AmericanWest Bancorporation (AWBC) Q4 2007 Earnings Call January 31, 2008 1:00 PM ET
Patrick J. Rusnak - Executive Vice President, Chief Operating Officer and Chief Financial Officer
Rick E. Shamberger - Executive Vice President and Chief Credit Officer
Robert M. Daugherty - President and Chief Executive Officer
Brett Rabatin - FTN Midwest
Fred Cannon - KBW
Jim Bradshaw - D.A. Davidson
Jason Werner - Howe Barnes
Hello, and welcome to the AmericanWest Bancorporation fourth quarter 2007 earnings conference call. (Operator Instructions) Now I would like to turn the conference over to Mr. Patrick Rusnak, Chief Operating Officer.
Patrick J. Rusnak
Good morning, and welcome to the AmericanWest Bancorporation fourth quarter earnings release conference call. With me this morning are Bob Daugherty, President and CEO, and Rick Shamberger Chief Credit Officer.
This call is being recorded and will be available for replay approximately one hour after its conclusion and will be available for 30 days. The recording may be accessed through our website at www.awbank.net/IR or by calling 877-344-7529 and entering the passcode 414984#.
During this call, we may make statements regarding future events, performance targets or results that are forward-looking in nature, which AmericanWest intends to be covered under the Private Securities Litigation Reform Act of 1995.
Such statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected. Factors which may cause actual results to differ from expectations are included in AmericanWest 2006 Form 10-K filed with the SEC on March 15, 2007.
AmericanWest cautions investors not to place undue reliance upon forward-looking statements and undertakes no obligation to publicly revise any forward-looking statements made during this conference call to reflect subsequent events or circumstances.
I will begin this morning with a review of our operating results for the fourth quarter, which in a word were disappointing. AmericanWest reported a loss for the quarter of $3.3 million or $0.19 per diluted share, a decrease of $0.39 from the same period in 2006 and $0.50 on a linked quarter basis.
The fourth quarter 2007 financial results reflect the provision for loan losses of $14.6 million or $0.85 per share before tax principally related to the deterioration in our residential construction and development portfolio. As a result of this charge and its impact on net income, standard performance metrics of ROA, ROE, return on tangible equity, are not meaningful for Q4 results.
The tax equivalent net interest margin for the fourth quarter of 2007 was 4.97%, down 25 basis points on a linked quarter basis and down 5 basis points from the fourth quarter of 2006.
This margin compression experienced during Q4 exceeded the expected range noted on last quarter’s call due to the impact of two subsequent 25 basis points reductions in the Fed Fund target rate and the impact of foregone and reversed interest on loans moved to non-accrual status during the quarter. With respect to the latter factor, the impact was approximately $550,000 or 13 basis points.
The average yield on loans for the fourth quarter of 2007 was 8.03%, down 42 basis points on a linked quarter basis and down 9 basis points from a year ago. The fourth quarter average loan yield was negatively impacted by approximately 13 basis points as a result of the $19 million increase in non-accrual loans during the quarter.
The balance of the reduction in the average yield was due to re-pricing of approximately $813 million of variable rate loans most of which were indexed to prime, which decreased by 66 basis points on an average basis during Q4 2007, as compared to Q3.
As of December 31, 2007 approximately 46% of the portfolio was indexed to prime with a reset of less than three months with the balance of the portfolio split about evenly between hybrid adjustable and fixed rate loans. The fixed rate loans have a remaining contractual maturity of approximately eight years.
Approximately $153 million or 19% of the variable rate loans tied to prime had contractual interest rate floors. The current average floor rate as of December 31, 2007 was 7.68%. Loan fees comprised 37 basis points of the total average yield on loans for the fourth quarter of 2007, down 1 basis point from the third quarter and down 10 basis points from the same period in 2006.
Net deferred loan fees represented about 21 basis points of total loans at December 31, 2007, which is the same as the level of September 30, 2007, and 11 basis points above the year-end 2006 level.
The reduction in the contribution of loan fees to average yield and an increase in deferred fees as percentage of total loans were both attributable to adjustments made to our accounting for deferred fees implemented during the first quarter of 2007.
The average rate exclusive of fees for new loans booked during the fourth quarter of 2007 was 7.77%, as compared to 8.18% during the third quarter of 2007. Fixed rate loans represented about 20% of the production for the fourth quarter with an average rate of 7.63%. The average rate for Q4 new variable and adjustable rate loan production was about 7.8%.
The average cost of the interest-bearing deposits for the fourth quarter of 2007 decreased by 21 basis points from the third quarter, reflecting our actions taken to reduce the costs of interest-bearing transaction and CD deposit rates with the Fed easing which began last September.
We’ve moved deposits rates down with each Fed reduction, up to and including the 75 basis point move on January 22 and we’re currently reviewing our rates for further reductions based on the 50 basis point easing announced yesterday.
Generally speaking, the deposit rate reductions that we’ve taken in the fourth quarter and in the first quarter of 2008 have been greater than those assumed in our outcome model.
Average deposits increased $9 million during the fourth quarter while the ending deposit balance declined by $68 million from the September 30 balance. The average savings and money market balances grew by $28 million during the quarter with the cost of these funds declining 28 basis points.
Non-interest-bearing DDA declined about $2 million on an average basis for the fourth quarter and comprised approximately 22% of total deposits for the fourth quarter of 2007, down slightly from the previous quarter and slightly above the similar quarter in 2006.
Our projection for the net interest margin for the first quarter of 2008, including the impact of yesterday’s 50 basis points easing is in the range of 4.65% to 4.75% at this time. The impact of the 25 basis point reduction in the Fed Funds target rate on a net interest margin based on our current model assumption continues to be approximately 7 basis points.
We recognize the provision for loan losses of $14.6 million for the fourth quarter of 2007 or 331 basis points of average loans annualized, compared with 29 basis points for the third quarter of 2007, and 15 basis points for the fourth quarter of 2006.
The provision for the full year 2007 was $17.3 million or 109 basis points of average loans annualized, compared to 47 basis points for 2006. Rick Shamberger will cover this area in a little more detail in a few minutes with his asset quality update.
Non-interest income was relative bright spot for us in the fourth quarter of 2007, totaling $4.6 million, an increase of 9% annualized on a linked quarter basis. Excluding the impact of $85,000 of gains realized in the connection with the foreclosed property during the third quarter of 2007, non-interest income grew to an annualized rate of 17% for the fourth quarter.
Deposit fee revenue increased by $135,000, or 21% annualized over Q3, driven principally by growth and overdraft fees of $69,000, and debit card fees of $94,000. As mentioned on prior calls, debit cards have been a principal area of focus for us over the past year and strong fourth quarter growth is relative of sales successes in our Utah markets and seasonally increased transaction volumes.
Mortgage banking revenues for the fourth quarter of 2007, was $889,000 down about $50,000 from Q3 and up 54% over the same period in 2006. The fourth quarter 2007 mortgage banking revenue was better than expected as we forecasted a decline of 15% to 20% on last quarter’s call.
We continue to have success with recruiting experienced lenders from both national and local bank competitors. Eleven were hired during the fourth quarter and we continue to pick up market share that was previously held by non-bank lenders. We are well positioned to capitalize on any increase in origination volume from a potential pick up in refinance activity given the recent reductions in market mortgage rates.
We also realized the first tangible results from our SBA, and other government guaranteed loan expansion initiatives, which were launched during the second quarter of 2007. A total of $2.3 million in loans were originated during the fourth quarter, up 35% over the prior quarter.
Of the total, $4.2 million of SBA loan production in 2007, 94% was originated in the second half of the year. Included in non-interest income for the fourth quarter of 2007, a $69,000 of gains recorded in connection with the sale of approximately $2 million of SBA loans, the bulk of which were originated during the fourth quarter.
The introduction of a companywide referral program and a new SBA lender incentive plan are expected to keep this program in the key initiatives spotlight for us during 2008.
Non-interest expense for the fourth quarter of 2007 was $18.4 million, down $368,000 on a linked quarter basis and up $4.1 million or 28% over the prior year period. The decrease in non-interest expense for Q4 as compared to Q3 was principally driven by lower salary and benefit costs, offset by an increase in occupancy and equipment and other non-interest expenses.
Compensation-related expense decreased by approximately $1 million compared to Q3 2007. This reduction was principally the result of $1.2 million of net credit adjustments related to certain compensation plan accruals, including performance-based restricted stock awards and our executive officer performance incentive plan for which performance targets were not achieved; offset by $270,000 of severance expense and the cost of new production staff.
With respect to the accrual adjustments they reflect the reversal of compensation expense recognized during the first three quarters of 2007 based on the previous expectation that target performance levels would be met.
The severance expense was recognized in connection with the consolidation of some back office functions scheduled for completion this month, which we expect will result in annualized expense savings in excess of $450,000.
The decrease in compensation-related expense was offset by increased occupancy and equipment expense of $289,000, most of which is related to the opening of our new Walker Center facility in Salt Lake City. We recognized $155,000 of foreclosed property expense during Q4, up by $110,000 over the Q3 level. This increase was principally due to recognition of a valuation adjustment on a single property of $77,000.
The effective tax benefit rate for Q4 was 40.4% and reflected the impact of the final 2007 pre-tax income being significantly lower than the previously estimated amounts on which accruals for the first three quarters of the year were based.
The lower pre-tax income was, of course, principally due to the higher level of loan loss provision recognized during the Q4. We expect the tax rate to be normalized for 2008 in the range of 32% to 34%.
Our efficiency ratio for the fourth quarter of 2007 was 63.3%. Efficiency ratio excluding the impact of the Q4 compensation accrual adjustment and interest reversal on non-accrual loans was 65.5%, as compared to 63.5% for Q3 2007.
The capital levels for AmericanWest Bank and the consolidated company were in excess of the requirement for well-capitalized status as of December 31. The two capital ratios we focus on – total risk based capital and tangible capital – were 10.31% and 7.06%, respectively, as of year-end for the consolidated company.
Both of these ratios remain within our target range given our current portfolio exposures although both were lower by approximately 20 basis points from the prior quarter due to the impact of the Q4 loan loss provision.
Although we have a stock repurchase authorization in effect and repurchased shares at the current market levels would meet our internal IRR targets we do not anticipate any repurchase activity will occur until our credit quality issues are stabilized and the total risk based capital ratio is at least 10.5%.
We also will be announcing the declaration of our quarterly dividend, $0.04 per share payable on February 26 to shareholders of record February 12, 2008. Although this distribution exceeds the Q4 net income per share, we believe at this time the current payout level will be sustainable and commensurate with the level of expected earnings generation and asset growth for 2008.
We will, of course, continue to monitor capital levels on an ongoing basis in light of operating results, asset growth, credit quality trends and economic conditions in our principal markets.
Should conditions dictate the preservation of all or some of the current quarterly distribution be retained, we will take appropriate action. Even though stock repurchases would meet our internal hurdle requirements for IRR and accretion at current pricing levels, again we do not expect to have any repurchases for the first half of 2008.
At this time, I typically hand the call over to Bob, but in light of the credit quality issues, I will now turn the call over to Rick for an update on asset quality.
Rick E. Shamberger
Thank you Pat. As on December 31 2007 our total non-performing assets excluding government guaranteed amounts were a 190 basis points of total assets, up 93 basis points from September 30 and up by 104 basis points from year end 2006.
Non-performing loans net of government guaranteed amounts at December 31, 2007 represented 221 basis points of total loans, as compared to 115 basis points as of September 30 and 94 basis point at December 31 2006. Other non-performing assets, which represent foreclosed properties, totaled $1.2 million at year-end and comprised of four properties.
During the fourth quarter 35 loans totaling approximately $30 million were placed on non-accrual status. Substantially all of the loans were related to residential construction or development projects.
In making the determination as to whether or not a construction or land development loan should be classified as impaired and placed on non- accrual status, which by the way we consider these two classifications as being one and the same, we focused principally on expected project absorption rates and borrower liquidity.
The existence of an interest reserve or borrower financial guarantee, individually or collectively, is not sufficient in our view to warrant classifying a loan as performing when the expected cash flows from the sale of lots or homes has been delayed due to market conditions and the borrower does not have liquidity sources in an amount sufficient to qualify as the primary source to be repay that for an extended period of time.
Fixed borrower relationships consisting of 20 individual loans represented $25.3 million or 86% of the total amount transferred to non-accrual during Q4.
In order to provide some color on these projects and hopefully answer some questions before they are asked, I would like to take a few minutes and do a high level overview of the fixed credits.
The largest loan in this group is related to a residential development in the Boise, Idaho metropolitan area. I’d like to emphasize that this is our only loan in the Boise market and has a carrying value of approximately $8.5 million.
This amount is supported by a current wholesale basis appraisal which is discounted for expected selling costs. The development is complete. Unfortunately there has been very little lot sales activity to date. This was further compounded by our borrower, a very large West Coast developer, having financial difficulties due to the overall slowdown in absorption for other unrelated projects.
Although the residential market in Boise is clearly tough, the project is well positioned from a location and retail cost price point. As expected finished lot prices are in the $60,000 to $80,000 range which will translate to a completed home of $225,000 to $250,000.
The borrower has been very cooperative in assisting and marketing the project to investors with the appropriate financial capacity and investment horizon. While the project is being marketed to investors we have started down the parallel path of initiating foreclosure action.
The second largest component of this group has an aggregate exposure of approximately $5.7 million related to a Utah based residential builder. Of this total approximately $4 million is for five spec homes in the St. George, Utah market and $1.7 million is for nine spec homes in the Provo market.
St. George projects are obviously on the higher end with completed sales values in the range of $1 million to $1.8 million. Despite the slow market conditions for high end product in St. George, we believe our current exposure is fully covered based on the discounted value of the collateral.
The fully dispersed aggregate value of these loans will be about $4.9 million, and the current aggregate appraised value of $7.3 million representing an equity position of 32%. The Provo area projects are all completed, single-family homes with expected sales prices in the range of $190,000 to $290,000.
We’ve reduced the carrying value of these loans by approximately 10% during the fourth quarter to a partial charge-off, and given the price point for these homes, we expect sales activity to pick up in the spring.
The third largest loan placed on non-accrual status is a $4.9 million land acquisition and development loan in the Provo area market. This project represents the fifth phase of a large subdivision in an established area. Infrastructure for this 46-lot project is completed; however, lot sales are well behind the original absorption forecast.
This is due in part to the general slowdown in the Provo market for homes in the $400,000 to $600,000 price range, which is the expected utilization for finished lots of this project size and quality in that market. We believe the current carrying value is supported by a liquidation valuation analysis.
The next significant loan moved to non-accrual status during Q4 was a $2.9 million residential development loan in the St George market. We have substantial equity position in this loan. The LTV on a discounted liquidation basis was 55%, and we expect that a large second lien holder will take at our position to avert foreclosure and protect their interests during the first quarter.
The two remaining relationships are both related to Provo area builder developers. One is secured by completed lots with a carrying value of approximately $1.6 million. We have initiated foreclosure action while evaluating sale proposals for the project.
Based on the current discounted appraisal no liquidation loss is expected at this time. The other relationship consisted of a raw land loan with a carrying value of $1.4 million and a $500,000 residential investment property loan.
The addition to non-accruals status during the fourth quarter were offset by principal reductions from pay downs of approximately $450,000; cash proceeds from the sale of 24 non-performing loans to third parties; $1.2 million of transfers to other real estate owned, and $5.2 million of charge-offs of loans which were included in the non-performing category as of September 30, 2007 of which $1.1 million was related to the third party loan sales.
Our portfolio delinquency remain within our target range at December 31, with 30 day delinquencies of $2.8 million or 16 basis points and 60 day delinquencies of $500,000 or 3 basis points. Both delinquency levels were comparable to the prior quarter end.
It should be noted that the ability of a borrower to keep payments current, whether through cash flows or interest reserves, is not necessarily a reliable indicator for a borrower’s ability to repay principal and interest in full in accordance with the loan terms, which is the GAAP definition of an impaired loan.
Potential problem loans, which we define as adversely classified loans not reported as non-performing totaled $26 million or 1.5% of total loans at December 31, 2007, as compared to 1.6% at September 30 and 1.6% at the December 31, 2006.
Substantially all of the loans placed on non-accrual status during Q4 were not adversely classified as of the prior quarter end and essentially by-passed the potential problem loan classification on their way to non-performing status.
As a result, the level of potential problem loans remain relatively flat without much activity for newly classified loans being added and reductions for loans transferred to non-performing status.
We are continuing to actively monitor our portfolio for any deterioration in borrower financial capacity and include a provision for timely loan officer grading adjustments as a key element of our lender incentive compensation plans.
Net charge-offs for the fourth quarter totaled $10.4 million or 235 basis points of average gross loans on an annualized basis. This compares to 47 basis points of average gross loans on an annualized basis for the third quarter of 2007, and 3 basis points for the same period last year. We did not have any significant charge-off recoveries during the fourth quarter.
Approximately $8.3 million or 79% of the total gross charge-offs were related to three credits. The charge-off of $2 million was recognized in connection with the residential acquisition and development loan located in the Boise area. This reduced the carrying value to $8.5 million, the current as-is appraised value net of expected sales costs.
The charge-off of $3.8 million was taken on the wood products manufacturing loan relationship, which we’ve discussed in detail on the last two earnings call to reduce the carrying value to $3.8 million at December 31, 2007.
Although this business was able to generate significant operating cash flows during third to fourth quarters, it was recently learned that a key long-term customer intends to discontinue its relationship and obtain product from other suppliers.
As a result, it appears likely that the company’s operations will be wound down in the near term and the existing inventory and accounts receivables liquidated. We believe the remaining $3.8 million balance is fully supported by the discounted collateral values, including high quality receivables, inventory and real estate unrelated to the business operations.
The third significant charge-off was for $2.5 million and recognized in connection with an unsecured short-term bridge loan. We are securing a judgment against the borrower in order to obtain a lien position on property with equity adequate to secure and eventually repay our loss.
As previously mentioned, an aggregate charge-off of $1.1 million was recognized in connection with the sale of 24 non-performing loans during the fourth quarter. The previously established allowance for loan losses for these was substantially sufficient to cover this charge-off.
For the year ended December 31 2007 net charge-offs were 93 basis points of average loans as compared to 54 basis points for 2006. It’s worth noting that our practice of recognizing charge-offs may be different from the approach used by other banks.
First, our recognition of charge-offs at the consolidated level is the same as what it is recorded at the bank level and reflected on the call report. We have no RAAP/GAAP difference.
Second, we generally recognize as charge-off any valuation reserve required for collateral dependent impaired loans as determined in accordance with FAS 114. We believe this approach is both consistent with GAAP and the most recent interagency guidance on the allowance for loan losses.
We also feel that this approach will over time provide a more accurate and useful view of loan losses incurred. It should be noted, however, this approach results in a lower allowance to loan ratio as the recorded charge-offs result in a mirrored reduction of the allowance of loans.
As Pat mentioned, we recognized a provision for loan loss of $14.6 million or 331 basis points with average loans annualized for the fourth quarter; this compares to 29 basis points for the third quarter of 2007.
This provision charge represent 140% of the net charge-offs recognized during the quarter, so we did experience a significant build in the allowance despite the high level of charge-offs.
Future provision will be dependent upon, among other things, changes in the internal risk ratings of loans, non-performing asset level, loan growth, economic conditions and charge-offs and recoveries. The allowance for credit losses to total loans ratio at year-end was 1.51% up 21 basis points from September 30 and 20 basis points from year-end 2006.
The increase in the allowance to loan ratio during the fourth quarter was principally due to the adjustments to the expected loss rate factors in our allowance model and the increased level of required allowance as determined by the model resulting from internal loan rating downgrades during the fourth quarter.
Included in the Q4 downgrades was the proactive measure of moving all performing residential construction and development loans to watch status based on the overall deterioration in the housing market.
Although not included in the potential problem loan total previously mentioned, watch loans are subjected to additional regular review by credit administration and allocated a higher loss factor in our allowance model.
The allowance coverage ratio at December 31 was 68%, as compared to a 113% at September 30 and 139% at year-end 2006. We believe that the allowance for credit losses at December 31 2007 was adequate.
We are also continuing to closely monitor our exposures to both commercial real estate and construction and development lending and the local economic conditions in our principal markets, especially key indicators or potential weakness in real estate and housing.
As of December 31, 2007, our land acquisition and development portfolio totaled $245 million or 14% of total loans outstanding. Approximately 84% of the total is related to residential land acquisition and development.
Our construction loan portfolio totaled $240 million as of December 31, 2007 and was segmented as follows. Commercial construction of a $128 million or 53% and consisting of owner occupied commercial real estate of $45 million; investor commercial real estate $67 million and multi-family commercial real estate commercial construction of $16 million.
Residential construction stands at $112 million or 47% of the construction portfolio and consist of $42 million in consumer residential construction, $50 million in builder spec construction and $20 million in builder custom construction.
Our main portfolio residential construction and development exposures are in four key markets: Utah County, Salt Lake County, Washington County, which was the St. George market, and the Spokane metropolitan area, which includes the adjacent Idaho panhandle counties.
Our residential construction and development exposures in the key recent healthy market trends for these areas are as follows. For the Utah County area, which includes Provo, we have $28 million residential construction and $83 million in land development loans.
The average price for quarter four sales in this market was $265,000, which was down about 2% from Q3. There is 15-month of housing inventory, which is up by one-month over the prior quarter.
In Salt Lake County, we have $9 million in residential construction loans and $18 million in land development loans. The average price for fourth quarter sales was $267,000 down about 6% from the third quarter. Current inventory stands at 8 months, down by one month over the prior quarter.
In St. George, the Washington County market, we have $11 million in residential construction and $20 million in land development loans. The average price in the fourth quarter for homes sold was $265,000 down about 2% from the third quarter. Currently there are 27 months of housing inventory, which is up by 2 months over the prior quarter.
In the Spokane metro area, we have $20 million in residential construction and $36 million in land development loans. The average price in the fourth quarter for home sold was $206,000 down about 1% from the third quarter. In the Spokane market there is currently six months of housing inventory, which is unchanged from the prior quarter.
We’ve received numerous inquiries about whether or not we offer two-step residential construction loan program. The short answer is, yes. As of December 31 2007 we had approximately $40 million of construction loans extended to consumers.
However, it should be noted that our loans in this category are fully underwritten on an individual basis both to our construction underwriting standards and the secondary market requirements to permanent mortgages.
As of December 31, none of the 187 loans in this segment were classified as non-performing or past due over 30 days. Obviously, the quickly changing real estate market conditions have made the job of forecasting somewhat like predicting the weather. At this time, we expect that our non-performing asset levels will remain at the current elevated levels in the 2% range for the first half 2008.
I will now turn the call back over to Bob for some additional comment.
Robert M. Daugherty
Thank you Rick and good morning. As both Rick and Pat have indicated, we were unable to sustain our current recent trend of improved operating performance into the fourth quarter due to increased loan loss provision. I am personally disappointed in the results and the credit situation overshadowing much of the successes we had achieved in 2007.
At the end of the day however, our report card is based on the bottom-line performance. As a result of our missing our internal ROA target of 103 basis points for the year, a significant portion of our performance-based compensation was forfeited. Since, Rick has provided you with a thorough recap of the credit situation, I will touch on that area only briefly.
As those of you have followed the AmericanWest story over the past few years, you’re aware that we have successfully dealt with credit issues in the past. Although, the circumstances of the credit, current credit situations are different from those experienced in our recent history, the approach to resolution will essentially be the same.
Problem loans are immediately removed the loan officer’s responsibility and managed by our special assets group, which is focused solely on expedient and financially acceptable workout arrangements. We also recently beefed up the staffing level of the special assets group through reassignment of existing employees with loan workout experience in order to facilitate the timely resolution of these problem credits.
Also we are not going to distinguish between problem loans originated internally and those acquired through the merger of Far West Bank. We have now been a combined organization for nine months and the due diligence for Far West Bank was completed well over a year ago.
AmericanWest has one credit administration process that has functioned for both groups for the entire portfolio since the deal closed and we’re not going to delegate away responsibilities simply because loans were originated before the merger was completed last April.
We finished the year with organic loan growth in line with our expectation of 10% annualized for the fourth quarter and 16% for the full year. We continue to be pleased with the continued traction being gained in the C&I and SBA loan categories. C&I lending was up $9 million for the fourth quarter representing annualized growth of $34 million.
On the internal expansion front, we completed several significant projects during the past few months. Our Sandpoint, Idaho financial center relocated to its permanent facility in October. This continues to be one of our most successful de novo expansions generating $19 million of loan growth and $12 million of core deposit growth since it was opened in the latter part of 2006.
Our new financial center located in historic Walker Center building in downtown Salt Lake City was opened last months, with over 400 people in attendance to the grand opening. Our loan production office in that same building was also relocated to office space adjacent to the financial center for better customer convenience.
Earlier this month we relocated our Sandy, Utah financial center to a new high visible core event retail complex and we currently have plans to convert our loan production office located in St. George, Utah into a full service financial center which is on track to be opened in the next couple of weeks.
As this time we only have two facilities projects scheduled for 2008. One is the construction of a new financial center in the Richland, Washington market, which is part of our best growing Tri-Cities area. This project is scheduled for completion during the summer of this upcoming year.
The other project involves the consolidation of various back office functions into a newly leased space here in Spokane. This space was obtained at a very attractive rental rate and the owners subsidizing virtually all the required leasehold improvements. Occupancy of this space will be completed during the first quarter of this year.
We expect to offset a substantial portion of this new expense for this facility through the elimination of other building leases and sale leaseback arrangements for existing owned facilities, which has both financial centers and support functions.
Credit quality, of course, is priority number one for us at this moment and for the foreseeable future given the residential real estate and overall economic weaknesses. As a result, we expect that our organic loan growth for 2008 will be significantly reduced from that which we experienced in 2007 and is likely to be in the upper single-digit range.
As Rick has indicated during his prepared remarks, we are taking a conservative approach in the early identification of problem projects and borrowers whose ability to repay debt has been adversely impacted by the current residential real estate market.
We are very pleased with the initial traction of the C&I and SBA areas of our organization with the latter of the two experiencing a significant lift in the Q4 of 2006. We see opportunity to further leverage internal expertise and market exposure with increased agricultural lending. As many of you know, our footprint includes some of the most productive wheat land in the world and commodity prices continue to be at record levels.
Pressure on top line performance from margin compression and reduced growth will definitely have an impact on our expected level of profitability for 2008. In addition to focusing on the non-interest revenue initiatives that have already been underway, including mortgage banking and SBA financing, we are also initiating a comprehensive review of our business staffing models and recent expansion initiatives which are currently not performing at expected levels.
Our management team is fully aware that the financial performance of AmericanWest Bank must be improved without taking undue risk and it is encumbered upon us to deliver results. So, we have some internal assessments to make, and some frank discussions to have with staff and difficult decisions to make over the next several months. We simply can’t blame the housing market or the economy for our weak financial performance.
That concludes this morning’s prepared remarks. At this time, we will be glad to answer any questions. We will not however, be providing any specific earnings guidance for 2008.
Operator lets please go ahead and open up the line for questions.
Our first question comes from Brett Rabatin - FTN Midwest.
Brett Rabatin - FTN Midwest
First, just on that last comment about no guidance, I understand that. Can you give us any thoughts on whether or not you will be accruing incentive comp for this year or plan to, based on performance metrics?
As it stands right now we have performance-based restricted stock that has an ROA performance target in it, and the annual expense is around $400,000 to $450,000 a year for that. We would only accrue expense if there was an expectation that the performance target would be achieved.
Last year we did have that expectation. That’s not the case right now so we will right now, based on the current expectation, not be accruing that $450,000. And the executive compensation plan is actually being reviewed by an outside consulting firm at the moment. There is no finalization to that program, but I think it is reasonable to expect that the payout levels would be commensurate with the overall corporate performance.
It should be noted that the largest components of our incentive compensation are related to production employees, both on the mortgage and commercial lending sides. And the levels there will likely be, at least on the commercial side, reduced somewhat just from lower volumes.
Brett Rabatin - FTN Midwest
And then secondly, I want to make sure I understood the discussion about the classified assets and the mention of the $26 million of loans that were potential problem loans, particularly given the guidance for MPA to stay flat if I understood that correctly.
First part of the question is, if I understood you correctly, you have those loans as potential problem loans, as a reflection of the current real estate environment and there is no weakness or potential weakness that you currently see in those loans, is that accurate?
The potential problem loans are loans that are adversely classified but not on non-accrual status. That essentially would be loans that would be at a substandard or worse type of rating level, but not on non-accrual.
That level has been relatively consistent, as Rick noted, over time. We’ve given this disclosure for over a year now, because it does give a glimpse into the portfolio beyond what is just provided in the non-performing category. And this is again based on our internal loan classification methods.
Aan increase in non-performing loans can come from two ways. It can be loans that move from potential problems to problems, or they are loans that can be fine and they bypass that step in the process and go directly to non-performing.
And largely that is what occurred during the fourth quarter, where we had an increase in non-performing loans, and the potential problem loans staying the same, was a result of, as Rick mentioned, approximately $30 million in loans moving to non-accrual status, and reductions of about $10 million through pay-downs and pay-offs and charge-offs.
Brett Rabatin - FTN Midwest
Maybe we can follow up offline about classifications and what not. I also wanted to just ask, you have almost all of the loan production coming from two markets. Is there any concerted effort to control growth in other areas? Or are those two specific places just doing that well vis-à-vis the rest of the footprint?
Robert M. Daugherty
We are really focusing our Washington and Idaho group on a couple of areas. They are spending a great deal of time at elevating their calling and business development in the C&I and SBA lending. We are seeing a lot of traction in this particular market in that regard.
Also we see opportunities in the agricultural markets given the strength of the commodity prices in our Palouse and other sections of the Idaho and Washington footprints. We do have some pretty stable markets in the Tri-Cities and in the Yakima market and we have not seen a lot of erosion in terms of economic erosion in the Spokane market.
So, we are looking for a little bit more rounded growth. But clearly the economy in Utah has been and continues to be very strong and we have seen a fair bit of traction down in that market place.
Brett Rabatin - FTN Midwest
Then just last, I was trying to keep up, but I didn’t catch, there was a mention of one market with 27 months of housing inventory, which market was that?
Rick E. Shamberger
That was the St. George, Utah market, the Washington County area.
Now our next question comes from Fred Cannon - KBW.
Fred Cannon - KBW
Thanks so much for the detail. I have to admit I may have missed it. On the first, the largest loan that you talked about, the problems with the West Coast builder, what were the locations of the problems, was that up and down the West Coast or just in Oregon or Washington?
Rick E. Shamberger
Primarily Washington, Idaho, and some in Arizona.
Fred Cannon - KBW
Pat, on the asset and liability sensitivity you gave us, you gave us some good detail in terms of the percent of assets that would re-price and the floors you have on those. How do you see and how much offset can we expect on the borrowings and deposit side to offset some of that pressure, especially given the 125 basis point move we’ve seen in the last week?
Up until now, Fred, we have been moving our deposit rates close to the level that the Fed is moving, without experiencing any significant run-off or attrition. So, last week we had an emergency deposit pricing committee meeting last Tuesday, and lowered the rates on average about 75 basis points.
That is a greater magnitude and faster than we have in our outcome model. Generally in an outcome model we have some assumption for some factor of whatever the Fed moves and generally with some lag.
It’s our internal belief that particularly the community bank competitors are going to be faced with the same challenge we are, and that it’s better for us to move our rate with the time when there is significant media attention about falling rates as it allows us, our front line staff to point to the newspaper or the TV in terms of re-orienting consumers that rates aren’t going up anymore.
I gave as an example to our Board meeting the other day my mother called me last Sunday from Pennsylvania wanting to know where she could get 5% on a CD. I told her that AmericanWest Bank couldn’t help her out. So, I think we’ve got significant ability to lower those rates.
And if I look back to the last cycle, it would have been in 2001 and 2002, of course, it was a different time and different place, but the situation there we ended up ultimately being less asset sensitive than we had modeled simply because we had greater ability to bring down deposit rates than were in the model assumptions.
Fred Cannon - KBW
If I just look at your average interest bearing deposits, Pat, of $1.2 billion. What percent of that could we expect to see the move down in line with Fed funds?
On the CD side, $1.2 million that includes about $512 million of CDs, the average duration of those CDs is 6 to 9 months. So, it will take little bit of time for that to cycle through. The biggest area would be in the savings and money market area because they are generally at the higher rates.
Interest bearing demand deposits, that’s about $550 million. So, I say that largely we should probably be able to bring that down somewhere between 75% and 100% of what the Fed is moving. That’s the savings and money market deposit line item of that page 12 of the earnings release.
The area that we don’t have as much probably is in the interest bearing demand deposits because they are already at relatively low rates. As I said, you can’t take a rate negative. So, that section, although it’s relatively small, is about $143 million.
There’s simply going to be a floor we are going to hit because those rates are relatively low, and that would be reflected, Fred, in the average cost of those for the fourth quarter was only 66 basis points. So, obviously we can’t bring that one down 75 basis points. That makes sense?
Fred Cannon - KBW
It does make sense unless you can get them to pay you.
That’s called a loan. We have enough issues there already, so does that cover it?
Fred Cannon - KBW
Yes, it does. Thanks, Pat.
Our next question comes from Jim Bradshaw - D.A. Davidson.
Jim Bradshaw - D.A. Davidson
Bob or Pat, I wonder if you have done or your auditors have done an analysis of the goodwill and whether there might be an impairment charge on that?
We do as part of our regular internal control process, do an assessment of goodwill and it is, of course, reviewed by our auditors. Although we haven’t filed our 10-K yet it’s our belief that we do not have an impairment of goodwill as of December 31.
Our goodwill model looks in terms of the valuation, not only the market value of the stock which at this moment is like $12.58 a share, but it also looks at other valuations that factor, for instance, an M&A estimated value, and so forth. So, at this point we do not have any goodwill impairment as of December 31, 2007.
Jim Bradshaw - D.A. Davidson
And similarly, Pat, where are your outside auditors in reviewing of the allowance for loan losses?
One of the reasons that we do our release a little on the later side, and we are at the tail end of the pack, is that I generally prefer to have as much of the audit process completed as possible by the time the earnings release goes out because I would like to have zero likelihood of a change between the earnings release and the 10-K.
All of our onsite field work is completed. The audit team still has to actually review and tick and tie the 10-K when it’s done. But we are essentially done with that audit process. And to be quite candid, from our initial take on numbers in the first week of January, a significant number of issues came up over the first couple of weeks of January, which resulted in a higher level of provision than we would have expected. So I think we are as complete with the audit process as you could be without having an opinion letter and a 10-K filed.
Jim Bradshaw - D.A. Davidson
Pat, how much of your spread income is fee income from the various construction loan buckets you have?
The fees represented 37 basis points of the average yield on loans for the fourth quarter, which was down one basis point from the third quarter. And, of the total fee income for the quarter of $1.6 million, it was more than half of it, Jim, was related to construction loans.
Jim Bradshaw - D.A. Davidson
So that’s going to be not as big a drag maybe on margins as the rate cuts probably are then?
The other factor, Jim, is that we defer the fees. The average construction loan has a term, depending on the type, maybe 12 months or a little bit longer. Production that we had during the second, third and fourth quarters of 2007, we will be continuing to accrete into income the deferred fees into 2008.
So even if the production machine in that area slows down, we still have $3.8 million of deferred fees as of the end of the year that have to come back to the income statement. And since most of that is attributed to construction loans, it’s going to come back in a shorter horizon as opposed to a longer horizon.
(Operator Instructions) And we have another question coming from Jason Werner - Howe Barnes.
Jason Werner - Howe Barnes
I have a question about the deposits and if you covered this in your comments I apologize. I wanted to get some color as to why we saw such a big decline in the period deposit balances, pretty much across board and every category was down?
Patrick J. Rusnak
I think it’s important to look at the average balances as opposed to the ending balances, in terms of ending balances there were declines in the CD category because we had a spike in some short-term public fund CDs that came on and got booked in September that we decided to let run off, and we have other just general transactional activity or seasonal activity that I think it’s better to look at the average balances as opposed to the period end balances.
There is just a lot of noise picking a single day, looking at September 30 and looking at December 31. So, we don’t see any adverse trends other than customer activity that is part of the normal business process. For example, our savings and money market deposits on average $560 million for the fourth quarter, $531 million for the third quarter.
Jason Werner - Howe Barnes
So you don’t think that at some point after cutting deposit rates that really played into it; you didn’t see some runoff due to (inaudible)?
Patrick J. Rusnak
I don’t think the rate changes that we had implemented in the fourth quarter I don’t think had any material impact on deposit balances or runoff.
Jason Werner - Howe Barnes
Okay and it’s probably too early to tell more recent cuts?
Patrick J. Rusnak
Right, it is too early to tell and obviously, if we get to a point that we have to make accommodations or adjustments we will, but one thing that we do Jason is that we allow authority for all of our front line staff to make pricing exceptions based on relationships, and we encourage that. But I’d rather not give away that level of pricing to everyone who wants to walk in the door, but we can certainly do it on an exception basis and we have a well-refined process for doing that.
At this time, it would appear that there are no further questions. Mr. Rusnak, would you like to make any closing comments, please?
Robert M. Daugherty
Yes, thank you very much. We want to thank everybody for joining us this morning and listening to our fourth quarter earnings conference call this morning. And we very much appreciate your continued support. And, of course, we are looking forward to discussing with you our first quarter operating results in April. In the meantime, have a great day. Thank you now.
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