Pacific Continental Corporation Q4 2008 Earnings Call Transcript

Pacific Continental Corporation (PCBK)

Q4 2008 Earnings Call

January 20, 2009 2:00 pm ET

Executives

Michael A. Reynolds – Chief Financial Officer & Executive Vice President

Hal M. Brown – Chief Executive Officer & Director

Roger S. Busse – President & Chief Operating Officer

Charlotte Boxer – President & Director Commercial Real Estate

Casey Hogan – Executive Vice President & Chief Credit Officer

Analysts

Jeffrey A. Rulis – D.A. Davidson & Co.

Timothy N. Coffey – FIG Partners, LLC

Tim O’Brien – Sandler O’Neill & Partners, LP

[Dustin Brombrow] – Regan McKinsey

Ross Haberman – Haberman Value Fund

Presentation

Operator

Welcome to today’s event Pacific Continental Corporation fourth quarter webcast and conference call. Before we get started I would like to explain some of the ways that you can participate. This presentation is being recorded and you are currently in listen only mode. At the end of today’s seminar we will have a question and answer session. (Operator Instructions) Without any further delay I would like to introduce our first presenter Mick Reynolds, Executive Vice President and Chief Financial Officer.

Michael A. Reynolds

This is Mick Reynolds, Executive Vice President and CFO of Pacific Continental Corporation. Welcome to Pacific Continental Corporation’s conference call and webcast to discuss our fourth quarter and full-year 2008 results. Presenting today will be Hal Brown, Chief Executive Officer; Roger Busse, President and Chief Operating Officer; and me.

We will update you on our recent activities and discuss the financial results reported in a press release distributed prior to market opening January 20, 2009. At the conclusion of our prepared remarks we will provide analyst and institutional investors with a question and answer opportunity where we will address any questions and provide additional background information where appropriate.

During the Q&A session Charlotte Boxer, President of Commercial Real Estate Markets and Casey Hogan, Executive Vice President and Chief Credit Officer will also be available to answer questions. Today’s press release is available in the investor relations section of our website at www.TheRightBank.com.

Before we commence the formal remarks, we advise you that this webcast contains forward-looking statements. Statements made are factual as of the time of this webcast. Such forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those projected. Pacific Continental Corporation undertakes no obligation to publically revise or update the forward-looking statement to reflect events or circumstances that arrive after the date of the company’s fourth quarter 2008 earnings release referenced in this webcast and the date of this webcast.

Participants and listeners should also carefully review any risk factors described in the company’s periodic reports on Form 10K, 10Q, 8K and any other documents filed or furnished from time-to-time with the Securities & Exchange Commission. This statement is included for the express purpose of invoking the Safe Harbor provisions.

Now, let me introduce and turn the call over to Hal Brown, our Chief Executive Officer.

Hal M. Brown

It seems as though an eternity has passed since we last spoke to you in October and we are pleased to be able to update you on our fourth quarter results and the prospects for 2009. During the fourth quarter the financial services industry continued to experience unprecedented change. The banking world gets more interesting with each passing week and adding to the industry woos is the prospect of an extended and deep recession.

Despite these obvious challenges Pacific Continental has continued to perform well and as you have read in our press release the fourth quarter results were really actually outstanding. These are good results and they continue to reflect the strong credit practices that were and continue to be employed in all segments of our portfolio.

It would be disingenuous for me however to claim that these best practices will leave our bank unscathed in this difficult environment. We experienced a slight increase in our non-performing assets and as Roger will speak to later, we believe this trend will continue during the first part of 2009. Nevertheless, we are comfortable with the complete credit analysis of our portfolio and we have our unallocated reserves at the highest approved levels.

Our fourth quarter core deposit growth was much less from that which we generally experience this time of year and it is apparent that the reduced commercial client activity is the reason for the lower deposits. On the asset side of the balance sheet and in contrast to what Congress is implying, we continue to make good loans as is evident by the 16% year-over-year growth. We remain comfortable that our many liquidity sources can be accessed should we need them and we regularly test their availability.

Interestingly, our Q4 2008 net interest margin expanded to the highest level in years as almost all of the favorable factors Mick cited as possible in our Q3 conference call came to pass. Finally, our capital position remains quite strong and with the addition of our successful private placement announced this January 7^th, our capital to risk weighted assets exceeds 12%.

As I said, these are unprecedented times and Pacific Continental continues to be a top performer. Our practice is to be transparent and we will continue that practice today. In fact, because of the current environment, we have expanded detail in our loan portfolio discussion and trust that this added disclosure will assist you in your evaluations and modeling. With that as an introduction I’ll ask Mick to continue the presentation.

Michael A. Reynolds

In my portion of the presentation I will be covering our net interest margin, liquidity position, non-interest income and non-interest expense. I will make a year-over-year comparison and when appropriate I will discuss comparisons on a link quarter basis. Also when appropriate and as best possible I will provide listeners and analysts with a first quarter 2009 expectation.

Our fourth quarter 2008 net interest margin was 5.28%, the highest quarterly net interest margin we have reported since the fourth quarter of 2006. For the full year 2008 our net interest margin was 5.21%, down only one basis point of last year’s margin of 5.22%. On a link quarter basis, our fourth quarter net interest margin was up 20 basis points over the prior quarter.

In our third quarter 2008 conference call I outlined several factors that could lead to the improvement of our fourth quarter net interest margin when compared to third quarter and indeed, those factors were present. These factors included the effect of interest rate floors on the bank’s variable prime rate loan portfolio, loan pricing opportunities due to the generally lower level of credit availability within our markets, the planned shortening of the maturity structure of the bank’s alternative funding which when combined with the activation of the floors has made the bank’s balance sheet slightly liability sensitive.

The multiple sources and the availability of overnight funding that allowed the bank to consistently use the lowest cost short term funding which has in turn led to an average cost of overnight borrowings at approximately one half of 1% during much of the fourth quarter. Last, the continued decline of the 91 day Treasury bill rate that has lowered the rate on approximately $121 million of the bank’s indexed money market accounts.

Looking forward, there are factors suggesting some margin compression during the first quarter 2009 when compared to fourth quarter 2008. These factors include the continued competitive pricing of core deposits in all of the bank’s markets, a core deposit promotion currently underway to attract money market and timed deposits at premium rates. Third, a strategic repositioning of the pricing of the bank’s core deposits particularly money market and savings products to both retain current clients and attract new clients.

Four, the fact that because virtually all of the bank’s non-maturing core deposits are at stated or virtual floors, there is no further margin lift available should short term market interest rates fall further. The practice and use of writing new and renewed loans with floors combined with an expected continuation of loan pricing opportunities in our market due to the reduce competition is expected to mitigate some of the factors that are projected to negatively impact the bank’s first quarter 2009 net interest margin.

However, despite these mitigating factors, we do expect a link quarter decline in the bank’s first quarter 2009 margin in the range of five to 10 basis points. Now, I’d like to discuss the bank’s current liquidity position. During the fourth quarter 2008 the bank did not experience the seasonal core deposit growth as in prior years as evidenced by the decline in average core deposits on a link quarter basis.

This decline as mentioned in the press release is due to economic conditions evident in our commercial client activity. As an example and evidence of this reduced activity, merchant bank card volumes on a November year-over-year basis declined 7% for the same client activity. The bank did experience a net gain in new deposit accounts and client relationships which bodes well when economic conditions improve.

However, the bank’s liquidity position still remains strong and management believes opportunities exist in all three of our markets to grow the core deposit relationships during the first quarter 2009. With the bank’s current core deposit promotion for money market and timed deposits, combined with its strategic repricing of certain portions of its core deposit base, some growth in core deposits is expected during the first quarter 2009.

In addition, the bank continues to have full access to a wide number of alternative funding sources. Presently, the bank has secured borrowing lines with the Federal Home Loan Bank of Seattle and the Federal Reserve Bank of San Francisco totaling $312.3 million. The bank also has unsecured borrowing lines with six correspondent banks totaling $118 million. These unsecured lines remain unchanged and fully intact when compared to a year ago and are regularly tested.

In addition, Pacific Continental has full access to the broker CD market and was actively using this funding source during the fourth quarter 2008 as spreads narrowed in this market and pricing became more competitive with other wholesale funding sources. As of December 31, 2008 the bank was using approximately $68 million in brokered CDs for funding.

Finally, the bank has approximately $35 million of short term funding available through the state of Oregon and Washington CD programs for community banks. In addition, during the fourth quarter 2008 the bank and the holding company enrolled in both the excess deposit and debt portions of the FDIC temporary liquidity guarantee program. While we had no qualifying debt outstanding at September 30, 2008 we do have the ability to issue qualifying debt of approximately $19 million with regulatory approval.

With these multiple alternative funding sources, the bank has ample access to liquidity and more important, is able to manage the use of these sources in a manner that maximizes the bank’s net interest margin. Turning to non-interest income, total non-interest income was $1 million in the fourth quarter 2008, virtually the same as reported for the third quarter. On a year-over-year basis, the bank continued to experience solid increases in account service charges on the analyzed business accounts due to the lower earnings credit on deposits and increased merchant bank card fees due to new merchant relationships and better margins.

Looking forward to the first quarter 2009, the bank expects non-interest income will be similar or slightly down from fourth quarter 2008. While service charges on analyzed accounts are expected to increase due to the low interest rate environment, merchant bank card fees are expected to drop in the first quarter 2009 due to seasonal declines in volume combined with the negative impact of the current economic conditions.

Last, I will report on our non-interest expense. As we projected in our third quarter 2008 conference call, on a link quarter basis non-interest expense of $7.4 million in fourth quarter was virtually unchanged from third quarter 2008 showing a slight $62,000 decline. For the full year 2008 non-interest expense was $29.6 million, an increase of $3.7 million or 14% over last year. Personnel expense accounted for the majority of this increase, up $2.4 million on a year-over-year basis.

Increased salary expense and increased benefits and taxes accounted for $1.7 million and $700,000 respectively. Approximately $442,000 of the increase in salaries was due to lower loan origination costs which are a direct offset to salary expense with the remaining $900,000 related to staff additions and performance increases. The increase in benefits and taxes was primarily attributable to higher group insurance costs, up $228,000 over last year and increased accruals for incentive compensation up $406,000 over last year.

Looking forward to the first quarter 2009 we do expect non-interest expense to increase over fourth quarter 2008 levels. The expected increase is due to higher FDIC insurance accruals expected to add approximately $250,000 to first quarter 2009 expenses combined with planned increase in marketing expenses. In addition, continued compression of loan origination costs which is a direct offset to salary expense is expected during the first quarter of 2009 when compared to the prior quarter which will increase reported salary expense for the quarter.

That completes my prepared remarks and now Roger will continue the presentation.

Roger S. Busse

Today my portion of the presentation will focus on credit quality particularly centered in our CRE and residential portfolio, the quarterly outlook for OREO and NPAs, as well as the adequacy of our provisioning and loan loss reserves. As we have consistently done on each conference call with regard to credit, we will provide you with the most transparent understanding of our portfolio possible.

After our formal comments are completed, Casey Hogan, Chief Credit Officer and Charlotte Boxer, President of Commercial Real Estate will join us to answer any additional questions you may have. Let me first set some context, in line with our expectations and previous conference call comments, the bank’s credit quality remained quite strong as of December 31, 2008.

Non-performing loans net of government guarantees were .71%. Losses hit our target expectation of .15% of the total portfolio and our updated CRE sensitivity and stress testing analysis continue to confirm a solid portfolio with strong LTVs and cash flows. I will provide more details about this study in a few moments including updated information on cap rates.

Our number of watch credits did rise moderately but again, in line with our expectations and as part of our early warning mentality and conservative approach to risk rating. In November, 2008 we initiated a special and in depth portfolio review by an independent third party group of all watch or worse rated credits and several higher risk pass rated credits. The purpose of this independent analysis was to validate the accuracy and timeliness of our risk ratings and action plans on any problem loans or even potential problem loans.

The results were very strong and we are very pleased. The third party examiners found no significant risk rate changes. They complimented the consistency and validity of the bank’s accuracy and timeliness of risk ratings as well as the strength of lender action plans to remediate or move our problem credits. Of course, another outcome of this report was the validation of the adequacy of our loan loss reserves at the current level or 1.15% as a percentage of period end loans.

These solid credit statistics and examiner results were combined with a record annual growth in loans for the year of $134.4 million or 16.35% over year-end 2007. This growth was centered in quality assets further strengthening the industry and geographic diversity of the portfolio. Consequently, there continued to be a stable growth in C&I lending of $39.2 million or 21% over the previous year-end.

Also, growth continued in our dental and professional segment. This segment now represents 12.8% of the total loan portfolio has only a handful of small problem loans and has the potential for further quality expansion even in the face of a severe recession, particularly at our Portland and Seattle markets.

Low yields due to solid pricing and our continued practice of setting floors on adjustable loans continue to help contribute significantly to our net interest margin. All loans with floors, or approximately $280 million of loans were active. All new loans and renewals require floors and we have set an absolute floor in our pricing parameters. Our gate keeping and underwriting continue to focus on loan quality first followed by profitability and then growth. This has never wavered.

More, we initiated recessionary credit practices and strategies which underscore enhanced analysis of all primary, secondary and tertiary sources of repayment and collateral values including in some cases orderly liquidation values, rigorous quarterly financial reviews, lender training for early detection of possible problem loans during our watch loan meetings, deeper review of stable and sustainable cash flows and analysis of our borrower’s client list. Expansion of our undesirable industry list also occurred.

This guarding the gate for new and renewing credits continues to prudently screen our asset expansion and maintain quality loan growth. With regard to commercial real estate, all of our CRE projects continued on normal schedules for completion. CRE construction accounted for 12.2% of the portfolio. As of December 31, 2008 we have only CRE construction project on watch at this time for approximately $700,000.

This project had some delays but is now proceeding on a revised schedule and is still pass rated. More important, in December we completed an updated quarterly CRE stress testing for investor properties. That is all properties non-owner occupied by vacancy and interest rate. This is a rigorous stress testing process, it has been praised by all third party examiners. The results continue to underscore a stable and resilient portfolio during the stress of a moderate to severe recession.

To be transparent, this quarter we reviewed and stressed 58% or $212.9 million of the CRE portfolio, that’s 115 individual loans with balances over $750,000. This sample included loans in all CRE segments including professional offices, warehouses, multipurpose office, recreational and restaurants, apartments, retail, hotels, assisted living facilities and by the way, we have no [Sun West] Properties and religious organizations.

I would remind you that we have no concentration in any of these segments. The stress testing pushes vacancy rates beyond rates expected for a severe recession. For example, the 2009 market outlook, that is the [Marcus & Milkamp] 2009 Annual Report anticipates apartment vacancies, for example, to raise 120 basis points to 6.6% vacancy in the Portland market. Our stress testing pushed vacancies for related credits up to 20%.

Overall, the final results identify two new credits overall in the portfolio as outliers but certainly having adequate cash flows at present and LTVs based on stressed cap rates. Two other credits were removed due to their strengthening. Overall, our total outlier credits remained constant at eight total credits. In sum, there were no significant changes as evidence of a resilient and seasoned CRE investment portfolio.

It is interesting to note the average LTVs in some of these segments in the PCB portfolio such as office buildings where the LTVs were 65.6%, apartments at 67.5%, hotels at 59.9%, retail anchored at 67.82%. Overall, the reviewed portfolio average LTV was a low 58.29%.

Some of you have asked for updates in vacancies and cap rates in our markets, let me provide some color for just a moment. Vacancy in Class A office space was up 30 basis points to 8.5% during 2008. 2009 expectation for Class As space vacancy is a rise to 11.8%. Class B & C office space vacancy is up to 14.8%. Cap rates have risen overall in office space from 6.75% to the low 7% range. However, in some Portland downtown buildings cap rates are still in the 5% range.

Seattle has seen some deterioration in vacancies and cap rates as well. At the end of year 2008 medical office vacancy was up 100 basis points to 6.3% but it may rise to 7% in 2009. Warehouse and industrial cap rates have risen as well to approximately 7%. Retail vacancy rates vary substantially by sub region but range from 8% to 15.7%. As we have consistently reported, we have minimal exposure to retail.

Finally, apartment vacancies could begin to rise from the current 5% to 6.8% while cap rates slipped to 6.5% from the current 5% cap rate. Traditionally cap rates for apartments as you all know are in the 8% range so they are still strong.

Now, I’d like to provide an overview of our trends in non-performing and OREO assets as described in just a moment and performing as the basis for our next quarter end outlook which we’ll provide some clarity on. First, we continue to see good contraction of problem credits in our consumer construction portfolios which is on target with our expectations and previous conference call comments.

As of December 31, 2008 OREO fell to 24 properties, 17 homes and 17 lots for $3.8 million in the consumer construction portfolio. Sales continue to reduce outstandings and we currently have two sales pending for $400,000. Non-performing loans in this portfolio were approximately $1.1 million at year end and fell to seven properties with one sale pending. There are minimal remaining credits expected to migrate to non-performing status. As we have noted we have seen the cap and we are now coming down.

While 2008 losses have been higher than expected in this portfolio due to market conditions, future losses based on our updated impairment analysis are minimal as our cash guarantees continue to cover the outlook for much of these deficiencies. Overall, we expect problem loans in the consumer construction portfolio to contract approximately $1 million by next quarter end or to approximately $4.2 million.

Second, we continue to hold the previously discussed $1.7 million commercial development property in Seattle area in non-performing assets. However, there is a sale possible in the next 90 days, perhaps even by quarter end and also great interest in this property by other potential buyers. While this is still tentative the negotiations continue, we believe it is probably this property will be sold and no loss is expected as the LTV is strong at 68%.

The only other additions to non-performing loans during the fourth quarter were two small loans. One was an SBA guaranteed loan for $320,000 and another small C&I loan for approximately $100,000. There are limited to no loss expectations on these properties as well. We have recently seen some isolated deterioration in our commercial residential builder portfolio. One Portland builder with residential projects totaling $7.2 million has entered negotiations with the bank on these projects.

To provide you with the most transparent outlook possible, the outcome on these negotiations is uncertain at this time but it is possible that approximately $5 to $6 million of these properties will migrate to non-accrual by the end of the first quarter or early second quarter. The mix includes both finished and unfinished homes and some lots. There is limited loss exposure as current updated appraisals have been received showing a blended LTV on a bulk sales value of 85%.

There is recourse to the developer as well who reported a 2008 over $5 million in liquidity although currently liquidity is obviously less certain and is being determined at this time. We are adequately and conservatively reserved on this relationship so no additional reserving is required.

There also is one project in Seattle that has four homes. Three are completed and one is construction totaling $2.2 million and there is some stress in this project. While there are active sales on two of the four homes on this project, it is possible that the failure of a sale would result in further downgrades thus, we’re being transparent. Updated appraisals, supplemented by recent offers show we have very little, if any, loss exposure. We are also adequately reserved on this credit.

Finally, we also identified there other small individual projects totaling less than $1.2 million that are or may come under stress. All are also well reserved, are recourse and have either sales pending or expected with minimal, if any, loss exposures. We do not expect these three credits to add to our next quarter end NPA totals.

In sum, total NPAs could rise above 1% by the end of the first quarter depending on the dispositions and pending sales or actions relating to these isolated credits I’ve discussed. But, there is limited, if any, loss exposure anticipated at this time.

I would like to make a quick comment on residential supply, absorptions and prices as well. Residential home prices and price declines vary by development, city and county but in the Portland and Seattle metropolitan areas where the majority of our projects resides, properties contracted 10.2% and 10.1% respectively. In Portland there were only 987 home sales, the lowest level since 1992.

Supply has now topped 12 to 14.2 months in most areas we serve. But, in many of our developments we are seeing lower inventories. As the economy continues in recession, we are realest and expect that there is the possibility of additional deterioration in the home builder portfolio. We will continue to be with you transparent and always forward-looking.

Finally, with regard to the allowance for loan loss, the bank’s allowance as a percentage of period end loans was 1.15% at year-end, well above the 1.05% position held at December 31, 2007. The contribution for the fourth quarter was $1.1 million and was primarily related to loan growth and to maintain the unallocated reserve percentage at the higher end of the board approved range or 9.81% of total reserves.

Overall, our credit quality remains solid and our reserves are deemed satisfactory at this time. It is expected that future additions to loan loss reserves will be related to primarily loan growth but we will maintain a conservative outlook with respect to the general economy of course. That concludes my remarks. I will now turn the presentation back to Hal who will conclude our prepared remarks for today.

Hal M. Brown

Certainly the general outlook for 2009 has deteriorated since the last time we spoke. The economic climate is not particularly conducive for expanded activity and we do expect contractions in our commercial and residential real estate portfolios. Fortunately, we can look to our C&I portfolio and in particular to our dental activity to offset most or all of this contraction.

As Roger mentioned, we have instituted recessionary loan practices that will enhance our early warning methodology and give us a heads up for any emerging issues. Despite what is a challenging environment, we remain very optimistic and comfortable that we will continue to perform as a top tier institution. Of course, you have noted a prudent degree of caution as evident by comments regarding possible migration on our loan portfolio and factors that might negatively impact our net interest margin.

As I mentioned at the last conference call, I want our listeners to again understand that the purpose and tone of these comments is not to imply any material deterioration but instead a continued commitment to our practice of full transparency. I believe that in difficult environments it is especially important for us to continue this best practice. Pacific Continental is in a very unique position, we are prepared to prudently take advantage of any opportunities that the current environment may present.

We have the capital to meet the needs of our existing clients and to selectively serve additional businesses as declines in credit availability become even more apparent. We are also aware that industry consolidation will take place in our markets. Our due diligence teams are active and I can assure you that we will use a careful approach when evaluating these opportunities. Our lending core value of quality, profitability and then growth in that order, can be applied equally well in the consolidation environment.

In concluding my prepared remarks, I must recognize the exceptional work of our employees and board of directors in what is turning out to be a very interesting time. Everyone has worked hard and has contributed in multiple ways. We are doing our very best to be good stewards of your investment. I appreciate your confidence in your company and we are now prepared to entertain your questions.

I want to remind you that both Charlotte and Casey are also available to answer your loan portfolio questions. Operator, will you please now open the lines for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Jeffrey A. Rulis – D.A. Davidson & Co.

Jeffrey A. Rulis – D.A. Davidson & Co.

I wanted to ask Mick, on the margins was there anything one-time in the quarter that would have added to that strength?

Michael A. Reynolds

No. It was generally just a regular old margin, nothing unusual.

Jeffrey A. Rulis – D.A. Davidson & Co.

Then on the loan-to-deposit ratio, it’s a little high. I don’t know if that concerns you or if you’re comfortable with the current level of borrowings that you have.

Michael A. Reynolds

Well, we manage liquidity on an overall basis. We have a number of different measures including both short term and liquidity measures and total liquidity available. So, I guess I use all the tools I have in my kit right now and yes, our borrowings from the secured borrowing lines are a little bit higher and I’ve kind of avoided the brokered CD market but as I said, recently the spreads have come back down. I’d expect the loan deposit ratio probably would improve in the first quarter. Not only from both our core deposit base and then also from the additional use of brokered deposits.

Jeffrey A. Rulis – D.A. Davidson & Co.

But just longer term could I assume that’s going to be a philosophy of the bank to kind of hold higher borrowings then peers?

Michael A. Reynolds

I’m not sure it’s a philosophy. I mean, we do try and position ourselves as a borrower of funds. We don’t particularly like to be in a funds sold position and so we would try and position that. One of the things that we do have Jeff is when times are good, and actually times have been pretty good for us with record loan growth but, we’re in some markets that have a lot of loan demand so it’s important for us to be able to continue funding those and yes, it’s probably going to require some wholesale funding in order to fund those, the growth that we expect.

Jeffrey A. Rulis – D.A. Davidson & Co.

Then one last question, I wondered if you guys took a look at the Bank of Clark County or, if yes or no you’d be interested in other like deals down the road?

Hal M. Brown

We certainly were aware of that opportunity as we’re aware of others when the FDIC present those. We did look at that opportunity, took a hard look at it. There’s some unique elements to their core deposits that we did not find attractive and so we passed on that.

Roger S. Busse

We would look though at other opportunities as Hal said and we have an active interest in any opportunities.

Operator

Your next question comes from Timothy N. Coffey – FIG Partners, LLC.

Timothy N. Coffey – FIG Partners, LLC

I’m wondering, do you have a specific loan loss reserve target? I know you’re at 1.15% right now and you said that was the upper range but do you have a target at all or are we kind of at it right now?

Roger S. Busse

We don’t a target. I’ll let Casey speak to that in just a second, I’ll just set the stage for any additional comments he might have. What we do look for is the unallocated reserve percentage in relation to the migration of the portfolio to be honest Tim. So, when you have an unallocated reserve percentage at the upper end and you’ve just completed a rather exhaustive portfolio analysis and also understand the outlook for migrations, which we do a very good job of doing, the percentage falls out where it may.

So, it’s really a very comprehensive review where we need to be and if that analysis and migration shows that we should be at a higher unallocated or use some of the unallocated and add reserves to cover losses or migration then we’ll do so. So, the 1.15% was the same as last quarter but that was just by happenstance, that wasn’t by target design.

Timothy N. Coffey – FIG Partners, LLC

Then the Portland NPAs, is that more of a general decline in the economy of Portland or was it just related to a borrower specific issue?

Roger S. Busse

It’s a borrower specific issue. We have one Portland builder there although, it’s appropriate to say as we repeat in this webcast that there’s a general economic decline in residential construction and that’s obvious from our many, many other peer reports. However, we don’t have the issue of our peers and that is because of Charlotte Boxer’s directive with regard to the kind of projects as we’ve described before, we’ll get involved in which are in field smaller construction, no major huge lots development types of divisions in the Portland metropolitan area.

As a result for us to have one builder to start to develop some stress or smaller projects is not to be a surprise to us. But again, our LTVs and our outlooks are good and we fully expect to not experience loss. We may have some but we don’t expect that. I don’t know Casey or Charlotte if you would add to that?

Charlotte Boxer

I’ll just add to that real briefly Roger in that what we also have are very good financially sound borrowers who continue to have the capacity to service the debt on our real estate. There is a major initiative that is going before Congress very shortly that’s called Fix Housing First as a proposal by the HBA and it would reduce interest rates to potential 2.99% for anyone buying a new home or for home sales only, not for refinances. So, there are a number of initiatives within this Fix Housing First that could help prop up the residential construction nationwide. There’s a lot of focus on trying to fix the housing.

Timothy N. Coffey – FIG Partners, LLC

Looking at the loan portfolio, can you provide any information on how much of the loans without floors might be maturing in the next couple of quarters?

Michael A. Reynolds

Tim, we don’t have that information available to us, not handy. We’ll get that information.

Operator

Your next question comes from Tim O’Brien – Sandler O’Neill & Partners, LP.

Tim O’Brien – Sandler O’Neill & Partners, LP

Just going over those numbers you gave us a little bit earlier, in your commercial real estate review you looked at 58% of your total commercial real estate portfolio or what was it 115 loans and of that you came across eight outlier credits, is that correct?

Roger S. Busse

We had originally had Tim eight outlier credits, we still have eight. Two came off, two came on and of those, these are higher risk pass rated credits except for one is already on watch I think as a result. These are just ones we would stress that might become outliers that aren’t yet already identified so this is a forward-looking approach.

Tim O’Brien – Sandler O’Neill & Partners, LP

So the eight outlier credits, that’s kind of separate so what you just said is two came on as a result of that stress test out of 115 loans, 58% of the portfolio?

Roger S. Busse

Yes, of the investor portfolio, that’s correct.

Tim O’Brien – Sandler O’Neill & Partners, LP

Another question, on the tax, that energy tax credit is that a recurring credit and how long will that last?

Michael A. Reynolds

Well, it is a recurring credit. It lasts for five years but now we get state tax credit through the next four years. But, in 2008 we were able to take the full benefit on the federal side of things so the federal piece of it was a one-time deal. Since we bought it so late in the year we were able to take a full year tax benefit for it rather than spreading it out.

We are actively doing some tax planning right now and would expect, if the opportunity arises the credits we typically buy, these business energy tax credits are with our clients so it makes a good partnership that way also. But, we are actually looking for those in the first quarter, that would smooth it out. Absent that, I expect our effective tax rate to probably go to about 37.5% in the first quarter 2009.

Tim O’Brien – Sandler O’Neill & Partners, LP

I think that’s your historic run rate approximately?

Michael A. Reynolds

If we do have the opportunity to purchase these tax credits we will advise that in a webcast or press release to give you some information.

Tim O’Brien – Sandler O’Neill & Partners, LP

When you buy them where do the cost show up? What line item?

Michael A. Reynolds

Well, I guess there’s no cost. Basically it’s like you’re pre-paying taxes so it’s a debt to current income tax payable.

Tim O’Brien – Sandler O’Neill & Partners, LP

Then, could you tell me how many of the consumer residential construction loans continue to be outstanding numerically?

Casey Hogan

We have roughly 130 to 135 total loans in that portfolio many of which all with the exception of just a few have been underwritten within the last year under much tighter underwriting standards and so forth. If you go back to when we first started talking about this portfolio we’ve got about 18 loans remaining that would be considered investor types of loans where we’ve experienced issues and of those 14 are being actively worked through our watch program and moving forward. Some of those are being included in the non-performers that we already talked about today.

Roger S. Busse

I think it’s important too to note that when we started this process and reported to you the stress we had 295 loans in that portfolio. 108 that we previously talked about were investor or investor related. About 84 of those were the ones that we were concerned about. Casey has paired that down significantly as we reported and now the total portfolio only has about 130 loans and only 18 of those are investor and those have already been identified and are working through the system.

So, we don’t see any growth or additions. As we said, we capped off and its running down now, I think. Casey wouldn’t you agree?

Casey Hogan

I would agree.

Tim O’Brien – Sandler O’Neill & Partners, LP

So 108 in the third quarter ’07 I think is when this all kind of got started and now it’s down to 18. And, also at that time there were 295 total and we’re down to 135?

Roger S. Busse

Correct.

Tim O’Brien – Sandler O’Neill & Partners, LP

Just doing the math, if I combined from last quarter and this quarter total I guess under stress loans or other real estate properties you have 20 properties in OREO last quarter, 17 this quarter. You had nine NPAs, and this is all consumer residential, this quarter you had seven. And then, the dollar amounts are $4.5 million and $4.4 million this quarter so the question is this, it looks like the cost per loan or the actual loan amount or the dollar amount that you guys have these things marked at crept up from about $165,000 per parcel to $180,000 this quarter? Does that make sense? That’s how I do the numbers any way.

Casey Hogan

Tim, I think again it depends on the size of the homes that are coming in but generally that $250,000 to $280,000 is the upper end probably as an average so I think you might take that snapshot in time and see an increase. But again, we also have a fair number of those that are lot only and we have them carried on the books at maybe $35,000. So, it’s a snapshot in time based on the averages.

We haven’t seen any real significant increase in the portfolio average as a whole. It’s just the ones we happen to be working with.

Roger S. Busse

[Inaudible] the current mix and it’s very possible Tim just what you stated that the average might because of the number and because of the number say lot loans versus completed homes, the mix has changed so that could cause that average to move up or down a little bit.

Tim O’Brien – Sandler O’Neill & Partners, LP

Do you have a date when you’re going file your call report approximately? I mean, I’m not going to hold you to it too hard?

Michael A. Reynolds

I believe we’ve already filed it Tim.

Tim O’Brien – Sandler O’Neill & Partners, LP

Oh really? It’s not up. But, that’s the FDIC issue.

Michael A. Reynolds

It was all approved yesterday at the board and I believe it’s been filed. I think it was filed today.

Tim O’Brien – Sandler O’Neill & Partners, LP

You guys had other construction land development loans increased sequentially in the last quarter, there’s some seasonality to that stuff though too right?

Roger S. Busse

Yes.

Tim O’Brien – Sandler O’Neill & Partners, LP

I’m going to switch gears on you real quick and ask this one other question that intrigued me, is by back of the envelope, looking at your cost of borrowings, and you guys alluded to this a little bit, it looks like your combined or blended cost of borrowings went from 3.03% in the third quarter on $222 million in average borrowings, and this is combined, to 1.63% on $256.8 million so a pretty huge drop, 140 basis points?

Michael A. Reynolds

Yes.

Tim O’Brien – Sandler O’Neill & Partners, LP

Can you walk me through the color you gave on that one more time on how you got there? Because, you didn’t allude to that benefit, obviously that translates to a significant benefit on your margin and you didn’t mention that in your press release. You implied that a lot of it had to do with loan floors.

Michael A. Reynolds

Well, it has to do with both I think Tim. I think I alluded to two things, one is the loan floors and we also alluded to the fact that in my comments I talked about the fact that we’ve kept our wholesale funding and alternative funding as short maturities.

Tim O’Brien – Sandler O’Neill & Partners, LP

A lot of liquidity opportunity out there.

Michael A. Reynolds

Right. So, we were able to take advantage of the falling rate environment immediately. I stayed out of the brokered CD market because the spreads were high. I have no lag time. But, we become liability sensitive so in a falling interest rate environment I can reprice very quickly. To give you an idea of why that feel, for the life of me, it was three months ago but it feels like three years ago now but, our borrowing rates in the third quarter were probably in the 1.5% range.

To give you some flavor, as of December 31^st we had $20 million in borrowings in term auctions from the Federal Reserve Bank of San Francisco at .26%. We had Federal Home Loan Bank cash management advances of $60 million at .63%. We had FHLB short term advances of $89 million at .50%. We had correspondent bank borrowings of $24 million at .45%. So, that’s the way it was throughout most of the fourth quarter and at those rates we certainly were able to take advantage on the cost of funds side, yes.

Tim O’Brien – Sandler O’Neill & Partners, LP

You gave guidance on margin which is great so as far as borrowing costs is concerned is the rate environment, it’s relatively static? It hasn’t changed much since what you were able to buy or the rates you agreed to pay on these borrowings in the fourth quarter remain similar now as they were then, right? The environment has changed?

Michael A. Reynolds

The environment at this point has not changed. The FHLB advanced rates have moved up a little bit but not significantly that it would materially impact the overall cost.

Tim O’Brien – Sandler O’Neill & Partners, LP

Do you guys have a sense of the Seattle FHLB situation under stress given the press release they put out?

Michael A. Reynolds

I’ve read through it. A lot of it has to do with the way they have to calculate the regulatory capital and it’s not because they believe they have any losses in their mortgage backed securities portfolio. They stress test just as we stressed test ours, we had some private label in our portfolio to and they’re stress tested every month. They don’t anticipate losses but their regulatory requirements are that if they make an investment and the market value falls to less than 85% of their market value, they have to start holding 130% capital against it.

So, they’re being forced to – they’ve got the capital, they’re still profitable it’s just from a regulatory standpoint they’re being forced to hold capital against investments that they don’t believe are going to have any losses in them.

Operator

Your next question comes from [Dustin Brombrow] – Regan McKinsey.

[Dustin Brombrow] – Regan McKinsey

I just have one kind of general question and, by the way, I appreciate the expanded detail on the credit but, mine was just about your decision to decline participation in the CPP program. Clearly, you guys are looking better on the asset side than a lot of competitors but given the current level of uncertainty I would guess it was a lively discussion. I was just hoping you would kind of just share kind of a fly on the wall perspective of that board room discussion.

Hal M. Brown

We don’t have time to go over the entire board room discussion. But, yes it was a lively discussion. You’ll recall that our date to apply was I believe November 14^th and during that time there was a lot of uncertainty in the financial services market so our board did decided to apply and between November 14^th and our preliminary approval on December 11^th we got a lot more information about the agreement.

Clearly, we were disturbed by the ability for the Treasury to unilaterally change the agreement, a lot of commentary by Congress as to how those funds should be used and we concluded after getting very good indication that our private placement would be successful and that our balance sheet was such that we could access the private capital markets that it was not necessary to participate in the bailout and we wanted to have all of the flexibility possible with our balance sheet for rewarding our shareholders with dividends, to pass or accept consolidation opportunities without any strong arming by the Treasury or FDIC. So, I think it was a prudent decision and one that has proved to be good for our shareholders.

[Dustin Brombrow] – Regan McKinsey

Just one follow up on that, you mentioned the unilateral ability of the government to change the terms and I did look over the term sheets on all of that, were you referring to an implied unilateral ability or was there something explicit you saw?

Michael A. Reynolds

I read an article earlier this morning, our new Treasury Secretary is undergoing hearings has already stated that the TARP capital agreement is going to be completely revamped and made much more difficult and tougher. That’s one of his first actions he plans to take meaning that banks are going to have to start having a lot more restrictions on how they can use the funds, how they’re going to have to report on it.

So, immediately it appears right now if this Treasury Secretary gets what he wants the TARP program and the agreements everyone signed are going to be different in a short period of time.

Roger S. Busse

There is a section too in the agreement, 5.2 or 5.3 that explicitly states that they have that right, to unilaterally change it, to answer your question on that.

[Dustin Brombrow] – Regan McKinsey

Your understand is, and clearly I’ve been watching all of this, is that the new restrictions that may be coming down the pike are retroactive to funds already dispersed as opposed to just on any new money?

Michael A. Reynolds

Yes, absolutely that’s our understanding.

Operator

Your next question comes from Ross Haberman – Haberman Value Fund.

Ross Haberman – Haberman Value Fund

I’ve got a quick question for Mick, Mick could you tell us do you have any municipal deposits in your Washington operation?

Michael A. Reynolds

Yes, we do have some municipal deposits.

Ross Haberman – Haberman Value Fund

I was wondering, I was hearing what came out of that Bank of Clark County merger was that other banks in the state with municipal deposits are going to have to cover the uninsured loss as the Bank of Clark County, $30 million. Have you heard about that and have you sort of worked out what your hit might be?

Michael A. Reynolds

Let me try to clarify that. There were $38 million of uninsured deposits, those did not include the public deposits. I’m not sure the public deposits were that high. But, yes the way that the law is structured two things happen the first thing you need to know is how much did they have, their collateral gets seized and then to the extent that there is a short fall in the amount of collateral then every bank or financial institution that holds public deposits based upon their prorated share of all the public deposits in the system may have to cough up some portion of the short fall if there is any.

In other words, if they don’t have the collateral to pay it off then everyone has to kick in. We are actually right at this point researching where we are at in that percentage. But Ross, frankly it is minuscule. But, it is possible we could have something come our way but we would not expect it to be a material amount. Just for your own information and the listeners, the state of Oregon has almost exactly the same law and regulation. So, if a bank in Oregon failed and did not have the collateral it would be a very similar type of action.

Ross Haberman – Haberman Value Fund

I was interested in more again, I know the numbers are fairly small and if you do get hit it might not be a material amount but, I guess I was thinking about more in the future if you see this happen to bigger banks with more substantial municipal exposure if you have some potential exposure?

Michael A. Reynolds

We know for example, in Washington, our maximum exposure, meaning that if every bank in the system fails and had no collateral our exposure is $478,000 in the whole state of Washington.

Ross Haberman – Haberman Value Fund

I don’t believe that’s going to happen.

Michael A. Reynolds

Right, I don’t either but certainly Ross, if a Wells Fargo or a US Bank, I know US Bank holds a large, large number of deposits, that certainly could cause ramifications everywhere.

Hal M. Brown

You’re not implying any problems.

Michael A. Reynolds

No, I’m not implying any problems. I’m saying if one of those larger institutions that have a large percentage, that could be a problem for everybody, yes.

Ross Haberman – Haberman Value Fund

Just a follow up question for Hal, Hal do you think going forward that potential deals are going to be structured like Clark County was? Or, again the FDIC if they had their druthers would push a whole bank acquisition as opposed to just any potential buyer getting the deposits and real estate and branches for free.

Hal M. Brown

Well, we don’t have a great deal of these transactions to look at to conclude how future ones will be done. But, the ones that we have been aware of thus far were offered originally as whole bank transactions with a loss share arrangement and I think the quick evaluation in the one so far has resulted in the conclusion that the loan portfolios have too big of a problem to take the whole bank and then they become a deposit only transaction.

So, we’ve got to look at each one individually. The information given is very sketchy, it changes every day as it comes forward. It makes the evaluation difficult but I don’t think we can conclude any particular strategy with respect to how those will be issued.

Ross Haberman – Haberman Value Fund

Do you see these types of government take overs a further depressant to the real estate market? Because like in Clark County’s case, I don’t know the government is going to get all these loans now, they’re going to blow them out over the next three, to six, to nine months which is only going to further depress prices.

Hal M. Brown

I don’t know if they’ve announced they’re going to dump their real estate holdings. I think they’ll be prudent in trying to minimize the losses to the funds. So, we’ll just have to see how they dispose of those over time.

Operator

At this time there are no further questions.

Hal M. Brown

With that I want to thank everybody for attending our conference call. We look forward to doing it again in about three months. Have a good day.

Operator

Ladies and gentlemen this does conclude today’s Pacific Continental Corporation fourth quarter webcast and conference call. Thank you very much for joining us. Thank you to our presenters. You may now disconnect.

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