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UNITED
STATES
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SECURITIES
AND EXCHANGE COMMISSION
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Washington,
D.C. 20549
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FORM
10-K
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ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES
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EXCHANGE
ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2010
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OR
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TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES
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EXCHANGE
ACT OF 1934 FOR THE TRANSITION PERIOD FROM
________to________
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Commission
File Number 0-26584
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BANNER
CORPORATION
(Exact
name of registrant as specified in its
charter)
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Washington
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91-1691604
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(State
or other jurisdiction of incorporation
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(I.R.S. Employer
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or
organization)
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Identification Number)
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10
South First Avenue, Walla Walla,
Washington 99362
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(Address
of principal executive offices and zip code)
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Registrant’s
telephone number, including area code: (509)
527-3636
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Securities
registered pursuant to Section 12(b) of the Act:
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Common
Stock, par value $.01 per share
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The
NASDAQ Stock Market LLC
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(Title
of Each Class)
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(Name
of Each Exchange on Which Registered)
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Securities
registered pursuant to section 12(g) of the Act:
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None.
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Indicate
by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities
Act
Yes
No
X
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Indicate
by check mark if the registrant is not required to file reports pursuant
to Section 13 or Section 15(d) of the Act
Yes
No
X
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Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X
No _______
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Indicate
by check mark whether the registrant has submitted electronically and
posted on its corporate Web site, if any, every Interactive Data File
required to be submitted and posted pursuant to Rule 405 of Regulation S-T
(§232.405 of this chapter) during the preceding 12 months (or for
such shorter period that the registrant was required to submit and post
such files) Yes ____
No ____
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Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulations S-K is not contained herein, and will not be contained, to the
best of registrant’s knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K.
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Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting
company. See definition of “large accelerated filer,”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act:
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Large
accelerated filer __________
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Accelerated
filer
X
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Non-accelerated
filer __________
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Smaller
reporting company
__________
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Indicate
by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act)
Yes
No
X
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The
aggregate market value of the voting and nonvoting common equity held by
nonaffiliates of the registrant based on the closing sales price of the
registrant’s common stock quoted on The NASDAQ Stock Market on June 30,
2010, was:
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Common
Stock - $198,208,268
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(The
exclusion from such amount of the market value of the shares owned by any
person shall not be deemed an admission by the Registrant that such person
is an affiliate of the Registrant.)
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The
number of shares outstanding of the registrant’s classes of common stock
as of February 28, 2011:
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Common
Stock, $.01 par value – 114,424,156 shares
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Documents
Incorporated by Reference
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Portions
of Proxy Statement for Annual Meeting of Shareholders to be held April 26,
2011 are incorporated by reference into Part III.
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Table
of Contents
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Page
Number
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Business
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4
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40
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Year
ended December 31, 2010 and 2009
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59
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Year
ended December 31, 2009 and 2008
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68
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71
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82
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Forward-Looking
Statements
Certain
matters in this Form 10-K constitute forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of
1995. These statements relate to our financial condition, results of
operations, plans, objectives, future performance or
business. Forward-looking statements are not statements of historical
fact, are based on certain assumptions and are generally identified by use of
the words “believes,” “expects,” “anticipates,” “estimates,” “forecasts,”
“intends,” “plans,” “targets,” “potentially,” “probably,” “projects,” “outlook”
or similar expressions or future or conditional verbs such as “may,” “will,”
“should,” “would” and “could.” Forward-looking statements include
statements with respect to our beliefs, plans, objectives, goals, expectations,
assumptions and statements about future economic performance and projections of
financial items. These forward-looking statements are subject to
known and unknown risks, uncertainties and other factors that could cause actual
results to differ materially from the results anticipated or implied by our
forward-looking statements, including, but not limited to: the credit risks of
lending activities, including changes in the level and trend of loan
delinquencies and write-offs and changes in our
allowance for loan losses and provision for loan losses that may be impacted by
deterioration in the housing and commercial real estate markets and may lead to
increased losses and nonperforming assets in our loan portfolio, and may result
in our allowance for loan losses not being adequate to cover actual losses and
require us to materially increase our reserves; changes in general economic
conditions, either nationally or in our market areas; changes in the levels of
general interest rates and the relative differences between short and long-term
interest rates, deposit interest rates, our net interest margin and funding
sources; fluctuations in the demand for loans, the number of unsold homes, land
and other properties and fluctuations in real estate values in our market areas;
secondary market conditions for loans and our ability to sell loans in the
secondary market; results of examinations of us by the Board of Governors of the
Federal Reserve System (the Federal Reserve Board) and of our bank subsidiaries
by the Federal Deposit Insurance Corporation (the FDIC), the Washington State
Department of Financial Institutions, Division of Banks (the Washington DFI) or
other regulatory authorities, including the possibility that any such regulatory
authority may, among other things, institute a formal or informal enforcement
action against us or any of the Banks which could require us to increase our
reserve for loan losses, write-down assets, change our regulatory capital
position or affect our ability to borrow funds, or maintain or increase
deposits, or impose additional requirements and restrictions on us, any of which
could adversely affect our liquidity and earnings; our compliance with
regulatory enforcement actions; the requirements and restrictions that have been
imposed upon Banner and Banner Bank under the memoranda of understanding with
the Federal Reserve Bank of San Francisco (in the case of Banner) and the FDIC
and the Washington DFI (in the case of Banner Bank) and the possibility that
Banner and Banner Bank will be unable to fully comply with the memoranda of
understanding, which could result in the imposition of additional requirements
or restrictions; legislative or regulatory changes that adversely affect our
business including changes in regulatory policies and principles, or the
interpretation of regulatory capital or other rules; the impact of the
Dodd-Frank Wall Street Reform and Consumer Protection Act and the implementing
regulations; our ability to attract and retain deposits; further increases in
premiums for deposit insurance; our ability to control operating costs and
expenses; the use of estimates in determining fair value of certain of our
assets, which estimates may prove to be incorrect and result in significant
declines in valuation; difficulties in reducing risk associated with the loans
on our balance sheet; staffing fluctuations in response to product demand or the
implementation of corporate strategies that affect our work force and potential
associated charges; the failure or security breach of computer systems on which
we depend; our ability to retain key members of our senior management team;
costs and effects of litigation, including settlements and judgments; our
ability to implement our business strategies; our ability to successfully
integrate any assets, liabilities, customers, systems, and management personnel
we may acquire into our operations and our ability to realize related revenue
synergies and cost savings within expected time frames and any goodwill charges
related thereto; our ability to manage loan delinquency rates; increased
competitive pressures among financial services companies; changes in consumer
spending, borrowing and savings habits; the availability of resources to address
changes in laws, rules, or regulations or to respond to regulatory actions; our
ability to pay dividends on our common and preferred stock and interest or
principal payments on our junior subordinated debentures; adverse changes in the
securities markets; inability of key third-party providers to perform their
obligations to us; changes in accounting policies and practices, as may be
adopted by the financial institution regulatory agencies or the Financial
Accounting Standards Board including additional guidance and interpretation on
accounting issues and details of the implementation of new accounting methods;
the economic impact of war or any terrorist activities; other economic,
competitive, governmental, regulatory, and technological factors affecting our
operations, pricing, products and services; future legislative changes in the
United States Department of Treasury (Treasury) Troubled Asset Relief Program
(TARP) Capital Purchase Program; and other risks detailed from time to time in
our filings with the Securities and Exchange Commission. Any
forward-looking statements are based upon management’s beliefs and assumptions
at the time they are made. We do not undertake and specifically
disclaim any obligation to update any forward-looking statements included in
this report or to update the reasons why actual results could differ from those
contained in such statements whether as a result of new information, future
events or otherwise. These risks could cause our actual results to
differ materially from those expressed in any forward-looking statements by, or
on behalf of, us. In light of these risks, uncertainties and
assumptions, the forward-looking statements discussed in this report might not
occur, and you should not put undue reliance on any forward-looking
statements.
As used
throughout this report, the terms “we,” “our,” “us,” or the “Company” refer to
Banner Corporation and its consolidated subsidiaries, unless the context
otherwise requires.
3
Banner
Corporation is a bank holding company incorporated in the State of Washington.
We are primarily engaged in the business of planning, directing and coordinating
the business activities of our wholly-owned subsidiaries, Banner Bank and
Islanders Bank. Banner Bank is a Washington-chartered commercial bank
that conducts business from its main office in Walla Walla, Washington and, as
of December 31, 2010, its 86 branch offices and seven loan production offices
located in Washington, Oregon and Idaho. Islanders Bank is also a
Washington-chartered commercial bank that conducts business from three locations
in San Juan County, Washington. Banner Corporation is subject to
regulation by the Board of Governors of the Federal Reserve System (the Federal
Reserve Board). Banner Bank and Islanders Bank (the Banks) are
subject to regulation by the Washington State Department of Financial
Institutions, Division of Banks and the Federal Deposit Insurance Corporation
(the FDIC). As of December 31, 2010, we had total consolidated assets
of $4.4 billion, net loans of $3.3 billion, total deposits of $3.6 billion and
total stockholders’ equity of $511 million.
Banner
Bank is a regional bank which offers a wide variety of commercial banking
services and financial products to individuals, businesses and public sector
entities in its primary market areas. Islanders Bank is a community
bank which offers similar banking services to individuals, businesses and public
entities located in the San Juan Islands. Our primary business is
that of traditional banking institutions, accepting deposits and originating
loans in locations surrounding our offices in portions of Washington, Oregon and
Idaho. Banner Bank is also an active participant in the secondary
market, engaging in mortgage banking operations largely through the origination
and sale of one- to four-family residential loans. Lending activities
include commercial business and commercial real estate loans, agriculture
business loans, construction and land development loans, one- to four-family
residential loans and consumer loans. A portion of Banner Bank’s
construction and mortgage lending activities are conducted through its
subsidiary, Community Financial Corporation (CFC), which is located in the Lake
Oswego area of Portland, Oregon. Our common stock is traded on the
NASDAQ Global Select Market under the ticker symbol “BANR.” As
discussed more thoroughly below and in later sections of this report, increased
loan delinquencies and defaults, particularly in the residential construction
and land development portions of our loan portfolio, have materially adversely
affected our results of operations for the past three years. While it is
difficult to predict when and how general economic conditions and the weak
housing markets that caused this increase in delinquencies and defaults will
improve, we anticipate that an elevated level of non-performing assets will
persist for a number of quarters and will have a continuing adverse effect on
our earnings during 2011. However, our goal is to move Banner
Corporation to a moderate risk profile and to maintain that profile moving
forward.
Over the
past several years, we have invested significantly in expanding our branch and
distribution systems with a primary emphasis on strengthening our market
presence in our five primary markets in the Northwest. Those markets
include the four largest metropolitan areas in the Northwest: the Puget Sound
region of Washington and the greater Boise, Idaho, Portland, Oregon, and
Spokane, Washington markets, as well as our historical base in the vibrant
agricultural communities in the Columbia Basin region of Washington and
Oregon. Our aggressive franchise expansion included the addition of
18 branches through acquisition, opening 27 new branches and relocating nine
others during the last six years. In 2007, we completed the
acquisitions of three smaller commercial banks in the State of
Washington. Over the same period, we also invested heavily in
advertising campaigns designed to significantly increase the brand awareness for
Banner Bank. These investments, which have been significant elements in our
strategies to grow loans, deposits and customer relationships, have increased
our presence within desirable marketplaces and allow us to better serve existing
and future customers. This emphasis on growth has resulted in an
elevated level of operating expenses during this period; however, we believe
that the expanded branch network and heightened brand awareness have created a
franchise that is well positioned to allow us to successfully execute on our
super community bank model as we move forward. That strategy is
focused on delivering customers, including middle market and small businesses,
business owners, their families and employees, a compelling value proposition by
providing the financial sophistication and breadth of products of a regional
bank while retaining the appeal and superior service level of a community
bank.
Weak
economic conditions and ongoing strains in the financial and housing markets
which accelerated throughout 2008 and generally continued in 2009 and 2010 have
presented an unusually challenging environment for banks and their holding
companies, including Banner Corporation. This has been particularly
evident in our need to provide for credit losses during this period at
significantly higher levels than our historical experience and has also
adversely affected our net interest income and other operating revenues and
expenses. As a result of these factors, for the year ended December
31, 2010, we had a net loss of $61.9 million which, after providing for the
preferred stock dividend and related discount accretion, resulted in a net loss
to common shareholders of $69.7 million, or ($1.03) per diluted share, compared
to a net loss to common shareholders of $43.5 million, or ($2.33) per diluted
share, for the year ended December 31, 2009. Our provision for loan
losses was $70.0 million for the year ended December 31, 2010, compared to
$109.0 million recorded in the prior year. Throughout the period 2008
through 2010, higher than historical provision for loan losses has been the most
significant factor affecting our operating results and, while we are encouraged
by the continuing reduction in our exposure to residential construction loans
and the recent slowdown in the emergence of new problem assets, looking forward
we anticipate our credit costs will remain elevated for a number of
quarters. (See Note 6 of the Notes to the Consolidated Financial
Statements, as well as “Asset Quality” below.) Although there have
been indications that economic conditions are improving, the pace of recovery
has been modest and uneven and the ongoing stress in the economy has been the
most significant challenge impacting our recent operating results. As
a result, like most financial institutions, our future operating results and
financial performance will be significantly affected by the course of recovery
from the recessionary downturn. However, improving our risk profile
and aggressively managing problem assets is a primary focus in the current
environment which we believe will lead to improved results in future
periods.
Aside
from the level of loan loss provision, our operating results depend primarily on
our net interest income, which is the difference between interest income on
interest-earning assets, consisting of loans and investment securities, and
interest expense on interest-bearing liabilities, composed primarily of customer
deposits and borrowings. Net interest income is primarily a function
of our interest rate spread, which is the difference between the yield earned on
interest-earning assets and the rate paid on interest-bearing liabilities, as
well as a function of the average balances of interest-earning assets and
interest-bearing liabilities. As more fully explained below, our net
interest income before provision for loan losses increased by $13.2 million, or
9.1%, for the year ended December 31, 2010 to $157.8 million compared to $144.6
million for the prior year, primarily as a result of an expansion of our net
interest spread and net interest margin due to a lower cost of
funds. This trend to
lower
funding costs and the resulting increase in the net interest margin was driven
by rapidly declining interest expense on deposits and represents an important
improvement in our core operating fundamentals, which should provide a solid
base to build upon as the economy recovers.
Our net
income also is affected by the level of our other operating income, including
deposit fees and service charges, loan origination and servicing fees, and gains
and losses on the sale of loans and securities, as well as our non-interest
operating expenses and income tax provisions. In addition, our net
income is affected by the net change in the value of certain financial
instruments carried at fair value. (See Note 22 of the Notes to the
Consolidated Financial Statements.) For the year ended December 31,
2010, we recorded a net gain of $1.7 million ($1.4 million after tax) in fair
value adjustments compared to a net gain of $12.5 million ($8.0 million after
tax) for the year ended December 31, 2009. Further, in 2010 we
recorded a full valuation allowance for our net deferred tax assets, which
resulted in an $18.0 million provision for income taxes for the year ended
December 31, 2010 compared to a tax benefit of $27.1 million for the year ended
December 31, 2009. That significant swing in our income tax provision
somewhat masked a meaningful reduction in our pre-tax loss, which decreased to
$43.9 million for the year ended December 31, 2010 compared to $62.8 million for
the year ended December 31, 2009.
See Item
7, “Management’s Discussion and Analysis of Financial Condition and Results of
Operations” for more detailed information about our financial performance and
critical accounting policies.
Regulatory
Actions: On March 23, 2010, Banner Bank entered into a
Memorandum of Understanding (Bank MOU) with the FDIC and Washington
DFI. Banner Corporation (the Company) also entered into a similar MOU
with the Federal Reserve Bank of San Francisco on March 29, 2010 (FRB
MOU). Under the Bank MOU, Banner Bank is required, among other
things, to develop and implement plans to reduce commercial real estate
concentrations; to improve asset quality and reduce classified assets; to
improve profitability; and to increase Tier 1 leverage capital to equal or
exceed 10% of average assets. In addition, Banner Bank is not
permitted to pay cash dividends to Banner Corporation without prior approval
from the FDIC and Washington DFI and the Company and Banner Bank must obtain
prior regulatory approval before adding any new director or senior executive
officer or changing the responsibilities of any current senior executive
officer. Further, the Company may not pay any dividends on common or
preferred stock, pay interest or principal on the balance of its junior
subordinated debentures or repurchase our common stock without the prior written
non-objection of the Federal Reserve Bank. See Item 1A, Risk Factors,
“We are required to comply with the terms of memoranda of understanding that we
have entered into with the FDIC and DFI and the Federal Reserve and lack of
compliance could result in additional regulatory actions.”
Management
Succession: On April 6, 2010, the Company announced the hiring
of Mark J. Grescovich as President of the Company and Banner Bank, succeeding D.
Michael Jones. Mr. Grescovich became a director of the Company and
the Bank on May 25, 2010 and was named Chief Executive Officer of the Company
and the Bank on August 18, 2010. Mr. Jones retired as an officer of
the Company and the Bank effective August 31, 2010 and continues to serve as a
director.
Secondary Offering of Common
Stock: On June 30, 2010, the Company announced the initial
closing of its offering of 75,000,000 shares of its common stock and the sale of
an additional 3,500,000 shares pursuant to the partial exercise of the
underwriters’ over-allotment option, at a price to the public of $2.00 per
share. On July 2, 2010, the Company further announced the completion
of this offering as the underwriters exercised their over-allotment option for
an additional 7,139,000 shares, at a price to the public of $2.00 per
share. Together with the 78,500,000 shares the Company issued on June
30, 2010 (including 3,500,000 shares issued pursuant to the underwriters’
initial exercise of their over-allotment option), the Company issued a total of
85,639,000 shares in the offering, resulting in net proceeds, after deducting
underwriting discounts and commissions and offering expenses, of approximately
$161.6 million.
Banner
intends to use a significant portion of the net proceeds from the offering to
strengthen Banner Bank’s regulatory capital ratios in accordance with the Bank
MOU and to support managed growth as economic conditions improve. To
that end, at December 31, 2010, the Company had invested a cumulative $110
million as additional paid-in common equity in Banner Bank. As a
result, the Tier 1 leverage capital of Banner Bank was 10.84% of average assets
on December 31, 2010, an increase from the 9.74% at December 31,
2009. The Company expects to use the remaining net proceeds for
general working capital purposes, including additional capital investments in
its subsidiary banks if appropriate.
Deferred Tax Asset Valuation
Allowance: The Company and its wholly-owned subsidiaries file
consolidated U.S. federal income tax returns, as well as state income tax
returns in Oregon and Idaho. Income taxes are accounted for using the
asset and liability method. Under this method a deferred tax asset or
liability is determined based on the enacted tax rates which are expected to be
in effect when the differences between the financial statement carrying amounts
and tax basis of existing assets and liabilities are expected to be reported in
the Company’s income tax returns. The effect on deferred taxes of a
change in tax rates is recognized in income in the period that includes the
enactment date. Under U.S. generally acceptable accounting principles
(GAAP), a valuation allowance is required to be recognized if it is “more likely
than not” that all or a portion of our deferred tax assets will not be
realized. While realization of the deferred tax asset is ultimately
dependent on a return to profitability, which management believes is more likely
than not, the guidance reflected in the accounting standard is significantly
influenced by consideration of recent historical operating
results. During the third quarter of 2010, we evaluated our net
deferred tax asset and determined it was prudent to establish a valuation
allowance against the entire asset. This action caused our income tax
expense to be $24.0 million for the third quarter. As a result,
despite incurring a pre-tax loss in both years, we recorded $18.0 million income
tax expense for the year ended December 31, 2010, compared to an income tax
benefit of $27.1 million for the year ended December 31, 2009. See
Note 13 of the Notes to the Consolidated Financial Statements for more
information.
FDIC
Prepayment: On November 12, 2009, the FDIC adopted a final
rule that required insured depository institutions to prepay an estimate of
their expected quarterly deposit insurance premiums for the fourth quarter of
2009 and for the three years ended December 31, 2010, 2011 and
2012. Insured institutions were required to deposit funds with the
FDIC in the amount of the prepaid assessment on December 30,
2009. The insured institutions will not receive interest on the
deposited funds. For purposes of calculating an institution’s prepaid
assessment amount, for
the
fourth quarter of 2009 and all of 2010, an institution’s assessment rate was its
total base assessment rate in effect on September 30, 2009. That rate
was then increased by three basis points for all of 2011 and
2012. Again, for purposes of calculating the prepaid amount, an
institution’s third quarter 2009 assessment base was assumed to increase
quarterly by an estimated five percent annual growth rate through the end of
2012. Each institution was directed to record the entire amount of
its prepaid assessment as a prepaid expense (asset). Thereafter, each
institution will record an expense (charge to earnings) for its regular
quarterly assessment for the quarter and an offsetting credit to the prepaid
assessment until the asset is exhausted. Once the asset is exhausted,
the institution will record an expense and an accrued expense payable each
quarter for its regular assessment, which would be paid in arrears to the FDIC
at the end of the following quarter. If the prepaid assessment is not
exhausted by June 30, 2013, any remaining amount will be returned to the
institution. For Banner Corporation, this total prepaid assessment
was $31.6 million and was paid in December 30, 2009. The balance of
this prepaid assessment was $21.6 million at December 31, 2010.
Participation in the U.S. Treasury’s
Capital Purchase Program: On November 21, 2008, we received
$124 million from the U.S. Treasury Department as part of the Treasury’s Capital
Purchase Program. We issued $124 million in senior preferred stock,
with a related warrant to purchase up to $18.6 million in common stock, to the
U.S. Treasury. The warrant provides the Treasury the option to
purchase up to 1,707,989 shares of Banner Corporation common stock at a price of
$10.89 per share at any time during the next ten years. The preferred
stock pays a 5% dividend for the first five years, after which the rate will
increase to 9% if the preferred shares are not redeemed by the
Company. The terms and conditions of the transaction and the
preferred stock conform to those provided by the U.S. Treasury. A
summary of the Capital Purchase Program can be found on the Treasury’s web site
at
www.treasury.gov/initiatives/financial-stability/investment-programs/cpp/Pages/
capitalpurchaseprogram.aspx. The additional capital enhances our
capacity to support the communities we serve through expanded lending activities
and economic development. This capital also adds flexibility in
considering strategic opportunities that may be available to us.
Goodwill
Write-Off: As a result of the significant decline in our stock
price and market capitalization over the course of 2008 and in conjunction with
similar declines in the value of most financial institutions and the ongoing
disruption in related financial markets, we decided to reduce the carrying value
of goodwill in our Consolidated Statements of Financial Condition by recording a
$50 million write-down in the second quarter and, in response to worsening
economic indicators and further price declines, an additional $71 million
write-down in the fourth quarter of 2008. The total $121 million
write-off of goodwill was a non-cash charge that did not affect the Company’s or
the Banks’ liquidity or operations. The adjustment brought our book
value and tangible book value more closely in line with each other and more
accurately reflected current market conditions. Also, since goodwill
is excluded from regulatory capital, the impairment charge (which was not
deductible for tax purposes) did not have an adverse effect on the regulatory
capital ratios of the Company or either of our subsidiary banks, each of which
continues to remain “well capitalized” under the regulatory
requirements. See Note 21 of the Notes to Consolidated Financial
Statements for additional information with respect to our valuation of
intangible assets.
General: All of our lending
activities are conducted through Banner Bank, its subsidiary, Community
Financial Corporation, and Islanders Bank. We offer a wide range of
loan products to meet the demands of our customers and our loan portfolio is
very diversified by product type, borrower and geographic location within our
market area. We originate loans for our own loan portfolio and for
sale in the secondary market. Management’s strategy has been to
maintain a well diversified portfolio with a significant percentage of assets in
the loan portfolio having more frequent interest rate repricing terms or shorter
maturities than traditional long-term fixed-rate mortgage loans. As
part of this effort, we have developed a variety of floating or adjustable
interest rate products that correlate more closely with our cost of funds,
particularly loans for commercial business and real estate, agricultural
business, and construction and development purposes. However, in
response to customer demand, we continue to originate fixed-rate loans,
including fixed interest rate mortgage loans with terms of up to 30
years. The relative amount of fixed-rate loans and adjustable-rate
loans that can be originated at any time is largely determined by the demand for
each in a competitive environment.
Historically,
our lending activities have been primarily directed toward the origination of
real estate and commercial loans. Until recent periods, real estate
lending activities were significantly focused on residential construction and
land development loans and first mortgages on owner-occupied, one- to
four-family residential properties; however, over the past three years our
origination of construction and land development loans has declined
substantially and the proportion of the portfolio invested in these types of
loans has declined materially. Our residential mortgage loan
originations also decreased during this cycle, although less significantly than
the decline in construction and land development lending as exceptionally low
interest rates supported demand for loans to refinance existing debt as well as
loans to finance home purchases. Despite modest demand, our
residential mortgage loan portfolio has increased in amount and as a proportion
of our total loan portfolio during this cycle, although residential mortgage
loan balances were slightly lower at December 31, 2010 than a year
earlier. Our real estate lending activities have also included the
origination of multifamily and commercial real estate loans. Our
commercial business lending has been directed toward meeting the credit and
related deposit needs of various small- to medium-sized business and
agri-business borrowers operating in our primary market
areas. Reflecting the weak economy, in recent periods demand for
these types of commercial business loans has been modest and total outstanding
balances have declined. Our consumer loan activity is primarily
directed at meeting demand from our existing deposit customers and, while we
have increased our emphasis on consumer lending in recent years, demand for
consumer loans also has been modest during this period of economic weakness as
many consumers have been focused on reducing their personal
debt. While continuing our commitment to residential lending,
including our mortgage banking activities, we expect commercial lending
(including owner-occupied commercial real estate, commercial business and
agricultural loans) and consumer lending to become increasingly more important
activities for us. By contrast, we anticipate residential
construction and related land development lending, which at December 31, 2010
represented 9% of the loan portfolio, compared to 14% a year earlier and more
than 30% at its peak during the second quarter of 2007, will continue to be
restrained by market conditions for the foreseeable future, as well as by our
efforts to manage our concentration in this type of lending. We also
expect non-owner-occupied investor commercial real estate lending, for both
construction and longer-term financing, will be modest in the near term as we
manage our concentration in these types of loans.
At
December 31, 2010, our net loan portfolio totaled $3.3 billion. For
additional information concerning our loan portfolio, see Item 7, “Management’s
Discussion and Analysis of Financial Condition—Comparison of Financial Condition
at December 31, 2010 and 2009—Loans
and
Lending.” See also Tables 7 and 8 contained therein, which sets forth
the composition and geographic concentration of our loan portfolio, and Tables 9
and 10, which contain information regarding the loans maturing in our
portfolio.
One- to Four-Family Residential Real
Estate Lending: At both Banner Bank and Islanders Bank, we
originate loans secured by first mortgages on one- to four-family residences in
the Northwest communities where we have offices. Banner Bank’s
mortgage lending subsidiary, CFC, provides residential lending primarily in the
greater Portland, Oregon and Pasco (Tri Cities), Washington market
areas. While we offer a wide range of products, we have not engaged
in any sub-prime lending programs, which we define as loans to borrowers with
poor credit histories or undocumented repayment capabilities and with excessive
reliance on the collateral as the source of repayment. However, we
have experienced a modest increase in delinquencies on our residential loans in
response to the weakened housing market conditions. At December 31,
2010, $683 million, or 20% of our loan portfolio, consisted of permanent loans
on one- to four-family residences.
We offer
fixed- and adjustable-rate mortgages (ARMs) at rates and terms competitive with
market conditions, primarily with the intent of selling these loans into the
secondary market. Fixed-rate loans generally are offered on a fully
amortizing basis for terms ranging from 15 to 30 years at interest rates and
fees that reflect current secondary market pricing. Most ARM products
offered adjust annually after an initial period ranging from one to five years,
subject to a limitation on the annual change of 1.0% to 2.0% and a lifetime
limitation of 5.0% to 6.0%. For a small portion of the portfolio,
where the initial period exceeds one year, the first rate change may exceed the
annual limitation on subsequent rate changes. Our ARM products most
frequently adjust based upon the average yield on U.S. Treasury securities
adjusted to a constant maturity of one year or certain LIBOR indices plus a
margin or spread above the index. ARM loans held in our portfolio may
allow for interest-only payments for an initial period up to five years but do
not provide for negative amortization of principal and carry no prepayment
restrictions. The retention of ARM loans in our loan portfolio can
help reduce our exposure to changes in interest rates. However,
borrower demand for ARM loans versus fixed-rate mortgage loans is a function of
the level of interest rates, the expectations of changes in the level of
interest rates and the difference between the initial interest rates and fees
charged for each type of loan. In recent years, borrower demand for
ARM loans has been limited and we have chosen not to aggressively pursue ARM
loans by offering minimally profitable, deeply discounted teaser rates or
option-payment ARM products. As a result, ARM loans have represented
only a small portion of our loans originated during this period and of our
portfolio.
Our
residential loans are generally underwritten and documented in accordance with
the guidelines established by the Federal Home Loan Mortgage Corporation
(Freddie Mac or FHLMC) and the Federal National Mortgage Association (Fannie Mae
or FNMA). Government insured loans are underwritten and documented in
accordance with the guidelines established by the Department of Housing and
Urban Development (HUD) and the Veterans Administration (VA). In the
loan approval process, we assess the borrower’s ability to repay the loan, the
adequacy of the proposed security, the employment stability of the borrower and
the creditworthiness of the borrower. For ARM loans, our standard
practice provides for underwriting based upon fully indexed interest rates and
payments. Generally, we will lend up to 95% of the lesser of the
appraised value of the property or purchase price of the property on
conventional loans, although higher loan-to-value ratios are available on
certain government insured programs. We require private mortgage
insurance on conventional residential loans with a loan-to-value ratio at
origination exceeding 80%. For the past three years, a meaningful
number of exceptions to these general underwriting guidelines have been granted
in connection with the sale or refinance of properties, particularly new
construction, for which we were already providing financing. These
exceptions most commonly relate to loan-to-value and mortgage insurance
requirements and not to credit underwriting or loan documentation
standards. Such exceptions will likely continue in the near term to
facilitate troubled loan resolution in the current distressed housing market,
and may result in loans having performance characteristics different from the
rest of our one- to four-family loan portfolio.
Through
our mortgage banking activities, we sell residential loans on either a
servicing-retained or servicing-released basis. The decision to hold
or sell loans is based on asset/liability management goals and policies and
market conditions. During the past three years, we have sold a
significant portion of our conventional residential mortgage originations and
nearly all of our government insured loans in the secondary market.
Construction and Land
Lending: Historically, we have invested a significant portion
of our loan portfolio in residential construction and land loans to professional
home builders and developers; however, the amount of this investment has been
substantially reduced in recent years. To a lesser extent, we also
originate construction loans for commercial and multifamily real
estate. In years prior to 2008, residential construction and land
development lending was an area of major emphasis at Banner Bank and the primary
focus of its subsidiary, CFC. Our largest concentrations of
construction and land development loans are in the greater Puget Sound region of
Washington State and the Portland, Oregon market area. We also have
construction and land loans for properties to a much smaller extent in the
greater Boise area and certain eastern Washington and eastern Oregon
markets. At December 31, 2010, construction and land loans totaled
$444 million, or 13% of total loans of the Company, consisting of $154 million
of one- to four-family construction loans, $168 million of residential land or
land development loans, $90 million of commercial and multifamily real estate
construction loans and $32 million of commercial land or land development
loans.
Prior to
2008, construction and land lending afforded us the opportunity to achieve
higher interest rates and fees with shorter terms to maturity than were usually
available on other types of lending. Construction and land lending,
however, involves a higher degree of risk than other lending opportunities
because of the inherent difficulty in estimating both a property’s value at
completion of the project and the estimated cost of the project. If
the estimate of construction cost proves to be inaccurate, we may be required to
advance funds beyond the amount originally committed to permit completion of the
project. If the estimate of value upon completion proves to be
inaccurate, we may be confronted at, or prior to, the maturity of the loan with
a project the value of which is insufficient to assure full
repayment. Disagreements between borrowers and builders and the
failure of builders to pay subcontractors may also jeopardize
projects. Loans to builders to construct homes for which no purchaser
has been identified carry additional risk because the payoff for the loan is
dependent on the builder’s ability to sell the property before the construction
loan is due. We attempt to address these risks by adhering to strict
underwriting policies, disbursement procedures and monitoring
practices.
Construction
loans made by us include those with a sale contract or permanent loan in place
for the finished homes and those for which purchasers for the finished homes may
be identified either during or following the construction period. We
actively monitor the number of unsold homes in our construction loan portfolio
and local housing markets to attempt to maintain an appropriate balance between
home sales and new loan originations. The maximum number of
speculative loans approved for each builder is based on a combination of
factors, including
the
financial capacity of the builder, the market demand for the finished product
and the ratio of sold to unsold inventory the builder maintains. We
have attempted to diversify the risk associated with speculative construction
lending by doing business with a large number of small and mid-sized builders
spread over a relatively large geographic region with numerous sub-markets
within our three-state service area.
Loans for
the construction of one- to four-family residences are generally made for a term
of twelve to eighteen months. Our loan policies include maximum
loan-to-value ratios of up to 80% for speculative loans (loans that are not
presold). Individual speculative loan requests are supported by an
independent appraisal of the property, a set of plans, a cost breakdown and a
completed specifications form. Underwriting is focused on the
borrowers’ financial strength, credit history and demonstrated ability to
produce a quality product and effectively market and manage their
operations. All speculative construction loans must be approved by
senior loan officers.
Historically,
we have also made land loans to developers, builders and individuals to finance
the acquisition and/or development of improved lots or unimproved land, although
over the past three years we generally have not originated this type of
loan. In making land loans, we follow underwriting policies and
disbursement and monitoring procedures similar to those for construction
loans. The initial term on land loans is typically one to three years
with interest only payments, payable monthly, and provisions for principal
reduction as lots are sold and released from the lien of the
mortgage.
We
regularly monitor the construction and land loan portfolios and the economic
conditions and housing inventory in each of our markets and decrease this type
of lending if we perceive unfavorable market conditions such as the existing
economic environment. Housing markets in most areas of the Pacific
Northwest have significantly deteriorated over the past three years
and our origination of new construction loans has declined sharply as a
result. We believe that the underwriting policies and internal
monitoring systems we have in place have helped to mitigate some of the risks
inherent in construction and land lending; however, current weak housing market
conditions have nonetheless resulted in a material increase of delinquencies and
charge-offs in our construction and land loan
portfolios. Construction and land loans, including residential,
commercial and multifamily, represent 13% of our portfolio and are responsible
for approximately 50% of our non-performing loans. Although well
diversified with respect to sub-markets, price ranges and borrowers, our
construction and land loans are significantly concentrated in the greater Puget
Sound region of Washington State and the Portland, Oregon market
area. Reducing the amount of non-performing construction and land
development loans and related real estate acquired through foreclosure is
currently the most critical issue that we face and need to resolve to return to
acceptable levels of profitability. The most significant risk in this
portfolio relates to the land development loans as demand for building lots is
currently weak. (See “Asset Quality” below and Item 7, “Management’s
Discussion and Analysis of Financial Condition and Results of Operations—Asset
Quality.”)
Commercial and Multifamily Real
Estate Lending: We originate loans secured by multifamily and
commercial real estate including, as noted above, loans for construction of
multifamily and commercial real estate projects. Commercial real
estate loans are made for both owner-occupied and investor
properties. At December 31, 2010, our loan portfolio included $135
million in multifamily and $1.066 billion in commercial real estate loans,
including $515 million in owner-occupied commercial real estate loans and $551
million in non-owner-occupied commercial real estate loans, which in aggregate
comprised 31% of our total loans. Multifamily and commercial real
estate lending affords us an opportunity to receive interest at rates higher
than those generally available from one- to four-family residential
lending. However, loans secured by multifamily and commercial
properties are generally greater in amount, more difficult to evaluate and
monitor and, therefore, potentially riskier than one- to four-family residential
mortgage loans. Because payments on loans secured by multifamily and
commercial properties are often dependent on the successful operation and
management of the properties, repayment of these loans may be affected by
adverse conditions in the real estate market or the economy. In
originating multifamily and commercial real estate loans, we consider the
location, marketability and overall attractiveness of the
properties. Our current underwriting guidelines for multifamily and
commercial real estate loans require an appraisal from a qualified independent
appraiser and an economic analysis of each property with regard to the annual
revenue and expenses, debt service coverage and fair value to determine the
maximum loan amount. In the approval process we assess the borrowers’
willingness and ability to manage the property and repay the loan and the
adequacy of the collateral in relation to the loan amount.
Multifamily
and commercial real estate loans originated by us are both fixed- and
adjustable-rate loans generally with intermediate terms of five to ten
years. Most multifamily and commercial real estate loans originated
in the past five years are linked to various U.S. Treasury indices, Federal Home
Loan Bank advance rates, certain prime rates or other market rate
indices. Rates on these adjustable-rate loans generally adjust with a
frequency of one to five years after an initial fixed-rate period ranging from
one to ten years. Our commercial real estate portfolio consists of
loans on a variety of property types with no large concentrations by property
type, location or borrower. At December 31, 2010, the average size of
our commercial real estate loans was $629,000 and the largest commercial real
estate loan in our portfolio was approximately $16 million.
Commercial Business
Lending: We are active in small- to medium-sized business
lending and are engaged to a lesser extent in agricultural lending primarily by
providing crop production loans. Our officers devote a great deal of
effort to developing customer relationships and the ability to serve these types
of borrowers. While also strengthening our commitment to small
business lending, in recent years we have added experienced officers and staff
focused on corporate lending opportunities for borrowers with credit needs
generally in a $3 million to $15 million range. In addition to
providing earning assets, this type of lending has helped us increase our
deposit base. Expanding commercial lending and related commercial
banking services is currently an area of significant focus, including recent
reorganization and additions to staffing in the areas of credit administration,
business development, and loan and deposit operations.
Commercial
business loans may entail greater risk than other types of
loans. Commercial business loans may be unsecured or secured by
special purpose or rapidly depreciating assets, such as equipment, inventory and
receivables, which may not provide an adequate source of repayment on defaulted
loans. In addition, commercial business loans are dependent on the
borrower’s continuing financial strength and management ability, as well as
market conditions for various products, services and commodities. For
these reasons, commercial business loans generally provide higher yields or
related revenue opportunities than many other types of loans but also require
more administrative and management attention. Loan terms, including
the fixed or adjustable interest rate, the loan maturity and the collateral
considerations, vary significantly and are negotiated on an individual loan
basis.
We
underwrite our commercial business loans on the basis of the borrower’s cash
flow and ability to service the debt from earnings rather than on the basis of
the underlying collateral value. We seek to structure these loans so
that they have more than one source of repayment. The borrower is
required to provide us with sufficient information to allow us to make a prudent
lending determination. In most instances, this information consists
of at least three years of financial statements, tax returns, a statement of
projected cash flows, current financial information on any guarantor and
information about the collateral. Loans to closely held businesses
typically require personal guarantees by the principals. Our
commercial loan portfolio is geographically dispersed across the market areas
serviced by our branch network and there are no significant concentrations by
industry or products.
Our
commercial business loans may be structured as term loans or as lines of
credit. Commercial business term loans are generally made to finance
the purchase of fixed assets and have maturities of five years or
less. Commercial business lines of credit are typically made for the
purpose of providing working capital and are usually approved with a term of one
year. Adjustable- or floating-rate loans are primarily tied to
various prime rate or LIBOR indices. At December 31, 2010, commercial
business loans totaled $585 million, or 17% of our total loans.
Agricultural
Lending: Agriculture is a major industry in many parts of our
service areas. While agricultural loans are not a large part of our
portfolio, we intend to continue to make agricultural loans to borrowers with a
strong capital base, sufficient management depth, proven ability to operate
through agricultural cycles, reliable cash flows and adequate financial
reporting. Payments on agricultural loans depend, to a large degree,
on the results of operations of the related farm entity. The
repayment is also subject to other economic and weather conditions as well as
market prices for agricultural products, which can be highly
volatile. At December 31, 2010, agricultural business loans,
including collateral secured loans to purchase farm land and equipment, totaled
$205 million, or 6% of our loan portfolio; however, the seasonal peak in
agricultural loans is usually closer to 8% of our total loans.
Agricultural
operating loans generally are made as a percentage of the borrower’s anticipated
income to support budgeted operating expenses. These loans are
secured by a blanket lien on all crops, livestock, equipment, accounts and
products and proceeds thereof. In the case of crops, consideration is
given to projected yields and prices from each commodity. The
interest rate is normally floating based on the prime rate or a LIBOR index plus
a negotiated margin. Because these loans are made to finance a farm
or ranch’s annual operations, they are usually written on a one-year review and
renewable basis. The renewal is dependent upon the prior year’s
performance and the forthcoming year’s projections as well as the overall
financial strength of the borrower. We carefully monitor these loans
and related variance reports on income and expenses compared to budget
estimates. To meet the seasonal operating needs of a farm, borrowers
may qualify for single payment notes, revolving lines of credit and/or
non-revolving lines of credit.
In
underwriting agricultural operating loans, we consider the cash flow of the
borrower based upon the expected operating results as well as the value of
collateral used to secure the loans. Collateral generally consists of
cash crops produced by the farm, such as milk, grains, fruit, grass seed, peas,
sugar beets, mint, onions, potatoes, corn and alfalfa or
livestock. In addition to considering cash flow and obtaining a
blanket security interest in the farm’s cash crop, we may also collateralize an
operating loan with the farm’s operating equipment, breeding stock, real estate
and federal agricultural program payments to the borrower.
We also
originate loans to finance the purchase of farm equipment. Loans to
purchase farm equipment are made for terms of up to seven years. On
occasion, we also originate agricultural real estate loans secured primarily by
first liens on farmland and improvements thereon located in our market areas,
although generally only to service the needs of our existing
customers. Loans are written in amounts ranging from 50% to 75% of
the tax assessed or appraised value of the property for terms of five to 20
years. These loans generally have interest rates that adjust at least
every five years based upon a U.S. Treasury index or Federal Home Loan Bank
advance rate plus a negotiated margin. Fixed-rate loans are granted
on terms usually not to exceed five years. In originating
agricultural real estate loans, we consider the debt service coverage of the
borrower’s cash flow, the appraised value of the underlying property, the
experience and knowledge of the borrower, and the borrower’s past performance
with us and/or the market area. These loans normally are not made to
start-up businesses and are reserved for existing customers with substantial
equity and a proven history.
Among the
more common risks to agricultural lending can be weather conditions and
disease. These risks may be mitigated through multi-peril crop
insurance. Commodity prices also present a risk, which may be reduced
by the use of set price contracts. Normally, required beginning and
projected operating margins provide for reasonable reserves to offset unexpected
yield and price deficiencies. In addition to these risks, we also
consider management succession, life insurance and business continuation plans
when evaluating agricultural loans.
Consumer and Other
Lending: We originate a variety of consumer loans, including
home equity lines of credit, automobile loans and loans secured by deposit
accounts. While consumer lending has traditionally been a small part
of our business, with loans made primarily to accommodate our existing customer
base, it has received consistent emphasis in recent years. Part of
this emphasis has been the reintroduction of a Banner Bank-funded credit card
program which we began marketing in the fourth quarter of
2005. Similar to other consumer loan programs, we focus this credit
card program on our existing customer base to add to the depth of our customer
relationships. Our underwriting of consumer loans is focused on the
borrower’s credit history and ability to repay the debt as evidenced by
documented sources of income. At December 31, 2010, we had $286
million, or 8% of our loans receivable, in consumer related loans.
Similar
to commercial loans, consumer loans often entail greater risk than residential
mortgage loans, particularly in the case of consumer loans which are unsecured
or secured by rapidly depreciating assets such as automobiles. In
such cases, any repossessed collateral for a defaulted consumer loan may not
provide an adequate source of repayment of the outstanding loan balance as a
result of the greater likelihood of damage, loss or depreciation. The
remaining deficiency often does not warrant further substantial collection
efforts against the borrower. In addition, consumer loan collections
are dependent on the borrower’s continuing financial stability, and thus are
more likely to be adversely affected by job loss, divorce, illness or personal
bankruptcy. Furthermore, the application of various federal and state
laws, including federal and state bankruptcy and insolvency laws, may limit the
amount which can be recovered on such loans. These loans may also
give rise to claims and defenses by a consumer loan borrower against an assignee
of such loans such as us, and a borrower may be able to assert against the
assignee claims and defenses that it has against the seller of the underlying
collateral.
Loan Solicitation and
Processing: We originate real estate loans in our market areas
by direct solicitation of real estate brokers, builders, depositors, walk-in
customers and visitors to our Internet website. Loan applications are
taken by our loan officers or through our Internet website and are processed in
branch or regional locations. Most underwriting and loan
administration functions for our real estate loans are performed by loan
personnel at central locations. We do not make loans originated by
independent third-party loan brokers or any similar wholesale loan origination
channels.
Our
commercial loan officers solicit commercial and agricultural business loans
through call programs focused on local businesses and farmers. While
commercial loan officers are delegated reasonable commitment authority based
upon their qualifications, credit decisions on significant commercial and
agricultural loans are made by senior loan officers or in certain instances by
the Board of Directors of Banner Bank and Islanders Bank.
We
originate consumer loans through various marketing efforts directed primarily
toward our existing deposit and loan customers. Consumer loan
applications are primarily underwritten and documented by centralized
administrative personnel.
Loan
Originations, Sales and Purchases
While we
originate a variety of loans, our ability to originate each type of loan is
dependent upon the relative customer demand and competition in each market we
serve. For the years ended December 31, 2010, 2009 and 2008, we
originated loans, net of repayments, of $114 million, $582 million and $562
million, respectively. The decreased level of originations, net of
repayments, during 2010 was significantly impacted by reduced demand from
creditworthy borrowers due to weak economic conditions, a substantial amount of
loan repayments, and continued charge-offs and transfers to REO.
We sell
many of our newly originated one- to four-family residential mortgage loans to
secondary market purchasers as part of our interest rate risk management
strategy. Proceeds from sales of loans for the years ended December
31, 2010, 2009 and 2008, totaled $351 million, $563 million and $366 million,
respectively. Sales of loans generally are beneficial to us because
these sales may generate income at the time of sale, provide funds for
additional lending and other investments, increase liquidity or reduce interest
rate risk. We sell loans on both a servicing-retained and a
servicing-released basis. All loans are sold without
recourse. See “Loan
Servicing.” At December 31, 2010, we had $3 million in loans
held for sale.
We
periodically purchase whole loans and loan participation interests primarily
during periods of reduced loan demand in our primary market area and at times to
support our Community Reinvestment Act lending activities. Any such
purchases are made generally consistent with our underwriting standards;
however, the loans may be located outside of our normal lending
area. During the years ended December 31, 2010 and 2009, we purchased
$341,000 and $1 million, respectively, of loans and loan participation
interests.
Loan
Servicing
We
receive fees from a variety of institutional owners in return for performing the
traditional services of collecting individual payments and managing portfolios
of sold loans. At December 31, 2010, we were servicing $705 million
of loans for others. Loan servicing includes processing payments,
accounting for loan funds and collecting and paying real estate taxes, hazard
insurance and other loan-related items such as private mortgage
insurance. In addition to earning fee income, we retain certain
amounts in escrow for the benefit of the lender for which we incur no interest
expense but are able to invest the funds into earning assets. At
December 31, 2010, we held $5.6 million in escrow for our portfolio of loans
serviced for others. The loan servicing portfolio at December 31,
2010 was composed of $445 million of Freddie Mac residential mortgage loans,
$102 million of Fannie Mae residential mortgage loans and $158 million of both
residential and non-residential mortgage loans serviced for a variety of private
investors. The portfolio included loans secured by property located
primarily in the states of Washington and Oregon. For the year ended
December 31, 2010, we recognized $951,000 of loan servicing fees, which was net
of $2.0 million of servicing rights amortization, in our results of
operations.
Mortgage Servicing
Rights: We record mortgage servicing rights (MSRs) with
respect to loans we originate and sell in the secondary market on a
servicing-retained basis. The value of MSRs is capitalized and
amortized in proportion to, and over the period of, the estimated future net
servicing income. For the years ended December 31, 2010, 2009 and
2008, we capitalized $1.7 million, $5.0 million and $1.6 million, respectively,
of MSRs relating to loans sold with servicing retained. No MSRs were
purchased in those periods. Amortization of MSRs for the years ended
December 31, 2010, 2009 and 2008, was $2.0 million, $2.1 million, and $902,000,
respectively. Management periodically evaluates the estimates and
assumptions used to determine the carrying values of MSRs and the amortization
of MSRs. These carrying values are adjusted when the valuation
indicates the carrying value is impaired. MSRs generally are
adversely affected by higher levels of current or anticipated prepayments
resulting from decreasing interest rates. At December 31, 2010, our
MSRs were carried at a value of $5.4 million, net of amortization.
Classified Assets: State and federal
regulations require that the Banks review and classify their problem assets on a
regular basis. In addition, in connection with examinations of
insured institutions, state and federal examiners have authority to identify
problem assets and, if appropriate, require them to be
classified. Historically, we have not had any meaningful differences
of opinion with the examiners with respect to asset
classification. Banner Bank’s Credit Policy Division reviews detailed
information with respect to the composition and performance of the loan
portfolios, including information on risk concentrations, delinquencies and
classified assets for both Banner Bank and Islanders Bank. The Credit
Policy Division approves all recommendations for new classified loans or, in the
case of smaller-balance homogeneous loans including residential real estate and
consumer loans, it has approved policies governing such classifications, or
changes in classifications, and develops and monitors action plans to resolve
the problems associated with the assets. The Credit Policy Division
also approves recommendations for establishing the appropriate level of the
allowance for loan losses. Significant problem loans are transferred
to Banner Bank’s Special Assets Department for resolution or collection
activities. The Banks’ and Banner Corporation’s Boards of Directors
are given a detailed report on
classified
assets and asset quality at least quarterly. For additional
information regarding asset quality and non-performing loans, see Item 7,
“Management’s Discussion and Analysis of Financial Condition—Comparison of
Financial Condition at December 31, 2010 and 2009—Asset Quality,” and Tables 15,
16 and 17 contained therein.
Allowance for Loan
Losses: In
originating loans, we recognize that losses will be experienced and that the
risk of loss will vary with, among other things, the type of loan being made,
the creditworthiness of the borrower over the term of the loan, general economic
conditions and, in the case of a secured loan, the quality of the security for
the loan. As a result, we maintain an allowance for loan losses
consistent with GAAP guidelines. We increase our allowance for loan
losses by charging provisions for possible loan losses against our
income. The allowance for losses on loans is maintained at a level
which, in management’s judgment, is sufficient to provide for probable losses
based on evaluating known and inherent risks in the loan portfolio and upon
continuing analysis of the factors underlying the quality of the loan
portfolio. At December 31, 2010, we had an allowance for loan losses
of $97 million, which represented 2.86% of net loans and 64% of non-performing
loans compared to 2.51% and 45%, respectively, at December 31,
2009. For additional information concerning our allowance for loan
losses, see Item 7, “Management’s Discussion and Analysis of Financial
Condition—Comparison of Results of Operations for the Years Ended December 31,
2010 and 2009—Provision and Allowance for Loan Losses,” and Tables 21 and 22
contained therein.
Real Estate
Owned: Real estate owned (REO) is property acquired by
foreclosure or receiving a deed in lieu of foreclosure, and is recorded at fair
value, less cost to sell. Development and improvement costs relating
to the property are capitalized. The carrying value of the property
is periodically evaluated by management and, if necessary, allowances are
established to reduce the carrying value to net realizable
value. Gains or losses at the time the property is sold are charged
or credited to operations in the period in which they are
realized. The amounts the Banks will ultimately recover from real
estate may differ substantially from the carrying value of the assets because of
market factors beyond the Banks’ control or because of changes in the Banks’
strategies for recovering the investment. If the book value of the
REO is determined to be in excess of the fair market value, a valuation
allowance is recognized against earnings. At December 31, 2010, we
had REO of $101 million, compared to $78 million at December 31,
2009. Valuation allowances recognized during 2010 totaled $15.1
million, compared with $1.6 million during 2009 and $823,000 during
2008. For additional information on REO, see Item 7, “Management’s
Discussion and Analysis of Financial Condition—Comparison of Financial Condition
at December 31, 2010 and 2009—Asset Quality” and Table 18 contained therein and
Note 7 of the Notes to the Consolidated Financial Statements.
Under
Washington state law, banks are permitted to invest in various types of
marketable securities. Authorized securities include but are not
limited to U.S. Treasury obligations, securities of various federal agencies
(including government-sponsored enterprises), mortgage-backed securities,
certain certificates of deposit of insured banks and savings institutions,
bankers’ acceptances, repurchase agreements, federal funds, commercial paper,
corporate debt and equity securities and obligations of states and their
political subdivisions. Our investment policies are designed to
provide and maintain adequate liquidity and to generate favorable rates of
return without incurring undue interest rate or credit risk. Our
policies generally limit investments to U.S. Government and agency (including
government-sponsored entities) securities, municipal bonds, certificates of
deposit, corporate debt obligations and mortgage-backed
securities. Investment in mortgage-backed securities may include
those issued or guaranteed by Freddie Mac, Fannie Mae, Government National
Mortgage Association (Ginnie Mae or GNMA) and privately-issued mortgage-backed
securities that have an AA credit rating or higher at the time of purchase, as
well as collateralized mortgage obligations (CMOs). A high credit
rating indicates only that the rating agency believes there is a low risk of
loss or default. To the best of our knowledge, we do not have any
investments in mortgage-backed securities, collateralized debt obligations or
structured investment vehicles that have a material exposure to sub-prime
mortgages. However, we do have investments in single-issuer and
collateralized debt obligations secured by pooled trust preferred securities
that have been materially adversely impacted by concerns related to the banking
and insurance industries as well as payment deferrals and defaults by certain
issuers. Further, all of our investment securities, including those
that have high credit ratings, are subject to market risk in so far as a change
in market rates of interest or other conditions may cause a change in an
investment’s earning performance and/or market value.
At
December 31, 2010, our consolidated investment portfolio totaled $368 million
and consisted principally of U.S. Government agency obligations, mortgage-backed
securities, municipal bonds and corporate debt obligations. From time
to time, investment levels may be increased or decreased depending upon yields
available on investment alternatives, and management’s projections as to the
demand for funds to be used in loan originations, deposits and other
activities. During the year ended December 31, 2010, holdings of
mortgage-backed securities decreased $19 million to $87 million, while U.S.
Treasury and agency obligations increased $45 million to $140 million, corporate
securities including equities increased $15 million to $59 million, and
municipal bonds increased $9 million to $83 million.
For
detailed information on our investment securities, see Item 7, “Management’s
Discussion and Analysis of Financial Condition—Comparison of Financial Condition
at December 31, 2010 and 2009—Investments,” and Tables 1 to 6 contained
therein.
Off-Balance-Sheet
Derivatives: Derivatives include
“off-balance-sheet” financial products whose value is dependent on the value of
an underlying financial asset, such as a stock, bond, foreign currency, or a
reference rate or index. Such derivatives include “forwards,”
“futures,” “options” or “swaps.” We generally have not invested in
“off-balance-sheet” derivative instruments, although investment policies
authorize such investments. However, through our acquisition of
F&M Bank in 2007 we became a party to approximately $23.0 million ($19.2
million as of December 31, 2010) in notional amounts of interest rate
swaps. These swaps serve as hedges to an equal amount of fixed-rate
loans which include market value prepayment penalties that mirror the provision
of the specifically matched interest rate swaps. The fair value
adjustments for these swaps and the related loans are reflected in other assets
or other liabilities as appropriate, and in the carrying value of the hedged
loans. Also, as a part of mortgage banking activities, we issue “rate
lock” commitments to borrowers and obtain offsetting “best efforts” delivery
commitments from purchasers of loans. While not providing any trading
or net settlement mechanisms, these off-balance-sheet commitments do have many
of the prescribed characteristics of derivatives and as a result are accounted
for as such. Accordingly, on December 31, 2010, we recorded an asset
of $310,000 and a liability of $310,000, representing the estimated market value
of those commitments. On December 31, 2010, we had no other
investment related off-balance-sheet derivatives.
General: Deposits,
FHLB advances (or other borrowings) and loan repayments are our major sources of
funds for lending and other investment purposes. Scheduled loan
repayments are a relatively stable source of funds, while deposit inflows and
outflows and loan prepayments are influenced by general economic, interest rate
and money market conditions and may vary significantly. Borrowings
may be used on a short-term basis to compensate for reductions in the
availability of funds from other sources. Borrowings may also be used
on a longer-term basis for general business purposes, including funding loans
and investments.
We
compete with other financial institutions and financial intermediaries in
attracting deposits. There is strong competition for transaction
balances and savings deposits from commercial banks, credit unions and nonbank
corporations, such as securities brokerage companies, mutual funds and other
diversified companies, some of which have nationwide networks of
offices. Much of the focus of our branch expansion, relocations and
renovation has been directed toward attracting additional deposit customer
relationships and balances. In addition, our electronic banking
activities including debit card and automated teller machine (ATM) programs,
online Internet banking services and, most recently, customer remote deposit and
mobile banking capabilities are all directed at providing products and services
that enhance customer relationships and result in growing deposit
balances. Growing core deposits (transaction and savings accounts) is
a fundamental element of our business strategy.
Deposit
Accounts: We generally attract deposits from within our
primary market areas by offering a broad selection of deposit instruments,
including demand checking accounts, negotiable order of withdrawal (NOW)
accounts, money market deposit accounts, regular savings accounts, certificates
of deposit, cash management services and retirement savings
plans. Deposit account terms vary according to the minimum balance
required, the time periods the funds must remain on deposit and the interest
rate, among other factors. In determining the terms of deposit
accounts, we consider current market interest rates, profitability to us,
matching deposit and loan products and customer preferences and
concerns. At December 31, 2010, we had $3.6 billion of deposits,
including $2.0 billion of transaction and savings accounts and $1.6 billion in
time deposits. For additional information concerning our deposit
accounts, see Item 7, “Management’s Discussion and Analysis of Financial
Condition—Comparison of Financial Condition at December 31, 2010 and
2009—Deposit Accounts.” See also Table 11 contained therein, which
sets forth the balances of deposits in the various types of accounts, and Table
12, which sets forth the amount of our certificates of deposit greater than
$100,000 by time remaining until maturity as of December 31, 2010.
Borrowings: While
deposits are the primary source of funds for our lending and investment
activities and for general business purposes, we also use borrowings to
supplement our supply of lendable funds, to meet deposit withdrawal requirements
and to more efficiently leverage our capital position. The
FHLB-Seattle serves as our primary borrowing source. The FHLB-Seattle
provides credit for member financial institutions such as Banner Bank and
Islanders Bank. As members, the Banks are required to own capital
stock in the FHLB-Seattle and are authorized to apply for advances on the
security of that stock and certain of their mortgage loans and securities
provided certain credit worthiness standards have been
met. Limitations on the amount of advances are based on the financial
condition of the member institution, the adequacy of collateral pledged to
secure the credit, and FHLB stock ownership requirements. At December
31, 2010, we had $44 million of borrowings from the FHLB-Seattle. At
that date, Banner Bank had been authorized by the FHLB-Seattle to borrow up to
$974 million under a blanket floating lien security agreement, while Islanders
Bank was approved to borrow up to $33 million under a similar
agreement. More recently, the Federal Reserve Bank of San Francisco
(FRBSF) has also served as an important source of borrowings. The
FRBSF provides credit based upon acceptable loan collateral, which includes
certain loan types not eligible for pledging to the FHLB-Seattle. At
December 31, 2010, based upon our available unencumbered collateral, Banner Bank
was eligible to borrow $373 million from the FRBSF, although at that date we had
no funds borrowed under this arrangement. Although eligible to
participate, Islanders Bank has not applied for approval to borrow from the
FRBSF. For additional information concerning our borrowings, see Item
7, “Management’s Discussion and Analysis of Financial Condition—Comparison of
Financial Condition at December 31, 2010 and 2009—Borrowings,” Table 14
contained therein, and Notes 10 and 11 of the Notes to the Consolidated
Financial Statements.
We issue
retail repurchase agreements, generally due within 90 days, as an additional
source of funds, primarily in connection with cash management services provided
to our larger deposit customers. At December 31, 2010, we had issued
retail repurchase agreements totaling $125 million, which were secured by a
pledge of certain U.S. Government and agency notes and mortgage-backed
securities with a market value of $133 million.
On March
31, 2009, Banner Bank completed an offering of $50 million of qualifying senior
bank notes that are guaranteed by the FDIC under the Temporary Liquidity
Guarantee Program (TLGP). These notes require interest only payments
for a term of three years with principal payable in full at
maturity. These notes provided supplemental funding which
strengthened the liquidity position of the Bank; however, going forward we do
not anticipate any additional borrowings under the TLGP.
We also
may borrow funds through the use of secured wholesale repurchase agreements with
securities brokers. However, we did not have any wholesale repurchase
borrowings during the three years ended December 31, 2010.
In
addition to our borrowings, we have also issued $120 million of junior
subordinated debentures in connection with the sale of trust preferred
securities (TPS). The TPS were issued from 2002 through 2007 by
special purpose business trusts formed by Banner Corporation and were sold in
private offerings to pooled investment vehicles. The junior
subordinated debentures associated with the TPS have been recorded as
liabilities and are reported at fair value on our Consolidated Statements of
Financial Condition; however, at December 31, 2010, all of the $48 million fair
value of the debentures qualifies as Tier 1 capital for regulatory capital
purposes. We have invested a significant portion of the proceeds from
the issuance of the TPS as additional paid in capital at Banner
Bank. For additional information about deposits and other sources of
funds, see Item 7, “Management’s Discussion and Analysis of Financial Condition
and Results of Operations—Liquidity and Capital Resources,” and Notes 9, 10, 11
and 12 of the Notes to the Consolidated Financial Statements contained in Item
8.
As of
December 31, 2010, we had 1,015 full-time and 77 part-time
employees. Banner Corporation has no employees except for those who
are also employees of Banner Bank, its subsidiaries, and Islanders
Bank. The employees are not represented by a collective bargaining
unit. We believe our relationship with our employees is
good.
Federal
Taxation
General: For tax
reporting purposes, we report our income on a calendar year basis using the
accrual method of accounting on a consolidated basis. We are subject
to federal income taxation in the same manner as other corporations with some
exceptions, including particularly the reserve for bad
debts. Reference is made to Note 13 of the Notes to the Consolidated
Financial Statements contained in Item 8 of this Form 10-K for additional
information concerning the income taxes payable by us.
State
Taxation
Washington Taxation: We are
subject to a Business and Occupation (B&O) tax which is imposed under
Washington law at the rate of 1.80% of gross receipts. For many
years, this rate had been 1.50%. However, on April 12, 2010, the
Washington State Legislature passed a law that temporarily increased this rate
to 1.80%. This new higher rate will be in effect for the period May
1, 2010 through June 30, 2013. Interest received on loans secured by
mortgages or deeds of trust on residential properties, residential
mortgage-backed securities, and certain U.S. Government and agency securities is
not subject to this tax. Our B&O tax expense was $2.3 million,
$2.2 million and $2.3 million for the years ended December 31, 2010, 2009 and
2008, respectively.
Oregon and Idaho Taxation:
Corporations with nexus in the states of Oregon and Idaho are subject to
a corporate level income tax. Our operations in those states resulted
in corporate income taxes of approximately $60,000, $21,000 and $422,000 (net of
federal tax benefit) for the years ended December 31, 2010, 2009 and 2008,
respectively. As our operations in these states increase, the state
income tax provision will have an increasing effect on our effective tax rate
and results of operations.
We
encounter significant competition both in attracting deposits and in originating
loans. Our most direct competition for deposits comes from other
commercial and savings banks, savings associations and credit unions with
offices in our market areas. We also experience competition from
securities firms, insurance companies, money market and mutual funds, and other
investment vehicles. We expect continued strong competition from such
financial institutions and investment vehicles in the foreseeable future,
including competition from on-line Internet banking competitors. Our
ability to attract and retain deposits depends on our ability to provide
transaction services and investment opportunities that satisfy the requirements
of depositors. We compete for deposits by offering a variety of
accounts and financial services, including robust electronic banking
capabilities, with competitive rates and terms, at convenient locations and
business hours, and delivered with a high level of personal service and
expertise.
Competition
for loans comes principally from other commercial banks, loan brokers, mortgage
banking companies, savings banks and credit unions and for agricultural loans
from the Farm Credit Administration. The competition for loans is
intense as a result of the large number of institutions competing in our market
areas. We compete for loans primarily by offering competitive rates
and fees and providing timely decisions and excellent service to
borrowers.
Banner
Bank and Islanders Bank
General: As
state-chartered, federally insured commercial banks, Banner Bank and Islanders
Bank (the Banks) are subject to extensive regulation and must comply with
various statutory and regulatory requirements, including prescribed minimum
capital standards. The Banks are regularly examined by the FDIC and
state banking regulators and file periodic reports concerning their activities
and financial condition with these banking regulators. The Banks’
relationship with depositors and borrowers also is regulated to a great extent
by both federal and state law, especially in such matters as the ownership of
deposit accounts and the form and content of mortgage and other loan
documents.
Federal
and state banking laws and regulations govern all areas of the operation of the
Banks, including reserves, loans, investments, deposits, capital, issuance of
securities, payment of dividends and establishment of
branches. Federal and state bank regulatory agencies also have the
general authority to limit the dividends paid by insured banks and bank holding
companies if such payments should be deemed to constitute an unsafe and unsound
practice. Under the Bank MOU, Banner Bank is not able to pay cash
dividends to Banner Corporation without the prior approval of the Washington DFI
and the FDIC. The respective primary federal regulators of Banner
Corporation, Banner Bank and Islanders Bank have authority to impose penalties,
initiate civil and administrative actions and take other steps intended to
prevent banks from engaging in unsafe or unsound practices.
State Regulation and
Supervision: As a Washington state-chartered commercial bank
with branches in the States of Washington, Oregon and Idaho, Banner Bank is
subject to the applicable provisions of Washington, Oregon and Idaho law and
regulations. State law and regulations govern Banner Bank’s ability
to take deposits and pay interest thereon, to make loans on or invest in
residential and other real estate, to make consumer loans, to invest in
securities, to offer various banking services to its customers and to establish
branch offices. In a similar fashion, Washington State laws and
regulations for state-chartered commercial banks also apply to Islanders
Bank.
Deposit
Insurance: The deposits of the Banks are insured up to
applicable limits by the Deposit Insurance Fund (DIF), which is administered by
the FDIC. The FDIC is an independent federal agency that insures the
deposits, up to applicable limits, of depository institutions and this insurance
is backed by the full faith and credit of the United States
government. As insurer of the Banks’ deposits, the FDIC has
supervisory and enforcement authority over Banner Ban k and Islanders
Bank. The FDIC imposes deposit insurance premiums and is authorized
to conduct examinations of and to require reporting by institutions insured by
the FDIC. It also may prohibit any institution insured by the FDIC
from engaging in any activity determined by regulation or order to pose a
serious risk to the institution and the DIF. The FDIC also has the
authority to initiate enforcement actions and may terminate the deposit
insurance if it determines that an institution has engaged in unsafe or unsound
practices or is in an unsafe or unsound condition.
Under the
rules in effect through March 31, 2011, the FDIC assesses deposit insurance
premiums on all FDIC-insured institutions quarterly based on annualized rates
for one of four risk categories, applying these rates to the institution’s
deposits. Each institution is assigned to one of four risk categories
based on its capital, supervisory ratings and other factors. Well
capitalized institutions that are financially sound with only a few minor
weaknesses are assigned to Risk Category I. Risk Categories II, III
and IV present progressively greater risks to the DIF. A range of
initial base assessment rates applies to each Risk Category, subject to
adjustments based on an institution’s unsecured debt, secured liabilities and
brokered deposits, such that the total base assessment rates after adjustments
range from 7 to 24 basis points for Risk Category I, 17 to 43 basis points for
Risk Category II, 27 to 58 basis points for Risk Category III, and 40 to 77.5
basis points for Risk Category IV. Rates increase uniformly by three
basis points effective January 1, 2011.
As
required by the Dodd-Frank Wall Street Reform and Consumer Protection Act
(Dodd-Frank Act), the FDIC has adopted rules effective April 1, 2011, under
which insurance premium assessments are based on an institution's total assets
minus its tangible equity (defined as Tier 1 capital) instead of its
deposits. Under these rules, an institution with total assets of less
than $10 billion will be assigned to a Risk Category as described above, and a
range of initial base assessment rates will apply to each category, subject to
adjustment downward based on unsecured debt issued by the institution and,
except for an institution in Risk Category I, adjustment upward if the
institution’s brokered deposits exceed 10% of its domestic deposits, to produce
total base assessment rates. Total base assessment rates range from
2.5 to 9 basis points for Risk Category I, 9 to 24 basis points for Risk
Category II, 18 to 33 basis points for Risk Category III, and 30 to 45 basis
points for Risk Category IV, all subject to further adjustment upward if the
institution holds more than a de minimis amount of
unsecured debt issued by another FDIC-insured institution. The FDIC may increase
or decrease its rates by 2.0 basis points without further
rulemaking.
In
addition to the regular quarterly assessments, due to losses and projected
losses attributed to failed institutions, the FDIC imposed on every insured
institution a special assessment of five basis points on the amount of each
depository institution’s assets reduced by the amount of its Tier 1 capital (not
to exceed 10 basis points of its assessment base for regular quarterly premiums)
as of June 30, 2009, which was collected on September 30, 2009.
As a
result of a decline in the reserve ratio (the ratio of the DIF to estimated
insured deposits) and concerns about expected failure costs and available liquid
assets in the DIF, the FDIC adopted a rule requiring each insured institution to
prepay on December 30, 2009 the estimated amount of its quarterly assessments
for the fourth quarter of 2009 and all quarters through the end of 2012 (in
addition to the regular quarterly assessment for the third quarter which was due
on December 30, 2009). The prepaid amount is recorded as an asset
with a zero risk weight and the institution will continue to record quarterly
expenses for deposit insurance. For purposes of calculating the
prepaid amount, assessments were measured at the institution’s assessment rate
as of September 30, 2009, with a uniform increase of 3 basis points effective
January 1, 2011, and were based on the institution’s assessment base for the
third quarter of 2009, with growth assumed quarterly at annual rate of
5%. If events cause actual assessments during the prepayment period
to vary from the prepaid amount, institutions will pay excess assessments in
cash or receive a rebate of prepaid amounts not exhausted after collection of
assessments due on June 30, 2013, as applicable. Collection of the
prepayment does not preclude the FDIC from changing assessment rates or revising
the risk-based assessment system in the future. The rule includes a
process for exemption from the prepayment for institutions whose safety and
soundness would be affected adversely. We prepaid $31.6 million
in FDIC assessments during the fourth quarter of 2009 and the balance of the
prepaid assessment was $21.6 million at December 31, 2010.
The
Dodd-Frank Act establishes 1.35% as the minimum reserve ratio. The FDIC has
adopted a plan under which it will meet this ratio by September 30, 2020, the
deadline imposed by the Dodd-Frank Act. The Dodd-Frank requires the
FDIC to offset the effect on institutions with assets less than $10 billion of
the increase in the statutory minimum reserve ratio to 1.35% from the former
statutory minimum of 1.15%. The FDIC has not yet announced how it
will implement this offset. In addition to the statutory minimum
ration, the FDIC must designate a reserve ratio, known as the designated reserve
ratio or DRR, which may exceed the statutory minimum. The FDIC has
established 2.0% as the DRR.
Federally
insured institutions are required to pay a Financing Corporation assessment in
order to fund the interest on bonds issued to resolve thrift failures in the
1980s. For the quarterly period ended December 31, 2010, the
Financing Corporation assessment equaled 1.04 basis points for each $100 in
domestic deposits. These assessments, which may be revised based upon
the level of DIF deposits, will continue until the bonds mature in the years
2017 through 2019. For 2010, the Banks incurred $399,000 in FICO
assessments.
The FDIC
may terminate the deposit insurance of any insured depository institution if it
determines after a hearing that the institution has engaged or is engaging in
unsafe or unsound practices, is in an unsafe or unsound condition to continue
operations, or has violated any applicable law, regulation, order or any
condition imposed by an agreement with the FDIC. It also may suspend
deposit insurance temporarily during the hearing process for the permanent
termination of insurance if the institution meets certain
criteria. If insurance of accounts is terminated, the accounts at the
institution at the time of the termination, less subsequent withdrawals, shall
continue to be insured for a period of six months to two years, as determined by
the FDIC. Management is not aware of any existing circumstances which
would result in termination of the deposit insurance of either Banner Bank or
Islanders Bank.
Prompt Corrective
Action: Federal statutes establish a supervisory framework
based on five capital categories: well capitalized, adequately
capitalized, undercapitalized, significantly undercapitalized and critically
undercapitalized. An institution’s category depends upon where its
capital levels are in relation to relevant capital measures, which include a
risk-based capital measure, a leverage ratio capital measure and certain
other
factors. The federal banking agencies have adopted regulations that
implement this statutory framework. Under these regulations, an
institution is treated as well capitalized if its ratio of total capital to
risk-weighted assets is 10% or more, its ratio of core capital to risk-weighted
assets is 6% or more, its ratio of core capital to adjusted total assets
(leverage ratio) is 5% or more, and it is not subject to any federal supervisory
order or directive to meet a specific capital level. In order to be
adequately capitalized, an institution must have a total risk-based capital
ratio of not less than 8%, a core capital to risk-weighted assets ratio of not
less than 4%, and a leverage ratio of not less than 4%. An
institution that is not well capitalized is subject to certain restrictions on
brokered deposits, including restrictions on the rates it can offer on its
deposits generally. Any institution which is neither well capitalized
nor adequately capitalized is considered undercapitalized.
Undercapitalized
institutions are subject to certain prompt corrective action requirements,
regulatory controls and restrictions which become more extensive as an
institution becomes more severely undercapitalized. Failure by either
Banner Bank and Islanders Bank to comply with applicable capital requirements
would, if unremedied, result in progressively more severe restrictions on its
activities and lead to enforcement actions, including, but not limited to, the
issuance of a capital directive to ensure the maintenance of required capital
levels and, ultimately, the appointment of the FDIC as receiver or
conservator. Banking regulators will take prompt corrective action
with respect to depository institutions that do not meet minimum capital
requirements. Additionally, approval of any regulatory application
filed for their review may be dependent on compliance with capital
requirements.
At
December 31, 2010, both Banner Bank and Islanders Bank were categorized as “well
capitalized” under the prompt corrective action regulations of the
FDIC.
Standards for Safety and
Soundness: The federal banking regulatory agencies have
prescribed, by regulation, guidelines for all insured depository institutions
relating to internal controls, information systems and internal audit
systems; loan documentation; credit underwriting; interest rate risk exposure;
asset growth; asset quality; earnings; and compensation, fees and
benefits. The guidelines set forth the safety and soundness standards
that the federal banking agencies use to identify and address problems at
insured depository institutions before capital becomes impaired. Each
insured depository institution must implement a comprehensive written
information security program that includes administrative, technical, and
physical safeguards appropriate to the institution’s size and complexity and the
nature and scope of its activities. The information security program
must be designed to ensure the security and confidentiality of customer
information, protect against any unanticipated threats or hazards to the
security or integrity of such information, protect against unauthorized access
to or use of such information that could result in substantial harm or
inconvenience to any customer, and ensure the proper disposal of customer and
consumer information. Each insured depository institution must also
develop and implement a risk-based response program to address incidents of
unauthorized access to customer information in customer information
systems. If the FDIC determines that an institution fails to meet any
of these guidelines, it may require an institution to submit to the FDIC an
acceptable plan to achieve compliance.
Capital Requirements:
Federally insured financial institutions, such as Banner Bank and
Islanders Bank, are required to maintain a minimum level of regulatory
capital. FDIC regulations recognize two types, or tiers, of
capital: core (Tier 1) capital and supplementary (Tier 2)
capital. Tier 1 capital generally includes common stockholders’
equity and qualifying noncumulative perpetual preferred stock, less most
intangible assets. Tier 2 capital, which is recognized
up to 100% of Tier 1 capital for risk-based capital purposes (after
any deductions for disallowed intangibles and disallowed deferred tax assets),
includes such items as qualifying general loan loss reserves (up to 1.25% of
risk-weighted assets), cumulative perpetual preferred stock, long-term preferred
stock, certain perpetual preferred stock, hybrid capital instruments including
mandatory convertible debt, term subordinated debt, intermediate-term preferred
stock (original average maturity of at least five years), and net unrealized
holding gains on equity securities (subject to certain limitations); provided,
however, the amount of term subordinated debt and intermediate term preferred
stock that may in included in Tier 2 capital for risk-based capital purposes is
limited to 50% of Tier 1 capital.
The FDIC
currently measures an institution’s capital using a leverage limit together with
certain risk-based ratios. The FDIC’s minimum leverage capital
requirement specifies a minimum ratio of Tier 1 capital to average total
assets. Most banks are required to maintain a minimum leverage ratio
of at least 3% to 4% of total assets. At December 31, 2010, Banner
Bank and Islanders Bank had Tier 1 leverage capital ratios of 10.84% and 11.25%,
respectively. The FDIC retains the right to require a particular
institution to maintain a higher capital level based on an institution’s
particular risk profile. Under the Bank MOU, we are required to
maintain Banner Bank’s leverage ratio at 10%.
FDIC
regulations also establish a measure of capital adequacy based on ratios of
qualifying capital to risk-weighted assets. Assets are placed in one
of four categories and given a percentage weight based on the relative risk of
the category. In addition, certain off-balance-sheet items are
converted to balance-sheet credit equivalent amounts, and each amount is then
assigned to one of the four categories. Under the guidelines, the
ratio of total capital (Tier 1 capital plus Tier 2 capital) to risk-weighted
assets must be at least 8%, and the ratio of Tier 1 capital to risk-weighted
assets must be at least 4%. In evaluating the adequacy of a bank’s
capital, the FDIC may also consider other factors that may affect the bank’s
financial condition. Such factors may include interest rate risk
exposure, liquidity, funding and market risks, the quality and level of
earnings, concentration of credit risk, risks arising from nontraditional
activities, loan and investment quality, the effectiveness of loan and
investment policies, and management’s ability to monitor and control financial
operating risks. At December 31, 2010, Banner Bank and Islanders Bank
had Tier 1 risk-based capital ratios of 13.83% and 13.21%, respectively, and
total risk-based capital ratios of 15.10% and 14.46%, respectively.
FDIC
capital requirements are designated as the minimum acceptable standards for
banks whose overall financial condition is fundamentally sound, which are
well-managed and have no material or significant financial
weaknesses. The FDIC capital regulations state that, where the FDIC
determines that the financial history or condition, including off-balance-sheet
risk, managerial resources and/or the future earnings prospects of a bank are
not adequate and/or a bank has a significant volume of assets classified
substandard, doubtful or loss or otherwise criticized, the FDIC may determine
that the minimum adequate amount of capital for the bank is greater than the
minimum standards established in the regulation.
We
believe that, under the current regulations, Banner Bank and Islanders Bank
exceed their minimum capital requirements. However, events beyond the
control of the Banks, such as weak or depressed economic conditions in areas
where they have most of their loans, could adversely affect future earnings and,
consequently, the ability of the Banks to meet their capital
requirements. For additional information concerning Banner Bank’s and
Islanders Bank’s capital, see Note 18 of the Notes to the Consolidated Financial
Statements.
Emergency Economic Stabilization Act
of 2008 (EESA): In October 2008, the EESA was
enacted. The EESA authorizes the U.S. Treasury Department to purchase
from financial institutions and their holding companies up to $700 billion in
mortgage loans, mortgage-related securities and certain other financial
instruments, including debt and equity securities issued by financial
institutions and their holding companies in a troubled asset relief program, or
TARP. The purpose of TARP is to restore confidence and stability to
the U.S. banking system and to encourage financial institutions to increase
their lending to customers and to each other. Under the TARP Capital
Purchase Program, or CPP, the Treasury may purchase debt or equity securities
from participating institutions. The TARP also allows direct
purchases or guarantees of troubled assets of financial
institutions. Participants in the CPP are subject to executive
compensation limits and are encouraged to expand their lending and mortgage loan
modifications. Banner completed its TARP CPP transaction on November
21, 2008 and received $124 million in funding from the U.S. Treasury
Department.
Temporary Liquidity Guarantee
Program: Following a systemic risk determination, the FDIC
established a Temporary Liquidity Guarantee Program, or TLGP, on October 14,
2008. There are two parts to the program: the Debt Guarantee Program,
or the DGP, and the Transaction Account Guarantee Program, or the TAGP, which
ended on December 31, 2010. Eligible entities generally are
participants unless they exercised opt out rights in timely
fashion. Banner Bank and Islanders Bank did not opt out of
these programs.
For the
DGP, eligible entities are generally U.S. bank holding companies, savings and
loan holding companies, and FDIC-insured institutions. Under the DGP,
the FDIC guarantees certain senior unsecured debt of an eligible entity that was
issued not later than October 31, 2009. The guarantee is effective
through the earlier of the maturity date or June 30, 2012 (for debt issued
before April 1, 2009) or December 31, 2012 (for debt issued on or after April 1,
2009). The DGP coverage limit is generally 125% of the eligible
entity’s eligible debt outstanding on September 30, 2008 and scheduled to mature
on or before June 30, 2009, or for certain institutions, 2% of liabilities as of
September 30, 2008. The nonrefundable DGP fee ranges from 50 to 100
basis points (annualized), depending on maturity, for covered debt outstanding
during the period until the earlier of maturity or June 30, 2012, with various
surcharges of 10 to 50 basis points applicable to debt with a maturity of one
year or more issued on or after April 1, 2009. Generally, eligible debt of a
participating entity becomes covered when and as issued until the coverage limit
is reached, except that under some circumstances, participating entities can
issue certain nonguaranteed debt. Various features of the
DGP require applications, additional fees, and approvals. On March 31, 2009,
Banner Bank completed an offering of $50 million of qualifying senior bank notes
that are guaranteed by the FDIC under the DGP. These notes require
interest only payments for a term of three years with principal payable in full
at maturity. Banner Bank is required to pay a 1.00% fee (annualized)
on this debt, which will result in a total fee of $1.5 million over three
years. None of the senior notes are redeemable prior to
maturity. We do not anticipate any additional borrowing under the
TLGP.
For the
TAGP, eligible entities are FDIC-insured institutions. Under the TAGP, the FDIC
provided unlimited deposit insurance coverage for non-interest-bearing
transaction accounts (typically business checking accounts), NOW accounts
bearing interest at 0.5% or less, and certain funds swept into
non-interest-bearing savings accounts. Other NOW accounts and money
market deposit accounts were not covered. TAGP coverage initially
lasted until December 31, 2009 and, unless the participant opted out, was
extended twice through December 31, 2010. On September 27, 2010, the
FDIC announced that it would not continue the TAGP beyond December 31,
2010. However, under the Dodd-Frank Act and the FDIC rules, separate
temporary coverage for non-interest-bearing transaction accounts and IOLTA
accounts became effective on December 31, 2010, terminating on December 31,
2012, so that all funds held in such accounts are fully insured, without
limit. Further, unlike the TAGP, all U.S. depository institutions
insured by the FDIC must participate; there is no opt out
provision. The FDIC does not plan to charge a separate assessment for
this temporary insurance.
The American Recovery and
Reinvestment Act of 2009 (ARRA): On February 17, 2009,
President Obama signed ARRA into law. ARRA is intended to revive the
U.S. economy by creating millions of new jobs and stemming home
foreclosures. For financial institutions that have received or will
receive financial assistance under TARP or related programs, the ARRA
significantly rewrites the original executive compensation and corporate
governance provisions of Section 111 of the EESA. Among the most
important changes instituted by the ARRA are new limits on the ability of TARP
recipients to pay incentive compensation to up to 20 of the next most
highly-compensated employees in addition to the “senior executive officers,” a
restriction on termination of employment payments to senior executive officers
and the five next most highly-compensated employees and a requirement that TARP
recipients implement “say on pay” shareholder votes. For additional
information regarding the TARP CPP, see Item 1A, Risk Factors—“Because of our
participation in the TARP Capital Purchase Program, we are subject to several
restrictions including restrictions on compensation paid to our
executives.”
The Dodd-Frank Wall Street Reform
and Consumer Protection Act of 2010: The Dodd-Frank Act
significantly changes the current bank regulatory structure and affects the
lending, deposit, investment, trading and operating activities of financial
institutions and their holding companies. The Dodd-Frank Act requires
various federal agencies to adopt a broad range of new implementing rules and
regulations, and to prepare numerous studies and reports for
Congress. The federal agencies are given significant discretion in
drafting the implementing rules and regulations, and consequently, many of the
details and much of the impact of the Dodd-Frank Act may not be known for many
months or years.
Certain
provisions of the Dodd-Frank Act are expected to have a near term impact on
Banner. For example, effective one year after the date of enactment,
the Dodd-Frank Act eliminates the federal prohibition on paying interest on
demand deposits, thus allowing businesses to have interest-bearing checking
accounts. Depending on competitive responses, this change to existing
law could have an adverse impact on the Company’s interest expense.
The
Dodd-Frank Act permanently increases the maximum amount of deposit insurance for
banks, savings institutions and credit unions to $250,000 per depositor,
retroactive to January 1, 2009.
The
Dodd-Frank Act requires publicly traded companies, such as Banner Corporation,
to give stockholders a non-binding vote on executive compensation and so-called
“golden parachute” payments and authorizes the Securities and Exchange
Commission to promulgate rules that would allow stockholders to nominate their
own candidates using a company’s proxy materials. The legislation
also directs the federal banking agencies to promulgate rules prohibiting
excessive and risky compensation paid to bank and bank holding company
executives, regardless of whether the company is publicly
traded.
The
Dodd-Frank Act creates a new Consumer Financial Protection Bureau with broad
powers to supervise and enforce consumer protection laws. The
Consumer Financial Protection Bureau has broad rule-making authority for a wide
range of consumer protection laws that apply to all banks and savings
institutions, including the authority to prohibit “unfair, deceptive or abusive”
acts and practices. The Consumer Financial Protection Bureau has
examination and enforcement authority over all banks and savings institutions
with more than $10 billion in assets. Financial institutions such as the Banks
with $10 billion or less in assets will continued to be examined for compliance
with the consumer laws by their primary bank regulators.
The
Dodd-Frank Act includes certain provisions concerning capital regulations which
are intended to subject bank holding companies to the same capital requirements
as their bank subsidiaries and to eliminate or significantly reduce the use of
hybrid capital instruments, especially trust preferred securities, as regulatory
capital. Under these provisions, trust preferred securities issued by a company,
such as Banner Corporation, with total consolidated assets of less than $15
billion before May 19, 2010 and treated as regulatory capital are grandfathered,
but any such securities issued later are not eligible as regulatory
capital. The federal banking regulators must develop regulations
setting minimum risk-based and leverage capital requirements for holding
companies and banks on a consolidated basis that are no less stringent than the
generally applicable requirements in effect for depository institutions under
the prompt corrective action regulations discussed above. The banking
regulators also must seek to make capital standards countercyclical so that the
required levels of capital increase in times of economic expansion and decrease
in times of economic contraction. The Act requires these new capital
regulations to be adopted in final form 18 months after the date of enactment of
the Dodd-Frank Act (July 21, 2010). To date, no proposed regulations
have been issued.
It is
difficult to predict at this time what specific impact the Dodd-Frank Act and
the yet to be written implementing rules and regulations will have on community
banks. However, it is expected that at a minimum they will increase
our operating and compliance costs and could increase our interest
expense.
Commercial Real Estate Lending
Concentrations: The
federal banking agencies have issued guidance on sound risk management practices
for concentrations in commercial real estate lending. The particular
focus is on exposure to commercial real estate loans that are dependent on the
cash flow from the real estate held as collateral and that are likely to be
sensitive to conditions in the commercial real estate market (as opposed to real
estate collateral held as a secondary source of repayment or as an abundance of
caution). The purpose of the guidance is not to limit a bank’s
commercial real estate lending but to guide banks in developing risk management
practices and capital levels commensurate with the level and nature of real
estate concentrations. The guidance directs the FDIC and other bank
regulatory agencies to focus their supervisory resources on institutions that
may have significant commercial real estate loan concentration
risk. A bank that has experienced rapid growth in commercial real
estate lending, has notable exposure to a specific type of commercial real
estate loan, or is approaching or exceeding the following supervisory criteria
may be identified for further supervisory analysis with respect to real estate
concentration risk:
|
·
|
Total
reported loans for construction, land development and other land represent
100% or more of the bank’s capital;
or
|
|
·
|
Total
commercial real estate loans (as defined in the guidance) represent 300%
or more of the bank’s total capital or the outstanding balance of the
bank’s commercial real estate loan portfolio has increased 50% or more
during the prior 36 months.
|
The
guidance provides that the strength of an institution’s lending and risk
management practices with respect to such concentrations will be taken into
account in supervisory guidance on evaluation of capital adequacy. As
of December 31, 2010, Banner Bank’s and Islanders Bank’s aggregate loans
for construction, land development and land loans were 107% and 63% of total
capital, respectively. In addition, at December 31, 2010, Banner
Bank’s and Islanders Bank’s loans on commercial real estate were 236% and 300%
of total capital, respectively. As part of the Bank MOU, Banner Bank
was required to develop and implement a plan to reduce its commercial real
estate concentration.
Activities and Investments of
Insured State-Chartered Financial Institutions: Federal law
generally limits the activities and equity investments of FDIC insured,
state-chartered banks to those that are permissible for national
banks. An insured state bank is not prohibited from, among other
things, (1) acquiring or retaining a majority interest in a subsidiary, (2)
investing as a limited partner in a partnership the sole purpose of which is
direct or indirect investment in the acquisition, rehabilitation or new
construction of a qualified housing project, provided that such limited
partnership investments may not exceed 2% of the bank’s total assets, (3)
acquiring up to 10% of the voting stock of a company that solely provides or
reinsures directors’, trustees’ and officers’ liability insurance coverage or
bankers’ blanket bond group insurance coverage for insured depository
institutions, and (4) acquiring or retaining the voting shares of a depository
institution if certain requirements are met.
Washington
State has enacted a law regarding financial institution
parity. Primarily, the law affords Washington-chartered commercial
banks the same powers as Washington-chartered savings banks. In order
for a bank to exercise these powers, it must provide 30 days notice to the
Director of the Washington Department of Financial Institutions and the Director
must authorize the requested activity. In addition, the law provides
that Washington-chartered commercial banks may exercise any of the powers that
the Federal Reserve has determined to be closely related to the business of
banking and the powers of national banks, subject to the approval of the
Director in certain situations. The law also provides that
Washington-chartered savings banks may exercise any of the powers of
Washington-chartered commercial banks, national banks and federally-chartered
savings banks, subject to the approval of the Director in certain
situations. Finally, the law provides additional flexibility for
Washington-chartered commercial and savings banks with respect to interest rates
on loans and other extensions of credit. Specifically, they may
charge the maximum interest rate allowable for loans and other extensions of
credit by federally-chartered financial institutions to Washington
residents.
Environmental Issues Associated With
Real Estate Lending: The Comprehensive Environmental Response,
Compensation and Liability Act (CERCLA) is a federal statute that generally
imposes strict liability on all prior and present “owners and operators” of
sites containing hazardous waste. However, Congress asked to protect
secured creditors by providing that the term “owner and operator” excludes a
person whose ownership is limited to protecting its security interest in the
site. Since the enactment of the CERCLA, this “secured creditor
exemption” has been the subject of judicial interpretations which have left open
the possibility that lenders could be liable for cleanup costs on contaminated
property that they hold as collateral for a loan. To the extent that
legal uncertainty exists in this area, all creditors, including Banner Bank
and
Islanders
Bank, that have made loans secured by properties with potential hazardous waste
contamination (such as petroleum contamination) could be subject to liability
for cleanup costs, which costs often substantially exceed the value of the
collateral property.
Federal Reserve
System: The Federal Reserve Board requires that all depository
institutions maintain reserves on transaction accounts or nonpersonal time
deposits. These reserves may be in the form of cash or
non-interest-bearing deposits with the regional Federal Reserve
Bank. NOW accounts and other types of accounts that permit payments
or transfers to third parties fall within the definition of transaction accounts
and are subject to Regulation D reserve requirements, as are any nonpersonal
time deposits at a bank. At December 31,
2010, the Banks’ deposits with the Federal Reserve Bank and vault cash exceeded
their reserve requirements.
Affiliate
Transactions: Banner Corporation, Banner Bank and Islanders
Bank are separate and distinct legal entities. Federal laws strictly limit the
ability of banks to engage in certain transactions with their affiliates,
including their bank holding companies. Transactions deemed to be a
“covered transaction” under Section 23A of the Federal Reserve Act and between a
subsidiary bank and its parent company or any nonbank subsidiary of the bank
holding company are limited to 10% of the subsidiary bank’s capital and surplus
and, with respect to the parent company and all such nonbank subsidiaries, to an
aggregate of 20% of the subsidiary bank’s capital and
surplus. Further, covered transactions that are loans and extensions
of credit generally are required to be secured by eligible collateral in
specified amounts. Federal law also requires that covered
transactions and certain other transactions listed in Section 23B of the Federal
Reserve Act between a bank and its affiliates be on terms as favorable to the
bank as transactions with nonaffiliates.
Community Reinvestment
Act: Banner Bank and Islanders Bank are subject to the
provisions of the Community Reinvestment Act of 1977 (CRA), which requires the
appropriate federal bank regulatory agency to assess a bank’s performance under
the CRA in meeting the credit needs of the community serviced by the bank,
including low and moderate income neighborhoods. The regulatory
agency’s assessment of the bank’s record is made available to the
public. Further, a bank’s CRA performance rating must be considered
in connection with a bank’s application to, among other things, to establish a
new branch office that will accept deposits, relocate an existing office or
merge or consolidate with, or acquire the assets or assume the liabilities of, a
federally regulated financial institution. Both Banner Bank and
Islanders Bank received a “satisfactory” rating during their most recent CRA
examinations.
Dividends: The
amount of dividends payable by the Banks to us will depend upon their earnings
and capital position, and is limited by federal and state laws, regulations and
policies. Federal law further provides that no insured depository
institution may make any capital distribution (which includes a cash dividend)
if, after making the distribution, the institution would be “undercapitalized,”
as defined in the prompt corrective action regulations. Moreover, the
federal bank regulatory agencies also have the general authority to limit the
dividends paid by insured banks if such payments should be deemed to constitute
an unsafe and unsound practice. Under the Bank MOU, Banner Bank is
not able to pay us dividends without the prior approval of the Washington DFI
and the FDIC.
Privacy
Standards: The Gramm-Leach-Bliley Financial Services
Modernization Act of 1999 (GLBA) modernized the financial services industry by
establishing a comprehensive framework to permit affiliations among commercial
banks, insurance companies, securities firms and other financial service
providers. Banner Bank and Islanders Bank are subject to FDIC
regulations implementing the privacy protection provisions of the
GLBA. These regulations require the Banks to disclose their privacy
policy, including informing consumers of their information sharing practices and
informing consumers of their rights to opt out of certain
practices.
Anti-Money Laundering and Customer
Identification: In response to the terrorist events of
September 11, 2001, the Uniting and Strengthening America by Providing
Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (USA
Patriot Act) was signed into law on October 26, 2001. The USA Patriot
Act gives the federal government new powers to address terrorist threats through
enhanced domestic security measures, expanded surveillance powers, increased
information sharing, and broadened anti-money laundering
requirements. Bank regulators are directed to consider a holding
company’s effectiveness in combating money laundering when ruling on Bank
Holding Company Act and Bank Merger Act applications. Banner Bank’s
and Islanders Bank’s policies and procedures comply with the requirements of the
USA Patriot Act.
Other Consumer Protection Laws and
Regulations: The Banks are subject to a broad array of federal
and state consumer protection laws and regulations that govern almost every
aspect of its business relationships with consumers. While the list
set forth below is not exhaustive, these include the Truth-in-Lending Act, the
Truth in Savings Act, the Electronic Fund Transfers Act, the Expedited Funds
Availability Act, the Equal Credit Opportunity Act, the Fair Housing Act, the
Real Estate Settlement Procedures Act, the Home Mortgage Disclosure Act, the
Fair Credit Reporting Act, the Right to Financial Privacy Act, the Home
Ownership and Equity Protection Act, the Fair Credit Billing Act, the Homeowners
Protection Act, the Check Clearing for the 21st Century Act, laws governing
flood insurance, laws governing consumer protections in connection with the sale
of insurance, federal and state laws prohibiting unfair and deceptive business
practices, and various regulations that implement some or all of the
foregoing. These laws and regulations mandate certain disclosure
requirements and regulate the manner in which financial institutions must deal
with customers when taking deposits, making loans, collecting loans, and
providing other services. Failure to comply with these laws and
regulations can subject the Banks to various penalties, including but not
limited to, enforcement actions, injunctions, fines, civil liability, criminal
penalties, punitive damages, and the loss of certain contractual
rights.
Banner
Corporation
General: Banner
Corporation, as sole shareholder of Banner Bank and Islanders Bank, is a bank
holding company registered with the Federal Reserve. Bank holding
companies are subject to comprehensive regulation by the Federal Reserve under
the Bank Holding Company Act of 1956, as amended, or the BHCA, and the
regulations of the Federal Reserve. We are required to file quarterly
reports with the Federal Reserve and provide additional information as the
Federal Reserve may require. The Federal Reserve may examine us, and
any of our subsidiaries, and charge us for the cost of the
examination. The Federal Reserve also has extensive enforcement
authority over bank holding companies, including, among other things, the
ability to assess civil money penalties, to issue cease and desist or removal
orders and to require that a holding company divest subsidiaries (including its
bank subsidiaries). In general, enforcement actions may be initiated
for violations of law and
regulations
and unsafe or unsound practices. Banner Corporation is also required
to file certain reports with, and otherwise comply with the rules and
regulations of the Securities and Exchange Commission.
The Bank Holding Company
Act: Under the BHCA, we are supervised by the Federal
Reserve. The Federal Reserve has a policy that a bank holding company
is required to serve as a source of financial and managerial strength to its
subsidiary banks and may not conduct its operations in an unsafe or unsound
manner. In addition, the Dodd-Frank Act and earlier Federal Reserve
policy provide that a bank holding company should serve as a source of strength
to its subsidiary banks by having the ability to provide financial assistance to
its subsidiary banks during periods of financial distress to the
banks. A bank holding company’s failure to meet its obligation to
serve as a source of strength to its subsidiary banks will generally be
considered by the Federal Reserve to be an unsafe and unsound banking practice
or a violation of the Federal Reserve’s regulations or both. The
Dodd-Frank Act requires new regulations to be promulgated concerning the source
of strength. Banner Corporation and any subsidiaries that it may
control are considered “affiliates” within the meaning of the Federal Reserve
Act, and transactions between Banner Bank and affiliates are subject to numerous
restrictions. With some exceptions, Banner Corporation, and its
subsidiaries, are prohibited from tying the provision of various services, such
as extensions of credit, to other services offered by Banner Corporation, or by
its affiliates.
Acquisitions: The
BHCA prohibits a bank holding company, with certain exceptions, from acquiring
ownership or control of more than 5% of the voting shares of any company that is
not a bank or bank holding company and from engaging in activities other than
those of banking, managing or controlling banks, or providing services for its
subsidiaries. Under the BHCA, the Federal Reserve may approve the
ownership of shares by a bank holding company in any company, the activities of
which the Federal Reserve has determined to be so closely related to the
business of banking or managing or controlling banks as to be a proper incident
thereto. These activities include: operating a savings
institution, mortgage company, finance company, credit card company or factoring
company; performing certain data processing operations; providing certain
investment and financial advice; underwriting and acting as an insurance agent
for certain types of credit-related insurance; leasing property on a
full-payout, non-operating basis; selling money orders, travelers’ checks and
U.S. Savings Bonds; real estate and personal property appraising; providing tax
planning and preparation services; and, subject to certain limitations,
providing securities brokerage services for customers.
Federal Securities Laws: Banner Corporation’s common
stock is registered with the Securities and Exchange Commission under Section
12(b) of the Securities Exchange Act of 1934, as amended. We are
subject to information, proxy solicitation, insider trading restrictions and
other requirements under the Securities Exchange Act of 1934 (the Exchange
Act).
Sarbanes-Oxley Act of
2002: The Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley
Act was signed into law on July 30, 2002 in response to public concerns
regarding corporate accountability in connection with various accounting
scandals. The stated goals of the Sarbanes-Oxley Act are to increase
corporate responsibility, to provide for enhanced penalties for accounting and
auditing improprieties at publicly traded companies and to protect investors by
improving the accuracy and reliability of corporate disclosures pursuant to the
securities laws. The Sarbanes-Oxley Act generally applies to all
companies that file or are required to file periodic reports with the Securities
and Exchange Commission (SEC), under the Exchange Act.
The
Sarbanes-Oxley Act includes very specific additional disclosure requirements and
corporate governance rules and requires the SEC and securities exchanges to
adopt extensive additional disclosure, corporate governance and other related
rules. The Sarbanes-Oxley Act represents significant federal
involvement in matters traditionally left to state regulatory systems, such as
the regulation of the accounting profession, and to state corporate law, such as
the relationship between a board of directors and management and between a board
of directors and its committees. Our policies and procedures have
been updated to comply with the requirements of the Sarbanes-Oxley
Act.
Interstate Banking and
Branching: The Federal Reserve must approve an application of
a bank holding company to acquire control of, or acquire all or substantially
all of the assets of, a bank located in a state other than the holding company’s
home state, without regard to whether the transaction is prohibited by the laws
of any state. The Federal Reserve may not approve the acquisition of
a bank that has not been in existence for the minimum time period (not exceeding
five years) specified by the statutory law of the host state. Nor may
the Federal Reserve approve an application if the applicant (and its depository
institution affiliates) controls or would control more than 10% of the insured
deposits in the United States or 30% or more of the deposits in the target
bank’s home state or in any state in which the target bank maintains a
branch. Federal law does not affect the authority of states to limit
the percentage of total insured deposits in the state which may be held or
controlled by a bank holding company to the extent such limitation does not
discriminate against out-of-state banks or bank holding
companies. Individual states may also waive the 30% state-wide
concentration limit contained in the federal law.
The
federal banking agencies are authorized to approve interstate merger
transactions without regard to whether the transaction is prohibited by the law
of any state, unless the home state of one of the banks adopted a law prior to
June 1, 1997 which applies equally to all out-of-state banks and expressly
prohibits merger transactions involving out-of-state
banks. Interstate acquisitions of branches will be permitted only if
the law of the state in which the branch is located permits such
acquisitions. Interstate mergers and branch acquisitions will also be
subject to the nationwide and statewide insured deposit concentration amounts
described above. Under the Dodd-Frank Act, the federal banking
agencies may generally approve interstate de novo branching.
Dividends: The
Federal Reserve has issued a policy statement on the payment of cash dividends
by bank holding companies, which expresses its view that although there are no
specific regulations restricting dividend payments by bank holding companies
other than state corporate laws, a bank holding company must maintain an
adequate capital position and generally should not pay cash dividends unless the
company’s net income for the past year is sufficient to fully fund the cash
dividends and that the prospective rate of earnings appears consistent with the
company’s capital needs, asset quality, and overall financial
condition. The Federal Reserve policy statement also indicates that
it would be inappropriate for a company experiencing serious financial problems
to borrow funds to pay dividends. As part of the FRB MOU, the Company
may not declare or pay any dividends on its common or preferred stock without
the prior written non-objection of the Federal Reserve.
Capital Requirements: The
Federal Reserve has established capital adequacy guidelines for bank holding
companies that generally parallel the capital requirements of the FDIC for the
Banks, although the Federal Reserve regulations provide for the inclusion of
certain trust preferred securities for up to 25% of Tier 1 capital in
determining compliance with the guidelines. The Federal Reserve
regulations provide that capital standards will be applied on a consolidated
basis in the case of a bank holding company with $500 million or more in total
consolidated assets. The guidelines require that a company’s total
risk-based capital must equal 8% of risk-weighted assets and one half of the 8%
(4%) must consist of Tier 1 (core) capital. As of December 31, 2010,
Banner Corporation’s total risk-based capital was 16.92% of risk-weighted assets
and its Tier 1 (core) capital was 15.65% of risk-weighted assets. As discussed
above, new capital regulations are to be issued under the Dodd-Frank Act and the
use of trust preferred securities as regulatory capital is now
restricted.
Stock
Repurchases: A bank holding company, except for certain
“well-capitalized” and highly rated bank holding companies, is required to give
the Federal Reserve prior written notice of any purchase or redemption of its
outstanding equity securities if the gross consideration for the purchase or
redemption, when combined with the net consideration paid for all such purchases
or redemptions during the preceding twelve months, is equal to 10% or more of
its consolidated net worth. The Federal Reserve may disapprove such a
purchase or redemption if it determines that the proposal would constitute an
unsafe or unsound practice or would violate any law, regulation, Federal Reserve
order or any condition imposed by, or written agreement with, the Federal
Reserve. The Company has been informed that it may not repurchase its
common stock without the prior written non-objection of the Federal Reserve
Bank. We did not repurchase any shares of common stock during the
2010 fiscal year.
Executive
Officers
The
following table sets forth information with respect to the executive officers of
Banner Corporation and Banner Bank as of December 31, 2010:
|
Name
|
Age
|
Position with Banner
Corporation
|
Position with Banner
Bank
|
|
Mark
J. Grescovich
|
46
|
President,
Chief Executive Officer,
Director
|
President,
Chief Executive Officer,
Director
|
|
D.
Michael Jones
|
68
|
Director
Former
President and Chief Executive
Officer—Retired
during 2010
|
Director
Former
President and Chief Executive
Officer—Retired
during 2010
|
|
Lloyd
W. Baker
|
62
|
Executive
Vice President,
|
Executive
Vice President,
|
|
Chief
Financial Officer
|
Chief
Financial Officer
|
||
|
Cynthia
D. Purcell
|
53
|
Executive
Vice President,
|
|
|
Retail
Banking and Administration
|
|||
|
Richard
B. Barton
|
67
|
Executive
Vice President,
|
|
|
Chief
Lending Officer
|
|||
|
Paul
E. Folz
|
56
|
Executive
Vice President,
|
|
|
Commercial
Banking
|
|||
|
Steven
W. Rust
|
63
|
Executive
Vice President,
|
|
|
Chief
Information Officer
|
|||
|
Douglas
M. Bennett
|
58
|
Executive
Vice President,
|
|
|
Real
Estate Lending Operations
|
|||
|
Tyrone
J. Bliss
|
53
|
Executive
Vice President,
|
|
|
Risk
Management and Compliance Officer
|
|||
|
Gary
W. Wagers
|
50
|
Executive
Vice President
|
|
|
Retail
Products and Services
|
|||
|
John
T. Wagner
|
60
|
Executive
Vice President
|
|
|
Corporate
Administration
|
Biographical
Information
Set forth
below is certain information regarding the executive officers of Banner
Corporation and Banner Bank. There are no family relationships among
or between the directors or executive officers.
Mark J. Grescovich is President and
Chief Executive Officer, and a director, of Banner Corporation and Banner
Bank. Mr. Grescovich joined the Bank in April 2010 and became Chief
Executive Officer in August 2010 following an extensive banking career
specializing in finance, credit administration and risk
management. Prior to joining the Bank, Mr. Grescovich was the
Executive Vice President and Chief Corporate Banking Officer for Akron,
Ohio-based FirstMerit Corporation and FirstMerit Bank N.A., a commercial bank
with $14.5 billion in assets and over 200 branch offices in three
states. He assumed the role and responsibility for FirstMerit’s
commercial and regional line of business in 2007, having served since 1994 in
various commercial and corporate banking positions, including that of Chief
Credit Officer. Prior to joining FirstMerit, Mr. Grescovich was a
Managing Partner in corporate finance with Sequoia Financial Group, Inc. of
Akron, Ohio and a commercial and corporate lending officer and credit analyst
with Society National Bank of Cleveland, Ohio.
D. Michael Jones retired in
2010 as President and Chief Executive Officer of Banner Corporation and Banner
Bank. He joined Banner Bank in 2002 following an extensive career in
banking, finance and accounting. Mr. Jones served as President and
Chief Executive Officer from 1996 to 2001 for Source Capital Corporation, a
lending company in Spokane, Washington. From 1987 to 1995, Mr. Jones
served as President of West One Bancorp, a large regional banking franchise
based in Boise, Idaho. Mr. Jones retired as President of the Company
on April 6, 2010 and Chief Executive Officer on August 31, 2010. He
is still a director of the Company and the Bank.
Lloyd W. Baker joined First
Savings Bank of Washington (now Banner Bank) in 1995 as Asset/Liability Manager,
has been a member of the executive management committee since 1998 and has
served as its Chief Financial Officer since 2000. His banking career
began in 1972.
Cynthia D. Purcell was
formerly the Chief Financial Officer of Inland Empire Bank (now Banner Bank),
which she joined in 1981, and has served in her current position as Executive
Vice President since 2000. Ms. Purcell is responsible for Retail
Banking and Administration.
Richard B. Barton joined
Banner Bank in 2002 as Chief Credit Officer. Mr. Barton’s banking
career began in 1972 with Seafirst Bank and Bank of America, where he served in
a variety of commercial lending and credit risk management
positions. In his last positions at Bank of America before joining
Banner Bank, he served as the senior real estate risk management executive for
the Pacific Northwest and as the credit risk management executive for the west
coast home builder division. Mr. Barton was named Chief Lending
Officer in 2008.
Paul E. Folz joined Banner
Bank in 2002. Mr. Folz has 31 years of commercial lending experience
and, prior to joining Banner, served as Washington Mutual’s Senior Vice
President in charge of commercial banking operations in the State of
Oregon.
Steven W. Rust joined Banner
Bank in October 2005. Mr. Rust brings over 32 years of relevant
industry experience to Banner Bank’s management team. Prior to
joining Banner Bank he was founder and president of InfoSoft Technology, through
which he worked for nine years as a technology consultant and interim Chief
Information Officer for banks and insurance companies. He worked 19
years with US Bank/West One Bancorp as Senior Vice President & Manager of
Information Systems.
Douglas M. Bennett, who
joined First Federal Savings and Loan (now Banner Bank) in 1974, has over 34
years of experience in real estate lending. He has served as a member
of Banner Bank’s executive management committee since 2004.
Tyrone J. Bliss joined Banner
Bank in 2002. Mr. Bliss is a Certified Regulatory Compliance Manager
with more than 31 years of commercial banking experience. Prior to
joining Banner Bank, his career included senior risk management and compliance
positions with Bank of America’s Consumer Finance Group, Barnett Banks, Inc.,
and Florida-based community banks.
Gary W. Wagers joined Banner
Bank as Senior Vice President, Consumer Lending Administration in 2002 and was
named to his current position in Retail Products and Services in January
2008. Mr. Wagers began his banking career in 1982 at Idaho First
National Bank. Prior to joining Banner Bank, his career included
senior management positions in retail lending and branch banking operations with
West One Bank and US Bank.
John T. Wagner began his
banking career in 1972 with Norwest Bank. He worked for Seafirst Bank and Bank
of America from 1977 to 2003, concluding his career there as Market President
for Eastern Washington and Idaho. He joined F&M Bank in October, 2003 as
President and Chief Operating Officer. Currently, John serves as Executive Vice
President at Banner Bank. He is a graduate of the University of
Montana with a bachelor’s degree in Finance. He is a 1986 graduate of
Pacific Coast Banking School and has completed the Executive Management Program
at Duke University.
Our
principal executive offices are located at 10 South First Avenue, Walla Walla,
Washington 99362. Our telephone number is (509)
527-3636. We maintain a website with the address
www.bannerbank.com. The information contained on our website is not
included as a part of, or incorporated by reference into, this Annual Report on
Form 10-K. Other than an investor’s own Internet access charges, we
make available free of charge through our website our Annual Report on Form
10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and
amendments to these reports, as soon as reasonably practicable after we have
electronically filed such material with, or furnished such material to, the
Securities and Exchange Commission.
An
investment in our common stock is subject to risks inherent in our
business. Before making an investment decision, you should carefully
consider the risks and uncertainties described below together with all of the
other information included in this report. In addition to the risks
and uncertainties described below, other risks and uncertainties not currently
known to us or that we currently deem to be immaterial also may materially and
adversely affect our business, financial condition and results of
operations. The value or market price of our common stock could
decline due to any of these identified or other risks, and you could lose all or
part of your investment. The risks discussed below also include
forward-looking statements, and our actual results may differ substantially from
those discussed in these forward-looking statements. This report is
qualified in its entirety by these risk factors.
Risks
Associated with Our Business
Our
business may continue to be adversely affected by downturns in the national
economy and the regional economies on which we depend.
Our
operations are significantly affected by national and regional economic
conditions. Substantially all of our loans are to businesses and
individuals in the states of Washington, Oregon and Idaho. All of our
branches and most of our deposit customers are also located in these three
states. A continuing decline in the economies of the markets in which
we operate, in particular the Puget Sound area of Washington State, the
Portland, Oregon metropolitan area, Boise, Idaho and the agricultural regions of
the Columbia Basin, could have a material adverse effect on our business,
financial condition, results of operations and prospects. In
particular, Washington, Oregon and Idaho have experienced home price declines,
increased foreclosures and high unemployment rates. As a result of
our high concentration of our customer base in the Puget Sound area of
Washington State, the deterioration of businesses in the Puget Sound area, or
one or more businesses with a large employee base in that area, also could have
a material adverse effect on our business, financial condition, results of
operations and prospects. In addition, weakness in the global economy
has adversely affected many businesses operating in our markets that are
dependent upon international trade.
A further
deterioration in economic conditions in the market areas we serve could result
in the following consequences, any of which could have a material adverse effect
on our business, financial condition and results of operations:
|
·
|
demand
for our products and services may
decline;
|
|
·
|
loan
delinquencies, problem assets and foreclosures may
increase;
|
|
·
|
collateral
for loans made may decline further in value;
and
|
|
·
|
the
amount of our low-cost or non-interest-bearing deposits may
decrease.
|
Declining
property values have increased the loan-to-value ratios on a significant portion
of our residential mortgage loan portfolio, which exposes us to greater risk of
loss.
Many of
our residential mortgage loans are secured by liens on mortgage properties in
which the borrowers have little or no equity because either we originated the
loan with a relatively high combined loan-to-value ratio or because of the
decline in home values in our market areas. Residential loans with
high combined loan-to-value ratios will be more sensitive to declining property
values than those with lower combined loan-to-value ratios and therefore may
experience a higher incidence of default and severity of losses. In
addition, if the borrowers sell their homes, such borrowers may be unable to
repay their loans in full from the sale proceeds. As a result, these
loans may experience higher rates of delinquencies, defaults and
losses.
Our
loan portfolio includes loans with a higher risk of loss.
We
originate construction and land loans, commercial and multifamily mortgage
loans, commercial business loans, consumer loans, agricultural mortgage loans
and agricultural loans as well as residential mortgage loans primarily within
our market areas. Generally, the types of loans other than the
residential mortgage loans have a higher risk of loss than the residential
mortgage loans. We had approximately $2.720 billion outstanding in
these types of higher risk loans at December 31, 2010 compared to approximately
$3.087 billion at December 31, 2009. These loans typically have
greater credit risk than residential real estate for the following
reasons
|
·
|
Construction and Land Loans.
At December 31, 2010, construction and land loans were $444 million
or 13% of our total loan portfolio. This type of lending
contains the inherent difficulty in estimating both a property’s value at
completion of the project and the estimated cost (including interest) of
the project. If the estimate of construction cost proves to be
inaccurate, we may be required to advance funds beyond the amount
originally committed to permit completion of the project. If
the estimate of value upon completion proves to be inaccurate, we may be
confronted at, or prior to, the maturity of the loan with a project the
value of which is insufficient to assure full repayment. In
addition, speculative construction loans to a builder are often associated
with homes that are not pre-sold, and thus pose a greater potential risk
to us than construction loans to individuals on their personal
residences. Loans on land under development or held for future
construction also poses additional risk because of the lack of income
being produced by the property and the potential illiquid nature of the
collateral. These risks can be significantly impacted by supply
and demand conditions. As a result, this type of lending often
involves the disbursement of substantial funds with repayment dependent on
the success of the ultimate project and the ability of the borrower to
sell the property, rather than the ability of the borrower or guarantor to
independently repay principal and interest. While our
origination of these types of loans has decreased significantly in the
last three years, we continue to have significant levels of construction
and land loan balances. Most of our construction loans are for
the construction of single family residences. Reflecting the
current slowdown in the residential market, the secondary market for
construction and land loans is not readily liquid, so we have less
opportunity to mitigate our credit risk by selling part or all of our
interest in these loans. If we foreclose on a construction or
land loan, our holding period for the collateral typically may be longer
than we have historically experienced because there are fewer potential
purchasers of the collateral. The decline in the number of
potential purchasers has contributed to the decline in the value of these
loans. Accordingly, charge-offs on construction and land loans
|
| may be larger than those incurred by other segments of our loan portfolio. At December 31, 2010, construction and land loans that were non-performing were $76 million or 50% of our total non-performing loans. |
|
·
|
Commercial and Multifamily
Real Estate Loans. At December 31, 2010, commercial and
multifamily real estate loans were $1.200 billion or 35% of our total loan
portfolio. These loans typically involve higher principal
amounts than other types of loans. Repayment is dependent upon
income being generated from the property securing the loan in amounts
sufficient to cover operating expenses and debt service, which may be
adversely affected by changes in the economy or local market
conditions. Commercial and multifamily real estate loans may
expose a lender to greater credit risk than loans secured by residential
real estate because the collateral securing these loans may not be sold as
easily as residential real estate. In addition, many of our
commercial and multifamily real estate loans are not fully amortizing and
contain large balloon payments upon maturity. Such balloon
payments may require the borrower to either sell or refinance the
underlying property in order to make the payment, which may increase the
risk of default or non-payment. This risk is exacerbated in the
current economic environment. At December 31, 2010, commercial
and multifamily real estate loans that were non-performing were $27
million or 18% of our total non-performing
loans.
|
|
·
|
Commercial Business
Loans. At December 31, 2010, commercial business loans
were $585 million or 17% of our total loan portfolio. Our commercial loans
are primarily made based on the cash flow of the borrower and secondarily
on the underlying collateral provided by the borrower. The
borrowers’ cash flow may be unpredictable, and collateral securing these
loans may fluctuate in value. Most often, this collateral is
accounts receivable, inventory, equipment or real estate. In
the case of loans secured by accounts receivable, the availability of
funds for the repayment of these loans may be substantially dependent on
the ability of the borrower to collect amounts due from its
customers. Other collateral securing loans may depreciate over
time, may be difficult to appraise, may be illiquid and may fluctuate in
value based on the success of the business. At December 31,
2010, commercial business loans that were non-performing were $21 million
or 14% of our total non-performing
loans.
|
|
·
|
Agricultural
Loans. At December 31, 2010, agricultural loans were
$205 million or 6% of our total loan portfolio. Repayment is
dependent upon the successful operation of the business, which is greatly
dependent on many things outside the control of either us or the
borrowers. These factors include weather, commodity prices, and
interest rates among others. Collateral securing these loans
may be difficult to evaluate, manage or liquidate and may not provide an
adequate source of repayment. At December 31, 2010,
agricultural loans that were non-performing were $6 million or 4% of our
total non-performing loans.
|
|
·
|
Consumer
Loans. At December 31, 2010, consumer loans were $286
million or 8% of our total loan portfolio. Consumer loans (such
as personal lines of credit) are collateralized, if at all, with assets
that may not provide an adequate source of payment of the loan due to
depreciation, damage, or loss. In addition, consumer loan
collections are dependent on the borrower’s continuing financial
stability, and thus are more likely to be adversely affected by job loss,
divorce, illness or personal bankruptcy. Furthermore, the
application of various federal and state laws, including federal and state
bankruptcy and insolvency laws, may limit the amount that can be recovered
on these loans. At December 31, 2010, consumer loans that were
non-performing were $2 million, or 2% of our total non-performing
loans.
|
Our
provision for loan losses and net loan charge-offs have increased significantly
in recent years and we may be required to make further increases in our
provisions for loan losses and to charge off additional loans in the future,
which could adversely affect our results of operations.
For the
year ended December 31, 2010, we recorded a provision for loan losses of $70.0
million, compared to $109.0 million for the year ended December 31,
2009. We also recorded net loan charge-offs of $67.9 million for the
year ended December 31, 2010, compared to $88.9 million for the year ended
December 31, 2009. Despite the decrease from the prior year, we are
still experiencing elevated levels of loan delinquencies and credit
losses. Slower sales, excess inventory and declining prices have been
the primary causes of the increase in delinquencies and foreclosures for
construction and land development loans which, including related real estate
owned, represent 54% of our non-performing assets at December 31,
2010. At December 31, 2010, our total non-performing assets had
decreased to $254.3 million compared to $295.9 million at December 31,
2009. Further, our portfolio is concentrated in construction and land
loans, commercial business and commercial real estate loans, all of which
generally have a higher risk of loss than residential mortgage
loans. If current weak conditions in the housing and real estate
markets continue, we expect that we will continue to experience higher than
normal delinquencies and credit losses. Moreover, if weak economic
conditions in our market areas persist, we could experience significantly higher
delinquencies and credit losses. As a result, we may be required to make further
increases in our provision for loan losses and to charge off additional loans in
the future, which could materially adversely affect our financial condition and
results of operations.
Our
allowance for loan losses may prove to be insufficient to absorb losses in our
loan portfolio.
Lending
money is a substantial part of our business and each loan carries a certain risk
that it will not be repaid in accordance with its terms or that any underlying
collateral will not be sufficient to assure repayment. This risk is
affected by, among other things:
· cash flow
of the borrower and/or the project being financed;
· the
changes and uncertainties as to the future value of the collateral, in the case
of a collateralized loan;
· the
duration of the loan;
· the
character and creditworthiness of a particular borrower; and
· changes
in economic and industry conditions.
We
maintain an allowance for loan losses, which is a reserve established through a
provision for loan losses charged to expense, which we believe is appropriate to
provide for probable losses in our loan portfolio. The amount of this allowance
is determined by our management through periodic reviews and consideration of
several factors, including, but not limited to:
|
·
|
our
general reserve, based on our historical default and loss experience,
certain macroeconomic factors, and management’s expectations of future
events;
|
|
·
|
our
specific reserve, based on our evaluation of non-performing loans and
their underlying collateral; and
|
|
·
|
an
unallocated reserve to provide for other credit losses inherent in our
portfolio that may not have been contemplated in the other loss
factors.
|
The
determination of the appropriate level of the allowance for loan losses
inherently involves a high degree of subjectivity and requires us to make
various assumptions and judgments about the collectability of our loan
portfolio, including the creditworthiness of our borrowers and the value of the
real estate and other assets serving as collateral for the repayment of many of
our loans. In determining the amount of the allowance for loan
losses, we review our loans and loss and delinquency experience, and evaluate
economic conditions and make significant estimates of current credit risks and
future trends, all of which may undergo material changes. If our
estimates are incorrect, the allowance for loan losses may not be sufficient to
cover losses inherent in our loan portfolio, resulting in the need for additions
to our allowance through an increase in the provision for loan
losses. Continuing deterioration in economic conditions affecting
borrowers, new information regarding existing loans, identification of
additional problem loans and other factors, both within and outside of our
control, may require an increase in the allowance for loan
losses. Our allowance for loan losses was 2.86% of total loans
outstanding and 64% of non-performing loans at December 31, 2010. In
addition, bank regulatory agencies periodically review our allowance for loan
losses and may require an increase in the provision for possible loan losses or
the recognition of further loan charge-offs, based on judgments different than
those of management. In addition, if charge-offs in future periods
exceed the allowance for loan losses, we will need additional provisions to
increase the allowance for loan losses. Any increases in the
provision for loan losses will result in a decrease in net income and may have a
material adverse effect on our financial condition, results of operations and
capital.
We
are required to comply with the terms of memoranda of understanding that we have
entered into with the FDIC and DFI and the Federal Reserve and lack of
compliance could result in additional regulatory actions.
On March
23, 2010, the FDIC and the DFI entered into an agreement on a Memorandum of
Understanding, or Bank MOU, with Banner Bank. Under the terms of the Bank MOU,
Banner Bank may not:
|
·
|
appoint
any new director or senior executive officer or change the
responsibilities of any current senior executive officers without the
prior written non-objection of the FDIC and/or the DFI;
and
|
|
·
|
pay
cash dividends to its holding company, Banner Corporation, without the
prior written consent of the FDIC and the
DFI.
|
Other
material provisions of the Bank MOU require Banner Bank to:
|
·
|
maintain
Tier 1 Capital of not less than 10.0% of Banner Bank’s adjusted total
assets pursuant to Part 325 of the FDIC Rules and Regulations by July 21,
2010, and maintain capital ratios above “well capitalized” thresholds as
defined under Section 325.103 of the FDIC Rules and
Regulations;
|
|
·
|
utilize
a comprehensive policy for determining the adequacy of the allowance for
loan loss;
|
|
·
|
formulate
and implement a written plan addressing retention of profits, reduction of
overhead expenses and a budget through 2012 acceptable to the FDIC and the
DFI;
|
|
·
|
eliminate
from its books all assets classified “Loss” that have not been previously
collected or charged-off;
|
|
·
|
by
June 30, 2010, reduce all assets classified “Substandard” in the report of
examination to not more than 80% of Tier 1 capital plus the allowance for
loan losses;
|
|
·
|
develop
a written plan for reducing adversely classified
assets;
|
|
·
|
develop
a written plan for reducing the aggregate amount of its commercial real
estate concentration; and
|
|
·
|
revise,
adopt and fully implement a written liquidity and funds management
policy.
|
Banner
Bank is required to provide the FDIC and DFI with progress reports regarding its
compliance with the provisions of the Bank MOU.
In
addition, on March 29, 2010, the Federal Reserve Bank of San Francisco entered
into a Memorandum of Understanding with Banner Corporation (the FRB
MOU). Under the terms of the FRB MOU, Banner Corporation, without
prior written approval, or non-objection, of the Federal Reserve Bank of San
Francisco, may not:
|
·
|
appoint
any new director or senior executive officer or change the
responsibilities of any current senior executive
officers;
|
|
·
|
receive
dividends or any other form of payment or distribution representing a
reduction in capital from Banner
Bank;
|
|
·
|
declare
or pay any dividends, or make any other capital distributions including
payments on our junior subordinated debentures underlying our trust
preferred securities;
|
|
·
|
incur,
renew, increase, or guarantee any
debt;
|
|
·
|
issue
any trust preferred securities; and
|
|
·
|
purchase
or redeem any of our stock.
|
Under the
FRB MOU, we also agreed to take any required action to ensure compliance by
Banner Bank with the Bank MOU and to submit to the Federal Reserve Bank of San
Francisco for review and approval a plan to maintain minimum levels of capital
at Banner Bank, as well as cash flow projections for Banner Corporation through
2011. We are also limited and/or prohibited, in certain
circumstances, in our ability to enter into contracts to pay and to make golden
parachute severance and indemnification payments. Under the FRB MOU,
the Company is required to provide the Federal Reserve Bank of San Francisco
with quarterly progress reports regarding its compliance with the provisions of
the FRB MOU and Banner Corporation financial statements.
At
December 31, 2010, Banner Corporation and the Banks each exceeded all current
regulatory capital requirements including the requirements included in both the
Bank MOU and FRB MOU. (See Item 1, “Business–Regulation,” and Note 18
of the Notes to the Consolidated Financial Statements for additional information
regarding regulatory capital requirements for Banner and the
Banks).
The Bank
MOU and the FRB MOU will remain in effect until stayed, modified, terminated or
suspended by the FDIC and the DFI or the Federal Reserve Bank of San Francisco,
as the case may be. If either Banner Corporation or Banner Bank were
found not in compliance with its respective MOU, it could be subject to various
remedies, including among others, the power to enjoin “unsafe or unsound”
practices, to require affirmative action to correct any conditions resulting
from any violation or practice, to direct an increase in capital, to restrict
growth, to remove officers and/or directors, and to assess civil monetary
penalties. Management of Banner Corporation and Banner Bank have been
taking action and implementing programs to comply with the requirements of the
FRB MOU and the Bank MOU, respectively. Although compliance will be
determined by the FDIC, DFI and the Federal Reserve Bank of San Francisco,
management believes that Banner Corporation and Banner Bank have complied and
will continue to comply in all material respects with the provisions of each
respective MOU. Any of these regulators may determine in their sole
discretion that the matters covered by the FRB MOU or the Bank MOU have not been
addressed satisfactorily, or that any current or past actions, violations or
deficiencies could be the subject of further regulatory enforcement
actions. Such enforcement actions could involve penalties or
limitations on our business and negatively affect our ability to implement our
business plan, pay dividends on our common stock or the value of our common
stock, as well as our financial condition and results of
operations.
Our
growth or future losses may require us to raise additional capital in the
future, but that capital may not be available when it is needed or the cost of
that capital may be very high.
We are
required by federal regulatory authorities to maintain adequate levels of
capital to support our operations. We may at some point, however, need to
raise additional capital to support continued growth or be required by our
regulators to increase our capital resources. Our ability to raise
additional capital, if needed, will depend on conditions in the capital markets
at that time, which are outside our control, and on our financial condition and
performance. Accordingly, we cannot make assurances that we will be able
to raise additional capital if needed on terms that are acceptable to us, or at
all. If we cannot raise additional capital when needed, our ability to
further expand our operations could be materially impaired and our financial
condition and liquidity could be materially and adversely
affected. In addition, if we are unable to raise additional capital
when required by our bank regulators, we may be subject to adverse regulatory
action. See “We are subject to various regulatory requirements and
may be subject to future additional regulatory restrictions and enforcement
actions.”
We
may have continuing losses and significant variation in our quarterly
results.
We
reported a net loss of $69.7 million available to common shareholders during the
year ended December 31, 2010 compared to a net loss of $43.5 million during the
year ended December 31, 2009. The net loss for the year ended
December 31, 2010 primarily resulted from our high level of non-performing
assets and the resultant reduction in interest income, increased provision for
loan losses and charges related to foreclosed real estate, in addition to a full
valuation allowance against our net deferred tax assets. In addition,
several other factors affecting our business can cause significant variations in
our quarterly results of operations. In particular, variations in the
volume of our loan originations and sales, the differences between our cost of
funds and the average interest rate earned on investments, special FDIC
insurance charges, significant changes in real estate valuations and the fair
valuation of our junior subordinated debentures or our investment securities
portfolio could have a material adverse effect on our results of operations and
financial condition.
If
our investments in real estate are not properly valued or sufficiently reserved
to cover actual losses, or if we are required to increase our valuation
reserves, our earnings could be reduced.
We obtain
updated valuations in the form of appraisals and broker price opinions when a
loan has been foreclosed and the property taken in as real estate owned (REO)
and at certain other times during the assets holding period. Our net
book value (NBV) in the loan at the time of foreclosure and thereafter is
compared to the updated market value of the foreclosed property less estimated
selling costs (fair value). A charge-off is recorded for any excess
in the asset’s NBV over its fair value. If our valuation process is
incorrect, or if property values decline, the fair value of the investments in
real estate may not be sufficient to recover our carrying value in such assets,
resulting in the need for additional charge-offs. Significant
charge-offs to our investments in real estate could have a material adverse
effect on our financial condition and results of operations.
In
addition, bank regulators periodically review our REO and may require us to
recognize further charge-offs. Any increase in our charge-offs, as
required by the bank regulators, may have a material adverse effect on our
financial condition and results of operations.
The
value of securities in our investment securities portfolio may be negatively
affected by disruptions in securities markets.
The
market for some of the investment securities held in our portfolio
has been experiencing volatility and disruption for more than two
years. These market conditions have affected and may
further detrimentally affect the value of these securities, such as through
reduced valuations because of the perception of heightened credit and liquidity
risks. There can be no assurance that the declines in market value
associated with these disruptions will not result in other-than-temporary
impairments of these assets, which would lead to accounting charges that could
have a material adverse effect on our net income and capital
levels.
An
increase in interest rates, change in the programs offered by governmental
sponsored entities (GSE) or our ability to qualify for such programs may reduce
our mortgage revenues, which would negatively impact our non-interest
income.
Our
mortgage banking operations provide a significant portion of our non-interest
income. We generate mortgage revenues primarily from gains on the
sale of single-family mortgage loans pursuant to programs currently offered by
Fannie Mae, Freddie Mac and non-GSE investors. These entities account
for a substantial portion of the secondary market in residential mortgage
loans. Any future changes in these programs, our eligibility to
participate in such programs, the criteria for loans to be accepted or laws that
significantly affect the activity of such entities
could, in
turn, materially adversely affect our results of operations. Further,
in a rising or higher interest rate environment, our originations of mortgage
loans may decrease, resulting in fewer loans that are available to be sold to
investors. This would result in a decrease in mortgage banking
revenues and a corresponding decrease in non-interest income. In
addition, our results of operations are affected by the amount of non-interest
expense associated with mortgage banking activities, such as salaries and
employee benefits, occupancy, equipment and data processing expense and other
operating costs. During periods of reduced loan demand, our results
of operations may be adversely affected to the extent that we are unable to
reduce expenses commensurate with the decline in loan originations.
Fluctuating
interest rates can adversely affect our profitability.
Our
profitability is dependent to a large extent upon net interest income, which is
the difference, or spread, between the interest earned on loans, securities and
other interest-earning assets and the interest paid on deposits, borrowings, and
other interest-bearing liabilities. Because of the differences in
maturities and repricing characteristics of our interest-earning assets and
interest-bearing liabilities, changes in interest rates do not produce
equivalent changes in interest income earned on interest-earning assets and
interest paid on interest-bearing liabilities. We principally manage
interest rate risk by managing the volume, mix and interest rate sensitivity of
our earning assets and funding liabilities. In a changing interest
rate environment, we may not be able to manage this risk
effectively. Changes in interest rates also can affect: (1) our
ability to originate and /or sell loans; (2) the value of our interest-earning
assets, which would negatively impact stockholders’ equity, our ability to
realize gains from the sale of such assets and the collateral value of pledged
assets; (3) our ability to obtain and retain deposits in competition with other
available investment alternatives; and (4) the ability of our borrowers to repay
adjustable or variable rate loans. Interest rates are highly sensitive to many
factors, including government monetary policies, domestic and international
economic and political conditions and other factors beyond our
control. If we are unable to manage interest rate risk effectively,
our business, financial condition and results of operations could be materially
harmed.
Further,
a significant portion of our adjustable rate loans have interest rate floors
below which the loan’s contractual interest rate may not
adjust. Approximately 63% of our loan portfolio was comprised of
adjustable or floating-rate loans at December 31, 2010, and approximately $1.5
billion, or 71%, of those loans contained interest rate floors, below which the
loans’ contractual interest rate may not adjust. At December 31,
2010, the weighted average floor interest rate of these loans was
5.67%. At that date, approximately $1.3 billion, or 84%, of these
loans were at their floor interest rate. The inability of our loans
to adjust downward can contribute to increased income in periods of declining
interest rates, although this result is subject to the risks that borrowers may
refinance these loans during periods of declining interest
rates. Also, when loans are at their floors, there is a further risk
that our interest income may not increase as rapidly as our cost of funds during
periods of increasing interest rates which could have a material adverse affect
on our results of operations.
Further
deterioration in the financial position of the Federal Home Loan Bank of Seattle
may result in future impairment losses on our investment in Federal Home Loan
Bank stock.
At
December 31, 2010, we owned $37.4 million of stock of the Federal Home Loan Bank
of Seattle, or FHLB. As a condition of membership at the FHLB, we are
required to purchase and hold a certain amount of FHLB stock. Our
stock purchase requirement is based, in part, upon the outstanding principal
balance of advances from the FHLB and is calculated in accordance with the
Capital Plan of the FHLB. Our FHLB stock has a par value of $100, is
carried at cost, and is subject to recoverability testing. The FHLB
announced that it had a risk-based capital deficiency under the regulations of
the Federal Housing Finance Agency (the "FHFA"), its primary regulator, as of
December 31, 2008, and that it would suspend future dividends and the repurchase
and redemption of outstanding common stock. As a result, the FHLB has
not paid a dividend since the fourth quarter of 2008. The FHLB has
communicated that it believes the calculation of risk-based capital under the
current rules of the FHFA significantly overstates the market risk of the FHLB's
private-label mortgage-backed securities in the current market environment and
that it has enough capital to cover the risks reflected in its balance
sheet. As a result, we have not recorded an impairment on our
investment in FHLB stock. However, further deterioration in the FHLB's financial
position may result in impairment in the value of those
securities. In addition, on October 25, 2010, the FHLB received a
consent order from the FHFA. The potential impact of the consent order is
unknown at this time. We will continue to monitor the financial condition of the
FHLB as it relates to, among other things, the recoverability of our
investment.
Financial
reform legislation recently enacted by Congress will, among other things,
tighten capital standards, create a new Consumer Financial Protection Bureau and
result in new laws and regulations that are expected to increase our costs of
operations.
On July
21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer
Protection Act (Dodd-Frank Act). This new law will significantly
change the current bank regulatory structure and affect the lending, deposit,
investment, trading and operating activities of financial institutions and their
holding companies. The Dodd-Frank Act requires various federal
agencies to adopt a broad range of new implementing rules and regulations, and
to prepare numerous studies and reports for Congress. The federal
agencies are given significant discretion in drafting the implementing rules and
regulations, and consequently, many of the details and much of the impact of the
Dodd-Frank Act may not be known for many months or years.
Among the
many requirements in the Dodd-Frank Act for new banking regulations is a
requirement for new capital regulations to be adopted within 18
months. These regulations must be at least as stringent as, and may
call for higher levels of capital than, current
regulations. Generally, trust preferred securities will no longer be
eligible as Tier 1 capital, but the Company’s currently outstanding trust
preferred securities will be grandfathered and its currently outstanding TARP
preferred securities will continue to qualify as Tier 1 capital. In
addition, the banking regulators are required to seek to make capital
requirements for banks and bank holding companies countercyclical so that
capital requirements increase in times of economic expansion and decrease in
times of economic contraction.
Certain
provisions of the Dodd-Frank Act are expected to have a near term impact on
Banner. For example, effective one year after the date of enactment,
the Dodd-Frank Act eliminates the federal prohibitions on paying interest on
demand deposits, thus allowing businesses to have interest-bearing checking
accounts. Depending on competitive responses, this significant change
to existing law could have an adverse impact on the Company’s interest
expense.
The
Dodd-Frank Act also broadens the base for Federal Deposit Insurance Corporation
insurance assessments. Assessments will now be based on the average
consolidated total assets less tangible equity capital of a financial
institution. The Dodd-Frank Act also permanently increases
the
maximum amount of deposit insurance for banks, savings institutions and credit
unions to $250,000 per depositor and non-interest-bearing transaction accounts
and IOLTA accounts have unlimited deposit insurance through December 31,
2012.
The
Dodd-Frank Act will require publicly traded companies to give stockholders a
non-binding vote on executive compensation and so-called “golden parachute”
payments and authorizes the Securities and Exchange Commission to promulgate
rules that would allow stockholders to nominate their own candidates using a
company’s proxy materials. The legislation also directs the federal
banking regulators to issue rules prohibiting incentive compensation that
encourages inappropriate risks. The legislation also directs the Federal Reserve
Board to promulgate rules prohibiting excessive compensation paid to bank
holding company executives, regardless of whether the company is publicly traded
or not.
The
Dodd-Frank Act creates a new Consumer Financial Protection Bureau with broad
powers to supervise and enforce consumer protection laws. The
Consumer Financial Protection Bureau has broad rule-making authority for a wide
range of consumer protection laws that apply to all banks and savings
institutions, including the authority to prohibit “unfair, deceptive or abusive”
acts and practices. The Consumer Financial Protection Bureau has
examination and enforcement authority over all banks and savings institutions
with more than $10 billion in assets. Financial institutions such as the Banks
with $10 billion or less in assets will continued to be examined for compliance
with the consumer laws by their primary bank regulators.
Many
aspects of the Dodd-Frank Act are subject to rulemaking and will take effect
over several years, making it difficult to anticipate the overall financial
impact on the Company. However, compliance with this new law and its
implementing regulations will result in additional operating costs that could
have a material adverse effect on our financial condition and results of
operations.
Increases
in deposit insurance premiums and special FDIC
assessments will negatively impact our earnings.
FDIC
insurance premiums increased significantly in 2009 and we may pay higher FDIC
premiums in the future.
The
Dodd-Frank Act established 1.35% as the minimum reserve ratio. The
FDIC has adopted a plan under which it will meet this ratio by the statutory
deadline of September 30, 2020. The Dodd-Frank Act requires the FDIC to offset
the effect on institutions with assets less than $10 billion of the increase in
the minimum reserve ratio to 1.35% from the former minimum of
1.15%. The FDIC has not announced how it will implement this
offset. In addition to the statutory minimum ratio, the FDIC must set
a designated reserve ratio or DRR, which may exceed the statutory
minimum. The FDIC has set 2.0 as the DRR.
As
required by the Dodd-Frank Act, the FDIC has adopted final regulations under
which insurance premiums are based on an institution's total assets minus its
tangible equity instead of its deposits. While our FDIC insurance
premiums initially will be reduced by these regulations, it is possible that our
future insurance premiums will increase under the final
regulations.
A
decline or lack of credit availability could limit our ability to replace
deposits and fund loan demand, which could adversely affect our earnings and
capital levels.
A decline
of lack of credit availability and the inability to obtain adequate funding to
replace deposits if necessary and fund loan growth may negatively affect asset
growth and, consequently, our earnings capability and capital
levels. In addition to any deposit growth, maturity of investment
securities and loan payments, we rely from time to time on advances from the
Federal Home Loan Bank of Seattle, borrowings from the Federal Reserve Bank of
San Francisco and certain other wholesale funding sources to fund loans and
replace deposits. Negative operating results or economic conditions
could adversely affect these additional funding sources, which could limit the
funds available to us. Our liquidity position could be significantly
constrained if we are unable to access funds from the Federal Home Loan Bank of
Seattle, the Federal Reserve Bank of San Francisco or other wholesale funding
sources or if adequate financing is not available at acceptable interest rates.
Finally, if we are required to rely more heavily on more expensive funding
sources, our revenues may not increase proportionately to cover our costs. In
this case, our results of operations and financial condition would be negatively
affected.
Failure to manage our growth may
adversely affect our performance.
Our
financial performance and profitability depend on our ability to manage past and
possible future growth. Future acquisitions and growth may present
operating, integration and other issues that could have a material adverse
effect on our business, financial condition or results of
operations.
Liquidity
risk could impair our ability to fund operations and jeopardize our financial
condition.
Liquidity
is essential to our business and the inability to obtain adequate funding may
negatively affect growth and, consequently, our earnings capability and capital
levels. An inability to raise funds through deposits, borrowings, the
sale of loans and other sources could have a substantial negative effect on our
liquidity. Our access to funding sources in amounts adequate to
finance our activities on terms which are acceptable to us could be impaired by
factors that affect us specifically or the financial services industry or
economy in general. Factors that could detrimentally impact our
access to liquidity sources include a decrease in the level of our business
activity as a result of a downturn in the Washington, Oregon or Idaho markets in
which our loans are concentrated or adverse regulatory action against
us. Our ability to borrow could also be impaired by factors that are
not specific to us, such as a disruption in the financial markets or negative
views and expectations about the prospects for the financial services industry
in light of the recent turmoil faced by banking organizations and the continued
uncertainty in credit markets. In addition, recent changes in the
collateralization requirements and other provisions of the Washington and Oregon
public funds deposit programs have changed the economic benefit associated with
accepting public funds deposits, which may affect our need to utilize
alternative sources of liquidity.
We
may engage in FDIC-assisted transactions, which could present additional risks
to our business.
We may
have opportunities to acquire the assets and liabilities of failed banks in
FDIC-assisted transactions, including transactions in the states of Washington,
Oregon and Idaho. Although these FDIC-assisted transactions typically
provide for FDIC assistance to an acquirer to mitigate certain risks, such as
sharing exposure to loan losses and providing indemnification against certain
liabilities of the failed institution, we are (and would be in future
transactions) subject to many of the same risks we would face in acquiring
another bank in a negotiated transaction, including risks associated with
maintaining customer relationships and failure to realize the anticipated
acquisition benefits in the amounts and within the timeframes we
expect. In addition, because these acquisitions are structured in a
manner that would not allow us the time and access to information normally
associated with preparing for and evaluating a negotiated acquisition, we may
face additional risks in FDIC-assisted transactions, including additional strain
on management resources, management of problem loans, problems related to
integration of personnel and operating systems and impact to our capital
resources requiring us to raise additional capital. We cannot provide
assurance that we would be successful in overcoming these risks or any other
problems encountered in connection with FDIC-assisted
transactions. Our inability to overcome these risks could have a
material adverse effect on our business, financial condition and results of
operations.
New
or changing tax, accounting, and regulatory rules and interpretations could
significantly impact strategic initiatives, results of operations, cash flows,
and financial condition.
The
financial services industry is extensively regulated. Federal and state banking
regulations are designed primarily to protect the deposit insurance funds and
consumers, not to benefit a company's stockholders. These regulations may
sometimes impose significant limitations on operations. The significant federal
and state banking regulations that affect us are described in this report under
the heading “Item 1. Business-Regulation.” These regulations, along
with the currently existing tax, accounting, securities, insurance, and monetary
laws, regulations, rules, standards, policies, and interpretations control the
methods by which financial institutions conduct business, implement strategic
initiatives and tax compliance, and govern financial reporting and disclosures.
These laws, regulations, rules, standards, policies, and interpretations are
constantly evolving and may change significantly over time.
Such
changes could subject us to additional costs, limit the types of financial
services and products we may offer, restrict mergers and acquisitions,
investments, access to capital, the location of banking offices, and/or increase
the ability of non-banks to offer competing financial services and products,
among other things. Further, recent regulatory changes to the rules
for overdraft fees for debit transactions and interchange fees could reduce our
fee income which would result in a reduction of our noninterest income. Our
failure to comply with laws, regulations or policies could result in sanctions
by regulatory agencies, civil money penalties and/or reputational damage, which
could have a material adverse effect on our business, financial condition and
results of operations. While we have policies and procedures designed
to prevent any such violations, there can be no assurance that such violations
will not occur.
Our
litigation related costs might continue to increase.
The Banks
are subject to a variety of legal proceedings that have arisen in the ordinary
course of the Banks’ business. In the current economic environment,
the Banks’ involvement in litigation has increased significantly, primarily as a
result of defaulted borrowers asserting claims to defeat or delay foreclosure
proceedings. The Banks believe that they have meritorious defenses in
legal actions where they have been named as defendants and are vigorously
defending these suits. Although management, based on discussion with
litigation counsel, believes that such proceedings will not have a material
adverse effect on the financial condition or operations of the Banks, there can
be no assurance that a resolution of any such legal matters will not result in
significant liability to the Banks nor have a material adverse impact on their
financial condition and results of operations or the Banks’ ability to meet
applicable regulatory requirements. Moreover, the expenses of pending
legal proceedings will adversely affect the Banks’ results of operations until
they are resolved. There can be no assurance that the Banks’ loan
workout and other activities will not expose the Banks to additional legal
actions, including lender liability or environmental claims.
Because
of our participation in the TARP Capital Purchase Program, we are subject to
several restrictions including restrictions on compensation paid to our
executives.
Our
ability to attract and retain key officers and employees may be impacted by
legislation and regulation affecting the financial services industry. In 2009,
the American Recovery and Reinvestment Act (ARRA) became law. The
ARRA, through the implementing regulations of the U.S. Treasury, significantly
expanded the executive compensation restrictions originally imposed on TARP
participants, including us. Among other things, these restrictions limit our
ability to pay bonuses and other incentive compensation and make severance
payments. These restrictions will continue to apply to us for as long as the
preferred stock we issued pursuant to the TARP Capital Purchase Program remains
outstanding. These restrictions may negatively affect our ability to compete
with financial institutions that are not subject to the same
limitations.
We are dependent on key personnel and
the loss of one or more of those key personnel may materially and adversely
affect our prospects.
Competition
for qualified employees and personnel in the banking industry is intense and
there are a limited number of qualified persons with knowledge of, and
experience in, the community banking industry where the Banks conduct their
business. The process of recruiting personnel with the combination of
skills and attributes required to carry out our strategies is often
lengthy. In addition, the American Recovery and Reinvestment Act has
imposed significant limitations on executive compensation for recipients, such
as us, of funds under the TARP Capital Purchase Program, which may make it more
difficult for us to retain and recruit key personnel. Our success
depends to a significant degree upon our ability to attract and retain qualified
management, loan origination, finance, administrative, marketing and technical
personnel and upon the continued contributions of our management and
personnel. In particular, our success has been and continues to be
highly dependent upon the abilities of key executives, including our President,
and certain other employees. In addition, our success has been and
continues to be highly dependent upon the services of our directors, many of
whom are at or nearing retirement age, and we may not be able to identify and
attract suitable candidates to replace such directors.
Our
business may be adversely affected by an increasing prevalence of fraud and
other financial crimes.
Our loans
to businesses and individuals and our deposit relationships and related
transactions are subject to exposure to the risk of loss due to fraud and other
financial crimes. Nationally, reported incidents of fraud and other
financial crimes have increased. We have also experienced an increase
in losses due to apparent fraud and other financial crimes. While we
have policies and procedures designed to prevent such losses, there can be no
assurance that such losses will not occur.
Managing reputational risk is important to attracting and maintaining customers, investors and employees.
Threats
to our reputation can come from many sources, including adverse sentiment about
financial institutions generally, unethical practices, employee misconduct,
failure to deliver minimum standards of service or quality, compliance
deficiencies, and questionable or fraudulent activities of our
customers. We have policies and procedures in place to protect our
reputation and promote ethical conduct, but these policies and procedures may
not be fully effective. Negative publicity regarding our business,
employees, or customers, with or without merit, may result in the loss of
customers, investors and employees, costly litigation, a decline in revenues and
increased governmental regulation.
We rely on communications,
information, operating and financial control systems technology from third-party
service providers, and we may suffer an interruption in those
systems.
We rely
heavily on third-party service providers for much of our communications,
information, operating and financial control systems technology, including our
internet banking services and data processing systems. Any failure or
interruption of these services or systems or breaches in security of these
systems could result in failures or interruptions in our customer relationship
management, general ledger, deposit, servicing and/or loan origination
systems. The occurrence of any failures or interruptions may require
us to identify alternative sources of such services, and we cannot assure you
that we could negotiate terms that are as favorable to us, or could obtain
services with similar functionality as found in our existing systems without the
need to expend substantial resources, if at all.
If
we defer payments of interest on our outstanding junior subordinated debentures
or if certain defaults relating to those debentures occur, we will be prohibited
from declaring or paying dividends or distributions on, and from making
liquidation payments with respect to, our common stock.
As of
December 31, 2010, we had outstanding $123.7 million aggregate principal amount
($48.4 million at fair value) of junior subordinated debentures issued in
connection with the sale of trust preferred securities through statutory
business trusts. We have also guaranteed these trust preferred
securities. There are currently six separate series of these junior
subordinated debentures outstanding, each series having been issued under a
separate indenture and with a separate guarantee. Each of these
indentures, together with the related guarantee, prohibits us, subject to
limited exceptions, from declaring or paying any dividends or distributions on,
or redeeming, repurchasing, acquiring or making any liquidation payments with
respect to, any of our capital stock at any time when (i) there shall have
occurred and be continuing an event of default under such indenture or any
event, act or condition that with notice or lapse of time or both would
constitute an event of default under such indenture; (ii) we are in default with
respect to payment of any obligations under such guarantee; or (iii) we have
deferred payment of interest on the junior subordinated debentures outstanding
under that indenture. In that regard, we are entitled, at our option
but subject to certain conditions, to defer payments of interest on the junior
subordinated debentures of each series from time to time for up to five
years.
Events of
default under the indenture generally consist of our failure to pay interest on
the junior subordinated debt securities under certain circumstances, our failure
to pay any principal of or premium on such junior subordinated debt securities
when due, our failure to comply with certain covenants under the indenture, and
certain events of bankruptcy, insolvency or liquidation relating to us or the
Bank. As a result of these provisions, if we were to elect to defer
payments of interest on any series of junior subordinated debentures, or if any
of the other events described in clause (i) or (ii) of the first paragraph of
this risk factor were to occur, we would be prohibited from declaring or paying
any dividends on our common stock, from repurchasing or otherwise acquiring any
such common stock, and from making any payments to holders of common stock in
the event of our liquidation, which would likely have a material adverse effect
on the market value of our common stock. Moreover, without
notice to or consent from the holders of our common stock, we may issue
additional series of junior subordinated debentures in the future with terms
similar to those of our existing junior subordinated debentures or enter into
other financing agreements that limit our ability to purchase or to pay
dividends or distributions on our capital stock, including our common
stock.
Also,
Banner may not pay interest on the junior subordinated debentures without the
prior written non-objection of the Federal Reserve. There can be no
assurance that the Federal Reserve will continue to allow us to make payments on
our junior subordinated debentures.
If
we are unable to redeem our Series A Preferred Stock by February 2014, the cost
of this capital to us will increase substantially.
The FRB
MOU prohibits us from redeeming our outstanding capital stock without the prior
written approval of the Federal Reserve Bank of San Francisco. If we
are unable to redeem our Series A Preferred Stock prior to February 15, 2014,
the cost of this capital to us will increase substantially on that date, from
5.0% per annum (approximately $6.2 million annually) to 9.0% per annum
(approximately $11.2 million annually). Depending on our financial
condition at the time, this increase in the annual dividend rate on the Series A
Preferred Stock could have a material negative effect on our liquidity and
ability to pay dividends to common shareholders.
None.
Banner
Corporation maintains its administrative offices and main branch office, which
is owned by us, in Walla Walla, Washington. In total, as of December
31, 2010, we have 89 branch offices located in Washington, Oregon and
Idaho. Three of those 89 are Islanders Bank branches and 86 are
Banner Bank branches. Sixty-four branches are located in Washington,
sixteen in Oregon and nine in Idaho. Of those offices, approximately
half are owned and the other half are leased facilities. We also have
nine leased locations for loan production offices spread throughout the same
three-state area. The lease terms for our branch and loan production
offices are not individually material. Lease expirations range from
one to 25 years. Administrative support offices are primarily in
Washington, where we have nine facilities, of which we own two and lease
seven. Additionally, we have one leased administrative support office
in Idaho and own one located in Oregon. In the opinion of management,
all properties are adequately covered by insurance, are in a good state of
repair and are appropriately designed for their present and future
use.
In the
normal course of business, we have various legal proceedings and other
contingent matters outstanding. These proceedings and the associated
legal claims are often contested and the outcome of individual matters is not
always predictable. These claims and counter-claims typically arise
during the course of collection efforts on problem loans or with respect to
action to enforce liens on properties in which we hold a security
interest. We are not a party to any pending legal proceedings that we
believe would have a material adverse effect on our financial condition or
operations.
Item 5 – Market for Registrant’s Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity Securities
Price
Range of Common Stock and Dividend Information
Our
common stock is traded on the NASDAQ Global Select Market under the symbol
“BANR.” Shareholders of record as of December 31, 2010 totaled 1,457
based upon securities position listings furnished to us by our transfer
agent. This total does not reflect the number of persons or entities
who hold stock in nominee or “street” name through various brokerage
firms. The following tables show the reported high and low sale
prices of our common stock for the periods presented, as well as the cash
dividends declared per share of common stock for each of those
periods.
|
Year
Ended December 31, 2010
|
High
|
Low
|
Cash
Dividend
Declared
|
||||||
|
First
quarter
|
$
|
4.00
|
$
|
2.51
|
$
|
0.01
|
|||
|
Second
quarter
|
8.15
|
1.91
|
0.01
|
||||||
|
Third
quarter
|
2.59
|
1.92
|
0.01
|
||||||
|
Fourth
quarter
|
2.36
|
1.56
|
0.01
|
||||||
|
Year
Ended December 31, 2009
|
High
|
Low
|
Cash
Dividend
Declared
|
||||||
|
First
quarter
|
$
|
10.39
|
$
|
1.81
|
$
|
0.01
|
|||
|
Second
quarter
|
6.71
|
3.04
|
0.01
|
||||||
|
Third
quarter
|
4.29
|
2.51
|
0.01
|
||||||
|
Fourth
quarter
|
3.55
|
2.07
|
0.01
|
The
timing and amount of cash dividends paid on our common stock depends on our
earnings, capital requirements, financial condition and other relevant factors
and is subject to the discretion of our board of directors. After
consideration of these factors, beginning in the third quarter of 2008, we
reduced our dividend payout to preserve our capital and further reduced our
dividend in the first quarter of 2009. There can be no assurance that
we will pay dividends on our common stock in the future.
Under the
FRB MOU, we may not declare or pay any dividends on common or preferred stock or
pay interest or principal on the balance of our junior subordinated debentures
without the FRBSF’s prior written non-objection.
Our
ability to pay dividends on our common stock depends primarily on dividends we
receive from Banner Bank and Islanders Bank. Under federal
regulations, the dollar amount of dividends the Banks may pay depends upon their
capital position and recent net income. Generally, if a bank
satisfies its regulatory capital requirements, it may make dividend payments up
to the limits prescribed under state law and FDIC regulations; however, under
the Bank MOU, Banner Bank is unable to pay dividends to Banner Corporation
without the prior consent of the FDIC and DFI. In addition, an
institution that has converted to a stock form of ownership may not declare or
pay a dividend on, or repurchase any of, its common stock if the effect thereof
would cause the regulatory capital of the institution to be reduced below the
amount required for the liquidation account which was established in connection
with the conversion. Banner Bank, our primary subsidiary, converted
to a stock form of ownership and is therefore subject to the limitation
described in the preceding sentence. In addition, under Washington
law, no bank may declare or pay any dividend in an amount greater than its
retained earnings. The Washington DFI has the power to require any
bank to suspend the payment of any and all dividends.
Further,
under Washington law, Banner Corporation is prohibited from paying a dividend
if, after making such dividend payment, it would be unable to pay its debts as
they become due in the usual course of business, or if its total liabilities,
plus the amount that would be needed, in the event Banner Corporation were to be
dissolved at the time of the dividend payment, to satisfy preferential rights on
dissolution of holders of preferred stock ranking senior in right of payment to
the capital stock on which the applicable distribution is to be made, exceed our
total assets.
In
addition to the foregoing regulatory considerations, there are numerous
governmental requirements and regulations that affect our business
activities. A change in applicable statutes, regulations or
regulatory policy may have a material effect on our business and on our ability
to pay dividends on our common stock.
In
addition to the legal and regulatory restrictions described above, certain
contractual provisions limit our ability to pay dividends on our common
stock. The securities purchase agreement between us and the Treasury,
pursuant to which we issued our Series A Preferred Stock and Warrant as part of
the TARP Capital Purchase Program, provides that prior to the earlier of (i)
November 21, 2011 and (ii) the date on which all of the shares of the Series A
Preferred Stock have been redeemed by us or transferred by Treasury to third
parties, we may not, without the consent of the Treasury, (a) pay a quarterly
cash dividend on our common stock of more than $.05 per share or (b) subject to
limited exceptions, redeem, repurchase or otherwise acquire shares of our common
stock or preferred stock, other than the Series A Preferred Stock, or any trust
preferred securities then outstanding. In addition, under the terms
of the Series A Preferred Stock, we may not pay dividends on our common stock
unless we are current in our dividend payments on the Series A Preferred
Stock. Dividends on the Series A Preferred Stock are payable
quarterly at a rate of 5% per annum for the first five years and a rate of 9%
per annum thereafter if not redeemed prior to that time.
Issuer
Purchases of Equity Securities
We did
not have any repurchases of our common stock from October 1, 2010 through
December 31, 2010 or at any time during 2010.
Equity
Compensation Plan Information
The
equity compensation plan information presented under Part III, Item 12 of this
report is incorporated herein by reference.
Performance
Graph. The following graph compares the cumulative total
shareholder return on Banner Corporation common stock with the cumulative total
return on the NASDAQ (U.S. Stock) Index, a peer group of the SNL $1 Billion to
$5 Billion Asset Bank Index and a peer group of the SNL NASDAQ Bank
Index. Total return assumes the reinvestment of all
dividends.
|
Period
Ending
|
||||||
|
Index
|
12/31/05
|
12/31/06
|
12/31/07
|
12/31/08
|
12/31/09
|
12/31/10
|
|
Banner
Corporation
|
100.00
|
144.74
|
95.91
|
32.68
|
9.39
|
8.26
|
|
NASDAQ
Composite
|
100.00
|
110.39
|
122.15
|
73.32
|
106.57
|
125.91
|
|
SNL
Bank $1B-$5B
|
100.00
|
115.72
|
84.29
|
69.91
|
50.11
|
56.81
|
|
SNL
Bank NASDAQ
|
100.00
|
112.27
|
88.14
|
64.01
|
51.93
|
61.27
|
*Assumes
$100 invested in Banner Corporation common stock and each index at the close of
business on December 31, 2005 and that all dividends were
reinvested. Information for the graph was provided by SNL Financial
L.C. © 2011.
Item 6 – Selected Financial Data
The
following condensed consolidated statements of operations and financial
condition and selected performance ratios as of December 31, 2010, 2009, 2008,
2007, and 2006 and for the years then ended have been derived from our audited
consolidated financial statements. Certain information for prior
years has been restated in accordance with the U.S. Securities and Exchange
Commission Staff Accounting Bulletin No. 108 which addresses how the effects of
prior year uncorrected misstatements should be considered when quantifying
misstatements in current year financial statements.
The
information below is qualified in its entirety by the detailed information
included elsewhere herein and should be read along with “Item 7. Management’s
Discussion and Analysis of Financial Condition and Results of Operations” and
“Item 8, Financial Statement and Supplementary Data.”
|
FINANCIAL
CONDITION DATA:
|
||||||||||||||||||||
|
December
31
|
||||||||||||||||||||
|
(In
thousands)
|
2010
|
2009
|
2008
|
2007
|
2006
|
|||||||||||||||
|
Restated
|
||||||||||||||||||||
|
Total
assets
|
$ | 4,406,082 | $ | 4,722,221 | $ | 4,584,368 | $ | 4,492,658 | $ | 3,495,566 | ||||||||||
|
Loans
receivable, net
|
3,305,716 | 3,694,852 | 3,886,211 | 3,763,790 | 2,930,455 | |||||||||||||||
|
Cash
and securities (1)
|
729,345 | 640,657 | 419,718 | 354,809 | 347,410 | |||||||||||||||
|
Deposits
|
3,591,198 | 3,865,550 | 3,778,850 | 3,620,593 | 2,794,592 | |||||||||||||||
|
Borrowings
|
267,761 | 414,315 | 318,421 | 372,039 | 404,330 | |||||||||||||||
|
Common
stockholders’ equity
|
392,472 | 287,721 | 317,433 | 437,846 | 250,607 | |||||||||||||||
|
Total
stockholders’ equity
|
511,472 | 405,128 | 433,348 | 437,846 | 250,607 | |||||||||||||||
|
Shares
outstanding
|
113,153 | 21,539 | 17,152 | 16,266 | 12,314 | |||||||||||||||
|
Shares
outstanding excluding unearned, restricted shares held in
ESOP
|
112,913 | 21,299 | 16,912 | 16,026 | 12,074 | |||||||||||||||
|
OPERATING
DATA:
|
||||||||||||||||||||
|
For
the Years Ended December 31
|
||||||||||||||||||||
|
(In
thousands)
|
2010 | 2009 | 2008 | 2007 | 2006 | |||||||||||||||
|
Restated
|
||||||||||||||||||||
|
Interest
income
|
$ | 218,082 | $ | 237,370 | $ | 273,158 | $ | 295,497 | $ | 243,019 | ||||||||||
|
Interest
expense
|
60,312 | 92,797 | 125,345 | 145,690 | 116,114 | |||||||||||||||
|
Net
interest income before provision for loan losses
|
157,770 | 144,573 | 147,813 | 149,807 | 126,905 | |||||||||||||||
|
Provision
for loan losses
|
70,000 | 109,000 | 62,500 | 5,900 | 5,500 | |||||||||||||||
|
Net
interest income
|
87,770 | 35,573 | 85,313 | 143,907 | 121,405 | |||||||||||||||
|
Deposit
fees and other service charges
|
22,009 | 21,394 | 21,540 | 16,573 | 11,417 | |||||||||||||||
|
Mortgage
banking operations
|
6,370 | 8,893 | 6,045 | 6,270 | 5,824 | |||||||||||||||
|
Other-than-temporary
impairment losses
|
(4,231 | ) | (1,511 | ) | -- | -- | -- | |||||||||||||
|
Net
change in valuation of financial instruments carried at fair
value
|
1,747 | 12,529 | 9,156 | 11,574 | -- | |||||||||||||||
|
Other
operating income
|
3,253 | 2,385 | 2,888 | 3,978 | 3,334 | |||||||||||||||
|
REO
operations
|
26,025 | 7,147 | 2,283 | 189 | (155 | ) | ||||||||||||||
|
Goodwill
write-off
|
-- | -- | 121,121 | -- | -- | |||||||||||||||
|
Insurance
recovery, net proceeds
|
-- | -- | -- | -- | (5,350 | ) | ||||||||||||||
|
Other
operating expenses
|
134,776 | 134,933 | 136,616 | 127,300 | 99,886 | |||||||||||||||
|
Income
(loss) before provision for income tax expense (benefit)
|
(43,883 | ) | (62,817 | ) | (135,078 | ) | 54,813 | 47,599 | ||||||||||||
|
Provision
for income tax expense (benefit)
|
18,013 | (27,053 | ) | (7,085 | ) | 17,890 | 16,055 | |||||||||||||
|
Net
income (loss)
|
$ | (61,896 | ) | $ | (35,764 | ) | $ | (127,993 | ) | $ | 36,923 | $ | 31,544 | |||||||
|
PER
COMMON SHARE DATA:
|
||||||||||||||||||||
|
At
or For the Years Ended December 31
|
||||||||||||||||||||
|
2010
|
2009
|
2008
|
2007
|
2006
|
||||||||||||||||
|
Net
income (loss):
|
Restated
|
|||||||||||||||||||
|
Basic
|
$ | (1.03 | ) | $ | (2.33 | ) | $ | (7.94 | ) | $ | 2.53 | $ | 2.65 | |||||||
|
Diluted
|
(1.03 | ) | (2.33 | ) | (7.94 | ) | 2.49 | 2.58 | ||||||||||||
|
Common
stockholders’ equity per share (2)
|
3.48 | 13.51 | 18.77 | 27.32 | 20.76 | |||||||||||||||
|
Common
stockholders’ tangible equity
per
share (2)
|
3.40 | 12.99 | 17.96 | 18.73 | 17.75 | |||||||||||||||
|
Cash
dividends
|
0.04 | 0.04 | 0.50 | 0.77 | 0.73 | |||||||||||||||
|
Dividend
payout ratio (basic)
|
(5.79 | )% | (1.72 | )% | (6.30 | )% | 30.43 | % | 27.55 | % | ||||||||||
|
Dividend
payout ratio (diluted)
|
(5.79 | )% | (1.72 | )% | (6.30 | )% | 30.92 | % | 28.29 | % | ||||||||||
|
OTHER
DATA:
|
|||||||||||
|
December
31
|
|||||||||||
|
2010
|
2009
|
2008
|
2007
|
2006
|
|||||||
|
Full
time equivalent employees
|
1,060
|
1,060
|
1,095
|
1,139
|
898
|
||||||
|
Number
of branches
|
89
|
89
|
86
|
84
|
58
|
||||||
|
KEY
FINANCIAL RATIOS:
|
|
At
or For the Years Ended December 31
|
||||||||||||||||||||
|
2010
|
2009
|
2008
|
2007
|
2006
|
||||||||||||||||
|
Performance
Ratios:
|
Restated
|
|||||||||||||||||||
|
Return
on average assets (3)
|
(1.36 | ) % | (0.78 | )% | (2.78 | )% | 0.91 | % | 0.96 | % | ||||||||||
|
Return
on average common equity (4)
|
(17.19 | ) | (11.69 | ) | (30.90 | ) | 10.07 | 13.29 | ||||||||||||
|
Average
common equity to average assets
|
7.90 | 6.71 | 8.99 | 9.06 | 7.19 | |||||||||||||||
|
Interest
rate spread (5)
|
3.61 | 3.23 | 3.36 | 3.86 | 3.97 | |||||||||||||||
|
Net
interest margin (6)
|
3.67 | 3.33 | 3.45 | 4.00 | 4.08 | |||||||||||||||
|
Non-interest
income to average assets
|
0.64 | 0.96 | 0.86 | 0.95 | 0.62 | |||||||||||||||
|
Non-interest
expense to average assets
|
3.53 | 3.12 | 5.65 | 3.15 | 2.86 | |||||||||||||||
|
Efficiency
ratio (7)
|
86.03 | 75.47 | 138.72 | 67.74 | 64.00 | |||||||||||||||
|
Average
interest-earning assets to interest- bearing liabilities
|
104.32 | 104.55 | 103.21 | 103.52 | 102.81 | |||||||||||||||
|
Selected
Financial Ratios:
|
||||||||||||||||||||
|
Allowance
for loan losses as a percent of total loans at end of
period
|
2.86 | 2.51 | 1.90 | 1.20 | 1.20 | |||||||||||||||
|
Net
charge-offs as a percent of average
outstanding
loans during the period
|
1.88 | 2.28 | 0.84 | 0.08 | 0.03 | |||||||||||||||
|
Non-performing
assets as a percent of total assets
|
5.77 | 6.27 | 4.56 | 0.99 | 0.43 | |||||||||||||||
|
Allowance
for loan losses as a percent of non-performing loans (8)
|
64.30 | 44.55 | 40.14 | 108.13 | 252.81 | |||||||||||||||
|
Tangible
common stockholders’ equity to tangible assets (9)
|
8.73 | 5.87 | 6.64 | 6.89 | 6.20 | |||||||||||||||
|
Consolidated
Capital Ratios:
|
||||||||||||||||||||
|
Total
capital to risk-weighted assets
|
16.92 | 12.73 | 13.11 | 11.72 | 11.80 | |||||||||||||||
|
Tier
1 capital to risk-weighted assets
|
15.65 | 11.47 | 11.86 | 10.58 | 9.53 | |||||||||||||||
|
Tier
1 leverage capital to average assets
|
12.24 | 9.62 | 10.32 | 10.04 | 8.76 | |||||||||||||||
| (1) | Includes securities available-for-sale and held-to-maturity. |
| (2) | Calculated using shares outstanding excluding unearned restricted shares held in ESOP. |
| (3) | Net income divided by average assets. |
| (4) | Net income divided by average common equity. |
| (5) | Difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. |
| (6) | Net interest income before provision for loan losses as a percent of average interest-earning assets. |
| (7) | Other operating expenses divided by the total of net interest income before loan losses and other operating income (non-interest income). |
| (8) | Non-performing loans consist of nonaccrual and 90 days past due loans. |
| (9) |
The
ratio of tangible common stockholders’ equity to tangible assets is a
non-GAAP financial measure. We calculate tangible common equity
by excluding the balance of goodwill, other intangible assets and
preferred equity from stockholders’ equity. We calculate
tangible assets by excluding the balance of goodwill and other intangible
assets from total assets. We believe that this is consistent
with the treatment by our bank regulatory agencies, which exclude goodwill
and other intangible assets from the calculation of risk-based capital
ratios. In addition, excluding preferred equity, the level of
which may vary from company to company, allows investors to more easily
compare our capital adequacy to other companies in the industry that also
use this measure. Management believes that this non-GAAP
financial measure provides information to investors that is useful in
understanding the basis of our capital position. However, this
non-GAAP financial measure is supplemental and is not a substitute for any
analysis based on GAAP. Because not all companies use the same
calculation of tangible common equity and tangible assets, this
presentation may not be comparable to other similarly titled measures as
calculated by other
companies.
|
Item 7 – Management’s Discussion and Analysis of Financial
Condition and Results of Operations
Management’s
discussion and analysis of results of operations is intended to assist in
understanding our financial condition and results of operations. The
information contained in this section should be read in conjunction with the
Consolidated Financial Statements and accompanying Notes to the Consolidated
Financial Statements contained in Item 8 of this Form 10-K.
We are a
bank holding company incorporated in the State of Washington and own two
subsidiary banks, Banner Bank and Islanders Bank. Banner Bank is a
Washington-chartered commercial bank that conducts business from its main office
in Walla Walla, Washington and, as of December 31, 2010, its 86 branch offices
and seven loan production offices located in Washington, Oregon and
Idaho. Islanders Bank is also a Washington-chartered commercial bank
and conducts its business from three locations in San Juan County,
Washington. As of December 31, 2010, we had total consolidated assets
of $4.4 billion, total loans of $3.4 billion, total deposits of $3.6 billion and
total stockholders’ equity of $511 million.
Banner
Bank is a regional bank which offers a wide variety of commercial banking
services and financial products to individuals, businesses and public sector
entities in its primary market areas. Islanders Bank is a community
bank which offers similar banking services to individuals, businesses and public
entities located in the San Juan Islands. The Banks’ primary business
is that of traditional banking institutions, accepting deposits and originating
loans in locations surrounding their offices in portions of Washington, Oregon
and Idaho. Banner Bank is also an active participant in the secondary
market, engaging in mortgage banking operations largely through the origination
and sale of one- to four-family residential loans.
Weak
economic conditions and ongoing strains in the financial and housing markets
which accelerated throughout 2008 (and generally continued in 2009 and 2010)
have presented an unusually challenging environment for banks and their holding
companies, including Banner Corporation. This has been particularly
evident in our need to provide for credit losses during this period at
significantly higher levels than our historical experience and has also
adversely affected our net interest income and other operating revenues and
expenses. As a result of these factors, for the year ended December
31, 2010, we had a net loss of $61.9 million which, after providing for the
preferred stock dividend and related discount accretion, resulted in a net loss
to common shareholders of $69.7 million, or ($1.03) per diluted share, compared
to a net loss to common shareholders of $43.5 million, or ($2.33) per diluted
share, for the year ended December 31, 2009. Although there have been
indications that economic conditions are improving, the pace of recovery has
been modest and uneven and the ongoing stress in the economy has been the most
significant challenge impacting our recent operating results. As a
result, like most financial institutions, our future operating results and
financial performance will be significantly affected by the course of recovery
from the recessionary downturn. However, improving our risk profile
by aggressively managing our problem assets was a primary focus in 2010 which
will continue moving forward and which we believe will lead to improved results
in future periods.
Our
provision for loan losses was $70.0 million for the year ended December 31,
2010, compared to $109.0 million recorded in the prior year. Despite
the decrease from 2009, the provision was significant in both years and reflects
material levels of delinquencies, non-performing loans and net charge-offs,
particularly for loans for the construction of one- to four-family homes and for
acquisition and development of land for residential properties. For
most of the past three years, housing markets remained weak in many of our
primary services areas, resulting in elevated levels of delinquencies and
non-performing assets, deterioration in property values, particularly for
residential land and building lots, and the need to provide for realized and
anticipated losses. By contrast, other non-housing related segments
of our loan portfolio, while showing some signs of stress, have performed as
expected with only normal levels of credit problems given the serious economic
slowdown. From 2008 through 2010, the higher than historical
provision for loan losses has been the most significant factor affecting our
operating results and, while we are encouraged by the continuing reduction in
our exposure to residential construction loans and the recent slowdown in the
emergence of new problem assets, looking forward we anticipate our credit costs
will remain elevated for a number of quarters and will continue to have an
adverse effect on our earnings during 2011. (See Note 6 of the Notes
to the Consolidated Financial Statements, as well as “Asset Quality”
below.)
Aside
from the level of loan loss provision, our operating results depend primarily on
our net interest income, which is the difference between interest income on
interest-earning assets, consisting of loans and investment securities, and
interest expense on interest-bearing liabilities, composed primarily of customer
deposits and borrowings. Net interest income is primarily a function
of our interest rate spread, which is the difference between the yield earned on
interest-earning assets and the rate paid on interest-bearing liabilities, as
well as a function of the average balances of interest-earning assets and
interest-bearing liabilities. As more fully explained below, our net
interest income before provision for loan losses increased by $13.2 million, or
9%, for the year ended December 31, 2010 to $157.8 million compared to $144.6
million for the prior year, primarily as a result of an expansion of our net
interest spread and net interest margin due to a lower cost of
funds. This trend to lower funding costs and the resulting increase
in the net interest margin was driven by rapidly declining interest expense on
deposits and represents an important improvement in our core operating
fundamentals. The increase in net interest income occurred despite
the continuing adverse impact of high levels of nonaccrual loans and other
non-performing assets on our net interest margin as substantial reductions in
our funding costs continued throughout 2010.
Our net
income also is affected by the level of our other operating income, including
deposit fees and service charges, loan origination and servicing fees, and gains
and losses on the sale of loans and securities, as well as our non-interest
operating expenses and income tax provisions. In addition, our net
income is affected by the net change in the value of certain financial
instruments carried at fair value. (See Note 22 of the Notes to the
Consolidated Financial Statements.) For the year ended December 31,
2010, we recorded a net gain of $1.7 million ($1.4 million after tax) in fair
value adjustments compared to a net gain of $12.5 million ($8.0 million after
tax) for the year ended December 31, 2009. Also, for the year ended
December 31, 2010, our net income included a $4.2 million other-than-temporary
impairment (OTTI) charge on certain securities, compared to a $1.5 million OTTI
charge in 2009. Further, reflecting unprecedented difficulties in the
operating environment for banking institutions and deteriorating market
conditions, in 2008 our financial results also included a $121.1 million
non-cash, non-tax deductible impairment charge for the write-off of
goodwill.
Other
operating income, excluding the fair value adjustments and OTTI losses
(charges), decreased $1.0 million to $31.6 million for the year ended December
31, 2010 from $32.7 million for the prior year, primarily as a result of
decreased gain on the sale of loans from mortgage banking operations somewhat
offset by an increase in loan servicing fees. Revenues (net interest
income before the provision for loan losses plus other operating income),
excluding fair value adjustments and OTTI charges, increased $12.2 million, or
7%, to $189.4 million for the year ended December 31, 2010, compared to $177.2
million for the year ended December 31, 2009. This growth in core
revenues was the result of the meaningful increase in our net interest income
which more than offset the modest decrease in other operating income, excluding
fair value adjustments and OTTI charges. Other operating expenses
were $160.8 million for the year ended December 31, 2010, an increase from
$142.1 million for the year ended December 31, 2009. The current
year’s expenses reflect significantly increased costs associated with problem
loan collection activities including professional services and charges related
to real estate owned, which were only slightly offset by reductions in
compensation, occupancy and deposit insurance. In addition, in 2010
we recorded a full valuation allowance for our net deferred tax assets, which
resulted in an $18.0 million provision for income taxes for the year ended
December 31, 2010 compared to a tax benefit of $27.1 million for the year ended
December 31, 2009. That significant swing in our income tax provision
somewhat masked a meaningful reduction in our pre-tax loss, which decreased to
$43.9 million for the year ended December 31, 2010 compared to $62.8 million for
the year ended December 31, 2009.
As noted
above, in the year ended December 31, 2010, our net income included a $1.7
million net gain in the valuation of the selected financial assets and
liabilities we record at fair value. The fair value adjustment
resulted in a partial offset of $1.4 million (net after tax), or $0.02 per
diluted share, from the net loss reported for the year ended December 31,
2010. By comparison, the $12.5 million fair value gain in the prior
year resulted in a partial offset of $8.0 million (net after tax), or $0.43 per
diluted share from the net loss in 2009. The net loss, excluding fair
value adjustments and OTTI losses, was $59.4 million for the year ended December
31, 2010, compared to $42.8 million for the year ended December 31,
2009. Revenues and other earnings information excluding the change in
valuation of financial instruments carried at fair value, OTTI losses and
goodwill impairment charges represent non-GAAP financial
measures. Management has presented these non-GAAP financial measures
in this discussion and analysis because it believes that they provide useful and
comparative information to assess trends in our core
operations. Where applicable, we have also presented comparable
earnings information using GAAP financial measures. For more
information on these non-GAAP measures, see the table below, as well as the
discussion on tangible common stockholders’ equity in footnote number nine to
the Key Financial Ratios tables on page 34. The decrease in earnings
from core operations primarily reflects the continued high levels of loan loss
provisioning, increased REO and collection costs and the valuation allowance
recognized against our net deferred tax asset. See “Comparison of
Results of Operations for the years ended December 31, 2010 and 2009” for more
detailed information about our financial performance.
The
following tables set forth reconciliations of non-GAAP financial measures
discussed in this report (dollars in thousands):
|
For
the Years Ended December 31
|
||||||||||||
|
2010
|
2009
|
2008
|
||||||||||
|
Total
other operating income
|
$ | 29,148 | $ | 43,690 | $ | 39,629 | ||||||
|
Less
other-than-temporary impairment losses
|
4,231 | 1,511 | -- | |||||||||
|
Less
change in valuation of financial instruments carried at fair
value
|
(1,747 | ) | (12,529 | ) | (9,156 | ) | ||||||
|
Total
other operating income, excluding fair value adjustments and
OTTI
|
$ | 31,632 | $ | 32,672 | $ | 30,473 | ||||||
|
Net
interest income before provision for loan losses
|
$ | 157,770 | $ | 144,573 | $ | 147,813 | ||||||
|
Total
other operating income
|
29,148 | 43,690 | 39,629 | |||||||||
|
Less
other-than-temporary impairment losses
|
4,231 | 1,511 | -- | |||||||||
|
Less
change in valuation of financial instruments carried at fair
value
|
(1,747 | ) | (12,529 | ) | (9,156 | ) | ||||||
|
Total
revenue, excluding fair value adjustments and OTTI
|
$ | 189,402 | $ | 177,245 | $ | 178,286 | ||||||
|
Net
income (loss)
|
$ | (61,896 | ) | $ | (35,764 | ) | $ | (127,993 | ) | |||
|
Less
other-than-temporary impairment losses
|
4,231 | 1,511 | -- | |||||||||
|
Less
change in valuation of financial instruments carried at fair
value
|
(1,747 | ) | (12,529 | ) | (9,156 | ) | ||||||
|
Less
goodwill write-off
|
-- | -- | 121,121 | |||||||||
|
Less
related tax expense (benefit)
|
52 | 3,966 | (40,307 | ) | ||||||||
|
Total
earnings (loss), excluding fair adjustments, OTTI charges and goodwill
write-off, net of related tax effects
|
$ | (59,360 | ) | $ | (42,816 | ) | $ | (56,335 | ) | |||
|
December
31
|
||||||||
|
2010
|
2009
|
|||||||
|
Stockholders’
equity
|
$ | 511,472 | $ | 405,128 | ||||
|
Other
intangible assets, net
|
8,609 | 11,070 | ||||||
|
Tangible
equity
|
502,863 | 394,058 | ||||||
|
Preferred
equity
|
119,000 | 117,407 | ||||||
|
Tangible
common stockholders’ equity
|
$ | 383,863 | $ | 276,651 | ||||
|
Total
assets
|
$ | 4,406,082 | $ | 4,722,221 | ||||
|
Other
intangible assets, net
|
8,609 | 11,070 | ||||||
|
Tangible
assets
|
$ | 4,397,473 | $ | 4,711,151 | ||||
|
Tangible
common stockholders’ equity to tangible assets
|
8.73 | % | 5.87 | % | ||||
We offer
a wide range of loan products to meet the demands of our customers.
Historically, our lending activities have been primarily directed toward the
origination of real estate and commercial loans. Until recent
periods, real estate lending activities were significantly focused on
residential construction and first mortgages on owner-occupied, one- to
four-family residential properties; however, over the past three years our
origination of construction and land development loans has declined materially
and the proportion of the portfolio invested in these types of loans has
declined substantially. Our residential mortgage loan originations
also decreased during this cycle, although less significantly than the decline
in construction and land development lending as exceptionally low interest rates
supported demand for loans to refinance existing debt as well as loans to
finance home purchases. Despite modest demand, our residential
mortgage loan portfolio has increased in amount and as a proportion of our total
loan portfolio during this cycle, although residential mortgage loan balances
were slightly lower at December 31, 2010 than a year earlier. Our
real estate lending activities have also included the origination of multifamily
and commercial real estate loans. Our commercial business lending has
been directed toward meeting the credit and related deposit needs of various
small- to medium-sized business and agri-business borrowers operating in our
primary market areas. Reflecting the recessionary economy, in recent
periods demand for these types of commercial business loans has been modest and
total outstanding balances have declined. Our consumer loan activity
is primarily directed at meeting demand from our existing deposit customers and,
while we have increased our emphasis on consumer lending in recent years, demand
for consumer loans also has been modest during this period of economic weakness
as many consumers have been focused on reducing their personal
debt. At December 31, 2010, our net loan portfolio totaled $3.306
billion compared to $3.695 billion at December 31, 2009.
Deposits,
customer retail repurchase agreements and loan repayments are the major sources
of our funds for lending and other investment purposes. We compete
with other financial institutions and financial intermediaries in attracting
deposits and we generally attract deposits within our primary market
areas. Much of the focus of our branch expansion, relocations and
renovation has been directed toward attracting additional deposit customer
relationships and balances. The long-term success of our deposit
gathering activities is reflected not only in the growth of deposit balances,
but also in increases in the level of deposit fees, service charges and other
payment processing revenues compared to periods prior to that
expansion. For the two years ended December 31, 2010, our total
deposit balances decreased largely as a result of our decision to significantly
reduce our exposure to public funds, brokered deposits and high cost
certificates of deposit. Over the same period we have had a
meaningful increase of transaction and savings accounts (checking, savings and
money market accounts) as we have remained focused on growing these core
deposits. Total deposits at December 31, 2010 decreased $274 million
to $3.591 billion, compared to $3.866 billion a year
earlier. However, over that time period certificates of deposit
decreased $384 million, and brokered and public deposits decreased $62 million
and $20 million, respectively. Core deposits increased $110 million,
with particularly strong growth in savings accounts.
Critical
Accounting Policies
In the
opinion of management, the accompanying consolidated statements of financial
condition and related consolidated statements of operations, comprehensive
income, changes in stockholders’ equity and cash flows reflect all adjustments
(which include reclassification and normal recurring adjustments) that are
necessary for a fair presentation in conformity with U.S. Generally Accepted
Accounting Principles (GAAP). The preparation of financial statements
in conformity with GAAP requires management to make estimates and assumptions
that affect amounts reported in the financial statements.
Various
elements of our accounting policies, by their nature, are inherently subject to
estimation techniques, valuation assumptions and other subjective
assessments. In particular, management has identified several
accounting policies that, due to the judgments, estimates and assumptions
inherent in those policies, are critical to an understanding of our financial
statements. These policies relate to (i) the methodology for the
recognition of interest income, (ii) determination of the provision and
allowance for loan and lease losses, (iii) the valuation of financial assets and
liabilities recorded at fair value, including other-than-temporary impairment
(OTTI) losses, (iv) the valuation of intangibles, such as goodwill, core deposit
intangibles and mortgage servicing rights, (v) the valuation of real estate held
for sale and (vi) the valuation of or recognition of deferred tax assets and
liabilities. These policies and judgments, estimates and assumptions
are described in greater detail below. Management believes that the
judgments, estimates and assumptions used in the preparation of the financial
statements are appropriate based on the factual circumstances at the
time. However, given the sensitivity of the financial statements to
these critical accounting policies, the use of other judgments, estimates and
assumptions could result in material differences in our results of operations or
financial condition. Further, subsequent changes in economic or
market conditions could have a material impact on these estimates and our
financial condition and operating results in future periods. There
have been no significant changes in our application of accounting policies since
December 31, 2009.
For
additional information concerning critical accounting policies, see Notes 1, 6,
13, 21 and 22 of the Notes to the Consolidated Financial Statements and the
following:
Interest
Income: (Notes 1 & 6) Interest on loans
and securities is accrued as earned unless management doubts the collectability
of the asset or the unpaid interest. Interest accruals on loans are
generally discontinued when loans become 90 days past due for payment of
interest and the loans are then placed on nonaccrual status. All
previously accrued but uncollected interest is deducted from interest income
upon transfer to nonaccrual status. For any future payments
collected, interest income is recognized only upon management’s assessment that
there is a strong likelihood that the full amount of a loan will be repaid or
recovered. A loan may be put on nonaccrual status sooner than this
policy would dictate if, in management’s judgment, the interest may be
uncollectable. While less common, similar interest reversal and
nonaccrual treatment is applied to investment securities if their ultimate
collectability becomes questionable.
Provision and Allowance for Loan
Losses: (Notes 1 & 6) The provision for loan
losses reflects the amount required to maintain the allowance for losses at an
appropriate level based upon management’s evaluation of the adequacy of general
and specific loss reserves. We maintain an allowance for loan losses
consistent in all material respects with the GAAP guidelines outlined in ASC
450,
Contingencies. We have established systematic methodologies
for the determination of the adequacy of our allowance for loan
losses. The methodologies are set forth in a formal policy and take
into consideration the need for an overall general valuation allowance as well
as specific allowances that are tied to individual problem loans. We
increase our allowance for loan losses by charging provisions for probable loan
losses against our income and value impaired loans consistent with the
accounting guidelines outlined in ASC 310, Receivables.
The
allowance for losses on loans is maintained at a level sufficient to provide for
probable losses based on evaluating known and inherent risks in the loan
portfolio and upon our continuing analysis of the factors underlying the quality
of the loan portfolio. These factors include, among others, changes
in the size and composition of the loan portfolio, delinquency rates, actual
loan loss experience, current and anticipated economic conditions, detailed
analysis of individual loans for which full collectability may not be assured,
and determination of the existence and realizable value of the collateral and
guarantees securing the loans. Realized losses related to specific
assets are applied as a reduction of the carrying value of the assets and
charged immediately against the allowance for loan loss
reserve. Recoveries on previously charged off loans are credited to
the allowance. The reserve is based upon factors and trends
identified by us at the time financial statements are
prepared. Although we use the best information available, future
adjustments to the allowance may be necessary due to economic, operating,
regulatory and other conditions beyond our control. The adequacy of
general and specific reserves is based on our continuing evaluation of the
pertinent factors underlying the quality of the loan portfolio, including
changes in the size and composition of the loan portfolio, delinquency rates,
actual loan loss experience and current economic conditions, as well as
individual review of certain large balance loans. Large groups of
smaller-balance homogeneous loans are collectively evaluated for
impairment. Loans that are collectively evaluated for impairment
include residential real estate and consumer loans and, as appropriate, smaller
balance non-homogeneous loans. Larger balance non-homogeneous
residential construction and land, commercial real estate, commercial business
loans and unsecured loans are individually evaluated for
impairment. Loans are considered impaired when, based on current
information and events, we determine that it is probable that we will be unable
to collect all amounts due according to the contractual terms of the loan
agreement. Factors involved in determining impairment include, but
are not limited to, the financial condition of the borrower, the value of the
underlying collateral and the current status of the economy. Impaired
loans are measured based on the present value of expected future cash flows
discounted at the loan’s effective interest rate or, as a practical expedient,
at the loan’s observable market price or the fair value of collateral if the
loan is collateral dependent. Subsequent changes in the value of
impaired loans are included within the provision for loan losses in the same
manner in which impairment initially was recognized or as a reduction in the
provision that would otherwise be reported.
Our
methodology for assessing the appropriateness of the allowance consists of
several key elements, which include specific allowances, an allocated formula
allowance and an unallocated allowance. Losses on specific loans are
provided for when the losses are probable and estimable. General loan
loss reserves are established to provide for inherent loan portfolio risks not
specifically provided for. The level of general reserves is based on
analysis of potential exposures existing in our loan portfolio including
evaluation of historical trends, current market conditions and other relevant
factors identified by us at the time the financial statements are
prepared. The formula allowance is calculated by applying loss
factors to outstanding loans, excluding those loans that are subject to
individual analysis for specific allowances. Loss factors are based
on our historical loss experience adjusted for significant environmental
considerations, including the experience of other banking organizations, which
in our judgment affect the collectability of the portfolio as of the evaluation
date. The unallocated allowance is based upon our evaluation of
various factors that are not directly measured in the determination of the
formula and specific allowances. This methodology may result in
losses or recoveries differing significantly from those provided in the
Consolidated Financial Statements.
While we
believe the estimates and assumptions used in our determination of the adequacy
of the allowance are reasonable, there can be no assurance that such estimates
and assumptions will not be proven incorrect in the future, or that the actual
amount of future provisions will not exceed the amount of past provisions or
that any increased provisions that may be required will not adversely impact our
financial condition and results of operations. In addition, the
determination of the amount of the Banks’ allowance for loan losses is subject
to review by bank regulators as part of the routine examination process, which
may result in the adjustment of reserves based upon their judgment of
information available to them at the time of their examination.
Fair Value Accounting and
Measurement: (Notes 1 and 22) We use fair value measurements
to record fair value adjustments to certain financial assets and liabilities and
to determine fair value disclosures. We include in the Notes to the
Consolidated Financial Statements information about the extent to which fair
value is used to measure financial assets and liabilities, the valuation
methodologies used and the impact on our results of operations and financial
condition. Additionally, for financial instruments not recorded at
fair value we disclose, where appropriate, our estimate of their fair
value. For more information regarding fair value accounting, please
refer to Note 22 in the Notes to the Consolidated Financial
Statements.
Goodwill and Other Intangible
Assets: (Notes 1 and 21) Goodwill and other
intangible assets consists primarily of goodwill, which represents the excess of
the purchase price over the fair value of net assets acquired in a business
combination accounted for under the purchase method, and core deposit
intangibles (CDI), which are amounts recorded in business combinations or
deposit purchase transactions related to the value of
transaction-related
deposits and the value of the customer relationships associated with the
deposits. Prior to December 31, 2008, the largest component of our
intangible assets was goodwill which arose from business combinations completed
in previous periods. However, for the year ended December 31, 2008,
we recorded $121.1 million of impairment charges, which eliminated all of the
goodwill previously carried in our Consolidated Statements of Financial
Condition. The other major component of our intangible assets is core
deposit intangibles, which is the value ascribed to the long-term deposit
relationships arising from acquisitions. Core deposit intangibles are
being amortized on an accelerated basis over a weighted average estimated useful
life of eight years. These assets are reviewed at least annually for
events or circumstances that could impact their recoverability. These
events could include loss of the underlying core deposits, increased competition
or adverse changes in the economy. To the extent other identifiable
intangible assets are deemed unrecoverable, impairment losses are recorded in
other non-interest expense to reduce the carrying amount of the
assets.
Real Estate Held for
Sale: (Notes 1 and 7) Property acquired by
foreclosure or deed in lieu of foreclosure is recorded at fair value, less cost
to sell. Development and improvement costs relating to the property
are capitalized. The carrying value of the property is periodically
evaluated by management and, if necessary, allowances are established to reduce
the carrying value to net realizable value. Gains or losses at the
time the property is sold are charged or credited to operations in the period in
which they are realized. The amounts the Banks will ultimately
recover from real estate held for sale may differ substantially from the
carrying value of the assets because of market factors beyond the Banks’ control
or because of changes in the Banks’ strategies for recovering the
investment.
Income Taxes and Deferred
Taxes: (Note 13) The Company and its wholly-owned
subsidiaries file consolidated U.S. federal income tax returns, as well as state
income tax returns in Oregon and Idaho. Income taxes are accounted
for using the asset and liability method. Under this method a
deferred tax asset or liability is determined based on the enacted tax rates
which are expected to be in effect when the differences between the financial
statement carrying amounts and tax basis of existing assets and liabilities are
expected to be reported in the Company’s income tax returns. The
effect on deferred taxes of a change in tax rates is recognized in income in the
period that includes the enactment date. Under GAAP (ASC 740), a
valuation allowance is required to be recognized if it is “more likely than not”
that all or a portion of our deferred tax assets will not be
realized.
Accounting
Standards Recently Adopted or Issued
In
July 2010, FASB issued Accounting Standards Update (ASU) No. 2010-20, Disclosures about the Credit Quality
of Financing Receivables and the Allowance for Credit
Losses. ASU No. 2010-20 provides enhanced disclosures related
to the credit quality of financing receivables and the allowance for credit
losses, and provides that new and existing disclosures should be disaggregated
based on how an entity develops its allowance for credit losses and how it
manages credit exposures. Under the provisions of this ASU,
additional disclosures required for financing receivables include information
regarding the aging of past due receivables, credit quality indicators, and
modifications of financing receivables. The provisions of ASU No.
2010-20 are effective for periods ending after December 15, 2010, with the
exception of the amendments to the rollforward of the allowance for credit
losses and the disclosures about modifications which are effective for periods
beginning after December 15, 2010. Comparative disclosures are
required only for periods ending subsequent to initial adoption. This
ASU was implemented for the period ending December 31, 2010 and did not have a
material effect on the Company’s consolidated financial statements.
In April
2010, FASB issued ASU No. 2010-18, Effect of a Loan Modification When
the Loan Is Part of a Pool That Is Accounted for as a Single Asset—A Consensus
of the FASB Emerging Issues Task Force. ASU No. 2010-18
clarifies that a creditor should not apply specific guidance in ASC 310-40,
Troubled Debt Restructurings
by Creditors, to acquired loans accounted for as a pooled asset under ASC
310-30, Loans and Debt
Securities Acquired with Deteriorated Credit Quality. However,
that guidance in ASC 310-30 continues to apply to acquired loans within the
scope of ASC 310-30 that a creditor accounts for individually. This
amended guidance is effective for a modification of a loan(s) accounted for
within a pool under ASC 310-30 occurring in the first interim or annual period
ending on or after July 15, 2010. The amended guidance must be
applied prospectively, and early application is permitted. Upon
initial application of the amended guidance, an entity may make a one-time
election to terminate accounting for loans as a pool under ASC
310-30. An entity may make the election on a pool-by-pool
basis. The election does not preclude an entity from applying pool
accounting to future acquisitions of loans with credit
deterioration. The implementation of this ASU did not have a material
impact on the Company’s consolidated financial statements.
In March
2010, FASB issued ASU No. 2010-11, Scope Exception Related to Embedded
Credit Derivatives. The ASU clarifies that certain embedded
derivatives, such as those contained in certain securitizations, CDOs and
structured notes, should be considered embedded credit derivatives subject to
potential bifurcation and separate fair value accounting. The ASU
allows any beneficial interest issued by a securitization vehicle to be
accounted for under the fair value option at transition. At
transition, the Company may elect to reclassify various debt securities (on an
instrument-by-instrument basis) from held-to-maturity (HTM) or
available-for-sale (AFS) to trading. The new rules were effective
July 1, 2010. The implementation of this ASU did not have a material
impact on the Company’s consolidated financial statements.
In
February 2010, FASB issued ASU No. 2010-09, Subsequent Events (Topic
855)—Amendments to Certain Recognition and Disclosure
Requirements. ASU No. 2010-09 establishes separate subsequent
event recognition criteria and disclosure requirements for SEC
filers. SEC filers are defined in this update as entities that are
required to file or to furnish their financial statements with either the SEC or
another appropriate agency (such as the FDIC or Office of Thrift Supervision)
under Section 12(i) of the Securities and Exchange Act of 1934, as
amended. Effective with the release date, the financial statements of
SEC filers will no longer disclose either the date through which subsequent
events were reviewed or that subsequent events were evaluated through the date
the financial statements were issued. The requirement to evaluate
subsequent events through the date of issuance is still in place; only the
disclosure is affected. This ASU also removes the requirement to make
those disclosures in financial statements revised for either a correction of an
error or a retrospective application of an accounting change. The
implementation of this ASU did not have a material impact on the Company’s
consolidated financial statements.
In
January 2010, FASB issued ASU No. 2010-06, Fair Value Measurements and
Disclosures (Topic 820)—Improving Disclosures about Fair Value
Measurements. ASU No. 2010-06 requires (i) fair value
disclosures by each class of assets and liabilities (generally a subset within a
line item as presented in the statement of financial position) rather than major
category, (ii) for items measured at fair value on a recurring basis, the
amounts
of significant transfers between Levels 1 and 2, and transfers into and out of
Level 3, and the reasons for those transfers, including separate discussion
related to the transfers into each level apart from transfers out of each level,
and (iii) gross presentation of the amounts of purchases, sales, issuances, and
settlements in the Level 3 recurring measurement reconciliation.
Additionally,
the ASU clarifies that a description of the valuation techniques(s) and inputs
used to measure fair values is required for both recurring and nonrecurring fair
value measurements. Also, if a valuation technique has changed,
entities should disclose that change and the reason for the
change. Disclosures other than the gross presentation changes in the
Level 3 reconciliation are effective for the first reporting period beginning
after December 15, 2009. The requirement to present the Level 3
activity of purchases, sales, issuances, and settlements on a gross basis will
be effective for fiscal years beginning after December 15, 2010. The
implementation of this ASU did not have a material impact on the Company’s
consolidated financial statements.
In
January 2010, the Board of Governors of the Federal Reserve System issued final
risk-based capital rules related to the adoption of FASB ASC Topic 860-10 and
FASB ASC Topic 810-10. Banking organizations affected by these recent
pronouncements generally will be subject to higher regulatory capital
requirements intended to better align risk-based capital levels with the actual
risks of certain exposures. The implementation of the new risk-based
capital rules in relation to these new pronouncements did not have a material
impact on the Company’s consolidated financial statements.
In
December 2009, FASB issued ASU No. 2009-16, Transfers and Servicing (Topic
860)—Accounting for Transfers of Financial Assets. This update
codifies SFAS No. 166,
Accounting for Transfers of Financial Assets—An Amendment of FASB Statement No.
140, which was previously issued by FASB in June 2009 but was not
included in the original codification. ASU 2009-16 eliminates the concept of a
qualifying special-purpose entity, creates more stringent conditions for
reporting a transfer of a portion of a financial asset as a sale, clarifies
other sale-accounting criteria, and changes the initial measurement of a
transferor’s interest in transferred financial assets. This statement
is effective for annual reporting periods beginning after November 15, 2009, and
for interim periods therein. This standard primarily impacts the
Company’s accounting and reporting of transfers representing a portion of a
financial asset for which the Company has a continuing
involvement. In order to recognize the transfer of a portion of a
financial asset as a sale, the transferred portion and any portion that
continues to be held by the transferor must represent a participating interest,
and the transfer of the participating interest must meet the conditions for
surrender of control. To qualify as a participating interest, (i) the
portions of a financial asset must represent a proportionate ownership interest
in an entire financial asset, (ii) from the date of transfer, all cash flows
received from the entire financial asset must be divided proportionately among
the participating interest holders in an amount equal to their share of
ownership, (iii) involve no recourse (other than standard representation
and warranties) to, or subordination by, any participating interest holder,
and (iv) no party has the right to pledge or exchange the entire
financial asset. If the participating interest or surrender of
control criteria are not met, the transfer is not accounted for as a sale and
derecognition of the asset is not appropriate. Rather, the
transaction is accounted for as a secured borrowing arrangement. The
implementation of this ASU did not have a material impact during the year ended
December 31, 2010 on the Company’s consolidated financial
statements.
In
December 2009, FASB issued ASU No. 2009-17, Consolidations (Topic
810)—Improvements to Financial Reporting by Enterprises Involved with Variable
Interest Entities. This update codifies SFAS No. 167, Amendments to FASB Interpretation
No. 46(R), which was previously issued by FASB in June 2009 but was not
included in the original codification. ASU 2009-17 eliminates FASB
Interpretations 46(R) (FIN 46(R)) exceptions to consolidating qualifying
special-purpose entities, contains new criteria for determining the primary
beneficiary, and increases the frequency of required reassessments to determine
whether a company is the primary beneficiary of a variable interest entity
(VIE). The new guidance also contains a new requirement that any term,
transaction, or arrangement that does not have a substantive effect on an
entity’s status as a variable interest entity, a company’s power over a variable
interest entity, or a company’s obligation to absorb losses or its right to
receive benefits of an entity must be disregarded in applying the previous
provisions. The elimination of the qualifying special-purpose entity
concept and its consolidation exceptions means more entities will be subject to
consolidation assessments and reassessments. This statement requires
additional disclosures regarding an entity’s involvement in a variable interest
entity. This statement is effective for annual reporting periods
beginning after November 15, 2009, and for interim periods
therein. The implementation of this ASU did not have a material
impact during the year ended December 31, 2010 on the Company’s consolidated
financial statements.
General. Total
assets decreased $316 million, or 7%, to $4.406 billion at December 31, 2010,
from $4.722 billion at December 31, 2009. Net loans receivable (gross
loans less loans in process, deferred fees and discounts, and allowance for loan
losses) decreased $389 million, or 11%, to $3.306 billion at December 31, 2010,
from $3.695 billion at December 31, 2009. The contraction in net
loans was largely due to decreases of $202 million in one- to four-family
construction and related land loans and $59 million in commercial and
multifamily construction and related land loans. We continue to
maintain a significant, although meaningfully decreased, investment in
construction and land loans; however, new originations of these types of loans
during the past three years has declined substantially and is expected to remain
modest for the foreseeable future. As a result of the much slower
pace of new originations and continuing payoffs on existing loans, transfers to
real estate owned and charge offs, loans to finance the construction of one- to
four-family residential real estate, which totaled $153 million at December 31,
2010, have decreased by $502 million, or 77%, since their peak quarter-end
balance of $655 million at June 30, 2007. In addition, land and
development loans (both residential and commercial) have decreased by $302
million, or 60%, compared to their peak quarter-end balances at March 31,
2008. Given the current housing and economic environment, we
anticipate that construction and land loan balances will continue to decline for
the foreseeable future, although the pace of decline will be more modest as
originations of new construction loans likely will increase somewhat as
inventories of completed homes have been reduced and the build out of existing
development projects will be cautiously continued. Most other
categories of loans also decreased during the year, including a $52 million
decrease in commercial business loans, as demand for new loans was weak and
utilization of existing credit lines was low despite the modest recovery in the
general economy. The decrease in loan balances for the year also
reflects our efforts to reduce our exposure to certain weaker credits as we
continue to aggressively manage problem assets.
Securities
increased to $368 million from $318 million at December 31, 2009, as we made
several purchases of available-for-sale securities as trading securities were
called or matured. During the year ended December 31, 2010, net fair
value adjustments for trading and available-for-sale securities had a very
minimal effect on their carrying values as the investment market experienced
reduced volatility as compared to 2008 and 2009. At December 31,
2010, the fair value of our trading securities was $33 million less than their
amortized cost. The reduction reflected in the fair value of these
securities compared to their amortized cost primarily was centralized in
single-issuer trust preferred securities and collateralized debt obligations
secured by pools of trust preferred securities issued by bank holding companies
and insurance companies, as well as a difference of $7 million in the value of
Fannie Mae and Freddie Mac common and preferred equity securities, offset by
small gains in all other trading securities. (See Note 4 of the Notes
to the Consolidated Financial Statements.) Our available-for-sale
portfolio grew significantly during the year, as purchases of U.S. Government
and agency obligations exceeded maturities by $82
million. Periodically we also acquire securities which are designated
as held-to-maturity, although this portfolio decreased by $3 million from the
prior year balances.
Real
estate owned acquired through foreclosures increased $23 million, to $101
million at December 31, 2010 compared to $78 million at December 31,
2009. The December 31, 2010 total included $60 million in land or
land development projects, $14 million in commercial real estate and $27 million
in single-family homes and related residential construction. During
the year ended December 31, 2010, we transferred $88 million of loans into REO,
capitalized additional investments of $4 million in acquired properties,
disposed of approximately $52 million of properties and recognized $17 million
of charges against current earnings for valuation adjustments related to sold or
currently owned properties. Further declines in the value of residential real
estate, including in particular building lots and land development projects for
residential use, had a material adverse impact on the carrying value of REO and
our results of operations for the year ended December 31, 2010. (See “Asset
Quality” discussion below.)
Deposits
decreased $274 million, or 7%, to $3.591 billion at December 31, 2010, from
$3.866 billion at December 31, 2009. Non-interest-bearing deposits
increased by $18 million, or 3%, to $600 million from $582 million, and
interest-bearing transaction and savings accounts increased by $92 million, or
7%, to $1.433 billion at December 31, 2010 from $1.341 million at December 31,
2009. More than offsetting these increases, certificates of deposit
decreased $384 million, or 20%, to $1.557 billion at December 31, 2010 from
$1.942 billion at December 31, 2009. Part of the decrease in
certificates of deposit was brokered certificates, which decreased $62 million
from the prior year balances; however, much of the decrease reflects
management’s pricing decision to allow maturing higher priced retail
certificates to migrate off the balance sheet or into core
deposits.
FHLB
advances decreased $146 million, to $44 million at December 31, 2010, from $190
million at December 31, 2009, while other borrowings decreased only $1 million
to $176 million at December 31, 2010. The decrease in FHLB advances
reflects maturities of advances and no additional borrowing as a part of our
short-term cash management activities. Included in other borrowings
were $50 million of qualifying senior bank notes covered by the TLGP with a
fixed interest rate of 2.625% and a maturity date of March 31,
2012. This debt, which does not require any collateralization, was
issued in March 2009 to strengthen our overall liquidity position as we adjusted
to a lower level of public funds deposits. Other borrowings at
December 31, 2010 also include $125 million of retail repurchase agreements that
are primarily related to customer cash management accounts. No
additional junior subordinated debentures were issued or matured during the year
and the fair value of these instruments was essentially unchanged at $48
million, reflecting increased stability in the interest rate
markets. For more information, see Notes 10, 11 and 12 of the Notes
to the Consolidated Financial Statements.
During the year ended December 31, 2010, we issued 5,858,920 additional shares of common stock for $16 million at an average net per share price of $2.77 through our Dividend Reinvestment and Direct Stock Purchase and Sale Plan. Additionally, we completed a secondary offering of 85,639,000 shares of our common stock and received $162 million, net of offering costs. The increase in stock issuance activity was partially offset by the changes in retained earnings as a result of losses from operations and the accrual and payment of preferred and common stock dividends, resulting in a net $106 million increase in stockholders’ equity. During the year ended December 31, 2010, we did not repurchase any shares of Banner Corporation common stock.
Investments: At December 31, 2010,
our consolidated investment portfolio totaled $368 million and consisted
principally of U.S. Government and agency obligations, mortgage-backed and
mortgage-related securities, municipal bonds, and corporate debt
obligations. From time to time, our investment levels may be
increased or decreased depending upon yields available on investment
alternatives and management’s projections as to the demand for funds to be used
in our loan origination, deposit and other activities. During the
year ended December 31, 2010, our aggregate investment in securities increased
$50 million. Holdings of U.S. Government and agency obligations
increased $45 million, corporate bonds increased $15 million and municipal bonds
increased $9 million. Partially offsetting these increases was a net
decrease in mortgage-backed securities of $19 million.
U.S. Government and Agency
Obligations: Our portfolio of U.S. Government and agency
obligations had a carrying value of $140 million (also $140 million at amortized
cost, with a fair value adjustment of only $129,000) at December 31, 2010, a
weighted average contractual maturity of 2.7 years and a weighted average coupon
rate of 1.10%. Most of the U.S. Government and agency obligations we
own include call features which allow the issuing agency the right to call the
securities at various dates prior to the final maturity. These
securities are primarily pledged as collateral for retail repurchase
agreements.
Mortgage-Backed
Obligations: At December 31, 2010, our mortgage-backed and
mortgage-related securities had a carrying value of $87 million ($83 million at
amortized cost, with a fair value adjustment of $4 million). The
weighted average coupon rate of these securities was 4.53% and the weighted
average contractual maturity was 19.2 years, although we receive principal
payments on these securities each period resulting in a much shorter expected
average life. As of December 31, 2010, 88% of the mortgage-backed and
mortgage-related securities pay interest at a fixed rate and 12% pay at an
adjustable-interest rate. We do not believe that any of our
mortgage-backed obligations had a meaningful exposure to sub-prime
mortgages.
Municipal
Bonds: The carrying value of our tax-exempt bonds at December
31, 2010 was $76 million (with an amortized cost of $75 million), and was
comprised of general obligation bonds (i.e., backed by the general credit of the
issuer) and revenue bonds (i.e., backed by revenues from the specific project
being financed) issued by cities and counties and various housing authorities,
and hospital, school, water and sanitation
districts
located in the states of Washington, Oregon and Idaho, our primary service
area. We also had taxable bonds in our municipal bond portfolio,
which at December 31, 2010 had a carrying value of $7 million (also $7 million
at amortized cost). Many of our qualifying municipal bonds are not
rated by a nationally recognized credit rating agency due to the smaller size of
the total issuance and a portion of these bonds have been acquired through
direct private placement by the issuers. We have not experienced any
defaults or payment deferrals on our municipal bonds. At December 31,
2010, our municipal bond portfolio, including taxable and tax-exempt, had a
weighted average maturity of approximately 11.2 years and an average coupon rate
of 4.46%.
Corporate
Bonds: Our corporate bond portfolio, which had a carrying
value of $58 million ($87 million at amortized cost) at December 31, 2010, was
comprised principally of long-term fixed- and adjustable-rate capital securities
issued by financial institutions, including collateralized debt obligations
secured by pooled trust preferred securities and short-term FDIC guaranteed
notes issued by certain large money center financial
institutions. The market for the capital securities deteriorated
significantly in 2008 and 2009 and in our opinion is not currently functioning
in a meaningful manner. As a result, the fair value estimates for
many of these securities are more subjective than in previous
periods. Nonetheless, it is apparent that the values have declined
appreciably, which is reflected in our financial statements and results of
operations. In addition to the disruption in the market for these
securities, the decline in value also reflects deterioration in the financial
condition of some of the issuing financial institutions and payment deferrals
and defaults by certain institutions. The short-term FDIC guaranteed
notes were purchased for liquidity management purposes in 2010 and have fair
values that approximate amortized cost. (See Critical Accounting
Policies and Note 22 of the Notes to the Consolidated Financial
Statements.) At December 31, 2010, the portfolio had a weighted
average maturity of 14.1 years and a weighted average coupon rate of
2.16%.
The
following tables set forth certain information regarding carrying values and
percentage of total carrying values of our portfolio of securities—trading and
securities—available-for-sale, both carried at estimated fair market value, and
securities—held-to-maturity, carried at amortized cost as of December 31, 2010,
2009 and 2008 (dollars in thousands):
Table 1:
Securities—Trading
|
2010
|
2009
|
2008
|
||||||||||||||||||||||
|
Carrying
Value
|
Percent
of Total
|
Carrying
Value
|
Percent
of Total
|
Carrying
Value
|
Percent
of Total
|
|||||||||||||||||||
|
U.S.
Government and agency obligations
|
$ | 4,379 | 4.6 | % | $ | 41,255 | 28.0 | % | $ | 70,389 | 34.5 | % | ||||||||||||
|
Municipal
bonds:
|
||||||||||||||||||||||||
|
Taxable
|
693 | 0.7 | 1,034 | 0.7 | 2,041 | 1.0 | ||||||||||||||||||
|
Tax
exempt
|
5,705 | 6.0 | 6,117 | 4.2 | 9,988 | 4.9 | ||||||||||||||||||
|
Total
municipal bonds
|
6,398 | 6.7 | 7,151 | 4.9 | 12,029 | 5.9 | ||||||||||||||||||
|
Corporate
bonds
|
34,724 | 36.4 | 35,017 | 23.8 | 40,220 | 19.7 | ||||||||||||||||||
|
Mortgage-backed
or related securities:
|
||||||||||||||||||||||||
|
FHLMC
|
17,347 | 18.2 | 25,837 | 17.6 | 35,538 | 17.5 | ||||||||||||||||||
|
FNMA
|
32,341 | 33.9 | 37,549 | 25.5 | 45,492 | 22.3 | ||||||||||||||||||
|
Total
mortgage-backed
or
related securities
|
49,688 | 52.1 | 63,386 | 43.1 | 81,030 | 39.8 | ||||||||||||||||||
|
Equity
securities
|
190 | 0.2 | 342 | 0.2 | 234 | 0.1 | ||||||||||||||||||
|
Total
securities—trading
|
$ | 95,379 | 100.0 | % | $ | 147,151 | 100.0 | % | $ | 203,902 | 100.0 | % | ||||||||||||
Table 2:
Securities—Available-for-Sale
|
2010
|
2009
|
2008
|
||||||||||||||||||||||
|
Carrying
Value
|
Percent
of Total
|
Carrying
Value
|
Percent
of Total
|
Carrying
Value
|
Percent
of Total
|
|||||||||||||||||||
|
U.S.
Government and agency obligations
|
$ | 135,428 | 67.6 | % | $ | 53,112 | 55.5 | % | $ | -- | -- | % | ||||||||||||
|
Municipal
bonds:
|
||||||||||||||||||||||||
|
Taxable
|
775 | 0.4 | -- | -- | -- | -- | ||||||||||||||||||