Western Alliance Bancorporation - 10-Q quarterly report FY

 

 

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.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o      Accelerated filer þ      Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Common Stock Issued and Outstanding: 30,413,953 shares as of April 30, 2007.

 

Table of Contents

See Notes to Unaudited Consolidated Financial Statements.

See Notes to Unaudited Consolidated Financial Statements.

See Notes to Unaudited Consolidated Financial Statements.

(Dollars in thousands, except per share amounts)

Western Alliance Bancorporation is a bank holding company providing a full range of banking services to commercial and consumer customers through its wholly owned subsidiaries Bank of Nevada and First Independent Bank of Nevada, operating in Nevada, Alliance Bank of Arizona, operating in Arizona, Torrey Pines Bank and Alta Alliance Bank, operating in California, Miller/Russell & Associates, Inc., operating in Nevada, Arizona and Southern California, and Premier Trust, Inc., operating in Nevada and Arizona. These entities are collectively referred to herein as the Company. First Independent Bank was acquired on March 31, 2007. The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America and general industry practices.

The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. A material estimate that is particularly susceptible to significant change in the near term relates to the determination of the allowance for loan losses.

The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, Bank of Nevada, First Independent Bank of Nevada, Alliance Bank of Arizona, Torrey Pines Bank, Alta Alliance Bank (collectively referred to herein as the Banks), Miller/Russell & Associates, Inc., and Premier Trust, Inc. All significant intercompany balances and transactions have been eliminated in consolidation.

The accompanying unaudited consolidated financial statements as of March 31, 2007 and 2006 have been prepared in condensed format, and therefore do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. These statements have been prepared on a basis that is substantially consistent with the accounting principles applied to our consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2006.

The information furnished in these interim statements reflects all adjustments which are, in the opinion of management, necessary for a fair statement of the results for each respective period presented. Such adjustments are of a normal recurring nature. The results of operations in the interim statements are not necessarily indicative of the results that may be expected for any other quarter or for the full year. The interim financial information should be read in conjunction with the Company’s audited financial statements.

Condensed financial information as of December 31, 2006 has been presented next to the interim consolidated balance sheet for informational purposes.

In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement 109 (FIN 48), which clarifies the accounting for uncertainty in tax positions. This Interpretation provides that the tax effects from an uncertain tax position can be recognized in our financial statements only if the position is more likely than not of being sustained on audit, based on the technical merits of the position. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006, with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. For further discussion of the impact of FIN 48, please refer to Note 8 of these financial statements.

In September 2006, the FASB ratified the consensus of the Emerging Issues Task Force (EITF) Issue No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangement. EITF 06-4 applies to endorsement split dollar life insurance policies that provide a benefit to an employee that extends to postretirement periods and requires an employer to recognize a liability for future benefits over the service period based on the substantive agreement with the employee. EITF 06-4 is effective for fiscal years beginning after December 15, 2007, with early adoption permitted. We do not expect EITF 06-4 to have a material impact on our financial statements.

The Company elected early adoption of SFAS 159, The Fair Value Option for Financial Assets and Financial Liabilities, effective January 1, 2007. Instruments for which the fair value option (FVO) was adopted and the reasons therefore are as follows:

The junior subordinated debt, with a balance of $61.9 million at January 1, 2007, (before the application of SFAS 159) is a primary source of funding for the Company’s held-to-maturity portfolio, which excluding tax-advantaged municipal obligations had an amortized cost of $90.5 million at the same date. The held-to-maturity portfolio consists primarily of fixed rate and hybrid adjustable rate mortgage-backed securities and collateralized mortgage obligations. The junior subordinated debt includes $20.0 million which carries a fixed rate through June 2011, with the remaining balances carrying rates which re-set at least semi-annually. This represents a natural hedge on the Company’s balance sheet, with changes in fair value of the fixed rate securities and fixed rate junior subordinated debt moving inversely from one another as market rates move up and down. The early adoption of SFAS 159 on these instruments will more accurately reflect this hedge in the Company’s consolidated financial statements. The FVO was not elected for tax-advantaged securities since the tax benefit is based upon the contractual rate paid on the security at time of purchase and does not include changes in fair value or accretion or amortization of discounts or premiums resulting from revaluation. The carrying value of these tax-advantaged securities was $7.9 million at March 31, 2007.

Fixed-rate available-for-sale securities had an amortized cost of $215.6 million and an aggregate net unrealized loss of $5.9 million at January 1, 2007. These securities represent some of the most volatile on the Company’s balance sheet with long durations and low coupon rates relative to the market. While initially these investments were funded with relatively long duration non-interest bearing and administered rate money market deposits, as the liability structure of the company has shortened they are now preponderantly funded with overnight Federal Home Loan Bank borrowings, customer repurchase agreements and CDs. All of these sources of funding have pricing which moves with the market, and thus

there is not an effective match for the fixed rate securities on the liability side of the balance sheet. This causes much volatility in reported earnings as interest rates move and the net interest margin contracts and expands. The Company’s ability to hedge the market-value risk on the securities was historically limited by the complexities of accounting for derivative financial instruments. The adoption of SFAS 159 on these securities will provide more transparency in the consolidated financial statements as users will be more able to ascertain changes in the Company’s net income caused by changes in market interest rates. The FVO was not elected for variable-rate available-for-sale securities since the liability funding match is more closely aligned with these shorter duration assets.

The following table provides the impact of adoption on the Company’s balance sheet as January 1, 2007 (in thousands):

All securities for which the fair value measurement option has been elected are included in a separate line item on the balance sheet entitled “securities measured at fair value.”

For the three months ended March 31, 2007, gains and losses from fair value changes included in the Consolidated Statement of Income were as follows (in thousands):

The difference between the aggregate fair value of $70.4 million and the aggregate unpaid principal balance of $69.1 million of junior subordinated debt was $1.3 million at March 31, 2007.

Interest income on securities measured at fair value are accounted for similarly to those classified as available for sale and held to maturity. As of January 1, 2007, a discount or premium was calculated for each security based upon the difference between the par value and the fair value at that date. These premiums and discounts will generally be recognized in interest income over the term of the securities. For mortgage-backed securities, estimates of prepayments are considered in the constant yield calculations. Interest expense on junior subordinated debt is also determined under a constant yield calculation. As of January 1, 2007, a premium was recorded for certain junior subordinated debt offerings. These premiums are being amortized over the expected lives of the offerings.

Concurrent with the adoption of SFAS 159, the Company adopted SFAS 157, Fair Value Measurements, effective January 1, 2007. SFAS 159 requires early adoption of SFAS 157 if the company chooses to early adopt SFAS 159. SFAS 157 provides a definition of fair value and provides a framework for calculating fair value.

The Company measures certain assets and liabilities at fair value on a recurring basis, including securities available for sale, securities measured at market value and junior subordinated debt. The fair value of these assets and liabilities were determined using the following inputs at March 31, 2007:

To value securities available for sale and securities measured at fair value the Company utilizes matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on the securities’ relationship to other benchmark quoted securities.

Junior subordinated debt is valued by comparing interest rates and spreads to benchmark indices offered to institutions with similar credit profiles to our own and discounting the cash flows on our offerings using these market rates.

Effective March 31, 2007, the Company acquired 100% of the outstanding common stock of First Independent Capital of Nevada (FICN), headquartered in Reno, Nevada. FICN is the parent company of First Independent Bank of Nevada (FIB). The tax-free merger was accomplished according to the Agreement and Plan of Merger (the Merger Agreement), dated December 19, 2006. At the date of

acquisition, FIB became a wholly-owned subsidiary of the Company. As the merger closed on March 30, 2007, FIB’s results for the three months ended March 31, 2007 were not included with the Company’s results of operations. The merger increases the Company’s presence in Northern Nevada.

Total assets, loans and deposits acquired in this merger were $530.7 million, $292.8 million and $402.9 million, respectively and are included in the Company’s consolidated balance sheet as of March 31, 2007. We also added four full service offices in Northern Nevada through this merger.

As provided by the Merger Agreement and based on valuation amounts determined as of the merger date, approximately 1.12 million shares of FICN common stock were exchanged for approximately $21.9 million in cash and approximately 2.5 million shares of the Company’s common stock at a calculated exchange ratio of 2.84412. The exchange of shares represented approximately 8% of the Company’s outstanding common stock as of the merger date. As part of the acquisition, 389,000 replacement options with a grant date fair value of $10.1 million were issued to FICN shareholders. As part of the merger agreement, $2.0 million of contingent consideration may be paid pro rata to the FICN shareholders at any time prior to the two-year anniversary of the merger date, depending on the performance of certain loans segregated in the FICN portfolio.

The merger was accounted for under the purchase method of accounting in accordance with SFAS No. 141, Business Combinations. Accordingly, the purchase price was allocated to the assets acquired and the liabilities assumed based on their estimated fair values at the merger date. Appropriate amounts and adjustments shown were recorded by FIB and included in the FIB reporting segment. Certain amounts, including goodwill, are subject to change when the determination of the asset and liability values is finalized within one year from the merger date. Valuations of certain assets and liabilities of FIB will be performed with the assistance of independent valuation consultants. None of the resulting goodwill is expected to be deductible for tax purposes.

Diluted earnings per share is based on the weighted average outstanding common shares during each period, including common stock equivalents. Basic earnings per share is based on the weighted average outstanding common shares during the period.

Basic and diluted earnings per share, based on the weighted average outstanding shares, are summarized as follows:

The components of the Company’s loan portfolio as of March 31, 2007 and December 31, 2006 are as follows (in thousands):

Changes in the allowance for loan losses for the three months ended March 31, 2007 and 2006 are as follows (in thousands):

At March 31, 2007, total impaired and non-accrual loans were $2.6 million, compared with $2.3 million at December 31, 2006. Loans past due 90 days or more and still accruing were $2.5 million at March 31, 2007 and $794,000 at December 31, 2006.

In the normal course of business, the Company is involved in various legal proceedings. In the opinion of management, any liability resulting from such proceedings would not have a material adverse effect on the consolidated financial statements.

A summary of the contract amount of the Company’s exposure to off-balance sheet risk is as follows:

For the three months ended March 31, 2007, 157,000 stock options with a weighted average exercise price of $34.80 per share were granted to certain key employees. The Company estimates the value of each option award on the date of grant using a Black-Scholes valuation model. The weighted average grant date fair value of these options was $11.43 per option. These stock options generally have a vesting period of four years and a life of seven years.

As of March 31, 2007, there were 2.6 million options outstanding, compared with 2.3 million at March 31, 2006. Related to the acquisition of FICN, 389,000 replacement options with a weighted average exercise price of $20.28 were issued. These replacement options had a total fair value of $10.1 million, were fully vested as of the grant date, and were included in the purchase price.

For the three months ended March 31, 2007 and March 31, 2006 the company recognized stock-based compensation expense related to options of $355,000 and $99,000 respectively.

For the three months ended March 31, 2007, 181,625 shares of restricted stock were also issued with a weighted average grant date fair value of $34.45 per share. The Company estimates the compensation cost for restricted stock grants based upon the grant date fair value. Generally, these restricted stock grants have a 3-year vesting period.

There were 399,000 and 134,000 restricted shares outstanding at March 31, 2007 and 2006, respectively. For the three months ended March 31, 2007 and March 31, 2006 the Company recognized stock-based compensation of $915,000 and $214,000 related to the Company’s restricted stock plan.

The Company files income tax returns in the U.S. federal jurisdiction and in various states. The Company is no longer subject to U.S. federal, state or local tax examinations by tax authorities for years before 2003. The Company has not undergone any recent examinations by the Internal Revenue Service.

The Company adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, on January 1, 2007. Management believes that the Company has appropriate support for the income tax positions taken and to be taken on its tax returns and that its accruals for tax liabilities are adequate for all open years on an assessment of many factors including past experience and interpretations of tax law applied to the facts of each matter.

The Company would recognize interest accrued related to unrecognized tax benefits in tax expense. The Company has not recognized or accrued any interest or penalties for the periods ended March 31, 2007 and 2006.

The following is a summary of selected operating segment information as of and for the periods ended March 31, 2007 and 2006:

The following discussion should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2006 and our unaudited consolidated financial statements and related footnotes in the Quarterly Report on Form 10-Q. Unless the context requires otherwise, the terms “Company”, “us”, “we”, and “our” refer to Western Alliance Bancorporation on a consolidated basis.

Certain statements contained in this document, including, without limitation, statements containing the words “believes”, “anticipates”, “intends”, “expects”, “should” and words of similar import, constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Act of 1934. Such forward looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among others, the following: general economic and business conditions in those areas in which we operate, demographic changes, competition, fluctuations in interest rates, changes in business strategy or development plans, changes in governmental regulation, credit quality, the availability of capital to fund the expansion of our business, and other factors referenced in this Report. Except as required by law, we disclaim any obligation to update any such factors or to publicly announce the results of any revisions to any of the forward-looking statements contained herein to reflect future events or developments.

During the first quarter of 2007, we remained focused on increasing our earnings through growth of our interest earning assets funded with low-cost deposits. We continue to explore and invest in new and expanded business lines and products, including cash management services, credit cards, wealth management and equipment leasing. Organic loan growth for the quarter ended March 31, 2007 was $40.0 million, or 1.3%, as compared to $153.2 million, or 8.5% for the same period in 2006. Gross loans acquired in the FICN merger were $292.8 million. Organic deposit growth was $45.9 million, or 1.3%, for the three months ended March 31, 2007, compared to $141.5 million, or 5.9% for the same period in 2006. Total deposits acquired in the FICN merger were $402.9 million. We reported net income of $11.4 million, or $0.39 per diluted share, for the quarter ended March 31, 2007, as compared to $8.4 million, or $0.33 per diluted share, for the same period in 2006. The increase in earnings is primarily due to higher net interest income, due primarily to an increase in loans and the increase in interest rates. The provision for loan losses decreased $0.1 million from the three months ended March 31, 2006 to the same period in 2007, due to the lower loan growth. Non-interest income for the quarter ended March 31, 2007 increased 59.9% from the same period in the prior year, due to increases in trust and investment advisory fees, service charges and income from bank owned life insurance, as well as gain realized on the sale of a branch location. Non-interest expense for the quarter ended March 31, 2007 increased 48.2% from the same period in 2006, due primarily to increases in costs as a result of our continuing organic growth and acquisition activity.

SFAS 159 and 157 were adopted by the Company on January 31, 2007. A detailed explanation of the adoptions is included in Note 2 of the financial statements.

Selected financial highlights are presented in the table below.

As a bank holding company, we focus on several factors in evaluating our financial condition and results of operations, including:

Return on Average Equity. Our net income for the three months ended March 31, 2007 increased 35.1% to $11.4 million compared to $8.4 million for the three months ended March 31, 2006. The increase in net income was due primarily to an increase in interest income of $25.1 million and an increase in non-interest income of $2.1 million, offset by an increase of $13.7 million in interest expense and a $9.4 million increase in non-interest expense. Basic earnings per share increased to $0.42 per share for the three months ended March 31, 2007 compared to $0.37 per share for the same period in 2006. Diluted earnings per share was $0.39 per share for the three month period ended March 31, 2007, compared to $0.33 per share for the same period in 2006. The increase in net income offset by the increase in equity resulted in an ROE of 11.17% for the three months ended March 31, 2007 compared to 13.75% for the three months ended March 31, 2006. ROTE increased 23.6% to 17.11%.

Return on Average Assets. Our ROA for the three months ended March 31, 2007 decreased to 1.13% compared to 1.19% for the same period in 2006. The decrease in ROA are primarily due to the increases in intangible assets as a result of merger and acquisition activity. ROTA decreased to 1.16% from 1.19% for the same period in 2006.

Asset Quality. For all banks and bank holding companies, asset quality plays a significant role in the overall financial condition of the institution and results of operations. We measure asset quality in terms of non-accrual and restructured loans and assets as a percentage of gross loans and assets, and net charge-offs as a percentage of average loans. Net charge-offs are calculated as the difference between charged-off loans and recovery payments received on previously charged-off loans. As of March 31, 2007, impaired and non-accrual loans were $2.6 million compared to $2.3 million at March 31, 2006. Non-accrual loans as a percentage of gross loans as of March 31, 2007 were 0.05% compared to less than 0.01% as of March 31, 2006. For the three months ended March 31, 2007 and March 31, 2006, net charge-offs/(recoveries) as a percentage of average loans were 0.02% and (0.02)%, respectively.

Asset Growth. The ability to produce loans and generate deposits is fundamental to our asset growth. Our assets and liabilities are comprised primarily of loans and deposits, respectively.

Total assets increased 32.1% to $4.7 billion as of March 31, 2007 from $3.6 billion as of March 31, 2006. Gross loans grew 41.7% (20.7% organically) to $3.3 billion as of March 31, 2007 from $2.4 billion as of March 31, 2006. Total deposits increased 30.2% (9.8% organically) to $3.8 billion as of March 31, 2007 from $3.0 billion as of March 31, 2006.

Operating Efficiency. Operating efficiency is measured in terms of how efficiently income before income taxes is generated as a percentage of revenue. Our tax-equivalent efficiency ratio (non-interest expenses divided by the sum of net interest income and non interest income, tax adjusted) was 62.0% for the three months ended March 31, 2007, compared to 59.0% for the same period in 2006.

The Notes to Audited Consolidated Financial Statements for the year ended December 31, 2006 contain a summary of our significant accounting policies, including discussions on recently issued accounting pronouncements, our adoption of them and the related impact of their adoption. We believe that certain of these policies, along with various estimates that we are required to make in recording our financial transactions, are important to have a complete picture of our financial position. In addition, these estimates require us to make complex and subjective judgments, many of which include matters with a high degree of uncertainty. The following is a discussion of these critical accounting policies and significant estimates. In addition to the information about these policies that can be found in Note 1 of the Audited Consolidated Financial Statements filed with the Company’s Annual Report on Form 10-K, the following should be considered:

The Company elected early adoption of SFAS 159, The Fair Value Option for Financial Assets and Financial Liabilities, effective January 1, 2007. Instruments for which the fair value option (FVO) was adopted and the reasons therefore are as follows:

The junior subordinated debt, with a balance of $61.9 million at January 1, 2007, (before the application of SFAS 159) is the primary source of funding for the Company’s held-to-maturity portfolio, which excluding tax-advantaged municipal obligations had an amortized cost of $90.5 million at the same date. The held-to-maturity portfolio consists primarily of fixed rate and hybrid adjustable rate mortgage backed securities and collateralized mortgage obligations. The junior subordinated debt includes $20.0 million which carries a fixed rate through June 2011, with the remaining balances carrying rates which re-set at least semi-annually. This represents a natural hedge on the Company’s balance sheet, with changes in fair value of the fixed rate securities and fixed rate junior subordinated debt moving inversely from one another as market rates move up and down. The early adoption of SFAS 159 on these instruments will more accurately reflect this hedge in the Company’s consolidated financial statements. The FVO was not elected for tax-advantaged securities since the tax benefit is based upon the contractual rate paid on the security at time of purchase and does not include changes in fair value or accretion or amortization of discounts or premiums.

Fixed-rate available-for-sale securities had an amortized cost of $215.6 million and an aggregate net unrealized loss of $5.9 million at January 1, 2007. These securities represent some of the most volatile on the Company’s balance sheet with long durations and low coupon rates relative to the market. While initially these investments were funded with relatively long duration non-interest bearing and administered rate money market deposits, as the liability structure of the company has shortened they are now preponderantly funded with overnight Federal Home Loan Bank borrowings, customer repurchase agreements and CDs. All of these sources of funding have pricing which moves with the market, and thus there is not an effective match for the fixed rate securities on the liability side of the balance sheet. This causes much volatility in reported earnings as interest rates move and the net interest margin contracts and expands. The Company’s ability to hedge the market-value risk on the securities was historically limited by the complexities of accounting for derivative financial instruments. The adoption of SFAS 159 on these securities will provide more transparency in the consolidated financial statements as users will be more able to ascertain changes in the Company’s net income caused by changes in market interest rates. The FVO was not elected for variable-rate available-for-sale securities since the liability funding match is more closely aligned with these shorter duration assets. The carrying value of these tax-advantaged securities was $7.9 million at March 31, 2007.

Concurrent with the adoption of SFAS 159, the Company adopted SFAS 157, Fair Value Measurements, effective January 1, 2007. SFAS 159 requires early adoption of SFAS 157 if the company chooses to early adopt SFAS 159. SFAS 157 provides a definition of fair value and provides a framework for calculating fair value.

The Company adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, on January 1, 2007. Management believes that the Company has appropriate support for the income tax positions taken and to be taken on its tax returns and that its accruals for tax liabilities are adequate for all open years on an assessment of many factors including past experience and interpretations of tax law applied to the facts of each matter.

The Company would recognize interest accrued related to unrecognized tax benefits in tax expense. The Company has not recognized or accrued any interest or penalties for the periods ended March 31, 2007 and 2006.

Our results of operations depend substantially on net interest income, which is the difference between interest income on interest-earning assets, consisting primarily of loans receivable, securities and other short-term investments, and interest expense on interest-bearing liabilities, consisting primarily of deposits and borrowings. Our results of operations are also dependent upon our generation of non-interest income, consisting primarily of income from trust and investment advisory services and banking service fees. Other factors contributing to our results of operations include our provisions for loan losses, gains or losses on sales of securities and income taxes, as well as the level of our non-interest expenses, such as compensation and benefits, occupancy and equipment and other miscellaneous operating expenses.

The following table sets forth a summary financial overview for the three months ended March 31, 2007 and 2006.

The 35.1% increase in net income in the three months ended March 31, 2007 compared to the same period in 2006 was attributable primarily to an increase in net interest income of $11.5 million, a decrease in the provision for loan losses of $0.1 million and an increase in non-interest income of $2.4, offset by an increase of $9.4 million in non-interest expense. The increase in net interest income for the three months ended March 31, 2007 over the same period 2006 was the result of an increase in the volume of and yield earned on interest-earning assets, primarily loans.

Net Interest Income and Net Interest Margin. The 39.0% increase in net interest income for the three months ended March 31, 2007 compared to the same period in 2006 was due to an increase in interest income of $11.5 million, reflecting the effect of an increase of $992.0 million in average interest-bearing assets which was funded with an increase of $965.6 million in average deposits, of which $170.6 million were non-interest bearing.

The average yield on our interest-earning assets was 7.52% for the three months ended March 31, 2007, compared to 6.49% for the same period in 2006. The increase in the yield on our interest-earning assets is a result of an increase in market rates, repricing on our adjustable rate loans, and new loans originated with higher interest rates because of the higher interest rate environment. Also, loans which typically yield more than our other interest-bearing assets, increased as a percent of total interest-bearing assets from 73.1% for the three months ended March 31, 2006, to 83.1% for the same period in 2007.

The cost of our average interest-bearing liabilities increased to 4.12% in the three months ended March 31, 2007, from 2.99% in the three months ended March 31, 2006, which is a result of higher rates paid on deposit accounts and borrowings, partially offset by a reduction in interest expense related to the adoption of FAS 159.

Average Balances and Average Interest Rates. The tables below set forth balance sheet items on a daily average basis for the three months ended March 31, 2007 and 2006 and present the daily average interest rates earned on assets and the daily average interest rates paid on liabilities for such periods. Non-accrual loans have been included in the average loan balances. Securities include securities available for sale, securities held to maturity and securities carried at market value pursuant to the adoption of FAS 159. Securities available for sale are carried at amortized cost for purposes of calculating the average rate received on taxable securities above. Yields on tax-exempt securities and loans are computed on a tax equivalent basis.

Net Interest Income. The table below demonstrates the relative impact on net interest income of changes in the volume of earning assets and interest-bearing liabilities and changes in rates earned and paid by us on such assets and liabilities. For purposes of this table, non-accrual loans have been included in the average loan balances.

Provision for Loan Losses. The provision for loan losses in each period is reflected as a charge against earnings in that period. The provision is equal to the amount required to maintain the allowance for loan losses at a level that, in our judgment, is adequate to absorb probable loan losses inherent in the loan portfolio.

Our provision for loan losses was $441 for the three months ended March 31, 2007, compared to $541 for the same period in 2006. Factors that impact the provision for loan losses are net charge-offs or recoveries, changes in the size and mix of the loan portfolio, and the recognition of changes in current risk factors. The decrease from 2006 to 2007 is due to slower loan growth.

Non-Interest Income. We earn non-interest income primarily through fees related to: