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Banner Corporation (NASDAQ:BANR)

Q1 2010 Earnings Call Transcript

April 22, 2010 11:00 am ET

Executives

Mike Jones – CEO

Albert Marshall – Secretary

Lloyd Baker – EVP and CFO

Rick Barton – EVP and Chief Lending Officer

Mark Grescovich – President

Analysts

Matthew Clark – KBW

Jeff Rulis – DA Davidson

Sara Hasan – McAdams Wright Ragen

Louis Feldman – Wells Capital Management

Brent Christ – Sirios Capital Management

Brian Freckmann – LS Capital

Kipling Peterson – Columbia Ventures Corporation

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Banner Corporation First Quarter 2010 Conference Call. During today's presentation, all participants will be in a listen-only mode. Following the presentation, the conference will be opened for questions. (Operator Instructions).

This conference is being recorded today, Thursday, April 22, 2010. I would now like to turn the conference over to Mike Jones. Please go ahead, sir.

Mike Jones

Thank you very much. And let me add my welcome to all of you to the first quarter results conference call for Banner Corporation. With me today is Lloyd Baker, our Chief Financial officer; Rick Barton, our Chief Lending and Credit Officer; Albert Marshall, the Secretary of the Corporation. And I'm very pleased to indicate that we also have Mark Grescovich here with us. He is the new President of Banner Bank and Banner Corporation and he will have a few comments to say after we get through reporting on the first quarter results.

So, with that, Albert, would you please read the paragraph?

Albert Marshall

Sure. Thank you. Good morning, everyone. Our presentation today discusses Banner's business outlook and will include forward-looking statements. Both statements include descriptions of management's plans, objectives, or goals for future operations, products and services, forecast of financial or other performance measures, and statements about Banner's general outlook for economic and other conditions.

We also may make other forward-looking statements in the question-and-answer period following management's discussion. These forward-looking statements are subject to a number of risks and uncertainties, and actual results may differ materially from those discussed today.

Information on the risk factors that could cause actual results to differ are available from the earnings press release that was released yesterday and a recently filed Form 10-K for the year ended December 31, 2009. Forward-looking statements are effective only as of the date they are made and Banner assumes no obligation to update information concerning its expectations. Thank you.

Mike Jones

Thanks, Albert. Now, what I’d like to do is have Lloyd kind of go, Lloyd Baker, our Chief Financial Officer go through our results for the first quarter.

So with that, Lloyd, why don't you go ahead?

Lloyd Baker

Okay. Great. Thanks and good morning, everyone. It's good to be with you again; it seems like we just did this not that long ago. For the past couple of days, I’ve been contemplating what I would say about the first quarter's operating results.

In that process, I kept coming to the same conclusion, which was to say, for Banner Corporation the first quarter was pretty unremarkable. There was nothing unanticipated; there was nothing requiring a complicated explanation. It was pretty much what we expected, although it may have been better than what some others expected and for the most part, things were generally improving. Actually, given the difficult economic environment that we’re still dealing with, that perhaps is remarkable.

For us and for most banks for that matter, the first quarter is always a challenge when comparing to the preceding quarter simply because it’s shorter, there are fewer business days. That means there are fewer days to earn interest, as well as to close loans and earn payment processing and other transaction fees.

Nonetheless, our total revenues for the first quarter at $45.2 million were nearly unchanged, compared to immediately preceding quarter and were slightly more than 5.5% stronger than the first quarter a year ago.

Of course, the most significant component of our revenue is net interest income. Net interest income was $38.2 million for the quarter. It was essentially unchanged again compared to the fourth quarter, despite the two fewer days and a meaningful decrease in earning assets.

But that net interest income was more than 9% greater than the $35 million amount in the first quarter of 2009, which was rewarding to see that kind of improvement. The improvement, compared to a year ago in net interest income reflects a 12 basis point improvement in our net interest margin during the most recent quarter, which represents a continuation of the margin expansion we've reported for the past three quarters now.

For the quarter, net interest margin was 3.61%, which was 35 basis points better than the 3.26% level that we recorded in the first quarter a year ago. This margin expansion has been very significant – has been driven, excuse me, by very significant improvement in our funding costs, which in turn has primarily been driven by continuing declines in cost of deposits.

Deposit costs declined by 15 basis points for the quarter and were 85 basis points lower than the same quarter a year earlier. By contrast, loan yields continue to be very stable, actually went up a couple of basis points during the quarter.

The trend towards lower deposit costs has been a very significant factor for us for a number of quarters and it had been, excuse me, has been significant for us for a number of quarters.

In deposit costs, importantly, deposit costs decreased every month during the quarter, another trend that has been in place allowing us the expectation of lower funding costs next quarter.

With respect to non-interest income, deposit fees and other payment revenues continued to be adversely impacted by the slow economy, as well as, the shorter quarter that I mentioned but actually increase compared to a year ago, reflecting continuing account growth.

Mortgage Banking revenues were pretty modest during the quarter. Activity was down, particularly by comparison to a year ago where we had seen a significant amount of refinancing activity and the kickoff of our Home Rush program a year ago, which caused the first quarter's Mortgage Banking revenues at that time to be quite strong.

The other non-interest revenue item worthy of mentioning is that loan servicing revenues returned to more normal levels for the last couple of quarters or for the fourth quarter of last year, I guess. In the first quarter of last year, we took some impairment charges reflecting that refinance activity that I mentioned. That no longer seems appropriate and we see an improvement in loan servicing revenues.

Credit costs for the quarter were still much higher than we would normally find acceptable. They were lower than the preceding quarter, however, and significantly lower than the first three quarters of 2009, continuing a trend of improvement that we’ve noted for our last two conference calls.

Although, we were disappointed that the level of non-performing assets did not decline during the quarter, we nonetheless continue to believe that lower credit costs, the trend of lower credit costs is intact and further reductions in quarterly loan loss provisioning will occur going forward. Rick and Mike obviously will have more to say more about loan loss and credit quality metrics.

Manageable operating expenses were well in line with our expectations, which has been the pattern now for a number of quarters, generally below the level of a year ago. However, as has also been the pattern, we had higher collection and legal expenses, including carrying costs associated with real estate owned some modest valuation adjustments on real estate owned as well.

We also compared to a year ago had higher FDIC insurance premiums. As a result, operating expenses were slightly higher. But again, as I mentioned, really in line with where we would expect to be as expense discipline has continued.

So, the net of all of that, unfortunately was still a loss for the quarter of $1.5 million, down from the amount that we reported the previous quarter. As I mentioned, trends generally improving but not to the level to get us back to a profit quite yet.

Just a couple of comments with respect to the balance sheet, importantly we saw further reduction in construction and development loans as we continued to reduce our risk exposure to that type of lending.

Unfortunately, we also had net reduction in most other categories of loans and while some of that was at our choice, much of it is a reflection of still very modest business and consumer loan demand despite what seems to be a strengthening recovery.

This tepid loan demand I think is pretty consistent with what we’ve been seeing reported by other banking institutions and it certainly will be the most important sign of things turning around in the economy when we see a pickup in that loan demand.

We did also on the asset side see an increase in REO of about $17 million. That's actually not a bad thing in that it allowed us to get control of more properties as we work through the collection process.

We did have sales of REO of about $10 million during the quarter, so we continue to have success moving properties once we get our hands on them. I think Rick will probably speak to that.

And then on the deposit side of the balance sheet or the liability side, deposits, non-interest-bearing accounts declined from the exceptionally high level that we had at December 31. That's primarily a seasonal factor.

But deposits – non-interest bearing deposits were up by 8%, compared to a year ago, again reflecting really solid activity in our retail deposit gathering franchise. And of course, that was a significant factor which led to the continuing decline in our funding costs.

So, the only other comment, I guess with respect to the balance sheet is in the capital accounts, we had – capital was nearly unchanged, up just slightly from the prior quarter end.

Capital ratios generally improved very modestly but still keep us well in excess of the well-capitalized levels under the regulatory guidelines. And our tangible book value per share closed the quarter out at $12.18.

So, that's what I have to say in terms of prepared remarks. As always, I look forward to questions that I’m sure will come and Mike?

Mike Jones

Thanks, Lloyd. What I'd like to do now is to have Rick Barton, our Chief Credit and Lending – and Chief Lending Officer, make a few comments about the loan portfolio, asset quality and how he sees the region.

So Rick, would you go ahead?

Rick Barton

Okay. Thanks Mike. As Lloyd alluded to, we've continued to see a cresting of our aggregate credit quality metrics during the first quarter of 2010. The provision expense went from $17 to $14 million and charge-offs decreased from $16.9 million in the fourth quarter of last year to $13.5 million on a net basis during the first quarter of 2010.

Non-performing assets unfortunately only shrank nominally a little over $1 million. The improvement here would have been significantly better if it were not for a large multifamily construction loan that was placed on non-accrual during the quarter because of construction delays and associated issues with the funding process.

The mix of NPAs continued to change during the quarter. As Lloyd noted, REO grew by a significant number. That was a result of our aggressive collection strategies when we determined that borrowers are no longer adding value to the problem resolution process. The $95 million of REO that we now have is concentrated in residential construction and land assets.

We’re continuing to have good success in marketing completed homes as we foreclose them and have seen some increase in the sales of land assets during the last quarter. We’re optimistic that the sale of land assets will continue to accelerate during 2010.

One other metric the past dues needs a brief mention, the percentage of loans 30 to 89 days past due in non-accrual increased during the quarter because of a number of pending renewals that were not completed before quarter end.

Also, the smaller total loan portfolio contributed to the percentage increase. And during the quarter, the ALLL as a percentage of the total loan portfolio grew from 2.51% to 2.60%.

We’re hopeful that the collection liquidation programs we have in place will continue to show results as we go forward. An example of this is the continuation of our Great Northwest Home Rush program in 2010 under the Peace of Mind mortgage moniker. That program this year has already resulted in the sale of 57 homes that we have financed. 30 of those have already closed, resulting in $15 million in loan payoffs out of the construction portfolio.

The progress that we make in problem loan resolution, particularly in the residential construction portfolio will continue to be a function of the economic environment that varies pretty widely amongst our different markets.

The Colombia base end market – markets that are agriculturally driven remain stable and have been impacted at least by the recent economic downturn. Puget Sound appears to be stabilizing in King County where the bulk of our loan and REO assets are located. Prices are stabilizing and the recent Shiller Index showed modest value improvement as far as home values are concerned.

As standing inventory has continued to come into balance, interest and loan assets, excuse me, land assets has grown and deal structures for the sale of land are beginning to show some signs of improvement.

The same assets or the same comments that I just made about King County really still do not apply due to the Snohomish and Pierce County areas in Puget Sound. Fortunately, our exposures in those two counties are really fairly limited and are only $28 million each of the two counties.

Also should be noted that throughout the region, CRE is under pressure but our credit metrics in this portfolio remain good. We continue to have a very proactive program of portfolio management. The Portland market is measurably weaker than Puget Sound because of higher unemployment and the state's rate of reliance on the forest products industry.

The housing markets in Oregon, particularly Portland are still in the process of stabilization. But we’re seeing that fairly priced and well marketed homes are being able to be sold. Again, the CRE fundamentals in the metropolitan Portland market are weak.

Boise is the weakest of the major markets that we’re active in. Employment issues continue and many of the residential submarkets continue to be out of balance with prices continuing to be very unstable.

Fortunately, for us our remaining exposure in Boise is quite modest. We only have $8 million of homes remaining in the portfolio and the land exposure there is in the $19 million range. I think, Mike, that's the only set of comments I have with regards to markets.

The only other thing I would like to mention is that we do face a continuing challenge in our markets from the health of the financial services industry in the Northwest. We continue to see instances of residential land assets being dumped in many markets and this dumping may not only put pressure on those builders who remained in a performing status and put them at a competitive disadvantage but also impact the liquidation activities that we’ve in process for our REO assets.

With that, Mike, I’ll turn it back to you.

Mike Jones

Okay. Thanks, Rick, for your comments. What I'd like to do at this point is reintroduce you all to Mark Grescovich, who is the President of the Banner Corporation and Banner Bank.

For those of you that were not involved in the conference call or the press release relative to his coming on board at Banner. Mark comes to us from Ohio where he was previously with First Merit Corporation and First Merit Bank, which is a first rate bank located in Ohio and the surrounding states around that particular area.

He is a first rate commercial banker that has a wonderful reputation throughout the Midwest and East Coast. We’re really looking forward to him leading Banner Corporation on to the next level.

So with that, Mark, I'd like to have you make a few comments, if you wouldn't mind.

Mark Grescovich

Great. Thank you, Mike, and hello, everyone. I first want to convey my excitement to be here at Banner Corporation and to lead the company forward. For some of you who are not familiar with me, my background is as a senior executive with a larger regional bank, as Mike said, First Merit Bank, First Merit Corporation.

My executive experience includes risk management, successfully running a large, geographically diverse community bank model, implementing prudent market share expansion strategies and turnaround management.

As President, my role in the holding company and bank is to manage all operations of the company with all executive management reporting to me with the obvious exception of Mike Jones. My philosophy to banking is to maintain a strong credit and risk management culture throughout all of the organization, have a client-centric focus and execution of the business model and disciplined capital management and growth strategies.

With those comments, I look forward to working with all of our employees to improve the performance of Banner Corporation. Mike?

Mike Jones

Thanks Mark. I think now at this point, Marisha, we would like to turn it open to questions, if we could, please.

Question-and-Answer Session

Operator

Thank you, sir. We will now begin the question-and-answer session. (Operator Instructions) Our first question comes from the line of Matthew Clark with KBW. Please go ahead.

Matthew Clark – KBW

Good morning, guys.

Mike Jones

Hi, Matthew.

Matthew Clark – KBW

Can you first talk to the – I'm sorry, Cascade sold some lots during the quarter. I think it's high 40s, maybe 50% type loss rates on land development and lot-related type loans I think north of Seattle and I know you guys do have some exposure there. You guys have, I think, about $256 million in land development overall in all your markets. Just trying to get a sense for how you feel about that exposure. And along those lines, it looks like you guys have taken about a 8% cum loss rate on construction to date and that's I think well below what we've seen elsewhere. I am just curious as to how you feel about that loss rate going forward and how that – I guess – and I will have a follow-up question. Thanks.

Mike Jones

Matthew, I think I will have Rick Barton answer that question. Rick, would you mind answering it, please?

Rick Barton

No. I will try to get Mathew's points there. Well, first of all, based on the comments I already made, we have to acknowledge that it’s a continuing challenge to work through the problem assets, but we feel better and better about how we are positioned. I've done some work looking at how we underwrote the portfolio originally. And on a cumulative basis, the raw land lots and A&D financing that we did were about an aggregate 60% loan to value. So on the front end, we were fairly conservative in the way that we underwrote that portfolio.

Today, trying to look at our remaining balance and compare it to the aggregate updated appraisals that we have, we are at about a 44% aggregate current balance to the updated appraisal amount that we have, so we think that we continue to be realistically positioned in those remaining loan assets and that carries over into what we have in the REO pouch. The majority of that portfolio is in the residential arena and the residential land arena, specifically.

Today, those REO balances, if you compared them to the original loan balances, were about – excuse me, to the original appraisal balances, they're about 49% of the original appraisals. When we look at today's REO balance at – to the current appraisals that we have that are about 81% of the aggregate current appraisal balance, so while there still is work to be done and challenges to be met, we think we are relatively well-positioned vis-a-vis the value of the assets.

Matthew Clark – KBW

Okay. And then the – if you look relative to your peak in construction loans, I think they are down about $525 million from the peak. It looks like 20% of that has come by way of loss. The other piece – it looks like with that decline there have been kind of a like increase in theory and mortgage, residential mortgage. I'm just trying to get a better sense for how much of that decline in construction might be you guys helping to refinance or finance credits to resolve construction projects or to help absorption there that might be moving into those two other buckets? Just trying to get a sense for what could be considered a high risk, maybe within CRE that might've gone to a mini-perm and within mortgage that might've gone to the more favorable mortgage terms.

Mike Jones

Go ahead, Rick.

Rick Barton

As I mentioned, this year, we've had through the Peace of Mind Program, 30 closings already. The aggregate loan balances there are in the $12 million range. Looking at a spread of that portfolio, we continue to have the same underwriting criteria in place where we are limiting deals to about 700 credit scores, job stability, et cetera. But interestingly, in looking at what's happening in that portfolio, so far about 50% of the closings, a little more than 50% of the closings this year are at an 80% loan to value or less. So we feel pretty good about what's going into the portfolio so far this year.

Looking back at 2009 order of magnitude, we probably had $120 million in financing associated with the Great Northwest Home Rush project. Out of that portfolio, we have had a single foreclosure. We've had a handful of delinquency issues. I when I say a handful, I mean literally. And again, when we take a look at a spread of the way that portfolio was put together, a surprising number of the homes approaching, again, 50% had down payments of 20% or more. So while we have had a pretty significant number of loans go into the one to four family portfolio as a result of our financing efforts, the credit quality and credit metrics there look quite strong so far.

Matthew Clark – KBW

Okay. And then in terms of age of reserves, it looks like from at least your fourth quarter TFR, you had about $509 million of construction that was living off interest reserves. I think that number has grown over the last couple of quarters. I'm just curious why that would be growing and I would think for most banks, a lot of these borrowers should be off interest reserves by now. I'm just curious as to what's going on there.

Rick Barton

Well, in the construction, residential construction portfolio, there are very few and I'm having trouble coming up with any instances I can think of specifically that have continuing interest reserves. There are some that have minor interest reserves left, but most of the loans that are performing in the residential construction portfolio, particularly the land part of it are being supported by builder personal assets.

The commercial construction portfolio is limited to low $100 million range, $120 million, $130 million. And some of those projects clearly still are on interest reserve as part of the normal construction and underwriting cycle.

Matthew Clark – KBW

Okay. So is there some suggestion that might be incorrect I guess in the call report then?

Lloyd Baker

Matt, this is Lloyd. I believe that number gets reported based on the original terms of the deal, whether it's still on interest reserve or not.

Matthew Clark – KBW

Okay.

Lloyd Baker

So, to Rick's point, we don't have that magnitude of loans that are living off of reserves.

Matthew Clark – KBW

Okay. And then lastly, just in terms of capital raising efforts, is there any sense for timing and when you think you might get back out on the road to seek to raise some capital?

Mike Jones

Matthew, we've had some preliminary discussions with some investment bankers, including some people from your shop. And at this point in time, we've made no determination as to when, how or how much or whatever it is we're going to do in the capital raising arena at this point. But we certainly are looking at it.

Matthew Clark – KBW

Okay. Great, that's all. Thanks.

Operator

Thank you. Our next question comes from the line of Jeff Rulis with DA Davidson. Please go ahead.

Jeff Rulis – DA Davidson

Good morning.

Lloyd Baker

Hi, Jeff.

Jeff Rulis – DA Davidson

Lloyd, I don't know if there is any discussion that you've had on the deferred tax asset, if you anticipate any adjustment there or posting an allowance against that anticipated.

Lloyd Baker

Well, obviously, we've had discussions. We look at it every quarter. Let me size it. The deferred tax asset, net, is about $14.5 million. We and our accountants continue to agree that there is not a need for an allowance against that asset.

Just as an aside, where it most importantly comes into play is in the capital ratio calculations at the bank and a significant amount of that is disallowed in that capital calculation. So, if we were to put up a valuation allowance against it, it would not have a meaningful impact on the bank's capital ratios. We don't, at this point in time, but we believe a valuation allowance is appropriate.

Jeff Rulis – DA Davidson

And then kind of circling back to the Home Rush, I guess if you could discuss the reasons for closing that down, I guess it's not really a rush if it extends for a longer period but in terms of –

Mike Jones

We milked that really well for the whole. We sold like about 380 houses out of that great Northwest Home Rush.

Rick Barton

Yeah. We did, Mike.

Mike Jones

And so we just changed the name and now we call it a "Peace of Mind" mortgage, which actually has two nice features to it, that has, in case you lose your job, is we carry your payment for six months. It's got some home warranty built into it that we also were able to purchase for a very nominal amount in the marketplace, which helps buyers to buy homes.

And I think Rick indicated, in his commentary, that we have had 50 sales in that area and I believe 30 of which have closed, so we feel pretty good about just renaming it and doing the same thing. But to be honest with you, we're getting down to where we don't have a whole lot of houses to put into that program. Particularly in all of the markets except perhaps Portland, we are down to the teens in terms of numbers of houses available.

Jeff Rulis – DA Davidson

Okay. So to some degree, it's still – some of those properties are still being worked. It's just maybe not labeled the same?

Mike Jones

Exactly.

Jeff Rulis – DA Davidson

Okay. And then a couple of questions on the margin and just a quick check – you guys still remain asset-sensitive, or how would you put the balance sheet at this point?

Lloyd Baker

Yeah. We still think that rising rates is a good thing for us. We still don't anticipate that to occur any time real soon. But we are mostly flat. And like a lot of people we are – we are challenged right now, to be honest with you, to estimate what kind of customer and management behavior we will see when interest rates eventually do move up, but it doesn't appear to us to be a large risk at this time.

The larger risk would be, as you've heard me say, this a number of times, if we stay at the very low level of interest rates that we are at for a really extended period of time, our asset yields will continue to compress. And that will be the long-term challenge. But I think all of us expect that, sooner or later, rates will go up.

Jeff Rulis – DA Davidson

So on the other side, on the funding costs and Lloyd, you alluded to, given the trends in Q1, that could extend next quarter. I mean, if funding costs are at 169, I mean how low can that really be driven down to or –?

Lloyd Baker

Well, we actually think it can continue to move down. A couple of reasons for that – we are constantly evolving the mix and, as I noted, we had growth, year-over-year growth anyhow, in non-interest-bearing accounts. We also have some interest-bearing transaction accounts that allow us – that were associated with some of our newer branches that were still in the process of moving down towards what we think are the appropriate levels. And so there's room there. And then we still have CDs that roll over from time to time.

So that trend, as I noted – and we've seen deposit costs drop month after month after month. Now, eventually we're going to hit the bottom, but we're not there yet.

Mike Jones

No. And actually deposit costs in April were below what we have in for the quarter, so.

Jeff Rulis – DA Davidson

Good. Okay. And then last one – I apologize for the series of questions here, but the large multifamily credit that was added to non-accrual, Rick, I don't know if you can comment on the size of that. I didn't – there was some commentary. I don't know if there was timing issue, if there was some belief that may be coming back out any time soon, if you could just provide some color on that.

Rick Barton

Well, it stands out in the press release tables, as far as nonperforming loans are concerned, pretty starkly. It's approximately an $11 million exposure and it is being actively worked by our special credits people. At this juncture, it is early in the game, so I don't want to put a timeline on it. And given the fact that it is an active workout credit, I don't want to get into very much in the way of particulars about what's going on. I think that needs to be best played out between ourselves and the borrower.

Jeff Rulis – DA Davidson

Okay. Thanks.

Operator

Thank you. Our next question comes from the line of Sara Hasan with McAdams Wright Ragen.

Sara Hasan – McAdams Wright Ragen

Good morning, guys.

Rick Barton

Hi, Sara.

Sara Hasan – McAdams Wright Ragen

Rick, you mentioned that past dues in the 30 to 89-day bucket increased because of a number of pending renewals that weren't completed before quarter end. So have those fallen since the end of the quarter?

Rick Barton

When you say fallen, have they been consummated?

Sara Hasan – McAdams Wright Ragen

Yes.

Rick Barton

All right. Yes, they have been.

Sara Hasan – McAdams Wright Ragen

So where do 30 to 89-day past dues stand today?

Lloyd Baker

We can't give you that.

Sara Hasan – McAdams Wright Ragen

I thought I would try.

Lloyd Baker

Yes. It's a nice try, Sara.

Sara Hasan – McAdams Wright Ragen

I know, I know. Alright, so they have still more.

Mike Jones

Still more.

Sara Hasan – McAdams Wright Ragen

Okay. That's good. And then, could you talk about your conversations with the regulators, particularly with respect to capital?

Mike Jones

Well, the one thing in the MOUs that we have that we actually signed on March 23 is that the requirement for us to come up with a plan in the next 120 days for how we would get our Tier 1 leverage ratio to – inside Banner Bank to over 10%. I believe it is at 971 as we sit here today. And that's part of this capital raise issue we were discussing a little bit earlier.

Other than that, we don't have any particular requirements by the regulators for capital and so forth. So there are several ways to get there, one of which is raising capital.

Sara Hasan – McAdams Wright Ragen

And are you still considering continuing to reduce the size of the balance sheet?

Mike Jones

Well, that's kind of a less than a zero-sum game. At some point, you start, not impacting your revenue numbers, as we would not like, not to do that. We are actively looking in the market to do good loans that we can do throughout the communities with particularly emphasis we have in the small business arena. The hard part with some of the problems some of our competitors in the marketplace are having – now are looking at companies that have been in a recession for a couple of years.

And you look at some of these companies and they have gone through a lot of their balance sheet liquidity and they, frankly, probably don't have earnings in either of the last two years. And the last thing we want to do is put some classified loans on our books as we take those over. But we are looking and we do expect to grow the balance sheet and it will grow as we go forward.

Sara Hasan – McAdams Wright Ragen

All right. Thank you.

Mike Jones

Yeah, particularly in the agricultural loan arena.

Sara Hasan – McAdams Wright Ragen

Thanks.

Operator

Thank you. Our next question comes from the line of Louis Feldman with Wells Capital Management. Please go ahead.

Louis Feldman – Wells Capital Management

Sara beat me to the punch. So I will step back at this point.

Lloyd Baker

Come on, Lou.

Operator

Thank you. Our next question comes from the line of Brent Christ with Sirios Capital Management. Please go ahead.

Brent Christ – Sirios Capital Management

Good morning, guys.

Lloyd Baker

Hi, Brent. Just with respect to the MOU, had you guys disclosed that before? I know in the K you said you were expecting one.

Mike Jones

Yes. It is going to be fully discussed in the K.

Brent Christ – Sirios Capital Management

Okay. And then are there any other components to it other than the 10% leverage ratio target, or is that the crux of the – ?

Mike Jones

No. It – well, I guess it's standard. It's in the 10-K as reducing classified assets and reducing real estate concentrations, most of which we've done.

Brent Christ – Sirios Capital Management

Okay. And then just a question on the OREO, the $95 million of balances, could you give us a sense of where that's marked to? Or in other words, how much charge-offs you have taken on those? And then the $10 million that you sold this quarter, kind of what the realization value was when you disposed of it?

Mike Jones

Rick, do you want to answer that?

Rick Barton

With respect to the sales that we had during the quarter that were $10 million, $11 million in total. That's essentially the amount that we realized on a net basis from the sale of those assets. There were some losses associated with the sales that were consummated and the total write-downs we had against the REO portfolio associated with the sales were right at the $0.5 million range. So about 5%, which is reasonably good performance in today's markets, particularly given that a good chunk of those REO sales were out of the Portland market.

Brent Christ – Sirios Capital Management

And were those finished homes, or land or lots?

Rick Barton

For the most part, they were finished homes, but we are seeing some lots, finished lots, begin to move out. The finished lot prices that we are getting are tracking fairly well to where we have the assets valued on the books.

Brent Christ – Sirios Capital Management

Where are the values of the remaining $95 million, kind of relative to the original gross amount of the loans?

Rick Barton

Well, the balances we have aggregately in the portfolio, as I mentioned before, track to 49% of the original appraisal amounts. And In aggregate, the REO balances to the current appraisals that we have track at about 81%.

Brent Christ – Sirios Capital Management

And you underwrote those on average to a 60% LTV?

Rick Barton

For the land assets, yes, 60% LTV and for the home assets, about an 80% LTV.

Brent Christ – Sirios Capital Management

Okay. Great. Thank you.

Operator

Thank you. Our next question comes from the line of Brian Freckmann [ph] with LS Capital [ph]. Please go ahead.

Brian Freckmann – LS Capital

Hi, guys. How are you?

Mike Jones

Good.

Brian Freckmann – LS Capital

Just maybe I missed it. Number one, could you breakout on REO? I don't think I saw how that is broken out. You guys do a good job on non-performing and performing. What's in the REO, if you could sort of bucket that as you know, under commercial multifamily all of that?

Mike Jones

Rick?

Lloyd Baker

Rick, do you have that number?

Rick Barton

I'm trying to get to that, the table. Do you have that there, Lloyd, right in front of you?

Lloyd Baker

No. I don't. I apologize.

Rick Barton

Okay. About 50% plus of our REO is in the construction and land area, residential construction and land with a good portion of that being lots and land. We've got a couple of pieces of commercial real estate in there that total between the two about $10 million. And we've got a small number that came out of the one to four family portfolio. I am still trying to get to my sheet that has that and not coming up with it. But that's pretty generally, how the portfolio is made up in terms of rough concentrations.

Brian Freckmann – LS Capital

Okay. The provision against that, have you guys disclosed that?

Lloyd Baker

There is no provision against it. It has been fairly valued as it is transferred from loans into REO.

Brian Freckmann – LS Capital

Okay. Okay. And then the last question I have is you guys on your 10-K, there was sort of below some of the numbers, there was a comment you guys made that there is $204 million of let's call them other loans that are not non-accrual but you would say are possible concerns. And then I see 30 and 89 days still increasing and I tend to have some concern there.

Could you maybe give me an update on what that number is of those sort of accruing but in concern loans are? I'm sorry. I am sort of referring to the 10-K. I think it was on page 55 or 54 of your 10-K. There is $204 million that I guess are sort of in its limbo?

Lloyd Baker

Yes. That would be classified loans that aren't otherwise reflected in nonperforming loans or nonperforming assets.

Mike Jones

Or watch loans.

Brian Freckmann – LS Capital

Yeah. I mean you called them watch loans. What's the watch loan right now? I mean since you disclosed in the 10-K, I'm sort of curious if you would disclose it right now.

Mike Jones

I don't know that we know that.

Lloyd Baker

I don't know that we have that number yet. It will be in the Q when we finalize the Q.

Brian Freckmann – LS Capital

Okay. Okay. All right. Well, thanks, guys. I appreciate it.

Operator

Your next question comes from the line of Matthew Clark with KBW. Please go ahead.

Matthew Clark – KBW

Hi, guys. Actually, that question was my question as well. And then the other one, I just wanted to get an update on your – right there. I think last year, it was sometime in June, but just curious as to what the upcoming – when the upcoming one is.

Mike Jones

We haven't been notified. So I'm going to guess it's probably sometime in the August, September timeframe something like that probably.

Matthew Clark – KBW

Okay. Great. Thanks, guys.

Mike Jones

That's just a guess, Matthew.

Operator

The next question comes from the line of Kipling Peterson with Columbia Ventures Corporation. Please go ahead.

Kipling Peterson – Columbia Ventures Corporation

Good morning. A couple of questions. Mr. Jones, in the not too distant past that presentation you said you thought there was a shot of having a profitable first quarter. But you were fairly confident that the second quarter was more possible to be profitable. I am just wondering if that is still your outlook.

And then B, as far as the capital raise goes, I think, on the last call, you mentioned that you had agreed to raise somewhere between $20 and $25 million to meet some of what the regulators were looking at. I'm wondering. Does that figure oscillate as your capital ratios improve? And B, have you considered just doing a rights offering as one of the other Pacific Northwest banks recently did as the number needed seems to be less than the $75 million that you were out for late last year?

Mike Jones

Well, First of all, you have to understand that I was disappointed we did not make a profit in the first quarter. I fully expected we were going to be able to do that. And if and buts were candy and nuts, we would be there except for a couple of problems that took place in the first quarter. I remain optimistic that we should get to the black in the second quarter, as I was before and I think things will get better in that area.

The $25 million as it relates to capital is what it would take to increase the Tier 1 leverage ratio in the bank to over 10% from where it was at the time I made that comment. I believe (inaudible). So it will change because the balance sheet is somewhat smaller now than it was then and so to get to that particular ratio, it would be a little bit less than that. However, we are not going to do a capital raise for $25 million. We would raise a significantly greater amount of money than that.

Kipling Peterson – Columbia Ventures Corporation

And have you considered just a rights offering?

Mike Jones

It is certainly one of the things we would like to do. And the CFO that is sitting here looking at me has got a big smile on his face because that's exactly what he would like to do, is a rights offering, so.

Kipling Peterson – Columbia Ventures Corporation

Great. Thank you.

Operator

Thank you. Our next question comes from the line of Louis Feldman with Wells Capital Management. Please go ahead.

Louis Feldman – Wells Capital Management

Yeah. I found my other two questions. One, Mike, you commented on Portland that you and/or Rick commented on Portland being weaker. What ways is it weaker in terms of volumes, in terms of people looking at houses, et cetera? Can you give us a little color on that?

Mike Jones

Yeah. I think the unemployment levels in the Portland marketplace are higher than they are in our other markets. And I think that the job outlook probably is a little less rosy in some of those markets than it is compared to Puget Sound.

Louis Feldman – Wells Capital Management

For the Rose City?

Mike Jones

And have another big concentration of our problem real estate loans. As a result, I think people are a little more reluctant to buy. I think there was more supply proportionally speaking, speaking in available in the market in Portland than there was in Puget Sound, particularly where we do business. We are very fortunate that we don't have a lot – and as Rick said earlier in Snohomish and Pierce County in the state of Washington, because we would probably have a different answer if we did.

We don't have very much there and as a result, what we have in the King County area, particularly East King County area, is better and more healthy than it is in the Portland marketplace. And we just see more volume of activity in the Puget Sound marketplace more buyers willing to buy.

Louis Feldman – Wells Capital Management

So things are not rosy in the Rose City? They're worse?

Mike Jones

I think they are getting better, I do. But there's just a lot of supply in that marketplace.

Louis Feldman – Wells Capital Management

Yeah. Most of it all over in Happy Valley. And then Lloyd, how is the DRIP program working at this point in time, in terms of capital inflows?

Lloyd Baker

It continues to function. We sold about $1.5 million shares in the first quarter, which brought in roughly $4.5 million of capital. We did just recently complete a registration of an additional $4.5 million shares under the DRIP. And we had a funding this month for about $1 million, as I recall. $2.2, excuse me, I'm out of sync. So it continues to be a viable way for us to augment our capital, which helped us in terms of relationships with regulators.

Louis Feldman – Wells Capital Management

Okay. Great. Thank you very much.

Operator

Thank you. At this time, I don't show any further questions. I would now like to turn it back over to management for any closing remarks. Please go ahead.

Mike Jones

Thank you very much to all of you for taking the time to listen to our first quarter conference call. We are optimistic as it relates on a go-forward basis. We are very pleased that, Mark is here. He will be the new leader of this organization as we go forward. We look forward to being a very strong commercial bank and we hope to have much better results to report to you at the end of the second quarter. So with that, thank you very much.

Operator

Thank you. Ladies and gentlemen, that concludes the conference for today. If you would like to listen to a replay of today's conference, please dial 303-590-3030 or 1800-406-7325, using the access code 4283091. Thank you for your participation. You may now disconnect.

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