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COLB > SEC Filings for COLB > Form 10-K on 3-Mar-2014All Recent SEC Filings

Show all filings for COLUMBIA BANKING SYSTEM INC

Form 10-K for COLUMBIA BANKING SYSTEM INC


3-Mar-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

This discussion should be read in conjunction with our Consolidated Financial Statements and related notes in "Item 8. Financial Statements and Supplementary Data" of this report. In the following discussion, unless otherwise noted, references to increases or decreases in average balances in items of income and expense for a particular period and balances at a particular date refer to the comparison with corresponding amounts for the period or date for the previous year.
Critical Accounting Policies
We have established certain accounting policies in preparing our Consolidated Financial Statements that are in accordance with accounting principles generally accepted in the United States. Our significant accounting policies are presented in Note 1 to the Consolidated Financial Statements in "Item 8. Financial Statements and Supplementary Data" of this report. Certain of these policies require the use of judgments, estimates and economic assumptions which may prove inaccurate or are subject to variation that may significantly affect our reported results of operations and financial position for the periods presented or in future periods. Management believes that the judgments, estimates and economic assumptions used in the preparation of the Consolidated Financial Statements are appropriate given the factual circumstances at the time. We consider the following policies to be most critical in understanding the judgments that are involved in preparing our consolidated financial statements. Allowance for Loan and Lease Losses
The allowance for loan and lease losses ("ALLL") is established to absorb known and inherent losses in our loan and lease portfolio. Our methodology in determining the appropriate level of the ALLL includes components for a general valuation allowance in accordance with the Contingencies topic of the Financial Accounting Standards Board Accounting Standards Codification ("FASB ASC"), a specific valuation allowance in accordance with the Receivables topic of the FASB ASC and an unallocated component. Both quantitative and qualitative factors are considered in determining the appropriate level of the ALLL. Quantitative factors include historical loss experience, delinquency and charge-off trends and the evaluation of specific loss estimates for problem loans. Qualitative factors include existing general economic and business conditions in our market areas as well as the duration of the current business cycle. Changes in any of the factors mentioned could have a significant impact on our calculation of the ALLL. Our ALLL policy and the judgments, estimates and economic assumptions involved are described in greater detail in the "Allowance for Noncovered Loan and Lease Losses and Unfunded Commitments and Letters of Credit" section of this discussion and in Note 1 to the Consolidated Financial Statements in "Item 8. Financial Statements and Supplementary Data" of this report. Business Combinations
The Company applies the acquisition method of accounting for business combinations. Under the acquisition method, the acquiring entity in a business combination recognizes 100 percent of the assets acquired and liabilities assumed at their acquisition date fair values. Management utilizes prevailing valuation techniques appropriate for the asset or liability being measured in determining these fair values. Any excess of the purchase price over amounts allocated to assets acquired, including identifiable intangible assets, and liabilities assumed is recorded as goodwill. Where amounts allocated to assets acquired and liabilities assumed is greater than the purchase price, a bargain purchase gain is recognized. Acquisition-related costs are expensed as incurred. Acquired Impaired Loans
Loans acquired at a discount for which it is probable that all contractual payments will not be received are generally accounted for under ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality ("ASC 310-30"). In addition, certain acquired loans with evidence of deteriorated credit quality may be accounted for under this topic even if it is not yet probable that all contractual payments will not be received. These loans are recorded at fair value at the time of acquisition. Estimated credit losses are included in the determination of fair value, therefore, an allowance for loan losses is not recorded on the acquisition date. The excess of expected cash flows at acquisition over the initial investment in acquired loans ("accretable yield") is recorded as interest income over the life of the loans if the timing and amount of the future cash flows is reasonably estimable. Subsequent to acquisition, the Company aggregates individual loans with common risk characteristics into pools of loans. Increases in estimated cash flows over those expected at the acquisition date are recognized as interest income, prospectively. Decreases in expected cash flows after the acquisition date are recognized by recording an allowance for loan losses.


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Loans accounted for under ASC 310-30 are generally considered accruing and performing loans as the loans accrete interest income over the estimated life of the loan when cash flows are reasonably estimable. Accordingly, acquired impaired loans that are contractually past due are still considered to be accruing and performing loans. If the timing and amount of future cash flows is not reasonably estimable, the loans may be classified as nonaccrual loans and the purchase price discount on those loans is not recorded as interest income until the timing and amount of future cash flows can be reasonably estimated. FDIC Loss-sharing Asset
In conjunction with certain of the FDIC-assisted acquisitions, the Bank entered into loss-sharing agreements with the FDIC. At the date of the acquisitions, the Company elected to account for amounts receivable under the loss-sharing agreements as an indemnification asset in accordance with the Business Combinations topic of the FASB ASC. Subsequent to initial recognition, the FDIC loss-sharing asset is reviewed quarterly and adjusted for any changes in expected cash flows. These adjustments are measured on the same basis as the related covered assets. Any decrease in expected cash flows due to an increase in expected credit losses will increase the FDIC loss-sharing asset and any increase in expected future cash flows due to a decrease in expected credit losses will decrease the FDIC loss-sharing asset. Increases and decreases to the FDIC loss-sharing asset are recorded as adjustments to noninterest income. Valuation and Recoverability of Goodwill Goodwill represented $344.0 million of our $7.16 billion in total assets and $1.05 billion in total shareholders' equity as of December 31, 2013. The Company has one, single reporting unit. We review goodwill for impairment annually, during the third quarter, and also test for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of our reporting unit below its carrying amount. Such events and circumstances may include among others: a significant adverse change in legal factors or in the general business climate; significant decline in our stock price and market capitalization; unanticipated competition; the testing for recoverability of a significant asset group within the reporting unit; and an adverse action or assessment by a regulator. Any adverse change in these factors could have a significant impact on the recoverability of goodwill and could have a material impact on our consolidated financial statements.
Under the Intangibles - Goodwill and Other topic of the FASB ASC, the testing for impairment may begin with an assessment of qualitative factors to determine if it is more likely than not that the fair value of a reporting unit is less than its carrying amount. When required, the goodwill impairment test involves a two-step process. In step one we would test goodwill for impairment by comparing the fair value of the reporting unit with its carrying amount. If the fair value of the reporting unit exceeds the carrying amount of the reporting unit, goodwill is not deemed to be impaired, and no further testing is necessary. If the carrying amount of the reporting unit were to exceed the fair value of the reporting unit, we would perform a second test to measure the amount of impairment loss, if any. To measure the amount of any impairment loss, we would determine the implied fair value of goodwill in the same manner as if the reporting unit were being acquired in a business combination. Specifically, we would allocate the fair value of the reporting unit to all of the assets and liabilities of the reporting unit in a hypothetical calculation that would determine the implied fair value of goodwill. If the implied fair value of goodwill is less than the recorded goodwill, we would record an impairment charge for the difference.
The accounting estimates related to our goodwill require us to make considerable assumptions about fair values. Our assumptions regarding fair values require significant judgment about economic and industry factors, as well as our views regarding the growth and earnings prospects of the bank. Changes in these judgments, either individually or collectively, may have a significant effect on the estimated fair values.
Based on the results of the annual goodwill impairment test, we determined that no goodwill impairment charges were required as our single reporting unit's fair value exceeded its carrying amount. As of December 31, 2013 we determined there were no events or circumstances which would more likely than not reduce the fair value of our reporting unit below its carrying amount.
Even though we determined that there was no goodwill impairment during 2013, additional adverse changes in the operating environment for the financial services industry may result in a future impairment charge.
Please refer to Note 10 to the Consolidated Financial Statements in "Item 8. Financial Statements and Supplementary Data" of this report for further discussion.


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2013 Highlights
Consolidated net income for 2013 was $60.0 million, or $1.21 per diluted common share, compared with a net income of $46.1 million, or $1.16 per diluted common share, in 2012.

Net interest income for 2013 increased 22% to $291.1 million compared to $238.9 million for 2012. Interest income was $296.9 million in 2013, compared to $248.5 million in 2012. The increase was primarily due to the interest and accretion income related to the West Coast acquisition, which closed on April 1, 2013. Interest expense decreased $3.7 million due to lower average cost of interest-bearing deposits and lower Federal Home Loan Bank advance balances during the year.

Provision expense on noncovered loans was $3.2 million in 2013, compared to $13.5 million in 2012, a decrease of 77%. Provision expense on covered loans was a recapture of $3.3 million in 2013, compared to a provision of $25.9 million in 2012. The noncovered loan provision for the current year and prior year approximated net charge-offs for the respective period. The provision recapture on covered loans during the current year was due to increased expected future cash flows as remeasured during the current year when compared to the prior year's remeasurement.

Noninterest income was $26.7 million for 2013, a small decrease from $27.1 million for 2012. The decrease was primarily due to the adverse change of $20.6 million in the change in the FDIC loss-sharing asset, partially offset by increases of 18.4 million in service charges and other fees and $3.7 million in other noninterest expense.

Noninterest expense increased $68.0 million, or 42% to $230.9 million for 2013 due to additional ongoing noninterest expense resulting from the West Coast acquisition as well as the acquisition-related expenses of $25.5 million recorded in 2013, compared to only $1.8 million for the prior year period.

Total assets at December 31, 2013 were $7.16 billion, up 46% from $4.91 billion at the end of 2012, primarily due to the acquisition of West Coast.

Investment securities available for sale totaled $1.66 billion at December 31, 2013 compared to $1.00 billion at December 31, 2012.

Loans, excluding covered loans, were $4.22 billion, up 67% from $2.53 billion at the end of 2012. The increase from December 31, 2012 was due in large part to the acquisition of West Coast, which added $1.41 billion in loans.

The allowance for noncovered loan and lease losses was relatively unchanged at $52.3 million at December 31, 2013 compared to $52.2 million at December 31, 2012 due to improved loan quality on a substantially larger loan portfolio. The Company's allowance amounts to 1.24% of total noncovered loans, compared with 2.07% at the end of 2012. This ratio was impacted by including recently acquired loans in the ratio, which had a fair value discount applied as of the acquisition date. Please refer to the section titled "Allowance for Loan and Lease Losses and Unfunded Commitments and Letters of Credit" for further discussion.

Nonperforming assets totaled $57.9 million at December 31, 2013, up from $48.5 million at December 31, 2012. The increase in nonperforming assets was primarily due to the nonperforming assets acquired from West Coast, which consisted of $9.4 million of nonaccrual loans and $6.9 million of other real estate owned at December 31, 2013. However, nonperforming assets to year end assets, excluding covered loans, decreased to 0.84% at December 31, 2013 compared to 1.48% at December 31, 2012. Net loan charge-offs were $3.1 million in 2013, compared with $14.3 million in 2012.

Deposits totaled $5.96 billion at December 31, 2013 compared to $4.04 billion at December 31, 2012. Core deposits totaled $5.70 billion at December 31, 2013, comprising 96% of total deposits compared to $3.80 billion, or 94%, of total deposits at December 31, 2012.

The Company is well capitalized with a total risk-based capital ratio of 14.68% at December 31, 2013 compared to 20.62% at December 31, 2012. The decrease in the total risk-based capital ratio was due to the deployment of capital for the acquisition of West Coast.

The number of branches increased from 99 at December 31, 2012 to 142 at December 31, 2013 due to the acquisition of West Coast.


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Business Combinations
On April 1, 2013, the Company completed its acquisition of West Coast. The Company acquired approximately $2.63 billion in assets, including $1.41 billion in loans measured at fair value, and approximately $1.88 billion in deposits. See Note 2 to the Consolidated Financial Statements in "Item 8. Financial Statements" of this report for further information regarding this acquisition. On August 5, 2011, the Bank acquired certain assets and assumed certain liabilities of the Bank of Whitman from the FDIC in an FDIC-assisted transaction. The Bank and the FDIC entered into a modified whole bank purchase and assumption agreement without loss share. The bank acquired approximately $437.5 million in assets, including $200.0 million in loans measured at fair value, and approximately $401.1 million in deposits located in nine branches in eastern Washington. The Bank participated in a competitive bid process in which the accepted bid included no deposit premium on non-brokered deposits and a negative bid of $30.0 million on net assets acquired.
On May 27, 2011, the Bank acquired certain assets and assumed certain liabilities of First Heritage Bank from the FDIC in an FDIC-assisted transaction. The Bank acquired approximately $165.0 million in assets and approximately $159.5 million in deposits located in five branches in the King and Snohomish counties of Washington. First Heritage Bank's loans and other real estate assets acquired of approximately $89.7 million are subject to a loss-sharing agreement with the FDIC. The Bank participated in a competitive bid process in which the accepted bid included a 0.75% deposit premium on non-brokered deposits and a negative bid of $10.5 million on net assets acquired.
On May 20, 2011, the Bank acquired certain assets and assumed certain liabilities of Summit Bank from the FDIC, in an FDIC-assisted transaction. The Bank acquired approximately $131.1 million in assets and approximately $123.3 million in deposits located in three branches in the northern Puget Sound region of Washington. Summit Bank's loans and other real estate assets acquired of approximately $71.9 million are subject to a loss-sharing agreement with the FDIC. The Bank participated in a competitive bid process in which the accepted bid included a 0.75% deposit premium on non-brokered deposits and a negative bid of $9.5 million on net assets acquired.


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RESULTS OF OPERATIONS

Summary
A summary of the Company's results of operations for each of the last five years
ended December 31 follows:

                                   Increase                                Increase
                Year ended        (Decrease)          Year ended          (Decrease)                Years ended December 31,
                   2013         Amount       %           2012          Amount        %          2011          2010          2009
                                                 (dollars in thousands, except per share amounts)
Interest
income         $  296,935     $ 48,431       19     $    248,504     $ (2,767 )       (1 )   $ 251,271     $ 185,879     $ 143,035
Interest
expense             5,840       (3,737 )    (39 )          9,577       (4,958 )      (34 )      14,535        21,092        27,683
Net interest
income            291,095       52,168       22          238,927        2,191          1       236,736       164,787       115,352
Provision
for loan and
lease losses        3,160      (10,315 )    (77 )         13,475        6,075         82         7,400        41,291        63,500
Provision
(recapture)
for losses
on covered
loans              (3,261 )    (29,153 )   (113 )         25,892       27,540     (1,671 )      (1,648 )       6,055             -
Noninterest
income
(loss)             26,700         (358 )     (1 )         27,058       36,341       (391 )      (9,283 )      52,781        29,690
Noninterest
expense:
Compensation
and employee
benefits          125,432       39,998       47           85,434        3,882          5        81,552        69,780        47,275
Other
expense           105,454       27,975       36           77,479        3,272          4        74,207        67,367        47,213
Total             230,886       67,973       42          162,913        7,154          5       155,759       137,147        94,488
Income
(loss)
before
income taxes       87,010       23,305       37           63,705       (2,237 )       (3 )      65,942        33,075       (12,946 )
Provision
(benefit)
for income
taxes              26,994        9,432       54           17,562         (343 )       (2 )      17,905         2,291        (8,978 )
Net income
(loss)         $   60,016     $ 13,873       30     $     46,143     $ (1,894 )       (4 )   $  48,037     $  30,784     $  (3,968 )
Less:
Dividends on
preferred
stock                  32           32        -                -            -          -             -         4,947         4,403
Net income
(loss)
applicable
to common
shareholders   $   59,984     $ 13,841       30     $     46,143     $ (1,894 )       (4 )   $  48,037     $  25,837     $  (8,371 )
Earnings
(loss) per
common
share,
diluted        $     1.21     $   0.05        4     $       1.16     $  (0.05 )       (4 )   $    1.21     $    0.72     $   (0.38 )

Net Interest Income
Net interest income is the difference between interest income and interest expense. Net interest income on a fully taxable-equivalent basis expressed as a percentage of average total interest-earning assets is referred to as the net interest margin, which represents the average net effective yield on interest-earning assets.


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The following table sets forth the average balances of all major categories of interest-earning assets and interest-bearing liabilities, the total dollar amounts of interest income on interest-earning assets and interest expense on interest-bearing liabilities, the average yield earned on interest-earning assets and average rate paid on interest-bearing liabilities by category and in total, net interest income, net interest spread, net interest margin and the ratio of average interest-earning assets to interest-earning liabilities:

Net Interest Income Summary
                                               2013                                     2012                                     2011
                                               Interest                                 Interest                                 Interest
                                 Average        Earned/     Average       Average        Earned/     Average       Average        Earned/     Average
                                Balances         Paid         Rate       Balances         Paid         Rate       Balances         Paid         Rate
                                                                               (dollars in thousands)
ASSETS
Loans, excluding covered
loans, net (1)(3)             $ 3,783,925     $ 213,191       5.63 %   $ 2,413,307     $ 131,413       5.45 %   $ 2,064,568     $ 126,520       6.13 %
Covered loans, net (2)            356,901        53,712      15.05 %       487,213        88,785      18.22 %       542,698        92,467      17.04 %
Taxable securities              1,155,066        20,459       1.77 %       740,418        18,276       2.47 %       675,010        21,870       3.24 %
Tax exempt securities (3)         319,678        15,262       4.77 %       270,876        15,423       5.69 %       253,881        15,736       6.20 %
Interest-earning deposits
with banks and federal
funds sold                        138,973           355       0.26 %       334,910           854       0.26 %       335,267           839       0.25 %
Total interest-earning
assets                          5,754,543       302,979       5.27 %     4,246,724       254,751       6.00 %     3,871,424       257,432       6.65 %
Other earning assets              111,228                                   76,327                                   57,518
Noninterest-earning assets        692,746                                  503,232                                  580,068
Total assets                  $ 6,558,517                              $ 4,826,283                              $ 4,509,010
LIABILITIES AND SHAREHOLDERS' EQUITY
Certificates of deposit       $   535,656     $   1,998       0.37 %   $   543,349     $   3,257       0.60 %   $   636,074     $   5,093       0.80 %
Savings accounts                  445,666            94       0.02 %       298,223            77       0.03 %       247,073           152       0.06 %
Interest-bearing demand         1,048,482           587       0.06 %       790,887           869       0.11 %       704,484         1,393       0.20 %
Money market accounts           1,566,539         1,283       0.08 %     1,051,171         1,684       0.16 %       969,548         3,840       0.40 %
Total interest-bearing
deposits                        3,596,343         3,962       0.11 %     2,683,630         5,887       0.22 %     2,557,179        10,478       0.41 %
Federal Home Loan Bank
advances (4)                       51,030         1,144       2.24 %       100,337         3,211       3.20 %       120,419         2,980       2.47 %
Long-term subordinated debt             -             -          - %             -             -          - %        14,746           579       3.93 %
Other borrowings and
interest-bearing
liabilities                        35,772           734       2.05 %        25,000           479       1.92 %        24,899           498       2.00 %
Total interest-bearing
liabilities                     3,683,145         5,840       0.16 %     2,808,967         9,577       0.34 %     2,717,243        14,535       0.53 %
Noninterest-bearing
deposits                        1,824,234                                1,192,036                                  984,220
Other noninterest-bearing
liabilities                        72,039                                   64,095                                   76,821
Shareholders' equity              979,099                                  761,185                                  730,726
Total liabilities &
shareholders' equity          $ 6,558,517                              $ 4,826,283                              $ 4,509,010
Net interest income                           $ 297,139                                $ 245,174                                $ 242,897
Net interest spread                                           5.11 %                                   5.66 %                                   6.12 %
Net interest margin                                           5.16 %                                   5.77 %                                   6.27 %

Average interest-earning assets to average interest-bearing liabilities 156.24 % 151.18 % 142.48 %



(1) Nonaccrual loans were included in loans. Amortized net deferred loan fees and net unearned discounts on certain acquired loans were included in the interest income calculations. The amortization of net deferred loan fees was $3.3 million in 2013, $2.1 million in 2012 and $1.3 million in 2011. The accretion of net unearned discounts on certain acquired loans was $28.4 million in 2013, $5.9 million in 2012, and $14.3 million in 2011.

(2) Incremental accretion on acquired impaired loans is included in covered loan interest earned. The incremental accretion income on acquired impaired loans was $29.8 million in 2013, $55.3 million in 2012 and $53.1 million in 2011.

(3) Yields on fully taxable equivalent basis, based on a marginal tax rate of 35%. The tax equivalent yield adjustment to interest earned on noncovered loans was $619 thousand, $765 thousand and $567 thousand for the years ended December 31, 2013, 2012, and 2011, respectively. The tax equivalent yield adjustment to interest earned on tax exempt securities was $5.4 million, $5.5 million and $5.6 million for the years ended December 31, 2013, 2012, and 2011, respectively.

(4) Federal Home Loan Bank advances includes prepayment charges of $1.5 million and $603 thousand in 2013 and 2012, respectively. No prepayment charges were recorded on Federal Home Loan Bank advances during 2011. As a result of the 2013 prepayment, the Company recorded $874 thousand in premium amortization, which partially offset the impact of the prepayment charge.


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Net interest income is impacted by the volume (changes in volume multiplied by prior rate), interest rate (changes in rate multiplied by prior volume) and the mix of interest-earning assets and interest-bearing liabilities. The following table shows changes in net interest income on a fully taxable-equivalent basis between 2013 and 2012, as well as between 2012 and 2011 broken down between volume and rate. Changes attributable to the combined effect of volume and interest rates have been allocated proportionately to the changes due to volume and the changes due to interest rates: . . .

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