Columbia Banking System Inc (COLB) 2009 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to Columbia Banking System's third quarter 2009 earnings conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. Instructions will be given at that time. If you should require assistance during the conference please press star, zero. As a reminder, this conference is being recorded.

I would now like to turn the call over to your host, Melanie Dressel, President and Chief Executive Officer of Columbia Banking Systems.

Thank you, Christie. Good afternoon, everyone, and welcome to Columbia's conference call. Joining me on the call today are Gary Schminkey, our Chief Financial Officer, and Andy McDonald, our Chief Credit Officer. Mark Nelson, Chief Operating Officer, will also be available for questions following our formal presentation.

Of course I need to remind you that we will be making some forward-looking statements today, which are subject to economic and other factors. For a full discussion of risks and uncertainties associated with the forward-looking statements please refer to our securities filings and in particular form 10-K filed with the SEC for the year 2008.

I'm going to assume you've all had a chance to see our results. We'll be providing additional clarity and details to that information. Gary Schminkey will provide a brief summary of our results for the quarter, including our equity position, liquidity ratio and net interest margin. Andy McDonald will review our credit quality information, including our allowance for loan losses, charge-offs, and our loan mix. I'll conclude by discussing our strategies as we move toward the end of this year and into 2010. We will then open the discussion to questions.

In our press release this morning we reported a net loss for the third quarter 2009 of $2.6 million, or $0.11 per common share, reflecting our comparatively high provision for loan losses. The level of our provision for loan losses continues to be the result of the decline in real estate values, particularly in the residential land, lot, and lot development areas. Gary and Andy will go into more depth about the quarter's results a bit later.

We're beginning to see what appears to be a slight improvement in the economy. Despite the need to devote extra attention to our credit issues, our fundamental strength allows us to remain externally focused on our markets and our current and potential customers and to move ahead with strategies that will position us to be strong and competitive when we really turn the corner in this economic cycle.

At this point, I'd like to underscore our strengths and the reasons why we're so confident about Columbia's future. First, we continue to be very well capitalized, with 19.06% total risk-based capital at the end of the third quarter. A major highlight of the quarter, of course, was our capital raise of a $120 million through a public common stock offering in August. The investment community clearly demonstrated that it believes in what we're doing and in the marketplace here in the Pacific Northwest. In addition to our capital we have ample sources of available liquidity with a ratio of 50%, translating into about $1.5 billion to meet the loan and deposit needs of our customers.

Our net interest margin continues to be stable and with 4.34% for the quarter. Our exceptional level of core deposits is an important reason we have maintained that relatively stable net interest margin. They are over 83% of our total deposits and result in the strong relationships we continue to build with our customers.

We continue to focus on increasing our share of the market and the communities we serve, and to that end we have added experienced teams of bankers and retail locations which give us access to new clients and greater coverage within our market areas.

We're very proud and pleased that we have a reputation as a great place to work. Once again we have been awarded one of the best places to work in Washington for 2009 from both the Puget Sound Business Journal and Seattle Business Magazine. Of course, this recognition has really helped to attract excellent bankers who really want to work with us.

Now I'd like to review with you what we're currently seeing in the economy in the market areas we serve. While the recession may technically be over, the economic pressures in Washington and Oregon are ongoing and will continue to be challenging for some time. I mentioned before how important shipping and warehousing is to Washington, since we are the most export-focused state in the country, at more than 2.5 times the national average.

Pacific Rim countries are dealing with economic woes as well, and container traffic and volume are continuing their downward trend. With the largest decrease in inbound international containers ever recorded, container shipping is down 16% year-to-date, reflecting the decreased consumer demand for products. The Port of Tacoma still expresses confidence, however, in an upward trend for the longer term for trans-Pacific trade, particularly with China, predicted to increase up to 60% in the next six or seven years.

After dipping a bit in July, Washington state's unemployment rate rose to 9.2% in August and 9.3% last month, below the national average of 9.8% for September. A year ago, the unemployment rate was just 5.4%. The industry that cut the most jobs was government at 44%, where most of the decrease were employees in the public school system, although this may simply be a seasonal adjustment. Other industries recording the largest declines were construction and manufacturing. About 70% of the job losses in construction were in nonresidential specialty trade contractors. This reverses the trend earlier in the year when the residential side was taking the highest job losses.

Many economists believe that even with an economic revival, a weak employment market could linger for years and the normal unemployment rate will be higher. Small and mid-size businesses are retrenching, and only very modest growth is foreseen in the near term.

Our headquarters and primary market area is in Pierce County where the jobless rate has shown a slight decline. The unemployment rate in September dipped slightly to 9%, down from 9.1% in August. New home construction close sales in Pierce County were up 25% from last August, about the same level as in September of 2008. Prices for new construction were down slightly from August, and down about 7% from a year ago. Re-sales for the county were up 10% from last month and up 12% from September 2008, while resale prices declined 4% month-over-month and were down 8% from a year ago.

The Seattle-King County area has fared somewhat better than the rest of the state. Their unemployment rate has been the same for the past two months at 8.9%. New home construction sales for King County dropped 2% from August and were down about 12% from September of last year. Prices for new construction were up 7% from last month and down just 2% from September of 2008. Re-sales changed very little from last month but were up 14% from a year ago, and resale prices were up 2% from last month but down 8% from a year ago.

While its unemployment rate is still high, Oregon's jobless rate dropped in September to 11.5% from around 12% in August -- the lowest rate since last February. This is a real positive sign, I think, particularly since September usually sees a seasonal decline in employment as people go back to work -- or I'm sorry, go back to school.

Residential housing sales activity in the metro area of Portland, Oregon has continued to show improvement in September over sales from the same month last year. Pending sales were up 34% and closed sales rose about 10% from a year ago. The average sale prices of homes in the Portland area have declined about 10% since September of 2008.

We're thankful for the relatively stable presence of the military here in western Washington. The military is a very important part of the regional economy, accounting for about $3 billion in payroll and roughly 125,000 jobs in the Puget Sound region, with more than 40,000 of those jobs in Pierce County alone.

Like the rest of the country we are beginning to see some signs of improvement in the economy. We do have a diverse economy, which should help us recover more quickly from other areas of the country that lack the economic diversity of the Pacific Northwest. I mentioned last quarter that Moodys.com is predicting that Washington and Oregon are among the six states poised to lead the country out of the recession, in part based upon the well-entrenched high tech industry.

Now with that brief economic recap, I'd like to turn the call over to Gary.

Thanks, Melanie.

This morning we announced a net loss applicable to common shareholders of $2.6 million for the third quarter of 2009 or $0.11 per diluted common share, compared to a net loss of $8.8 million or $0.49 per diluted common share for the same quarter last year. The primary driver for these results was a $16.5 million provision for loan losses expense incurred during the quarter. As Melanie mentioned, the provision expense was driven by the decline in real estate values along with lingering softness in our regional economy. Now I'd like to review a few of the important points about Columbia's fundamentals.

As Melanie mentioned, Columbia raised $120 million in capital through a public offering of our common shares last August offering 9.8 million shares, including 1.3 million shares related to an over-allotment option at a price of $12.25 per share. Our net proceeds were about $114 million.

Our total risk-based capital ratio increased to 19.06%, up from 14.25% at December 31st, 2008, and 14.61% at June 30th, 2009. Our capital ratios are well in excess of the regulatory definition of well-capitalized of 10%. Our excess capital over and above the 10% minimum to be well-capitalized is roughly $224 million.

We also measure our tangible common equity to tangible assets. At the end of the third quarter this ratio stood at 11.5% as compared to 8% at December 31st, 2008, and 8.1% for the second quarter of 2009.

Our liquidity ratio is a measure to track the funds available to meet the needs of our customers and for the general operations of the Company. We are very pleased to have a liquidity ratio of about 50% or well over $1.5 billion, up from 34% at the end of the fourth quarter of last year and 42% at the end of the second quarter of this year.

The ratio improved over the first nine months due to a lower asset base, decreased borrowing, and the expansion of our borrowing capacity at the Federal Reserve. Much of our liquidity comes from the bank's investment and loan portfolios, which are utilized to secure our borrowing lines at the FHLB of Seattle and the Federal Reserve Bank. We also have other sources of liquidity such as repurchase agreements and wholesale funding sources, which we needed to assist in managing our balance sheet.

Our tax equivalent net interest margin for the third quarter was 4.34%, unchanged from 4.34% one year ago, but down fractionally from 4.38% for the second quarter of 2009. During the third quarter we had interest reversals related to non-accrual loans of $559,000, which negatively impacted our net interest margin by approximately eight basis points. Average interest-earning asset yields have decreased to 5.28%, or 85 basis points, from 6.13% for the same quarter in 2008. Average interest-bearing liability costs have decreased 95 basis points to 1.29% from 2.24% a year ago.

We have been successful in decreasing the cost of interest-bearing deposits by 20 basis points this quarter and 46 basis points for the first nine months of this year. Non-performing assets entered the quarter at 4.7% of total assets as compared to 3.54% at year-end 2008. Non-performing assets as of September 30th were $148.9 million and net charge-offs were $13.7 million for the third quarter compared to net charge-offs of $16.4 million for the same period in 2008.

The provision for loan losses was $16.5 million for the third quarter versus $10.5 million for the same period last year. Looking ahead, the volatility in the economy makes it likely that we will experience elevated provisions for the foreseeable future.

Our loans ended the quarter at $2.1 billion, down $168 million from year-end 2008. Our commercial business loans totaled $754 million, down from $811 million at December 31st, 2008. The decline in commercial business loans is primarily a result of loan pay-downs and decreased line of credit usage.

Commercial real estate loan totals are essentially unchanged from year-end 2008 at $863 million, while consumer loans are down by about $10 million or 5%. Our commercial construction loans have declined by $29 million or 36%, and residential construction has decreased $79 million or 38%, all compared to December 31st, 2008.

Core deposits rose about 4% from $1.94 billion at the end of 2008 to $2 billion at September 30th. If we exclude CDs less than $100,000, core deposits increased by $128 million or about 8%, mostly centered in our non-interest-bearing demands and money market accounts. The decline in CDs is due to the maturity of short-term promotional specials offered during the second and third quarters of 2008, coupled with our election to focus on lower-cost non-maturity deposit funding alternatives, rather than growth within this portion of our deposit base. Offsetting the growth in core deposits was a decline in interest-bearing demand accounts, which decreased $72 million during the first nine months. We attribute the decline in interest-bearing demand deposits to depositors moving funds to government-backed sweep accounts and paying down their borrowings.

Our efficiency ratio was 60.85% for the third quarter 2009 compared to 60.34% for the third quarter of last year. While we were successful at managing our expenses, the efficiency ratio increased due to lower net interest income as a result of earning asset totals and interest rate reductions in the fourth quarter of last year. We will continue to work toward achieving a ratio in the mid-50s, but in the near term we expect additional expenses going forward as we maintain higher volumes of other real estate owned and work our way through problem credits. The net cost of operation of REO was $218,000 for the third quarter compared to $4,000 for the same period last year.

Compensation and benefit costs for the third quarter were down $204,000 or about 2.5% from a year earlier. As mentioned in our press release we are expanding our presence in the Portland/Vancouver area by hiring talented bankers and adding two retail locations. This will have some impact on our expense ratios over the next year or so as these teams build up their portfolios. But over the long term, we expect they will have a very favorable effect on the Company's performance metrics.

Non-interest income was $7.2 million compared to a loss of $11 million a year earlier. The increase was primarily due to the $18.5 million expense in the third quarter of last year related to the other-than-temporary impairment charge for the decline in fair value of our investment and preferred stock issued by Freddie Mac and Fannie Mae. Excluding the impact of the impairment charge, non-interest income was down 5% from September 30th, 2008, due to a combination of lower volume in merchant services activity and decreases in other income items.

Other income was down about 20% from the third quarter of 2008 due to reduced fees from mortgage banking activity and reduced income from our customer interest rate swap program.

We recorded a tax benefit of $1.8 million for the third quarter. The tax benefit is primarily the result of earnings from our tax-exempt municipal securities along with other tax-exempt investments such as bank-owned life insurance and affordable housing partnerships.

Historically, we have had an effective tax rate in the range of 26% to 28%. However, in the current economic environment our mix of tax-exempt income to total income is much higher than in the past. It is difficult to provide an effective tax rate range for the coming year, because we do not know the ratio of tax-exempt income to total income in advance.

Lastly, our board of directors declared a $0.01 dividend for the third quarter, unchanged from the first and second quarters of 2009. The board reviewed our dividend in light of our current market valuation, dividend yield, payout ratio, and our desire to retain capital.

At this point I'd like to turn the call over to Andy McDonald, our Chief Credit Officer. Andy?

Thanks, Gary. For the quarter, the bank's level of nonperforming assets increased 19 basis points from 4.51% of total assets to 4.70% of total assets. While we are disappointed that the overall level of nonperforming assets increased, we are encouraged by the fact that the rate of increase in our nonperforming assets, which had been increasing in excess of 50 basis points per quarter, has begun to slow. This is also the case when looking at our nonperforming loans relative to period end loans -- the rate of growth is declining here as well.

Compared to our peers in Washington state as measured by the FDIC, these metrics can be viewed favorably as the average nonperforming asset to total asset ratio was 7.80% for commercial banks in Washington state as of June 30th. However, we are in no way satisfied with these results and continue to be diligent and aggressive in our approach to dealing with these issues. Certainly the economic environment has placed some strong headwinds in front of us, but we continue to make progress towards resolving the challenges we face.

The portfolio which continues to show the greatest weakness is our one-to-four-family residential construction bucket. This was certainly the case during the third quarter as $9.3 million of the $12.7 million increase in nonperforming assets was attributable to the one-to-four-family residential construction bucket. The rest of the increase was split evenly between the commercial business bucket and the commercial real estate term bucket. We saw modest increases of around $2.5 million each in nonperforming assets. The commercial real estate construction bucket actually saw a modest decline in nonperforming assets of approximately $2.2 million for the quarter. So outside of the one-to-four-family residential construction bucket, our nonperforming assets were essentially stable.

Charge-offs for the quarter were approximately $13.7 million and continue to be centered in the construction portfolio. Net charge-offs in the one-to-four-family residential construction portfolio were $5.7 million and again centered in residential land and lot development loans.

Commercial real estate charge-offs of $2.4 million were primarily related to retail construction loans. The commercial business pool had charge-offs of approximately $4.9 million, and these were centered in loans related to the construction and real estate development industries. The balance of approximately $700,000 was distributed across the rest of the loan portfolio.

Next I would like to go over the numbers by loan pool, and we'll begin with the one-to-four-family residential loan portfolio. As of September 30th, we had approximately $131 million in residential one-to-four-family construction loans, down 54% from the peak in March of 2008. It can be broken out as follows -- $47.9 million in vertical construction, $38.8 million in lot loans, $28.4 million in acquisition and development loans, also called lot development loans, and $15.5 million in residential land loans.

In total, $65.5 million or 50% of this portfolio is on non-accrual as of September 30th, 2009. In the vertical category we have $17.6 million on non-accrual, $17.8 million in the lot categories on non-accrual, and $23.4 million of the acquisition and development loans are on non-accrual. We also have $6.8 million of the residential land loans on non-accrual as of September 30th.

By market we have $46.7 million in Pierce County one-to-four-family construction loans, of which 49% or $22.8 million is on non-accrual. In Snohomish County, we are now down to about $3.4 million in one-to-four-family residential construction loans as of September 30th, all of which are on non-accrual, and you can see in this county we're down to the last few credits. King County continues to represent the market where we have the most exposure with $53.7 million in one-to-four-family construction loans, of which 57% are now on non-accrual.

King County, which had been one of our best-performing markets, was negatively impacted by two large relationships which were placed on non-accrual this past quarter. One is a $6.9 million lot development loan in which we are pursuing a troubled debt restructure with the borrower and have set aside a specific reserve of $2.3 million pending the final outcome of the troubled debt restructure. The other relationship comprises a combination of vertical construction and lot loans, which total $8.2 million. We have set aside specific reserves of $2.4 million for this relationship.

Finally, the Portland market is now down to around $8.8 million with 46% of this market on non-accrual.

As anticipated the commercial construction bucket remains modest at approximately $51.7 million, down slightly from last quarter's total of $56.1 million. The largest component in this portfolio remains our condominium exposure at around $18.5 million, which is slowly being worked down. Owner-occupied construction loans account for $10 million and the balance, $23.1 million, is in income property construction loans. Approximately 37% of this bucket is on non-accrual, or $19 million, which is down $25.7 -- which is down from $25.7 million last quarter. The non-accrual loans in this bucket are comprised of condominium and retail development construction loans.

Moving on to the commercial real estate perm pool, there was a modest amount of negative migration during the quarter of $2.5 million, resulting in non-accrual loan totals in this pool increasing from $24.2 million to $26.6 million. This places about 3% of the pool on non-accrual. So for the quarter, this pool remained relatively stable. By asset class we have $10.2 million in warehouse, $4 million in office, $2 million in retail, and the balance spread across various property types in the non-accrual category. Three loans essentially account for about half of the non-accrual loans in this bucket. Excluding those loans, the average non-accrual loan in this bucket is about $436,000, so we have a lot of granularity in this bucket.

The commercial business pool, similar to the commercial real estate perm pool, is relatively stable during the third quarter. Non-accruals in this bucket picked up slightly from $12 million as of June 30th to $15 million as of September 30th, and represent about 2% of the total pool. Again, most of the issues in this pool are related to the construction and real estate development industries. The average non-accrual loan in this pool is approximately $542,000.

Our consumer loan bucket has approximately $204 million in total loans, of which approximately $1.7 million is on non-accrual. This is down slightly from last quarter when we had about $2.2 million in non-accrual. The largest component in this pool is the [Helock] portfolio, which accounts for $85 million or 42% of the total consumer portfolio. Delinquencies in this portfolio have been running around 1.7%, which is considerably better than the Washington state average and the national average, which are 3.41% and 4.86%, respectively. We believe the reason is a reflection in both our customer base, which tends to be older and more affluent, and our underwriting, which is resulting in average credit scores of 754 and combined LTVs of around 59%.

Finally, we have our one-to-four-family perm pool with $64.3 million in total loans. The increase in this portfolio during the quarter was attributable to our builder banking promotion in which we provided financing for single-family residential homes in which we provided the underlying construction financing. The average credit score for the loans booked under this program has been 773 with an average LTD of 88%. This portfolio saw a modest update in non-accrual loans of $786,000 for the quarter. In total, roughly 4% of this portfolio, or $2.6 million, is on non-accrual.

That concludes my prepared comments, and I will now turn the call back over the Melanie.

Thanks, Andy. While we're still challenged by problem credit, we're not happy and we're not happy with the charge-offs we've taken. We are pleased with our ability to significantly reduce our exposure in residential construction loans.

My optimism is also fueled by this morning's news about the 3.5% growth in gross domestic product and that the tax credit for the first-time homebuyers will likely be extended and expanded.

In my comments earlier, I mentioned that while we are of course focused on managing our credit issues, we're continuing to move forward with the strategies we've developed to improve earnings and increase our market share. We have improved back room efficiencies and have been diligent in managing our level of overall non-interest expense.

We know an external focus is something that we've really -- we know an external focus to grow our market share is essential for our long-term success, and we believe the disruption in our market area provides a real opportunity to enhance our franchise value and increase our market share.

With our reputation being a great place to work, and our capacity and willingness to lend, we've been able to attract top bankers, most of whom have been recently added to our Vancouver, Washington, and Portland, Oregon, locations. These bankers have well-established track records in developing the type of business banking that is the focus of Columbia Bank, and they are especially well-positioned to help us develop core deposit business relationships as well as fee-based wealth management services.

In July, we opened our full-service branch in Renton, Washington. We received regulatory approval for a new branch location in downtown Vancouver, Washington, which we expect to open by the end of the year, and we received our approval just today for a new location in Portland, which we hope to open during the first quarter of 2010.

I'm really excited about our ability to move forward with our strategic initiatives that will help position us to be in an even stronger, more competitive position as the economy recovers. Columbia's one of the strongest franchises in the Pacific Northwest. We are very well capitalized with multiple sources of liquidity.

We are aggressively managing our credit issues and have a disciplined approach to expense controls. Our net interest margin is stable, and we have diverse loan and deposit portfolios. We have a well-earned reputation for delivering excellent customer service, resulting in an exceptional core deposit base.

We have the additional reputation of being a great place to work, which has enabled us to attract the talented bankers we need now and to have a strong base from which to operate when the economy recovers. We have real optimism in Columbia's future and we are truly looking forward to the opportunities ahead.

With that, those are our prepared comments. Before we open the call for your questions I'd just like to remind you that Gary Schminkey, our Chief Financial Officer, Andy McDonald, our Chief Credit Officer, and Mark Nelson, our Chief Operating Officer, are with me answer your questions.

And now Christie, if you'll open the call for questions?

(Operator Instructions).

Your first question comes from the line of Jeff Rulis of D.A. Davidson.

Good afternoon.

Hi, Jeff.

Hi. I was hoping that maybe you could -- Melanie sort of opened with an economic overview, but based on some recent events, if you could quantify the sort of impact of Boeing placing the second 787 line out of state, and I guess some of the -- if you could also relate to the Russell and Expedia job losses in Tacoma. If you could just sort of quantify that impact.

Sure. Well, we can't quantify Boeing's announcement about building the second line in South Carolina, because it's not that jobs are leaving Washington state, it's just that the new jobs that would have been created by that line will obviously be in South Carolina. So I wish that I knew what the impact would be four or five years down the road, but I just don't know that.

As far as Russell, we were very disappointed that they chose to go to Seattle, although certainly Seattle is part of our marketplace as well. So on one hand, we hate to lose them in Tacoma, but they are staying in the state.

And I guess that the good news/bad news with the Russell decision is that Tacoma doesn't have a lot of class A office space, and that's been one of the chicken-and-the-egg economic development factors, is do you build more class A office space to attract more companies to be headquartered or have large employment bases here in Tacoma, or do you get the employer first and then build the office space? So the bad news is that we're losing about 500 jobs out of Tacoma going to Seattle but we also get class A office space that will be available for others to consider. It's my understanding that there are there companies that are already looking at that space as single tenants.

And then Expedia, that really has not had a major impact. Mark has something he'd like to add.

Hi, Jeff.

Hi.

This morning in our chamber board meeting we had a representative from Boeing talking about impact, and of course as Melanie said near-term probably have no impact. It's just the potential for the future.

At the same time, they were talking about Boeing's Fredrickson plant here in Pierce County that makes some wing and tail subassemblies, and in actuality that will probably see the benefit of the second production line, even though it's across the country, because they will be supplying both production facilities, and any increase in volume will directly positively impact that plant in the near term. So there could be some positive benefits as well here in Pierce County.

Okay, thanks. And then you guys touched a couple of times on bringing on some new bankers or new groups. Is this anything different than what you've disclosed I believe last quarter from the Portland/Vancouver area?

The only difference is we have -- the people are actually on board now. We've been phasing in over the summer. Just to give you a recap, we brought in folks from two different commercial teams and a private banking team, and then we were also able to get an investment officer that really helped round out our investment in that Portland market. These are folks that we have been aware of in the marketplace. They were really our top picks of folks we'd like to have at Columbia, and so it was really a positive opportunity for us to be able to track them and get them on board so quickly.

Okay, and then finally I think Andy touched on this a little bit, but if you could talk about your sort of TDR philosophy. I'm aware that you don't have a -- you have a zero balance now, but I think you mentioned you may be seeking one on the King County problem credit. But I guess your overall approach -- are you aggressively approaching strained borrowers or just on a case-by-case, if you could talk about that.

Sure. Well, we will obviously enter into TDRs, forbearance agreements, and work out plans with the customers and the folks that we still consider to have a strong character who are working diligently and trying to resolve the issues that they are facing and obviously the ones that the bank is facing.

In terms of the accounting of the TDRs, we don't handle those assets a whole lot different than we do any of our other non-accrual or non-performing assets. We still write them down to whatever the appraisals will support, even though we may have tranches of notes that are above the asset value.

And since a lot of these TDRs are really still reliant on the underlying collateral to be the source of repayment, we are not aggressive in our approach and I don't think you're going to see a lot of them go back on accrual in the near term, simply because we're going to need to see a sustained and probably slightly trending upward market for both lot and house sales and prices.

And while certainly the housing market for completed homes has improved, that improvement's been isolated primarily in the new home, first-time buyer market. It's not broad across all of the various second home or jumbo homes or higher-end homes, and the lot and land market continues to be very weak. So until all of those stars align, we will keep those TDRs on non-accrual.

Okay, and the terms on the TDRs, are those for a set amount of time or is it just modified going forward and you reassess it?

Well, the agreements are generally going to be structured specific to the credit. Certainly credits that have a lot of homes or a lot of lots are going to require periods of time that could go out two or three years.

Some of those arrangements though are going to be much shorter in nature; only maybe a year to 18 months, so they're really specific to the credit.

Okay. Thank you.

Your next question comes from the line of Matt Clark of KBW.

Hey.

Hi, Matt.

Good afternoon. First question really is on the deposit balances and the money market line jumped this quarter, at least end of period up $115 million. It looks like you saw, though, some slippage in non-interest-bearing and end-of-period relative to the average balances during the quarter.

I'm just curious -- is there some sort of a new business that you guys won that came in on that money market line or is it just shifting balances from non-interest to money market?

Yes, I think people are looking for any kind of earnings that they can get at all. There's been a lot of movement away from (inaudible) deposits. People -- or non-interest-bearing deposits. People were very nervous in the beginning. We moved a lot of balances in there because of the FDIC insurance on non-interest-bearing transactional accounts. Now we're seeing some of those accounts wanting to go into our slightly higher interest-bearing money market accounts to get some return on those. They're still insured, however.

Right, okay. So not necessarily any big wins or anything.

No.

No.

Okay. Then from a cost perspective, in terms of interest-bearing deposit costs, I think those are down another nine basis points or so, to about 1.18%. Just curious in terms of how much more relief you have there from a cost perspective, whether or not you think we're kind of nearing a bottom and maybe it might -- maybe it relates to a desire to extend out some of your CD customers at higher rates.

While we don't really have a lot of interest from CD customers in extending out today, they're pretty sophisticated. I would say, though, that we're pretty much nearing the bottom of our ability to lower our deposit costs. There could be a few basis points here and there, you know, if liquidity allows us to retire FHLB borrowings and things like that. But in general, I think we're pretty near the bottom.

Okay.

We are still seeing some irrational pricing on the CD side from other banks in the markets that we serve.

Right. Then on the loan yield side, they were up nicely despite interest income reversal I think of about 11 basis points to 5.54%. Just curious as to whether or not we can see that -- is that just -- I guess that's despite construction loan yields running off. I'm just curious as to what that uptick is and whether or not it's somewhat sustainable. Is that new production going on or is that just high rates?

Well, it's really a reflection of how we've chosen to position ourselves, really, over the last 12 to 18 months. We've been consistent on putting in floors in our loans. As we've gotten through the renewal cycle on our short-term loans you're beginning to see some of the impact of that. And while we've been through a considerable portion of it, there's maybe another 20% of our portfolio that might yet benefit from that in the next few months.

Okay. Okay, and then maybe on the margin, I guess drilling down to the margin here a little bit more, I assume we're going to continue to see the gain from the termination of the swaps benefit the margin. I'm just, I guess, all-in, trying to get a sense of where this margin might go from here. It's been obviously very, very stable for quite a long time. I'm just curious as to what the outlook might be.

Matt, yes, I think the amortization of a swap termination fee, I think that's probably very immaterial to our overall margin. So I would anticipate the margin staying within the range that we talked about.

Okay. Okay, that's it for me, thank you.

Thanks, Matt.

Your next question comes from the line of John Hecht of JMP Securities.

Afternoon, thanks for taking my questions.

Hi, John.

How are you? I'm wondering, can you guys give us a sense for your lending flows? What were new loans versus loan amortization during the quarter, and what types of loans did you see being made during the quarter?

Well, the first thing I want to say is loan volume is definitely off. We're seeing more repayments than we are new opportunities. And while there are new opportunities out there because of the disruption in the market, I would say most of our decrease in loan totals have been due to repayments of problem loans. Those are the construction things that Andy's group was working through to the normal amortization of our term debt to land pay down, and finally we've had two or three businesses that sold during this last quarter that resulted in mid-six-figure pay-downs of lines. Beyond that I don't have specific numbers in each of those categories.

Okay. I wonder if you can get more granularity in your CRE loan portfolio, particularly in the maturity concentration, and maybe you can give an update on the LTV and debt service coverage based on updated appraisals where you have them?

Sure. There really hasn't been a material change in the LTVs or the debt coverage that I talked about last quarter. We're still hovering in that mid-60% range for LTVs and the debt coverage on the non-owner-occupied stuff is still hovering in that 155-160 range. So again, that continues to be fairly stable.

The originations are primarily -- the years you're probably interested in are 2004, $73 million; 2005, $69 million; 2006, $97 million; and then it kind of starts to drop down -- $62 million in 2007. So those are kind of probably the years that you're most interested in.

What's the duration on those on average?

We typically do five-year term or a five-year re-price with a 10-year term.

Okay. Okay, and then the last thing I wonder if maybe Melanie could discuss, you've given the strong capital base there now, maybe discuss opportunities for in-market acquisitions and maybe FDIC-assisted, things of that nature.

Well, I think that to do an open bank acquisition in this economic cycle makes it pretty difficult. Just getting comfortable with somebody else's loan portfolio is probably the biggest issue.

FDIC-assisted transactions, there could be some that are coming up, but I guess that what we really are trying to focus on the most is organic growth that we can really control. If the other things come to pass, that's great. But one thing about FDIC-assisted transactions would be that those are non-negotiated bids, so you can't control your opportunity, number one, to bid, and the second is your successful bid.

So we just really see a lot of opportunity to grow organically. We've brought on teams of bankers in markets where we didn't have a lot of coverage who are introducing us to new clients, new prospects, and we really think that we will have an opportunity to grow organically. There is a lot of disruption in the marketplace in the Pacific Northwest.

Great, I appreciate the call. Thank you, guys.

Sure, thank you.

Your next question comes from the line of Aaron Deer of Sandler O'Neill & Partners.

Hi, Aaron.

Hi, guys, how is everyone?

Good.

Good, thanks.

Good. I guess I think it was Jeff that asked the question kind of talking about your philosophy of TDRs. As something related to that, what are your thoughts with respect to trying to keep MPAs from growing or try to bring those down? Have you guys look at either loan sales or restructuring to work out efforts to try to keep that from drifting any higher, your MPA level from drifting higher?

Yes, we have. The loan sale market is still -- it's a buyer's market and as we discussed last quarter, we find that if we can work with our builders, with the lots and land that we have and get houses built on them, the loss content to the bank is a whole lot less.

Today, you can't build a lot for what it's worth -- or the cost would exceed what it's worth, so the market for those assets is very depressed, and you're going to get $0.20 to $0.30 on the dollar for residential lots. So the only people who are buying it are just very speculative, and they're not necessarily people who will ultimately build a home on it.

We still have a loss content on the lot if we put a home on it, but instead of the loss content being 70%, we can drop that down to about 20% to 25%. So by putting a home on the lot, we can still recover so much more than we could if we just sold the lot. Doing a note sale for the lot just doesn't make sense, and given our capital and liquidity levels, we're not necessarily motivated because of those reasons to shred shareholder capital that way.

Fair enough. Then, Gary, could you talk a little bit about the types of securities that you've been buying in terms of both what they are as well as yield and duration, and then any plans to continue deploying some of these deposits and excess liquidity that you have?

Well first of all, in August we did purchase some securities -- roughly $110 million, give or take, split about half Ginnie Mae and half Fannie and Freddy. The duration, we're talking in the three, many go to the three-year range, some of it into four-year but average around three because some of it was in the two-year category.

Really looking for something -- a place to do short-term, put some of our cash to work, but not go long with these securities. So we expect them to roll off between two and four years for reinvestment. Yields on these, we're talking an average yield of 3%, 3.25%, roughly, in that duration, and again about a three-year average.

Okay, and plans to do any more short-term investing, given the lack of lending opportunities right now?

Well, not at this time. It's something that we look at from time to time as part of our [outgrow] strategy. Really, in our view it isn't the time to stretch for yield on the investment portfolio or go out long in the portfolio, so it's -- certainly if we can increase bank profitability over the short term and keep them very short, then we can minimize the effect of tying up those funds, but we certainly don't want to be in an upside-down position should rates start to move up and we really can't do anything about that.

Okay. Thanks, everyone.

Thank you.

Sure.

Your next question comes from the line of Joe Morford of RBC Capital Markets.

Hi, Joe.

Thanks, good afternoon, everyone.

Hi.

Aaron asked one of my questions, but I guess a couple of follow-ups. One, earlier I think in terms of appraisals, I'm sure you've talked about this before, but could you just remind us how often you get appraisals done on your commercial real estate portfolio and tell us what percentage may have been appraised in the past three to six months?

Well, for our construction portfolio, which is where we have most of the problems, as the loans migrate downward -- and this is true for the term portfolio as well -- so if a loan goes from just being a past credit to, like, our watch list, and there's a process of revalidating the value of the property that's primarily an internal process with some guidance from credit administration and our appraisal group.

As loans migrate down into the criticized and classified levels, there's still an internal process but the level of, if you will, confirmation or approval of whatever we think that value is is raised eventually to the point where it goes to our appraisal department and then if it becomes classified and it's now a substandard credit, we will automatically then trigger a new appraisal. We will then, at a minimum, as long as the credit remains substandard, get an appraisal every year.

If we need to enter into a forbearance or some kind of a work-out agreement, we then have expectations that we outline clearly as to the borrower's performance for the project. If the performance then varies from whatever our expectations were when we entered into that agreement, either the leasing up isn't occurring or the rental rates aren't occurring or the absorption isn't occurring or the houses aren't selling, and that deviation gets above more than 10% to 15% of what our expectation was, that will also trigger a reappraisal.

So I have certain properties, especially in the construction bucket, where I've probably purchased three or four appraisals now in the last year as those projects have continued to struggle. So our process and our policy is driven by the risk rating, it's driven by the agreement that we have with the borrower, and they're driven by how the properties perform.

Okay, that makes sense. Given that there's not been that many issues in the CRE term, probably not a lot of recent appraisals done there.

No. When I talk to you about the values being in the mid-60% range that is predominately values that were determined at origination date.

Okay, great. Then I guess the other question is I know you have elaborate reserve methodology and one ratio never tells the whole story, but help us get comfortable with a reserve that's 40% of nonperforming loans and more than -- or it's actually less than the annualized run rate of charge-offs, if you look at a percentage of loans.

Well, I think that again, as soon as we identify the issues, we're not reluctant to charge the asset down. So we believe, and we go through a FAS-114 analysis for all of our substandard loans greater than $500,000 to make sure that we have adequate collateral to support the loan balance.

Again, combined with that appraisal policy and process that I was talking to you about before, the combination of those two processes makes us have to really make sure that we're carrying the assets at the appropriate value. So for example, in this last quarter about $3 million of our charge-offs were associated with loans that had been previously charged down, and that's a direct result of that process.

So we're constantly reevaluating those assets at all times, and so we really believe that based on the most current information we have, those assets have been marked to market appropriately.

Okay, great. That helps a lot. Thanks a lot.

Thank you.

Your next question comes from the line of Adam Klauber of Fox-Pitt.

Hi, Adam.

Yes, good quarter and credit. Provision was down, charge-off was down, and MPAs decelerated for the most in two quarters. I was wondering, did the problem watch list also decelerate from last quarter?

What we're seeing is kind of what I've talked about before, which is in certain segments of the book, yes, we're seeing that the migration is actually -- has turned the corner, if you will, and that's predominately in the construction book.

But we have continued to see an increase in the watch list loans in our CNI and our CRE books. Some of that is just because of the stress-testing that we do. We create these what we call lists, loans of interest, and often times we will place those on our watch list until we can feel very comfortable that because of our stress-testing and what it determined, do we really have a problem or not?

So we'll continue that process and that has driven some increase in the watch list level in the CRE and the CNI book.

Okay, thanks. Also in your remarks you said credit may remain elevated. Is that referring to the beginning or to the early part of 2010?

Yes, I would say that for the -- the near term as being defined as the next couple of quarters.

Okay, okay, that's helpful. As far as the loan teams that you've brought on, how long will it take them to start really bringing in incremental loans to, in effect, pay for themselves?

They're actually on budget for what our original anticipation was. They're putting loans and deposit totals on pretty significantly. I would expect that our deposit totals out of that group will be in the low seven-figure numbers by the end of the year, and our loan generation on the books will probably be mid-six-figure.

Okay. Finally, what's your deferred tax asset as of the third quarter?

I'm sorry, what was the question?

What is the deferred tax asset?

Yes.

I think I'm going to have to get back to you on that one for the full amount.

Okay. Okay, that's great. Thank you very much.

Thank you, Adam.

Thanks, Adam.

There are no further questions at this time.

Okay, well, thank you, everyone, for joining us, and we'll talk to you next quarter.

This concludes today's conference call. You may now disconnect.