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West Coast Bancorp (NASDAQ:WCBO)

Q3 2009 Earnings Call

October 26, 2009 2:00 pm ET

Executives

Bob Sznewajs – President and CEO

Dick Rasmussen – EVP, General Counsel and Secretary

Anders Giltvedt – EVP and CFO

Hadley Robbins – EVP and Chief Credit Officer

Analysts

Jeff Rulis – D.A. Davidson & Co.

Matthew Clark - KBW

[Ross Hepperman] – Unidentified Company

Operator

Welcome everyone to the West Coast Bancorp quarter three conference call. (Operator instructions) Bob, you may begin your conference.

Bob Sznewajs

Thank you. The first thing I would like to do is to introduce the people who are here today on the call and then Mr. Rasmussen, our General Counsel, will read the introductory remarks. I am Bob Sznewajs, President and Chief Executive Officer of West Coast Bank. Also on the call is Anders Giltvedt, Chief Financial Officer; Hadley Robbins, our Chief Credit Officer and let me introduce Dick Rasmussen, our General Counsel.

Dick Rasmussen

Thank you, Bob. In today's call, we will make statements regarding future events, performance or results that are forward-looking statements. Our actual results could be quite different from those expressed or implied by our forward-looking statements. Please do not place undue reliance on forward-looking statements. They are not guarantees. They speak only as of the date they are made and we do not undertake any obligation to update them.

For some factors that may cause our results to differ from our expectations please refer to our SEC filings including our most recent form 10-K as updated in our most recent quarterly report on form 10-Q. In particular, we direct you to the discussion in our 10-K of certain risk factors affecting our business.

Bob, back to you.

Bob Sznewajs

Thank you very much. Good morning or afternoon depending upon where you are today. We certainly appreciate all of you joining us on the call. If you had a chance to look at the press release you know we had some very exciting information to share with you today. There are three major topics associated with the press release. First was the increase in the rate in the capital that was discussed. Second, the bank entered into a regulatory agreement. Third, would be third quarter operating results.

I am going to talk briefly about the reasons, the why and etc. associated with the capital because this is a very terrific moment for the company from my perspective. As you know, over the last several years we have worked very hard to focus on two objectives of preserving capital and enhancing liquidity. This capital raise will certainly give us the ability now to begin to make loans, which is very important and will allow us to generate revenue which will allow us to return to profitability sooner. So the capital event is a very significant thing to happen to us at this point in time.

We are very pleased. We have a group of highly respected investors who participated in this private placement and they have spent a great deal of time talking to the company, meeting with the company about the game plan, its strategy and reviewing our results. Just to kind of quickly give you an overview of the transaction, the holding company received $155 million in cash of which $134.2 million was allocated to West Coast Bank to strengthen its liquidity. In addition to that $5 million was retained at the holding company and the difference is related to transaction expenses.

At the bank level, the total risk based capital as you see increases to in excess of 17% which is about $150 million over the well-capitalized guideline of 10%. This capital can do many things for us. Obviously the amount of capital relative to our classified assets improves significantly. It will have a very favorable impact on our clients, our customers and our community.

The terms of why did we raise capital, we knew that we had to grow the loan portfolio to create revenues to return to profitability at some point in time in the future. The additional capital really provides us with the cushion necessary to deal with the current economic times while simultaneously growing our loan portfolio in a controlled way to qualified borrowers.

We are very aware of the economy we are in and the circumstances which caused us the issues that we have had in the last two years. So we clearly understand what we need to not do in the future. Having said that, we have a very experienced group of commercial lenders and our C&I strategy is well understood and recognized within our company and it is one we have operated successfully on for many years.

That combined with the sophisticated products and services we have and the cash management and treasury management side has contributed significantly to the core deposit base we have which is a very high value asset of our company. We continue to run demand deposits of 25% of total deposits with business deposits being about 90% of those demand deposits and overall business deposits being roughly 50% of total deposits. I would point out the capital raise far exceeded what the regulators had expected in the regulatory order we entered into. I will talk a little bit about that later.

The question is how will the capital be deployed. It obviously creates additional liquidity for us and it allows us to do a couple of things. One, to reduce some of our higher cost deposits that we have. Even though it is a very attractive low cost deposit base it allows us to do that. It will also allow us to take our existing excess liquidity and to reinvest it at higher rates and at the same time trying to make loans.

Turning on the loan machine is a process that will take 6-9 months. However, we remain confident in our ability to be successful in this marketplace especially since our lenders have not been out actively in the marketplace. We have been very defensive, just trying to make sure we take care of existing customers. We also think the pricing of the new loans is attractive to us relative to historical levels. While we understand it is going to take time, it is something I feel very comfortable in our ability to do based upon the people we have and the strategy that we have been executing over a long period of time.

It also provides strength to continue to invest in new products and services to meet the needs of our customers and to remain current because maintaining the level and sophistication of these products is a critical element of our strategy and this ensures our ability to do that.

Just a very simple highlight of the transaction, the holding company issued preferred stock to the investors in exchange for cash. That cash, as I mentioned previously was invested in the capital structure of the bank. Once the shareholders approve the issuance of the additional common stock from the holding company the preferred shares would be exchanged for common shares of the holding company and at that point in time the additional capital will improve the capital ratios of the holding company.

The board and management strongly supports this authorization and the issuance of additional shares by shareholders. It obviously increases our capital, our ability to make loans and shows a great sign of strength in our community. Another important aspect is that in addition to the investments and important to enhancing and continuing with the products that we have, the bank strategy remains unchanged. It is a strategy that ourselves and the investors are very confident in. We will continue to do that. We think our strategy in the Pacific Northwest is one that has been successful and will continue to be.

Also the existing management team will stay in place and remain the same so that is another important dimension to share with all of you. With respect to the capital at the holding company level, it clearly puts us at the high end once the shareholders approve the authorization of the existing shares. That certainly puts us at the high end of capital of almost any bank in the region. Even though we don’t have September 30th numbers for all of the banks we have June 30th numbers.

At the bank’s level it is equally true in our view, even though again, we haven’t seen the numbers for our competitors, but at the bank level we will certainly be at the very high end of the capital bank level in excess of 17%.

We will have new investors who will be represented on the board and we look forward to that. They will bring us skill and perspective and information that we view as being very healthy. The existing board is totally supportive of that. There is a vetting process that our governance procedures will take place and then there is a regulatory process for the Directors to be approved. We look forward to that insight and information and perspective we will get from the new directors.

With respect to the regulatory agreement, in our view there is nothing in that agreement which precludes us from executing against our strategic plan. The new capital put in, as I mentioned earlier, far exceeds what is required on the capital ratios that have been identified. We already had liquidity that was at and above what was asked for as part of the agreement. We already have the capability with our concentrations and construction lending and real estate lending to make loans within the guidance. The additional capital and liquidity obviously gives us more room to do that.

From all the capital, it really helps us to go forward. The agreement as we have talked to our people today did not have any impact on normal operations. It is business as usual and we have spent time this morning communicating with our people so they feel comfortable talking to our customers and explaining to them what is going on and what all this means.

The issues that are in the order will be dealt with by the board and executive management. Again, I will mention they really do not have an impact on our strategy. It gives us the ability to continue to grow in the C&I category which is important to us in both supporting the loans and the growth in the deposit base. As I mentioned earlier, we are very excited about this. The capital raise has been an important aspect of our strategy and so I think it positions well for us into the future.

As you may or may not know, to my knowledge we are the only bank in the Pacific Northwest that has a regulatory order that has been able to raise capital. The others that have raised capital have either done it through TARP or through a public offering.

As I said, we are excited about this and we are moving forward with running the company and getting back to business as usual. With that I am going to turn it over to Anders and Hadley to talk about the third quarter briefly.

Anders Giltvedt

Thank you Bob. In the announcement this morning we did include a summary for the results of the third quarter along with important financial schedules. I will just briefly cover some key items in the quarter. We also intend to file our third quarter 10-Q with a little more detail over the next week.

The third quarter loss was $12.4 million after tax. There were two main drivers of the loss. First, elevated provision for loan losses continued in the quarter at slightly over $20 million and Hadley will speak to that in just a second. Secondarily, net interest income declined 4.6% from the third quarter last year to $19 million in this most recent quarter and that resulted primarily from the shift from high yielding loans to lower yielding investment securities as well as interest bearing cash balances. Combined, the two latter increased over $350 million year-over-year. Over the same time period loans contracted $288 million or 14% while deposits grew $94 million or 5%.

The unusually low interest rate environment also reduced the benefit for our sizeable non-interest bearing [DBA] portfolio and additionally net interest income was also negatively affected by the lengthening of the Federal Home Loan bank borrowing in the second quarter this year.

The decline in the loan portfolio was led by the contraction in the construction loan category which fell $181 million or 55% from September 30th of last year; $250 million or 8% of the portfolio at quarter end. Lower C&I balances caused the remaining loan balance contraction. Net interest margin [inaudible] and contracted to 3.14% in the most recent quarter. We were negatively impacted by the same factor impacting net interest income.

Evidencing that our core business model is holding up well in this environment, our sales efforts continue to generate very solid net new core deposit account growth which is an important driver of future payment system revenues and other fee income. We added 2,300 net new checking accounts during the third quarter representing an annualized growth rate of over 10% which is one of the strongest growth rates that we have had since early 2005.

Non-interest income fell about $2.4 million in the quarter, year-over-year third quarter. Adjusting for the OTTI charge in Q3 last year and that reduction was mainly caused by the $2.6 million higher OREO valuation adjustments in the most recent quarter.

Year-over-year Q3 total expenses increased $1.3 million. This was due to higher FDIC insurance as well as increased OREO expenses. Excluding those two items the remaining expense declined 3%.

With that I would like to hand it over to Hadley.

Hadley Robbins

Thank you Anders. Loan portfolio results for the third quarter continue to be characterized by elevated provision levels driven primarily by charge offs being high but declining levels of NPA. NPA declined $2 million in the third quarter from $211 million in Q2 to $209 million in Q3. Although a small reduction, it represents the second consecutive quarter that NPA levels have posted a decline.

The reduction in NPA continues to be led by a successful disposition and collection efforts associated with the Two-step residential properties which produced a decline in NPA of about $18 million. This favorable results was offset by increases in NPA, however, occurring in other segments of our loan portfolio. Our C&I book of business experienced the largest increase in NPA through growth in non-accrual loans that totaled about $15 million. Quarter end NPA represented about 7.86% of total assets compared to 8.06% at June 30, 2009. Non-accrual loans are the largest component of NPA which totaled $132 million at quarter end.

Non-accrual loans with collateral deficiencies have been written down to fair value of their collateral less selling costs. At September 20, 2009 non-accrual loans had been written down approximately $41 million or 24% of original principal balance. Overall NPA including OREO which at September 30 was $77 million has been written down to charge off or evaluation adjustments $86 million or approximately 29% of original principal.

Although NPAs are elevated they remain at moderate levels for a large cross section of our portfolio. For example, commercial term real estate, commercial construction home equity and consumer loans together represent about $1.2 billion or 66% of the portfolio. Collectively we have NPA of about $17 million or 69 basis points total assets.

The book value of OREO properties declined from $84 million in Q2 to $77 million in Q3 and represents 301 real estate properties. The two-step portfolio continues to dominate the population in OREO, representing about 233 properties with a book value of $57 million. During the quarter 57 two-step properties sold totaling $13.4 million. At quarter end there were 68 non-two step properties with a book value of $20 million and during the quarter 27 properties were sold amounting to $5.4 million. Overall then, total property disposition efforts in the third quarter amounted to about 84 properties with a book value of $18.8 million.

Looking forward we expect to take into possession larger projects in OREO that are currently classified non-accrual starting in the fourth quarter. The actual timing of bank control of these properties is difficult to predict and may vary materially pending the outcome of our negotiations with [inaudible]. A number of new properties booked into OREO going forward will be site development projects. Disposition plans are already in place for most of these properties which are designed to produce an orderly and timely liquidation of these assets.

Net charge offs in the third quarter were $18.8 million or 4.01% annualized of average loans outstanding. This compares to $11 million or 2.30% for the second quarter. Approximately $14 million or 77% of third quarter net charge offs are linked to impairment charges which are primarily associated with residential, construction and land loans that experienced declines in collateral value.

Baseline provision expense closely mirrors the movement in net charge offs. As previously mentioned, net charge offs were $18.8 million in the third quarter which triggered a commensurate increase in provision expense of $20.3 million. For the quarter provision expense exceeded net charge offs by about $1.5 million. The additional reserves were largely allocated to our portfolio of home equity loans.

Third quarter allowance for credit losses was $40 million or 2.20% of total loans compared to second quarter ACL of $38.5 million or 2.01%. Unallocated reserves remained essentially unchanged at 9.7% of the ACL versus 10% for Q2.

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

In terms of looking forward, NPA, the eventual timing and amount of NPA is subject to a number of factors many of which are outside the bank’s direct control. However, based on what we know today we believe the total NPA is at or close to a peak in terms of asset levels. We expect to see some additional C&I and residential construction borrowers added to non-accrual as well as other additions from other segments in our portfolio. Yet at the same time these increases in NPA will be offset by our ongoing efforts in reducing both two-step and non-two step OREO and by resolving problem loans.

At this point in time, provision expense we are not looking for material improvement in regional economic activity through 2009 and well into 2010. This will continue to put financial pressure on our non-two step borrowers and particularly builders and developers and C&I businesses dependent upon residential home activity. While the recent reductions in residential home activity in a number of markets should increase the stabilization of home prices which will lead to more stable trends in the future. These trends along with economic challenges coupled with high unemployment levels are also expected to put pressure on our consumer and commercial mortgages related to these portfolios yet our performance to date continues to be satisfactory in both the CRE portfolio and the home equity portfolio.

Expect fourth quarter provision expense to continue to be at elevated levels driven by additional impairment charges in our residential construction portfolio and by charge offs in the C&I portfolio. Provision expense associated with the two-step portfolio should be relatively modest. Going forward we will continue to put provision at levels that reflect portfolio performance trends and our assessment of market conditions.

With that, I will turn it over to Bob.

Bob Sznewajs

Thank you Hadley. Again, I will just reiterate we are very excited about the capital raise and the prospects that will bring to our company over the coming time period. We also believe it is going to put us in a position of returning to business as usual in terms of being able to grow loans in a responsible way in targeted segments which we have identified and to begin to create additional revenue streams that would be associated therein.

So with that, I would like to open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Jeff Rulis – D.A. Davidson & Co.

Jeff Rulis – D.A. Davidson & Co.

A couple of questions on the capital. Any indication from the regulators the preferred equity would be counted as Tier I ahead of conversion?

Anders Giltvedt

Under the current guidelines as well as the structure of our preferred shares they will not be counted as capital until the conversion occurs at the holding company.

Jeff Rulis – D.A. Davidson & Co.

Do you have a pro forma TCE ratio assuming conversion?

Anders Giltvedt

We can follow up on the tangible common equity. I would suggest you look at the 10Q when that is filed. I don’t have it in front of me.

Jeff Rulis – D.A. Davidson & Co.

In terms of the actual coupon, this is a straight 15% on the $155 million. I assume that would start paying on March 1 if there is no conversion?

Anders Giltvedt

That is correct.

Jeff Rulis – D.A. Davidson & Co.

To sum it up, was the bank approached by this set of investors or did you approach them? If you could talk as much as you can, I guess, on sort of that relationship.

Bob Sznewajs

This will all be laid out in the proxy statement we expect to be filing soon. In the interest of taking up time today on the call I think you will have an explanation of that in the proxy statement which we expect to work on and to be out quickly.

Jeff Rulis – D.A. Davidson & Co.

Switching gears then, a pretty big jump in C&I nonaccruals. If you could be a little more specific as to what business sectors that was in.

Hadley Robbins

That represents primarily one large loan that was a shared national credit that went non-accrual.

Jeff Rulis – D.A. Davidson & Co.

Then what business sector?

Hadley Robbins

The business sector was gaming and entertainment.

Anders Giltvedt

Just to follow-up on the TCE ratio, obviously at the Bancorp it didn’t increase since it doesn’t count as common equity. At the bank level issued is slightly north of 12%.

Operator

The next question comes from the line of Matthew Clark – KBW.

Matthew Clark - KBW

Is there anything lumpy in net charge offs this quarter from that syndicated credit that went non-accrual?

Hadley Robbins

There is a charge off associated with that loan that went non-accrual we just referenced. The amount is approximately $3 million.

Matthew Clark - KBW

The overall size of the [STIC] book at the end of the quarter?

Hadley Robbins

I don’t have that in front of me but it is less than $30 million in terms of the [STIC] book.

Matthew Clark - KBW

In terms of the potential timing of when you might be able to get that shareholder approval in terms of when that meeting might be? Will that might be a fourth quarter event or is it something that might be in the first quarter?

Bob Sznewajs

Our attorneys are working very diligently on doing that. The timing of that is to be as soon as possible so we can get the shareholder vote as quickly as possible. Very likely first quarter next year.

Matthew Clark - KBW

On the deferred tax asset, I guess how much in the way of additional losses need to be incurred before you might have to set aside an allowance for that $19 million?

Anders Giltvedt

I don’t think it is really a matter of how much losses you take, it is really a matter of accounting for the allowance and how long you have been in a loss position and so forth.

Matthew Clark - KBW

In terms of that analysis though do you have any…

Anders Giltvedt

There is a number of things happening on the regulatory side as well in Washington. We just wanted to make sure people were aware that could become an issue in future reporting periods. I can’t really speculate on what the final…

Matthew Clark - KBW

Assuming you don’t get the five-year…

Anders Giltvedt

Whatever it turns out to be.

Matthew Clark - KBW

Lastly, in terms of your expectation for shrinking the balance sheet. How much more do you think the balance sheet might shrink before we see it stabilize?

Hadley Robbins

That is something we really can’t answer at this point in time. There are a number of factors that are involved on both the loan and the deposit sides. We are hopeful and are planning on and actually put in place plans to reactivate the loan generation and our loan officers have been developing plans in anticipation of the point in time where we could have the capital to do that. We have also gone through a process of identifying areas that would be less desirable versus those that are more desirable. Then of course we have the economy.

So our goal is to get that revenue generation going as prudently and as quickly as we can. With respect to the deposit side we are in the process now of looking at what alternatives are available to us.

Operator

The next question comes from the line of [Ross Hepperman] – Unidentified Company.

[Ross Hepperman] – Unidentified Company

A couple of follow-ups on the [STIC] question. I think you said the overall portfolio was over $30 million. What would you say is the average size of the loans or future loans?

Hadley Robbins

There are essentially three loans in that book of business.

[Ross Hepperman] – Unidentified Company

So $10 million.

Hadley Robbins

Yes.

[Ross Hepperman] – Unidentified Company

The nature of them? Are they CRE?

Hadley Robbins

No. They are primarily C&I credits. One is related to the housing industry very directly as a wholesale supplier of building materials. The larger one we just got done talking about earlier is a gaming credit. The other is a performing gaming credit as well.

[Ross Hepperman] – Unidentified Company

Were there any comments about that on your last exam?

Hadley Robbins

I’m sorry, we don’t comment on exams.

Operator

There are no further questions in the queue.

Bob Sznewajs

We certainly appreciate everyone taking the time to join us today. We look forward to talking to you at the end of next quarter. Thank you.

Operator

This concludes today’s conference. You may disconnect at this time.

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