)
Tax-equivalent adjustment relates to non-taxable investment interest income. Interest and rates are presented on a fully taxable –equivalent basis using a tax rate of 34%.
|
|
The following table sets forth the effects of changing rates and volumes on net interest income of the Company for the quarter-ended June 30, 2014 compared to the quarter-ended June 30, 2013. Variances that were insignificant have been allocated based upon the percentage relationship of changes in volume and changes in rate to the total net change.
|
Three Months Ended June 30,
|
|
2014 vs. 2013
|
|
|
|
|
|
|
|
|
|
|
|
Increase (Decrease) Due to
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
|
|
|
|
|
Increase
|
|
(in thousands)
|
Volume
|
|
Rate
|
|
(Decrease)
|
|
|
|
|
|
|
|
|
|
|
|
Interest Income:
|
|
|
|
|
|
|
|
|
|
Mortgage loans
|
$
|
(455
|
)
|
$
|
(157
|
)
|
$
|
(612
|
)
|
Non-mortgage loans
|
|
603
|
|
|
(425
|
)
|
|
178
|
|
Mortgage-backed securities
|
|
462
|
|
|
2
|
|
|
464
|
|
Investment securities
(1)
|
|
38
|
|
|
7
|
|
|
45
|
|
Daily interest-bearing
|
|
-
|
|
|
-
|
|
|
-
|
|
Other earning assets
|
|
(99
|
)
|
|
59
|
|
|
(40
|
)
|
Total interest income
|
|
549
|
|
|
(514
|
)
|
|
35
|
|
|
|
|
|
|
|
|
|
|
|
Interest Expense:
|
|
|
|
|
|
|
|
|
|
Regular savings accounts
|
|
5
|
|
|
(8
|
)
|
|
(3
|
)
|
Interest checking accounts
|
|
3
|
|
|
(10
|
)
|
|
(7
|
)
|
Money market deposit accounts
|
|
7
|
|
|
(57
|
)
|
|
(50
|
)
|
Certificates of deposit
|
|
(45
|
)
|
|
(62
|
)
|
|
(107
|
)
|
Other interest-bearing liabilities
|
|
-
|
|
|
(3
|
)
|
|
(3
|
)
|
Total interest expense
|
|
(30
|
)
|
|
(140
|
)
|
|
(170
|
)
|
Net interest income
|
$
|
579
|
|
$
|
(374
|
)
|
$
|
205
|
|
|
|
|
|
|
|
|
|
|
|
(1)
Interest is presented on a fully tax-equivalent basis using a tax rate of 34%
|
|
Provision for Loan Losses.
The recapture of loan losses for the three months ended June 30, 2014 was $300,000 and $2.5 million for the same period in the prior year. The recapture of the provision for loan losses were primarily a result of a decrease in net charge-offs and the decline in the level of delinquent, nonperforming and classified loans, as well as the stabilization of real estate values in our market areas. Although real estate values and the economy in our market areas have recently improved, classified and nonperforming loans remain at higher levels compared to historical trends as the pace of recovery has been modest and uneven. The relatively weak economy has also adversely affected the Bank’s commercial business and commercial real estate customers although classified commercial real estate loans have improved recently, decreasing to $18.8 million at June 30, 2014 compared to $19.8 million at March 31, 2014.
Net recoveries for the three months ended June 30, 2014 and 2013 were $30,000 and $554,000, respectively. Annualized net recoveries to average net loans for the three-month period ended June 30, 2014 and 2013 was 0.02% and 0.42%, respectively. The net recoveries occurred primarily as a result of the decrease in nonperforming loans and stabilization of real estate values as well as an increase in recoveries on previously charged off loans. Nonperforming loans were $13.1 million at June 30, 2014, compared to $21.4 million at June 30, 2013. The ratio of allowance for loan losses to nonperforming loans was 94.09% at June 30, 2014 compared to 64.03% at June 30, 2013. See “Asset Quality” above for additional information related to asset quality that management considers in determining the provision for loan losses.
Impaired loans are subjected to an impairment analysis to determine an appropriate reserve amount to be held against each loan. As of June 30, 2014, the Company had identified $25.5 million of impaired loans. Because the significant majority of the impaired loans are collateral dependent, nearly all of the specific allowances are calculated based on the fair value of the collateral. Of those impaired loans, $24.1 million have no specific valuation allowance as their estimated collateral value is equal to or exceeds the carrying costs, which in some cases is the result of previous loan charge-offs. Charge-offs on these impaired loans totaled $1.2 million from their original loan balance. The remaining $1.4 million of impaired loans have specific valuation allowances totaling $137,000.
Non-Interest Income.
Non-interest income decreased $36,000 for the three months ended June 30, 2014 compared to the same prior year period. The decrease between the periods resulted from a decrease of $191,000 on the gain on the sale of loans held for sale during the three months ended June 30, 2014 compared the three months ended June 30, 2013. The decrease in gain on the sale of loans held for sale was primarily due to the decrease in mortgage related activity as a result of an increase in mortgage interest rates during the first half of calendar year 2013 which curtailed refinancing activity. This decrease was offset by an increase in asset management fees of $84,000, which were driven by an increase in assets under management in addition to an increase in the fee structure assessed to cusotmers. Further, the decrease was offset by an increase of $35,000 in other non-interest income, reflecting, among other items, gains on REO sales of $5,000 for the three months ended June 30, 2014 compared to losses of $28,000 on REO sales for the same prior year period.
Non-Interest Expense.
Non-interest expense decreased $1.5 million to $7.7 million for the three months ended June 30, 2014 compared to $9.2 million for the three months ended June 30, 2013. Management continues to focus on managing controllable costs as the Company proactively adjusts to lower levels of real estate lending activity. REO expenses (which includes operating costs and write-downs on property) decreased $996,000 primarily due to the overall decrease in REO balances at June 30, 2014 compared to June 30, 2013. Data processing expenses decreased $218,000 compared to the same period in the prior year as a result of conversion related expense in the prior year for the Company’s core operating system conversion. The Company’s FDIC insurance premiums also decreased $236,000 compared to the same period in prior year reflecting the Bank’s improved financial condition. Offsetting these decreases was an increase in salaries and employee benefits of $304,000 for the three months ended June 30, 2014 compared to the same prior year period. The increase in salaries and employee benefits was due to an increase in staffing in the Company’s lending groups as well as the reinstatement of incentive plans for the Company’s lending and retail employees.
Income Taxes.
The provision for income taxes was $394,000 for the three months ended June 30, 2014 compared to $17,000 for the three months ended June 30, 2013. The effective tax rate for the three months ended June 30, 2014 and 2013 was 34.7% and 1.0%, respectively. As of June 30, 2013, the Company carried a deferred tax asset valuation allowance against its deferred tax asset which resulted in the minimum tax expense incurred during the three months ended June 30, 2013, which resulted in a minimal effective tax rate compared to the statutory tax rate. The Company’s effective tax rate at June 30, 2014 remains lower than the statutory tax rate primarily as a result of non-taxable income generated from investments in bank owned life insurance. At March 31, 2014, the Company reversed its deferred tax asset valuation allowance related to the Company’s’ deferred tax assets as management deemed that it was no longer appropriate to carry a deferred tax asset valuation allowance as a result of changes in the factors considered by management when the Company initially established the valuation allowance. In making this conclusion, management considered, among other factors, the Company’s earnings during the past three years, including that the Company had seven consecutive profitable quarters, the improvement in the Company’s asset quality and financial condition, as well as projected earnings and the impact from the Company’s balance sheet restructure.