Welcome everyone to the West Coast Bancorp Q4 2009 conference call. (Operator instructions) I would now like to turn the call over to your Mr. Robert Sznewajs. You may begin your conference.
Good morning/afternoon everybody. We appreciate you taking time to join us today on the call. With me this morning are Xandra McKeown, who is Executive Vice President responsible for Commercial Lending; Anders Giltvedt, Chief Financial Officer; Hadley Robbins, our Chief Credit Officer; and with that I’m going to turn it over to Dick, our General Counsel.
Thank you, Robert. 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 loses, revenue, income, cost of funds, taxes, cash flows, capital, key financial ratios, the housing market, and the economy.
Our actual results could be quite different from those expressed or implied by our forward-looking statements, particularly in these uncertain economic times where 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.
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.
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, www.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.
Robert, back to you.
Thank you Dick, hopefully you’ve had a chance to go through our press release which we’ve modified quite a bit to hopefully give you more detail or concise information. I’d like to take a few minutes to go through some of the events that occurred in the fourth quarter and I want to review somewhat the sequence of events for everyone so that we can just kind of refresh our memories in terms of what’s transpired, how they fit into our strategy for the fourth quarter of 2009 and for the full year 2010 because I think it will give you some perspective in terms of what when on.
By way of review on October 26, the company successfully raised $155 million of private capital with $139.2 million of the net proceeds to the holding company of which $134.2 million was immediately invested in the bank by the holding company.
This significantly improved the bank’s regulatory capital allowing the bank to have a total capital ratio to be at 15.25% at year-end 2009. The fourth quarter net loss reflected several items, first the $23.4 million tax expense to establish the deferred tax asset valuation allowance, a provision for credit losses of $35.2 million, an OREO valuation adjustments and losses related to property dispositions of $14.5 million, and Anders and Hadley will both go through some of the pieces of this later.
As a result of our strategy related to problem loans and OREO disposition, our total nonperforming loans declined by $55.6 million or 27% from the previous quarter to $152.9 million representing the lowest level of nonperforming loans for the bank since the second quarter of 2008 and Hadley will go into more detail on this.
The capital from the private placement gave us the opportunity to reduce nonperforming loans while we grow our existing loan portfolio and targeted customer segments. This approach of growing loans will over time reverse the negative operating leverage and improve our net interest margin as we grow our loan revenue.
This is important to understand as part of our 2010 strategy. It is expected that both of these can be done while maintaining our capital levels at expected levels. To fund the future loan growth we reduced the size of our existing investment portfolio which is currently over $500 million. Drawing the loans will take some time, but we’re actively pursuing opportunities in the marketplace in a very targeted and controlled way by customer segment with our sales force.
We have had activities underway both internally and externally with the capital raise to achieve this objective. I believe we understand the challenge of this economy but we also believe that with our people and existing products along with the turmoil in our marketplace this can be accomplished during 2010.
Also as you are aware our shareholders last week by an overwhelming majority approved the authorization of the issuance of the common shares to replace preferred shares outstanding at the time of the private placement. This approval increased on a pro forma basis the total capital ratio of the holding company to 15.7% at year-end 2009 as reflected in the table in the press release. And with that I’m going to turn it over to Anders Giltvedt.
Thank you Robert, good morning or afternoon to all of you. Let’s begin by briefly discussing the capital raise followed by comments focusing on the results, taxes, and trends. We appreciate it was a complex quarter for us.
As Robert noted, $134.2 million capital contribution to the bank in October had already improved the bank’s regulatory capital ratios at year-end 2009. Additionally as announced on January 20, shareholders approved an increase in authorized common shares from 50 million to 250 million and the conversion of the preferred stock issued in the company’s October, 2009 capital raise into common stock.
The shareholders approval will result in significant improvement to Bancorp’s regulatory capital ratio as well. The capital raise for Bancorp now qualifies as Tier 1 capital at the holding company level for regulatory purposes. The pro forma capital ratio is summarized in Table one of the release this morning.
Let me also briefly touch on the common and preferred shares outstanding, on January 27 the Series A preferred stock issued in the transactions will convert into 71.4 million shares of common stock. Including the existing 15.6 million common shares outstanding, the company will have approximately 87.1 million common shares outstanding on January 27.
Additionally approximately 121,000 shares of preferred B preferred stock are now mandatorily convertible into a total of 6.1 million common shares of common stock when those shares are sold by the original investors in a widely dispersed offering.
Also certain investors hold warrants that effectively allow such investors to acquire 12 million common shares at a price of $2.00 per share upon transfer of the warrants of shares in a widely dispersed offering. Taking into account the capital raise and the conversion of the preferred A preferred shares the pro forma year-end book value would have been approximately $2.83.
But pro forma book value does not include the impact of the future conversion of the Series B preferred shares which again will add 6.1 million common shares to outstanding shares for a total of 93.1 million at such time.
Okay let me briefly turn to the quarter, as we announced this morning the fourth quarter and full year losses were $51.8 million and $94 million respectively and the were effected by the three significant items Robert mentioned; a provision for credit losses of $35.2 million, valuation adjustments and loses of the lower disposition of about $14.5 million, and the establishment of the over $23.4 million deferred tax asset valuation allowance which increased the company’s net loss in the quarter by the same amount.
Combined these three items negatively effected the fourth quarter and full year loss by approximately $74 million or $56 million after-tax. Since the taxes had a significant impact on the result, I’d like to discuss the tax situation in more details.
Due to the tax loss changes in late 2009 the company will be able to carry back losses from 2009 to offset federal taxes paid over the previous five years at the posted two years under prior tax laws. This increased the company’s capacity to carry back losses by approximately $50 million to the grand total of [inaudible] million.
Partly as a result of this the company expects to receive and estimated $29 million federal tax return refund in early 2010. This refund will not run through the income statement. The cash refund would have been approximately $17 million less if not for the tax law changes and the deferred tax to assets more importantly, would have been about $17 million higher.
We established the $23.4 million deferred tax valuation allowance against the deferred tax asset balance at year-end and that reduced the period end deferred tax asset balance to about $2.2 million. The primary factors in establishing the company’s cumulative losses over the past two years.
As shown in table 10 of the release, the $23.4 million valuation allowance resulted in a fourth quarter income tax expense of $5.5 million rather than the $17.8 million benefit for income taxes that would otherwise have been recognized in the fourth quarter without establishing the valuation allowance.
Looking forward we will review that deferred tax valuation allowance on a quarterly basis and any future reversals of the deferred tax asset valuation allowance as a result of the company returning to profitability, will reverse the valuation allowance and decrease the company’s income tax expense therefore increase after-tax income in the period of the reversal.
Over to the balance sheet, during 2009 total loans declined by approximately $240 million or 16% to $1.7 billion. The recession as well as de-leveraging by our borrowers combined with our internal lending and capital management strategies dramatically effected new loan originations in 2009 and that was particularly the case for construction and commercial loans.
The construction loan portfolio which we have dedicated a great deal of resources towards contracted $185 million or 65% in the past 12 months. This portfolio not only measures about 6% of total loans, as compared to negative 25% as it peaks towards the end of 2007. Throughout 2009 the local housing market continues to work through its over supply.
As evidenced by only 7400 new housing permits issued in the state of Oregon in 2009, there was not much activity in the residential housing industry or any [inaudible] in our markets in 2009. On a positive note however, within the markets we operate the rural housing unit inventory has continued to fall, price has appeared to have stabilized, and the monthly inventory in the December of 2009 was just above eight months which was down about from nearly 15 months a year ago.
Furthermore our commercial loan balances declined $112 million or 23% during 2009 and as we all know the recession had a significant adverse impact on employment and manufacturing activity in the region. The number of manufacturing jobs in Oregon as an example has declined 22% or 46,000 since its peak of nearly 210,000 in 2006.
Our loan production expectations for 2010 are significantly above the volume we generated in 2009 but our future success will certainly to a large degree hinge on the economic environment including the scope and timing of the recovery, which will effect the demand for loans. It should be mentioned that the Pacific Northwest historically has lagged the nation in and out of recessions by about six months or so.
We will also focus on reducing our $99 million in nonaccrual loan balance and our result from this effort will impact our overall loan portfolio growth. Fourth quarter average total deposits of $2.15 billion increased 6% or approximately $121 million from the final quarter last year. Low cost core demand and savings deposit categories grew over $145 million or 18% over the same period improving the company’s already attractive deposit mix and cost.
The rate paid on average deposits was 99 basis points in Q4, down 69 basis points from Q4 in 2008. We added nearly 6,000 net new checking accounts during 2009. As a result of the major balance sheet changes our loan to deposit ratio declined from 102% 12 months ago to 80% at year-end 2009.
Loan and deposit trends also caused the company’s investment portfolio to grow nearly $360 million in 2009 representing a meaningful 22% of total earning assets, up from 9% a year ago. The balance sheet changes have led to significant improvements in the company’s liquidity measures but certainly added pressure on our net interest income and margins.
The excess cash was primarily invested in mortgage backed securities and US government agency securities. And overall projected the ratio of 3.5 years at year-end 2009. The securities purchased are expected to provide sufficient cash flows for future loan growth including that in a reasonable rising interest rate environment.
Let me also briefly make some comments on the income statement, the company’s Q4 net interest margin of 305 decreased 65 basis points from the fourth quarter last year. As a result net interest income declined $1.9 million from the fourth quarter last year to $19.2 million. These declines were primarily caused by three factors; the considerable shift in the earning asset mix, the lengthening of the company’s federal home loan borrowings in the first half of 2009, and thirdly the lower benefits from non-interest bearing demand deposits in the recent low rate environment.
However the spread between loans, the yield loans on rate and deposits actually improved 43 basis points from Q4 2008. Sequential quarters the margin declined nine basis points but again the deposit spread improved. The MPA including interest reversals reduced the fourth quarter net interest margin by approximately 46 basis points, so that’s about the same as we experienced in the immediately preceding quarter.
Looking forward improvements in the net interest margin and the net interest income will be driven by our ability to grow loans which would improve the yield on earning assets. There is not much room for further reduction in our cost of funds from a competitive perspective or based on the likely direction of market interest rates.
In short we need help from the economy to grow our loan totals. Fourth quarter 2009 non-interest income actually was a loss of $6.1 million due to the $14.5 million [OREO] valuation adjustments and the losses associated with OREO dispositions. In the final quarter of 2008 total non-interest income was $4.3 million with OREO valuation adjustments and losses totaling $3.7 million.
Table eight in our earnings release details the fee loss in more detail. Excluding the OREO valuation adjustments and losses on dispositions the company’s non-interest income increased slightly or 4% to $8.3 million in the year over year fourth quarter. Fourth quarter 2009 totaled non-interest expense was $24.2 million, and increased 7% to $1.6 million from the same period in 2008.
The combination of $1.1 million higher equipment and occupancy expense related to fixed asset charges, the $0.4 million increased in FDIC insurance premium, and a $1.4 million increase in [inaudible] caused the fourth quarter year over year expense increase. Total personnel expense [rose] slightly in the most recent quarter compared to the same quarter of 2008. For the full year total personnel expense declined nearly $3 million or 6% from 2008.
And with that I would like to hand it over to Hadley.
Thank you Anders, managing down MPA levels is an important ongoing strategic company objective, and during the fourth quarter significant progress was made. MPA declined 27% or $56 million in the fourth quarter from $209 million at September 30, 2009 to $153 million at December 31, 2009.
This the lowest MPA level since the second quarter of 2008. MPA as a percentage of total assets also declined from 7.9% to 5.6%. The amount of cumulative charge-offs and valuation adjustments applied to year-end MPA totaled $90.5 million and this is broken down in terms of charge-offs of $81 million and valuation adjustments of $9.5 million.
Collectively these charges represent 38% of the original principal. For the most part the cumulative $81 million in MPA charge-offs largely relate to three portfolio segments; residential construction loans about $32.7 million, commercial loans about $21.2 million, and two-step loans of about $13.7 million.
The two components making up total MPA nonaccrual and OREO were $99 million and $54 million respectively at year-end. Both components declined during the fourth quarter and contributing to the overall reduction we saw in MPA mentioned above.
Nonaccrual loans declined $33 million while OREO declined $23 million. The bank’s [MPA] levels have now trended down for three consecutive quarters. A number of factors contributed to the decrease in nonaccrual loans and OREO and taking a look at nonaccrual loans first, the most significant elements driving the net $33 million reduction during the fourth quarter were moving $27.3 million in nonaccrual loans to OREO.
Although this is still a component of MPA we now have control of these properties which is an important point and can aggressively apply our disposition strategies using the same team that has successfully led the reductions to date. Its my expectation that we’ll bring a number of the new properties under sales contract in the first quarter and start to see reductions as early as the second quarter in these balances.
Other elements contributing to the reduction in nonaccrual loans are recording impairment related charge-offs of $24.7 million pay offs the $7.9 million and other changes of about $2 million, the largest of which is fluctuations in loan balance and those trended down.
These factors were offset by an inflow of new nonaccrual loans of $29.3 million. The single largest category of new loans classified nonaccrual during the fourth quarter was residential construction loans. And within this category new nonaccrual site development loans accounted for approximately $7 million.
With regard to OREO significant elements driving the $23 million net reduction in fourth quarter include the disposition of 165 OREO properties with a total book value of $42.3 million, valuation adjustments net of capital improvements of $4.8 million. These two elements were offset by additions to OREO of 536 properties in the amount of $24.2 million.
Most new OREO properties booked in the fourth quarter consist of 405 lots within nine site development projects. These projects are primarily located in the state of Washington, in Maple Valley, Vancouver, Washougal and Puyallup, as well as in Salem, Oregon.
OREO sales for two-step and non two-step properties were strong during the fourth quarter, 44 non two-step properties were sold decreasing book value $12.2 million. The loss on sale of non two-step properties was $1.4 million. Two-step property sales were substantially higher, 121 two-step properties were sold in the fourth quarter which further reduced OREO $30.1 million.
The loss on the sale of two-step properties was $6.2 million which was elevated as a result of a decision to pursue a bulk sale. The bulk sale of two-step properties used the single most significant disposition effort in the fourth quarter.
Sixty-nine two-step properties with a book value of $18.9 million were sold. The final sales price was $12.7 million which result in a loss on sale of $6.7 million or about 35% of book value. Although this loss on sale may be higher than what could have been realized if properties were sold on an incremental basis over time, the accelerated disposition of these assets favorably positioned the bank to achieve a number of desired outcomes.
We were able to reduce carrying costs, we were able to convert cash proceeds to earnings assets, and we also had the ability to focus our disposition team on the newly booked site development properties mentioned earlier.
Net charge-offs for the fourth quarter were $35.9 million or 7.94% annualized of average loans outstanding. This compares to $18.8 million or 4.01% for the third quarter. Net charge-offs during the fourth quarter were largely related to the following; impairment charge-offs on nonaccrual loans totaling $24.7 million, charge-offs associated with booking OREO of $6.5 million, a troubled debt restructure charge of $3.9 million, and other miscellaneous charge-offs of about $800,000.
Net charge-offs were concentrated in three of the banks portfolio. The largest was CNI $13.3 million, followed by residential construction $10.5 million, and real estate mortgage portfolio of $6.8 million. Provision for the fourth quarter was $35.2 million. Net charge-offs mentioned above represent the single largest factor driving provision expense during the fourth quarter.
Also during the fourth quarter upward pressure on provision expense was caused by the migration of borrowers to higher classifications of credit risk. However this pressure was primarily neutralized by lower loan levels which eliminated the need for reserves and relieve provision expense. And secondarily by the recapture of reserves as loans move from loan pools covered by our allowance for credit loss reserves to individually impaired loans.
The volume of bank’s risk rating migration is predominantly within the non-classified range of risk ratings. Risk rating changes are observed across the majority of our portfolio segments yet most severe movement continues to be concentrated in borrowers directly and indirectly related to the housing industry.
At year-end the allowance for credit losses was $39.4 million or 2.29% of total loans. This compared to third quarter allowance for credit losses of $40 million or 2.2%. Unallocated reserves increased to 12.7% of the allowance for credit losses versus 9.7% for third quarter. The current level of unallocated reserves is high by historical standards, however we continue to believe higher levels of unallocated reserves are appropriate given continued downward pressure on real estate values and higher levels of uncertainty associated with strained economic conditions.
In looking forward, the eventual timing and amount of MPA is subject to a number of forces, many of which are outside the bank’s direct control. However based on what we know today, and barring any unexpected deterioration in our CRE portfolio, we believe that total MPA levels peaked during the second quarter of 2009 and will continue to trend down in the first quarter of 2010.
At this point we’re not looking for a material improvement in regional economic activity however we are hopeful that positive economic trends start gaining momentum sometime in the second half of 2010. Until our regional economy generates and sustains higher levels of overall business activity, financial pressures will continue to challenge a number of our borrowers and satisfying the full range of claims on our cash flow.
During the first quarter of 2010 I expect the bank’s provision expense to continue to be largely influenced by impairment charges and risk rating migration. First quarter provision expense should trend down from the levels seen in the third and fourth quarters of 2009. That concludes my comments, and with that I’ll turn it back to Robert.
Thank you both Hadley and Anders, with that I’d like to open it up for questions please.
(Operator Instructions) Your first question comes from the line of Lewis Feldman – Unspecified Company
Lewis Feldman – Unspecified Company
Anders how was Scandinavia.
Very nice thank you.
Lewis Feldman – Unspecified Company
Of the $14 million in valuations, your OREO valuation adjustments, I’m assuming that’s the $6 million was included within that $14 million on the bulk sale, is that correct.
Lewis Feldman – Unspecified Company
To what extent, and that was slightly higher than what you had been experiencing on the individual sales.
Lewis Feldman – Unspecified Company
To what extent, on what percentage basis, were you looking a 15% to 20% on the stuff you were selling individually and this was I believe you said, somewhere around 33% to 35%.
Right, I did a comparison of the bulk sale based on original principal, not necessarily book value so I backed both comparisons up to the original principal amount. And its about a 15% additional discount based on that.
Lewis Feldman – Unspecified Company
Are you looking at any additional potential bulk sales at this point in time.
At this point in time, I am not.
Lewis Feldman – Unspecified Company
And then did I hear you correctly, did I hear you quote we need help from the economy to grow loans.
I think that’s fairly obvious if you look at loan totals for banks particularly in the Northwest for the last 18 months. There’s a significant contraction and I don’t think for anybody in our markets to aggressively grow loan totals without the help of the economy.
Lewis Feldman – Unspecified Company
I guess I would come back to comments you made last quarter or I can’t remember whether it was on the last quarterly call or on one of the group meetings that you held, where management was making the statement that you felt you could comfortably potentially pursue commercial real estate because after the transaction had been done it’s a process of ramping it up but certainly there is a need for commercial real estate loans out there as long as they’re reasonable quality. But you’re not taking that into consideration or you are taking that.
Let me just clarify for a second, clearly relative to the existing borrowers and utilization of their lines, it is impacted by the economy. Having said that we have a very active plan in place to, and targeted customer segments, to take advantage of things that are going on in the marketplace. So I wouldn’t just react to that one comment about the economy.
Of course the economy is a factor but on the other hand we do believe that there are sufficient opportunities in the marketplace given everything that’s going on and with the depth and breadth of our sales force across the market areas for us to significantly higher loan originations in 2010 from the previous year.
I’m not sure exactly what comment you were referring to but it could be also the recognition of we’re not constrained by capital and we’re not constrained by commercial real estate concentration limits in our ability to grow. We have a very experienced sales force and as Robert indicated earlier in this call we have been engaged in a number of both internal and external activities since the capital raise which will position us very well to take advantage of opportunities.
As you are well aware in the past we’ve made some very favorable hiring decisions where we’ve hired experienced bankers from the market to join our team. We’re continuing to pursue and look at those opportunities and there’s a significant level of discussions going on today with our bankers and businesses that are in the market.
Your final question comes from the line of Jeffrey Rulis - D.A. Davidson & Co.
Jeffrey Rulis - D.A. Davidson & Co.
Just a couple, I guess as the loan to deposit ratio is now down to 80% any chance you manage deposit growth or even allow some run off to protect margins given the continued loan run off.
That’s a very good point, we foresee some shrinkage in the deposit growth going forward. A $100 million in nonaccrual loans that we’ve got to be working down, part of the asset side, also we have a negative spread on a fair amount of cash and shorter investments we’re sitting on. So I do see us working those balances down in 2010.
Jeffrey Rulis - D.A. Davidson & Co.
In terms of the total capital surplus above, I’m wondering if you had the, in dollar terms, given the pro forma ratios on both total risk based and leverage ratio at the bank level versus the 10% level. Do you have those dollar terms available.
Let me get you those.
Jeffrey Rulis - D.A. Davidson & Co.
And then I guess one additional follow-up, I guess this is the first time in awhile net charge-offs have exceeded the loan loss provisions albeit modestly in this quarter, is there any signal there that you’re going to begin to charge down the reserve to some degree or is Q4 kind of a one-time event.
That’s kind of a intersection of a number of forces one of which is lower loan levels. If you look at the level of our provision unallocated actually increased and so I think that looking forward I continue to believe that provisioning levels should come down in the first quarter.
But the forces that drive that I’ll follow closely and I’m sure you will as well.
I would say the leverage ratio, that’s the one with the lowest margin to the agreement, its approximately $15 million based on current average total quarterly assets. But as I indicated we would expect the average quarterly asset balance to come down somewhat as we move into 2010.
There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.
I want to thank everybody for participating on the call and thank you very much.
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