Banner Corp (BANR) 2007 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome back to Banner Corporation's 2007 Third Quarter Conference Call. At this time, all participants are in a listen-only mode. Later, we'll conduct a question-and-answer session, and instructions will be given at that time. If you should require assistance any time during the call, please press the star followed by a zero, and operator will assist you. As a reminder, this call is being recorded today Friday, October 26th, 2007.

Now, I would lying to turn the conference over to Mr. Mike Jones, President and CEO. Please go ahead, sir.

Thank you, Patty. Thank you all for joining us today for this conference.

I'm sitting here with Lloyd Baker, the Chief Financial Officer of the corporation, and Al Marshall, the Secretary of the corporation. We'll lead off first with the paragraph relative to items of estimates and so forth that Al Marshall will read.

Good morning.

Our presentation today discusses Banner's business outlook and will include forward-looking statements. Those statements include descriptions of management's plans, objectives or goals for future operations, products, 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-Q for the quarter ended June 30, 2007. Forward-looking statements are effective only as of the date they are made, and Banner assumes no obligation to update information concerning these expectations.

Thanks, Albert. Lloyd, why don't you kind of go through a review of the third quarter results? And then afterwards, I'll have some comments.

Okay. Thank you, Mike. And good morning, everyone.

This morning's press release, I think, would best be described as presenting pretty mixed results for Banner Corporation for the quarter just ended. I've actually thought of it kind of like the old Ragu commercials. If you want it, it's in there. Of course, net income was $10 million or $0.64 for the quarter, and that compared to $8 million and $0.65 a year earlier. However, net income from recurring operations, which is our preferred way of looking at our operation, was just $8 million. That's excluding the fair value adjustments. $8 million or $0.51 per share compared to $8 million or $0.65 cents per share a year earlier. That brings our total earnings for the first nine months of the year to $23.4 million. That's at 13% increase when compared to the first nine months of last year.

How you look at these mixed results really depends on whether you choose to see the glass as half empty or half full. For the pessimist, you can see that there was no loan growth, very little deposit growth, loan origination's higher expenses, an increase in non-performing assets and lower earnings per share. On the other hand, if you're the optimist, which is how I describe myself, you can point to a stable net interest margin at 410 for the quarter, substantial year-over-year revenue growth. That's up 26% compared to a year ago. For that matter, revenue growth was quite good compared to the prior quarter, which had an annualized growth rate of 28% there. Retail deposit growth, if you exclude some discretionary funds that we allowed to run off, was actually an increase of $83 million, which was good. We had good CNI loan growth and good consumer loan growth. Those targeted areas were up 23% and 39% on an annualized basis. We had modest and stable net charge-offs and credit costs. Our loan loss provision is $1.5 million, was right in line with prior quarters, up certainly from a year ago, but right in line with what we've been doing this year. Net charge-offs, $536,000, so credit costs for provisioning was at three times the net charge-offs.

We strengthened our capital position, which was augmented with the addition of $25 million of trust preferred securities that we issued during the quarter at very attractive rates. We recorded, as I mentioned, a $3 million gain in the fair value of financial instruments that we carry on the books at fair value. We opened two new branch offices, relocated a third into a brand-new facility. We completed the data processing conversion and now have the former F & M franchise on the same date of processing platform as the rest of Banner Bank. We enjoyed a still solid Northwest economy, notwithstanding certain concerns about housing. We continue to be the optimistic about the Northwest economy. And although we didn't close it until October 10th, following the quarter, we did close on our third acquisition for the year.

So, on balance, I'd characterize our performance and positioning for the third quarter -- how would I characterize it? Clearly, growth slowed, in large part, reflecting our concerns as well as those of our customers with respect to various housing markets. But just as clearly, our franchise and our balance sheet are stronger, allowing us to be optimistic as we look forward. Near term, there will be pressure on the net interest margin as a result of declining asset yields. That seems likely, and it will challenge us to effectively manage funding costs going forward. On the other hand, operating expenses, which have been elevated, will present us with good opportunities for improvement in the next few quarters. And our asset quality, as I mentioned, while not immune from the stress that has affected many financial institutions, appears to be very manageable with provisioning well in excess of charge-offs and reserves in a very solid position.

So, with that introduction, I'd like to highlight a few of the numbers on the financial statements that are in the press release that you have. And I'm going to refer to the page numbers as I have them. I hope that that's the same way you have them. Page 5 of the press release contains our results of operations comparative income statements for the quarter ended September as well as September a year ago in June, end of nine months. For us, it's always important to look at the growth in net interest income. You can see that for the quarter, net interest income was $40.7 million. That's up $2.5 million from the previous quarter and $8 million more than we earned the same period a year ago. I've already mentioned provision a couple of times, but I think it's important to note it was $1.5 million compared to $1.4 million in the June quarter and $1 million a year ago. So, a half a million dollar increase from a year ago. In the other operating income line, I've mentioned the strength and improved franchise growth. It's very evident in the deposit fee line, where we recorded an increase of $600,000 -- $660,000 actually, compared to the previous quarter. And we're up 56% on a year-over-year basis to $4.7 million compared to $3 million for the same quarter a year ago. Fee income -- deposit fee income is up 40% for the first nine months of this year compared to a year ago. So, again, much strength in franchise and a larger and much stronger balance sheet. Mortgage banking operations continued at a very similar pace that they have been for sometime now. We recorded a gain on sale of loans of just roughly $1.8 million compared to $1.8 million in the prior quarter and $1.7 million a year ago.

So, as I mentioned, revenue growth is evidenced in those, both the growth in the margin -- the net interest income line, I should say, and the growth in other operating revenues is strong. You can see on that page also the affects of the fair value accounting adjustments. Quite honestly, we knew we were injecting some volatility into earnings when we put certain assets and liabilities on a fair value accounting scheme. We didn't anticipate as much as we have seen in the last couple of quarters. You can see that those fair value adjustments contributed about $3 million this quarter compared to a charge in the prior quarter. That was driven significantly by what was going on in the trust preferred markets as well as the affect on our securities portfolio. But nearly two-thirds of that adjustment is reflective of widening spreads on trust preferred instruments, which we carry at fair value.

The expense side, I mentioned expenses were high for the quarter. Just pretty much across the board. Perhaps the exception to that, in many respects, is compensation, which was not particularly out of line. Remember, with respect to all of these numbers, we had a full three months of our acquisitions of F & M Bank and Islanders Bank in this quarter compared to just two in the previous quarter and obviously none a year ago. So, compensation was up. Loan origination -- capitalized loan origination cost declined by $720,000, which has the affect of increasing expenses and gives you some indication of the slowing originations that I mentioned. There were certainly offsets there in compensation. Occupancy, information services reflecting the addition of the new franchises, and important in the information services in miscellaneous categories. We did note in the announcement approximately $700,000 worth of unusual charges as a result of the data processing conversion at F & M. Those were expenses that we would not only expect to not be there in future quarters, but, as we've noted, we're optimistic that they will lead to some improved expense numbers as we're able to receive some operating efficiencies now that that conversion is behind us. And so -- Again, the net of that gets us to a number of $9.9 million for the quarter. And further down the page, as noted, our preferred measure, which removes the effects of the fair value accounting and removes the effects in the first half of 2006 of the insurance recovery that we enjoyed last year. Looking at that adjusted income line again, roughly $8 million for the quarter.

We flip over to the statement of condition on page 6. Just a couple of observations here. You can see that the combination of securities and federal funds sold has really stabilized with the balance sheet adjusting, restructuring, if you will. Reducing securities positions has really been achieved at this point in time. And I'd expect those numbers to stay relatively stable going forward. The loan portfolio, at nearly $3.6 billion, while flat for the quarter -- and we'll see some detail on page 7 -- is still $700 million larger than it was a year ago, and that certainly leads to stronger earnings potential going forward. On the deposit side, I've noted that -- we noted in the press release that aggregate deposits were fairly flat, but you can see that non-interest bearing accounts actually increased by about $18 million. And embedded in the public -- excuse me, in the interest bearing area, as we noted, there was about $77 million of accounts that we allowed to run off in our retail deposit growth was really $83 million. You can also note that we, as I mentioned, issued additional junior subordinated debentures during the period. That was done on July 31st, and fortunately was done at very attractive spreads relative to the market, as the market turmoil changed that pricing significantly subsequent to that issuance. Net worth is increased by over $11 million for the quarter, again, evidencing strength.

On the next -- on page 7, just a couple of quick points that I've emphasized, that I have made before, but I want to emphasize them. If you look at the loan totals on page 7, you're going to see that a number of the real estate loan categories declined slightly, notably construction loans, as we are seeing houses sell and loans [pay down]. On the other side of the coin, commercial business loans were up $35 million for the quarter. That's 23% annualized growth rate. And consumer loans were up $17 million at 39% annualized growth rate.

In the non-performing asset table on page 7, we did see an increase in non-performing loans that increased by about $6.7 million. That increase was primarily related to two large credit relationships, one for about $5 million in the Salem market, and the other is about a $2 million relationship in the Portland market. We had an increase in REO, which relates, interestingly, not to housing, which I'm sure some people would expect. It's the result of a business loan. But non-performing assets at 54 basis points, while up still very manageable. Right below that, in the area where we look at changes in the allowances, as I've noted, net charge-offs came in at just $536,000 for the quarter, so the allowance grew to $44.2 million and 1.22% of loans outstanding. I think I've already talked about the deposit area pretty significantly. The only point I would make there, I guess, is if you look at the mix of deposits compared to a year ago, interest-bearing certificates of deposits were 57% of the total portfolio a year ago. That's declined to 51%. Obviously, that means that the transaction account totals, both interest bearing and non-interest, are now 49% of the total deposit mix.

I'm not going to spend a lot of time talking about the ratio calculations on page 8. I'm sure there will be some questions. The point I would make is that assets yields were down for the fourth quarter. Funding costs were down as well for the fourth quarter and is a result of, really, a better mix. We saw that margin stabilize at 410. Non-interest revenues continue to run at about 69 basis points when you adjust out the fair value adjustments. And as I've noted, the operating expenses were elevated as a result, really, of the conversion activity as well as our ongoing branch growth activity.

So, as I said, mixed result. There's a lot in there. There's a lot to be optimistic about, and there's certainly some disappointments as well. I look forward to answering any questions you might have after Mike has had a chance to give you his take on the quarter.

Thanks, Lloyd.

Just to embellish a couple of things that Lloyd said. First, focusing on the $700,000 in conversion expenses -- those are hard costs that we paid to people for either travel to help us do that and/or for outside consultants to help do that conversion. That does not include the significant amount of overtime and charges that were paid here for staffing our branches, as we've brought a team together from both banks to make these conversions that we will not experience on a go-forward basis in the fourth quarter and so forth. The amount is really considerably larger than $700,000 that is there, as relates to the one-time cost in that particular area.

We expect that conversion to do two major things for us. First of all, we expect to have an annualized savings of data processing costs in a million-dollar range on an annual basis from that conversion. Secondly, from that, we now are in a position to begin to right size the staffing of the acquired entity F & M Bank because we're operating off of one system, and it simply will not take nearly as many people to do that as it would when we had both systems for a period there of five months. So we expect significant savings to begin to show up in the fourth quarter and into the first and second quarter of next year.

It's noted in there, in the -- excuse me, expenses area that we are going o be opening three new branches in the fourth quarter, but I want to hasten to add a couple of things to you. Unfortunately, due to some construction delays in all three of those facilities, the staff for those offices have been hired and have been on board for the vast majority of the third quarter. So, we do not expect increased operating expenses from a staffing standpoint because of those new branches coming on in the fourth quarter, which I think will help us with expense ratios in the fourth quarter and beyond. In the balance sheet, in the loan totals, as a part of acquiring F & M Bank, we elected to have about $30 million of their loans, which were participated loans with other community banks in the region, moved out of the bank. We are not in the participation business with other community banks. And as a result of that, it masks a little bit of what was happening in the growth in the loan portfolio because of that $30 million.

One of the areas that I have been told by several people you would like to hear information about really revolves around our view of the four markets we serve in. And those are as follows. For those of you that have listened to my presentation at various investor conferences over the last several months will be aware of this. We are still very bullish on what's happening in King County in the Seattle area and for that matter, Puget Sound. I look forward to that being a continuing source of strength for us in both loan development and asset quality as we go forward. The area that I think has been the most concern to a lot of people of our competitors in the northwest is Boise. We saw Boise coming several months ago, actually, a few quarters ago, and gradually have scaled back our presence there. I think our presence in the one to four construction arena in that particular area peaked in the first quarter this year at $120 million. It currently sits at approximately $80 million in terms of outstanding. When I say Boise, I'm really talking about Southwest Idaho more than I am talking just about Boise. We believe Boise's economy is pretty strong. I think there's an overhang of excess supply of inventory of housing in that market. It has significant migration. That market has great job creation going on in that area. As a matter of fact, the unemployment in the Greater Boise area is just above 2%, as we (inaudible) to that. So, we're very optimistic about the outlook for the Boise marketplace. We are, however, and have, to this point, backed away from financing new projects in that market and frankly have done that for now -- this would be the third quarter that we've been in that particular position. That's an example how we've managed things. You've heard in the past, if you have listened to our calls in the past, we were concerned about the Tri-Cities market in the central part of the state of Washington. This goes back about two or three years ago, and we backed away from financing in that particular marketplace. As it turns out, some of our builders did the same thing in that particular market, backed away from it. They went and worked their way through the excess inventory, and frankly, it's a very strong market now in terms of housing in the Tri-Cities area, and there is no excess supply. So, it's a much more normal housing market. And we are now back in looking at projects in the Tri-Cities area because there is no overhang.

Another good example of that is the Bellingham, Washington market, which sits in the northwestern corner of the state of Washington. It's a wonderful city. A lot of people enjoy living there. A lot of people moving into the marketplace. It, frankly, got way ahead of itself in terms of real estate projects for people. We backed away from that about a year and maybe six quarters ago in that particular marketplace. It's worked its way through its excess inventory and now is in a very good position to move forward. I have to admit it was somewhat helped by the Canadian dollar coming to parity with U.S. dollar and the Canadian people coming into that market looking for housing opportunities on a go-forward basis. So, we're pleased with that. The point of bringing all of this up to you is that we watch these markets very carefully, ongoing and continually. As we see opportunities for new projects in a good market with not a lot of excess inventory, we will go forward. Where we don't see it, where we see excess, we will tend to back away, and we're probably amongst the first to back away in those markets.

Continuing on, though. In other markets, the Spokane, Washington market is a market that we've been in, done some work in. We, frankly, have fairly nominal commitment into the real estate market in that particular area. Spokane is one of those cities that did not get a big run-up, does not have an excess of inventory in the marketplace. It just continues to move forward on a slowly growing basis, which is a good way for it to be developed in the future. So, we're enthused about the prospects in Spokane.

The one market that is giving us some concern as we're sitting here today is the Portland, Oregon marketplace. It clearly has an overhang on the market in terms of residential. We have backed away from it significantly beginning in the first part of this year in terms of new projects, and we are working our way through that inventory, excess inventory of houses and lots in that particular market as we speak. If I had to rank a market I think is the weakest at the present time, it would be the Portland, Oregon marketplace. But again, the economy is strong. Unemployment is acceptable in that market. It's approximately at the national average. It has tremendous export business into the far east. Things are going well in the various companies that are doing that. So, we're very hopeful and expect the Portland market to move through its bit of an overhang in terms of supply of housing fairly quickly during the next couple of quarters. So, as a result of those areas, we're pretty optimistic about where we are from a credit quality standpoint in our one to four residential arena. We looked very good and very comfortable with both our commercial and consumer lending at the present time.

I hope you find some of that information helpful because those are the fundamentally four large metropolitan markets we serve in the Pacific Northwest. We also have a commitment into the agriculture arena , and in Eastern Washington, Eastern Oregon, for that matter, up in Northern Puget Sound. This is one of the areas that the farmers get to understand why it is they are a farmer. The quantity of their crops is outstanding. The quality of their crops, particularly the weak crop in terms of its protein count, is outstanding. It is well received into the international markets. The commodity prices, frankly, are out of sight in terms of what these farmers are able to sell their wheat for. We expect they are going to have a very, very good year. And we think some of the growth that's going to take place in our deposits or during the fourth quarter will come from our farmers selling their crops during that period of time. So, all in all, we are pretty bullish on the economy of the Pacific Northwest.

I think I've prattled on long enough. So, at this point, why don't we open up for questions?

Thank you. (Operator Instructions)

And our first question comes from the line of Matthew Clark from KBW. Please, go ahead.

Good morning.

Can we just maybe first start with the construction portfolio and particularly, I guess, on the one- to-four family construction piece and the land development piece that's (inaudible) related. If not, we can even take the whole construction book, if you want, all four categories. But can you give us a sense as to what portion of your outstandings are considered classified at this stage? I mean we have seen surprisingly some big jumps around the country. Granted they are very different markets and can easily be bad lenders, but there are a couple of banks that are at least regulated by OTS, obviously, not what you guys are regulated by. We've seen, in a couple of cases, with PFB and BBX, where they're close to 50% of their residential construction loans are considered classified now. But just curious as to how the classified list -- the amount, how large it is today and how it's been trending? ?

Matthew, it's Mike Jones. Our construction portfolio is approximately a $1.1 billion in size, and at the current time, less than 4% of it is classified. And we don't expect to see it go up a lot. Now, I have to tell you, there aren't any of them that aren't being watched on a daily basis by us because we are watching what our builders are doing. But as far as being classified, substandard or doubtful, it will be well less than 4% of that portfolio.

Okay. And, I guess, how are you not seeing any deterioration in Boise despite pulling back a few quarters ago, I would suspect, given the change in market conditions since August. There would be increased cancellations, and projects may, all of a sudden, not necessarily be completed at the same pace or on time as previously expected. Can you just give us a sense as to what you're seeing there that's different?

We have a wonderful set of competitors in the Boise Idaho marketplace that were pretty aggressive in the period when we are going the other way. They have taken us out of several projects in that particular area that, for all I know, could be problems today. But there were issues where we did not want to be involved, and so we scaled back significantly earlier. We are a whole bunch more careful about what we do in terms of making advances against loans. The property gets inspected. If we have any sense at all, the subs are not getting paid. We pay them directly on the advances, do not send them through the builder. Because of that, when you get a piece of property that's in trouble -- and there's an exception, too, to this -- but in general we are in very good position relative to the value of the property and are able to move through the process of getting them sold on the other side fairly easily. I think that's the primary main reason to it. The second part is we just haven't been involved in that much land in that particular marketplace. I think, Matthew, you remember that about 85% of what we do in residential construction is Puget Sound in the Portland marketplace.

Okay. And then can you give us your exposure in Portland, given your concerns there?

Exposure in one-to-four residential in that marketplace is about $330 million.

Okay. And then finally, on the margin side or maybe the earning asset yield side, can you remind us what portion of your loan book is prime-based and what might be adjustable within the the next, say, three to six months?

Matthew, it's Lloyd.

Between prime and LIBOR, you're probably looking at a little over 50% of the loan book. And then the other 50% is about half-adjustable rates, which we price anywhere from next month to five years from now, and then the balance would be fixed. That may overstate the fixed just a little bit.

Okay. And then are there any loans -- do you have any loan floors currently? And if so, when does the trigger occur?

We do have some loan floors, but we have to be a little cautious here because, to be fair, there is some stress out there. And I know that on occasions, rather than have a borrower in trouble, we're going to break that floor. It's not quite the same scenario as when floors held yields up about four years ago.

Okay. But the magnitude of those floors, I mean, is it meaningful enough, or no?

It's meaningful, but I think that it's fair to focus on the fact that 50% of that portfolio is tied to prime and LIBOR, and as a result, the yields are going to decline if the fed moves again, obviously. As I mentioned early on, that means we need to be pretty nimble with our funding costs and liability pricing.

Okay. Great. Thanks, guys.

Thank you. And our next question comes from the line of Jim Bradshaw from D. A. Davidson. Please, go ahead.

Good morning.

Hi, Jim.

Mike or Lloyd, how did your philosophy change on deposit pricing over the course of the quarter? Did you see the fed cuts coming and start bringing, or were you able to bring prices down? And so, where do you sit now in terms of free pricing on non-deposit prices?

Jim, you and I had conversations for all of you that we, as a bank, up until just recently, tended to price in the upper quartile of pricing, or for deposits, across the competition in the various markets we were in. We were doing that to pay down the Federal Home Loan Bank borrowings, to get rid of that particular area. And frankly, it was a great way for us to build activity levels up in new branches, so that we could break them much quicker by getting more deposits in those particular branches. That was largely completed early in the third quarter. So, we now have deposit growth more than sufficient for the loan growth that we are experiencing. And for that matter, for the loan growth, we've historically had over the last ten years, which is roughly a compound growth rate of 20% a year. Because of that in the third quarter, we have begun the process of moving our pricing down more closely to the middle of the pack of our competition in those marketplaces. We still have some capacity to go in that regard. And that's a good news, part of it. Of course, the bad news, part of it, is we start with a higher price deposit portfolio than other competition because many didn't go up that much at the time, in prior quarters. So, we have room to move our liability costs down.

Okay. Good. And, Lloyd, I don't see any buyback in the quarter. I presume that's mostly due to sort of corporate events that kept you out rather than a philosophical thinking on buyback. Is that a fair assumption?

That's correct. As you know, we had a pending merger and we (inaudible) during the pricing period of that. That took us nearly to our normal blackout period. So, we did not execute on any transactions. We do still have the authorization to do that, and we do have the cash available to do that as well.

Okay, good. Just a technical question, the $700,000 or so in conversion costs, were those numbers sprinkled, and in what line items are they in?

They are about half in the data processing line, and the other half is in the miscellaneous line on this analysis.

Okay, good. And then lastly, can you give me any clarity on the dividend reinvestment program, sort of how much -- is there any quarterly trend that you've been able to detect so far on how many new shares are getting issued each quarter?

Yes, there is, Jim. You really have to break it down into two pieces. There's a de minimus amount that people can purchase either through dividend reinvestment or just outright purchase. And that seems to be running at a pace of about $3 million a quarter.

Okay.

And then in the first quarter of this year, as you know, we also have a discretionary piece of that where we can issue waivers on larger purchases. We did that in the first quarter. We have not in the last two quarters. Won't likely do that going forward is our capital position now, is at a level that we're comfortable with, given our growth projections.

Okay, perfect. Thanks very much, guys.

Thanks, Jim.

Thank you. And our next question comes from the line of Jason Werner from Howe Barnes. Please, go ahead.

Good morning.

Good morning.

You guys might have said this, and I missed it. I apologize if I did. But I was curious on the two new credits, the non-accrual, what was the collateral [security] on those two credits?

One was a land development project, and the other was two or three houses. I don't recall the number now.

So, the bigger one was a land development?

Yes, it was.

And we need to indicate to you why we're not concerned about it. The fact of the matter is our particular development is fine. Unfortunately, this builder has a large credit with a couple of other financial institutions in projects not related to this particular site where they have run out of money. And as a result of running out of the money, they are not able to support any part of their portfolio. But our particular project, as soon as we get ownership of it, will be easily sold.

You said that was in Salem?

Yes. Our piece is.

Okay. Then if I remember correctly, you said that, looking forward, to expect some pressure on margin. I was wondering if you would quantify what you think is likely in the fourth quarter given the fed cut.

Well, it is -- many of you have heard us say for a long time, we consider ourselves pretty well-balanced on an interest rate risk perspective. But the pressure we anticipated, obviously asset yields are going to decline. The last fed cut was late in the third quarter. It's going to have a full quarter's worth of impact. And there's certainly the possibility that the fed is going to move again. I'm not sure that I want to quantify it other than to say that it's going to require us to be nimble on the funding side. But I think it's more likely to see a couple of basis points decline and a couple basis points improvement. Now, offsetting that, to be fair, we will have the addition of the NCW franchise during the quarter, and that will help the margin a little bit.

Although it's only a $100 million bank, I'd be quick to point out. I think it's fair to say that we don't expect much movement either way in the margin.

Okay. Thank you, guys.

Thank you. And our next question comes from the line of Brett Villaume from Fig Partners. Please, go ahead.

Gong, gentlemen.

Good morning.

I wanted to see if you would comment on your appetite for acquisitions in the next year, and also just your general thoughts about pricing in the Pacific Northwest on deals.

We have a full plate. You won't see us acquiring anything in the next year. And we frankly -- the conversion we did on the bank, the F & M bank, went as well as it could possibly have gone. We had very, very few problems other than training our people how to use a new system and so forth. But in general, I think it was absolutely transparent to our customers. It takes a lot of effort to do that. And it took a lot of our people a lot of weekends, a lot of late nights getting that done. And as a result of that, we have internally focused a whole bunch of people in that acquired bank that has had an impact on the overall level of profitability during the third quarter. We need to get those people back out on the street doing business and continue to grow the franchise that way.

We think we are at a position in terms of size now, where, for us, it has to be a very, very important acquisition for us to consider it from a strategic standpoint because we now have a branch system large enough to generate core deposits to fund our loan growth on a go-forward basis. And I think we're at a position where we don't need to look at acquisitions. Now, you may scratch your head on that in terms of, "Why did you buy the one in Wenatchee?" It was fairly simple. With the one in Wenatchee for us, we already had the fifth place market share in a growing, dynamic economy there. The bank we acquired had the sixth place market share in a growing economy. Both banks had two branches each. By putting them together, we will have the second place market share in that particular community. And then when we get done with it, we will have two branches. So, there's significant cost savings to us in an acquisition like that, but we're not likely to do those.

As it relates to opportunities in the Pacific Northwest, there are a lot of banks, smaller banks for sale in this particular market. We will always look at the book if it's presented to us. My best guess is the seller's expectations of pricing have not come down to the level of what buyers are willing to pay, so I'm going to guess you're not going to see too many of these done unless it's a real stress situation during the next year, by anyone.

Thank you. That was great.

Then the other question I had was just, you said that you may have some staff reductions soon, and I was curious whether or not there's the opportunity for branch consolidations as well.

Yes, we will. It's not may, we will have staff reductions that are taking place in the fourth quarter. And we've told those people what would happen and how long we expected to need them and so forth. So, it's not going to come as a big shock to those people as we let them go during the course of the fourth quarter. And then, hopefully, we've treated them fine during this period of time.

There are some branches. The branches in the F & M system are smaller than ours by a considerable amount. I mean, the first effort that we're going to make with several of those branches is to put our sales culture on them and see if we can get them to grow to a size that we're more comfortable with. If, in fact, that doesn't happen, there's a possibility we will consolidate some of those branches in the Spokane marketplace.

Thank you very much. Appreciate it.

Thank you. And once again, ladies and gentlemen, if you would like to ask a question, press the star followed by the 1. As a reminder, if you are using a speaker phone pick up the handset prior to pressing the numbers.

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

Good morning. This is a question on the FHLB out of Seattle. Couple of years ago, you mentioned that with their difficulties, they had stopped paying dividends and were no longer redeeming excess stock of the members. I just wondered, I noticed they are paying dividends now. And with your reduced borrowings, are you looking to see if you can have some of your stock redeemed?

Yes. [ LAUGHTER ] Yes. I am -- first of all, I think, to be fair about it, I think the Federal Home Loan Bank of Seattle and the whole federal home loan bank system is a great asset to the commercial banking industry. But I like to view it as a secondary source of liquidity. It should be used occassionally when you have mismatches and imbalances between your deposit growth and loan growth but not on a permanent basis. We have substantial capacity to borrow money from that particular institution. And to have that capacity, you have to have a fairly large investment into it. And we have a request into them to be amongst the first to redeem a substantial portion of our stock in the Federal Home Loan Bank when their regulators allow that to take place. The dividend they are paying us is pretty small.

Great. Thank you.

You bet.

Thank you. And our next question comes from the line of Barry White from River Capital. Please, go ahead.

Can you just tell me the pro forma tangible value per share for the October 10th acquisition?

Pro forma tangible book value. Of them?

Of you, guys. Once that takes place. When the new shares are going to be issued --

The transaction has been closed. You know, we need to get back to you on that one. I don't want to throw out a number to you that's going to be wrong, and I apologize for that.

Okay. Thanks.

Thank you. And once again, ladies and gentlemen, if you would like to ask a question, press the star followed by 1. As a reminder, if you are using a speaker phone, please pick up the handset prior to pressing the numbers.

And our next question comes from the line of Ross Haberman from Haberman Fund.

How are you, gentlemen? Good morning.

Hi, Ross.

Lloyd, I just have an accounting question. That increase in evaluation of financial instruments to $3 million -- I got on late. Could you explain that again, and how recurring and non-recurring is it?

[laughter]

I got on late, I do apologize.

How recurring it is, there will be something in there every quarter. What direction it will go, if you look at the prior quarter, and the magnitude of it is a big question mark. We really have, at this point, two items that result in that adjustment. One is the securities portfolio you can see recurring as available for sale. That is about $160 million. And you know, that's like any fair market adjustment on securities. It's driven primarily by which way interest rates go. The second piece -- and for the quarter that just ended, that piece was a little $1 million, positive.

Okay.

The second piece is the more interesting one right at the moment, and that's our junior supported debentures or trust (inaudible) securities, if you will. For those who follow the market, you know there was a great deal of turmoil in that market, and as a result, during the quarter, spreads widened out dramatically from a low point of 135 to somewhere in the neighborhood of 275 to 300.

Right.

We took a conservative approach to our evaluation there because we think some of that turmoil will work itself out over time. And we'd just as soon not see that market value turn around as dramatically as it might. So, we took a very conservative approach to valuing those. I think we used a spread of about 225, and that resulted in about a $2 million change in before tax net worth, the value on those.

Okay. That was it. Thanks.

Thanks, Russ.

Thank you. I'm sure we have no further questions at this time. Please continue with any closing remarks.

Again, I want to express appreciation for all of you listening to our third quarter conference call and the results that were in that quarter.

It's a fairly complicated quarter for us. I used to think of us as a pretty simple bank. But clearly, in the third quarter, a number of things were going on in this institution that were not usual, and we expect them to be not recurring. Some of you know my reputation. Over the years, on various companies, I've been an acquirer of other banks. But this third quarter reminded me why, if we can do this organically, it's much, much better for us to do that, because it, really, when you start to convert these banks causes you to become way too internally focused. Particularly if they are large relative to your size, such as the F & M transaction was. The little transaction we have in Wenatchee will not be that big at all for us as we go forward, and we expect to convert that bank in the first quarter of next year. So, as we hopefully get back on the street and start looking around in the marketplace for the businesses out there, not only in the CNI and consumer area, which I think we did a very good job in the third quarter, but also the real estate arena. And there are great opportunities for us to do transactions out there particularly in the Puget Sound region, which is where we have most of what we do in that particular area. We're pretty optimistic about the prospects for the bank on a go-forward basis in terms of asset generation.

So, with that, we look forward to talking with you in the future and, again, thank you very much for listening in.

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation, and you may now disconnect.