West Coast Bancorp Q2 2009 Earnings Call Transcript

Jul.24.09 | About: West Coast (WCBO)

West Coast Bancorp (NASDAQ:WCBO)

Q2 2009 Earnings Call Transcript

July 24, 2009 2:00 pm ET


Bob Sznewajs – President and CEO

Dick Rasmussen – EVP, General Counsel and Secretary

Anders Giltvedt – EVP and CFO

Hadley Robbins – EVP and Chief Credit Officer


Louis Feldman – Hoefer & Arnett Inc.

Jeff Rulis – D.A. Davidson & Co.

Joe Morford – RBC Capital Markets


Good morning. My name is Russell and I will be your conference operator today. At this time, I would like to welcome everyone to the West Coast Bancorp Q2 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.

Bob Sznewajs

Okay, thank you, Russell. With me today are Xandra McKeown, who is responsible for our commercial lending area; Anders Giltvedt, Chief Financial Officer; Hadley Robbins, our Chief Credit Officer; Dick Rasmussen, our General Counsel. And Dick I will turn it over to you.

Dick Rasmussen

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 and deposit growth, credit quality, the provision and allowance for credit losses, other real estate owned capital expenses, liquidity, our balance sheet, the housing market and the economy.

Our actual results could be quite different from those expressed or implied by our forward-looking statements, particularly in these uncertain economic times of rapid changes in conditions may cause even near-term results to deviate significantly from 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.

Bob Sznewajs

Hi, thank you very much. Good morning everybody. Thank you for joining us for the call. As we have talked in the past, in this environment our operating strategies have been oriented towards maintaining our capital levels and to improve our funding position, and I'm sure you have had a chance to look at our earnings release, and it is clear to me we have accomplished both of those.

The reduction in both loan balance and unused commitments over the last 18 months has preserved approximately 17 million in capital to offset the operating losses we have had during that time period to help us maintain our capital ratios. We have also been maintaining our ability to meet the core borrowing needs of our existing customers, which is very important to us, and it has also been an integral part of our strategy.

Our capital ratios as you have noticed has increased slightly, while our leverage and tangible equity ratios have remained at acceptable levels. Our loan to deposit ratio has fallen to 91% from 97% over the past three months and this is consistent with our strategy. Also our cost of interest-bearing deposits has continued to decline from 1.95% for this quarter compared to 1.74% in the first quarter of this year. I think indicative of our ability to hold, attract and retain low-cost deposits.

With respect to credit quality, which will be talked about later, in the first quarter, our total two-step portion of the OREO book has clearly peaked and will continue to decline for the remainder of the year. Combined with the seasonal trends, the introduction of several very attractive mortgage financing options for prospective buyers, this is (inaudible) the disposition of both two-step and non-two-step residential OREO properties.

And to date we have not had a large amount of non-two-step OREO properties to sell, however basically the inflow and the outflow and the non-two-step OREO for the quarter was relatively equal.

At the residential construction and land portfolio continues to decline, 247 million at the end of June 30, a decline of 29 million from the previous quarter. This portfolio now represents less than 8% of our total loan portfolio. The expense reductions were getting the full benefit of those, however, the higher FDIC charges have mitigated against that.

And for other details now I will turn it over to it Anders, who is going to talk about the balance sheet.

Anders Giltvedt

Thank you. Good morning and good afternoon everybody. Let me start with the balance sheet and the capital side. As Bob mentioned, it is pretty evident in our balance sheet we have focused diligently on managing our capital resources and risk-weighted assets over the past 18 months. The company's total commitments declined over 460 million or 16% over the past year.

The sharp decline in loan production coupled with the discretionary exit of certain relationships cost 11% or 237 million decline in total loans. The reduction here was mainly driven by the 169 million or 57% year-over-year contraction in the residential construction loan balances.

Total construction balances declined 18% just in the most recent quarter alone. A sizeable decline in our total construction portfolio, even our risk exposure has been meaningfully reduced over the past 12 to 18 months. As Bob noted, our total residential land and construction portfolio at June 30 accounted for less than 8% of total loans, down from 15% a year ago, and 24% at year-end 2007.

Our cost savings initiatives have also preserved capital, and it is an ongoing process to identify additional opportunities to reduce controllable expenses. Okay, in terms of core deposit and liquidity, our well-positioned branch franchises within the markets we operate continue to generate very good strong profitable low-cost deposit-base for us.

Additionally, our diversified product offering and very knowledgeable and experienced team members have produced an excellent deposit mix, where the CD mix has remained substantially below industry peers.

We were also very pleased with the sales results in the second quarter. We added over 2000 net new checking accounts, representing an annual growth of over 9%. Total checking account balances represented an attractive 37% of total average deposits in Q2. Over the past 12 months, as Bob indicated, we have also focused on enhancing our overall liquidity and funding positions as well as extending the repricing on the liability side, and we have accomplished an improvement in a number of fronts.

From mainly due to the higher deposits and lower loan balances, we saw over 200 million or 69% increase in our investment portfolio and short-term holdings in the second quarter. Our loan to deposit ratio declined from 104% a year ago to 91%. Consequently, our liquidity ratios have increased and our non-core funding dependence ratio declined from a level already much better than our peers.

During the second quarter, we also locked in from our perspective relatively low longer-term funding costs and reduced exposure to the volatility of the short-term funding market and potentially higher market interest rates. Additionally, we selectively reduced our public time deposits or moved these funds into fully insured transaction products due to the increase pledging requirements and the shared liability structure for uninsured public funds in Oregon and Washington.

We maintained fully pledged funding lines at both Fed and the Federal Home Loan Bank with a combined borrowing capacity of 370 million at June 30th.

Okay, let me switch over to the income statement. The net interest margin contracted to 44 basis points for the same quarter last year, and that was due to the earnings asset mix from loans to investments and the lengthening of the repricing for CDs from the Federal Home Loan Bank borrowings. The value of the non-interest-bearing DDAs also declined year-over-year. The loan deposit spread year-over-year remained unchanged.

While the net interest margin declined 17 basis points from Q1, net interest income however stayed relatively unchanged. The quarter-over-quarter margin compression was due to the earnings asset mix again and the liability extension, as our loans to interest-bearing deposits spread was unchanged.

As indicated in the release, recurring fee income improved in Q2. Deposit service charges grew 6% year-over-year in Q2 as that account base expanded 4% year-over-year, and the transaction volume picked up significantly from the first quarter benefiting our payment systems revenues. This was also supported by our debit and credit card account basis, which grew 10% and 14% respectively over the past year.

Adjusting for the higher FDIC insurance assessment rates and the special assessments in the second quarter, second-quarter total non-interest expense declined 4% since the same period in 2008. Personnel expense decreased 11%, and we also kept a close tab on any other controllable expense items.

I will spend a couple of minutes on the two-step portfolio. The two-step loan portfolio declined to 10 million at June 30 or about 0.5% of the total portfolio compared to 7% a year ago. The modest remaining balances are all classified as non-accruals, and since the program was discontinued approximately 18 months ago, the total two-step commitments have come down from nearly $400 million.

During the second quarter, total two-step NPAs fell by 17 million from 97 million to 80 million, an 18% decline, and non-accrual balance declining 14 million and OREO balances decreasing 3 million to 70 million. Q2 and Q3 are the seasonally strong home sales quarters within our markets. Combined with excellent sales efforts, we closed 54 two-step integrated properties and OREO short sales during the second quarter with net proceeds of 13.4 million, which was more than double the proceeds on the sales in the first quarter.

As of June 30th, we have disposed of 175 two-step related properties of which 125 was OREO sales and 50 were short sales. At quarter-end, we now have 278 two-step OREO properties, the continuing slowing pace of two-step properties coming into Oreo in the third quarter, the number of properties in the two-step portfolio will trend down meaningfully in the future periods. As an indication of solid sales results, our two-step holding period has averaged approximately 5 months compared to a 13-month average housing inventory level within our markets since June 2008 at the point at which our OREO inventory and sales efforts wrapped up.

Our sales momentum has continued at the strong pace recently, and at quarter-end we had 42 pending sales representing proceeds of approximately 10 million compared to 36 pending sales entering the second quarter. We see similar positive trends for disposing of the non-standard residential OREO properties as well.

The loss and final disposition of the two-step properties continue to be relatively minor, indicating as in the past that our write-down process works well, and capture market values changes appropriately. At June 30, this 70 million in remaining two-step OREO balances have been written down by approximately 34% from its original balance of 105 million. The projected 33% total loss rate on the 42 pending two-step property sales with no additional loss upon final disposition.

Excluding the cost of carrying the two-step and unpaid [ph] balances the negative second-quarter pre-tax impact from provisioning OREO valuation adjustments and operating expenses for the two-step portfolio is estimated at approximately 6.3 million, which is down from about 8.7 million in the first quarter. If you assume a 35% tax rate on that, the second-quarter negative EPS impact would be $0.26, a decline from approximately $0.34 in the first quarter.

While we do expect additional two-step provisioning OREO valuation adjustments and expenses in future quarters, we do anticipate the combined negative impact to continue to diminish in the third quarter and forward.

Let me also spend a couple of minutes on the local housing market. From our perspective, it appears there is a trend towards stabilization in our markets. Historically the local housing market inventory trends up significantly during the first-half of the year. This did not occur in 2009. The number of new and existing homes listed during this period declined from 50,000 in 2007 to 34,000 in 2008 to less than 20,000 in 2009. Consequently despite lower sales, our local housing inventory increased a very modest 1400 units in the first-half of 2009 compared to 13,000 and 12,200 during the same periods in ‘07 and ‘08.

Any potential pent-up inventory of unlisted existing homes has yet to show up in the numbers. Our aggregate market housing supply in June was 8.9 months, which was the lowest since October of 2007. The inventory decline was broad-based across all the counties where we operate including Clark County where we have meaningful non-performing construction balances.

Clark County’s inventory was 8.2 months, the lowest monthly inventory supplies since August 2007. The year-over-year decline in aggregate housing across our markets that began in early 2009 continued to accelerate in June at 19% year-over-year reduction. A 31% reduction in Clark county inventory year-over-year represents the largest reduction amongst our markets.

Also of note, albeit small at 1% June aggregate number of homes sold in our markets experienced it first year-over-year monthly increase in over three years. Oregon’s Deschutes, Clark, and Clackamas counties, which were the hardest hit areas in 2008, exhibited the best percentage of improvements in sales from the lowest in mid-2008. While too early to make any firm conclusion, it appears that the housing overhang is beginning to fade away in our markets, at least for new construction.

In short, the combination of lower inventory and higher sales caused the area changed in the number of months of supply of homes in our market contract for the first time since late 2005. Home prices have declined year-over-year throughout the market, however, the aggregate market price increased 3.3% in June over May, and measured the largest month-over-month increase in prices since May 2007. And looking at the trend in pricing, it appears that the year-over-year percentage and dollar decline in home prices have stabilized over the past few months, indicating at least slowing rate of decline, price decline.

Just a couple of final observations, given what has been a prolonged recessionary economic environment for us, we expect to maintain a very defensive position going forward and staying focused on managing existing portfolio, liquidity, and capital. We expect the loan portfolio to continue to contract in the third quarter and the economic direction influencing the trend in the latter part of the year.

And with that I like to hand it over to Hadley Robbins.

Hadley Robbins

Thank you. I will talk about the loan portfolio at this time, and my comments this morning will focus on the second-quarter performance of the bank non-two-step portfolio overall, followed by a discussion of individual loan segments.

In the second quarter, non-two-step loans decreased $68 million to 1.9 billion. Loan segments with the largest declines were C&I 34 million, commercial construction 16 million, and residential construction 14 million. The reduction in loan totals is the result of our efforts to selectively reduce exposure across all loan segments including active efforts to shrink and rebalance the mix of our real estate portfolio.

Poor economic conditions have also impacted loan totals by reducing the level of new originations. The origination activity is largely confined to servicing existing core clients as Bob mentioned based mostly within our C&I and HQ [ph] loan segments. During the second quarter, delinquency in the non-two-step portfolio defined as loans 30 to 89 past due increased 6.5 million to 16 million or 0.84% of outstanding loans at June 30.

The increase in delinquency is primarily related to higher levels of past due residential construction and mortgage loans. The delinquency in our residential construction portfolio consists of two development projects totaling 5.1 million, while delinquency in our residential mortgage portfolio is largely tied to one residential land acquisition loan of 3.3 million.

Non-performing assets increased 13 million in the second quarter which was less than the first quarter increase of 30 million. Quarter-end NPA represented about 5% of total assets compared to 4.74% at March 31, 2009.

NPA in the second-quarter consists mostly of an increase of non-accrual loans of 11.8 million. All individually risk-rated non-accrual loans were considered impaired, which totaled 110 million. Those with collateral deficiencies have been written down to fair value of the asset less selling cost. As of June 30, these loans have been written down approximately 31 million or 22% of their original principal values.

Second-quarter increase in non-accrual balances are spread across C&I, residential construction, mortgage and CRE portfolios segments. However, one borrower with outstanding loans of about 4.8 million related to land acquisition and development activities accounts for a significant portion of the overall increase in NPA.

Although NPA has increased, they remain controllable at this level for a large cross-section of our portfolio. For example, commercial term real estate, commercial construction, home equity and consumer loans together represent about outstanding loans of 1.7 billion or 88% of the total non-two-step portfolio, and collectively we had NPA of 47.5 million or about 1.82% of total assets.

It is important to note that the overall bank level of NPA, including both two-step and non-two-step loans declined slightly 4.9 million to 211 million. The reduction is directly related to a $17 million decline in the two-step portfolio previously mentioned by Anders.

Book value of non-two-step OREO property at quarter-end was 14.2 million and represents 57 residential real estate properties. Overall non-two-step OREO property has been written down approximately 28.2%. During the quarter, 15 new properties in the amount of 3.9 million were added to OREO, while 11 properties representing 2.8 million of book value were sold.

OREO properties are largely located in Clark County in the state of Washington and Deschutes County in the state of Oregon. With the summer selling season under way, we continue to expect many of these properties to sell before year-end. Looking forward regarding OREO, we also expect to take possession of larger projects that are currently classified as non-accrual in the second half of 2009. The actual timing of the banks control these properties is difficult to predict and may vary materially depending upon the outcome of borrower negotiations and legal proceedings.

New OREO properties expected during the second half of 2009 will consist primarily of site development projects. In anticipation of increased OREO, we have added staff dedicated to OREO disposition and management. We are also taking actions to accelerate our sales cycle for example; we selectively evaluate the feasibility or short sale early in the resolution process before taking possession. We also prepare specific sales strategies for each property in advance, so that we are prepared to execute swiftly upon taking possession.

To assist in the sale of bank OREO properties and in absorption of projects financed by the bank, we have developed a number of loan programs to assist qualified homebuyers, residential construction loans for partially completed two-step homes, condo financing, attractively priced conforming residential mortgages, and jumbo mortgage loans. Today the financing activity under these programs is minimal, the total loans amounting to about 3.2 million as of June 30.

Non-two-step net charge-offs were lower at 8.9 million in the second quarter or 1.81% annualized of average loans outstanding. This compares to 11.1 million or 2.21% for the first quarter, approximately $7.5 million or 85% of second-quarter net charge-offs are linked to impairment charges, which by and large reflect declining real estate values for residential construction and land loans.

The baseline provision expense closely mirrors the movement of net charge-offs. As mentioned above net charge-offs declined in the second quarter to about 8.9 million. Likewise provision expense was lower in the second quarter at 9 million as compared to $20 million level posted in the first quarter. Although quarter-over-quarter provision expense was lower, the amount of second-quarter provision expense slightly exceeded net charge-offs.

Second-quarter non-two-step allowance for credit losses was 38.6 million or 2.02% of total non-two-step loans, which compared to first quarter ACL of 38.5 million or 1.95%. Unallocated reserves declined from first quarter levels of 5.8 million or 15% of the ACL to 3.8 million or 10% at quarter and. Part of this reduction is due to adjusting our general valuation allowance factors that costs required reserves to increase, which absorbed a portion of our unallocated reserves.

The current 10% unallocated reserve level remains high by historical standards, and at this point in time we believe higher levels of unallocated reserves are appropriate given downward pressure on real estate values and strained economic conditions.

Next I will provide an overview of individual loan segments starting with residential construction. Total outstanding residential construction loans excluding land were 119 million at June 30, a decline of 13 million from the first quarter. The residential construction portfolio contains 57 million in site development and 62 million in vertical construction. Residential construction projects financed by the bank including condos are mainly located in Clark County and King County, both 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 4.94% or 5.9 million at June 30, up from 2.84% or 3.7 million at March 31. As previously mentioned, delinquency was concentrated in two development projects with total loans outstanding of about $5.1 million.

At quarter-end, non-accrued residential construction loans, excluding land were essentially unchanged at 46 million or 39% of outstanding residential construction loans. This compared to 47 million or 35% of the previous quarter. The largest concentration of non-accrual residential construction loans were in site development totaling 33.7 million. The vertical construction segment was less at 12.4. All non-accrual individually risk-rated residential construction loans have been measured for impairment and charged down to fair value of the selling cost, cumulative charge-offs associated with impaired residential construction loans are about 18 million or 29% of original principle.

The residential construction loan portfolio is 6% of the bank's total loans, which is lower than many of our peers in the North West, residential construction loans and in particular site development loans are becoming a smaller component of our loan mix, and will remain so going forward in the foreseeable future.

Commercial construction, the commercial construction portfolio continues to perform well. In the second-quarter delinquency was low at 6 basis points of outstanding commercial construction loans, quarter-end NPAs were $2.9 million, which is largely tied to one project in central Oregon. Net charge-offs for the commercial construction portfolio were zero in both the second-quarter and year-to-date.

The portfolio's outstanding loan balance was 72 million at June 13, 2009, which declined sharply thereafter by 19 million to 52 million on July 2. The reduction in the commercial construction loan totals was due to a scheduled payoff by an outside third-party of a large fully stabilized retail facility.

Term commercial real estate, term commercial real estate portfolio is the largest segment of the bank's portfolio. At June 30, outstanding term real estate loans totaled 878 million representing about 46% of all non-two-step loans. The mix between owner-occupied and non-owner occupied is about 49% for owner-occupied and 51% for non-owner occupied. CRE properties are primarily located in Oregon and are concentrated in the cities of Portland and Salem, which together account for 70% of the total CRE portfolio.

Property types are mixed with office and retail are representing the most significant product types, with office at about 190 million or 22% of CRE loans and retail at about 130 million or 15%. Portfolio performance continues to be satisfactory. At June 30, 2009 term real estate loans 30 to 89 days past due were only about 30 basis points at term real estate loans. NPAs were also low at 6.9% or 30 basis points of total assets.

Year-to-date charge-offs were minimal at 578,000. Today the stress testing results continue to reinforce the underlying strength of this mature and seasoned portfolio. Our stress testing does not point to specific realms with potential weakness. However, widespread concerns have not surfaced at this time.

Given the disruption in secondary markets, rising cap rates and tighter lending criteria and industry-wide concern exists regarding whether CRE term borrowers can re-margin equity requirements when their loans come due. At this point in time this risk within our portfolio appears manageable. Maturities within the bank's CRE term portfolio are well distributed over time mitigating the risk that a significant number of borrowers would be exposed to unfavorable conditions when refinancing or restructuring maturing loans occur.

During the next 24 months, 62 million in CRE loans mature, which is about 7% of the CRE portfolio. And that is broken down as follows, 36.4 million through 6/30/2010, about 26 million through 6/30/2011. Maturing loans during this time frame are prominently in the Portland and Salem market areas and on average have loans to value below 50% based on the original appraisal amount.

Mortgage portfolio. At June 30, 2009 standard mortgages were about 84 million or about 4% of the bank's portfolio. This category includes a range of consumer and commercial purpose loans secured by residential real estate. About 28 million or 33% of its portfolio relates to consumer purpose loans, most of which is conventional real estate mortgages. The remaining 56 million or 67% represent commercial purpose loans secured by residential real estate.

The largest components in the commercial purpose segment include 28 million in non-owner occupied properties with first-lien positions, for example, rentals; and 18 million in residential land loans held for future development. During the second quarter non-accruals increased 5 million to 14 million within this category or 17% of total standard mortgage loans. Most of this increase is tied to one commercial real estate land loan in the amount of 3.8 million. Currently land loans represent the largest loan class of non-accrual balances within this portfolio segment.

Commercial and industrial loans, the banks C&I loans are 429 million at quarter-end, representing 22% of total non-two-step loans. At June 30, C&I loans 30 to 89 days past due were 1.8 million or 42 basis points of total C&I loans. Non-accrual commercial loans increased about 2 million to 34 million or 7.9% of total C&I loans compared to 29 million or 6.3% at March 31st. The amount of non-accrual C&I continues to be dominated by three large relationships negatively impacted by the deterioration in the housing industry, and retrenchment of consumer spending, which totaled 27 million or about 6.3% in C&I loans.

In general, we have seen a downward risk-rating in the migration develop among commercial businesses that operate within the supply chain of product and are services used by the housing industry, and are heavily dependent upon discretionary consumer spending. We expect this trend to continue through 2009 and into 2010. Net charge-offs in the C&I portfolio totaled 1.3 million in the second quarter compared to 1.1 million in the first quarter of 2009.

The bank’s HEQ [ph] portfolio was 280 million or 15% of total non-two-step loans in the HEQ portfolio consist mostly of lines [ph] 248 million and loans of 32 million. Outstanding HEQ loans were essentially unchanged quarter to quarter. Approximately one-third of the portfolio has first lien mortgage positions, while the remaining two-thirds of the HEQ portfolio has second lien positions.

Portfolio performance measures continue to hold satisfactorily despite economic turbulence in the rising levels of unemployment, delinquent loans at June 30 remain low at 3 basis points of HEQ loans and year-to-date net charge-offs are also low at 1.8 million or about 65 basis points.

Likewise non-performing assets are nominal at 2.1 million or about 10 basis points of total assets. Line utilization continues to fall within our historic range at 59% of total commitments, and total commitments are about 423 million. Non-standard mortgage loans, non-standard mortgage loans which represent mortgages provided to previous two-step borrowers who are interested in retaining their properties totaled 24 million or about 1.2% of the banks portfolio.

During the second quarter, non-accrual and delinquent loans remained essentially flat at about 10 million and 1 million respectively. During the quarter four non-standard mortgage loans totaling 960,000 were moved from non-accrual to performing. These loans all had seasoned payment track records of at least six months. The non-standard mortgage loan portfolio will run-off over time as loans are paid for transition to OREO. We currently have 28 non-standard OREO properties with a book value of about 7 million. During the second quarter, five non-standard OREO properties with the book value of 1.2 million were sold.

Onto forward-looking statements, NPA the eventual timing of the amount of NPAs subject to a number of factors, many of which are outside the banks direct control. However, based on what we know today, we believe that total NPAs at or close to the peak in terms of asset levels. We expect to see some additional C&I and residential construction borrowers added to non-accruals as well as additions from other segments of our loan portfolio yet at the same time, these increases in NPA will be offset by our ongoing efforts in reducing both the two-step portfolio and non-two-step Oreo, as well as resolving problem loans through troubled debt restructure, debt shift, and liquidation.

Provision, at this point we are looking not to have material improvement in the residential housing sector, a meaningful rebound and regional economic activity through the end of 2009. This will continue to put financial pressure on our non-two-step borrowers and in particular builders, developers and C&I businesses dependent upon residential home activity.

However, as Anders has mentioned we have noticed recent reductions in home residential home inventory in a number of our markets, which should help stabilize prices if these trends continue.

High unemployment levels are also expected to put pressure on our consumer and mortgage related portfolios. The performance today in these two portfolios continues to be satisfactory. We would expect a significant deterioration in credit quality in the bank's term commercial real estate or home equity portfolios, which certainly put additional pressure on the level of our provisioning.

I expect third-quarter provision expense to be influenced by additional impairment charges in the residential construction portfolio and by charge-offs in the C&I portfolio. Provision expenses associated with the two-step portfolio will be relatively modest and, less than $2 million during the second half of 2009.

Going forward, we will continue with provision of levels that reflect portfolio performance trends and assessment of market conditions. The bank reserves at June 30, 2009, we believe the allowance for credit losses are 38.6 million or 2.01% of total loans is adequate. We will continue to assess the adequacy of our allowance for credit losses on a monthly basis, and make adjustments based on our view of reserves required to cover losses inherent in the loan portfolio.

That concludes my comments and with that I will turn it over to Bob.

Bob Sznewajs

Okay, thanks, Hadley. Just a couple of quick points, as Hadley pointed out our NPAs have remained stable for the last two quarters. Anders pointed out that the impact of the two-step program has declined from little over 9 million in the first quarter of a year to a little more than 6 million in the second quarter of the year. And we expect that to continue to decline in the last half of the year.

With all this activity going on, our people have continued to be very dedicated to our core strategy of growing our business and meeting our customers needs. We were most recently recognized in the Salem market, which is the market in which we have the number one deposit share of any bank in the state and is the second largest deposit market in the state, as having – being recognized as the number one bank in that area. So I'm very proud of our people, who have continued to demonstrate the dedication and commitment to our customers and be recognized as compared to our peers.

So with that, I will now open it for questions.

Question-and-Answer Session


(Operator instructions) The first question comes from Louis Feldman.

Louis Feldman – Hoefer & Arnett Inc.

You know it is that when I intentionally wait, still come in first. Good morning. Hadley, would you, I wanted to double-check, you said that you got 62 million of CRE maturing over the next 24 months, about half of it is between now and June 2010 and half in 2011, is that correct?

Hadley Robbins


Bob Sznewajs


Louis Feldman – Hoefer & Arnett Inc.

Okay. I guess the question I have, in terms of the stuff that is maturing, in terms of some of the other longer-term loans, in terms of debt service coverage ratios, if the owner is able to meet that, will it fault the regulators to tell you whether to mark down or not, and have they given any indications that they want you to given the amount of pressure that has been written recently about the fact that banks are not taking the required marks on declining values on CRE?

Bob Sznewajs

Yes, I read the recent Wall Street article. And we don't comment on our relationship with the regulators, but what we look at essentially relative to the capacity of maturing loans to perform, and to try to position ourselves to understand how that is going to unfold in the future is, through our stress testing we delve deeply into the portfolio. Anything over $1 million we stress test NOI, and we stress test it at sequential levels of added burden and check the debt service coverage ratio, and their capacity to manage to those levels.

If we identify anything under the stress test that we apply that kicks out that is a concern, we do a full review of the credit, site visit, updated rentals and do a forecast based of that. So with that process in place we making every effort to identify do we have potential to sort this in this portfolio? At this point the performance, it is the performance and not surfacing in our stress testing is trying to look forward and we are not identifying anything at this point that is systemic.

Again I have mentioned that there are individual cases that we have as concerns, but we will be closely monitoring this going forward and report on each meeting that we have.

Louis Feldman – Hoefer & Arnett Inc.

Okay, thank you. And then one other question, you mentioned potential for larger developmental projects coming into OREO, how would you seek to potentially dispose those, would you try and build it, you know, hire someone to build it out and market it as vertical, or would you try and get rid of it as a package to a different developer.

Hadley Robbins

Very good question. I think in each case it is specific to the property and its location and the state of its development. And that – what we will be doing is in every case you know we look at every option available, but we designed a strategy that ranges from short sale, as I mentioned before, the property is in our possession to bulk sale to build out, and we have a disciplined approach to that to ensure that the bank takes the right course of action.

We haven't had any at this point in time. We are currently working on a few short sales, but the strategies are in place and those strategies range from sale of the property outright to another developer to potentially building them out. Yet that is going to be a very carefully considered decision if we do that.

Louis Feldman – Hoefer & Arnett Inc.

Okay, thank you. I've got a couple more, but let me step back to let others ask questions right now.

Bob Sznewajs



Your next question comes from Jeff Rulis.

Jeff Rulis – D.A. Davidson & Co.

Hi, guys.

Bob Sznewajs

Good morning or good afternoon.

Jeff Rulis – D.A. Davidson & Co.

Hadley, you may have touched on this, but in terms of NPA balances certainly in Q2 it looks like the two-step declines outstripped increases elsewhere based on the pending sales on two steps do you see that continuing on as long as you still have a two-step balance to work down?

Hadley Robbins

Right, I think that the two-step problem as we sell through that OREO will naturally have a very favorable influence on the overall level of NPA, but yet there will be a continued transition within the portfolio from the non-two-step side that will offset that to some degree. As I have indicated, you know based on what we know today, and it is what we know today, it looks like we're stabilizing at this point overall for NPA, and I think I believe that that it is probably the best place to leave it.

Jeff Rulis – D.A. Davidson & Co.

In terms of just the balance sheet and managing that, you guys have averaged about 50 million in loan run-off over the last year, this quarter was a little bit more aggressive, is that a conscious decision to pick those up or is it more timing, and then secondarily I guess if you could sort of indicate what you think loan run-off for the remainder of the year would be?

Anders Giltvedt

I did not look at the second quarter relative to the other quarters. So it is just the timing. As Hadley indicated, we had a $19 million commercial construction credit payoff July 2nd that could have happened easily on June 30, which have reduced loan volumes even further in the second quarter.

I think in the third quarter clearly the construction side is going to continue to contract. I think the economy will dictate the level of reductions in the remaining portfolios that deals with commercial real estate, C&I, home equity and small business, and SPA [ph] for that matter as well. So, it is going to appreciate. It is difficult to look beyond the next 90 days.

Jeff Rulis – D.A. Davidson & Co.

Sure, okay. Thanks.


Your next question comes from Joe Morford.

Joe Morford – RBC Capital Markets

Good afternoon everyone.

Bob Sznewajs

Good afternoon.

Hadley Robbins

Good afternoon.

Joe Morford – RBC Capital Markets

I was just wondering if you could talk a bit more about different stress tests you have recently run on your loan portfolio be it the government SCAP scenarios and or your own internal projections and what have they indicated about any additional capital needs that may be required?

Bob Sznewajs

I will just – I will give you a kind of an overview of the stress testing that we do.

Joe Morford – RBC Capital Markets

Okay, that will be great.

Bob Sznewajs

The stress testing program at a portfolio level and at the portfolio level we apply a number of different scenarios and those scenarios are designed of course to stress in various scenario assumptions that we create, and of course the increase in difficulty against the portfolio, and they do point to areas within the portfolio that potentially have higher risk and we utilize call report data [ph] as a basis for that benchmark against industry.

We also stress test the HEQ portfolio as well as the terminal real estate portfolio that I mentioned. And again all of that is designed for the purpose of trying to position ourselves to be pro-active in identifying the areas of risk and to design strategies to respond to that.

Hadley Robbins

And I would just add in certain of the portfolios given this economic environment we have been in over the last 12 to 18 months that it had the impact of underwriting during that time period, and if you know the home equity portfolio for example, has pretty much flattened out, which normally you will be seeing increases in that portfolio, but the amount of new home equity loans we have made over the last 12 to 18 months has been relatively modest compared to prior periods. So we tend to – and each portfolio is obviously very different.

We're not making new real estate construction – residential construction loans for obvious reasons. The C&I is a very active portfolio, which was there to meet the needs of existing customers and are making loans all the time regardless of the category that it falls in. On the other hand home equity is something that we have been controlling and you know making the underwriting improve relative to the economic conditions. So it showed really kind of various strategies, portfolio by portfolio.

Joe Morford – RBC Capital Markets

I guess another related question on the capital is, you have all done a good job of maintaining the ratios by shrinking your risk-weighted assets, but I'm curious if you're also having any conversations with outside parties about making any additional capital infusions at this point?

Bob Sznewajs

As always with capital, our viewpoint has been to, all options are always on the table for us. We are always looking at a lot of things, considering a lot of things and when we have decided something or when we make the decision then we will announce it.

Joe Morford – RBC Capital Markets

Okay, I guess one last question separately on the credit quality, you talked about resolving problem credits through troubled debt restructurings, I wonder if you could quantify the amount of restructured loans at period end and how did that compare with say first quarter and are those balances included within non-accrual loans.

Anders Giltvedt

Yes, we have – I don't have the amounts in front of me, but I will say that they are not substantial at this point. And we are actively considering structures that would fall in that category as C&I portfolio particularly this year, in the residential construction portfolio allow itself for us to strategically put those in place.

Joe Morford – RBC Capital Markets

Okay, thanks so much.


(Operator instructions) Your next question comes from Louis Feldman.

Louis Feldman – Hoefer & Arnett Inc.

First off, I wanted to say, Bob, congratulations to your team down at Woodburn for getting that branch back open.

Bob Sznewajs

Oh, thank you, it was a big event for the community, and obviously for the people whose lives have been permanently affected and our people. So thanks Louis.

Louis Feldman – Hoefer & Arnett Inc.

First off, last couple of quarters on the C&I side you talked about the nursery and tree farm credits, can I get an update on those?

Hadley Robbins

We have, as I mentioned the nursery industry has been pretty hard hit by the deterioration in the housing industry, and the segments that have been hit hard at least in our experience has been those that are related to (inaudible), and those products typically go into new subdivision development, and the continued stress is there. We are through the sales cycle now and the results are coming in. I haven't been given the actual results of some of our largest borrowers at this point that are finalized, but I will say it hasn't been a great year, and the issues have been price and volume both, and it has translated into levels of cash flow for them to be able to continue operations without difficulty.

Louis Feldman – Hoefer & Arnett Inc.

Either that is something that you are looking at that that you consider a higher risk in potential additional downgrades?

Hadley Robbins

There certainly is a migration that could occur within that category.

Louis Feldman – Hoefer & Arnett Inc.

And then on the valuation adjustments on the non-interest income or the OREO adjustments, can you give us a little more color on that given that your statements have been that your marks have been pretty close to what you'll been able to sell them at. So I guess, can you talk about the difference there or is that an accrual of all the different little marks and that is what it adds up to?

Hadley Robbins

It is quite simple. You write it down obviously when it is getting impaired as a loan. Then you can also write down a second time as a loan when you move it into OREO. After it has been sitting in OREO for three or six months or whatever and you have either a new appraisal you have a reduced listing price on a particular property, you have valuation adjustment and you probably are aware the reduction in housing value in Oregon – particularly in the first few months in 2009 is what you are seeing on the reappraisals and the valuation allowance now.

So let us say you had an appraisal in November/December of 2008, when you reappraise it at this point you capture the market decline that occurred between that time and now. And as I indicated earlier, it appears to us that the rate of decline has been certainly less, and the data shows that if you look at April to June. But it was pretty evident particularly during the first quarter, last part of 2008 and the early part of 2009 that is when the housing price declines were certainly more pronounced than they are now.

Louis Feldman – Hoefer & Arnett Inc.

Thanks. And Anders, one other quick thing. You said the average holding time for the two-step houses was about five months, and I thought I heard you say it was similar for the stuff outside, is that correct?

Anders Giltvedt

Yes, it is a little harder to describe, on the non-standard it is actually probably even faster. I think it is 4 point something, low 4 months. On the non – outside the two-step and the non-standard, we haven’t really had much to sell the residential properties that we have had in there has moved substantially at the same rate as to two-step. It may be slightly slower, but again the number of properties we have had there has been insignificant in the scheme of things.

Louis Feldman – Hoefer & Arnett Inc.

Okay. Thank you very much.


There are no further audio questions, sir.

Bob Sznewajs

Okay. Well, we thank everybody for participating on the call and you have a great week-end. Thank you.


This concludes today's conference call. You may now disconnect.

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