Columbia Banking System - 10-Q quarterly report FY

The interim unaudited consolidated condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for condensed interim financial information and with instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain financial information and footnotes have been omitted or condensed. The consolidated condensed financial statements include the accounts of the Company, and its wholly owned banking subsidiary Columbia Bank. All intercompany transactions and accounts have been eliminated in consolidation. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair statement of the results for the interim periods presented have been included. The consolidated financial statements and results of operations presented in this report on Form 10-Q include financial information for Mountain Bank Holding Company and Town Center Bancorp, which were merged into Columbia Bank in the third quarter of 2007.  The results of operations for the six months ended June 30, 2008 are not necessarily indicative of results to be anticipated for the year ending December 31, 2008. The accompanying interim unaudited consolidated condensed financial statements should be read in conjunction with the financial statements and related notes contained in the Company’s 2007 Annual Report on Form 10-K.

The significant accounting policies used in preparation of our consolidated financial statements are disclosed in our 2007 Annual Report on Form 10-K. There have not been any other changes in our significant accounting policies compared to those contained in our 2007 10-K disclosure for the year ended December 31, 2007.

In May 2008, the FASB issued Statement of Financial Accounting Standards No. 162, The Hierarchy of Generally Accepted Accounting Principles (“SFAS 162”).  This statement identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (“GAAP”) in the United States (the GAAP hierarchy).  This Statement is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles.  Adoption of SFAS 162 is not expected to have any effect on the Company’s financial condition or results of operations.

In March 2008, the FASB issued Statement of Financial Accounting Standards No. 161, Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133(“SFAS 161”).  This Statement requires enhanced disclosures about an entity’s derivative and hedging activities and is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008.  The Company plans to apply the enhanced disclosure provisions of SFAS 161 to all derivative and hedging activities.

On January 1, 2008, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements.   SFAS 157 defines fair value, establishes a framework for measuring fair value under accounting principles generally accepted in the United States of America, and expands disclosures about fair value measurement.  For further information, see Note 6 of the Notes to Unaudited Consolidated Condensed Financial Statements.

On January 1, 2008, the Company began applying the consensus reached by the Emerging Issues Task Force in Issue No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements (“EITF 06-4”).  EITF 06-4 provides recognition guidance regarding liabilities and related compensation costs for endorsement split-dollar life insurance arrangements that provide a benefit to an employee that extends to postretirement periods.  The Company recognized the effects of applying the consensus through a change in accounting principle with a cumulative-effect charge to retained earnings of $2.1 million, net of income taxes of $1.2 million.  During the second quarter of 2008 the Company entered into transactions whereby certain current and former officers of the Company agreed to terminate the split-dollar portion of their bank owned life insurance policies in exchange for individual life insurance policies.  In the second quarter of 2008 the Company recognized the net effect of those transactions as a reduction of compensation expense totaling $107,000.

The following table sets forth the computation of basic and diluted earnings per share for the six months ended June 30, 2008 and 2007 (in thousands, except for per share data):

Potential dilutive shares are excluded from the computation of earnings per share if their effect is anti-dilutive. For the three and six month periods ended June 30, 2008, there were 36,981 anti-dilutive shares outstanding related to options to acquire common stock.  There were no anti-dilutive shares outstanding related to options to acquire common stock for the same periods last year.

On January 24, 2008, the Company declared a quarterly cash dividend of $0.17 per share, payable on February 20, 2008 to shareholders of record as of the close of business on February 6, 2008. On April 24, 2008, the Company declared a quarterly cash dividend of $0.17 per share, payable on May 21, 2008, to shareholders of record at the close of business May 7, 2008. Subsequent to quarter end, on July 24, 2008, the Company declared a quarterly cash dividend of $0.17 per share, payable on August 20, 2008, to shareholders of record at the close of business August 6, 2008.  The payment of cash dividends is subject to Federal regulatory requirements for capital levels and other restrictions. In addition, the cash dividends paid by Columbia Bank to the Company are subject to both Federal and State regulatory requirements.

The Company is managed along two major lines of business: commercial banking and retail banking. The treasury function of the Company, included in the “Other” category, although not considered a line of business, is responsible for the management of investments and interest rate risk. In addition, the provision for loan and lease losses is included in the “Other” category.  On April 1, 2008, the Bank of Astoria banking subsidiary was merged into the Columbia Bank banking subsidiary.  This change in internal organizational structure also changes the composition of the Company’s reportable segments.  Accordingly, segment results for the Bank of Astoria are now included in the Retail Banking segment.  Prior period segment reporting has been restated to reflect this change.

The Company generates segment results that include balances directly attributable to business line activities. The financial results of each segment are derived from the Company’s general ledger system. Overhead, including sales and back office support functions and other indirect expenses are not allocated to the major lines of business. Goodwill resulting from business combinations is included in the Retail Banking segment. Since the Company is not specifically organized around lines of business, most reportable segments comprise more than one operating activity.

The principal activities conducted by commercial banking are the origination of commercial business relationships, private banking services and real estate lending. Retail banking includes all deposit products, with their related fee income, and all consumer loan products as well as commercial loan products offered in the Company’s branch offices.

Effective January 1, 2008 the Company implemented a more robust internal funds transfer pricing methodology.  Internal funds transfer pricing refers to the process we utilize to give an earnings credit to a branch or revenue center for the deposit funds they generate while providing an earnings charge to the centers that use deposit funds to make loans.  The implementation of this methodology changed the basis of measurement for segment net interest income as presented in the tables below.  Generally, this methodology had the effect of increasing net interest income for the commercial banking segment with a corresponding decrease in net interest income for the retail banking segment.  The increase in net interest

The organizational structure of the Company and its business line financial results are not necessarily comparable with information from other financial institutions. Financial highlights by lines of business are as follows:

The components of comprehensive income (loss) are as follows:

The following table presents activity in the allowance for loan and lease losses for the three and six months ended June 30, 2008 and 2007:

The Company had $96 million in goodwill at June 30, 2008 and December 31, 2007. At June 30, 2008 and December 31, 2007, the Company had a core deposit intangible (“CDI”) asset of $6.5 million and $7.1 million, respectively. In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets”, goodwill is not amortized but is reviewed for potential impairment at the reporting unit level during the third quarter on an annual basis and between annual tests if events or circumstances indicate a potential impairment. An impairment loss is recorded to the extent that the carrying amount of goodwill exceeds its implied fair value. The CDI is evaluated for impairment if events and circumstances indicate a possible impairment. The CDI is amortized on an accelerated basis over an estimated life of approximately 10 years. Amortization expense related to the CDI was $296,000 and $96,000 for the three months ended June 30, 2008 and June 30, 2007 and $592,000 and $192,000 for the six months ended June 30, 2008 and June 30, 2007, respectively. The CDI amortization expense is included in other noninterest expense on the consolidated condensed statements of income.

On March 18, 2008 Visa, Inc. (“Visa”) completed its initial public offering (“IPO”). On March 31, 2008 Visa funded a litigation escrow account with $3.0 billion from the IPO proceeds. Based on the Company’s Visa USA membership percentage, the expected economic benefit to the Company from this escrow account is $889,200. Accordingly, the Company recognized a recapture of previously accrued legal expense of $889,200. This recapture is included in the legal and professional services line item of the consolidated condensed statements of income and is a reduction of the $1.8 million Visa litigation liability the Company accrued during the fourth quarter of 2007. The Company’s remaining Visa litigation reserve of approximately $888,000, which is included in other liabilities on the consolidated condensed balance sheets, will be subject to ongoing review and adjusted accordingly as information on Visa’s litigation matters emerges.

This discussion should be read in conjunction with the unaudited consolidated condensed financial statements of Columbia Banking System, Inc. (referred to in this report as “we”, “our”, and “the Company”) and notes thereto presented elsewhere in this report and with the December 31, 2007 audited consolidated financial statements and its accompanying notes included in our recent Annual Report on Form 10-K. In the following discussion, unless otherwise noted, references to increases or decreases in average balances in items of income and expense for a particular period and balances at a particular date refer to the comparison with corresponding amounts for the period or date one year earlier.

This Quarterly Report on Form 10-Q may be deemed to include forward looking statements, which management believes to be a benefit to shareholders.  These forward looking statements describe management’s expectations regarding future events and developments such as future operating results, growth in loans and deposits, continued success of our style of banking and the strength of the local economy. The words “will,” “believe,” “expect,” “should,” and “anticipate” and words of similar construction are intended in part to help identify forward looking statements. Future events are difficult to predict, and the expectations described above are necessarily subject to risk and uncertainty that may cause actual results to differ materially and adversely. In addition to discussions about risks and uncertainties set forth from time to time in our filings with the SEC, factors that may cause actual results to differ materially from those contemplated by such forward looking statements include, among others, the following possibilities: (1) local and national economic conditions are less favorable than expected or have a more direct and pronounced effect on us than expected and adversely affect our ability to continue internal growth at historical rates and maintain the quality of our earning assets; (2) a continued decline in the housing/real estate market; (3) changes in interest rates significantly reduce interest margins and negatively affect funding sources; (4) deterioration of credit quality that could, among other things, increase defaults and delinquency risks in the Company’s loan portfolios (5) projected business increases following strategic expansion activities are lower than expected; (6) competitive pressure among financial institutions increases significantly; (7) legislation or regulatory requirements or changes adversely affect the businesses in which we are engaged; and (8) our ability to realize the efficiencies we expect to receive from our investments in personnel, acquisitions and infrastructure.

Management has identified the accounting policies related to the allowance for loan and lease losses as critical to an understanding of our financial statements. These policies and related estimates are discussed in “Item 7. Management Discussion and Analysis of Financial Condition and Results of Operation” under the heading “Allowance for Loan and Lease Losses and Unfunded Loan Commitments and Letters of Credit” in our 2007 Annual Report on Form 10-K. There have not been any material changes in our critical accounting policies relating to the allowance for loan and lease losses as compared to those disclosed in our 2007 Annual Report on Form 10-K.

Our results of operations are dependent to a large degree on our net interest income. We also generate noninterest income through service charges and fees, merchant services fees, and bank owned life insurance. Our operating expenses consist primarily of compensation and employee benefits, occupancy, merchant card processing, data processing and legal and professional fees. Like most financial institutions, our interest income and cost of funds are affected significantly by general economic conditions, particularly changes in market interest rates, and by government policies and actions of regulatory authorities.

For the three months ended June 30, 2008 we experienced a slight increase in our net interest margin when compared to the same period in 2007.  This increase resulted primarily from decreased funding costs.  For the second quarter of 2008 interest income increased 2% while interest expense decreased 20%, when compared to the same period in 2007.  The increase in interest income for the period is primarily due to increased loan volume whereas the decrease in interest expense

The following tables set forth the average balances of all major categories of interest-earning assets and interest-bearing liabilities, the total dollar amounts of interest income on interest-earning assets and interest expense on interest-bearing liabilities, the average yield earned on interest-earning assets and average rate paid on interest-bearing liabilities by category and in total, net interest income and net interest margin.

During the second quarter of 2008, the Company allocated $15.4 million to its provision for loan and lease losses, compared to $329,000 for the same period in 2007.  For the six months ended June 30, 2008, the Company allocated $17.4 million to its provision for loan and lease losses, compared to $967,000 for the first half of 2007.  The additional provision is due to the weakness in the for-sale housing industry resulting from the slowing economic environment and an increase in non-accrual loans.  The increased provision will increase the Company’s total allowance for loan losses to 1.83% of net loans at June 30, 2008.  See the discussion under “Nonperforming Assets” for details related to the non-accrual loans.

Noninterest income increased $2.6 million, or 38%, to $9.3 million for the second quarter of 2008 from $6.7 million for the second quarter of 2007. The increase in noninterest income is primarily due to pre-tax income of $1.1 million from the redemption of shares of MasterCard International shares obtained in connection with its 2006 initial public offering and $612,364 of pre-tax income from the receipt of insurance proceeds from the death of a former officer covered by BOLI.   In addition, service charges and other fees increased $445,000, or 14%, during the second quarter of 2008 as compared to the same period in 2007.  This increase is the result of a change in the Company’s deposit account fee structure in conjunction with an increase in the number of deposit accounts, primarily due to the third quarter 2007 acquisitions.

For the six months ended June 30, 2008, noninterest income increased $6.5 million, or 51%, compared to the same period in 2007.  The increase in noninterest income is primarily due to the gain on the redemption of Visa and MasterCard shares of $3.0 million and a gain on the sale of investment securities of $882,000.  In addition, service charges and other fees increased $1.1 million, or 17% during the first six months of 2008 as compared to the same period in 2007 reflecting a change in our deposit account fee structure in conjunction with an increase in the number of deposit accounts.

Total noninterest expense increased $3.1 million, or 15%, for the second quarter of 2008 from $20.3 million for the second quarter of 2007.  This increase is primarily a result of increased salary expense as a result of the third quarter 2007 acquisitions and the expansion of the retail branch and professional lending teams.  Regulatory premiums in the current quarter increased $328,000 from the same period one year ago.  This increase is due to the fact that, in the prior year period, we benefited from a federal deposit insurance premium credit which offset the majority of federal deposit insurance premiums due.  Based upon recent events and the state of the economy, it is likely that the Federal Deposit Insurance Corporation may increase federal deposit insurance premiums in the near future.  Depending on circumstances, this increase may be relatively significant and will add to our cost of operations.  Finally, data processing expenses and core deposit intangible expense increased $230,000 and $200,000 compared to the same period in 2007 primarily as a result of the 2007 third quarter acquisitions.

Total noninterest expense for the first six months of 2008 increased $6.3 million, or 15%, as compared to the same period in 2007. This increase is due primarily to increased compensation and employee benefits and other expense increases as discussed above.  Regulatory premiums were $728,000 higher for the first six months of 2008 than in the same period last year.  As noted above, this increase relates to a credit we received in 2007 which offset the majority of FDIC premiums due.  Finally, occupancy expenses increased $676,000 from the first half of 2007, primarily due to the third quarter acquisitions and two new branch locations opened during the fourth quarter 2007.

The following table presents selected items included in other noninterest expense and the associated change from period to period:

In managing our business, we review the efficiency ratio, on a fully taxable-equivalent basis (see definition in table below), which is not defined in accounting principles generally accepted in the United States.  Our efficiency ratio [noninterest expense divided by the sum of net interest income and noninterest income on a tax equivalent basis, excluding any gains and losses arising from nonrecurring transactions] was 59.31% for the second quarter 2008 and was 60.77% for the first six months of 2008, compared to 60.04% and 61.68% for the second quarter and first six months of 2007, respectively. The second quarter change in the efficiency ratio is due to the increase in net interest income driven primarily by the drop in interest expense.

The following table presents a reconciliation of the financial data utilized to calculate the efficiency ratio (a non-GAAP financial measure) to the same measures calculated and presented in accordance with GAAP: