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CACB > SEC Filings for CACB > Form 10-K on 31-Mar-2014All Recent SEC Filings

Show all filings for CASCADE BANCORP

Form 10-K for CASCADE BANCORP


31-Mar-2014

Annual Report


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

This discussion highlights key information as determined by management but may not contain all of the information that is important to you. For a more complete understanding, the following should be read in conjunction with the Company's audited consolidated financial statements and the notes thereto as of December 31, 2013 and 2012 and for each of the years in the three-year period ended December 31, 2013 included in Item 8 of this Annual Report on Form 10-K.

Cautionary Information Concerning Forward-Looking Statements This Annual Report on Form 10-K contains forward-looking statements about the Company's plans and anticipated results of operations and financial condition including those in connection with the proposed merger with Home. These statements include, but are not limited to, our plans, objectives, expectations and intentions and are not statements of historical fact. When used in this report, the word "expects," "believes," "anticipates," "could," "may," "will," "should," "plan," "predicts," "projections," "continue" and other similar expressions constitute forward-looking statements, as do any other statements that expressly or implicitly predict future events, results or performance, and such statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Certain risks and uncertainties and the Company's success in managing such risks and uncertainties could cause actual results to differ materially from those projected, including among others, the risk factors described in Item 1A of this report.
These forward-looking statements speak only as of the date of this report. The Company undertakes no obligation to publish revised forward-looking statements to reflect the occurrence of unanticipated events or circumstances after the date hereof. Readers should carefully review all disclosures filed by the Company from time to time with the SEC.
Regulatory Orders Terminated in 2013
On September 5, 2013, the FDIC and the DFCS terminated the MOU, issued to the Bank in March 2013. Prior to March 2013, the Bank was under the Order issued by the FDIC and the DFCS in August 2009.
On October 23, 2013, the FRB and the DFCS terminated the FRB-MOU issued to Bancorp in July 2013. Between October 2009 and July 2013, the Company was under the Written Agreement entered into with the FRB and the DFCS in October 2009. 2011 Capital Raise
In January 2011, Cascade completed a $177.0 million Capital Raise, which is described in the section Item 1 of this report. Capital Raise proceeds in the amount of $167.9 million (net of offering costs) were received on January 28, 2011, of which approximately $150.4 million was contributed to the Bank. Approximately $15.0 million of the Capital Raise proceeds were used to extinguish $68.6 million of the Company's junior subordinated debentures and $3.9 million of related accrued interest payable, resulting in a pre-tax extraordinary gain of approximately $54.9 million ($32.8 million after tax). During the second quarter of 2011, the Company received an additional $0.2 million in proceeds from the issuance of an additional 50,000 shares of common stock in connection with the completion of the Capital Raise. See Note 2 to Item 8 of this report for additional information regarding the Capital Raise.


2011 Bulk Sale of Distressed Assets
In September 2011, the Bank entered into the Bulk Sale, also described in Item 1 of this report, pursuant to which the Bank sold approximately $110.0 million (carrying amount) of certain non-performing, substandard and related performing loans and approximately $2.0 million of OREO. In connection with the Bulk Sale, the Bank received approximately $58.0 million in cash from the buyer, incurred approximately $3.0 million in related closing costs and recorded loan charge-offs totaling approximately $54.0 million. See Note 2 of Item 8 of this report for additional information regarding these transactions. Critical Accounting Policies and Accounting Estimates

Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and which could potentially result in materially different results under different assumptions and conditions. The Company believes that its most critical accounting policies upon which its financial condition depends, and which involve the most complex or subjective decisions or assessments are set forth below. Reserve for Credit Losses
The Company's reserve for credit losses provides for estimated losses based upon evaluations of known and inherent risks in the loan portfolio and related loan commitments. Arriving at an estimate of the appropriate level of reserve for credit losses (which consists of the Company's reserve for loan losses and reserve for loan commitments) involves a high degree of judgment and assessment of multiple variables that result in a methodology with relatively complex calculations and analysis. Management uses historical information to assess the adequacy of the reserve for loan losses and considers qualitative factors including economic conditions and a range of other factors in its determination of the reserve. On an ongoing basis, the Company seeks to enhance and refine its methodology such that the reserve is at an appropriate level and responsive to changing conditions. In this regard, as of June 30, 2013, management implemented a homogeneous pool approach to estimating reserves for consumer and small business loans. This change is not expected to have a material effect on the level of the reserve for loan losses. However, the Company's methodology may not accurately estimate inherent loss or external factors and changing economic conditions may impact the loan portfolio and the level of reserves in ways currently unforeseen.
The reserve for loan losses is increased by provisions for loan losses and by recoveries of loans previously charged-off and reduced by loans charged-off. The reserve for loan commitments is increased and decreased through non-interest expense. For more discussion of Cascade's methodology of assessing the adequacy of the reserve for credit losses, see "Loan Portfolio and Credit Quality" below in this Item 7.
Deferred Income Taxes
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision (credit) for income taxes. A valuation allowance, if needed, reduces deferred tax assets to the expected amount to be realized.

Deferred tax assets are recognized subject to management's judgment that realization is "more likely than not." Uncertain tax positions that meet the more likely than not recognition threshold are measured to determine the amount of benefit to recognize. An uncertain tax position is measured at the amount of benefit that management believes has a greater than 50% likelihood of realization upon settlement. Tax benefits not meeting our realization criteria represent unrecognized tax benefits. We account for interest and penalties as a component of income tax expense.

Cascade reversed its deferred tax asset ("DTA") valuation allowance as of June 30, 2013 due to management's determination that it was more likely than not that a significant portion of the Company's DTA would be realized. The determination resulted from consideration of both the positive and negative evidence available that can be objectively verified. Considering the guidance in paragraphs 21-23 of Accounting Standards Codification ("ASC") 740-10-30, forming a conclusion that a valuation allowance is not needed is difficult when there is negative evidence such as cumulative losses in recent years. Such a condition, which existed at June 30, 2013, is considered a significant piece of negative evidence that is difficult to overcome. Accordingly, in its determination of DTA, the Company analyzed and evaluated the nature and timing of relevant facts and circumstances with respect to its cumulative loss.

The Company has revised and enhanced loan underwriting and credit risk management standards which have been important in creating credit quality improvements and current profitability. Improvement in underwriting and credit risk management practices can be attributed to a number of key initiatives, including replacement of leadership responsible for credit risk management, the implementation of a centralized credit structure, a comprehensive revision to credit policies including specific


concentration limits and standardized loan origination and monitoring practices. These initiatives have been reviewed and approved by the Board of Directors and examined by bank regulators.

The credit risk management infrastructure has been reconstituted with people with a strong depth and breadth of industry experience who have developed sound credit processes and lending initiatives. A formal loan concentration policy was adopted to limit and manage exposure to certain loan concentrations, including acquisition, development and construction ("ADC") loans and commercial real estate ("CRE") loans. This enhanced policy provides a more detailed program for portfolio risk management and reporting, including setting limits and sub-limits on ADC and CRE loans as a percentage of risk-based capital (in the aggregate and by loan type), having large borrower concentration limits, and monitoring by geography, industry and portfolio mix.

Since implementation of strengthened policies, historically high loan loss categories such as land acquisition and residential construction and development loans (within the CRE portfolio) have decreased dramatically. Since its peak at 720% of regulatory capital (defined as total risk based capital) in 2010, non-owner occupied CRE (including ADC) has decreased to 255% of regulatory capital. Since its peak at 293% of regulatory capital in 2008, ADC has decreased to 34% of regulatory capital (primarily comprised of non-speculative commercial construction).

Credit risk management has developed various strategies for the remediation of criticized and classified assets, including exit and rehabilitation strategies. Classified assets have decreased 81% from their peak levels in 2011. Also a robust and centralized credit structure supporting consistent underwriting standards has been developed; centralized credit authority has been established to improve quality and consistency; and the Company has invested in systems and experienced credit resources to strengthen origination, underwriting, approval and collateral valuation processes.

Management evaluated the unique and non-recurring loss evidence as an important consideration in the evaluation of the Company's cumulative loss. While this loss occurred, the nature and timing of the components of loss can be assessed to determine whether the subsequent actions taken by management to strengthen credit risk management mitigate the risk that such losses would recur in the forecast period used to evaluate the utilization of the DTA. Management determined that the steps taken to strengthen its credit risk management process have addressed the conditions that existed when the loans were created and the losses were incurred. The outcome of this evaluation is an important factor in management's determination that positive evidence overcomes the existence of the cumulative loss in the recent past.

Positive considerations also evaluated by management include reduction of the risk inherent in the loan portfolio as indicated by the reduction of classified loans, strengthening of the credit risk management process, elimination of substantially all of the OREO properties, termination of all existing regulatory agreements and orders, profitable performance during the past two years, development of new products and services that strengthen non-interest income (including customer swap arrangements, mortgage lending, and enhanced credit card products), opportunities that exist to bring operating costs in line with peer groups, the Company's strong capital and liquidity positions, substantial improvements resulting from new members of the Board of Directors and management, new leadership in the production units, strong loan production focused on commercial lending, implementation of a productive sales management culture, strengthening of the Company's governance and oversight and the sustained improvement in the economic conditions at a national and local level.

The following table presents information associated with the discussion above for the periods shown (dollars in thousands):

                                                              December 31,
                                           2013           2012           2011            2010
Reserve for loan losses                $   20,857     $   27,261     $   43,905     $     46,668
Substandard loans                          41,194        126,708        171,349          188,435
Impaired loans                             40,467         68,671         72,015          130,824
Past due loans                              7,530         31,323         10,331           88,954
TDRs                                       34,475         44,968         45,597           62,822
Other real estate owned                     3,144          6,552         21,270           39,536
Total loans                               996,232        858,164        899,143        1,226,360
Bancorp Tier 1 leverage (to average
assets)                                      10.5 %         10.4 %          9.4 %            0.4 %

As management determined that positive evidence outweighed the negative, long-term financial forecasts were developed to assess the Company's capacity to realize the DTA. This process included a variety of scenarios necessary to understand a range


of outcomes whether considered probable or not. Generally these various scenarios contemplated very unfavorable through moderately favorable outcomes thought to be possible. As a result of this analysis management concluded it was more likely than not that forecasted earnings performance would allow for the realization of the DTA in a timely manner.

As of December 31, 2013, Cascade had a net deferred tax asset of $50.1 million. This compares to no deferred tax asset as of December 31, 2012 as the Company recorded a valuation allowance to fully offset its deferred tax asset in 2012. There are a number of tax issues that impact the deferred tax asset balance, including changes in temporary differences between the financial statement and tax recognition of revenue and expenses and estimates as to the deductibility of prior losses.
OREO and Foreclosed Assets
OREO and other foreclosed assets acquired through loan foreclosure are initially recorded at estimated fair value less costs to sell when acquired, establishing a new cost basis. The adjustment at the time of foreclosure is recorded through the reserve for loan losses. Due to the subjective nature of establishing the asset's fair value when it is acquired, the actual fair value of the OREO or foreclosed asset could differ from the original estimate. If it is determined that fair value declines subsequent to foreclosure, a valuation allowance is recorded through non-interest expense. Operating costs associated with the assets after acquisition are also recorded as non-interest expense. Gains and losses on the disposition of OREO and foreclosed assets are netted and posted to other non-interest expenses.
Economic Conditions
The Company's business is closely tied to the economies of Idaho and Oregon which in turn are influenced by regional and national economic trends and conditions. Idaho and Oregon have recently been experiencing improved economic trends, including gains in employment and increased real estate activity. National and regional economies and real estate prices are also stabilizing and in certain cases improved; however, lingering effects of the severe economic downturn from 2007 through 2009, including fiscal imbalances, continue to affect employment and business and consumer confidence to some degree and the future direction of the economy remains uncertain. The Company's markets continue to be sensitive to real estate values and unemployment rates continue to be higher than prior to the downturn. An unforeseen economic shock or a return of adverse economic conditions could cause deterioration of local economies and adversely affect the Company's financial condition and results of operations. Consolidated Results of Operations - Years ended December 31, 2013, 2012, and 2011
Net Income/Loss
Our consolidated results of operations are dependent to a large degree on our net interest income. We also generate other income primarily through service charges and fees, card issuer and merchant service fees, earnings on bank-owned-life insurance ("BOLI") and mortgage banking income. Our operating expenses consist in large part of compensation, employee benefits expense, occupancy, communications, equipment, information technology, insurance expenses, professional and outside services, and expenses related to OREO. Interest income and cost of funds are affected significantly by general economic conditions, particularly changes in market interest rates, and by government policies and actions of regulatory authorities.
In 2013, the Company recorded net income of $50.8 million, compared to a net income of $6.0 million in 2012 and a net loss of $47.3 million in 2011. During these periods, net income (loss) per common share was $1.08, $0.13 and $(1.08), respectively. The increase in net income in 2013 compared to 2012 is primarily due to an income tax benefit of $50.1 million primarily realized through the reversal of the valuation allowance against the Company's DTA in the second quarter of 2013. Net income increased in 2012 compared to 2011 mainly as a result of significantly reduced credit costs, including a lower loan loss provision and reduced cost incurred in connection with the disposition of OREO. The Company recorded a $1.0 million loan loss provision in 2013, a $1.1 million loan loss provision in 2012 and a $75.0 million loan loss provision in 2011. The Company's reduction in loan losses from 2011 was due primarily to the Bulk Sale. OREO-related expenses also declined to $0.5 million and $1.7 million in 2013 and 2012, respectively, from $17.9 million in 2011 primarily due to the Bulk Sale. Net income in 2013 and 2012 also benefited from revenue related to revitalized residential mortgage originations, contributing approximately $4.3 million to net income each year, compared to $0.5 million in 2011. Net Interest Income
For most financial institutions, including the Company, the primary component of earnings is net interest income. Net interest income is the difference between interest income earned, principally from loans and investment securities portfolio, and interest paid, principally on customer deposits and borrowings. Changes in net interest income typically result from changes in volume, spread and margin. Volume refers to the dollar level of interest-earning assets and interest-bearing liabilities. Spread refers to the difference between the yield on interest-earning assets and the cost of interest-bearing liabilities. Margin refers to net


interest income divided by interest-earning assets and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities.
Net interest income was $48.2 million in 2013, a $1.7 million or 3.3% decrease from 2012. Net interest income also decreased $5.5 million or 10.0% in 2012 from 2011. Yields earned on assets decreased to 4.12% for 2013 as compared to 4.52% in 2012 and 4.66% in 2011 mainly due to declining market interest rates combined with a change in earning asset mix, whereby lower yielding securities volumes were up while higher yielding average loan balances declined. Meanwhile, the average rates paid on interest bearing liabilities for 2013 decreased to 0.37% compared to 0.67% in 2012 and 1.24% in 2011.
2013 total interest income decreased $3.9 million or 7.1% compared to total interest income in 2012 due mainly to lower rates on average earning loans. Partially offsetting this decline was $1.0 million in interest income from the full repayment of a loan on non-accrual. 2012 total interest income decreased approximately $12.2 million or 18.2% compared to total interest income in 2011 primarily due to significantly lower average earning loans in 2012 compared to 2011. Total interest expense declined by $2.2 million or 44.6% in 2013 as compared to 2012 mainly due to repricing of maturing time deposits and borrowings which carry higher rates than core deposits. Borrowing rate costs were specifically benefited in 2013 when the Bank paid off $60.0 million of FHLB advances bearing a weighted average interest rate of 3.17%, thereby decreasing interest expense. Similarly 2012 interest expense declined $6.7 million or 57.3% as compared to 2011 mainly due to reduced volumes of time deposits and borrowings which carry higher rates than core deposits.
The overall decline in net interest income from 2011 through 2013 was largely due to the declining rate environment especially on loans and investments. Net Interest Margin (NIM)
The Company's net interest margin ("NIM") decreased to 3.90% for 2013 compared to 4.11% for 2012 and 3.85% for 2011. The decrease in 2013 compared to 2012 was primarily due to decreased rates on earning assets in 2013.
The following table presents further analysis of the components of the Company's NIM and sets forth for 2013, 2012, and 2011 information with regard to average balances of assets and liabilities, as well as total dollar amounts of interest income from interest-earning assets and interest expense on interest-bearing liabilities, resultant average yields or rates, net interest income, net interest spread, net interest margin and the ratio of average interest-earning assets to average interest-bearing liabilities for the Company:


                                                                         Year ended December 31,
(dollars in thousands)                  2013                                      2012                                      2011
                                        Interest      Average                     Interest      Average                     Interest      Average
                          Average        Income/     Yield or       Average        Income/     Yield or       Average        Income/     Yield or
                          Balance        Expense       Rates        Balance        Expense       Rates        Balance        Expense       Rates
Assets
Investment securities  $   220,383     $   5,436        2.47 %   $   257,987         5,839        2.26 %   $   134,370         4,961        3.69 %
Interest bearing
balances due from
other banks                 92,748           245        0.26 %        83,735           208        0.25 %       211,952           533        0.25 %
Federal funds sold              22             -           - %            23             -           - %         2,261             2        0.09 %
Federal Home Loan Bank
stock                       10,130             -           - %        10,441             -           - %        10,472             -           - %
Loans (1)(2)(3)            914,493        45,304        4.95 %       862,057     $  48,832        5.66 %     1,080,120     $  61,604        5.70 %
Total earning
assets/interest income   1,237,776        50,985        4.12 %     1,214,243        54,879        4.52 %     1,439,175        67,100        4.66 %
Reserve for loan
losses                     (23,782 )                                 (39,691 )                                 (38,768 )
Cash and due from
banks                       30,972                                    30,142                                    32,280
Premises and
equipment, net              34,067                                    33,906                                    34,610
Bank-owned life
insurance                   36,115                                    35,166                                    34,021
Accrued interest and
other assets                41,489                                    24,585                                    51,617
Total assets           $ 1,356,637                               $ 1,298,351                               $ 1,552,935

Liabilities and
Stockholders' Equity
Interest bearing
demand deposits        $   536,129           732        0.14 %   $   501,141         1,051        0.21 %   $   482,526         2,100        0.44 %
Savings deposits            45,457            22        0.05 %        36,910            23        0.06 %        33,445            55        0.16 %
Time deposits              136,600         1,045        0.77 %       144,485         2,017        1.40 %       268,592         5,559        2.07 %
Other borrowings            37,441           970        2.59 %        60,000         1,908        3.18 %       156,963         3,990        2.54 %
Total interest bearing
liabilities/interest
expense                    755,627         2,769        0.37 %       742,536         4,999        0.67 %       941,526        11,704        1.24 %
Demand deposits            412,396                                   394,382                                   399,251
Other liabilities           22,324                                    24,260                                    27,919
Total liabilities        1,190,347                                 1,161,178                                 1,368,696
Stockholders' equity       166,290                                   137,173                                   184,239
Total liabilities and
stockholders' equity   $ 1,356,637                               $ 1,298,351                               $ 1,552,935

Net interest income                    $  48,216                                 $  49,880                                 $  55,396

Net interest spread                                     3.75 %                                    3.85 %                                    3.42 %

Net interest income to
earning assets                                          3.90 %                                    4.11 %                                    3.85 %

(1) Average non-accrual loans included in the computation of average loans was $15.8 million for 2013, $11.1 million for 2012, and $48.4 million for 2011.


(2) Loan related fees, including prepayment penalties, recognized during the period and included in the yield calculation totaled $1.6 million in 2013, $0.5 million in 2012, and $2.0 million in 2011.
(3) Include loans held for sale. Changes in Interest Income and Expense
The following table shows the dollar amount of the increase (decrease) in the Company's consolidated interest income and expense, and attributes such variance to "volume" or "rate" changes. The changes in net interest income due to changes in both average volume and average interest rate have been allocated to the average volume change or the average interest rate change in proportion to the absolute amounts of the change in each.

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