West Coast Bancorp (Oregon) (NASDAQ:WCBO)
Q4 2008 Earnings Call
January 20, 2009 11:00 am ET
Bob Sznewajs - President and CEO
Dick Rasmussen - EVP, General Counsel and Secretary
Xandra McKeown - EVP, Commercial Banking
Hadley Robbins - EVP, Chief Credit Officer
Anders Giltvedt - EVP, CFO
Louis Feldman - Hoefer & Arnett Inc
Jeff Rulis - D.A. Davidson & Co.
Good morning. My name is Crystal and I will be your conference operator today. At this time, I would like to welcome everyone to the West Coast Bancorp Q4 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions].
Mr. Sznewajs, you may begin your conference.
Thank you, Crystal. Good morning, everybody, and I guess Happy New Year. Joining me today are Xandra McKeown; Hadley Robbins, Anders Giltvedt; and Dick Rasmussen. And Dick will begin by reading the forward-looking statements.
Thank you, Bob. In today's call, we will make statements regarding future events, performance or results that are forward-looking statements, including statements regarding loan deposit and fee growth, market competition, credit quality, the provision and the allowance for credit losses of the real estate owned capital expenses, earnings, key financial ratios, the housing market and the economy.
Our actual results could be quite different from those expressed or implied by our forward-looking statements. Please do not place undue reliance on forward-looking statements. They are not guarantees. They speak only as of the date they are made, and we do not undertake any obligation to update them to reflect changes that occur.
For some factors that may cause our actual results to differ from our expectations, please refer to our SEC filings, including our most recent reports on Forms 10-K and 10-Q. In particular, we direct you to the discussion in our 10-K of certain risk factors affecting our business.
We may, during the course of this call, refer to certain non-GAAP financial measures. Those measures are explained and reconciled to GAAP financial measures in our most recent earnings release, which can be found on the Investor Relations section of our website, wcb.com. This call is being recorded and may be accessed and replayed beginning later today by going to the Investor Relations section of our website.
Bob, back to you.
Thanks, Dick. For those of you that have had a chance to read the press release and the related tables, you will note there is, I think, some additional disclosure in there compared to previous periods. We think it's important to have that in there. I have a great appreciation to Anders and the staff that had to prepare all of this information, but we felt it was appropriate as opposed to maybe even waiting until you get the 10-K. So, hopefully, you'll find the information informative.
The fourth quarter results, obviously, were influenced by the provisioning for the residential construction real estate portfolio and the two-step as well, and Hadley is going to cover that in more detail. Make note of the fact that our capital ratios remain at high levels, 10.93%. If you go back several years to December 31, '06, it was a 10.24%. At the end of December 31, '07, it was 10.54 and now we're sitting at 10.93.
The capital for the quarter was influenced by a couple things. One; the $9.8 million capital injection to the bank, and Anders is going to talk about that, that was made in the fourth quarter of 2008. And as we have talked in the past, we continue to manage the growth in our risk-weighted assets.
We've also made extensive efforts to reduce our cost in '08 and also will have impacts in '09. To give you some examples of reductions in cost in '08, there were no bonuses paid to anyone in the company in 2008. We've enacted a salary freeze for the total company going into effect for 2009. There was no 401(k) match for any employee in 2008.
We have eliminated almost 60 FTE positions since August 2008. These reductions include positions already eliminated in 2008, the elimination of open positions, staff reductions and attrition. In addition to that, we've made many other reductions in operating expenses as part of our Go Green initiative, which we have talked about previously. We've also had reductions in incentive pay.
The loan portfolio outside the two-step nonstandard and residential construction segments, which account for the vast majority of the loan portfolio, approximately 89%, its NPAs are only 1.09% of total assets and is performing really very different and quite good compared to the residential construction real estate portion of the loan portfolio, and Hadley is going to go through this in a lot of detail.
The two-step portfolio continues to perform as expected with the general decline in housing values. Our loss rate in the sale of property is exceeding our original estimate, which was made 12 months ago. The rate of the disposition of homes continues to meet our expectations. And also, as we noted in the last conference call, the two-step nonperforming assets clearly have peaked at the end of the third quarter, and Anders and Hadley are going to be covering this as well in more detail.
In my view, our people in this area have done really a terrific job, and the disposition of these properties is a very important aspect of what our objectives are and have been, and especially going into 2009.
The other point I would like to make which is, I think evident in the numbers if you have a chance to look at, and I think this is an important point, so I'd ask you to really focus on with the information we've provided to you in the tables.
Relative to our peers, our exposure to the residential real estate construction area is really quite modest, and especially if you analyze the mix between land, developed lots, and the vertical or the constructed homes.
As we're all learning in this environment that each one of those sections if you will that makes up residential real estate construction have different dynamics going on with them in this marketplace and these dynamics are from our view point very likely to continue through 2009.
On the other hand, our basic business of growing high performance checking accounts for small business and consumers is performing well along with our entire payment systems business. However, the payment systems business which is impacted by consumer spending as it was somewhat in the fourth quarter and that's just a general economic thing both in terms of the basic business model, we're very pleased with that.
I'd also want to thank our people. I think our people have done a terrific job in these extraordinary times and we spend a great deal of time talking to our people and trying to educate them about the industry in general, the economy, and especially our bank and I believe our people are reacting very well with this and I am very proud of the actions and the attitude they have while we are working our way through this current economic situation.
So, I'll have some remarks at the end. With that, I'm going to turn it over to Anders.
Thank you, Bob. Good morning, everybody. Let me start with the balance sheet. Total loan balances during 2008 on track at 5% or $108 million and that decline was very close to the expectations we've laid out early in the year and that was obviously caused by the $210 million or 80% decrease in the two-step loan portfolio. Excluding the two-step loans, the loan portfolio grew approximately 5% or $102 million, again pretty consistent with what we had anticipated earlier in the year.
The total construction portfolio has contracted 45% or $235 million from its peak at year-end 2007, and the total construction portfolio accounted for less than 14% of loans at year-end, and that's compared to 24% a year ago. Excluding the remaining $53 million in the two-step loan portfolio, the shrinking construction components represented about 11% of loans at year-end 2008.
The two-step loan portfolio now accounts for less than 3% of the total loan portfolio and that compares to about 12% of the total portfolio at year-end 2007. The remaining unfunded commitments are now insignificant and that's down from about $80 million at year-end 2007.
Since the two-step program was discontinued approximately 15 months ago, total two-step commitments have contracted 87% from $399 million to $53 million.
The mortgage loan category, which includes single-family residential mortgages, home equity and lines and nonstandard mortgages, grew 62 million during 2008. The home equity balances increased 37 million or 15% during the past 12 months.
At the yearend 2008, the home equity portfolio stood at approximately 273 million. The nonstandard residential mortgage portfolio, which was a portfolio where we attempted to manage certain two-step borrowers into, particularly for those that wanted to retain their homes, was at $33 million at yearend 2007, up from $7 million a year ago.
Since September 30th, the nonstandard portfolios decreased $1 million. And we do anticipate the balances for this portfolio to decline further into 2009. Only a limited number of nonstandard loans have been originated since the second quarter of 2008 in this portfolio.
With that, I'd like to hand it over to Xandra to talk more about the loan portfolio.
Good morning, everyone. I'll first focus my comments on a detailed summary of our loan production during the quarter. New loan commitments booked during the fourth quarter of $98 million decreased approximately 10% from the prior quarter. A quarter-over-quarter comparison shows the following trend by product.
First of all, C&I new loan commitments booked during the fourth quarter were $46 million, up $5 million from the third quarter; construction, $16 million in new loan commitments during the fourth quarter, which was up $11 million from the third quarter. The majority of this was commercial. It was centered in one multi-family project as well as two commercial projects. These were all to long-time clients, all of which were fully-integrated relationships, and each of which maintains significant deposits with West Coast Bank.
Our mortgage new loan commitments were $15 million, which was down $4 million from the third quarter. Commercial real estate was $19 million, which was down $23 million from the third quarter and was essentially driven by our restriction of non-owner-occupied loans. Consumer was flat quarter-over-quarter at $2 million.
A full year-over-year comparison for 2008. New loan commitments booked were $576 million, down 43% or $434 million from 2007, which was primarily driven by a year-over-year decline of $364 million in the construction category. The breakdown of total 2008 production is as follows. 35% of this was in the C&I category; 31%, commercial real estate; 20%, mortgage; and 12%, construction.
Turning now to the loan portfolio growth, which excludes two-step balances, as Anders indicated, the Bank's loan portfolio grew only modestly $3.8 million quarter-over-quarter, while demonstrating year-over-year growth of $105 million or 5.5%.
On a linked-quarter basis, declines in C&I and non-two-step construction categories were offset by growth in mortgage and term commercial real estate portfolios. The decline in the C&I category was primarily attributable to decisions by Bank management to reduce exposure to industries and/or customers that presented a higher risk profile, some of which had direct or indirect ties to the residential construction sector.
Overall line of credit utilization was approximately 1% higher than the prior quarter. And even with new loan production in the term commercial real estate book declining over the past two quarters, balances grew in this book quarter-over-quarter due to a significantly slowing pace of prepayments.
Turning our attention now to the pipeline, the pipeline continued to decline indicative of; first of all, current market conditions; secondly, economic weakness; and lastly, our desire to control risk-weighted asset growth. The pipeline is down 60% when compared to the prior quarter, and those components which experienced the greatest linked-quarter declines were; first of all, term commercial real estate, followed then by C&I and construction.
The makeup of the pipeline is appropriate and reflective of current market weakness, as well as our desire to minimize growth in the investor term commercial real estate book.
I thought I'd give you some additional color and conversation on our ag portfolio because as all of you know we have exposure to agricultural commodities with a strong agri banking team located in the Willamette Valley. At yearend, this portfolio represented approximately 10% of total bank outstanding loans with the top three concentrations including; first, miscellaneous crops; secondly, nursery; and third, dairy.
My reason for sharing comments regarding the ag portfolio this morning with you are in light of the impact of the weather over the holidays and some of the media reports earlier this month. While the temperatures were colder during the 2007, 2008 winter period, the combination of deep snow covered with freezing rain and ice created significant stress on greenhouse structures, causing some of them to collapse under the weight.
In early January, the OAN, which is Oregon Association of Nurseries, reported that a survey of their members in 12 Oregon counties sustained between $18 million and $31 million in damages, $11 million of which is estimated to be the impact to the structures. West Coast Bank's nursery segment, which also includes Christmas trees, represents approximately 3% of total bank outstanding at yearend.
A review of our nursery clients indicates that only one of them had significant structural damage that has the potential to cause significant financial impact. Other clients who might have been impacted had only modest damage to structures. Typically these were covered by insurance and with minimal impact to planting.
While the impact to plantings during dormancy is largely unknown until plants begin to emerge from dormancy, for the most part the location of our clients just fortunately did not happen to fall within the geographical swath that was hardest hit by the snow and ice, which was approximately Multnomah, [Nordsen] through Boring, which for those of you who aren't aware of these communities it's the East County of Portland.
The OAN has aggressively sought government emergency aid for their member growers. We've recently heard from the USDA that they are anticipating an emergency loan program to be approved. However, details are yet unknown.
We continue to believe that agriculture represents an important part of the communities and economies of the states of Oregon and Washington, and we remain committed to this industry. The key is having experienced staff who are capable of recognizing and managing the early and ongoing risk, which is something that we are very comfortable with.
In my closing comments I would share with you that the quarter presented challenges from many perspectives as we work through this particular stage in the economic cycle. We have focused our efforts on our existing customer base, both to manage risk as well as to enhance retention.
And we recognize that opportunities for the immediate future for new borrowing relationships have narrowed due to spreading economic weakness from residential construction into other sectors. This has not only impacted our most recent level of new borrower production, but also our current pipeline. We are being very selective with new borrowing relationships and the evaluation of their risk profile. I do not see a material change in this over the next few quarters.
I'll end my comments today with a brief review of the guidance we are giving to our bankers for the types of lending opportunities that we will and will not entertain, and this is very similar to what was shared with you last quarter, but first of all, I'd like you to know that for any of our teams, we are very focused on carefully and closely managing the deposits of our large commercial clients; whether those clients are commercial real estate, ag, or C&I clients in nature.
First of all, our CRE teams; we intend to remain visible and engaged in our markets, because ultimately the weakness will indeed cycle through, however at this time, we're not pursuing any residential or condo construction, whether that would be land, vertical, or development. Any loan activity, currently only represents draws against existing commitments.
Secondly, any new commercial construction projects are highly dependent upon the specific product and the submarket as we believe the risk profile is increasing for retail and office given the underlying economic fundamentals.
Third, hospitality must have a track record of sustained occupancy. These are considered on an exception basis and only for existing clients. Fourth, convalescent and assisted care facilities are considered again on an exception basis only due to internal concentration limits. And lastly, more favorable credit fundamentals exist currently in properties such as light industrial, storage, and multi-family. However, we do indeed evaluate these target properties on an ongoing basis.
In terms of guidance for our agricultural team, no expansion of the nursery segment due to internal concentration limits, as well as weakness experienced by those that produce product for the residential construction sector.
And for our C&I teams, wider opportunities are believed to exist in this sector, particularly in light of the depth of our expertise. However, we are proceeding with caution on all new borrowers that have exposure to residential housing, such as services or contractors which support housing or those who are dependent upon discretionary consumer spending.
And in all cases, it is within the confines of favorable historical financial performance, strong management teams, sponsorship, and other solid credit fundamentals. Our culture and strategy has always been one of strong engagement and remaining close to the client. Our bankers are increasingly focused on this activity and ways in which we can continue to bring value to these client relationships.
And with that, I'll turn it back to Anders.
Thank you, Xandra. Let me go into liability side of the balance sheet. Fourth quarter average total deposits declined 4% from the same quarter in 2007 with the average non-CD balances declining 6% and CD balances increasing 2%. Still at 29%, our CDs represented a much smaller percentage of total deposits than for our peers, and we believe that's the result of our diversified product offering and the high level of client relationship service and focus throughout the company.
Outside the [CDs] program, we had no broker deposits at year-end 2008. The average non-interest bearing DDA held relatively steady at 23% of total average deposits in the most recent quarter, and the total checking account balance for the company represented 36% of average total deposits in Q4. Again, I think that reflects our excellent core deposit franchise.
Consistent with what we have experienced over the past year, the average balance per account continued to decline for non-interest, interest bearing checking, as well as for money market accounts, and this was particularly prevalent in the business segment. For example, the total business money market balances contracted 30% year-over-year in Q4 despite a slight increase in the number of accounts.
We also are yet to see the average non-interest-bearing business checking accounts rebound, which has been a historical pattern when short-term rates and the earnings credits has come down.
Within the consumer segment, we also have seen a similar pattern continue. The average total balance, DDA balance, declined 6%, basically a 13% decline in the average balance in the account was partially offset by the 7% increase in number of accounts. The good news is that we are growing our core deposit balance and account base for both business and consumers.
In terms of our capital, with the uncertain economy and no capital generated by earnings in 2008 due to the elevated provision level, we focused on carefully managing our risk-weighted assets, as Bob mentioned, throughout the year. And the recent weak economic data, this continues into 2009.
Also, as noted in the earnings release, in Q4, Bancorp and Bank settled up their inter-company tax position at yearend. And this resulted in a $9.8 million capital contribution to the Bank. Consequently, despite the $5.8 million loss in 2008, the bank's total capital ratio improved to 10.93% from 10.54% at yearend 2007. The Bank's Tier 1 and tangible common equity ratios at 9.68% and 7.35%, respectively, were also solid.
We continue to evaluate our projected capital needs, considering not only our risk-weighted assets and the company's earnings projections, but also all the economic data that indicates there is more pain to come in 2009. We also view our cost savings initiatives being a method to preserve capital.
Let's spend a couple of minutes on the trends in the two-step portfolio, which is managed separately from the rest of the Bank. During the fourth quarter, total two-tiered step commitments declined $53 million or 47% from $100 million at September 30th. Total two-step NPAs fell by $18 million over the same period with the non-accrual balances declining $33 million and OREO increasing $15 million, the latter being a result of taking more ownership of properties.
The fourth quarter reflected a continued shift from managing the collection of active two-step loans to managing the disposition of the OREO properties. This transition accelerated in the fourth quarter and will continue through the end of the second quarter in 2009, at which time, essentially all non-accrual two-step loans are expected to be in OREO.
41 two-step related to OREO short sales were completed in Q4, with net proceeds totaling nearly $12 million. This was in line with our sales forecast in the quarter, despite the major snow and ice storm affecting our ability to get the deals closed during the last two weeks in December. At yearend, we had 21 pending sales across, I would say, both geography, price range and completion status.
We continue to update a large number of appraisals in Q4, as evidenced by the unfavorable effect on the income statement from the two-step portfolio in the quarter. Excluding the cost of carrying the two-step NPAs, the overall negative Q4 pretax earnings impact from the two-step portfolio was approximately $9.4 million. If you apply a 35% tax rate, the fourth-quarter EPS impact would have been $0.37 a share. This was nearly twice the EPS impact in each of the prior three quarters.
And then, going into the key components in Q4, as noted in the earnings release the current economic conditions, which clearly are worse than anticipated when we established the reserve for two-step at yearend 2007, pressured our overall default rate and severity of loss assumptions, the probability of default increased, particularly for the tail-end of the portfolio that matured in the fourth quarter.
Additionally, the appraisals obtained in Q4 reflects the housing inventory level being high and negative, but not dramatically, so trends in home prices. Per RMLS listing services, the average housing price within our markets declined 11% from December 2007 to December 2008, and ranged from a low of 4% in Yamhill County, which is just southwest of Portland, to a more severe decline of 24% in Deschutes County where Bend is located.
As a result of this, based upon the 21 pending and the 102 closed two-step property sales, our loss percentage also trended up, and this resulted in the fourth quarter provision for two-step loans of about $4.8 million. At the yearend, the remaining $110 million in two-step nonperforming assets had been written down approximately 23% from its original balance. And to help you with a comparison, the expected loss rate on the 21 pending sales at yearend is expected to be 26.7%, so not dramatically different.
As we had mentioned before, built into our process all properties are reappraised within 45 days of the properties' expected foreclosure date, and if the current housing market trends continue, we expect additional provisions for reappraised properties in Q1, but a meaningful decline in the following quarters.
Consistent GAAP, it is also important to note that there can be no general valuation reserve in our loan models since all the non-accruing two-step loans have already been individually impaired.
The second impact came from OREO valuation adjustments and OREO gains and losses from property disposition. These are recorded in non-interest income and consisted of $2.9 million in valuation adjustments from off dated appraisals within the $60 million OREO portfolio and a $0.3 million loss on completed sales of 28 OREO properties.
The minor OREO loss on sales continued to indicate that we're writing down the properties to reasonable levels relative to the actual final disposition prize for those properties. We do anticipate some additional OREO valuation adjustments to be charged against non-interest income in Q1, but less than that in Q4.
Finally, the collection and disposition expenses directly associated with the two-step loans and OREO portfolios amounted to approximately $1.2 million in the most recent quarter. That's about flat with what we experienced in the third quarter. These expenses include personnel, legal, and operating costs. We expect this expense to remain fairly constant for Q1, then to trend down significantly in subsequent quarters.
From a full year perspective, we estimate that the 2008 full earnings impact from the two-step portfolio, including the disposition and collection activities, amounted to approximately $25 million pre-tax or assuming a 35% tax rate, about $1 per share. This number does not include the cost of carrying the NPAs. We do not see a repeat of this impact in 2009, and we believe the quarterly negative run rate effect from this portfolio to continue to taper off as we go through 2009.
The current economic headwind is obviously a wildcard for us. However, with a combination of over $5 million in pending sales at this stage, more properties in OREO, our sales experience, along with attractive mortgage rates, this suggests to us that our property volume sales should continue at a solid level in Q1 and then even more so in Q2 considering the seasonality of home sales in our local markets.
With only a handful of remaining performing two-step loans, the two-step NPA balances will extend its decline in Q1 with a continued balance transfer from non-accruals to OREO.
Okay, let me step back to the income statement, and the net interest income declined $7 million from the same quarter in 2007, primarily as the combination of a smaller construction portfolio and the margin contracting 92 basis points. That was slightly below our projected range from last conference call of 3.8 to 4%. It seems we didn't foresee the degree to which the Fed acted in Q4.
The value of non-interest bearing deposits reduced a margin by about 28 basis points year-over-year, while the spread contracted 51 basis points, and this was due to, first, lower loan fees, which reduced the margin by about 18 basis points and that was all due to shrinking construction loan fees.
Second, interest differentials which affected the margin by 14 basis points, and finally, there's still a very competitive environment for deposits in our market which has certainly affected our ability to align funding costs at a rapidly declining market interest rate which reduced our loan yields.
There is currently a market disconnect from the historical relationship between the market interest rates and that of money market and CD pricing. Linked quarter, the margin declined 2.6%, basically from the same factors as we discussed year-over-year.
Special non-interest income, the fourth quarter fee income declined $4.3 million from the same quarter in 2007, and the key factor was the $2.7 million decline in two-step and non-two-step OREO valuation adjustments and losses, which there were none up in 2007.
Additionally, the turmoil in credit and equity markets also impacted trust and investment revenue which declined $0.5 million year-over-year. As a result of the steady although slower growth in number of accounts for both business and consumers, transaction accounts, and costs associated with those new accounts, our deposits services charges grew 4% from Q4 a year ago.
Our payment system business revenues managed to expand slightly from Q4 2007, despite the economy and despite the decline in the transaction volume in the mergers business caused by the slower economy. With the secondary SBA market effectively being shutdown during Q4, there were no gains or sales associated with this business in Q4.
Our total non-interest expense increased $1.6 million or 8% from the same quarter in 2007. However, adjusting for the reversal of the $1.4 million litigation reserve in Q4 of 2007, the fourth quarter expense was substantially flat year-over-year.
As indicated in the earnings release, total personnel costs fell 6% or $0.7 million from Q4 2007. The reduction in salary and benefits and commission expense was partially offset by lower deferred costs, the latter of which contracted over 40% or $0.6 million from the same quarter in 2007 due to the substantial drop in loan origination in the construction segment.
Marketing expenses also fell by $0.5 million compared to the same quarter of last year. The decline in personnel and marketing costs is more than offset by the $1.2 million previously noted in the collection and disposition expenses related to the two-step program, of which there were none in the same quarter of 2007, as well as the $0.5 million increase in the FDIC insurance premium costs.
And with that, I'd like to hand it over to Hadley to discuss our credit metrics.
Thank you, Anders. Anders has covered the relevant points about the two-step portfolio, so my comments this morning will focus on the Bank's non-two-step portfolio. I will first cover overall portfolio credit quality metrics followed by a discussion of specific loan segments.
The non-two-step loan portfolio represents total loans of about $2 billion at December 31, 2008. The loan portfolio is distributed across five primary loan segments: the first, commercial loans, approximately 23% of the total non-two-step loans; residential and commercial real estate construction, about 14%; real estate mortgage, 19%, and this segment includes our home equity loans and lines; commercial owner-occupied and non-owner-occupied real estate term loans, 43%; and consumer installment loans, 1%.
During the fourth quarter, we have seen continued deterioration in economic conditions across our marketplace. A number of months of home inventory hit new highs, as Anders has revealed. We have also seen foreclosure rates continue to rise, bankruptcies accelerate, and unemployment levels have increased and are expected to continue to rise through 2009.
Export activity is also soft and as trading partners adjust to lower levels of demand and consumer confidence is at all-time lows, matched by lower levels of spending that will test the sustainability of many retail business models. Absolutely, the times are uniquely challenging.
This economic climate has clearly had an impact on the non-two-step portfolio credit quality as seen in higher levels of delinquency, NPA and net charge-offs on an overall basis. However, at this point in time, stress on credit quality measures have largely been isolated in two loan product types: commercial residential construction and land loans and nonstandard mortgage loans.
These two loan categories account for outstanding loans of about $192 million or about 10% of the total non-two-step portfolio and represents 77% of total NPA. The remaining 90% of the loan portfolio, as we have discussed, has performed acceptably in 2008 with the NPAs slightly above 1%.
Now on to more specific comments about portfolio credit quality metrics, starting with delinquency, the overall delinquency in the non-two-step portfolio, defined as loans 30 to 89 days past due, decreased 20 basis points during the fourth quarter from 50 basis points at September 30, 2008, to 34 basis points at December 31, 2008.
The decrease in delinquency is primarily related to past due residential construction loans being classified non-accrual during the quarter. We also saw fourth-quarter reductions in delinquency in real estate mortgage and commercial construction. However, this was offset by higher delinquencies in the C&I portfolio.
Non-two-step total non-performing assets increased $32 million from $56 million at September 30, 2008, to $88 million at December 31. At yearend, NPA represented about 3.49% of total non two-step loans. The fourth quarter increase in NPA consists of non-accrual loans of $25 million and a $7 million increase in OREO. This is largely attributed to the deterioration of residential construction loans. NPAs for term commercial real estate and C&I loans, our two largest loan segments, declined during the fourth quarter.
OREO, the book value of non two-step OREO property at yearend was $10 million and represents 37 residential real estate properties. Residential OREO properties are largely located in Clark County in the State of Washington and Deschutes County in the State of Oregon. Most properties were booked into OREO during the third and fourth quarter.
During the fourth quarter, OREO book volume was reduced approximately $500,000 due to negative valuation adjustments associated with updated appraisals. Two minor sales also completed a reduced book value by about $384,000.
Non-accrual, as previously mentioned, non-accrual loans increased $25 million during the fourth quarter. This increase is largely due to higher levels of non-accrual loans in both the residential construction loans, up $16.3 million, and to a lesser extent nonstandard residential mortgages, $3.4 million. Non-accrual residential construction loans are largely located in Clark County in the State of Washington and Marion and Deschutes counties in the State of Oregon.
Net charge-offs, non two-step net charge-offs were $15 million in the fourth quarter or 2.88% of average annualized loans. This compares to $5.9 million or 1.11% for the third quarter. The higher level of charge-off activity during the fourth quarter was related to residential construction loans, $5.3 million, commercial loans, $3.2 million, and by nonstandard mortgage loans, $2.5 million. Net charge-offs for full year 2008 were $25 million or 1.17% of average annualized loans.
On a provision, the combination of negative risk-weighting changes, adjustment to reserve percentages, and the higher net charge-offs during the fourth quarter increased the provision requirements to $12 million as compared to $7 million in the third quarter. Fourth quarter net charge-offs exceeded provision expense by $3.4 million. However, fourth quarter net charge-offs included $3.6 million in charge-offs that were previously funded in the third quarter as one-time specific reserves.
On a full year basis, non two-step provision expense of $31 million exceeded net charge-offs of $25 million. This higher level of provisioning contributed to a year-over-year increase in the non two-step allowance for credit losses, which increased from $23.8 million or 1.25% of total non two-step loans at December 31, 2007 to $29.5 million or 1.47% at December 31, 2008.
On the discussion of loan segments, starting first with residential construction and land loans, at December 31, 2008, the Bank's total outstanding loans in residential construction and land loans was $159 million. This portfolio consists of $23 million in land, site development of $65 million, and construction of residences or vertical construction, $71 million.
Residential construction projects financed by the bank, including condos, are mainly located in Clark and King counties within the State of Washington and Multnomah County within the State of Oregon. Overall, delinquency in the residential construction portfolio as a percentage of outstanding residential construction loans was 64 basis points or 863,000 at December 31, 2008, a decline of 4.56% compared to September 30, 2008.
As previously mentioned, classifying past due residential construction loans non-accrual largely explains the drop in delinquency during the fourth quarter. At year-end, non-accrual residential construction loans were $42.6 million or 27% of outstanding residential construction loans, up from $26.3 million or 16% in the previous quarter.
Loans to borrowers involved in site development exhibit the most deterioration triggering non-accrual status. At December 31, 2008, the remaining residential site development loans considered performing or accrual totaled about $37 million and represented less than 2% of our non-two-step portfolio.
All non-accrual residential construction loans have been impaired. The write-down associated with impaired loans is the most significant factor contributing to overall levels of net charge-offs for this loan segment. Net charge-offs totaled $12 million for full year 2008 and charge-offs related to impairment were about $10 million.
During the second quarter of 2007, we significantly curtailed originating new residential construction loans as discussed by Xandra, and by the first quarter of 2008, new origination activity has seized.
Residential construction loan commitments peaked during the second quarter in 2008. Today, loan activity mainly represents draws under existing commitments. At December 31, unused commitments were about $34 million.
During 2009, we expect to see a material reduction in residential construction loan balances. However, given the destabilized condition of the housing industry, borrowers need more time to work through lot and home inventory. A number of loan maturities will need to be extended delaying the pace and degree of loan balance reductions.
Commercial construction and land loans; at December 31, 2008, the bank's commercial construction and land loans totaled $115 million. This portfolio consists of land at $23 million, site development of about $1 million, and vertical construction of $92 million or 80% of total commercial construction loans.
At December 31, delinquency in commercial construction portfolio as a percentage of outstanding commercial construction loans was 473,000 or 41 basis points of total commercial construction loans, as compared to 807,000 or 74 basis points at September 30, 2008. At this point in time, we have one commercial construction project in non-accrual status in the amount of $2.9 million located in Klamath County.
We expect the current economic climate to have a negative impact on commercial properties, especially commercial properties and sectors of the market most exposed to cutbacks in spending by consumers and corporations. For example, retail strip centers and shopping malls, office buildings, wholesale distribution, and hotel properties. Accordingly, we have significantly curtailed our origination activity for commercial construction, particularly in non-owner investor properties which Xandra alluded to earlier.
At December 31, 2008, our commercial construction portfolio is 22% owner occupied and 77% non-owner occupied. Projects are primarily located in three counties; Clark County in the State of Washington and in Oregon, Washington County and Yamhill County.
The top three product types as a percentage of outstanding loans are retail, office and manufacturing. It's important to note that we have a significant retail project located in the Portland area in about $19 million, which is a stabilized occupancy.
Term commercial real estate. Term commercial real estate loans are the largest component of the Bank's real estate portfolio. At December 31, 2008, outstanding term real estate loans totaled $882 million, representing about 43% of all non-two-step loans. The mix between our owner-occupied and non-owner-occupied continues to be about 50-50.
The three counties with the largest amount of outstanding loans in Oregon include Multnomah County, Marion County, and Washington County. Property types are mixed with office and medical buildings, representing the most significant product types, followed by manufacturing and industrial.
At 12/31/2008, term real estate loans 30 to 89 days past due were only about 15 basis points of the term real estate portfolio. Non-accruals were $3 million or 34 basis points, and net charge-offs were less than $1 million for full year 2008.
The home equity portfolio. Home equity portfolio continues to perform satisfactorily. At quarter-end, outstanding loans were $273 million or about 13.5% of total non-two-step loans. The $273 million is broken down between lines of $240 million and loans of $33 million. Delinquency was four basis points and non-accruals were low at 38 basis points. Net charge-offs for the fourth quarter were 121,000 or 4 basis points, and for full-year 2008, 244,000 or 9 basis points.
With rising levels of unemployment, line utilization is something we watch closely. At December 31, 2008, overall line utilization was approximately 56%.
The nonstandard portfolio segment. Nonstandard mortgage loans, which represent mortgages provided to previous two-step borrowers who are motivated to retain their properties, totaled $33 million at December 31st. New originations for the quarter amounted to $3.8 million and will diminish going forward as the two-step portfolio fully matures.
We believe the level of nonstandard loans, both accrual and non-accrual, peaked in the fourth quarter and will decline going forward. Delinquent nonstandard loans 30 to 89 days past due were $956,000 or about 3.10% at quarter-end. During the fourth quarter, NPA levels associated with the nonstandard loans increased approximately $7.8 million to $19.6 million and consisted of non-accrual loans of $15.2 million and OREO of $4.4 million, which includes about 16 properties.
Of note, nearly 40% of the $15 million in nonstandard mortgage loans on non-accrual status continued to receive timely loan payments. As of September 31, 2008, all nonstandard loans have been measured for impairment and written down to fair value of their underlying collateral less selling expense. Net charge-offs associated with nonstandard loans for full year 2008 was about $3 million and were largely related to impairment charges.
Commercial and industrial loans. The Bank's C&I loans were $482 million at quarter-end, representing 23% of the total non-two-step loans. We have seen a downward risk rating migration develop among commercial businesses that operate within the supply chain of product and/or services used by the housing industry.
A number of these businesses, contractors, wholesale suppliers, nurseries, wood products have experienced declines in sales volume, slower turnover of current assets and declining levels of profitability that have made some downgrades necessary. By and large, most of these businesses are responding timely to changes in the economic environment by taking appropriate actions. Most are focused on conserving cash either by postponing expenditures, reducing expenses or selling non-contributing assets.
At December 31, 2008, commercial loans 30 to 89 days past due were $2.8 million or 58 basis points of C&I loans, which represents an increase over third quarter delinquencies of 6 basis points. Non-accrual commercial loans were essentially flat at $6.2 million or 1.28% of total C&I loans compared to $6.6 million or 1.32% at September 30, 2008.
An increasing amount of non-accrual C&I loans are related to the nursery segment of our agricultural portfolio, as discussed by Xandra. Shade tree growers are finding the downturn in housing especially difficult.
Net charge-offs in the C&I portfolio totaled $3.2 million in the fourth quarter and $6.5 million for full year 2008 or approximately 1.27% of average annual C&I loans.
At this point, we're not looking for a material improvement in economic conditions through 2009. As mentioned previously, these conditions will continue to put pressure on our builders and developers, and the C&I business is dependent upon residential home activity. I expect first quarter provision expense to be largely driven by deterioration in residential construction.
Overall, it's likely that first quarter provision expense will continue at elevated levels. December 31, 2008, we believe that the allowance for credit losses of $29.9 million or 1.45% is adequate to cover losses inherent in the total loan portfolio.
Back to you, Anders.
Thank you, Hadley. Let me give you a couple of observations on the local economy and the latest data we have for November through December that will be released later today. It may just have been released this morning.
Seasonally adjusted Oregon non-farm payroll employment had declined by about 35,000 or 2% from the peak in February of 2008. The state lost about 6,300 jobs in November, and that's the fourth consecutive monthly loss of more than 4,000 jobs. The state's unemployment rate rose to 8.1% compared to the national average of 6.7% and from 5.4% a year ago.
Except for the past couple of years, Oregon's unemployment rate has generally exceeded the national unemployment average by 1.5% to 2% due in part to the immigration. So that's not an unusual situation for Oregon.
In Washington, job losses have been slightly less over the past year at 22,000 or 0.8%. In both October and November, the year-over-year employment growth was slightly negative, less than 1%. For history, during the 2001 recession, Washington employment levels declined for 12 consecutive months.
After first showing up in construction, job losses now are in both states extended across more industries with losses in manufacturing, leisure and hospitality, trade, transportation and utilities. The only positive sectors were education and health services along with governmental employment.
In terms of the housing market, within Oregon and Washington, the counties where we operate home sales in December was down 32% from last year December, closing the monthly inventory to increase to about 14 months, up from about 11 months, a level of which was fairly stable throughout 2008. Positively, the inventory was only up 4% year-over-year in December, and that's the smallest year-over-year monthly increase since we began our tracking sometime in 2005.
In terms of our outlook for 2009, it's obviously very difficult at this stage to provide a lot of color, but we certainly expect to maintain a defensive position. While we do have the capabilities and capacity to grow, we believe it's prudent to stay focused on managing the portfolio and its credit issues at this point.
It is important to understand while our residential construction NPA level is elevated between two-step and non-two-step residential properties, our total loan portfolio exposure going forward to residential land and site development is less than 4% of total loans and thus quite limited.
This number is significantly lower than nearly all community banks in the Pacific Northwest. For example, in dollars the remaining performing residential and commercial site development and land loan site development loans was less than $40 million at year-end 2008.
As Hadley mentioned, the other important variable is how the non-residential construction portfolio representing 90% of total loans will hold up in a sustained weak economy. A modest loan production for the time being and a shift of non-accrual two-step and other residential construction loans into OREO, we anticipate that loan portfolio will continue to contract in the first half of 2009.
In terms of the margins, we project the margins to move up slightly compared to the most recent quarter. Our deposit balances should move pretty much in line with our loan balances as we're trying to continue to manage our total overall average loan to deposit ratio.
With respect to fee income, market sensitive revenues as was the case in the last half of 2008, will stay under pressure until the equity and/or credit markets return to a more stable condition.
As Bob indicated in the context of the environment and the potential for further economic slowing, we are and will continue to be managing our expense base very tightly where there are opportunities to do so without affecting our strong customer relationships.
And with that, I will hand it back to Bob.
Okay. Thanks everybody. I will make few remarks here. While 2008 was a challenging year, I think we are expecting and preparing for 2009 to be similar in terms of challenging.
I like to just take a minute to reflect on a couple of things that may be of interest to all of you. If we look at our combined net income for the years 2007 and 2008, we have a profit of $16.8 million in 2007 and a loss this year. For the two years, a combined profit of $11 million. For the two years 2007 and 2008, we had total provision for loan losses of over $79 million.
During those two years we have valuation adjustments in excess of $5 million and during those two years, we had in excess of $6 million of OTTI adjustments, Freddie Mac, Fannie Mae, Lehman Brothers, etc., etc. So, over the past few years between total provision, valuation adjustment and OTTI, we have absorbed over $90 million of charges. And during that period, we have had a net income of about $11 million.
However, during the three-year period from 12/31/06 to 12/31/08, our capital ratio has gone from 10.23% to 10.93%, an improvement to 70 basis points. As Anders indicated, the impact of the two-step to us in 2008 was roughly $15 million after-tax or $1 a share. We expect that to diminish in 2009.
And I'd point this out to put this in the context to look at the strength of our core businesses, whether it be payment systems or the core deposit business, the strength of the rest of the 90% of our portfolio, which is operating we believe at good levels relative to the economic condition, and our ability to manage operating expenses, which we have put a great deal of scrutiny to, along with our ability to manage our risk-based assets so that we can manage to the capital levels that we have indicated and to remain well-capitalized, because that's clearly our goal.
Another way to look at this, at our current capital levels, we have a pretax cushion of excess of $30 million to maintain well capitalized at 10%. So, while 2009 is going to be a challenging year, I think we have done our best to prepare ourselves.
The last thought I am going to leave you with, in the conference call we had with the management team yesterday, I laid out our short-term objectives for 2009: continue to grow our core deposits in all customer segments, continued timely communication with our employees and customers, continued disposition of OREO properties, continued growth of risk-based assets, control our operating expenses and to maintain our well-capitalized status.
So, with that, I realize we have gone quite a bit of time, but hopefully you found the information useful. We'd now like to open it up for questions.
[Operator Instructions]. Your first question comes from the line of Jeff Rulis.
Jeff Rulis - D.A. Davidson & Co.
Jeff Rulis - D.A. Davidson & Co.
I wanted to see if you had any more capacity to downstream capital from the holding company at the bank if there is a bit of a room there.
Jeff Rulis - D.A. Davidson & Co.
Okay. And given sort of your expectation, I guess, everyone's expectation that 2009 will remain challenging on the economic front, I don't know if you could comment any more specifically on a potential capital raise or any other options, the capital purchase program, if you are looking at those things, if you could comment on that.
As we have talked or said in previous calls, we continue to analyze our capital position. We continue to take actions that we think are in our best interest to preserve and grow capital, as evidenced by controlling operating expenses, which is the least costly form of capital for us to raise. As you know, we reduced the dividend to $0.01 and controlled our risk-based assets. So, we continue to manage all of the things that we have talked about in the past.
Jeff Rulis - D.A. Davidson & Co.
And then, just real quick; Anders, I don't know if you could just breakout the margin decline in the quarter, the 32 basis points. Could you break that out in terms of what was interest dispersal, what was just core margin compression?
Are you talking about linked-quarters?
Jeff Rulis - D.A. Davidson & Co.
It was a combination of lower amortized construction fees in the margin, slightly lower value of the DDAs given the current market rates, as well as a compression in the spread between loan and deposits, due to the rapid decrease in market interest rates.
Jeff Rulis - D.A. Davidson & Co.
But in terms of a basis point interest reversals, was what portion of that 32 basis points?
That was not meaningful. That was not substantial in the quarter.
Jeff Rulis - D.A. Davidson & Co.
Your next question comes from the line of Louis Feldman.
Louis Feldman - Hoefer & Arnett Inc
Louis Feldman - Hoefer & Arnett Inc
A couple of questions, kind of split between Hadley and Xandra. In terms of C&I, CRE and HELOC, Xandra, did I hear you correctly in terms of the CRE construction, that was more in terms of that was not new origination, but balances rose because prepayments slowed. Is that correct?
That was CRE term portfolio, yes.
Louis Feldman - Hoefer & Arnett Inc
CRE term portfolio, so not construction?
Louis Feldman - Hoefer & Arnett Inc
Okay. And then, Hadley, can you talk about what you're seeing in terms of potential deterioration on the CRE term portfolio as well as C&I? And I would throw in there; given the miserable last two weeks of December that we had, have you seen any early figures from some of your retail C&I borrowers or businesses that might have been impacted and can you comment on that?
I will start with the CRE term portfolio. As explained in the comments I had, the portfolio is performing nicely at this point in time. We are aware absolutely of the risks in the marketplace, but we are taking action to monitor that portfolio very aggressively through stress testing. And we are particularly interested in the impact that a retail environment under pressure has, as well as we also are looking at those customers that have leasee's that depend greatly upon any kind of business linked to the housing industry as well. And so, we're sorting through the portfolio.
At this point in time, we believe the portfolio is very mature, which is a benefit to us, as well as not at this point identifying any large issues within the book. So I feel pretty comfortable at this point in time. With regard to where we stand with retail clients, we expect to have some clients with retail problems. At this point in time, they are very minimal. We don't have a big retail exposure. And so, it's something absolutely that we're focused on and will track, but at this point in time not aware of anything that's substantial.
Louis Feldman - Hoefer & Arnett Inc
And then, I would ask the same about the HELOC portfolio.
The HELOC portfolio, as I've indicated, has performed very well. Naturally, we're concerned about rising levels of unemployment and how that ripples through. Both delinquencies, net charge-offs are low and we haven't seen a material change in the behavior of the portfolio. We have seen and we break it down pretty granular in terms of looking at it. We have seen some market segments within the portfolio have increased levels of utilization, but there's small overall.
Louis Feldman - Hoefer & Arnett Inc
Okay. Thank you, very much.
[Operator Instructions]. You do have a follow-up question from Louis Feldman.
Louis Feldman - Hoefer & Arnett Inc
Actually never mind. I will just simply pass on it. I was going to ask you straight out if you had applied for TARP or not, because this is the time to do it, but I will just skip it at this point in time. Thank you.
There are no further questions at this time.
Okay. We thank everybody for participating, apologize somewhat for taking longer than usual, but on the other hand, we hope you found the information helpful and thorough. So, thank you all and we will talk to you next quarter. Bye.
This concludes today's West Coast Bancorp Q4 conference call. You may now disconnect.
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