b10q.htm
 

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

 

 
FORM 10-Q

 

 
 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 30, 2008.
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from                     to                    .
 
Commission File Number 0-20288

 

 
COLUMBIA BANKING SYSTEM, INC.
(Exact name of issuer as specified in its charter)
 
   
Washington
91-1422237
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification Number)
 
   
1301 “A” Street
Tacoma, Washington
98402-2156
(Address of principal executive offices)
(Zip Code)
 
(253) 305-1900
(Issuer’s telephone number, including area code)
 

 
 
(Former name, former address and former fiscal year, if changed since last report)

 

 
 
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, and (2) has been subject to such filing requirements for the past 90 days. Yes  x    No  ¨
 
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” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer  ¨                Accelerated filer  x                Non-accelerated filer  ¨
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
Yes  ¨    No  x
 
 
The number of shares of common stock outstanding at July 31, 2008 was 18,151,288

 
 


 


TABLE OF CONTENTS
     
 
Page
   
 
     
Item 1.
 
     
 
        1
     
 
        2
     
 
        3
     
 
        4
     
 
        5
     
Item 2.
        12
     
Item 3.
        25
     
Item 4.
        25
   
 
     
Item 1.
        26
     
Item 1A.
        26
     
Item 2.
        27
     
Item 3.
        27
     
Item 4.
        28
     
Item 5.
        28
     
Item 6.
        29
     
 
        30

















i


PART I - FINANCIAL INFORMATION

Item 1.                      FINANCIAL STATEMENTS

CONSOLIDATED CONDENSED STATEMENTS OF INCOME
 
Columbia Banking System, Inc.
(Unaudited)
 
   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
(in thousands except per share)
 
2008
   
2007
   
2008
   
2007
 
Interest Income
                       
Loans
  $ 37,334     $ 36,224     $ 78,637     $ 70,254  
Taxable securities
    4,895       4,657       9,875       9,442  
Tax-exempt securities
    1,999       1,960       4,000       3,920  
Federal funds sold and deposits in banks
    95       414       244       785  
Total interest income
    44,323       43,255       92,756       84,401  
                                 
Interest Expense
                               
Deposits
    11,461       13,617       26,296       25,776  
Federal Home Loan Bank advances
    1,995       2,484       4,577       5,663  
Long-term obligations
    429       513       916       1,020  
Other borrowings
    164       946       366       1,544  
Total interest expense
    14,049       17,560       32,155       34,003  
                                 
Net Interest Income
    30,274       25,695       60,601       50,398  
Provision for loan and lease losses
    15,350       329       17,426       967  
Net interest income after provision for loan and lease losses
    14,924       25,366       43,175       49,431  
                                 
Noninterest Income
                               
Service charges and other fees
    3,738       3,293       7,306       6,252  
Merchant services fees
    2,162       2,124       4,078       4,093  
Redemption of Visa and Mastercard shares
    1,066       -       3,028       -  
Gain on sale of investment securities, net
    -       -       882       -  
Bank owned life insurance ("BOLI")
    549       451       1,054       877  
Other
    1,790       873       3,114       1,696  
Total noninterest income
    9,305       6,741       19,462       12,918  
                                 
Noninterest Expense
                               
Compensation and employee benefits
    12,348       10,848       25,744       22,206  
Occupancy
    3,199       2,945       6,458       5,782  
Merchant processing
    904       884       1,770       1,707  
Advertising and promotion
    637       657       1,218       1,204  
Data processing
    783       553       1,598       1,120  
Legal and professional fees
    765       687       714       1,510  
Taxes, licenses and fees
    796       703       1,547       1,316  
Net gain on sale of other real estate owned
    -       -       (23 )     -  
Other
    3,935       2,989       7,895       5,823  
Total noninterest expense
    23,367       20,266       46,921       40,668  
                                 
Income before income taxes
    862       11,841       15,716       21,681  
Provision (benefit) for income taxes
    (1,074 )     3,297       2,803       5,854  
                                 
Net Income
  $ 1,936     $ 8,544     $ 12,913     $ 15,827  
                                 
Net income per common share
                               
Basic
  $ 0.11     $ 0.53     $ 0.72     $ 0.98  
Diluted
  $ 0.11     $ 0.53     $ 0.72     $ 0.97  
Dividends paid per common share
  $ 0.17     $ 0.17     $ 0.34     $ 0.32  
Weighted average number of common shares outstanding
    17,898       16,126       17,874       16,115  
Weighted average number of diluted common shares outstanding
    18,021       16,258       17,998       16,261  
 
See accompanying notes to unaudited consolidated condensed financial statements.

1


CONSOLIDATED CONDENSED BALANCE SHEETS
 
Columbia Banking System, Inc.
(Unaudited)

       
June 30,
   
December 31,
 
(in thousands)
     
2008
   
2007
 
ASSETS
               
Cash and due from banks
      $ 97,076     $ 82,735  
Interest-earning deposits with banks
        8,552       11,240  
Federal funds sold
        10,000       -  
Total cash and cash equivalents
        115,628       93,975  
Securities available for sale at fair value (amortized cost of $554,547 and $558,685, respectively)
        549,755       561,366  
Federal Home Loan Bank stock at cost
        17,260       11,607  
Loans held for sale
        3,323       4,482  
Loans, net of deferred loan fees of ($3,867) and ($3,931), respectively
      2,275,719       2,282,728  
Less: allowance for loan and lease losses
        41,724       26,599  
Loans, net
        2,233,995       2,256,129  
Interest receivable
        12,289       14,622  
Premises and equipment, net
        60,558       56,122  
Other real estate owned
        -       181  
Goodwill
        96,116       96,011  
Core deposit intangible, net
        6,458       7,050  
Other assets
        74,225       77,168  
Total Assets
      $ 3,169,607     $ 3,178,713  
LIABILITIES AND SHAREHOLDERS' EQUITY
                   
Deposits:
                   
Non-interest bearing
      $ 480,612     $ 468,237  
Interest-bearing
        1,918,312       2,029,824  
Total deposits
        2,398,924       2,498,061  
Short-term borrowings:
                   
Federal Home Loan Bank advances
        329,000       257,670  
Securities sold under agreements to repurchase
        25,000       -  
Other borrowings
        5,107       5,061  
Total short-term borrowings
        359,107       262,731  
Long-term subordinated debt
        25,561       25,519  
Other liabilities
        41,745       50,671  
Total liabilities
        2,825,337       2,836,982  
Commitments and contingent liabilities (note 10)
                   
Shareholders' equity:
                   
Preferred stock (no par value)
        -       -  
Authorized, 2 million shares; none outstanding
                   
 
June 30,
December 31,
               
 
2008
2007
               
Common Stock (no par value)
                   
Authorized shares
 63,034
 63,034
               
Issued and outstanding
 18,111
 17,953
    228,826       226,550  
Retained earnings
        114,810       110,169  
Accumulated other comprehensive income
        634       5,012  
Total shareholders' equity
        344,270       341,731  
Total Liabilities and Shareholders' Equity
      $ 3,169,607     $ 3,178,713  

 
 
See accompanying notes to unaudited consolidated condensed financial statements.

 

2




 CONSOLIDATED CONDENSED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
 
Columbia Banking System, Inc.
(Unaudited)
 

   
Common Stock
         
Accumulated
       
                     
Other
   
Total
 
   
Number of
         
Retained
   
Comprehensive
   
Shareholders'
 
(in thousands)
 
Shares
   
Amount
   
Earnings
   
Income (Loss)
   
Equity
 
Balance at January 1, 2007
    16,060     $ 166,763     $ 89,037     $ (3,453 )   $ 252,347  
Comprehensive income:
                                       
Net income
    -       -       15,827       -       15,827  
Other comprehensive loss, net of tax:
                                       
Net unrealized loss from securities, net of reclassification adjustments
    -       -       -       (4,063 )     (4,063 )
Net unrealized loss from cash flow hedging instruments
    -       -       -       (813 )     (813 )
Total comprehensive income
                                    10,951  
Issuance of stock under stock option and other plans
    64       986       -       -       986  
Stock award compensation expense
    42       368       -       -       368  
Stock option compensation expense
    -       92       -       -       92  
Tax benefit associated with stock-based compensation
    -       192       -       -       192  
Cash dividends paid on common stock
    -       -       (5,163 )     -       (5,163 )
Balance at June 30, 2007
    16,166     $ 168,401     $ 99,701     $ (8,329 )   $ 259,773  
                                         
Balance at January 1, 2008
    17,953     $ 226,550     $ 110,169     $ 5,012     $ 341,731  
Cumulative effect of change in accounting principle (note 2)
    -       -       (2,137 )     -       (2,137 )
Comprehensive income:
                                       
Net income
    -       -       12,913       -       12,913  
Other comprehensive loss, net of tax:
                                       
Net unrealized loss from securities, net of reclassification adjustments
    -       -       -       (4,816 )     (4,816 )
Net unrealized gain from cash flow hedging instruments
    -       -       -       438       438  
Total comprehensive income
                                    8,535  
Issuance of stock under stock option and other plans
    93       1,399       -       -       1,399  
Stock award compensation expense
    65       739       -       -       739  
Tax benefit associated with stock-based compensation
    -       138       -       -       138  
Cash dividends paid on common stock
    -       -       (6,135 )     -       (6,135 )
Balance at June 30, 2008
    18,111     $ 228,826     $ 114,810     $ 634     $ 344,270  
 
 
See accompanying notes to unaudited consolidated condensed financial statements.
 

3


CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
 
Columbia Banking System, Inc.
(Unaudited)


   
Six Months Ended June 30,
 
(in thousands)
 
2008
   
2007
 
Cash Flows From Operating Activities
           
Net Income
  $ 12,913     $ 15,827  
Adjustments to reconcile net income to net cash provided by operating activities
         
Provision for loan and lease losses
    17,426       967  
Deferred income tax benefit
    (429 )     (960 )
Excess tax benefit from stock-based compensation
    (138 )     (192 )
Stock-based compensation expense
    739       460  
Depreciation, amortization and accretion
    3,363       3,043  
Net realized gain on sale of securities
    (882 )     -  
Net realized gain on sale of other real estate and fixed assets
    (119 )     (2 )
Net change in:
               
Loans held for sale
    1,159       (1,618 )
Interest receivable
    2,333       (800 )
Interest payable
    (2,184 )     1,159  
Other assets
    (1,431 )     (614 )
Other liabilities
    (7,750 )     (266 )
Net cash provided by operating activities
    25,000       17,004  
Cash Flows From Investing Activities
               
Purchases of securities available for sale
    (76,907 )     (2,388 )
Proceeds from sales of securities available for sale
    51,358       -  
Proceeds from principal repayments and maturities of securities available for sale
    30,105       29,554  
Proceeds from maturities of securities held to maturity
    -       250  
Loans originated and acquired, net of principal collected
    3,717       (150,510 )
Purchases of premises and equipment
    (7,019 )     (2,691 )
Proceeds from disposal of premises and equipment
    114       196  
Purchase of FHLB stock
    (5,653 )     -  
Proceeds from termination of cash flow hedging instruments
    8,093       -  
Proceeds from sales of other real estate and other personal property owned
    204       -  
Net cash provided by(used in) investing activities
    4,012       (125,589 )
Cash Flows From Financing Activities
               
Net increase(decrease) in deposits
    (99,137 )     93,974  
Proceeds from Federal Home Loan Bank advances
    1,491,268       1,635,250  
Repayment from Federal Home Loan Bank advances
    (1,419,938 )     (1,679,350 )
Net increase in repurchase agreement borrowings
    25,000       50,000  
Net increase(decrease) in other borrowings
    46       (149 )
Cash dividends paid on common stock
    (6,135 )     (5,163 )
Proceeds from issuance of common stock
    1,399       986  
Excess tax benefit from stock-based compensation
    138       192  
Net cash provided by(used in) financing activities
    (7,359 )     95,740  
Increase(decrease) in cash and cash equivalents
    21,653       (12,845 )
Cash and cash equivalents at beginning of period
    93,975       104,344  
Cash and cash equivalents at end of period
  $ 115,628     $ 91,499  
Supplemental Information:
               
Cash paid for interest
  $ 34,339     $ 32,844  
Cash paid for income tax
  $ 8,652     $ 6,550  
 
 
See accompanying notes to unaudited consolidated condensed financial statements.

4


 
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
 
Columbia Banking System, Inc.
 
1. Basis of Presentation and Significant Accounting Policies
 
(a)
Basis of Presentation
 
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.
 
(b)
Significant Accounting Policies
 
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.
 
2. Accounting Pronouncements Recently Issued or Adopted
 
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.

5


 
3. Earnings per share
 
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):
 
   
For The Three Months Ended
   
For The Six Months Ended
 
(in thousands except per share)
 
6/30/2008
   
6/30/2007
   
6/30/2008
   
6/30/2007
 
Net Income
  $ 1,936     $ 8,544     $ 12,913     $ 15,827  
Weighted average common shares outstanding (for basic calculation)
    17,898       16,126       17,874       16,115  
Dilutive effect of outstanding common stock options and nonvested restricted shares
    123       132       124       146  
Weighted average common stock and common equivalent shares outstanding (for diluted calculation)
    18,021       16,258       17,998       16,261  
Earnings per common share - basic
  $ 0.11     $ 0.53     $ 0.72     $ 0.98  
Earnings per common share - diluted
  $ 0.11     $ 0.53     $ 0.72     $ 0.97  
 
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.
 
4. Dividends
 
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.
 
5. Business Segment Information
 
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

6


income for the commercial banking segment is driven primarily by the earnings credit for deposit funds generated within that segment.  In prior years, the retail banking segment benefited from the earnings credit for deposit funds generated by the commercial banking segment.  Segment net interest income after provision for loan and lease losses for the current quarter is not directly comparable to the same line item in the first quarter of last year as the prior quarter cannot practicably be restated.
 
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:
 
Condensed Statements of Income:

   
Three Months Ended June 30, 2008
 
(in thousands)
 
Commercial Banking
   
Retail Banking
   
Other
   
Total
 
Net interest income
  $ 13,088     $ 14,556     $ 2,630     $ 30,274  
Provision for loan and lease losses
                    (15,350 )     (15,350 )
Net interest income after provision for loan and lease losses
    13,088       14,556       (12,720 )     14,924  
Noninterest income
    829       2,321       6,155       9,305  
Noninterest expense
    (3,271 )     (7,901 )     (12,195 )     (23,367 )
Income (loss) before income taxes
    10,646       8,976       (18,760 )     862  
Income tax benefit
                            1,074  
Net income
                          $ 1,936  
Total assets
  $ 1,460,556     $ 1,057,061     $ 651,990     $ 3,169,607  
                                 
   
Three Months Ended June 30, 2007
 
(in thousands)
 
Commercial Banking
   
Retail Banking
   
Other
   
Total
 
Net interest income
  $ 6,947     $ 19,043     $ (295 )   $ 25,695  
Provision for loan and lease losses
                    (329 )     (329 )
Net interest income after provision for loan and lease losses
    6,947       19,043       (624 )     25,366  
Noninterest income
    725       2,023       3,993       6,741  
Noninterest expense
    (2,575 )     (6,553 )     (11,138 )     (20,266 )
Income (loss) before income taxes
    5,097       14,513       (7,769 )     11,841  
Income tax provision
                            (3,297 )
Net income
                          $ 8,544  
Total assets
  $ 1,354,301     $ 667,325     $ 639,320     $ 2,660,946  
 


7


 

   
Six Months Ended June 30, 2008
 
(in thousands)
 
Commercial Banking
   
Retail Banking
   
Other
   
Total
 
Net interest income
  $ 26,720     $ 30,607     $ 3,274     $ 60,601  
Provision for loan and lease losses
                    (17,426 )     (17,426 )
Net interest income after provision for loan and lease losses
    26,720       30,607       (14,152 )     43,175  
Noninterest income
    2,002       4,565       12,895       19,462  
Noninterest expense
    (5,967 )     (17,099 )     (23,855 )     (46,921 )
Income (loss) before income taxes
    22,755       18,073       (25,112 )     15,716  
Income tax provision
                            (2,803 )
Net income
                          $ 12,913  
Total assets
  $ 1,460,556     $ 1,057,061     $ 651,990     $ 3,169,607  
                                 
   
Six Months Ended June 30, 2007
 
(in thousands)
 
Commercial Banking
   
Retail Banking
   
Other
   
Total
 
Net interest income
  $ 13,403     $ 37,782     $ (787 )   $ 50,398  
Provision for loan and lease losses
                    (967 )     (967 )
Net interest income after provision for loan and lease losses
    13,403       37,782       (1,754 )     49,431  
Noninterest income
    1,360       3,895       7,663       12,918  
Noninterest expense
    (5,378 )     (12,759 )     (22,531 )     (40,668 )
Income (loss) before income taxes
    9,385       28,918       (16,622 )     21,681  
Income tax provision
                            (5,854 )
Net income
                          $ 15,827  
Total assets
  $ 1,354,301     $ 667,325     $ 639,320     $ 2,660,946  
 


8


 

6. Fair Value Accounting and Measurement

SFAS 157 defines fair value, establishes a consistent framework for measuring fair value and expands disclosure requirements about fair value.  We hold fixed and variable rate interest bearing securities, investments in marketable equity securities and certain other financial instruments, which are carried at fair value.  Fair value is determined based upon quoted prices when available or through the use of alternative approaches, such as matrix or model pricing, when market quotes are not readily accessible or available.

The valuation techniques are based upon observable and unobservable inputs.  Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our own market assumptions.  These two types of inputs create the following fair value hierarchy:

Level 1 – Quoted prices for identical instruments in active markets that are accessible at the measurement date
Level 2 – Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model derived valuations whose inputs are observable or whose significant value drivers are observable.
Level 3 – Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable.

Fair values are determined as follows:

Certain preferred stock securities at fair value are priced using quoted prices for identical instruments in active markets and are classified within level 1 of the valuation hierarchy.

Other securities at fair value are priced using matrix pricing based on the securities’ relationship to other benchmark quoted prices, and under the provisions of SFAS 157 are considered a Level 2 input method.

Interest rate swap positions are valued in models, which use as their basis, readily observable market parameters and are classified within level 2 of the valuation hierarchy

The following table sets forth the Company’s financial assets and liabilities that were accounted for at fair values as of June 30, 2008 by level within the fair value hierarchy.  As required by SFAS 157, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement:


         
Fair Value Measurements at Reporting Date Using
 
 
(in thousands)
 
June 30, 2008
   
Quoted Prices in Active Markets for Identical Assets (Level 1)
   
Significant Other Observable Inputs (Level 2)
   
Significant Unobservable Inputs (Level 3)
 
Assets
                       
Securities available for sale
  $ 549,755     $ 20,238     $ 529,517     $ -  
Interest rate swap agreements
  $ 3,151     $ -     $ 3,151     $ -  
                                 
Liabilities
                               
Interest rate swap agreements
  $ 3,151     $ -     $ 3,151     $ -  



9


7. Comprehensive Income (Loss)
 
The components of comprehensive income (loss) are as follows:


   
Three Months Ended
 
   
June 30,
 
(in thousands)
 
2008
   
2007
 
Net income as reported
  $ 1,936     $ 8,544  
Unrealized loss from securities:
               
Net unrealized holding loss from available for sale securities arising during the period, net of tax of $3,712 and $3,782
    (6,737 )     (6,851 )
Reclassification adjustment of net (gain)loss from sale of available for sale securities included in income, net of tax of $0 and $0
    -       -  
Net unrealized loss from securities, net of reclassification adjustment
    (6,737 )     (6,851 )
Unrealized loss from cash flow hedging instruments:
               
Net unrealized loss from cash flow hedging instruments arising during the period, net of tax of $0 and $480
    -       (881 )
Reclassification adjustment of net (gain)loss included in income, net of tax of $124 and $(5)
    (225 )     10  
Net unrealized loss from cash flow hedging instruments
    (225 )     (871 )
Total comprehensive income (loss)
  $ (5,026 )   $ 822  
                 
                 
   
Six Months Ended
 
   
June 30,
 
(in thousands)
 
2008
   
2007
 
Net income as reported
  $ 12,913     $ 15,827  
Unrealized loss from securities:
               
Net unrealized holding loss from available for sale securities arising during the period, net of tax of $2,345 and $2,267
    (4,245 )     (4,063 )
Reclassification adjustment of net gain from sale of available for sale securities included in income, net of tax of $311 and $0
    (571 )     -  
Net unrealized loss from securities, net of reclassification adjustment
    (4,816 )     (4,063 )
Unrealized gain(loss) from cash flow hedging instruments:
               
Net unrealized gain(loss) from cash flow hedging instruments arising during the period, net of tax of $(425) and $451
    739       (826 )
Reclassification adjustment of net (gain)loss included in income, net of tax of $166 and $(7)
    (301 )     13  
Net unrealized gain(loss) from cash flow hedging instruments
    438       (813 )
Total comprehensive income
  $ 8,535     $ 10,951  
 
 
8. Allowance for Loan and Lease Losses and Unfunded Loan Commitments and Letters of Credit
 
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:
 

   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
(in thousands)
 
2008
   
2007
   
2008
   
2007
 
Beginning balance
  $ 27,914     $ 20,819     $ 26,599     $ 20,182  
Provision charged to expense
    15,350       329       17,426       967  
Loans charged off
    (1,688 )     (175 )     (2,903 )     (326 )
Recoveries
    148       366       602       516  
Ending balance
  $ 41,724     $ 21,339     $ 41,724     $ 21,339  
 


10

 
Changes in the allowance for unfunded loan commitments and letters of credit are summarized as follows:
 
   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
(in thousands)
 
2008
   
2007
   
2008
   
2007
 
Beginning balance
  $ 349     $ 339     $ 349     $ 339  
Net changes in the allowance for unfunded commitments and letters of credit
    110       -       110       -  
Ending balance
  $ 459     $ 339     $ 459     $ 339  

 
9. Goodwill and Intangible Assets
 
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.
 

 
10. Commitments and Contingent Liabilities
 
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.


 

11


Item 2.                      MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS
 
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.
 
NOTE REGARDING FORWARD LOOKING STATEMENTS
 
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.
 
CRITICAL ACCOUNTING POLICIES
 
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.
 
OVERVIEW
 
Note:  The second quarter and first six months of 2007 financial information does not include the results of Mountain Bank Holding Company and Town Center Bancorp, which were both acquired on July 23, 2007.
 
Earnings Summary
 
The Company reported net income for the second quarter of $1.9 million or $.11 per diluted share, compared to $8.5 million or $.53 per diluted share for the second quarter of 2007.  Return on average assets and return on average equity were 0.24% and 2.19%, respectively, for the second quarter of 2008, compared with returns of 1.29% and 13.04%, respectively for the same period of 2007.  The Company’s results for the second quarter of 2008 declined from the same period in 2007, as a result of a provision for loan and lease losses of $15.4 million as discussed below.  The results of the second quarter of 2008 reflect the financial consolidation of Mountain Bank Holding Company and Town Center Bancorp, which were both acquired on July 23, 2007; accordingly, the financial information for the second quarter of 2007 does not include the results of the two organizations.
 
The Company reported net income of $12.9 million for the first six months of 2008 or $.72 per diluted share, compared with $15.8 million or $.97 per diluted share for the first six months of 2007.  Return on average assets and return on average equity were .82% and 7.37%, respectively, for the first six months of 2008, compared with returns of 1.22% and 12.29%, respectively for the first six months of 2007.  As stated above, the Company’s results for the first six months of 2008 declined from the same period in 2007, as a result of a provision for loan and lease losses of $17.4 million as discussed

12


 
below.  The results of the first six months reflect the financial consolidation of Mountain Bank Holding Company and Town Center Bancorp, which were both acquired on July 23, 2007; accordingly, the financial information for the first six months of 2007 does not include the results of the two organizations.
 
Revenue (net interest income plus noninterest income) for the three months ended June 30, 2008 was $39.6 million, or 22%, higher than the same period in 2007.  The increase reflected a 38% increase in noninterest income driven primarily by proceeds from the redemption of MasterCard International shares totaling $1.1 million, increased service charges and other fees, and the receipt of life insurance proceeds received in connection with the death of a former officer covered by a bank owned life insurance policy.  Net interest income increased 18% from the prior year driven primarily by growth in earning assets.  Excluding the $1.1 million gain arising from the redemption of the MasterCard shares, revenue was $38.5 million, or 19%, higher than the same period last year.
 
Revenue (net interest income plus noninterest income) for the first six months of 2008 was $80.1 million, or 26%, higher than the first six months of 2007, reflecting a 51% increase in noninterest income driven primarily by gains on the sale of investment securities, proceeds from the redemption of Visa and MasterCard shares and increased service charges and other fees.  Net interest income increased 20% from the prior year driven primarily by growth in earning assets.  Excluding the $882,000 gain arising from the sale of investment securities and the $3.0 million gain from the Visa and MasterCard’s IPO, revenue was $76.2 million, or 20%, higher than the same period last year.
 
Total noninterest expense in the quarter ended June 30, 2008 was $23.4 million, or 15%, higher than in the second quarter of 2007, principally due to higher compensation costs and other expenses.  The higher compensation costs and other expenses were driven in part by the 2007 acquisitions and the expansion of the retail branch and professional lending team.
 
Total noninterest expense in the first six months of 2008 was $46.9 million, or 15%, higher than in the first six months of 2007, principally due to higher operating costs from investments in personnel, branches and data processing.  These increases were mitigated by a partial reversal, totaling $889,000, of legal expenses related to certain Visa litigation previously accrued in the fourth quarter of 2007.
 
The provision for loan and lease losses for the second quarter of 2008 was $15.4 million compared with $329,000 for the second quarter of 2007.  The additional provision is due to the weakness in the for-sale housing industry resulting from the slowing economic environment and non-accrual loans increasing to $71.7 million at June 30, 2008 compared to $14.0 million at December 31, 2007 and $14.4 million at March 31, 2008.  The provision increased the Company’s total allowance for loan and lease losses to 1.83% of net loans at June 30, 2008.  Net charge-offs for the current quarter were $1.5 million compared to net recoveries of $191,000 for the second quarter of 2007.
 
The provision for loan and lease losses for the first six months of 2008 was $17.4 million compared with $967,000 for the first six months of 2007.  Net charge-offs for the first six months of 2008 were $2.3 million as compared with net recoveries of $190,000 for the first six months of 2007.
 
RESULTS OF OPERATIONS
 
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.
 
Note:  The first six months of 2007 financial information does not include the results of Mountain Bank Holding Company and Town Center Bancorp, which were both acquired on July 23, 2007.
 
Net Interest Income
 
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

13


 
is primarily due to rate decreases on interest bearing deposits and borrowed funds.  For the six months ended June 30, 2008 interest income increased 10% over the same period in 2007 whereas interest expense decreased 5%.  Similar to the quarterly results, the increase in interest income in the first half of the year was driven primarily by loan growth and the decrease in interest expense driven by rate decreases on interest bearing deposits and borrowed funds.

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.
 
 

   
Three months ending June 30,
   
Three months ending June 30,
 
   
2008
   
2007
 
                                     
   
Average
   
Interest
   
Average
   
Average
   
Interest
   
Average
 
(in thousands)
 
Balances (1)
   
Earned / Paid
   
Rate
   
Balances (1)
   
Earned / Paid
   
Rate
 
ASSETS
                                   
Loans, net (2)
  $ 2,297,661     $ 37,437       6.55 %   $ 1,846,163     $ 36,224       7.87 %
Securities (2)
    584,780       8,172       5.62 %     582,378       7,692       5.30 %
Interest-earning deposits with banks and federal funds sold
    20,008       95       1.91 %     32,062       414       5.18 %
Total interest-earning assets
    2,902,449     $ 45,704       6.33 %     2,460,603     $ 44,330       7.23 %
Other earning assets
    47,780                       39,196                  
Noninterest-earning assets
    232,648                       155,064                  
     Total assets
  $ 3,182,877                     $ 2,654,863                  
                                                 
LIABILITIES AND SHAREHOLDERS' EQUITY
                                               
Certificates of deposit
  $ 798,844     $ 7,369       3.71 %   $ 604,307     $ 6,613       4.39 %
Savings accounts
    115,889       103       0.36 %     105,089       109       0.42 %
Interest-bearing demand and money market accounts
    1,035,391       3,989       1.55 %     960,729       6,894       2.88 %
Total interest-bearing deposits
    1,950,124       11,461       2.36 %     1,670,125       13,616       3.27 %
Federal Home Loan Bank advances
    313,763       1,995       2.56 %     180,952       2,485       5.51 %
Securities sold under agreements to repurchase
    25,000       118       1.89 %     70,000       945       5.41 %
Other borrowings and interest-bearing liabilities
    5,122       46       3.64 %     263       2       2.60 %
Long-term subordinated debt
    25,547       429       6.76 %     22,401       512       9.17 %
     Total interest-bearing liabilities
    2,319,556     $ 14,049       2.44 %     1,943,741     $ 17,560       3.62 %
Noninterest-bearing deposits
    463,101                       420,148                  
Other noninterest-bearing liabilities
    45,361                       28,069                  
Shareholders' equity
    354,859                       262,905                  
Total liabilities & shareholders' equity
  $ 3,182,877                     $ 2,654,863                  
                                                 
Net interest income (2)
          $ 31,655                     $ 26,770          
                                                 
Net interest margin
                    4.39 %                     4.36 %
 
(1)
Nonaccrual loans have been included in the tables as loans carrying a zero yield. Interest reversals for the second quarter ended June 30, 2008 related to nonaccrual loans totaled $335,000.  Excluding the impact of interest reversals, net interest margin for the quarter would have been 4.43%.  Amortized net deferred loan fees were included in the interest income calculations. The amortization of net deferred loan fees was $984,000 and $706,000 for the three months ended June 30, 2008 and 2007, respectively.
 
(2)
Tax-exempt income is calculated on a tax equivalent basis, based on a marginal tax rate of 35%.
 


14



 
   
Six months ending June 30,
   
Six months ending June 30,
 
   
2008
   
2007
 
         
Interest
               
Interest
       
   
Average
   
Earned/
   
Average
   
Average
   
Earned/
   
Average
 
(in thousands)
 
Balances (1)
   
Paid
   
Rate
   
Balances (1)
   
Paid
   
Rate
 
ASSETS
                                   
Loans, net (2)
  $ 2,301,125     $ 78,825       6.89 %   $ 1,806,150     $ 70,254       7.84 %
Securities (2)
    583,418       16,472       5.68 %     590,122       15,512       5.30 %
Interest-earning deposits with banks and federal funds sold
    19,767       244       2.48 %     30,404       785       5.20 %
Total interest-earning assets
    2,904,310     $ 95,541       6.62 %     2,426,676     $ 86,551       7.19 %
Other earning assets
    47,470                       38,987                  
Noninterest-earning assets
    232,665                       154,971                  
     Total assets
  $ 3,184,445                     $ 2,620,634                  
                                                 
LIABILITIES AND SHAREHOLDERS' EQUITY
                                               
Certificates of deposit
  $ 821,845     $ 16,457       4.03 %   $ 580,748     $ 12,454       4.32 %
Savings accounts
    115,378       217       0.38 %     107,139       218       0.41 %
Interest-bearing demand and money market accounts
    1,039,886       9,622       1.86 %     941,178       13,103       2.81 %
Total interest-bearing deposits
    1,977,109       26,296       2.67 %     1,629,065       25,775       3.19 %
Federal Home Loan Bank advances
    298,908       4,577       3.08 %     206,953       5,664       5.52 %
Securities sold under agreements to repurchase
    22,115       260       2.36 %     57,293       1,540       5.42 %
Other borrowings and interest-bearing liabilities
    5,188       106       4.11 %     308       4       2.62 %
Long-term subordinated debt
    25,537       916       7.21 %     22,392       1,020       9.18 %
     Total interest-bearing liabilities
    2,328,857     $ 32,155       2.78 %     1,916,011     $ 34,003       3.58 %
Noninterest-bearing deposits
    457,099                       416,886                  
Other noninterest-bearing liabilities
    45,906                       28,120                  
Shareholders' equity
    352,583                       259,617                  
Total liabilities & shareholders' equity
  $ 3,184,445