S-1 1 ds1.htm FORM S-1 Form S-1
Table of Contents

As filed with the Securities and Exchange Commission on July 29, 2011

Registration No. 333-            

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form S-1

REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933

 

 

South Valley Bancorp, Inc.

(Exact name of registrant as specified in its charter)

 

Oregon   6022   93-1251649

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification Number)

803 Main Street

Klamath Falls, OR 97601

(541) 882-3281

(Address, including zip code and telephone number, including area code, of registrant’s principal executive offices)

Loren L. Lawrie

Executive Vice President and Chief Financial Officer

South Valley Bancorp, Inc.

803 Main Street

Klamath Falls, OR 97601

(541) 882-3281

(Name, address, including zip code and telephone number, including area code, of agent for service)

 

 

Copies to:

 

Andrew H. Ognall

Lane Powell PC

601 SW Second Avenue, Suite 2100

Portland, Oregon 97204

Telephone: (503) 778-2169

Facsimile: (503) 778-2200

 

John R. Thomas

Rebecca H. Hoskins

Perkins Coie LLP

1120 NW Couch Street, Tenth Floor

Portland, Oregon 97209

Telephone: (503) 727-2144

Facsimile: (503) 346-2144

 

 

Approximate date of commencement of proposed sale to the public:

As soon as practicable after this Registration Statement becomes effective.

 

 

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.    ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   x    Smaller reporting company   ¨
(Do not check if a smaller reporting company)  

CALCULATION OF REGISTRATION FEE

 

 

Title of each Class of

Securities to be Registered

  Proposed Maximum Aggregate
Offering Price(1)
 

Amount of

Registration Fee

Common Stock

  $46,000,000   $5,340.60

 

 

(1)   Estimated solely for the purpose of calculating the registration fee in accordance with Rule 457(o) under the Securities Act of 1933, as amended, and includes shares of Common Stock issuable upon exercise of the underwriters’ option to purchase additional shares to cover over-allotments, if any.

 

 

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until the Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


Table of Contents

The information in this prospectus is not complete and may be changed. We may not sell these securities until the Registration Statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and we are not soliciting an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

SUBJECT TO COMPLETION, DATED JULY 29, 2011

Preliminary Prospectus

                     Shares

LOGO

South Valley Bancorp, Inc.

Common Stock

 

 

This is the initial public offering of shares of Common Stock of South Valley Bancorp, Inc. No public market for our Common Stock currently exists. We are offering                  shares of our Common Stock. The selling shareholders are offering                  shares of our Common Stock. We will not receive any proceeds from the sale of shares of Common Stock by the selling shareholders. We expect the initial public offering price to be between $         and $         per share. We intend to apply to list our Common Stock on The NASDAQ Capital Market under the symbol “SVBT.”

The shares of our Common Stock are not savings accounts, deposits or other obligations of any bank or savings institution, are not insured by the Federal Deposit Insurance Corporation (“FDIC”) or any other governmental agency, and are subject to investment risks, including possible loss of the entire amount invested.

Investing in our Common Stock involves risks. See “Risk Factors” beginning on page 14 to read about factors you should consider before buying our Common Stock.

 

 

Neither the Securities and Exchange Commission (“SEC”) nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

 

 

     Per Share      Total  

Initial public offering price

   $                    $                

Underwriting discounts and commissions

   $         $     

Proceeds to South Valley Bancorp, Inc. (before expenses)

   $         $     

Proceeds to the selling shareholders (before expenses)

   $         $     

We and the selling shareholders have granted the underwriters an option to purchase, on the same terms and conditions as set forth above, up to an additional                  shares of Common Stock to cover over-allotments, if any. The underwriters may exercise this option at any time within 30 days of the date of this prospectus.

The underwriters expect to deliver the Common Stock, in book-entry form only, through the facilities of The Depository Trust Company, against payment on or about                     , 2011.

D.A. Davidson & Co.

The date of this prospectus is                     , 2011.


Table of Contents

LOGO


Table of Contents

Table of contents

 

About this prospectus

     ii   

Cautionary note regarding forward-looking statements

     ii   

Industry and market data

     iv   

Summary

     1   

Risk factors

     14   

Use of proceeds

     31   

Dividend policy

     32   

Capitalization

     34   

Dilution

     36   

Selected historical consolidated financial data

     38   

Management’s discussion and analysis of financial condition and results of operations

     43   

Business

     102   

Regulation and supervision

     120   

Management

     133   

Compensation of executive officers

     141   

Certain relationships and related transactions

     147   

Principal shareholders

     149   

Selling shareholders

     151   

Description of employee stock ownership plan

     152   

Description of capital stock

     153   

Shares eligible for future sale

     159   

Material U.S. federal tax consequences to non-U.S. shareholders

     161   

Underwriting

     165   

Legal matters

     170   

Experts

     170   

Where you can find more information

     170   

Index to consolidated financial statements

     F-1   

 

i


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About this prospectus

You should rely only on the information contained in this prospectus or in any free writing prospectus we may authorize to be delivered to you. We, the selling shareholders and the underwriters have not authorized anyone to provide you with different or additional information. If anyone provides you with different or inconsistent information, you should not rely on it. We and the selling shareholders are offering to sell and seeking offers to buy shares of Holding Company common stock, which we refer to in this prospectus as our Common Stock, only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or any sale of our Common Stock. Our business, financial condition and results of operations may have changed since that date.

Unless otherwise indicated or the context requires, all information in this prospectus:

 

 

assumes that the underwriters’ option is not exercised; and

 

 

assumes an initial offering price of $         per share (the midpoint of the estimated initial public offering price set forth on the cover page of this prospectus).

When we refer to “we,” “our,” “us” or the “Company” in this prospectus, we mean South Valley Bancorp, Inc. and our consolidated subsidiaries, including our wholly owned subsidiaries, South Valley Bank & Trust and Elliott-Ledgerwood & Company doing business as South Valley Wealth Management, unless the context indicates that we refer only to the parent company, South Valley Bancorp, Inc. When we refer to the “Bank” in this prospectus, we mean South Valley Bank & Trust. When we refer to the “Holding Company” in this prospectus, we mean South Valley Bancorp, Inc. When we refer to the “Board” in this prospectus, we mean the Holding Company’s board of directors.

“Your Business First” is our registered trademark in the United States. Other trademarks and trade names referred to in this prospectus are the property of their respective owners.

Cautionary note regarding forward-looking statements

This prospectus contains forward-looking statements, which are based on assumptions and estimates and describe our plans, strategies, and prospects, and can generally be identified by the use of words such as “may,” “could,” “expect,” “intend,” “plan,” “seek,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “continue,” “likely,” “will,” “would,” “should” and variations of these terms and similar expressions, or the negative of these terms or similar expressions. Forward-looking statements are subject to significant known and unknown risks that are difficult to predict and could be affected by many other factors. Therefore, our actual results, performance or achievements may differ materially from those expressed in or implied by these forward-looking statements. Factors that may cause actual results to differ materially from current expectations are described in the section entitled “Risk Factors,” and include, without limitation:

 

 

our ability to attract new deposits and loans;

 

 

demand for financial services in our regions;

 

 

our focus on local small and medium sized businesses;

 

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competitive market pricing factors;

 

 

deterioration or delayed recovery in economic conditions that could result in decreased asset quality and increased loan losses;

 

 

time, effort and expense associated with resolving non-performing assets;

 

 

risks associated with concentrations in real estate related loans, including changes in the prices, values and sales volumes of commercial and residential real estate;

 

 

market interest rate volatility;

 

 

stability of funding sources and continued availability of borrowings;

 

 

changes in regulatory requirements or the results of regulatory examinations;

 

 

our dependence on our management team and ability to recruit and retain key qualified personnel;

 

 

regulatory requirements to maintain minimum capital levels;

 

 

our ability to raise capital on reasonable terms;

 

 

inability to find suitable expansion opportunities;

 

 

risks related to assets acquired from other organizations, including exposure to unrecoverable losses on acquired loans and provisions of our loss-sharing agreements with the FDIC;

 

 

risks related to the continued integration of new personnel and acquired businesses;

 

 

regulatory limits on the Bank’s ability to pay dividends to the Holding Company and regulatory limits on the Holding Company’s ability to repurchase its outstanding shares of capital stock or to pay dividends to its shareholders; and

 

 

the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) and related regulations on our business and competitiveness.

These factors and the other risk factors described in this prospectus are not necessarily all of the important factors that could cause our actual results to differ materially from those expressed in or implied by any of the forward-looking statements in this prospectus. Other unknown factors also could harm our results.

All forward-looking statements attributable to us or persons acting on our behalf, or the selling shareholders, are expressly qualified in their entirety by the cautionary statements set forth in this prospectus. Forward-looking statements speak only as of the date they are made and we do not undertake or assume any obligation to update publicly any of these statements to reflect actual results, new information or future events, changes in assumptions or changes in other factors affecting forward-looking statements, except to the extent required by applicable laws. If we update one or more forward-looking statements, no inference should be drawn that we will make additional updates with respect to those or other forward-looking statements.

 

iii


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Industry and market data

This prospectus includes statistical and other industry and market data and forecasts that we obtained from industry and government publications, research, studies and surveys. These sources include, among others, publications and data compiled by the Board of Governors of the Federal Reserve System, or Federal Reserve, the FDIC, the Bureau of Labor Statistics and SNL Financial LC. Third party publications, surveys and forecasts generally state that the information contained therein has been obtained from sources believed to be reliable, but there is no assurance as to the accuracy or completeness of included information. When we refer to the “SNL Peer Group” in this prospectus, we mean a peer group reported by SNL Financial LC consisting of banks headquartered in Oregon or Washington, excluding banks with holding companies headquartered outside Oregon or Washington. Although we are responsible for the adequacy and accuracy of the disclosures in this prospectus, we have not independently verified any of the data from third party sources nor have we ascertained the underlying economic assumptions relied upon therein. Forecasts are particularly likely to be inaccurate, especially over long periods of time. Although we are not aware of any misstatements regarding the industry and market data presented in this prospectus, our estimates involve risks and uncertainties and are subject to change based on various factors, including those discussed in the section captioned “Risk Factors.”

 

iv


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Summary

The following summary highlights selected information contained in this prospectus. This summary does not contain all of the information that you should consider before investing in our Common Stock. You should read the entire prospectus carefully, especially the “Risk Factors” section and the consolidated financial statements and the accompanying notes included in this prospectus.

Our Company

South Valley Bancorp, Inc. is a bank holding company headquartered in Klamath Falls, Oregon. As of March 31, 2011, we had consolidated assets of $849.2 million, deposits of $748.3 million and net loans of $628.1 million. Our wholly owned bank subsidiary, South Valley Bank & Trust, has grown to become the sixth largest bank in Oregon of all banks headquartered in Oregon (excluding banks with out-of-state holding companies). In addition, as of March 31, 2011, the Bank’s trust department had $166.2 million of assets under administration and our broker-dealer and investment adviser subsidiary, South Valley Wealth Management, had $307.5 million of assets under administration.

We deliver a wide range of community banking, trust and wealth management products and services to our clients and strive to provide exceptional, personalized service. We believe our locally managed and community-focused way of doing business attracts clients and helps us build shareholder value. Our clients include businesses, individuals, not-for-profit organizations and municipalities that participate in a wide range of industries, including agriculture, education, health care, manufacturing, real estate and transportation.

The Bank operates 24 full-service community banking offices across four regions in Oregon: Klamath/Lake, Central Oregon, Rogue and Three Rivers. Each of our regions has between five and eight branches. One branch in each region serves as the regional headquarters. The following table illustrates our branch system by region and indicates the location of our regional headquarters.

 

Regions    Counties    Number of
branches
     Regional
headquarters

 

Klamath/Lake

   Klamath      5       Klamath Falls
   Lake      1      

 

Central Oregon

   Crook      1      
   Deschutes      5       Bend
   Jefferson      1      
   Klamath      1      

 

Rogue

   Jackson      5       Medford

 

Three Rivers

   Josephine      5       Grants Pass

 

In addition, South Valley Wealth Management provides wealth management services through one office in each of our four regions.

 

 

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Our founding principles and growth

In 1977, our founders organized the Bank on the principles of providing personalized, business-banking services to the local community, being an active participant in our community, understanding our clients and their business priorities and supporting local decision-making.

Since our transition to a bank holding company structure in 1998, we have grown organically and through acquisitions and strategic hiring. The following is a list of important milestones in the development of our operations and geographic presence:

 

 

1999—acquired Washington Mutual’s trust division

 

 

2001—acquired our broker-dealer subsidiary from Elliott-Ledgerwood, today known as South Valley Wealth Management

 

 

2001—hired a team of 8 commercial bankers in the Rogue region

 

 

2004—hired a team of 11 commercial bankers in the Central Oregon region and added our first branch in Bend, Oregon

 

 

2005—completed Bank rebranding and adopted “Your Business First” client service standard

 

 

2005 to 2008—expanded branch network with 10 new locations and established nationwide ATM access for our clients

 

 

2010—hired an additional team of 10 commercial bankers in the Central Oregon region

 

 

2010—entered the Three Rivers region through an FDIC-assisted acquisition of Home Valley Bank, which included five branch locations and loss-sharing agreements on substantially all acquired loans and foreclosed real estate

Our competitive strengths

We believe our competitive strengths include the following:

 

 

Experienced and locally connected management.    Since our inception, our success has been built on a combination of strong leadership and local banking relationships. Our experienced management team contributes to our strong presence within the communities of our four regions through active leadership and a variety of other local connections. The following table presents the average years of industry experience of our management team, collectively representing over 370 years of banking experience, mostly in Oregon:

 

Management level    Number of
persons
    

Average years of

industry
experience

     Average
years at the
bank
 

 

 

Executive management team

     3         32         19   

Senior vice presidents

     4         30         11   

Regional credit administrators

     4         24         5   

Regional branch administrators

     4         13         6   

 

 

 

 

Diverse loan portfolio.    Our loan portfolio is diverse in terms of type of client, loan product and industry. Our three largest loan segment concentrations (as a percentage of total non-acquired loans as of March 31, 2011) include: owner and non-owner occupied commercial real estate of 35.7%, commercial and industrial of 25.9% and agriculture of 13.1%. Since

 

 

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December 31, 2009, the Bank’s non-acquired loan portfolio has consistently remained at or below the supervisory criteria for commercial real estate and construction loans as a percentage of the Bank’s capital.

 

 

Effective credit risk management.    We have developed prudent credit standards and disciplined underwriting practices that, combined with our understanding of our regions and our clients, enable us to manage credit risk effectively. As of March 31, 2011, our ratio of non-acquired non-accrual loans to total loans was 3.24%, while the SNL Peer Group (banks headquartered in Oregon and Washington, excluding banks with holding companies headquartered outside Oregon or Washington) on average reported a 4.20% ratio of non-accrual loans to total loans.

 

 

Strong net interest margin.    Over numerous economic cycles, our stable deposit base has provided us with a relatively low cost of funds, an advantage that we believe may become more pronounced if interest rates rise significantly. We fund our lending activities and other assets principally through deposits from clients who in many cases have had long-term relationships with the Bank. We generally do not use brokered deposits and do not rely on wholesale funding sources. As of March 31, 2011, our total deposits were $748.3 million, of which 78.3% were core deposits (i.e., total deposits excluding time deposits in excess of $100,000). The following table compares the Bank’s yield on earning assets, cost of interest-bearing liabilities, and net interest margin for the quarter ended March 31, 2011 to averages for the SNL Peer Group, as reported by SNL Financial LC for the same period:

 

      Bank      SNL Peer Group
average
 

 

 

Yield on earning assets

     5.42%         5.04%   

Cost of interest-bearing liabilities

     1.06%         1.22%   

Net interest margin (fully taxable equivalent)

     4.50%         4.07%   

 

 

 

 

Market leader with community focus.    We have established and maintain many valuable long-term client relationships in our four regions. We have focused on banking in smaller communities where we believe our founding principles and community banking platform can be successful. Based on FDIC data as of June 30, 2010, and after giving effect to the FDIC-assisted acquisition of Home Valley Bank, we were ranked first in deposit market share in two of our four regions—Klamath/Lake and Three Rivers.

 

 

Community banking model with branch-level accountability.    We emphasize local authority, accountability and responsibility to develop and retain high-quality client relationships. Our regional and branch managers have authority, within company-wide guidelines, to advertise locally, make loan underwriting and pricing decisions and manage client relationships. This approach permits local managers to appropriately tailor loan products and pricing to specific client needs and local market conditions. Each branch is accountable through monthly reporting and regularly scheduled leadership meetings. We support our regional and branch managers with centralized operations technology, advertising and marketing resources, management tools, and significant investment in our branches. We believe that our community banking model and infrastructure investments provide us the capacity to further grow our business.

 

 

Attractive platform for banking professionals.    We believe our founding principles and community banking platform provides us with a competitive advantage in recruiting and

 

 

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retaining experienced banking professionals who have relationships in southern or central Oregon. Some of our past growth has been driven by our ability to attract and retain talented bankers and professionals. For example, we have hired several teams of commercial bankers with shared values from larger institutions to successfully expand our presence in the Central Oregon and Rogue regions.

Our business strategy

We intend to leverage our competitive strengths as we pursue the following business strategies:

 

 

Focus on long-term profitability.    Over the last six years we have grown from nine to 24 branches and from $553.5 million in assets at December 31, 2005 to $849.2 million in assets at March 31, 2011. Our average annual return on average assets from 2005 to 2010 was 0.74%. We will focus on enhancing our profitability by exercising a disciplined approach to product pricing, expense control and balance sheet mix, and by leveraging our past investment in our workforce, brand and technology infrastructure to increase our interest income and non-interest income. We expect our overall cost of funds will further improve relative to our peers as our newer branches mature and we assimilate recently acquired client relationships. In addition, we will seek to generate stable and recurring fee revenue though our wealth management subsidiary and the Bank’s trust services division.

 

 

Build long-term client relationships.    We intend to continue to build long-term client relationships with small and medium sized businesses and individuals in our regions by continuing to implement our “Your Business First” standard of client service. We believe continued adherence to our founding principles and execution of our community banking model in our regions will enable us to build and maintain strong brand recognition and attract and maintain long-term clients.

 

 

Maintain and grow market share.    We ranked first in deposit market share in two of our four regions—Klamath/Lake and Three Rivers. We intend to continue achieving organic growth through the anticipated economic recovery and population growth within our regions and by capturing incremental market share from our competitors. We believe that our brand recognition, resources and financial strength, combined with our community banking model, will enable us to attract clients from large national banks that operate in our regions, and from other competitors that may struggle to satisfy client needs in the face of increased regulatory burdens and financial stress. With our increased capital levels from this offering, we expect to expand our market share in our Central Oregon and Rogue regions and strengthen our market leading positions in our Klamath/Lake and Three Rivers regions.

 

 

Continue to build a diversified loan portfolio.    We will continue to focus on business lines that diversify our credit portfolio and client base and provide attractive margin opportunities. Our management team has significant experience in agricultural, owner-occupied commercial real estate and health care related lending, and we believe these areas provide the Bank an opportunity to address lending segments that are important to the local economies within our regions. In addition, we plan to continue to mitigate our loan concentration risks over the long term and leverage our experience as a strategic partner with government agencies and programs.

 

 

Focus on asset quality and disciplined underwriting.    Effective credit risk management will continue to be a high priority for us. Bill Castle, our President and Chief Executive Officer, sets

 

 

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the tone at the top of the organization with his banking experience as a former chief credit officer and commercial lender. We plan to maintain our focus on loan types and markets where we have community and industry knowledge and a historical record of success. Although delinquencies in our loan portfolio have increased primarily as a result of the current economic downturn, we will continue to strive for strong asset quality by adhering to prudent underwriting criteria and diligently applying our collection efforts. To address our elevated level of problem assets, we will continue to focus our attention and resources on loan workouts and, where appropriate, loan modifications.

 

 

Maintain a strong balance sheet.    We intend to maintain a strong balance sheet, which has thus far enabled us to endure the economic downturn better than many of our competitors. Although we have experienced increased levels of non-performing loans, delinquencies, adversely classified assets and loan losses, our loan loss coverage ratios remain relatively strong. As of March 31, 2011, the ratio of our allowance for loan losses to total non-acquired loans was 2.30%. While we exceeded published “well capitalized” standards at March 31, 2011, we remain subject to a regulatory Memorandum of Understanding that requires us to, among other things, increase by August 22, 2011 and maintain the Bank’s Tier 1 capital so that it equals or exceeds 10% of the Bank’s average total assets (calculated in accordance with FDIC regulations). See “—Regulatory Agreements” for more information. We have been working diligently to comply with this regulatory Memorandum of Understanding and expect that the proceeds of this offering will satisfy its capital improvement requirements.

Our regions

We operate in four contiguous regions of central and southern Oregon: Klamath/Lake, Central Oregon, Rogue and Three Rivers. Our regions consist of smaller communities located along the major north-south highways (Interstate 5 and US Route 97) and railroads that connect California, Oregon and Washington. The economies of these four regions have historically been based on lumber, wood products and agriculture, but have experienced a trend toward diversification with a focus on economic activities such as education, health care, tourism and light manufacturing. Several communities in the Central Oregon and Rogue regions have experienced significant population growth in recent years.

 

 

Klamath/Lake.    Our corporate headquarters office and Klamath/Lake regional headquarters are located in Klamath Falls, which is situated along US Route 97 and less than 20 miles north of the California border. Klamath Falls is the transportation hub for south central Oregon and north central California. The region’s traditional reliance on wood products has broadened to include a focus on health care, technology and education. The region also has a diverse and substantial agriculture and ranching industry. In addition, government plays a significant role in this region’s economy. For example, the local offices of the Bureau of Land Management are responsible for managing 3.5 million acres of public lands in the region.

 

 

Central Oregon.    Our Central Oregon regional headquarters office is located in Bend, along US Route 97. This region’s key industries include manufacturing, which primarily centers on building products and has expanded to include manufacturing related to aviation, technology and pharmaceuticals. Corporate headquarters operations and administrative centers also play a prominent role in this region’s economy. In addition, the healthcare sector, agriculture, ranching and related services, and tourism are important to the region’s economy.

 

 

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Rogue.    Our Rogue regional headquarters office is located in Medford. This region consists of Jackson County, along the I-5 corridor and bordering California. Key industries in this region include education, healthcare, agriculture, manufacturing and distribution. Tourism is also important to this region, with wineries, outdoor recreation and the Oregon Shakespeare Festival.

 

 

Three Rivers.    Our Three Rivers regional headquarters office is located in Grants Pass. This region consists of Josephine County, along the I-5 corridor, and lies west of our Rogue region. The wood products industry plays an important role, along with a mix of light manufacturing, secondary wood products, retail trade and service-based industries. Medical and retirement facilities have expanded into the region in recent years. Tourism is also important to this region, with outdoor recreation activities involving the Rogue, Illinois and Applegate Rivers.

The following table contains information regarding our four regions and the Bank’s deposits in these regions:

 

            Bank information                   Projected growth     Unemployment
rate(1)
 
          2010-2015    
Counties by region   Total
market
deposits
($000s)
    Deposit
market
share
rank
    Deposits
($000s)
    Market
share
    Number
of
branches
    Population     Median
household
income
    Population     Median
household
income
    Unempl.
rate
(May
2011)
    Change
over last
twelve
months
 

 

 

Klamath/Lake(2)

                     

Klamath County

  $ 779,395        1            $ 268,194        34.41%        6        66,425      $ 39,388        0.39%        14.13%        11.1%        -110 bps   

Lake County

  $ 93,933        1            $ 35,032        37.29%        1        7,363      $ 36,050        -0.81%        14.78%        11.6%        -100 bps   

Central Oregon

                     

Crook County

  $ 213,218        6            $ 5,847        2.74%        1        25,089      $ 43,070        12.06%        15.05%        14.5%        -140 bps   

Deschutes County

  $ 2,635,087        8            $ 114,858        4.36%        5        168,710      $ 53,137        13.90%        12.07%        11.6%        -210 bps   

Jefferson County

  $ 133,426        6            $ 1,990        1.49%        1        21,828      $ 45,122        3.06%        15.05%        12.0%        -100 bps   

Rogue

                     

Jackson County

  $ 2,796,890        11            $ 90,070        3.22%        5        208,541      $ 47,042        4.90%        14.81%        10.9%        -130 bps   

Three Rivers(3)

                     

Josephine County

  $ 1,291,985        1            $ 227,935        17.64%        5        83,853      $ 38,770        2.74%        15.13%        11.6%        -180 bps   

United States

              $ 54,442        3.85%        12.39%        9.1%        -60 bps   

 

 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Source: SNL Financial LC

Note: Deposit, market share and population data as of June 30, 2010.

 

(1)   Unemployment data as of May 2011, not seasonally adjusted.

 

(2)   The Bank’s Gilchrist branch is located in Klamath County, but the Bank considers Gilchrist to be in its Central Oregon region. This table includes Gilchrist in the Klamath/Lake region. We present information elsewhere in this prospectus with the Gilchrist branch deposits in the Central Oregon region.

 

(3)   Josephine County deposits are deposits of Home Valley Bank as of June 30, 2010.

Regulatory matters

Primarily as a result of the challenging economic environment in which we have been operating, we have experienced increased levels of non-performing assets, delinquencies and adversely classified assets, as well as net losses from operations in 2009 and increased provisions for loan losses and charge-offs in 2009 and 2010. In addition, we used a portion of our capital to support the assets acquired in our FDIC-assisted acquisition of Home Valley Bank on July 23, 2010. On September 20, 2010, the FDIC and the Oregon Department of Consumer and Business Services Division of Finance and Corporate Securities (“DFCS”) issued a joint Safety and Soundness Examination Report (“Examination Report”) based on the Bank’s results of operations for the

 

 

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six months ended, and financial condition as of, June 30, 2010, which date preceded the date we completed the FDIC-assisted acquisition of Home Valley Bank. On February 22, 2011, the Bank entered into a Memorandum of Understanding (“MOU”) with the FDIC and the DFCS. Under the MOU, the Bank is required to, among other things, reduce all assets classified as “Substandard” in the Examination Report (that have not been previously charged off) by 50% by June 22, 2011, and by 70% by August 22, 2011; and develop and implement plans to improve asset quality and lending and collection practices, increase profitability, and maintain a minimum primary liquidity ratio (net cash, short-term and marketable assets divided by net deposits and short-term liabilities) of at least 15% and a maximum net non-core funding dependence ratio (non-core funding such as brokered deposits, certificates of deposit greater than $100,000 and borrowed funds, divided by longer-term assets such as loans and securities that mature in more than one year) of 20%. The MOU also requires us to increase by August 22, 2011 and maintain the Bank’s Tier 1 capital so that it equals or exceeds 10% of the Bank’s average total assets (calculated in accordance with applicable FDIC regulations). We refer to this ratio of Tier 1 capital to the Bank’s average total assets as our Tier 1 leverage ratio. The Bank’s Tier 1 capital primarily consists of its common shareholders’ equity. On May 18, 2011, the Board adopted resolutions at the direction of the Federal Reserve Bank of San Francisco requiring us to take corrective actions and refrain from specified actions to ensure the Bank’s compliance with the MOU, and that are substantially similar in substance and scope to the MOU.

Under the MOU, the Bank may not pay cash dividends to us without prior written approval from the FDIC and the DFCS. Under the board resolutions, we may not pay any dividends on or repurchase our Common Stock, or receive dividends from the Bank, without the prior written approval of the Federal Reserve Bank of San Francisco and the DFCS. We do not expect to be permitted to pay or receive dividends or repurchase shares until we meet all of the requirements of the MOU and the board resolutions. We and the Bank each must obtain prior regulatory approval before adding any new director or senior executive officer or changing the responsibilities of any current senior executive officer. The MOU will remain in effect until stayed, modified, terminated or suspended by the FDIC and the DFCS.

We are working diligently to comply with the MOU and the board resolutions. We are making progress with respect to reducing assets classified as “Substandard;” however, we did not meet the MOU’s 50% “Substandard” asset reduction requirement by June 22, 2011, and do not believe we will meet the MOU’s 70% Substandard asset reduction requirement by August 22, 2011. We expect significant improvement in asset quality will be a gradual process dependent in part on the pace of broader economic recovery. As of March 31, 2011, we had reduced the Bank’s assets classified as “Substandard” in the Examination Report (that had not been previously charged off) by 16.1%. As of March 31, 2011, the Bank’s primary liquidity ratio was 13.64% and the Bank’s net non-core funding dependence ratio was 23.71%. We have implemented a number of plans and policies in relation to lending and collection practices, allowance for loan losses methodology, disposition of adversely classified assets and collection of delinquent loans, which we have discussed with the FDIC or submitted to the FDIC for review. As of March 31, 2011, the Bank’s Tier 1 leverage ratio was 8.14% and we do not believe the Bank will attain a Tier 1 leverage ratio of at least 10% by August 22, 2011. We expect that the Bank’s Tier 1 leverage ratio will meet or exceed the 10% MOU requirement upon completion of the offering contemplated by this prospectus. For additional information regarding the MOU and the board resolutions, see “Risk Factors—We are required to comply with the terms of the MOU, and lack of compliance could result in additional regulatory actions” and “Business—Regulatory Agreements.”

 

 

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FDIC-assisted acquisition of Home Valley Bank

On July 23, 2010, we completed the FDIC-assisted acquisition of Home Valley Bank, acquiring approximately $244.9 million of assets and assuming $242.6 million of liabilities, including $227.2 million of deposits, at cost basis as of the acquisition date. The acquisition expanded the Bank’s geographic presence into Josephine County with four branches in Grants Pass and one in Cave Junction. The purchase and assumption agreement with the FDIC provides for two separate loss-sharing agreements, which, in addition to fair value adjustments, significantly mitigates our risk of future loss on the loan portfolio we acquired. These loss-sharing agreements with the FDIC provide for specified credit loss protection for substantially all acquired loans and foreclosed real estate. Under the terms of these loss-sharing agreements, the FDIC will absorb 80% of losses and share in 80% of loss recoveries on $214.0 million of cost-basis acquired assets (as of the acquisition date). The term for loss-sharing and recoveries sharing on residential real estate loans is 10 years, the term for loss-sharing on non-residential real estate loans is 5 years, and the term for recoveries sharing on non-residential real estate loans is 8 years. At the acquisition date, the Bank estimated the Home Valley Bank acquired assets would incur approximately $34.2 million of losses, and we recorded a $26.7 million FDIC indemnification asset based on the present value of expected loss reimbursements.

We accounted for the FDIC-assisted transaction using the acquisition method of accounting; accordingly, our balance sheet includes the estimates of the fair value of the assets acquired and liabilities assumed. Our results of operations for the twelve months ended December 31, 2010 include the effects of the acquisition from the date of the transaction. We recorded a bargain purchase gain of $4.6 million in the third quarter of 2010 that represents the excess of the estimated fair value of the assets acquired over the estimated fair value of liabilities assumed in the FDIC-assisted acquisition of Home Valley Bank. During the first quarter of 2011, the acquisition contributed pre-tax earnings of $0.8 million, including $1.7 million in net interest income, $0.2 million in change in indemnification asset and $0.1 million in fee income, offset by $0.5 million in salaries and employee benefits, $0.6 million in other operating and occupancy expenses, and $0.1 million in provision for loan losses.

A copy of the purchase and assumption agreement between the Bank and the FDIC, including the loss-sharing agreements, is filed as Exhibit 2.1 to the Registration Statement, of which this prospectus constitutes a part and is incorporated herein by reference. The description of the loss-sharing agreements and terms of the FDIC-assisted acquisition of Home Valley Bank set forth above and elsewhere in this prospectus does not purport to be complete, and is qualified by reference to the full text of the purchase and assumption agreement.

Recent developments

Operating results for the three months ended June 30, 2011

The following presents an overview of the operating results for the three months ended June 30, 2011 and key financial information as of June 30, 2011. These items are subject to the risks and uncertainties relating to our business described under “Risk Factors” and elsewhere in this prospectus.

 

 

Net income for the quarter ended June 30, 2011 was $1.0 million, or $0.15 per diluted share, compared to $52,000, or $0.01 per diluted share, for the quarter ended March 31, 2011 and $0.6 million, or $0.09 per diluted share, for the quarter ended June 30, 2010.

 

 

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Net interest margin for the quarter ended June 30, 2011 was 4.45%, which increased by six basis points compared to the preceding quarter and decreased by 61 basis points compared to the quarter ended June 30, 2010. Net interest income was $8.2 million for the quarter ended June 30, 2011, compared to $8.1 million for the quarter ended March 31, 2011 and $6.4 million for the quarter ended June 30, 2010.

 

 

The cost of interest-bearing liabilities for the quarter ended June 30, 2011 was 1.0%, which decreased by 13 basis points compared to the preceding quarter and decreased by 28 basis points compared to the quarter ended June 30, 2010.

 

 

Non-acquired non-accrual loans as of June 30, 2011 were $10.7 million, a decrease of $10 million, or 48.55%, from March 31, 2011 and an increase of $4.3 million or 68.73% from June 30, 2010. Non-acquired non-accrual loans represented 1.73% of total loans at June 30, 2011 compared to 3.24% of total loans at March 31, 2011 and 1.31% of total loans at June 30, 2010.

 

 

Non-acquired non-performing assets as of June 30, 2011 were $29.2 million, a decrease of $3.4 million or 10.37% from March 31, 2011 and an increase of $12.4 million or 74.11% from June 30, 2010. Non-acquired non-performing assets represented 3.40% of total assets at June 30, 2011 compared to 3.83% of total assets at March 31, 2011 and 2.72% of total assets at June 30, 2010.

 

 

As of June 30, 2011 we had reduced the Bank’s assets classified as “Substandard” in the September 2010 Examination Report by $22.9 million, or 24.22%.

 

 

The provision for loan losses for the quarter ended June 30, 2011 was $2.4 million, compared to $1.5 million for the preceding quarter and $1.0 million for the quarter ended June 30, 2010. The allowance for loan losses as a percentage of total loans was 1.55% as of June 30, 2011, compared to 1.75% as of March 31, 2011 and 1.48% as of June 30, 2010.

 

 

Net charge-offs for the quarter ended June 30, 2011 were $4.0 million, compared to $1.5 million for the quarter ended March 31, 2011 and $0.7 million for the quarter ended June 30, 2010.

 

 

The ratio of tangible common equity to tangible assets was 8.46% at June 30, 2011, compared to 8.34% at March 31, 2011 and 11.25% at June 30, 2010.

 

 

The Tier 1 leverage ratio was 8.40% at June 30, 2011, compared to 8.24% at March 31, 2011 and 11.46% at June 30, 2010.

 

 

Tangible book value per share was $10.67 at June 30, 2011, compared to $10.45 at March 31, 2011 and $10.00 at June 30, 2010.

Our corporate information

We are incorporated under the laws of Oregon. Our principal executive offices are located at 803 Main Street, Klamath Falls, OR 97601. Our telephone number is (541) 882-3281. We maintain an internet website at www.southvalleybank.com. The information contained on or accessible from our website does not constitute a part of this prospectus and is not incorporated by reference into this prospectus.

 

 

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The offering

The following summary of the offering contains basic information about the offering and our Common Stock and is not intended to be complete. It does not contain all of the information that may be important to you. For a more complete description of our Common Stock, please refer to the section of this prospectus entitled “Description of Capital Stock—Common Stock.”

 

Common stock offered by us

                 shares

 

Common stock offered by the selling shareholders

                 shares

 

Underwriters’ option to purchase additional shares of common stock

                 shares from us and                  shares from the selling shareholders

 

Common stock to be outstanding immediately after this offering

                 shares
                   shares if the underwriters’ option is exercised in full

 

  The number of shares of Common Stock to be outstanding after this offering is based on                  shares outstanding as of                     , 2011, and excludes                  shares of our Common Stock issuable upon exercise of outstanding warrants.

 

Use of proceeds

We estimate that our net proceeds from this offering, after deducting underwriting discounts, commissions and estimated offering expenses, will be approximately $         million, or approximately $         million if the underwriters’ option is exercised in full, based on an assumed offering price of $         per share. We intend to use the net proceeds to strengthen our regulatory capital, to support our long-term growth and for general corporate purposes. We will not receive any of the proceeds from the sale of shares by selling shareholders. See “Use of Proceeds” for additional information.

 

Proposed NASDAQ listing

We intend to apply to list our Common Stock on The NASDAQ Capital Market under the symbol “SVBT.”

 

Risk factors

An investment in our Common Stock involves a high degree of risk. See “Risk Factors” and the other information included in this prospectus for a discussion of factors you should carefully consider before investing in shares of our Common Stock.

 

 

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Summary selected historical consolidated financial data

The following table sets forth certain of our historical consolidated financial data. The summary consolidated financial data as of December 31, 2010 and 2009 and for the years ended December 31, 2010, 2009 and 2008 have been derived from our audited consolidated financial statements included elsewhere in this prospectus. The summary consolidated financial data as of March 31, 2011 and for the three months ended March 31, 2011 and 2010 have been derived from our unaudited consolidated financial statements included elsewhere in this prospectus. The summary consolidated financial data as of December 31, 2008, 2007 and 2006 and for the years ended December 31, 2007 and 2006 have been derived from our audited consolidated financial statements that are not included in this prospectus.

On July 23, 2010, we completed the FDIC-assisted acquisition of Home Valley Bank, acquiring approximately $244.9 million of assets and assuming $242.6 million of liabilities, including $227.2 million of deposits, at cost basis as of the acquisition date. The purchase and assumption agreement with the FDIC provides for two separate loss-sharing agreements, which, in addition to fair value adjustments, significantly mitigates our risk of future loss on the loan portfolio we acquired. These loss-sharing agreements provide for specified credit loss protection for substantially all acquired loans and foreclosed real estate. Under the terms of the loss-sharing agreements, the FDIC will absorb 80% of losses and share in 80% of loss recoveries on $214.0 million of cost-basis acquired assets (as of the acquisition date). The term for loss-sharing and recoveries sharing on residential real estate loans is 10 years, the term for loss-sharing on non-residential real estate loans is 5 years, and the term for recoveries sharing on non-residential real estate loans is 8 years. At the acquisition date, the Bank estimated the Home Valley Bank acquired assets would incur approximately $34.2 million of losses, and we recorded a $26.7 million FDIC indemnification asset based on the present value of expected loss reimbursements. We accounted for the FDIC-assisted transaction using the acquisition method of accounting; accordingly, our balance sheet includes the estimates of the fair value of the assets acquired and liabilities assumed. Our results of operations for the twelve months ended December 31, 2010 include the effects of the acquisition from the date of the transaction. We recorded a bargain purchase gain of $4.6 million in the third quarter of 2010 that represents the excess of the estimated fair value of the assets acquired over the estimated fair value of liabilities assumed in the FDIC-assisted acquisition of Home Valley Bank. The acquired loan portfolio and other real estate owned (“OREO”) are referred to as “acquired loans” and “covered OREO,” respectively, and these are presented as separate line items in our consolidated financial statements. See Note 2 of the notes to the audited consolidated financial statements included in this prospectus. The results and other financial data of Home Valley Bank are not included in the table below for periods prior to the date of acquisition and, therefore, the data for such prior periods may not be comparable in all respects.

 

 

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This summary historical consolidated financial data should be read in conjunction with other information contained in this prospectus, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and accompanying notes included elsewhere in this prospectus. Our historical financial results are not necessarily indicative of results to be expected in any future period.

 

     As of or for the three
months ended
March 31,
    As of or for the year ended
December 31,
 
(dollars in thousands, except per
share data)
  2011     2010     2010     2009     2008     2007     2006  

 

 

Selected Consolidated Balance Sheet Data:

             

Cash and cash equivalents

  $ 73,839      $ 23,119      $ 54,028      $ 21,420      $ 16,918      $ 16,617      $ 15,283   

Investment securities, available-for-sale

    49,052        44,058        51,096        44,091        48,581        59,615        60,279   

Non-acquired loans

    484,937        481,973        487,891        489,037        502,695        494,875        463,185   

Acquired loans

    154,299               158,550                               

Allowance for loan losses

    (11,166     (6,797     (11,123     (6,719     (5,277     (5,290     (4,960

Total assets

    849,170        601,338        845,271        606,065        614,566        598,761        563,123   

Total deposits

    748,279        499,721        741,816        505,612        474,136        462,879        489,648   

Total shareholders’ equity

    73,067        67,231        72,336        65,272        70,410        68,406        62,367   

Selected Consolidated Statement of Operations Data:

             

Interest income

  $ 10,031      $ 8,102      $ 36,705      $ 34,963      $ 37,844      $ 42,161      $ 37,617   

Interest expense

    1,908        1,696        6,910        8,797        11,566        15,797        14,477   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

    8,123        6,406        29,795        26,166        26,278        26,364        23,140   

Provision for loan losses

    1,525        502        8,881        6,755        595        115        333   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income after provision for loan losses

    6,598        5,904        20,914        19,411        25,683        26,249        22,807   

Non-interest income

    1,538        1,030        9,928        4,049        4,164        4,676        6,366   

Non-interest expense

    8,059        5,609        27,689        27,606        21,816        20,991        20,335   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

    77        1,325        3,153        (4,146     8,031        9,934        8,838   

Provision (benefit) for income taxes

    25        414        423        (2,183     2,527        3,205        2,534   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

  $ 52      $ 911      $ 2,730      $ (1,963   $ 5,504      $ 6,729      $ 6,304   

 

 

Selected Share Data:

             

Earnings (loss) per common share-basic

  $ 0.01      $ 0.14      $ 0.41      $ (0.30   $ 0.82      $ 1.01      $ 0.96   

Earnings (loss) per common share-diluted

  $ 0.01      $ 0.14      $ 0.41      $ (0.30   $ 0.82      $ 1.01      $ 0.96   

Dividends paid per common share

  $      $      $      $ 0.24      $ 0.32      $ 0.30      $ 0.28   

Dividend payout ratio

    0.00%        0.00%        0.00%        (79.92%     39.42%        29.58%        29.11%   

Book value per common share

  $ 10.81      $ 10.39      $ 10.79      $ 10.17      $ 10.65      $ 10.22      $ 9.44   

Tangible book value per common share

  $ 10.45      $ 10.02      $ 10.42      $ 9.79      $ 10.29      $ 9.86      $ 9.08   

Weighted average common shares outstanding-basic

    6,712,105        6,464,354        6,616,058        6,555,699        6,723,246        6,659,975        6,581,914   

Weighted average common shares outstanding-diluted

    6,723,598        6,464,354        6,619,697        6,555,699        6,723,246        6,659,975        6,581,914   

Common shares outstanding at period end

    6,756,189        6,469,878        6,706,379        6,420,911        6,611,706        6,694,915        6,605,626   

 

 

 

 

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     As of or for the three
months ended
March 31,
    As of or for the year ended
December 31,
 
(dollars in thousands)         2011                 2010           2010     2009     2008     2007     2006  

 

 

Selected Financial Ratios:

             

Return on average shareholders’ equity(1)

    0.29%        5.37%        3.81%        (2.88%     7.77%        10.16%        10.28%   

Return on average assets(1)

    0.02%        0.61%        0.38%        (0.32%     0.91%        1.17%        1.13%   

Interest income to average earning assets(1)(2)

    5.44%        6.11%        5.85%        6.35%        6.70%        7.65%        7.09%   

Interest expense to average earning assets(1)

    1.05%        1.29%        1.11%        1.61%        2.07%        2.95%        2.81%   

Net interest margin(1)(2)

    4.39%        4.82%        4.74%        4.73%        4.63%        4.70%        4.28%   

Non-interest income to average assets(1)

    0.74%        0.69%        1.39%        0.66%        0.69%        0.81%        1.14%   

Non-interest expense to average assets(1)

    3.87%        3.76%        3.86%        4.52%        3.63%        3.66%        3.65%   

Efficiency ratio

    83.42%        75.43%        69.71%        91.37%        71.66%        67.63%        68.92%   

Loan to deposit ratio

    85.43%        96.45%        87.14%        96.72%        106.02%        106.91%        94.60%   

Capital Ratios:

             

Average shareholders’ equity to average assets

    8.73%        11.38%        9.98%        11.15%        11.78%        11.53%        10.99%   

Tier 1 leverage ratio

    8.35%        10.72%        8.24%        10.23%        11.17%        11.09%        10.53%   

Tier 1 risk-based capital ratio

    11.99%        11.90%        11.72%        11.54%        11.96%        11.93%        11.73%   

Total risk-based capital ratio

    13.25%        13.15%        12.98%        12.78%        12.91%        12.92%        12.73%   

Selected Asset Quality Ratios:

             

Non-acquired non-accrual loans to total loans

    3.24%        1.48%        1.97%        1.97%        0.36%        0.13%        0.30%   

Non-acquired non-performing assets to total assets

    3.83%        4.06%        2.82%        3.80%        0.82%        0.27%        0.38%   

Allowance for loan losses to total non-acquired loans

    2.30%        1.41%        2.28%        1.37%        1.05%        1.07%        1.07%   

Net charge-offs (recoveries) to average total loans

    0.23%        0.09%        0.80%        1.07%        0.12%        (0.05%     (0.06%

 

 
(1)   Annualized for the three month periods ended March 31, 2011 and 2010.

 

(2)   Tax exempt income has been adjusted to a tax equivalent basis at a 34% tax rate. The amount of such adjustment was an addition to the recorded interest income of approximately $126 and $132 for the three months ended March 31, 2011 and 2010, respectively, and $525, $535 and $517 for the years ended December 31, 2010, 2009, and 2008, respectively.

 

 

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Risk factors

Before investing in our Common Stock, you should carefully consider all information included in this prospectus, including our consolidated financial statements and accompanying notes. In particular, you should carefully consider the risks described below before purchasing shares of our Common Stock in this offering. Investing in our Common Stock involves a high degree of risk. Any of the following factors could harm our future business, financial condition and results of operations and could result in a partial or complete loss of your investment. These risks are not the only ones that we may face. Other risks of which we are not aware, including those that relate to the banking and financial services industry in general and us in particular, or those which we do not currently believe are material, may harm our future business, financial condition and results of operations.

Continued weak or worsening regional and national business and economic conditions, and regulatory responses to such conditions could constrain our growth and profitability and have a material adverse effect on our business, financial condition and results of operations.

Our business and operations are sensitive to general business and economic conditions in the United States, and southern and central Oregon, specifically. If the national, regional and local economies are unable to overcome stagnant growth, high unemployment rates and depressed real estate markets resulting from the economic recession that began in 2007, or experience worsening economic conditions, our growth and profitability could be constrained. Weak economic conditions are characterized by, among other indicators, fluctuations in debt and equity capital markets, increased delinquencies on mortgage, commercial and consumer loans, residential and commercial real estate price declines and lower home sales and commercial activity. All of these factors are generally detrimental to our business. We expect only moderate improvement in these conditions in the near future. In particular, we may face the following risks in connection with these events:

 

 

We face increased regulation of our industry, including as a result of the Dodd-Frank Act. Compliance with this and other regulations will increase our costs and reduce existing sources of revenue and may limit our ability to pursue opportunities.

 

 

Our ability to assess the creditworthiness of our clients may be impaired if the models and approaches we use to select, manage and underwrite our clients become less predictive of future performance.

 

 

The process we use to estimate losses inherent in our loan portfolio requires difficult, subjective and complex judgments, including forecasts of economic conditions and how these economic predictions might impair the ability of our borrowers to repay their loans, which process may no longer be capable of accurate estimation and may, in turn, adversely affect its reliability.

 

 

We may be required to pay significantly higher FDIC insurance premiums in the future if industry losses further deplete the FDIC deposit insurance fund.

 

 

Changes in interest rates as a result of a failure to increase the United States’ debt ceiling could affect our current interest income spread.

 

 

Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions and government sponsored entities.

 

 

We may face increased competition due to consolidation within the financial services industry.

 

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If current levels of market disruption and volatility continue or worsen, our ability to access capital may be adversely affected and asset quality may further deteriorate, which would harm our business, financial condition and results of operations.

Our geographic concentration exposes us to the risk of the adverse effects and consequences of any regional or local disasters or economic downturn that disproportionately affect southern and central Oregon.

We conduct our operations almost exclusively in Oregon, specifically southern and central Oregon. Substantially all of the real estate loans in our portfolio are secured by properties located in the four regions we serve in Oregon, and substantially all of the real estate loans in our loan portfolio are made to borrowers who live and conduct business in those regions. Our lack of geographic diversification poses risks because our financial condition and results of operations are highly dependent on the economic conditions of the regions we serve, where regional or local disasters (such as earthquakes, fires, floods or droughts) or adverse economic developments, among other things, could affect the volume of loan originations, increase the level of non-performing assets, increase the rate of foreclosure losses on loans and reduce the value of our loans. Since 2009, Oregon has had one of the nation’s highest unemployment rates and major employers in Oregon have implemented substantial employee layoffs or scaled back growth plans. Severe declines in housing prices and property values have been particularly acute in our regions. Oregon continues to face fiscal challenges, the long-term effects of which on the state’s economy cannot be predicted. Southern and central Oregon include significant rural areas in which agriculture is an important industry and therefore the economies of these regions can be greatly affected by severe weather conditions and the allocation of water resources, including droughts in the Klamath Basin that may decrease agricultural productivity. Our agriculture loans have been increasing as a percentage of our non-acquired loan portfolio over the past five years and we expect this trend to continue. As of March 31, 2011, agriculture loans represented 13.1% of our non-acquired loan portfolio. Lower crop yields or reduced commodity prices could have a material adverse effect on our business, financial condition and results of operations. Any regional or local disasters or further deterioration of economic conditions that affect southern and central Oregon may affect us and our profitability more significantly and more adversely than our competitors that are less geographically concentrated.

A large percentage of our loan portfolio is secured by real estate, in particular commercial real estate. Continued deterioration in the real estate market or other segments of our loan portfolio could have a material adverse effect on our business, financial condition and results of operations.

As of March 31, 2011, approximately 46.8% of our loan portfolio, excluding acquired loans, was secured by commercial real estate, and approximately 7.6% of our loan portfolio was secured by residential real estate, excluding residential real estate securing agricultural loans. Since 2007 we have experienced elevated levels of net charge-offs and an increase in our loan loss provisions as a result of increased levels of commercial and consumer delinquencies and declining real estate values. Increases in commercial and consumer delinquency levels or continued declines in real estate market values would require increased net charge-offs and continuing increased provisions for loan losses, which could have a material adverse effect on our business, financial condition and results of operations. The market value of real estate can fluctuate significantly in a short period of time as a result of local market conditions. Adverse changes affecting real estate values and the liquidity of real estate in one or more of our regions could increase the credit risk associated with our loan portfolio, and could result in losses that would adversely affect our

 

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profitability. Adverse changes in the economy affecting real estate values and liquidity in our primary market area could significantly impair the value of property pledged as collateral on loans and affect our ability to sell the collateral upon foreclosure without a loss or additional losses. Collateral may have to be sold for less than the outstanding balance of the loan, which could result in losses on the loan. These declines and losses would have a material adverse effect on our business, financial condition and results of operations.

We are required to comply with the terms of an MOU with the FDIC and the DFCS, and lack of compliance could result in additional regulatory actions.

Under federal and state laws pertaining to the safety and soundness of insured depository institutions and their holding companies, state and federal banking authorities may compel or restrict certain actions on our part if they determine that we have insufficient capital or are otherwise operating in a manner that may be deemed to be inconsistent with safe and sound banking practices. The banking authorities can request that we enter into formal or informal supervisory agreements, including, without limitation, board resolutions, memoranda of understanding, written agreements and consent orders, or failing to secure our consent, impose on us a cease and desist order pursuant to which we could be required to take identified corrective actions to address cited concerns, or to refrain from taking identified actions.

On February 22, 2011, the Bank entered into the MOU with the FDIC and DFCS. Under the terms of the MOU, the Bank agreed to, among other things:

 

 

not appoint any new director or senior executive officer or change the responsibilities of any current senior executive officers without the prior written non-objection of the FDIC and the DFCS;

 

 

increase by August 22, 2011 and thereafter maintain the Bank’s Tier 1 capital so that it equals or exceeds 10% of the Bank’s average total assets (calculated in accordance with applicable FDIC regulations and in addition to a fully funded allowance for loan and lease losses);

 

 

reduce all assets classified as “Substandard” in the Examination Report (that we had not previously charged off) by 50% by June 22, 2011, and by 70% by August 22, 2011;

 

 

refrain from approving any extension of credit to any borrower who had a loan classified as “Substandard” in the Examination Report without first collecting in cash all interest due;

 

 

not pay dividends without the prior written approval of the FDIC and the DFCS;

 

 

develop a liquidity and funds management plan including a minimum primary liquidity ratio (net cash, short-term and marketable assets divided by net deposits and short-term liabilities) of at least 15% and a maximum net non-core funding dependence ratio (non-core funding such as brokered deposits, certificates of deposit greater than $100,000 and borrowed funds divided by longer-term assets such as loans and securities that mature in more than one year) of 20%;

 

 

develop and implement plans to improve asset quality and increase profitability; and

 

 

develop and implement policies to improve lending, valuation, credit grading and collection practices.

On May 18, 2011, the Board adopted resolutions at the direction of the Federal Reserve Bank of San Francisco and the DFCS requiring the Holding Company to take specified corrective actions

 

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and refrain from specified actions that are substantially similar in substance and scope to the MOU. Under the board resolutions, the Holding Company may not pay any dividends on or repurchase its Common Stock, or receive dividends from the Bank, without the prior written approval of the Federal Reserve Bank of San Francisco and the DFCS. The Holding Company must obtain the prior written approval of the Federal Reserve Bank of San Francisco and the DFCS to add any new director or senior executive officer or change the responsibilities of any current senior executive officer. We do not expect to be permitted to pay or receive dividends or repurchase shares until we meet all of the requirements of the MOU and the board resolutions.

Compliance with the MOU will be determined by the FDIC and the DFCS. As of March 31, 2011, the Bank’s Tier 1 leverage ratio was 8.14%, and we do not believe we will attain a Tier 1 leverage ratio of at least 10% by August 22, 2011. We expect that the Bank’s Tier 1 leverage ratio will meet or exceed the 10% MOU requirement upon completion of the offering contemplated by this prospectus. While we have reduced the Bank’s assets classified as “Substandard” in the Examination Report (that we had not previously charged off) by 16.1% from June 30, 2010 through March 31, 2011, we did not meet the MOU’s 50% Substandard asset reduction requirement by June 22, 2011, and do not believe we will meet the MOU’s 70% Substandard asset reduction requirements by August 22, 2011. We expect that significant improvement in asset quality will be a gradual process dependent in part on the pace of broader economic recovery and the successful completion of a recapitalization, and related repurchase through a rights offering of common stock, of JELD-WEN Holding, inc. (“JELD-WEN”), a private company and the holding company of JELD-WEN, inc., a global window and door manufacturer headquartered in Klamath Falls, Oregon. As of March 31, 2011, the Bank’s primary liquidity ratio was 13.64% and the Bank’s net non-core funding dependence ratio was 23.71%. The Bank has implemented a liquidity plan, but, as of March 31, 2011, had not met the 20% non-core funding dependence ratio and 15% primary liquidity ratio targets. The MOU will remain in effect until stayed, modified, terminated or suspended by the FDIC and the DFCS. Until the provisions of the MOU are terminated or suspended, and the board resolutions are permitted to be rescinded, we expect that we would continue to pay higher deposit insurance premiums, be limited in our ability to pursue acquisitions, open new branches, develop new lines of business and be subject to heightened scrutiny in any matter requiring regulatory approval.

If we are unable to comply with the terms of our current MOU and board resolutions or any future orders, memoranda of understanding, board resolutions, regulatory actions or supervisory agreements to which we may become subject, or if the FDIC and DFCS deem to be material our failure to improve our Tier 1 leverage ratio to 10% or more, or reduce our Substandard assets, within the allotted time periods, then we could become subject to additional supervisory actions and orders, possibly including cease and desist orders, prompt corrective action restrictions or other regulatory actions. If our regulators were to take these additional actions, then we could, among other things, become subject to additional costs, as well as significant restrictions on our ability to grow our business and conduct our existing business, and we could be required to raise additional capital, dispose of assets and liabilities within a prescribed period of time, or both. The terms of any such supervisory action could have a material adverse effect on our business, financial condition and results of operations.

The majority of our assets are loans, which if not timely repaid would result in losses.

We are subject to credit risk, which is the risk of losing principal or interest as a result of borrowers’ failure to repay loans in accordance with their terms. Underwriting and documentation controls cannot mitigate all credit risk. A downturn in the economy or the real

 

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estate market in our regions or a rapid increase in interest rates could have a negative effect on collateral values and borrowers’ ability to repay. To the extent loans are not paid timely by borrowers, the loans are placed on non-accrual status, thereby reducing interest income. Further, under these circumstances, an additional provision for loan losses or unfunded commitments may be required. At March 31, 2011, our non-acquired non-performing loans, which includes all non-accrual loans, loans past due 90 days and still accruing, and performing troubled debt restructurings, which we refer to as performing TDRs, were 6.00% of our non-acquired loans, and our non-acquired non-performing assets, which includes non-acquired non-performing loans and non-acquired foreclosed real estate, were 3.83% of our total assets. As of March 31, 2011, we had classified $6.46 million, or 1.33% of our non-acquired loans, as performing TDRs. We restructured these loans in response to borrower financial difficulty, and generally provided for a temporary modification of loan repayment terms. These levels of non-performing loans and assets are elevated compared to the levels we historically experienced prior to 2009. Our non-performing assets adversely affect our net income in various ways. Until economic and market conditions improve, we expect to continue to incur additional losses relating to non-performing loans. We do not record interest income on non-accrual loans, thereby adversely affecting our income. We also incur increasing loan administration costs in monitoring, restructuring or foreclosing on collateral securing non-performing loans. When we receive collateral through foreclosures and similar proceedings, we are required to mark the related loan to the then fair market value of the collateral, which may result in a loss. An increase in the level of non-performing assets also increases our risk profile and may affect the capital levels bank regulatory authorities believe are appropriate in light of these risks, which would require us to seek to raise additional capital or sell assets. Decreases in the value of problem assets, the underlying collateral or in the borrowers’ performance or financial condition, could adversely affect our business, financial condition and results of operations. A further decline in the economic conditions in any of our regions or other factors could adversely affect clients with restructured loans and cause clients to become delinquent or otherwise default or call into question their ability to repay full interest and principal in accordance with the restructured terms, which would result in the restructured loan being reclassified as non-accrual. In addition, the resolution of non-performing assets requires significant commitments of time from management, which can be detrimental to performance of their other responsibilities. We could experience further increases in non-performing loans in the future. An increase in, or continued elevated levels of, delinquent, non-performing or non-accrual loans could have a material adverse effect on our business, financial condition and results of operations.

A meaningful number and amount of our loans are to employees of JELD-WEN, inc. or are secured by JELD-WEN common stock.

JELD-WEN, inc. has its headquarters in Klamath Falls, Oregon, and engages primarily in the manufacturing and world-wide sale of windows and doors. As of March 31, 2011, we had $30.5 million loans outstanding to clients that are either employees of JELD-WEN, inc. or clients with loans secured by JELD-WEN stock. On May 4, 2011, Onex Corporation announced that it had agreed to invest $675 million and acquire a significant interest in JELD-WEN subject to regulatory approvals and the completion of debt financing. We expect that the completion of the Onex Corporation investment and related debt financing would provide benefits to the Bank, including through the repurchase of shares of JELD-WEN common stock from Bank clients. If the Onex Corporation investment and related debt financing are not completed, JELD-WEN’s financial condition could be adversely affected and the value of JELD-WEN common stock used by Bank clients as collateral for loans or as a source of liquidity could further decline. Any

 

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significant adverse change in JELD-WEN’s business, liquidity position or prospects could result in increased net charge-offs and provisions for loan losses for loans dependent on the success of JELD-WEN, which could have a material adverse effect on our business, financial condition and results of operations. During 2008, we acquired 10,069 shares of JELD-WEN common stock in settlement of a client’s defaulted, unsecured loan obligation of approximately $7.0 million, the value of which is equally dependent on the success of JELD-WEN. In addition, no assurance is given that we will be successful in our efforts to manage risk associated with these loans and other assets, the value of which depends on the success of JELD-WEN.

We may be required, in the future, to recognize impairment with respect to securities that we hold, or sell certain securities that we hold at a loss.

Our securities portfolio currently includes some securities with unrecognized losses. We may continue to observe declines in the fair market value of these securities. We evaluate the securities portfolio for any other than temporary impairment each reporting period, as required by generally accepted accounting principles in the United States, and as of March 31, 2011, we did not recognize any securities as other-than-temporarily impaired. There is no assurance, however, that future evaluations of the securities portfolio will not require us to recognize an impairment charge with respect to these and other holdings. In 2008, we acquired 10,069 shares of JELD-WEN common stock valued at $7.2 million in settlement of a client’s defaulted, unsecured loan obligation. JELD-WEN common stock is inactively traded. The estimated value of the shares at the time of assignment was equivalent to the amount of principal and interest on a related loan to the client. During the year ended December 31, 2009, the Bank performed an evaluation of these shares and determined other-than-temporary impairment of $2.1 million should be recognized. There is a deferred tax asset of $0.9 million related to the impairment recognized. When these shares are disposed of, the Bank will have five years to generate a capital gain to allow for the capital loss deduction. If a capital gain is not realized, the deferred tax asset will be reversed and tax expense will be recognized. As of March 31, 2011, the carrying value of the shares was $5.1 million, or $507.63 per share. Oregon law requires that stock acquired by an Oregon state-chartered bank in settlement of a debt previously contracted be sold within two years of the date acquired. However, the DFCS may extend the time if it finds that an extension will not be detrimental to the public interest and will not contravene any other law. Although the DFCS has provided one extension of the time period during which we may hold the shares to January 23, 2012, there is no assurance that the DFCS will grant any further extensions. In addition, upon our acquisition of these shares, we entered into certain contractual restrictions on our ability to transfer them. Until December 23, 2011, we have agreed to provide the prior owner a right to repurchase the shares for an amount equal to the principal and interest that would have been then due under the original terms of the loan agreement with the Bank, and we have agreed not to sell the shares without the prior owner’s consent. From December 23, 2011, through December 23, 2013, the Bank has further agreed not to transfer these shares without first offering them to the prior owner. In May 2011, JELD-WEN conditionally offered to purchase outstanding shares of its common stock at $332 per share through a rights offering associated with JELD-WEN’s recapitalization plan. Management and the board of directors decided not to participate in the rights offering. We may be required in the future to sell the shares of JELD-WEN common stock that we hold, and the price at which we can sell the shares will depend on the market price of the shares, or the adjusted book value of JELD-WEN, and the liquidity of the shares at that time, which are outside of our control. We may recognize an impairment or incur a loss on the shares upon sale, which could have a material adverse effect on our business, financial condition and results of operations.

 

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In addition, as a condition of membership in the Federal Home Loan Bank of Seattle (“FHLB”), we are required to purchase and hold a certain amount of FHLB stock. Our stock purchase requirement is based, in part, upon the outstanding principal balance of advances from the FHLB. As of March 31, 2011, we had stock in the FHLB totaling $5.3 million. The FHLB stock held by us is carried at cost and is subject to recoverability testing under applicable accounting standards. As of March 31, 2011, the FHLB was unable to declare or pay dividends or repurchase capital stock without approval of the Federal Housing Finance Agency. As of March 31, 2011, we have not recognized an impairment charge related to our FHLB stock holdings. There can be no assurance, however, that future negative changes to the financial condition of the FHLB will not require us to recognize an impairment charge with respect to our holdings.

Our OREO may be subject to additional impairment and expense associated with ownership, and these properties may ultimately be sold at prices that are below appraised values and may adversely affect our results of operations.

Real estate owned by the Bank and not used in the ordinary course of its operations is referred to as OREO. We foreclose on and take title to the real estate collateral for defaulted loans as part of our business. We obtain appraisals on these assets prior to taking title to the properties and periodically thereafter. However, as a result of the difficult economic conditions in our regions, there is no assurance that these valuations will reflect the amount which may be paid by a willing purchaser in an arms-length transaction at the time of the final sale. Moreover, we do not make assurances that the losses associated with OREO will not exceed the estimated amounts, which would adversely affect our future results of operations. If actual losses exceed our estimates, our net income would be adversely affected. The adequacy of our loss estimates for our OREO depends on several factors, each of which can change without notice based on economic conditions, including the appraised value of the real property, economic conditions in the property’s sub-market, comparable sales, current buyer demand, availability of financing, entitlement and development obligations and costs and historic loss experience. We have taken further write-downs and had related reductions in our net income in recent periods due to decreased appraised value of OREO. We also expect that a substantial amount of management attention and effort will need to be directed at the management and resolution of OREO properties.

In addition, our earnings may be affected by various expenses associated with OREO, including personnel costs, insurance, taxes, completion and repair costs and other costs associated with property ownership, as well as by the funding costs associated with assets that are tied up in OREO. Moreover, our ability to sell OREO properties is affected by public perception that banks are inclined to accept large discounts from market value in order to liquidate properties quickly. Any decrease in market prices may lead to OREO write-downs, with a corresponding expense in our statement of operations. Further write-downs on OREO or an inability to sell OREO properties could have a material adverse effect on our business, results of operations and financial condition.

The loss of our key management or the inability to attract and retain key employees could result in a material adverse effect on our business.

We depend on our executive officers and key personnel to continue the implementation of our business strategy and could be harmed by the loss of their services. We believe that our growth and future success will depend in large part on the skills of our management team. Additionally, our future success and growth will depend on our ability to recruit and retain highly skilled

 

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employees with strong community relationships and specialized knowledge in the financial services industry. We face competition for qualified personnel in the financial services industry, and the loss of our key personnel or an inability to continue to attract, retain and motivate key personnel could adversely affect our business. We do not make any assurances that we will be able to retain our existing key personnel or attract and retain additional qualified personnel.

The accounting for loans acquired in connection with our FDIC-assisted acquisition of Home Valley Bank is based on numerous subjective determinations that may prove to be inaccurate and adversely affect our results of operations.

In connection with the Bank’s FDIC-assisted acquisition of Home Valley Bank, the Bank and the FDIC, as receiver, entered into a Purchase and Assumption Agreement, Whole Bank, All Deposits, which included a Single Family Shared-Loss Agreement and a Commercial Shared-Loss Agreement. Loans acquired in connection with the acquisition have been recorded at estimated fair value on the acquisition date without a carryover of the related allowance for loan losses. In general, the determination of estimated fair value of acquired loans requires management to make subjective determinations regarding discount rate, estimates of losses on defaults, market conditions and other factors that are highly subjective in nature. Our estimate of the fair value of acquired loans may prove to be inaccurate, and we ultimately may not recover the amount at which we recorded these loans on our balance sheet, which would require us to recognize losses. In our FDIC-assisted acquisition of Home Valley Bank, we recorded a loss-sharing asset that reflects our estimate of the timing and amount of future losses that are anticipated to occur in and used to value the acquired loan portfolio. In determining the size of the loss-sharing asset, we analyzed the loan portfolio based on historical loss experience, volume and classification of loans, volume and trends in delinquencies and non-accruals, local economic conditions and other pertinent information. If our assumptions relating to the timing or amount of expected losses are incorrect, our operating results could be negatively affected.

Loans acquired in connection with the FDIC-assisted acquisition of Home Valley Bank that have evidence of credit deterioration since origination and for which it is probable at the date of acquisition that we will not collect all contractually required principal and interest payments are accounted for under ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality (previously known as AICPA Statement of Position 03-3, Accounting for Certain Loans Acquired in a Transfer), or ASC 310-30. These credit-impaired loans, like acquired loan pools, have been recorded at estimated fair value on their acquisition date, based on subjective determinations regarding risk ratings, expected future cash flows and fair value of the underlying collateral, without a carryover of the related allowance for loan losses. We evaluate these loans quarterly to assess expected cash flows. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent increases in cash flows result in a reversal of the provision for loan losses to the extent of prior charges or a reclassification of the difference from non-accretable to accretable with a positive effect on interest income. Because the accounting for these loans is based on subjective measures that can change frequently, we may experience fluctuations in our net interest income and provisions for loan losses attributable to these loans. These fluctuations could adversely affect our results of operations.

The benefits of our FDIC-assisted acquisition of Home Valley Bank, including our loss-sharing agreements with the FDIC, may not be fully realized.

The FDIC-assisted acquisition of Home Valley Bank was structured in a manner that did not allow the time normally associated with evaluating and preparing for the integration of an acquired

 

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institution, and the anticipated benefits of the acquisition may not be realized fully or at all, or within the time period expected. We accounted for the FDIC-assisted transaction using the acquisition method of accounting; accordingly, our balance sheet includes the estimates of the fair value of the assets acquired and liabilities assumed. Our results of operations for the twelve months ended December 31, 2010 include the effects of the acquisition from the date of the transaction. We recorded a bargain purchase gain of $4.6 million in the third quarter of 2010 that represents the excess of the estimated fair value of the assets acquired over the estimated fair value of liabilities assumed in the FDIC-assisted acquisition of Home Valley Bank. During the first quarter of 2011, the acquisition contributed pre-tax earnings of $0.8 million, including $1.7 million in net interest income, $0.2 million in change in indemnification asset and $0.1 million in fee income, offset by $0.5 million in salaries and employee benefits, $0.6 million in other operating and occupancy expenses, and $0.1 million in provision for loan losses.

Our ability to obtain reimbursement under the loss-sharing agreements with the FDIC for losses on specified acquired Home Valley Bank assets depends on our compliance with the terms of the loss-sharing agreements. Management must certify to the FDIC on a quarterly basis our compliance with the terms of the loss-sharing agreements as a prerequisite to obtaining reimbursement from the FDIC for realized losses on covered assets. The terms of the loss-sharing agreements are extensive and failure to comply with any of the terms could result in a specific asset or group of assets permanently losing their loss-sharing coverage. Additionally, management may decide to forgo loss-share coverage on specific assets to allow greater flexibility over the management of these assets. Under the terms of these loss-sharing agreements, the FDIC will absorb 80% of losses and share in 80% of loss recoveries on $214.0 million of cost-basis acquired assets (as of the acquisition date). The term for loss-sharing and recoveries sharing on residential real estate loans is 10 years, the term for loss-sharing on non-residential real estate loans is 5 years, and the term for recoveries sharing on non-residential real estate loans is 8 years. At the acquisition date, the Bank estimated the Home Valley Bank acquired assets would incur approximately $34.2 million of losses, and we recorded a $26.7 million FDIC indemnification asset based on the present value of expected loss reimbursements. As of March 31, 2011, $160.0 million, or 18.8%, of our assets were covered by these loss-sharing agreements. No assurances are given that we will manage the covered assets in such a way as to maintain loss-share coverage on all these assets. Further, under the terms of the loss-sharing agreements, the assignment of the loss-sharing agreements to another entity generally requires the written consent of the FDIC. Additionally, the loss-sharing agreements have limited terms; therefore, any losses that we experience after the terms of the loss-sharing agreements have ended will not be recoverable from the FDIC, which would reduce our net income. Furthermore, the acquisition of assets and liabilities of failed depository institutions in FDIC-assisted transactions involves risks similar to those faced in unassisted acquisitions, even though the FDIC might provide assistance to mitigate certain risks by entering into loss-sharing arrangements.

Changes in interest rates could make it difficult to maintain our current interest income spread and could result in reduced earnings.

Our earnings are largely derived from net interest income, which is interest income and fees earned on loans and investments, less interest paid on deposits and other borrowings. Interest rates are highly sensitive to many factors that are beyond the control of our management, such as general economic conditions and the policies of various governmental and regulatory authorities. As interest rates change, net interest income may be affected. With fixed rate assets (such as fixed rate loans and most investment securities) and liabilities (such as certificates of deposit), the effect on net interest income depends on the cash flows associated with the

 

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maturity of the asset or liability. Asset/liability management policies may not be successfully implemented and from time to time our interest rate risk position is not balanced. As of March 31, 2011, we were liability-sensitive, meaning that an increase in interest rates could have an adverse impact on our net interest income. An unanticipated rapid decrease or increase in interest rates could have an adverse effect on the spreads between the interest rates earned on assets and the rates of interest paid on liabilities, and therefore on the level of net interest income. For instance, any rapid increase in interest rates in the future could result in interest expense increasing faster than interest income because of fixed rate loans, floating rate loans with floors that have not been reached and longer-term investments. Further, substantially higher interest rates generally reduce loan demand and may result in slower loan growth than previously experienced. The Obama administration and the United States Treasury have indicated that the federal government may not be able to make its debt payments in the near future if the federal debt ceiling is not raised. If legislation increasing the debt ceiling is not enacted and the debt ceiling is reached, or even if such legislation is enacted, credit rating agencies may downgrade the credit rating of the federal government, which could result in increased interest rates generally. For the reasons set forth above, an increase in interest rates generally as a result of such a credit rating downgrade could adversely affect our net interest income levels, thereby resulting in reduced earnings, and reduce loan demand.

The FDIC has increased insurance premiums to rebuild and maintain the Deposit Insurance Fund and there may be additional future premium increases and special assessments.

In 2009, the FDIC imposed a special deposit insurance assessment of five basis points on all insured deposits, and also required insured institutions to prepay estimated quarterly risk-based assessments through 2012. Our FDIC assessments doubled for the three months ended March 31, 2011 to $0.4 million compared to $0.2 million for the same period in 2010 as a result of organic deposit growth, deposits assumed in connection with the FDIC-assisted acquisition of Home Valley Bank, and an increased FDIC premium assessment rate due to the Bank’s financial condition.

The Dodd-Frank Act established 1.35% as the minimum deposit insurance fund reserve ratio. The FDIC has adopted a plan under which it will meet the statutory minimum fund reserve ratio of 1.35% by the statutory deadline of September 30, 2020. The Dodd-Frank Act requires the FDIC to offset the effect on institutions with assets less than $10 billion of the increase in the statutory minimum fund reserve ratio to 1.35% from the former statutory minimum of 1.15%. The FDIC has not announced how it will implement this offset. Also, the FDIC has determined that the fund reserve ratio should be 2.0%, but has not announced how it will increase the Deposit Insurance Fund to this level. Despite the FDIC’s actions to restore the deposit insurance fund, the fund will suffer additional losses in the future as a result of failures of insured institutions. There is no assurance that there will not be additional significant deposit insurance premium increases, special assessments or prepayments in order to restore the insurance fund’s reserve ratio. Further, the FDIC’s deposit insurance assessments are risk-based and because the Bank is a party to the MOU our insurance premiums rates are elevated and will remain so until the FDIC determines through a safety and soundness examination that our condition is improved. Any significant premium increases, special assessments or required prepayments could have a material adverse effect on our financial condition and results of operations.

The Dodd-Frank Act and other recent legislative and regulatory initiatives contain numerous provisions and requirements that could detrimentally affect our business.

The Dodd-Frank Act and related regulations subject us and other financial institutions to additional restrictions, oversight, reporting obligations and costs, which could have an adverse

 

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effect on our business, financial condition and results of operations. In addition, this increased regulation of the financial services industry restricts the ability of firms within the industry to conduct business consistent with historical practices, including aspects such as compensation, interest rates, new and inconsistent consumer protection regulations and mortgage regulation, among others. Congress or state legislatures could also adopt laws reducing the amount that borrowers are otherwise contractually required to pay under existing loan contracts, require lenders to extend or restructure certain loans or limit foreclosure and collection remedies. Federal and state regulatory authorities also frequently adopt changes to their regulations or change the manner in which existing regulations are applied. We cannot predict the substance or impact of pending or future legislation or regulation, or the application thereof. Compliance with new, currently pending and potential future regulation will significantly increase our costs, impede the efficiency of our internal business processes, may require us to increase our regulatory capital and may limit our ability to pursue business opportunities in an efficient manner. In response, we may be required to or choose to raise additional capital, which could have a dilutive effect on the existing holders of our Common Stock and adversely affect the market price of our Common Stock.

We may be required to raise additional capital in the future, but that capital may not be available when it is needed, or it may only be available on unacceptable terms, which could adversely affect our financial condition and results of operations.

We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. We expect that we will continue to be required to maintain our capital at elevated levels. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial performance. Accordingly, we may not be able to raise additional capital, if needed, on terms acceptable to us. If we cannot raise additional capital when needed, our ability to further expand our operations and pursue our business strategy could be materially impaired.

Conditions in the financial markets may limit our access to additional funding to meet our liquidity needs.

Liquidity is essential to our business. An inability to raise funds through deposits, borrowings, the sale or pledging as collateral of loans and other assets could have a substantial negative effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general. An adverse regulatory action against us could detrimentally affect our access to liquidity sources. Our ability to borrow could also be impaired by factors that we do not control, such as severe disruption of the financial markets or negative news and expectations about the prospects for the financial services industry as a whole, as evidenced by turmoil in the domestic and worldwide credit markets.

Our wholesale funding sources may prove insufficient to support our future growth or an unexpected reduction in deposits.

We must maintain sufficient funds to respond to the needs of borrowers or to address unanticipated deposit withdrawals. As a part of our liquidity management, we use a number of funding sources in addition to core deposit growth and repayments and maturities of loans and investments. If we grow more rapidly than any increase in our deposit balances, we are likely to become more dependent on these sources, which include advances from the FHLB and a number of correspondent banks, proceeds from the sale of loans and liquidity resources at the holding

 

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company. Our financial flexibility will be severely constrained if we are unable to maintain our access to funding or if adequate financing is not available to accommodate future growth at acceptable interest rates. If we are required to rely more heavily on more expensive funding sources to support future growth, our revenues may not increase proportionately to cover our costs, and our profitability would be adversely affected.

Monetary policies and regulations of the Federal Reserve could adversely affect our business, financial condition and results of operations.

Our earnings and growth are affected by the policies of the Federal Reserve. An important function of the Federal Reserve is to regulate the money supply and credit conditions. Among the instruments used by the Federal Reserve to implement these objectives are open market operations in U.S. government securities, adjustments of the discount rate and changes in reserve requirements against bank deposits. These instruments are used in varying combinations to influence overall economic growth and the distribution of credit, bank loans, investments and deposits. Their use also affects interest rates charged on loans or paid on deposits. The monetary policies and regulations of the Federal Reserve have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. The effects of these policies upon our business, financial condition and results of operations cannot be predicted.

As a bank holding company, the Holding Company’s ability to pay dividends, repurchase shares of capital stock or repay indebtedness depends upon cash assets held by the Holding Company and the results of operations of our subsidiaries.

The Holding Company is a separate and distinct legal entity from its subsidiaries, and it conducts substantially all of its operations through the Bank and receives substantially all of its revenue from dividends paid from the Bank. Various statutory provisions restrict the amount of dividends the Bank can pay to us without regulatory approval. The Bank may not pay cash dividends if that payment could reduce the amount of its capital below that necessary to meet the “adequately-capitalized” level in accordance with regulatory capital requirements. In addition, the Bank may not pay any dividends without first seeking regulatory approval pursuant to the terms of the MOU. It is also possible that, depending upon the financial condition of the Bank and other factors, regulatory authorities could conclude that payment of dividends or other payments, including payments to us, is an unsafe or unsound practice and impose restrictions or prohibit these payments. The Holding Company’s inability to receive dividends from the Bank could adversely affect our business, financial condition and results of operations. The Holding Company’s ability to pay dividends and repurchase shares of its capital stock, and to receive dividends from the Bank, is further limited by our board resolutions. See “Dividend Policy.”

A significant decline in the Holding Company’s market value could result in an impairment of goodwill.

As of March 31, 2011, we had acquisition-related goodwill of $2.4 million recorded on our balance sheet. Goodwill is deemed impaired if the net book value of a reporting unit exceeds its estimated fair value. The fair value is estimated using discounted cash flows of forecasted earnings, estimated sales price based on recent observable market transactions and market capitalization based on current stock price. If impairment is deemed to exist, a write down of the intangible goodwill asset would reduce our net income and could negatively affect our financial condition and results of operations.

 

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We are required to assess the recoverability of our deferred tax asset position on an ongoing basis.

As of March 31, 2011, a deferred tax asset position comprises $2.5 million of our total assets. Deferred tax assets are evaluated on a quarterly basis to determine if they are expected to be recoverable in the future. Our evaluation considers positive and negative evidence to assess whether it is more likely than not that a portion of the asset will not be realized. If it is more likely than not that a portion of the asset will not be realized, we are required to establish a valuation allowance, which would reduce our net income. The risk of a valuation allowance increases if continuing operating losses are incurred because the likelihood of our ability to receive the full benefit of a deferred tax asset decreases. Future negative operating performance or other negative evidence may result in a valuation allowance being recorded against some or all of the amount of our deferred tax asset. A valuation allowance on our deferred tax asset could have a material adverse effect on our financial condition and results of operations.

Our real estate lending exposes us to the risk of environmental liabilities.

In the course of our business, it is necessary to foreclose and take title to real estate, which could subject us to environmental liabilities with respect to these properties. Hazardous substances or waste, contaminants, pollutants or sources thereof may be discovered on properties during our ownership or after a sale to a third party. We could be held liable to a governmental authority or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clean up hazardous or toxic substances or chemical releases at these properties. The costs associated with investigation or remediation activities could be substantial and could substantially exceed the value of the real property. In addition, as the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. We may be unable to recover costs from any third party. These occurrences may materially reduce the value of the affected property, and we may find it difficult or impossible to use or sell the property prior to or following any environmental remediation. If we ever become subject to significant environmental liabilities, our business, financial condition and results of operations could be adversely affected. Further, a significant percentage of our loans are collateralized by a security interest in real estate. The value of our collateral could be adversely affected should the real estate be contaminated with hazardous substances, which could result in a loan charge-off and increased provision for loan losses.

The financial services industry is highly competitive.

We face pricing competition for loans and deposits. We also face competition with respect to client convenience, product lines, accessibility of service and service capabilities. Since July 21, 2011, with the repeal of Regulation Q pursuant to the Dodd-Frank Act, banks are permitted to pay interest on business checking accounts. Our competitors may offer our clients interest on formerly non-interest-bearing accounts. We may be required to incur additional interest expense to maintain client relationships. Our most direct competition comes from other banks, brokerages, mortgage companies and savings institutions. We also face competition from credit unions, government-sponsored enterprises, mutual fund companies, insurance companies and other non-bank businesses. This significant competition in attracting and retaining deposits and making loans as well as in providing other financial services throughout our market area may adversely affect our business, financial condition and results of operations.

 

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Involvement in non-bank business creates risks associated with the securities industry.

Our wealth management operations present special risks not borne by institutions that focus exclusively on commercial banking. For example, the brokerage industry is subject to fluctuations in the stock market that may have a significant adverse effect on transaction fees, client activity and client investment portfolio gains and losses. Likewise, additional or modified regulations may adversely affect South Valley Wealth Management’s operations. South Valley Wealth Management is also dependent on a small number of established brokers, whose departure could result in the loss of a significant number of client accounts. A significant decline in fees and commissions or trading losses suffered in the investment portfolio could adversely affect South Valley Wealth Management’s income and potentially require the contribution of additional capital to support its operations. South Valley Wealth Management is subject to arbitration claims arising from clients who assert their investments were not suitable or that their portfolios were too actively traded. These risks increase when the market, as a whole, declines. The risks associated with retail brokerage may not be supported by the income generated by those operations and may adversely affect our financial condition and results of operations.

We are subject to claims and litigation pertaining to our fiduciary responsibilities.

Some of the services we provide, such as trust and investment services, require us to act as fiduciaries for our clients and others. From time to time, third parties make claims and take legal action against us pertaining to the performance of our fiduciary responsibilities. If these claims and legal actions are not resolved in a manner favorable to us, we may be exposed to significant financial liability or our reputation could be damaged. Either of these results may adversely affect demand for our products and services or otherwise have a harmful effect on our business and, in turn, on our financial condition and results of operations.

Our banking and brokerage operations are subject to extensive government regulation that is expected to become more burdensome, increase our costs and make us less competitive compared to financial services firms that are not subject to the same regulation.

We and our subsidiaries are subject to extensive regulation under federal and state laws. These laws and regulations are primarily intended to protect clients, depositors and the deposit insurance fund, rather than shareholders. The Bank is an Oregon state-chartered commercial bank whose state regulator is the DFCS. The Bank is also subject to supervision by and the regulations of the FDIC, which insures bank deposits. South Valley Wealth Management is subject to extensive regulation by the SEC and the Financial Industry Regulatory Authority. The Holding Company is subject to regulation and supervision by the Federal Reserve, and will be subject to additional regulation by the SEC upon completion of this offering. Federal and state regulations may place banks and brokerage firms at a competitive disadvantage compared to less regulated competitors such as finance companies, credit unions, mortgage banking companies and leasing companies. There is also the possibility that laws could be enacted that would prohibit a company from controlling both an FDIC-insured bank and a broker dealer, or restrict their activities if under common ownership. For example, in 2010 a group of senators proposed reinstatement of the Glass-Steagall Act of 1933, which split commercial and investment banking, and was repealed by the Gramm-Leach-Bliley Act of 1999. Further, if we receive less than satisfactory results during regulatory examinations, we could be restricted from making acquisitions, opening new branches, developing new lines of business or continuing our business strategy for a period of time. Future changes in federal and state banking and brokerage regulations could adversely affect our operating results and ability to continue to compete effectively.

 

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Our deposit clients may pursue alternatives to bank deposits or otherwise seek to minimize their levels of uninsured bank deposits, causing us to lose a low cost source of funding.

Checking and savings accounts and other forms of deposits could decrease if our deposit clients perceive alternative investments as providing better returns or a weakness in our financial stability. Deposit clients may also seek to distribute their deposits over several banks to maximize FDIC insurance coverage. Similarly, technology and other changes are allowing parties to complete financial transactions that historically have involved banks without the involvement of any banks. The process of eliminating banks as intermediaries could result in the loss of fee income, as well as the loss of client deposits and income generated from those deposits. If, as a result of general economic conditions, market interest rates, competitive pressures or other factors, clients move money out of bank deposits in favor of alternative investments and our level of deposits decreases relative to our overall banking activities, we would lose a low cost source of funds, increasing our funding costs and adversely affecting our business, financial condition and results of operations.

The short-term and long-term effects of the new Basel III capital standards and the forthcoming new capital rules to be proposed for non-Basel III U.S. banks are uncertain.

The Basel Committee on Banking Supervision (“Basel Committee”) recently announced new standards that, if adopted, could lead to higher capital requirements and charges and higher leverage and liquidity ratios. These new Basel III capital standards will be phased in from January 1, 2013 to January 1, 2019, and it is not yet known how these standards will be implemented by U.S. regulators or applied to community banks of our size. Implementation of these standards, or any other new regulations, could require us to raise capital or reduce asset levels, including in ways that may adversely affect our results of operations or financial condition, and may adversely affect our ability to pay dividends. See “Supervision and Regulation—Capital Standards and Prompt Corrective Action—Dodd-Frank Act and Basel III.”

Our business is highly reliant on technology and third party vendors.

We depend on internal and outsourced technology and rely on third parties to provide services that are integral to our operations, such as web hosting and other Internet systems and deposit and other processing services. Any failure of these systems or disruption in the services provided by these third parties could adversely affect our ability to meet client needs and creates a risk of business loss, such as civil fines or damage claims from privacy breaches. Any reputation risk or damage we may suffer as a result of these disruptions could have an adverse effect on our business, financial condition and results of operations. We cannot be sure that we will be able to maintain these relationships on favorable terms. Risk management programs are expensive to maintain and will not protect us from all risks associated with maintaining the security of client information, proprietary data, external and internal intrusions, disaster recovery and failures in the controls used by vendors. Further, we are dependent on third party service providers for data processing and information processing services that support our day-to-day banking and brokerage services, and some of these providers are associated with our competitors. The loss of these third party relationships could produce disruption of service and significant costs in connection with replacing these services, which could adversely affect our business, financial condition and results of operations.

 

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There has been no active trading market for our Common Stock and an active trading market may not develop or be sustained, and the market price of our Common Stock may be volatile.

Before this offering, there has been no public market for our Common Stock. Although we intend to apply to list our Common Stock on The NASDAQ Capital Market, an active trading market for our Common Stock may never develop or be sustained. In addition, you will pay a price for our Common Stock in this offering that was not established in a competitive market. Instead, you will pay a price that we negotiated with the underwriters. See “Underwriting—IPO Pricing” for factors considered in determining the initial public offering price. The initial public offering price may not necessarily bear a close relationship to our book value or the fair market value of our assets and may be higher than the market price of our Common Stock after this offering. In particular, we do not assure you as to:

 

 

the likelihood that an active public trading market for the shares of our Common Stock will develop after this offering, or, if developed, that a public trading market can be sustained;

 

 

the liquidity of any public trading market;

 

 

the ability of our shareholders to sell their shares of our Common Stock; or

 

 

the price that our shareholders may obtain for their shares of our Common Stock.

If no public market develops, it may be difficult to resell our Common Stock at a price reflective of its intrinsic value. Even if an active trading market develops, the market price for shares of our Common Stock may be highly volatile and could be subject to wide fluctuations after this offering. We cannot predict how the shares of our Common Stock will trade in the future. Some of the factors that could affect our share price include:

 

 

our financial condition;

 

 

actual or anticipated variations in our operating results;

 

 

publication of research reports and recommendations by financial analysts;

 

 

fluctuations in the stock price and operating results of our competitors;

 

 

our ability to execute our business plan and forecasted growth;

 

 

additions or departures of key management personnel;

 

 

proposed or adopted regulatory changes or developments;

 

 

speculations reported in the press or investment community;

 

 

issuances of new equity pursuant to future offerings; and

 

 

general market and economic conditions.

In some cases, U.S. stock markets have produced downward pressure on stock prices for some issuers without regard to those issuers’ underlying financial strength. A significant decline in our stock price could result in substantial losses for individual shareholders and could lead to costly and disruptive securities litigation.

 

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The issuance of shares of Preferred Stock could negatively affect your investment in our Common Stock.

Our board of directors is authorized to issue classes or series of Preferred Stock without any further authorizing action required on the part of our shareholders. Our board of directors also has the authority, without shareholder approval, to set the terms of any classes or series of Preferred Stock that may be issued, such as voting rights, dividend rights and preferences over our Common Stock with respect to dividends or upon the liquidation, dissolution or winding up of our business. If we issue shares of Preferred Stock in the future that have a preference over our Common Stock with respect to the payment of dividends or upon liquidation, dissolution or winding up, or if we issue shares of Preferred Stock with voting rights that dilute the voting power of our Common Stock, the rights of holders of our Common Stock and the market price of our Common Stock could be adversely affected.

Some provisions of our articles of incorporation and bylaws and certain provisions of Oregon law and banking regulations may deter takeover attempts, which may limit the opportunity of our shareholders to sell shares at a favorable price and affect the market price of our Common Stock.

Some provisions of our articles of incorporation and bylaws, as in effect upon the completion of the offering made by this prospectus, may have anti-takeover effects and could delay, defer or prevent a tender offer or takeover attempt that a shareholder might consider to be in the shareholder’s best interest, including those attempts that might result in a premium over the market price for the shares held by shareholders, and may make removal of the incumbent management and directors more difficult. These provisions include:

 

 

the number of authorized but unissued shares of our Common Stock;

 

 

the ability of our board of directors to issue shares of Preferred Stock without shareholder approval with the rights, privileges and preferences as the board of directors may determine;

 

 

the authorization to consider the effects of certain corporate transactions on constituencies other than our shareholders;

 

 

procedures for advance notification of shareholder nominations and proposals; and

 

 

certain restrictions on the ability to call special meetings of our shareholders.

In addition, as an Oregon corporation, we are subject to the Oregon Control Share Act, the Oregon Business Combination Act and Oregon law that authorizes our board of directors to fill vacant and newly created directorships. These provisions, alone or together, could have the effect of deterring or delaying changes in incumbent management, proxy contests or changes in control even if it would be considered beneficial by some or all of our shareholders and could adversely affect the market price of our Common Stock. Further, the Holding Company and the Bank are subject to federal and state banking laws and regulations that restrict changes in control of the Holding Company or the Bank. These laws require prior regulatory approval for a change in control and are designed to protect the bank, its depositors and the FDIC’s Deposit Insurance Fund.

 

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Use of proceeds

We estimate that our net proceeds from this offering, after deducting underwriting discounts, commissions and estimated offering expenses, will be approximately $         million, or approximately $         million if the underwriters’ option is exercised in full, based on an assumed initial offering price of $         per share, which is the mid-point of the estimated public offering price range set forth on the cover page of this prospectus. A $1.00 increase or decrease in the assumed initial public offering price of $         per share would increase or decrease the net proceeds to us from this offering by approximately $         million, or approximately $         million if the underwriters’ option is exercised in full.

We intend to use our net proceeds from this offering:

 

 

to provide capital to the Bank to strengthen the Bank’s regulatory capital;

 

 

to support our long-term growth; and

 

 

for general corporate purposes.

We will not receive any proceeds from the sale of shares by the selling shareholders. See “Selling Shareholders” for additional information.

 

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Dividend policy

Prior to 2010, our policy had been to pay a semi-annual dividend to all holders of our Common Stock. We had paid dividends of $0.16 per share in January 2009 and of $0.08 per share in July 2009. Effective December 31, 2009, we suspended the payment of dividends on our Common Stock to preserve capital, and have not declared or paid a dividend to holders of our Common Stock since July 2009. The amount and timing of any future dividends has not been determined. The payment of dividends will depend upon a number of factors, including capital requirements, the Holding Company’s and the Bank’s financial condition and results of operations, tax considerations, statutory and regulatory limitations, general economic conditions and the restrictions described below. There is no assurance that we will declare and pay dividends on our Common Stock for any future period.

Dividend restrictions

The Federal Reserve, which regulates the activities of the Holding Company, has issued a policy statement on the payment of cash dividends by bank holding companies, which expresses the Federal Reserve’s view that a bank holding company should pay cash dividends only to the extent that its net income for the past year is sufficient to cover both the cash dividends and a rate of earnings retention that is consistent with the holding company’s capital needs, asset quality and overall financial condition. The Federal Reserve also indicated that it would be inappropriate for a company experiencing serious financial problems to borrow funds to pay dividends. Furthermore, a bank holding company may be prohibited from paying any dividends if the holding company’s bank subsidiary is not “adequately capitalized.” Under Oregon law, the Holding Company is allowed to make a distribution, including payment of a dividend, only if, after giving effect to the distribution, in the judgment of the board of directors: (1) the Holding Company would be able to pay its debts as they become due in the usual course of business; and (2) the Holding Company’s total assets would at least equal the sum of its total liabilities plus, unless the articles of incorporation permit otherwise, the amount that would be needed if the corporation were to be dissolved at the time of the distribution to satisfy the preferential rights upon dissolution, if any, of shareholders whose preferential rights are superior to those receiving the distribution. The Holding Company’s board of directors has adopted resolutions at the direction of the Federal Reserve requiring the Holding Company to take corrective actions and refrain from specified actions, including the payment of dividends or receipt of dividends or similar payments or distributions from the Bank without the prior written approval of the Federal Reserve and DFCS.

The Bank has entered into the MOU with the FDIC and the DFCS, pursuant to which it agreed, among other things, not to pay dividends without prior regulatory approval. We do not anticipate seeking or receiving approval for dividend payments until the provisions of the MOU are stayed or terminated and our Board is permitted by the Federal Reserve Bank of San Francisco to rescind the board resolutions.

Even after the MOU is terminated or suspended and we are permitted to rescind the board resolutions, various statutory provisions restrict the amount of dividends the Bank can pay to the Holding Company without regulatory approval. The Bank may not pay cash dividends if that payment could reduce the amount of its capital below that necessary to meet the “adequately capitalized” level in accordance with regulatory capital requirements. It is also possible that, depending upon the financial condition of the Bank and other factors, regulatory authorities

 

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could conclude that payment of dividends or other payments, including payments by the Bank to the Holding Company, is an unsafe or unsound practice and impose restrictions or prohibit these payments. Under Oregon law, the Bank may not pay dividends in excess of unreserved retained earnings, deducting therefrom, to the extent not already charged against earnings or reflected in a reserve, the following:

 

 

all bad debts, which are debts on which interest is past due and unpaid for at least six months, unless the debt is fully secured and in the process of collection;

 

 

all other assets charged-off as required by Oregon bank regulators or a state or federal examiner; and

 

 

all accrued expenses, interest and taxes of the institution.

 

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Capitalization

The following table sets forth our capitalization and regulatory capital and other ratios as of March 31, 2011, as follows:

 

 

on an actual basis; and

 

 

on an as adjusted basis to give effect to the receipt of the net proceeds to us from this offering of shares of our Common Stock at an assumed offering price of $         per share, which is the mid-point of the estimated public offering price set forth on the cover page of this prospectus after deducting underwriting discounts and commissions and estimated offering expenses, and the application of the net proceeds. A $1.00 increase or decrease in the assumed initial public offering price of $         per share would increase or decrease the net proceeds to us from this offering by approximately $         million, or approximately $         million if the underwriters’ option is exercised in full.

The following should be read in conjunction with “Use of Proceeds,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Selected Historical Consolidated Financial Data” and our financial statements and accompanying notes that are included elsewhere in this prospectus.

 

As of March 31, 2011

(unaudited)

 
(dollars in thousands, except per share data)    Actual      As
adjusted(1)
 

 

 

Borrowings and Obligations:

     

Federal Home Loan Bank borrowings

   $ 25,301       $ 25,301   

 

 

Shareholders’ Equity:

     

Common Stock, no par value, 10,000,000 shares authorized, 6,756,189 shares issued and outstanding(2)

   $ 42,949       $                

Retained earnings

     29,984      

Accumulated other comprehensive income, net of taxes

     134      
  

 

 

    

 

 

 

Total shareholders’ equity

   $ 73,067       $                

 

 

Capital Ratios(3):

     

Tangible common equity to tangible assets(4)

     8.34%         %   

Tier 1 leverage ratio

     8.35%         %   

Tier 1 risk-based capital ratio

     11.99%         %   

Total risk-based capital ratio

     13.25%         %   

Common Stock Data:

     

Common shares outstanding

     6,756,189      

Book value per share

   $ 10.81       $                

Tangible book value per share(5)

   $ 10.45       $                

 

 
(1)   Adjustments made to the “Actual” column to arrive at the “As Adjusted” column are an increase of $         to Common Stock and                  shares of Common Stock outstanding, which increases total shareholders’ equity, to give effect to the receipt of $         of net proceeds to us from the sale of our Common Stock in this offering. For purposes of determining “As Adjusted” capital ratios, the net proceeds to us of $         from the sale of our Common Stock in this offering are assumed to be invested in                 , which are     % risk weighted assets under applicable FDIC regulations related to risk-based capital ratios.

 

(2)   The above table excludes 246,132 shares of our Common Stock issuable upon exercise of outstanding warrants, which are exercisable for $13.50 per share until May 20, 2012.

 

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(3)   The “Tier 1 leverage ratio” is the ratio of Tier 1 capital to total consolidated average assets, as defined under applicable regulations, of the Holding Company. The “Tier 1 risk-based capital ratio” is the ratio of Tier 1 capital to total risk-weighted assets and the “total risk-based capital ratio” is the ratio of the sum of Tier 1 capital and Tier 2 capital to total risk-weighted assets. Tier 1 capital consists of core capital elements, which is primarily common shareholders’ equity for the Holding Company and the Bank. Tier 2 capital consists of supplementary core capital elements, including the allowance for loan losses and unrealized gains on equity securities, each subject to regulatory limitations. The net proceeds to us from our sale of Common Stock in this offering are presumed to be invested in short-term liquid securities which carry a 20% risk weighting for purposes of all adjusted risk-based capital ratios. If the underwriters’ option is exercised in full, net proceeds to us would be approximately $         million and the Holding Company’s tangible common equity to tangible assets, Tier 1 leverage ratio, Tier 1 risk-based capital ratio and total risk-based capital ratio would be     %,     %,     % and     %, respectively, and the Bank’s Tier 1 leverage ratio, Tier 1 risk-based capital ratio and total risk-based capital ratio would be     %,     % and     %, respectively.

 

(4)   Tangible common equity to tangible assets is a non-GAAP financial measure. The most directly comparable financial measure is total shareholders’ equity to total assets. See our reconciliation of non-GAAP financial measures to their most directly comparable GAAP financial measures under “Selected Historical Consolidated Financial Data.”

 

(5)   Tangible book value and tangible book value per share are non-GAAP financial measures. We calculate tangible book value (also referred to as “tangible common shareholders’ equity” or “tangible common equity”) as total shareholders’ equity less goodwill and other intangible assets. Tangible book value’s most directly comparable GAAP financial measure is total shareholders’ equity. We calculate tangible book value per share as tangible book value divided by shares of Common Stock outstanding and the most directly comparable GAAP financial measure is book value per share. See our reconciliation of non-GAAP financial measures to their most directly comparable GAAP financial measures under “Selected Historical Consolidated Financial Data.”

 

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Dilution

If you invest in our Common Stock, your ownership interest will be diluted to the extent of the difference between the price per share you pay and the as adjusted net tangible book value per share of our Common Stock immediately after this offering. Our historical net tangible book value as of March 31, 2011 was $70.6 million, or $10.45 per share of Common Stock. Net tangible book value per share is determined by dividing our total tangible assets, less our total liabilities, by the number of shares of Common Stock outstanding.

After giving effect to our sale of                  shares of Common Stock at an assumed initial public offering price of $         per share in this offering, and after deducting estimated underwriting discounts and commissions and offering expenses, our as adjusted net tangible book value as of March 31, 2011 would have been $         million, or $         per share. This amount represents an immediate increase in net tangible book value to our existing shareholders of $         per share and immediate dilution to new investors of $         per share. The following table illustrates this per share dilution:

 

Assumed initial public offering price per share

      $                

Net tangible book value of each share of our Common Stock as of March 31, 2011

   $                   

Increase in net tangible book value of each share of our Common Stock attributable to investors in this offering

   $                   

Adjusted net tangible book value per share after giving effect to this offering

      $                

Dilution in net tangible book value of each share of our Common Stock to investors in this offering

      $     

If the underwriters exercise in full their over-allotment option, dilution per share to investors in this offering would be approximately $         based on the assumptions set forth above.

Each $1.00 increase or decrease in the assumed public offering price of $         per share would increase or decrease, respectively, our adjusted net tangible book value by approximately $         million, or approximately $         per share, and the dilution per share to investors in this offering by approximately $         per share, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting estimated underwriting discounts and commissions and offering expenses. We may also increase or decrease the number of shares we are offering. An increase of              in the number of shares offered by us, together with a $1.00 increase in the assumed offering price of $         per share, would result in adjusted net tangible book value of approximately $         million, or $         per share, and the dilution per share to investors in this offering would be $         per share. Similarly, a decrease of                  million in the number of shares offered by us, together with a $1.00 decrease in the assumed public offering price of $         per share, would result in adjusted net tangible book value of approximately $         million, or $         per share, and the dilution per share to investors in this offering would be $         per share. The adjusted information discussed above is illustrative only and will adjust based on the actual public offering price and other terms of this offering determined at pricing.

The following table summarizes as of March 31, 2011, on an adjusted basis, the number of shares of Common Stock purchased from us, the total consideration paid to us and the average price per share paid by our existing shareholders and by investors participating in this offering, based upon

 

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an assumed initial public offering price of $         per share, the mid-point of the range on the cover of this prospectus, and before deducting estimated underwriting discounts and commissions and offering expenses payable by us.

 

      Shares purchased      Total consideration     

Avg. price

per share

 
     Number    Percentage      Amount      Percentage     

 

 

Existing shareholders

        %       $                      %       $                

New investors

        %            %      
  

 

  

 

 

    

 

 

    

 

 

    

 

 

 

Total

        100%       $                      100%      

 

 

An aggregate 650,000 shares of our Common Stock are reserved for future issuance under the 2011 Equity Incentive Plan. To the extent that stock options or other equity awards are issued under our equity incentive plan or we issue additional shares of Common Stock in the future, there will be further dilution to investors.

 

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Selected historical consolidated financial data

The following table sets forth certain of our historical consolidated financial data. The summary consolidated financial data as of December 31, 2010 and 2009 and for the years ended December 31, 2010, 2009 and 2008 have been derived from our audited consolidated financial statements included elsewhere in this prospectus. The summary consolidated financial data as of March 31, 2011 and 2010 and for the three months ended March 31, 2011 and 2010 have been derived from our unaudited consolidated financial statements included elsewhere in this prospectus. The summary consolidated financial data as of December 31, 2008, 2007 and 2006 and for the years ended December 31, 2007 and 2006 have been derived from our audited consolidated financial statements that are not included in this prospectus.

On July 23, 2010, we completed the FDIC-assisted acquisition of Home Valley Bank, acquiring approximately $244.9 million of assets and assuming $242.6 million of liabilities, including $227.2 million of deposits, at cost basis as of the acquisition date. The purchase and assumption agreement with the FDIC provided for two separate loss-sharing agreements between the FDIC and the Bank, which, in addition to fair value adjustments, significantly mitigates our risk of future loss on the loan portfolio we acquired. These loss-sharing agreements with the FDIC provide for specified credit loss protection for substantially all acquired loans and foreclosed real estate. Under the terms of the loss-sharing agreements, the FDIC will absorb 80% of losses and share in 80% of loss recoveries on $214.0 million of cost-basis acquired assets (as of the acquisition date). The term for loss-sharing and recoveries sharing on residential real estate loans is 10 years, the term for loss-sharing on non-residential real estate loans is 5 years, and the term for recoveries sharing on non-residential real estate loans is 8 years. At the acquisition date, the Bank estimated the Home Valley Bank acquired assets would incur approximately $34.2 million of losses, and we recorded a $26.7 million FDIC indemnification asset based on the present value of expected loss reimbursements. We accounted for the FDIC-assisted transaction using the acquisition method of accounting; accordingly, our balance sheet includes the estimates of the fair value of the assets acquired and liabilities assumed. Our results of operations for the twelve months ended December 31, 2010 include the effects of the acquisition from the date of the transaction. We recorded a bargain purchase gain of $4.6 million in the third quarter of 2010 that represents the excess of the estimated fair value of the assets acquired over the estimated fair value of liabilities assumed in the FDIC-assisted acquisition of Home Valley Bank. The acquired loan portfolio and OREO are referred to as “acquired loans” and “covered OREO,” respectively, and these are presented as separate line items in our consolidated financial statements. See Note 2 of the notes to the audited consolidated financial statements included in this prospectus. The results and other financial data of Home Valley Bank are not included in the table below for periods prior to the date of acquisition and, therefore, the data for such prior periods may not be comparable in all respects.

 

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This summary historical consolidated financial data should be read in conjunction with other information contained in this prospectus, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and accompanying notes included elsewhere in this prospectus. Our historical financial results are not necessarily indicative of results to be expected in any future period.

 

(dollars in thousands, except per
share data)
  As of or for the
three months ended
March 31,
    As of or for the year ended
December 31,
 
  2011     2010     2010     2009     2008     2007     2006  

 

 

Selected Consolidated Balance Sheet Data:

             

Cash and cash equivalents

  $ 73,839      $ 23,119      $ 54,028      $ 21,420      $ 16,918      $ 16,617      $ 15,283   

Investment securities, available-for-sale

    49,052        44,058        51,096        44,091        48,581        59,615        60,279   

Restricted equity securities

    5,256        3,950        5,256        3,950        3,950        1,545        1,545   

Loans held for sale

    1,086        561        3,435        1,572        344        1,051        105   

Non-acquired loans (net of deferred fees)

    484,937        481,973        487,891        489,037        502,695        494,875        463,185   

Acquired loans

    154,299               158,550                               

Allowance for loan losses

    (11,166     (6,797     (11,123     (6,719     (5,277     (5,290     (4,960

FDIC indemnification asset

    26,917               26,800                               

Other real estate owned

    3,421        5,893        4,007        2,977        1,485        189        1,116   

Covered OREO

    5,736               5,709                               

Goodwill

    2,387        2,387        2,387        2,387        2,387        2,387        2,418   

Core deposit intangible

    65               67                               

Other assets

    53,341        46,194        57,168        47,350        43,483        27,772        24,152   

Total assets

    849,170        601,338        845,271        606,065        614,566        598,761        563,123   

Non-interest bearing demand deposits

    87,990        60,566        87,641        60,413        56,798        70,030        70,054   

Interest-bearing transactions and savings accounts

    416,446        255,296        402,849        242,006        203,850        208,449        196,103   

Time deposits

    243,843        183,859        251,326        203,193        213,488        184,400        223,491   

Total deposits

    748,279        499,721        741,816        505,612        474,136        462,879        489,648   

Federal Home Loan Bank borrowings

    25,301        30,383        25,316        30,408        30,520        20,614        734   

Other liabilities

    2,523        4,003        5,803        4,773        39,500        46,862        10,374   

Total liabilities

    776,103        534,107        772,935        540,793        544,156        530,355        500,756   

Common stock

    42,949        38,579        42,160        37,836        35,863        31,944        30,124   

Retained earnings

    29,984        28,547        29,939        27,642        35,096        37,126        32,942   

Other comprehensive earnings

    134        105        237        (206     (549     (664     (699

Total shareholders’ equity

    73,067        67,231        72,336        65,272        70,410        68,406        62,367   

Total liabilities and shareholders’ equity

    849,170        601,338        845,271        606,065        614,566        598,761        563,123   

Selected Consolidated Statement of Operations Data:

             

Interest income

  $ 10,031      $ 8,102      $ 36,705      $ 34,963      $ 37,844      $ 42,161      $ 37,617   

Interest expense

    1,908        1,696        6,910        8,797        11,566        15,797        14,477   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

    8,123        6,406        29,795        26,166        26,278        26,364        23,140   

Provision for loan losses

    1,525        502        8,881        6,755        595        115        333   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income after provision for loan losses

    6,598        5,904        20,914        19,411        25,683        26,249        22,807   

Non-interest income

    1,538        1,030        9,928        4,049        4,164        4,676        6,366   

Non-interest expense

    8,059        5,609        27,689        27,606        21,816        20,991        20,335   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

    77        1,325        3,153        (4,146     8,031        9,934        8,838   

Provision (benefit) for income taxes

    25        414        423        (2,183     2,527        3,205        2,534   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

  $ 52      $ 911      $ 2,730      $ (1,963   $ 5,504      $ 6,729      $ 6,304   

 

 

 

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Table of Contents
(dollars in thousands, except per
share data)
  As of or for the three
months ended
March 31,
    As of or for the year ended
December 31,
 
  2011     2010     2010     2009     2008     2007     2006  

 

 

Selected Share Data:

             

Earnings (loss) per common share-basic

  $ 0.01      $ 0.14      $ 0.41      $ (0.30   $ 0.82      $ 1.01      $ 0.96   

Earnings (loss) per common share-diluted

  $ 0.01      $ 0.14      $ 0.41      $ (0.30   $ 0.82      $ 1.01      $ 0.96   

Dividends paid per common share

  $      $      $      $ 0.24      $ 0.32      $ 0.30      $           0.28   

Dividend payout ratio

    0.00%        0.00%        0.00%        (79.92%     39.42%        29.58%        29.11%   

Book value per common share

  $ 10.81      $ 10.39      $ 10.79      $ 10.17      $ 10.65      $ 10.22      $ 9.44   

Tangible book value per common share

  $ 10.45      $ 10.02      $ 10.42      $ 9.79      $ 10.29      $ 9.86      $ 9.08   

Weighted average common shares outstanding-basic

    6,712,105        6,464,354        6,616,058        6,555,699        6,723,246        6,659,975        6,581,914   

Weighted average common shares outstanding-diluted

    6,723,598        6,464,354        6,619,697        6,555,699        6,723,246        6,659,975        6,581,914   

Common shares outstanding at period end

    6,756,189        6,469,878        6,706,379        6,420,911        6,611,706        6,694,915        6,605,626   

 

 

 

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(dollars in thousands)   As of and for the
three months ended
March 31,
    As of and for the year ended
December 31,
 
  2011     2010     2010     2009     2008     2007     2006  

 

 

Selected Financial Ratios:

             

Return on average shareholders’ equity(1)

    0.29%        5.37%        3.81%        (2.88%     7.77%        10.16%        10.28%   

Return on average assets(1)

    0.02%        0.61%        0.38%        (0.32%     0.91%        1.17%        1.13%   

Interest income to average earning assets(1)(2)

    5.44%        6.11%        5.85%        6.35%        6.70%        7.65%        7.09%   

Interest expense to average earning assets(1)

    1.05%        1.29%        1.11%        1.61%        2.07%        2.95%        2.81%   

Net interest margin(1)(2)

    4.39%        4.82%        4.74%        4.73%        4.63%        4.70%        4.28%   

Non-interest income to average assets(1)

    0.74%        0.69%        1.39%        0.66%        0.69%        0.81%        1.14%   

Non-interest expense to average assets(1)

    3.87%        3.76%        3.86%        4.52%        3.63%        3.66%        3.65%   

Efficiency ratio

    83.42%        75.43%        69.71%        91.37%        71.66%        67.63%        68.92%   

Loan to deposit ratio

    85.43%        96.45%        87.14%        96.72%        106.02%        106.91%        94.60%   

Capital Ratios:

             

Average shareholders’ equity to average assets

    8.73%        11.38%        9.98%        11.15%        11.78%        11.53%        10.99%   

Tier 1 leverage ratio

    8.35%        10.72%        8.24%        10.23%        11.17%        11.09%        10.53%   

Tier 1 risk-based capital ratio

    11.99%        11.90%        11.72%        11.54%        11.96%        11.93%        11.73%   

Total risk-based capital ratio

    13.25%        13.15%        12.98%        12.78%        12.91%        12.92%        12.73%   

Selected Asset Quality Ratios:

             

Non-acquired loans 30-89 days past due to total non-acquired loans

    0.34%        0.37%        0.58%        0.02%        0.34%        0.18%        0.00%   

Non-acquired non-accrual loans to total loans

    3.24%        1.48%        1.97%        1.97%        0.36%        0.13%        0.30%   

Non-acquired non-accrual loans to total assets

    2.44%        1.18%        1.51%        1.59%        0.30%        0.11%        0.25%   

Non-acquired non-performing loans to total non-acquired loans

    6.00%        3.58%        4.07%        4.10%        0.70%        0.28%        0.46%   

Non-acquired non-performing assets to total assets

    3.83%        4.06%        2.82%        3.80%        0.82%        0.27%        0.38%   

Allowance for loan losses to total non-acquired loans

    2.30%        1.41%        2.28%        1.37%        1.05%        1.07%        1.07%   

Allowance for loan losses to total loans

    1.75%        1.41%        1.71%        1.37%        1.05%        1.07%        1.07%   

Allowance for loan losses to total non-acquired non-performing loans

    38.34%        39.45%        55.99%        33.51%        149.07%        377.59%        231.99%   

Net charge-offs (recoveries) to average total loans

    0.23%        0.09%        0.80%        1.07%        0.12%        (0.05%     (0.06%

 

 
(1)   Annualized for the three month periods ended March 31, 2011 and 2010.

 

(2)   Tax exempt income has been adjusted to a tax equivalent basis at a 34% tax rate. The amount of such adjustment was an addition to the recorded interest income of approximately $126 and $132 for the three months ended March 31, 2011 and 2010, respectively, and $525, $535 and $517 for the years ended December 31, 2010, 2009, and 2008, respectively.

 

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Non-GAAP financial measures

The tangible common equity to tangible assets ratio and tangible book value per share are non-GAAP measures generally used by financial analysts and investment bankers to evaluate capital adequacy. We calculate these non-GAAP measures as follows:

 

 

tangible common equity equals total shareholders’ equity less goodwill and other intangible assets;

 

 

tangible assets equals total assets less goodwill and other intangible assets; and

 

 

tangible book value per share equals tangible common equity (as described above) divided by shares of Common Stock outstanding.

Our management, banking regulators, many financial analysts and other investors use the tangible common equity to tangible assets ratio and tangible book value per share in conjunction with more traditional bank capital ratios to compare the capital adequacy of banking organizations with preferred equity, goodwill or other intangible assets, which typically stem from the accounting for business combinations. Tangible common equity, tangible assets, tangible book value per share or related measures should not be considered in isolation or as a substitute for total shareholders’ equity, total assets, book value per share or any other measure calculated in accordance with accounting principles generally accepted in the United States (GAAP). Moreover, the manner in which we calculate tangible common equity, tangible assets, tangible book value per share and any other related measures may differ from that of other companies reporting measures with similar names.

The following table reconciles, as of the dates set forth below, shareholders’ equity (on a GAAP basis) to tangible common equity and total assets (on a GAAP basis) to tangible assets and calculates our tangible book value per share:

 

     March 31,     December 31,  
(dollars in thousands)   2011     2010     2009     2008     2007     2006  

 

 

Tangible common equity:

           

Total equity—GAAP

  $ 73,067      $ 72,336      $ 65,272      $ 70,410      $ 68,406      $ 62,367   

Deduct: goodwill

    (2,387     (2,387     (2,387     (2,387     (2,387     (2,418

Deduct: core deposit intangible

    (65     (67                            
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Tangible common equity

  $ 70,615      $ 69,882      $ 62,885      $ 68,023      $ 66,019      $ 59,949   

 

 

Tangible assets:

           

Total assets—GAAP

  $ 849,170      $ 845,271      $ 606,065      $ 614,566      $ 598,761      $ 563,123   

Deduct: goodwill

    (2,387     (2,387     (2,387     (2,387     (2,387     (2,418

Deduct: core deposit intangible

    (65     (67                            
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Tangible assets

  $ 846,718      $ 842,817      $ 603,678      $ 612,179      $ 596,374      $ 560,705   

 

 

Common shares outstanding

    6,756,189        6,706,379        6,420,911        6,611,706        6,694,915        6,605,626   

Tangible common equity to tangible assets ratio

    8.34%        8.29%        10.42%        11.11%        11.07%        10.69%   

Tangible book value per share

  $ 10.45      $ 10.42      $ 9.79      $ 10.29      $ 9.86      $ 9.08   

 

 

 

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Management’s discussion and analysis of

financial condition and results of operations

You should read the following discussion and analysis of our financial condition and results of operations together with our financial statements and the related notes included in this prospectus. In addition to historical financial information, this discussion and analysis contains forward-looking statements reflecting our plans, estimates, outlook, beliefs and expectations that involve risks, assumptions and uncertainties. As a result of many factors, particularly those identified under “Risk Factors” and “Cautionary Note Regarding Forward-Looking Statements” in this prospectus, our actual results and the timing of events may differ materially from those anticipated in these forward-looking statements. We assume no obligation to update any of these forward-looking statements.

Overview

We were incorporated in 1997 under the laws of Oregon and became a bank holding company in 1998 and are headquartered in Klamath Falls, Oregon. We operate through two wholly owned subsidiaries, South Valley Bank & Trust and South Valley Wealth Management. South Valley Bank & Trust, an Oregon state-chartered bank, commenced operations in January 1977 and is a community bank with 24 branches in four regions of central and southern Oregon:

 

Regions    Counties    Number of
branches
   Regional
headquarters

 

Klamath/Lake

   Klamath    5    Klamath Falls
   Lake    1   

 

Central Oregon

   Crook    1   
   Deschutes    5    Bend
   Jefferson    1   
   Klamath    1   

 

Rogue

   Jackson    5    Medford

 

Three Rivers

   Josephine    5    Grants Pass

 

Our primary business is traditional community banking: accepting deposits and originating loans in the communities surrounding our branches. As a community bank, the Bank’s profitability depends primarily upon its levels of net interest income, which is the difference between interest income from interest-earning assets and interest expense on interest-bearing liabilities. When interest-earning assets approximate or exceed interest-bearing liabilities, any positive interest rate spread will generate net interest income.

As a bank holding company, the Holding Company is subject to the supervision of the Federal Reserve. As an Oregon chartered bank, the Bank is subject to primary supervision, periodic examination and regulation by the FDIC, its primary federal regulator, and the DFCS. Regulatory reform was a focal point in the financial services industry during 2010. The Dodd-Frank Act, which is discussed under “Our Business—Supervision and Regulation—Dodd-Frank Act,” was signed into law in July 2010 and is likely to result in sweeping changes to the financial services industry in how business is conducted and regulated.

 

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The banking industry was especially hard hit in 2010, with a reported 157 failed institutions. An additional 48 institutions have failed through July 1, 2011. As part of a plan to restore the FDIC’s Deposit Insurance Fund following significant decreases in its reserves, the FDIC has increased deposit insurance assessments. On January 1, 2009, the FDIC increased its assessment rates and has since imposed further rate increases and changes to the current risk-based assessment framework. In 2009, the FDIC required insured depository institutions to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012. We expect FDIC insurance premiums to remain elevated for the foreseeable future.

In response to the recession and uncertain market conditions, we implemented changes to our capital management practices designed to ensure our long-term success and conserve capital. In January and July of 2008 and January 2009 we paid dividends of $0.16 per share. In July 2009 we reduced the dividend to $0.08 per share and, effective December 31, 2009, we suspended the periodic cash dividend. In addition, during 2010 we limited repurchases of our Common Stock to transactions with our Employee Stock Ownership and Retirement Plan (“ESOP”). As required by the terms of our ESOP, the Holding Company repurchases shares of its Common Stock to meet the liquidity requirements of the ESOP. The Holding Company issues shares of Common Stock quarterly based on employee or Holding Company contributions during the period. The Holding Company repurchases shares of Common Stock to satisfy distribution requirements resulting from terminations of employment, employee diversifications, or employee hardship withdrawals. During the second quarter 2009, although we received notification that our application for participation in the TARP Capital Purchase Program was approved, we elected not to participate in the program.

Financial highlights

As of March 31, 2011, we had consolidated assets of $849.2 million, deposits of $748.3 million, net loans (non-acquired loans and acquired loans, less the allowance for loan losses) of $628.1 million and total shareholders’ equity of $73.1 million.

The following is a summary of the Holding Company’s significant changes in financial condition, results of operations and financial ratios for the periods indicated:

 

      As of or for the three
months ended

March 31,
     As of or for the year ended
December 31,
 
(dollars in thousands, except per share data)    2011      2010      2010      2009     2008  

 

 

Net interest income

   $ 8,123       $ 6,406       $ 29,795       $ 26,166      $ 26,278   

Provision for loan losses

   $ 1,525       $ 502       $ 8,881       $ 6,755      $ 595   

Net income

   $ 52       $ 911       $ 2,730       $ (1,963   $ 5,504   

Earnings (loss) per share—diluted

   $ 0.01       $ 0.14       $ 0.41       $ (0.30   $ 0.82   

Net interest margin(1)(2)

     4.39%         4.82%         4.74%         4.73%        4.63%   

Efficiency ratio

     83.42%         75.43%         69.71%         91.37%        71.66%   

Tier 1 leverage ratio

     8.35%         10.72%         8.24%         10.23%        11.17%   

Non-acquired non-performing assets to total assets(3)

     3.83%         4.06%         2.82%         3.80%        0.82%   

Allowance for loan losses to total non-acquired loans

     2.30%         1.41%         2.28%         1.37%        1.05%   

 

 

 

(1)   Tax exempt income has been adjusted to a tax equivalent basis at a 34% tax rate. The amount of such adjustment was an addition to the recorded interest income of approximately $126 and $155 for the three months ended March 31, 2011 and 2010, respectively, and $525, $535 and $517 for the years ended December 31, 2010, 2009, and 2008, respectively.

 

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(2)   Annualized for the three month periods ended March 31, 2011 and 2010.

 

(3)   Non-acquired non-performing assets consist of non-acquired non-accrual loans, non-acquired loans past due 90 days and still accruing, non-acquired performing troubled debt restructurings, and OREO.

FDIC-Assisted acquisition of Home Valley Bank

On July 23, 2010, we completed the FDIC-assisted acquisition of Home Valley Bank, acquiring approximately $244.9 million of assets and assuming $242.6 million of liabilities, including $227.2 million of deposits, at cost basis as of the acquisition date. The acquisition expanded the Bank’s geographic presence into Josephine County with four branches in Grants Pass and one in Cave Junction. The purchase and assumption agreement with the FDIC provides for two separate loss-sharing agreements, which, in addition to fair value adjustments, significantly mitigates our risk of future loss on the loan portfolio we acquired. These loss-sharing agreements with the FDIC provide for specified credit loss protection for substantially all acquired loans and foreclosed real estate. Under the terms of these loss-sharing agreements, the FDIC will absorb 80% of losses and share in 80% of loss recoveries on $214.0 million of cost-basis acquired assets (as of the acquisition date). The term for loss-sharing and recoveries sharing on residential real estate loans is 10 years, the term for loss-sharing on non-residential real estate loans is 5 years, and the term for recoveries sharing on non-residential real estate loans is 8 years. At the acquisition date, the Bank estimated the Home Valley Bank acquired assets would incur approximately $34.2 million of losses, and we recorded a $26.7 million FDIC indemnification asset based on the present value of expected loss reimbursements.

We accounted for the FDIC-assisted transaction using the acquisition method of accounting; accordingly, our balance sheet includes the estimates of the fair value of the assets acquired and liabilities assumed. Our results of operations for the twelve months ended December 31, 2010 include the effects of the acquisition from the date of the transaction. We recorded a bargain purchase gain of $4.6 million in the third quarter of 2010 that represents the excess of the estimated fair value of the assets acquired over the estimated fair value of liabilities assumed in the FDIC-assisted acquisition of Home Valley Bank. During the first quarter of 2011, the acquisition contributed pre-tax earnings of $0.8 million, including $1.7 million in net interest income, $0.2 million change in indemnification asset and $0.1 million in fee income, offset by $0.5 million in salaries and employee benefits, $0.6 million in other operating and occupancy expenses, and $0.1 million in provision for loan losses.

A copy of the purchase and assumption agreement between the Bank and the FDIC, including the loss-sharing agreements, is filed as Exhibit 2.1 to the Registration Statement, of which this prospectus constitutes a part and is incorporated herein by reference. The description of the loss-sharing agreements and terms of the FDIC-assisted acquisition of Home Valley Bank set forth above and elsewhere in this prospectus does not purport to be complete, and is qualified by reference to the full text of the purchase and assumption agreement.

We refer to our loans as acquired loans or non-acquired loans. The acquired loans are loans acquired in the FDIC-assisted acquisition of Home Valley Bank, substantially all of which are subject to loss-sharing agreements with the FDIC. Our acquired loans were valued as of acquisition date in accordance with Financial Accounting Standards Board Accounting Standards Codification (“FASB ASC”) 805, Business Combinations. Acquired loans purchased with evidence of credit deterioration since origination for which it is probable that all contractually required payments will not be collected are accounted for under ASC 310-30. The Bank elected to account for all acquired loans under ASC 310-30 due to the significant fair value discounts associated with the acquired portfolios and after considering the underwriting standards of Home Valley Bank.

 

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Under FASB ASC 805 and ASC 310-30, acquired loans are recorded at fair value at acquisition date, factoring in credit losses expected to be incurred over the life of the loan. No credit deterioration in excess of our acquisition date estimates has occurred through March 31, 2011. Accordingly, there is no allowance for loan losses established as of March 31, 2011 on acquired loans. We aggregated the acquired loans into pools based on individually evaluated common risk characteristics and we estimated aggregate expected cash flows for each pool. A pool is accounted for as a single asset with a single interest rate, cumulative loss rate and cash flow expectation. The excess of the cash flows expected to be collected over a pool’s carrying value is considered to be the accretable yield and is recognized as interest income over the estimated life of the loan or pool using the effective yield method. The accretable yield may change due to changes in the timing and amounts of expected cash flows. Changes in the accretable yield are disclosed quarterly. Management will periodically reassess its analysis of future expected cash flows of each of the acquired loan pools. Increases in cash flows will cause increases in interest income over the remaining life of a loan pool and decreases will result in recognition of impairment of a loan pool through a charge to the provision for loan losses, which will be mostly offset by an increase in the FDIC indemnification asset.

Regulatory matters

Primarily as a result of the challenging economic environment in which we have been operating, we have experienced increased levels of non-performing assets, delinquencies and adversely classified assets, as well as net losses from operations in 2009 and increased provisions for loan losses and charge-offs in 2009 and 2010. In addition, we used a portion of our capital to support the assets acquired in our FDIC-assisted acquisition of Home Valley Bank on July 23, 2010. On September 20, 2010, the FDIC and the DFCS issued an Examination Report based on the Bank’s results of operations for the six months ended, and financial condition as of, June 30, 2010, which date preceded the date we completed the FDIC-assisted acquisition of Home Valley Bank. On February 22, 2011, the Bank entered into the MOU with the FDIC and the DFCS.

Under the terms of the MOU, the Bank agreed to, among other things:

 

 

not appoint any new director or senior executive officer or change the responsibilities of any current senior executive officers without the prior written non-objection of the FDIC and the DFCS;

 

 

increase by August 22, 2011 and thereafter maintain the Bank’s Tier 1 capital so that it equals or exceeds 10% of the Bank’s average total assets (calculated in accordance with applicable FDIC regulations and in addition to a fully funded allowance for loan and lease losses);

 

 

reduce all assets classified as “Substandard” in the Examination Report (that we had not previously charged off) by 50% by June 22, 2011, and by 70% by August 22, 2011;

 

 

refrain from approving any extension of credit to any borrower who had a loan classified as “Substandard” in the Examination Report without first collecting in cash all interest due;

 

 

develop a liquidity and funds management plan including a minimum primary liquidity ratio (net cash, short-term and marketable assets divided by net deposits and short-term liabilities) of at least 15% and a maximum net non-core funding dependence ratio (non-core funding such as brokered deposits, certificates of deposit greater than $100,000 and borrowed funds divided by longer-term assets such as loans and securities that mature in more than one year) of 20%;

 

 

develop and implement plans to improve asset quality and increase profitability; and

 

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develop and implement policies to improve lending, valuation, credit grading and collection practices.

On May 18, 2011, the Board adopted resolutions at the direction of the Federal Reserve Bank of San Francisco requiring us to take corrective actions and refrain from specified actions to ensure the Bank’s compliance with the MOU, and that are substantially similar in substance and scope to the MOU.

Under the MOU, the Bank may not pay cash dividends to us without prior written approval from the FDIC and the DFCS. Under the board resolutions, the Holding Company may not pay any dividends on or repurchase its Common Stock, or receive dividends from the Bank, without the prior written approval of the Federal Reserve Bank of San Francisco and the DFCS. The Holding Company does not expect to be permitted to pay or receive dividends or repurchase shares until we meet all of the requirements of the MOU and the board resolutions. The Holding Company and the Bank each must obtain prior regulatory approval before adding any new director or senior executive officer or changing the responsibilities of any current senior executive officer. The MOU will remain in effect until stayed, modified, terminated or suspended by the FDIC and the DFCS. The board resolutions will remain in effect until the Federal Reserve Bank of San Francisco permit us to rescind them. For additional information regarding the MOU and the board resolutions, see “Risk Factors—We are required to comply with the terms of the MOU, and lack of compliance could result in additional regulatory actions” and “Business—Regulatory Matters.”

Results of operations

Quarters ended March 31, 2011 and 2010

Net income was $52,000, or $0.01 per share, for the first quarter of 2011 compared with net income of $0.9 million, or $0.14 per share, for the first quarter of 2010. The decrease was primarily attributed to increased income from the FDIC-assisted acquisition of Home Valley Bank of $0.8 million, decreased other fee income of $0.2 million and decreased taxes of $0.4 million, offset by a reduction in interest margin of $0.1 million, increased provision for loan losses of $0.9 million, impairment write-down due to valuation declines in real estate of $0.7 million and increased operating expenses of $0.6 million.

Net interest income

Net interest income for the three months ended March 31, 2011 was $8.1 million, an increase of $1.7 million, or 26.8%, compared to the same period in 2010, with the increase primarily attributable to the contributions from the FDIC-assisted acquisition of Home Valley Bank.

The Home Valley Bank loans we acquired were priced lower than our loans and the assumed deposits were priced higher. As a result, our net interest margin, on a tax-equivalent basis, declined from 4.82% for the first quarter of 2010 to 4.39% for the first quarter of 2011. During the comparable periods, our non-acquired loan portfolio yields continued to decline but were offset by declines in the cost of funds of non-acquired liabilities. The increase in average outstanding balance of our non-acquired loan portfolio during the comparable quarters was minimal and reflects the stresses of the current economic conditions.

Additionally, net interest income continued to be negatively affected by loans that are in non-accrual status. For the periods ended March 31, 2011 and 2010, interest income that would have been recognized if non-accrual loans had been current in accordance with their original terms totaled $0.7 million and $0.5 million, respectively.

 

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Average balances and rates

The following table presents, for the periods indicated, condensed average balance sheet information, together with interest income and yields earned on average interest-earning assets and interest expense and rates paid on average interest-bearing liabilities.

 

     Three months ended
March 31,
 
    2011     2010  
(dollars in thousands)   Average
balance
    Interest
income
or
expense
    Average
yields or
rates(4)
    Average
balance
    Interest
income
or
expense
    Average
yields or
rates(4)
 

 

 

Assets

           

Interest-earning assets:

           

Loans(1)(2)

  $ 484,787      $ 7,072        5.92%      $ 484,285      $ 7,507        6.29%   

Acquired loans

    158,989        2,254        5.75%        0        0        0.00%   

Taxable investment securities

    33,646        243        2.93%        26,333        199        3.06%   

Non-taxable investment securities(2)

    16,306        306        7.61%        17,531        329        7.61%   

Other interest-earning assets

    45,460        46        0.41%        5,168        4        0.31%   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-earning assets

    739,188        9,921        5.44%        533,317        8,039        6.11%   

Allowance for loan losses

    (11,054         (6,489    

Other assets

    116,060            77,814       
 

 

 

       

 

 

     

Total assets

  $ 844,194          $ 604,642       

 

 

Liabilities and shareholders’ equity

           

Interest-bearing liabilities:

           

Deposits:

           

Interest-bearing transaction accounts

  $ 181,474      $ 206        0.46%      $ 97,017      $ 57        0.24%   

Money market

    202,522        350        0.70%        134,809        259        0.78%   

Savings

    26,710        19        0.29%        16,775        10        0.24%   

Time deposits

    248,042        1,114        1.82%        194,759        1,065        2.22%   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-bearing deposits

    658,748        1,689        1.04%        443,360        1,391        1.27%   

Other borrowings(3)

    25,949        219        3.42%        34,651        304        3.56%   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-bearing liabilities

    684,697        1,908        1.13%        478,011        1,695        1.44%   

Non-interest bearing deposits

    82,217            55,882       

Other liabilities

    3,602            1,916       
 

 

 

       

 

 

     

Total liabilities

    770,516            535,809       

Shareholders’ equity

    73,679            68,832       
 

 

 

       

 

 

     

Total liabilities and shareholders’ equity

  $ 844,195          $ 604,641       

 

 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

    $ 8,013          $ 6,344     

 

 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest rate spread

        4.31%            4.67%   

 

 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest income to average earning assets(1)(2)

        5.44%            6.11%   

Interest expense to average earning assets

        1.05%            1.29%   
     

 

 

       

 

 

 

Net interest margin

        4.39%            4.82%   

 

 
(1)   Average balances includes non-acquired loans, non-accrual loans, and loans held for sale.

 

(2)   Tax exempt income has been adjusted to a tax equivalent basis at a 34% tax rate. The amount of such adjustment was an addition to the recorded interest income of approximately $126 and $132 for the three months ended March 31, 2011 and 2010, respectively.

 

(3)   Includes average balances of FHLB borrowings of $25,311 and $30,399 for the three months ended March 31, 2011 and 2010, respectively.

 

(4)   Yields or rates shown on an annualized basis.

 

 

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Rate and volume analysis

The following table presents, for the periods indicated, a summary of the changes in tax equivalent interest income and expense due to changes in average asset and liability balances (volume) and changes in average rates (rate), excluding interest income from non-accrual loans. Changes not attributable specifically to either volume or rate are allocated between both variances in proportion to the percentage change in average volume and average rate.

 

      Three months ended March 31,
2011 compared to 2010
 
         Increase (decrease) due to      
(dollars in thousands)    Rate     Volume     Total
change
 

 

 

Interest-earning assets:

      

Non-acquired loans(1)

   $ (443   $ 8      $ (435

Acquired loans

            2,254        2,254   

Taxable investment securities

     (9     53        44   

Non-taxable investment securities

            (23     (23

Other interest-earning assets

     1        41        42   
  

 

 

 

Total interest-earning assets

     (451     2,333        1,882   

Interest-bearing liabilities:

      

Interest-bearing transaction accounts

     77        72        149   

Money market

     (28     119        91   

Savings

     2        7        9   

Time deposits

     (211     260        49   

Other borrowings

     (12     (73     (85
  

 

 

 

Total interest-bearing liabilities

     (172     385        213   
  

 

 

 

Increase (decrease) in net interest income

   $ (279   $ 1,948      $ 1,669   

 

 
(1)   Consists of non-acquired loans and loans held for sale.

Provision for loan losses

The provision for non-acquired loan and lease losses was $1.5 million for the three months ended March 31, 2011, compared to $0.5 million for the same period in 2010. As an annualized percentage of average outstanding non-acquired loans, the provision for loan losses recorded for the three months ended March 31, 2011, was 1.27%, compared to 0.42% for the same period in 2010.

The increase in the provision for loan and lease losses for the three months ended March 31, 2011 compared to the same period in 2010 was principally attributable to the deterioration of two non-acquired loan assets. We may be required to recognize higher than normal provisions for loan losses in the near term as we continue to work through our remaining problem loans. If market conditions stabilize in our regions, we would expect a return to a more normal level of loan loss provision compared to the heightened levels of recent years. The provision for non-acquired loan and lease losses is based on management’s evaluation of inherent risks in the loan portfolio and a corresponding analysis of the allowance for non-acquired loan and lease losses. Additional discussion on loan quality and the allowance for non-acquired loan and lease losses is provided in “Financial Condition—Asset Quality.”

 

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Non-interest income

The following table presents the key components of non-interest income for the three months ended March 31, 2011 and 2010:

 

      Three months ended March 31,  
     2011 Compared to 2010  
(dollars in thousands)    2011     % of
total
    2010     % of
total
    Dollar
change
     Percent
change
 

 

 

Service charges on deposit accounts

   $ 342        22.24%      $ 319        30.97%      $ 23         7.21%   

Debit card and ATM fees

     328        21.33%        220        21.36%        108         49.09%   

Wealth management commissions and fees

     343        22.30%        307        29.81%        36         11.73%   

Trust and financial services

     291        18.92%        274        26.60%        17         6.20%   

Gain on sale of mortgage loans

     120        7.80%        68        6.60%        52         76.47%   

Change in FDIC indemnification asset

     233        15.15%               0.00%        233         100.00%   

Loss on investment in limited partnership

     (119     (7.74%     (158     (15.34%     39         (24.68%
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Total

   $ 1,538        100.00%      $ 1,030        100.00%      $ 508         49.32%   

 

 

The change in debit card and ATM fees was primarily a result of increased transaction volume associated with the FDIC-assisted acquisition of Home Valley Bank.

Fees and commissions earned from trust, financial, and wealth management services increased for the quarter ended March 31, 2011, compared to the same period in 2010, primarily as a result of improved market conditions and increased transaction volumes.

Activities related to mortgage loans sold on the secondary market improved significantly during the quarter ended March 31, 2011, which resulted in an increased level of gains on sales of these loans.

The change in the FDIC indemnification asset represents an increase in cash flows expected to be recoverable under the loss-sharing agreements entered into with the FDIC in connection with the FDIC-assisted acquisition of Home Valley Bank. Prior to July 23, 2010, we were not party to any FDIC loss-sharing agreements.

The loss on investment in limited partnerships represents our investments in various low-income housing projects. These losses are partially offset by tax credits received. The investments were also made to comply with the Community Reinvestment Act.

 

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Non-interest expense

The following table presents the key elements of non-interest expense for the three months ended March 31, 2011 and 2010:

 

      Three months ended March 31,  
     2011 Compared to 2010  
(dollars in thousands)    2011      % of
total
     2010      % of
total
     Dollar
change
    Percent
change
 

 

 

Salaries and employee benefits

   $ 3,816         47.35%       $ 3,041         54.22%       $ 775        25.49%   

Occupancy and equipment

     1,155         14.33%         916         16.33%         239        26.09%   

Loss on sales and impairment write-down of other real estate owned

     275         3.41%                 0.00%         275        100.00%   

Impairment of investment in real estate joint venture

     404         5.01%                 0.00%         404        100.00%   

Other real estate owned expenses

     83         1.03%         27         0.48%         56        207.41%   

Professional fees

     118         1.46%         139         2.48%         (21     (15.11%

Telecommunications

     152         1.89%         109         1.94%         43        39.45%   

Advertising

     43         0.53%         39         0.70%         4        10.26%   

FDIC deposit insurance assessments

     434         5.39%         213         3.80%         221        103.76%   

Acquisition-related expenses

     381         4.73%                 0.00%         381        100.00%   

Other expenses

     1,198         14.87%         1,125         20.06%         73        6.49%   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 8,059         100.00%       $ 5,609         100.00%       $ 2,450        43.68%   

 

 

Salaries and employee benefits costs increased $0.8 million for the three months ended March 31, 2011, compared to the same period in 2010. Approximately $0.6 million of the increase primarily resulted from the FDIC-assisted acquisition of Home Valley Bank, which we completed on July 23, 2010. Net occupancy and equipment expense increased $0.2 million for the three months ended March 31, 2011, compared to the same period in 2010. The increase in 2011 is the result of the cost of operating new locations through the FDIC-assisted acquisition of Home Valley Bank.

The difficult economic conditions in our market area have continued to detrimentally affect our non-acquired loan portfolio, leading to a continued elevated level of foreclosures and OREO. Through the first quarter of 2011, declines in the market values of these properties after foreclosure resulted in additional losses on the sale of the properties or by valuation adjustments. For the three months ended March 31, 2011, we recognized net losses on sale and valuation adjustments of non-acquired OREO properties of $0.3 million, compared to no losses on sale and valuation adjustments of non-acquired OREO properties for the same period in 2010. During the first quarter of 2011, we also incurred an impairment write-down of $0.4 million on our investment in a real estate joint venture based on our evaluation of a new appraisal of the underlying real estate.

FDIC assessments more than doubled for the three months ending March 31, 2011, compared to the same period in 2010. The increase resulted from organic deposit growth, deposits assumed in connection with the FDIC-assisted acquisition of Home Valley Bank, and increased FDIC premium rates due to the Bank’s financial condition.

On January 15, 2011, we completed the conversion of accounts of Home Valley Bank onto our core data processing system. Until this time, we operated two data processing systems, which resulted in higher data processing costs. During the first quarter of 2011, we incurred $0.4 million in non-recurring expenses related to the conversion. As a result of the conversion, we expect that our acquisition-related costs will decline in future periods.

 

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Income taxes

Our effective tax rate was 32.5% for the three months ended March 31, 2011, compared to 31.2% for the same period in 2010. Changes in effective tax rates were primarily due to fluctuations in tax exempt interest income as a percentage of total income, investment in low income housing and other tax credits.

 

      Three months ended
March 31,
 
(dollars in thousands)    2011     2010  

 

 

Federal income tax expense (benefit) at statutory rate

   $ 26      $ 450   

State income tax expense (benefit), net of federal income taxes

     5        87   

Effect of nontaxable municipal bond income

     (80     (83

Low-income housing credit

     (132     (104

Other

     206        64   
  

 

 

   

 

 

 

Income tax expense (benefit) at effective rate

   $ 25      $ 414   

 

 

Effective tax rate

     32.50%        31.20%   

 

 

Years ended December 31, 2010, 2009 and 2008

Net income was $2.7 million, or $0.41 per share, for 2010 compared with net loss of $2.0 million, or $0.30 per share, for 2009, and net income of $5.5 million, or $0.82 per share, for 2008.

The increase in net income for 2010 was principally attributable to the one time $4.6 million bargain purchase gain from the FDIC-assisted acquisition of Home Valley Bank, and increased net interest income, offset by an increase of $2.1 million in provision for loan losses and one-time acquisition related expenses of $0.9 million. The loss in 2009 compared to net income in 2008 was primarily due to increased provision for loan losses and impairment write-down of restricted equity securities and OREO.

Net interest income

Net interest income for 2010 was $29.8 million, an increase of $3.6 million, or 14%, from 2009. Net interest income for 2009 was $26.2 million, a slight decrease from 2008.

The increase for 2010 was attributable to growth in outstanding average interest-earnings asset, primarily acquired loans from the FDIC-assisted acquisition partially offset by a decline in non-acquired loans outstanding and a reduction in the cost of time deposits.

The slight decrease in net interest income for 2009 compared to 2008 was primarily attributable to a decline in outstanding average interest-earnings assets.

Net interest income was negatively affected by loans that are in a non-accrual status. For the periods ended December 31, 2010, 2009, and 2008 interest that would have been recognized if non-accrual loans had been current in accordance with their original terms totaled $1.8 million, $0.9 million, and $0.1 million respectively.

The net interest margin (net interest income as a percentage of average interest-earning assets) on a fully tax-equivalent basis was 4.74% for 2010, an increase of one basis point compared to 2009. Average yields on interest-earning assets declined 50 basis points, due to the addition of acquired loans from the FDIC-assisted acquisition of Home Valley Bank that earned interest at 61 basis points

 

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less than non-acquired loans, and a 22 basis point decrease in average yields on non-acquired loans. The decrease in yields was offset by a decrease in interest expense to earning assets of 51 basis point due to declining costs of interest-bearing deposits, and the effect of holding much higher levels of interest-bearing cash with the Federal Reserve Bank (at 25 basis points).

The net interest margin on a fully tax-equivalent basis was 4.73% for 2009, an increase of ten basis points compared to 2008. The increase in net interest margin primarily resulted from the decrease in interest expense to earning assets of 46 basis points in 2009 resulting from the lower costs of interest-bearing deposits, partially offset by the decreased yield on interest-earning assets of 35 basis points, primarily resulting from reductions in the prime rate and interest reversals of non accrual non-acquired loans.

 

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Average balances and rates

Our net interest income is affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities, as well as changes in the yields earned on interest-earnings assets and rates paid on deposits and borrowed funds.

The following table presents, for the periods indicated, condensed average balance sheet information, together with interest income and yields earned on average interest-earning assets and interest expense and rates paid on average interest-bearing liabilities.

 

     Year ended
December 31,
 
    2010     2009     2008  
(dollars in thousands)   Average
balance
    Interest
income or
expense
    Average
yields or
rates
    Average
balance
    Interest
income or
expense
    Average
yields or
rates
    Average
balance
    Interest
income or
expense
    Average
yields or
rates
 

 

 

Assets

                 

Interest-earning assets:

                 

Non-acquired loans(1)(2)

  $ 483,327      $ 30,026        6.21%      $ 495,857      $ 31,906        6.43%      $ 504,488      $ 34,234        6.79%   

Acquired loans

    76,930        4,307        5.60%        0        0        0.00%        0        0        0.00%   

Taxable investment securities

    30,219        704        2.33%        30,198        1,347        4.46%        35,404        1,792        5.06%   

Non-taxable investment securities(2)

    17,212        1,272        7.39%        17,862        1,346        7.54%        17,882        1,353        7.57%   

Other interest-earning assets

    13,884        79        0.57%        1,370        8        0.58%        869        25        0.00%   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-earning assets

    621,572        36,388        5.85%        545,287        34,607        6.35%        558,643        37,404        6.70%   

Allowance for loan losses

    (7,871         (5,531         (5,625    

Other assets

    103,120            70,966            48,534       
 

 

 

       

 

 

       

 

 

     

Total assets

  $ 716,821          $ 610,722          $ 601,552       

 

 

Liabilities and shareholders’ equity

                 

Interest-bearing liabilities:

                 

Deposits:

                 

Interest-bearing transaction accounts

  $ 143,259      $ 518        0.36%      $ 76,917      $ 134        0.17%      $ 66,102      $ 142        0.21%   

Money market

    158,129        1,179        0.75%        121,825        1,376        1.13%        115,253        2,047        1.78%   

Savings

    20,048        55        0.27%        16,017        39        0.24%        15,463        50        0.32%   

Time deposits

    213,947        4,037        1.89%        218,864        5,984        2.73%        204,400        7,276        3.56%   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-bearing deposits

    535,383        5,789        1.08%        433,623        7,533        1.74%        401,218        9,515        2.37%   

Other borrowings(3)

    32,879        1,119        3.40%        42,823        1,263        2.95%        68,348        2,051        3.00%   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-bearing liabilities

    568,262        6,908        1.22%        476,446        8,796        1.85%        469,566        11,566        2.46%   

Non interest-bearing deposits

    70,168            62,929            57,357       

Other liabilities

    6,832            3,223            3,750       
 

 

 

       

 

 

       

 

 

     

Total liabilities

    645,262            542,598            530,673       

Shareholders’ equity

    71,560            68,123            70,878       
 

 

 

       

 

 

       

 

 

     

Total liabilities and shareholders’ equity

  $ 716,822          $ 610,721          $ 601,551       

 

 

Net interest income

    $ 29,480          $ 25,811          $ 25,838     

 

 

Interest rate spread

        4.63%            4.50%            4.24%   

 

 

Interest income to average earning assets(1)(2)

        5.85%            6.35%            6.70%   

Interest expense to average earning assets

        1.11%            1.61%            2.07%   
     

 

 

       

 

 

       

 

 

 

Net interest margin

        4.74%            4.73%            4.63%   

 

 
(1)   Average balances consist of non-acquired loans and loans held for sale.

 

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Table of Contents
(2)   Tax exempt income has been adjusted to a tax equivalent basis at a 34% tax rate. The amount of such adjustment was an addition to the recorded interest income of approximately $525, $535 and $517 for the years ended December 31, 2010, 2009, and 2008, respectively.

 

(3)   Includes average balances of FHLB borrowings of $30,694, $30,463 and $35,645 for the years ended December 31, 2010, 2009 and 2008, respectively.

Rate and volume analysis

The following table presents, for the periods indicated, a summary of the changes in tax equivalent interest income and expense due to changes in average asset and liability balances (volume) and changes in average rates (rate), excluding interest income from non-accrual loans. Changes not attributable specifically to either volume or rate are allocated between both variances in proportion to the percentage change in average volume and average rate.

 

      2010 Compared to 2009     2009 Compared to 2008  
     Increase (decrease) due to     Increase (decrease) due to  
(dollars in thousands)    Rate     Volume     Total
change
    Rate     Volume     Total
change
 

 

 

Interest-earning assets:

            

Loans(1)

   $ (1,086   $ (794   $ (1,880   $ (1,750   $ (578   $ (2,328

Acquired loans

     (1     4,308        4,307                        

Taxable investment securities

     (644     1        (643     (199     (246     (445

Non-taxable investment securities

     (26     (48     (74     (5     (2     (7

Other interest-earning assets

            71        71        (26     9        (17
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-earning assets

     (1,757     3,538        1,781        (1,980     (817     (2,797

Interest-bearing liabilities:

            

Interest-bearing transaction accounts

     216        168        384        (29     21        (8

Money market

     (543     346        (197     (782     111        (671

Savings

     5        11        16        (13     2        (11

Time deposits

     (1,816     (131     (1,947     (1,779     487        (1,292

Other borrowings

     176        (320     (144     (33     (755     (788