Unassociated Document
 

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
             
   
 
(Mark One)
 
[X]    
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
 OF 1934 FOR THE QUARTERLY PERIOD ENDED September 30, 2008 .
 
 
                          OR
 
[   ]    
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
 
ACT OF 1934 FOR THE TRANSITION PERIOD FROM  _______________   to  _______________
   
 
Commission File Number 0-26584
BANNER CORPORATION
(Exact name of registrant as specified in its charter)
     
 
Washington
(State or other jurisdiction of incorporation or organization)
 
91-1691604
(I.R.S. Employer Identification Number)
 
 
 
10 South First Avenue, Walla Walla, Washington 99362
(Address of principal executive offices and zip code)
 
Registrant's telephone number, including area code:  (509) 527-3636
     
 
 
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.                                  Yes     [X]               No     [   ]
 
 
 
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
  [X]
Non-accelerated filer
  [   ]
Smaller reporting company
  [   ]  
 
 
           
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes
 [   ] 
No
  [X]  
 
 
APPLICABLE ONLY TO CORPORATE ISSUERS
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 
Title of class:
Common Stock, $.01 par value per share
 
As of  October 31, 2008
17,016,402 shares*
 
 
*  Includes 240,381 shares held by the Employee Stock Ownership Plan that have not been released, committed to be released, or    allocated to participant accounts.
 

 
 

 

BANNER CORPORATION AND SUBSIDIARIES
Table of Contents

PART I - FINANCIAL INFORMATION
 
Item 1 - Financial Statements.  The Consolidated Financial Statements of Banner Corporation and Subsidiaries filed as a part of the report are as follows:
 
Consolidated Statements of Financial Condition as of September 30, 2008 and December 31, 2007
3
   
Consolidated Statements of Operations for the Quarters and Nine Months Ended September 30, 2008 and 2007
4
   
Consolidated Statements of Comprehensive Income (Loss) for the Quarters and Nine Months Ended September 30, 2008 and 2007
5
   
Consolidated Statements of Changes in Stockholders’ Equity for the Nine Months Ended September 30, 2008 and 2007
6
   
Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2008 and 2007
9
   
Selected Notes to Consolidated Financial Statements
11
   
Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations
 
   
Special Note Regarding Forward-Looking Statements
24
   
Executive Overview
24
   
Comparison of Financial Condition at September 30, 2008 and December 31, 2007
27
   
Comparison of Results of Operations for the Quarters and Nine Months Ended September 30, 2008 and 2007
29
   
Asset Quality
36
   
Liquidity and Capital Resources
38
   
Financial Instruments with Off-Balance-Sheet Risk
39
   
Capital Requirements
39
   
Item 3 - Quantitative and Qualitative Disclosures About Market Risk
 
   
Market Risk and Asset/Liability Management
41
   
Sensitivity Analysis
41
   
Item 4 - Controls and Procedures
45
   
PART II - OTHER INFORMATION
 
   
Item 1 - Legal Proceedings
46
   
Item 1A - Risk Factors
46
   
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds
49
   
Item 3 - Defaults upon Senior Securities
49
   
Item 4 - Submission of Matters to a Vote of Security Holders
49
   
Item 5 - Other Information
49
   
Item 6 - Exhibits
50
   
SIGNATURES
51
 

 
 

 

BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Unaudited) (In thousands, except shares)
September 30, 2008 and December 31, 2007

   
September 30 
   
December 31 
 
ASSETS
   
2008
   
2007
 
Cash and due from banks
 
$
80,911
 
$
98,430
 
               
Securities at fair value, cost $256,669 and $204,279, respectively
   
239,009
   
202,863
 
Securities held to maturity, fair value $55,669 and $55,010, respectively
   
55,389
   
53,516
 
               
Federal Home Loan Bank (FHLB) stock
   
37,371
   
37,371
 
Loans receivable:
             
Held for sale, fair value $6,171 and $4,680, respectively
   
6,085
   
4,596
 
Held for portfolio
   
3,993,094
   
3,805,021
 
Allowance for loan losses
   
(58,846
)
 
(45,827
)
     
3,940,333
   
3,763,790
 
               
Accrued interest receivable
   
22,799
   
24,980
 
Real estate owned, held for sale, net
   
10,147
   
1,867
 
Property and equipment, net
   
97,958
   
98,098
 
Goodwill and other intangibles, net
   
85,513
   
137,654
 
Deferred income tax asset, net
   
7,058
   
--
 
Income taxes receivable, net
   
1,243
   
1,610
 
Bank-owned life insurance (BOLI)
   
52,500
   
51,483
 
Other assets
   
20,028
   
20,996
 
   
$
4,650,259
 
$
4,492,658
 
LIABILITIES
             
Deposits:
             
Non-interest-bearing
 
$
521,927
 
$
484,251
 
Interest-bearing transactions and savings accounts
   
1,086,621
   
1,288,112
 
Interest-bearing certificates
   
2,182,318
   
1,848,230
 
     
3,790,866
   
3,620,593
 
               
Advances from FHLB at fair value
   
209,243
   
167,045
 
Other borrowings
   
104,496
   
91,724
 
Junior subordinated debentures at fair value (issued in connection with Trust Preferred Securities)
   
101,358
   
113,270
 
Accrued expenses and other liabilities
   
44,486
   
47,989
 
Deferred compensation
   
12,880
   
11,596
 
Deferred income tax liability, net
   
--
   
2,595
 
     
4,263,329
   
4,054,812
 
COMMITMENTS AND CONTINGENCIES
             
               
STOCKHOLDERS’ EQUITY
             
Preferred stock - $0.01 par value, 500,000 shares authorized, none issued
   
--
   
--
 
Common stock - $0.01 par value per share, 25,000,000 shares authorized, 16,980,468 shares issued:
16,740,087 shares and 16,025,768 shares outstanding at September 30, 2008 and December 31, 2007, respectively
   
306,741
   
300,486
 
Retained earnings
   
82,377
   
139,636
 
Accumulated other comprehensive income (loss):
             
Unrealized loss on securities available for sale transferred to held to maturity
   
(135
)
 
(176
)
Unearned shares of common stock issued to Employee Stock Ownership Plan (ESOP) trust at cost:
             
240,381 and 240,381 restricted shares outstanding at September 30, 2008 and December 31, 2007, respectively
   
(1,987
)
 
(1,987
)
               
Carrying value of shares held in trust for stock related compensation plans
   
(8,871
)
 
(7,960
)
Liability for common stock issued to deferred, stock related, compensation plans
   
8,805
   
7,847
 
     
(66
)
 
(113
)
     
386,930
   
437,846
 
   
$
4,650,259
 
$
4,492,658
 

See selected notes to consolidated financial statements
 
 
3

 
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited) (In thousands except for per share amounts)
For the Quarters and Nine Months Ended September 30, 2008 and 2007

   
Quarters Ended
   
Nine Months Ended
 
   
September 30
   
September 30
 
   
2008 
   
2007
   
2008 
   
2007
 
INTEREST INCOME:
                       
Loans receivable
$
64,181 
 
$
75,668 
 
$
196,348 
 
$
208,543 
 
Mortgage-backed securities
 
1,040 
   
1,343 
   
3,280 
   
4,653 
 
Securities and cash equivalents
 
2,786 
   
2,199 
   
8,374 
   
5,871 
 
   
68,007 
   
79,210 
   
208,002 
   
219,067 
 
INTEREST EXPENSE:
                       
Deposits
 
26,818 
   
35,341 
   
84,446 
   
95,329 
 
FHLB advances
 
1,160 
   
292 
   
4,310 
   
3,733 
 
Other borrowings
 
734 
   
730 
   
1,874 
   
2,448 
 
Junior subordinated debentures
 
1,669 
   
2,177 
   
5,399 
   
6,600 
 
   
30,381 
   
38,540
   
96,029 
   
108,110 
 
                         
Net interest income before provision for loan losses
 
37,626 
   
40,670 
   
111,973 
   
110,957 
 
                         
PROVISION FOR LOAN LOSSES
 
8,000 
   
1,500 
   
29,500 
   
3,900 
 
Net interest income
 
29,626 
   
39,170 
   
82,473 
   
107,057 
 
                         
OTHER OPERATING INCOME:
                       
Deposit fees and other service charges
 
5,770 
   
4,750 
   
16,277 
   
11,803 
 
Mortgage banking operations
 
1,500 
   
1,782 
   
4,694 
   
4,945 
 
Loan servicing fees
 
536 
   
457 
   
1,485 
   
1,205 
 
Miscellaneous
 
286 
   
483 
   
980 
   
1,536 
 
   
8,092 
   
7,472 
   
23,436 
   
19,489 
 
Net change in valuation of financial instruments carried at fair value
 
(6,056 
)
 
3,062 
   
(4,584 
)
 
2,365 
 
Total other operating income
 
2,036 
   
10,534 
   
18,852 
   
21,854 
 
                         
OTHER OPERATING EXPENSES:
                       
Salary and employee benefits
 
18,241 
   
20,431 
   
57,623 
   
56,534 
 
Less capitalized loan origination costs
 
(2,040 
)
 
(2,455 
)
 
(7,009 
)
 
(8,224 
)
Occupancy and equipment
 
5,956 
   
5,484 
   
17,813 
   
14,942 
 
Information/computer data services
 
1,560 
   
2,031 
   
5,389 
   
   5,167 
 
Payment and card processing expenses
 
1,913 
   
1,466 
   
5,212 
   
3,752  
 
Professional services
 
1,117 
   
993 
   
3,203 
   
2,275 
 
Advertising and marketing
 
1,572 
   
2,423 
   
4,667 
   
6,147 
 
State/municipal business and use taxes
 
572 
   
549 
   
1,712 
   
1,427 
 
Amortization of core deposit intangibles
 
691 
   
793 
   
2,152 
   
1,145 
 
Miscellaneous
 
4,418 
   
3,131 
   
12,168 
   
9,051 
 
   
34,000 
   
34,846 
   
102,930 
   
92,216 
 
Goodwill write-off
 
--  
   
-- 
   
50,000 
   
--  
 
Total other operating expenses
 
34,000 
   
34,846 
   
152,930 
   
92,216  
 
                         
Income (loss) before provision for (benefit from) income taxes
 
(2,338 
)
 
14,858
   
(51,605
)
 
36,695 
 
                         
PROVISION FOR (BENEFIT FROM) INCOME TAXES
 
(1,347 
)
 
4,871
   
(2,143
)
 
11,784 
 
                         
NET INCOME (LOSS)
$
(991 
)
$
9,987
 
$
(49,462
)
$
24,911 
 
                         
Earnings (loss) per common share (see Note 9):
                       
Basic
$
(0.06 
)
$
0.64
 
$
(3.09 
)
$
1.76 
 
Diluted
$
(0.06 
)
$
0.64
 
$
(3.09 
)
$
1.73 
 
Cumulative dividends declared per common share:
$
0.05 
 
$
0.19
 
$
0.45 
 
$
0.57 
 
                         

See selected notes to consolidated financial statements

 

 

BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited) (In thousands)
For the Quarters and Nine Months Ended September 30, 2008 and 2007


   
Quarters Ended
September 30
   
Nine Months Ended
September 30
 
         
   
2008 
   
2007 
   
2008 
   
2007 
 
NET INCOME (LOSS)
$
(991
)
$
9,987 
 
$
(49,462 
)
$
24,911 
 
                         
OTHER COMPREHENSIVE INCOME, NET OF INCOME TAXES:
                       
Amortization of unrealized loss on tax exempt securities transferred from available-for-sale to held-to-maturity
 
13
   
13 
   
41
   
40 
 
Other comprehensive income
 
13
   
13 
   
41
   
40 
 
                         
COMPREHENSIVE INCOME (LOSS)
$
(978
)
$
10,000 
 
$
(49,421 
)
$
24,951 
 
 

 
See selected notes to consolidated financial statements

 

 

BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(Unaudited) (In thousands, except per share amounts)
For the Nine Months Ended September 30, 2008 and 2007


 
Common Stock
 
Retained Earnings
 
Accumulated Other Comprehensive Income (Loss)
 
Unearned Restricted ESOP Shares
 
Carrying Value, Net of Liability, Of Shares Held in Trust for Stock-Related Compensation Plans
 
Stockholders’ Equity
 
BALANCE, January 1, 2008
$
300,486 
 
$
139,636 
 
$
(176
)
$
(1,987
)
$
(113
)
$
437,846 
 
                                     
Net income (loss)
       
(49,462 
)
                   
(49,462 
)
                                     
Cumulative effect of adoption of EITF 06-4 relating to liabilities under split dollar life insurance arrangements
       
(617 
)
                   
(617 
)
                                     
Amortization of unrealized loss on tax exempt securities transferred from available for sale to held to maturity
             
41
               
41 
 
                                     
Cash dividend on common stock ($.45/share cumulative)
       
(7,180 
)
                   
(7,180 
)
                                     
Purchase and retirement of common stock
 
(14,265 
)
                         
(14,265 
)
                                     
Proceeds from issuance of common stock for exercise of stock options
 
594
                           
594 
 
                                     
Proceeds from issuance of common stock for stockholder reinvestment program
 
19,303 
                           
19,303 
 
                                     
Net issuance of stock through employer’s stock plans, including tax benefit
 
404 
                           
404 
 
                                     
Amortization of compensation expense related to stock options
 
219 
                           
219 
 
                                     
Amortization of compensation expense related to MRP
                         
47
   
47 
 
 
BALANCE, September 30, 2008
$
306,741 
 
$
82,377 
 
$
(135
)
$
(1,987
)
$
(66
)
$
386,930 
 
                                     

See selected notes to consolidated financial statements

 

 

BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (Continued)
(Unaudited) (In thousands, except per share amounts)
For the Nine Months Ended September 30, 2008 and 2007


 
Common Stock
 
Retained Earnings
 
Accumulated Other Comprehensive Income (Loss)
 
Unearned Restricted ESOP Shares
 
Carrying Value, Net of Liability, Of Shares Held in Trust for Stock-Related Compensation Plans
 
Stockholders’ Equity
 
BALANCE, January 1, 2007
 (As previously reported)
$
135,149 
 
$
120,206 
 
$
(2,852 
)
$
(1,987 
)
$
(289 
)
$
250,227 
 
                                     
Cumulative ESOP tax expense
       
(2,452 
)
                   
(2,452 
)
                                     
Tax benefit from prior periods
 
2,832 
                           
2,832 
 
                                     
Balance, January 1, 2007 (Restated)
 
137,981 
   
117,754 
   
(2,852 
)
 
(1,987 
)
 
(289 
)
 
250,607 
 
                                     
Net income
       
24,911 
                     
24,911
 
                                     
Cumulative effect of early adoption of SFAS Nos. 157 & 159 Fair Value Option
       
(3,520 
)
 
2,623
               
(897
)
                                     
Amortization of unrealized loss on tax exempt securities transferred from available for sale to held to maturity
             
40
               
40
 
                                     
Cash dividend on common stock ($.57/share cumulative)
       
(8,319 
)
                   
(8,319
)
                                     
Purchase and retirement of common stock
 
(430
)
                         
(430
)
                                     
Proceeds from issuance of common stock for exercise of stock options
 
1,568
                           
1,568
 
                                     
Proceeds from issuance of common stock for stockholder reinvestment program
 
32,921
                           
32,921
 
                                     
Acquisitions:
Shares issued to the shareholders of F&M Bank (“F&M”)
 
77,993
                           
77,993
 
                                     
Shares issued to the shareholders of San Juan Financial Holding Company (“SJFHC”)
 
35,134
                           
35,134
 
                                     
Net issuance of stock through employer’s stock plans, including tax benefit
 
58
                           
58
 
                                     
Amortization of compensation expense related to stock options
 
243
                           
243
 
                                     
Amortization of compensation expense related to MRP
                         
135
   
135
 
 
BALANCE, September 30, 2007
$
285,468
 
$
130,826
 
$
(189
)
$
(1,987
)
$
(154
)
$
413,964
 

See selected notes to consolidated financial statements

 

 

BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (continued)
(Unaudited) (In thousands)
For the Nine Months Ended September 30, 2008 and 2007


               
Nine Months Ended
September 30
 
               
2008
   
2007 
 
                         
SHARES ISSUED AND OUTSTANDING:
                       
Common stock, shares issued, beginning of period
             
16,266
   
12,314
 
                         
Purchase and retirement of common stock
             
(614
)
 
(11
)
Issuance of common stock for bank acquisitions
             
--
   
2,593
 
Issuance of common stock for exercised stock options and/or employee stock plans
             
31
   
84
 
Issuance of common stock for stockholder reinvestment program
             
1,297
   
841
 
Number of shares (retired) issued during the period
             
714
   
3,507
 
                         
SHARES ISSUED AND OUTSTANDING, END OF PERIOD
             
16,980
   
15,821
 
                         
UNEARNED, RESTRICTED ESOP SHARES:
                       
Number of shares, beginning of period
             
(240
)
 
(240
)
Issuance/adjustment of earned shares
             
--
   
--
 
Number of shares, end of period
             
(240
)
 
(240
)
                         
NET SHARES OUTSTANDING
             
16,740
   
15,581
 

 
See selected notes to consolidated financial statements

 

 

BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited) (In thousands)
For the Nine Months Ended September 30, 2008 and 2007

               
Nine Months Ended
September 30
 
               
2008
   
2007
 
OPERATING ACTIVITIES:
                       
Net income (loss)
           
$
(49,462
)
$
24,911
 
Adjustments to reconcile net income to net cash provided by
operating activities:
                       
Depreciation
             
7,857
   
5,832
 
Deferred income and expense, net of amortization
             
1,421
   
(1,303
)
Net change in valuation of financial instruments carried at fair value
             
4,584
   
(2,365
)
Purchases of securities at fair value
             
(94,487
)
 
(4,141
)
Principal repayments and maturities of securities at fair value
             
34,814
   
28,451
 
Proceeds from sales of securities at fair value
             
7,223
   
76,462
 
Deferred taxes
             
(9,653
)
 
(1,765
)
Equity-based compensation
             
266
   
657
 
Tax benefits realized from equity-based compensation
             
(404
)
 
(58
)
Increase in cash surrender value of bank-owned life insurance
             
(1,017
)
 
(1,520
)
Gain on sale of loans, excluding capitalized servicing rights
             
(3,705
)
 
(4,328
)
Loss (gain) on disposal of real estate held for sale and property
and equipment
             
658
   
(168
 
)
Provision for losses on loans and real estate held for sale
             
29,868
   
3,900
 
Origination of loans held for sale
             
(285,590
)
 
(312,021
)
Proceeds from sales of loans held for sale
             
284,101
   
312,980
 
Goodwill impairment
             
50,000
   
--
 
Net change in:
                       
Other assets
             
4,797
   
1,718
 
Other liabilities
             
(108
)
 
1,691
 
Net cash (used) provided by operating activities
             
(18,837
)
 
128,933
 
                         
INVESTING ACTIVITIES:
                       
Purchases of securities held to maturity
             
(2,617
)
 
(5,957
)
Principal repayments and maturities of securities held to maturity
             
696
   
508
 
Origination of loans, net of principal repayments
             
(204,521
)
 
(139,742
)
Purchases of loans and participating interest in loans
             
(10,381
)
 
(2,379
)
Purchases of property and equipment, net
             
(7,835
)
 
(25,354
)
Proceeds from sale of real estate held for sale, net
             
5,442
   
1,029
 
Cost of acquisitions, net of cash acquired
             
(150
)
 
(6,839
)
Other
             
(812
)
 
(151
)
Net cash used by investing activities
             
(220,178
)
 
(178,885
)
                         
FINANCING ACTIVITIES:
                       
Increase in deposits
             
170,273
   
330,221
 
Proceeds from FHLB advances
             
162,800
   
--
 
Repayment of FHLB advances
             
(120,837
)
 
(188,417
)
Increase (decrease) in wholesale repurchase agreement borrowings, net
             
--
   
(17,939
)
Increase (decrease) in other borrowings, net
             
12,772
   
(26,359
)
Proceeds from issuance of junior subordinated debentures
             
--
   
25,774
 
Investment in trust securities related to junior subordinated debentures
             
--
   
(774
)
Repayment of trust securities
             
--
   
(25,774
)
Cash dividends paid
             
(9,548
)
 
(7,641
)
Repurchases of stock, net of forfeitures
             
(14,265
)
 
(430
)
Tax benefits realized from equity-based compensation
             
404
   
58
 
Cash proceeds from issuance of stock, net of registration costs
             
19,303
   
32,841
 
Exercise of stock options
             
594
   
1,568
 
Net cash provided by financing activities
             
221,496
   
123,128
 
                         
NET INCREASE  IN CASH AND DUE FROM BANKS
             
(17,519
)
 
73,176
 
                         
CASH AND DUE FROM BANKS, BEGINNING OF PERIOD
             
98,430
   
73,385
 
CASH AND DUE FROM BANKS, END OF PERIOD
           
$
80,911
 
$
146,561
 

(Continued on next page)
 
 
9

 
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(Unaudited) (In thousands)
For the Nine Months Ended September 30, 2008 and 2007


               
Nine Months Ended
September 30
 
               
2008
   
2007
 
                         
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
                       
Interest paid in cash
           
$
99,366
 
$
105,444
 
Taxes paid in cash
             
6,827
   
8,309
 
Non-cash investing and financing transactions:
                       
Loans, net of discounts, specific loss allowances and unearned income, transferred to real estate owned and other repossessed assets
             
14,619
   
3,306
 
Net change in accrued dividends payable
             
2,368
   
678
 
Change in other assets/liabilities
             
1,718
   
1,688
 
Cash paid out in acquisitions
             
--
   
(26,719
)
Fair value of assets acquired
             
--
   
690,660
 
Liabilities assumed in acquisition
             
--
   
550,733
 
Stock based consideration issued for acquisition
             
--
   
(113,207
)
Adoption of EITF 06-4
Accrual of liability for split-dollar life insurance
             
617
   
--
 
Adoption of SFAS Nos. 157 and 159:
                       
Securities available for sale
  transferred to fair value
             
--
   
226,153
 
FHLB advances adjustment to fair value
             
--
   
678
 
Junior subordinated debentures
  including unamortized origination costs adjustment to fair value
             
--
   
2,079
 
Deferred tax asset related to fair value adjustments
             
--
   
(504
)
 

 
See selected notes to consolidated financial statements
 
 
10

 
 
BANNER CORPORATION AND SUBSIDIARIES
SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1:  BASIS OF PRESENTATION AND CRITICAL ACCOUNTING POLICIES

Banner Corporation (Banner or the Company) is a bank holding company incorporated in the State of Washington.  We are primarily engaged in the business of planning, directing and coordinating the business activities of our wholly owned subsidiaries, Banner Bank and, subsequent to May 1, 2007, Islanders Bank, as explained below.  Banner Bank is a Washington-chartered commercial bank that conducts business from its main office in Walla Walla, Washington and, as of September 30, 2008, its 83 branch offices and 12 loan production offices located in Washington, Oregon and Idaho.  Islanders Bank is also a Washington-chartered commercial bank that conducts business from three locations in San Juan County, Washington.  Banner Corporation is subject to regulation by the Board of Governors of the Federal Reserve System.  Banner Bank and Islanders Bank (the Banks) are subject to regulation by the Washington State Department of Financial Institutions, Division of Banks and the Federal Deposit Insurance Corporation (FDIC).  The consolidated financial statements and results of operation presented in this report on Form 10-Q include financial information for Islanders Bank and our other acquisitions, F&M Bank, Spokane, Washington, and NCW Community Bank, Wenatchee, Washington, which were merged into Banner Bank in 2007.  (See Note 5 of the Selected Notes to Consolidated Financial Statements for additional information with respect to these acquisitions.)

In the opinion of management, the accompanying consolidated statements of financial condition and related interim consolidated statements of operations, comprehensive income (loss), changes in stockholders’ equity and cash flows reflect all adjustments (which include reclassifications and normal recurring adjustments) that are necessary for a fair presentation in conformity with generally accepted accounting principles (GAAP).  The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect amounts reported in the financial statements.  Various elements of our accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments.  In particular, management has identified several accounting policies that, because of the judgments, estimates and assumptions inherent in those policies, are critical to an understanding of our financial statements.  Those policies relate to (i) the methodology for the recognition of interest income, (ii) determination of the provision and allowance for loan and lease losses and (iii) the valuation of financial assets and liabilities recorded at fair value, goodwill, mortgage servicing rights and real estate held for sale.  These policies and the judgments, estimates and assumptions are described in greater detail below in Management’s Discussion and Analysis of Financial Condition and Results of Operations and in Note 1 of the Notes to the Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2007 filed with the Securities and Exchange Commission (SEC).  Management believes that the judgments, estimates and assumptions used in the preparation of our consolidated financial statements are appropriate based on the factual circumstances at the time.  As more fully explained in Note 8, for the quarter ended September 30, 2008, as a result of the unprecedented disruption of certain financial markets, management determined that there were insufficient transactions or other market indicators to support changes in the fair value of our junior subordinated debentures and similar securities in our investment portfolio from their carrying values as of June 30, 2008.  However, given the sensitivity of the financial statements to these critical accounting policies, the use of different judgments, estimates and assumptions could result in material differences in our results of operations or financial condition.  There have been no significant changes in our application of accounting policies since December 31, 2007, except for the adoption of Emerging Issues Task Force Issue 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements, and the adoption of this standard did not have a material effect on our financial condition or results of operations (for additional information, see Note 2 of the Selected Notes to Consolidated Financial Statements).

Certain information and disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to the rules and regulations of the SEC.  Certain reclassifications have been made to the 2007 Consolidated Financial Statements and/or schedules to conform to the 2008 presentation.  These reclassifications may have affected certain ratios for the prior periods. The effect of these reclassifications is considered immaterial.  All significant intercompany transactions and balances have been eliminated.

The information included in this Form 10-Q should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2007 filed with the SEC.  Interim results are not necessarily indicative of results for a full year.

Note 2:  RECENT DEVELOPMENTS AND SIGNIFICANT EVENTS

Participation in the U.S. Treasury’s Capital Purchase Program:  On November 4, 2008, we announced that we have received preliminary approval to participate in the U.S. Treasury Department’s Capital Purchase Program.  As a participant, we plan to issue $124 million in senior preferred stock, with related warrants to purchase up to $18.6 million in common stock, to the U.S. Treasury.  The anticipated sale of the preferred stock and warrants is expected to close in approximately 30 days from the announcement date and is contingent upon completion of standard closing documents and subsequent registration with the Securities and Exchange Commission.  The preferred stock will pay a 5% dividend for the first five years, after which the rate will increase to 9% if the preferred shares are not redeemed by the Company.  The terms and conditions of the transaction and the preferred stock will conform to those provided by the U.S. Treasury.  A summary of the Capital Purchase Program can be found on the Treasury’s web site at www.ustreas.gov/initiatives/eesa.  The additional capital will enhance our capacity to support the communities we serve through expanded lending activities and economic development.  This capital will also add flexibility in considering strategic opportunities that likely will be available to us as the financial services industry continues to consolidate.

Fannie Mae and Freddie Mac Stock Valuation:  In September 2008, the United States Treasury announced a plan to place the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”) into conservatorship under the authority of the Federal Housing Finance Agency.  As of June 30, 2008, Banner Corporation owned both common and preferred equity securities issued by Fannie Mae and Freddie Mac with a combined book value of $6.9 million.  At September 30, 2008, the fair value of these securities had declined to approximately $569,000, with the decrease in the value included in the net fair value adjustments detailed in Note 8,
 
 
 
11

 
 
Fair Value Accounting and Measurement.  The events that led to the significant valuation adjustment for the Fannie Mae and Freddie Mac stock were disappointing and, unlike most fair value adjustments, we do not anticipate a meaningful recovery with respect to the valuation of that stock.  However, our holdings were not disproportionate to our asset size and net worth and the subsequent charge was not threatening to our “well capitalized” status or indicative of our recurring operations.

Goodwill write-off:  As a result of the significant decline in our stock price and market capitalization during the second quarter in conjunction with similar declines in the value of most financial institutions and the ongoing disruption in related financial markets, we decided as of June 30, 2008 to reduce the carrying value of goodwill by $50 million in our Consolidated Statements of Financial Condition.  This write-down of goodwill was a non-cash charge that did not affect the Company’s or the Banks’ liquidity or operations.  The adjustment brought our book value and tangible book value more closely in line with each other and more accurately reflected current market conditions.  Also, since goodwill is excluded from regulatory capital, the impairment charge (which was not deductible for tax purposes) did not have an adverse effect on the regulatory capital ratios of the Company or either of our subsidiary banks, each of which continues to remain “well capitalized” under the regulatory requirements.  (See Note 6 of the Selected Notes to Consolidated Financial Statements for additional information with respect to our valuation of intangible assets.)

Stock Repurchase and Option Exercise Activity:  On July 26, 2007, our Board of Directors authorized the purchase of up to 750,000 shares of our outstanding common stock over the next twelve months.  As of September 30, 2008, we had repurchased 663,600 shares of stock under this program.  During the nine months ended September 30, 2008, we repurchased 605,800 shares of our common stock under this program in a series of open market transactions at an average price of $23.20 per share.  The program was not renewed when it expired on July 26, 2008.

In addition to shares repurchased under this program, during the nine months ended September 30, 2008, we purchased 8,103 shares as consideration for the exercise of certain vested stock options at current market prices on the date of exercise.  In total, we issued 30,611 shares of common stock on exercise of vested options during the nine months ended September 30, 2008.

Issuance of Shares through Dividend Reinvestment and Direct Stock Purchase and Sale Plan:  During the year ended December 31, 2007, we issued 995,590 new shares of common stock at an average net price of $37.75 through our Dividend Reinvestment and Direct Stock Purchase and Sale Plan (DRIP).  On October 23, 2007, our Board of Directors authorized the registration and issuance of an additional 1,000,000 shares of common stock and, on July 22, 2008, our Board of Directors authorized the registration and issuance of an additional 3,000,000 shares of common stock through continuation of our DRIP.  During the nine months ended September 30, 2008, we issued 1,297,611 shares at an average price, net of issuance costs, of $14.88 per share through our DRIP.

Acquisitions of F&M Bank, San Juan Financial Holding Company and NCW Community Bank:  We completed the acquisitions of F&M Bank (F&M) and San Juan Financial Holding Company (SJFHC) effective May 1, 2007, and NCW Community Bank (NCW) effective October 10, 2007.  SJFHC was merged into Banner Corporation and its wholly owned subsidiary, Islanders Bank, has continued operations as a subsidiary of Banner Corporation.  F&M and NCW were merged into Banner Bank upon acquisition and now operate under the Banner Bank name.  The financial results for the quarter and year to date ended September 30, 2008 include the assets, liabilities and results of operations for all three of the acquired companies.  The financial results for the quarter and year to date ended September 30, 2007 include the assets and liabilities acquired in the F&M and SJFHC transactions as well as the impact of those two acquisitions subsequent to May 1, 2007 as reported in the results of operations. (See Note 5 of Selected Notes to Consolidated Financial Statements for additional information with respect to these acquisitions.)

Branch Expansion:  Over the past several years, we have invested significantly in expanding Banner Bank’s branch and distribution systems with a primary emphasis on the greater Boise, Idaho and Portland, Oregon markets and the Puget Sound region of Washington.  This branch expansion is a significant element in our strategy to grow loans, deposits and customer relationships.  This emphasis on growth has resulted in an elevated level of operating expenses; however, we believe that over time these new branches should help improve profitability by providing lower cost core deposits which will allow Banner Bank to proportionately reduce higher cost borrowings as a source of funds.  From March 2004 through September 2008, Banner Bank opened 28 new branch offices, relocated eight additional branch offices and significantly refurbished its main office in Walla Walla.  Branch expansion activity included ten new offices opened at various times during 2007 and two additional offices opened during the nine months ended September 30, 2008.  We plan a more moderate pace of expansion going forward and we do not plan to open any additional branches during the remainder of 2008.

Recently Adopted Accounting Standards: In September 2006, the Emerging Issues Task Force (EITF) issued EITF 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements.  EITF 06-4 implemented a change in accounting principle that required the recognition of a liability and related compensation costs for endorsement split-dollar life insurance policies that provide a benefit to an employee that extends to post-retirement periods.  On January 1, 2008, the Company adopted EITF 06-4 and recognized the effects of this change in accounting principle through a $617,000 cumulative effect adjustment charge to opening retained earnings and an increase in benefit plan reserve liability of the same amount.  The Company will record an annual charge in 2008 of approximately $64,000 from the adoption of EITF 06-4, including $48,000 expensed in the nine months ended September 30, 2008

Banner Corporation elected early adoption of Statement of Financial Accounting Standards (SFAS) No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, and SFAS No. 157, Fair Value Measurements, effective January 1, 2007.  SFAS No. 159, which was issued in February 2007, generally permits the measurement of selected eligible financial instruments at fair value at specified election dates.  SFAS No. 157 defines fair value, establishes a framework for measuring fair value under GAAP, and expands disclosures about fair value measurement.  We made this election to allow more flexibility with respect to the management of our investment securities, wholesale borrowings and interest rate risk position in future periods.
 
 
 
12


 
Upon adoption of SFAS No. 159, we selected fair value measurement for all of our “available for sale” investment securities, FHLB advances and junior subordinated debentures, which had fair values of approximately $226.2 million, $176.8 million and $124.4 million, respectively, on January 1, 2007.  The initial fair value measurement of these instruments resulted in a $3.5 million adjustment for the cumulative effect, net of tax, as a result of the change in accounting, which was recorded as a reduction in retained earnings as of January 1, 2007, and which under SFAS No. 159 has not been recognized in earnings.  While the adjustment to retained earnings is permanent, approximately $2.6 million of the amount was previously reported as accumulated other comprehensive loss at December 31, 2006, so the reduction in total stockholders’ equity was $897,000 on January 1, 2007.  Following the initial election, changes in the value of financial instruments recorded at fair value are recognized as gains or losses in earnings in subsequent financial reporting periods.  As a result of the adoption of SFAS No. 159 and changes in the fair value measurement of financial assets and liabilities, the Company recorded a net loss of $6.1 million ($3.9 million after tax) and a net gain of $3.1 million ($2.0 million after tax), respectively, for the quarters ended September 30, 2008 and 2007.  Likewise, for the nine month periods ended September 30, 2008 and 2007, the Company recorded a net loss of $4.6 million ($2.9 million after tax) and a net gain of $2.4 million ($1.5 million after tax), respectively.  (For further information, see Note 8 of the Selected Notes to Consolidated Financial Statements.)

In June 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, Accounting for Uncertainties in Income Taxes, an Interpretation of FASB Statement No. 109 (FIN 48).  On January 1, 2007, the Company adopted FIN 48.  FIN 48 prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.  Currently, the Company is subject to United States federal income tax and income tax of the States of Idaho and Oregon.  The years 2004 through 2006 remain open to examination for federal and state income taxes.  As of September 30, 2008 and December 31, 2007, the Company believes it had insignificant unrecognized tax benefits or uncertain tax positions.  In addition, the Company had no material accrued interest or penalties as of either date.  It is our policy to record interest and penalties as a component of income tax expense.  The amount of interest and penalties for the year ended December 31, 2007 was also immaterial.  The adoption of this accounting standard has not had a material impact on the Company’s Consolidated Financial Statements.

Note 3:  RESTATEMENT UNDER SECURITIES AND EXCHANGE COMMISSION STAFF ACCOUNTING BULLETIN (SAB) 108

In connection with reviewing our previous accounting for the tax (benefits) provisions related to stock-based compensation for our ESOP share releases, exercises of non-qualified stock options and distributions of stock from deferred compensation plans, we determined there were net immaterial errors in the reporting in prior period financial statements.  These errors resulted in the understatement of our previously reported income tax provisions as a result of the difference between the tax and book accounting basis for ESOP share releases to individual participants, as well as benefits to stockholders’ equity from the release of our shares of common stock in connection with the exercise of stock options and deferred compensation distributions.  We concluded that while the amounts related to individual years were immaterial, in the aggregate they resulted in cumulative adjustments that Banner’s Board of Directors and management felt required the restatement of previously reported financial statements.  The effects of these adjustments were reductions of $380,000 in income taxes payable and $2.4 million in retained earnings and increases of $2.8 million and $380,000, respectively, in common stock (paid-in capital) and total stockholders’ equity as of December 31, 2006.  These adjustments are reflected in the September 30, 2007 Consolidated Statement of Financial Condition and Consolidated Statement of Changes in Stockholder’s Equity that are shown for comparative purposes in these financial statements.  The restatement has had no impact on management’s previous conclusions regarding the effectiveness of internal controls over financial reporting and disclosure controls and procedures for the years ended December 31, 2006 and 2005, nor on our conclusions for the year ended December 31, 2007.  These adjustments have immaterially affected certain previously reported ratios for the quarter ended September 30, 2007.

The following tables summarize the impact of the restatement discussed above on the Consolidated Financial Statements as of September 30, 2007 previously filed with SEC on Form 10-Q on November 9, 2007 (in thousands):
     
 
As Previously Reported
 
Adjustment
 
Restated 
 
Consolidated Statement of Financial Condition as of
December 31, 2007
                 
                   
Income taxes payable
$
2,504
 
$
(380
)
$
2,124
 
                   
Common stock
 
135,149
   
2,832
   
137,981
 
Retained earnings
 
120,206
   
(2,452
)
 
117,754
 
Total stockholders’ equity
 
250,227
   
380
   
250,607
 
                   
Consolidated Statements of Changes in Stockholders’ Equity
as of September 30, 2007 (Beginning Balance)
                 
                   
Common stock
 
135,149
   
2,832
   
137,981
 
Retained earnings
 
120,206
   
(2,452
)
 
117,754
 
Total stockholders’ equity
 
250,227
   
380
   
250,607
 
                   

 
 

 
13



Note 4:  BUSINESS SEGMENTS

The Company is managed by legal entity and not by lines of business.  Each of the Banks is a community oriented commercial bank chartered in the State of Washington.  The Banks’ primary business is that of a traditional banking institution, gathering deposits and originating loans for its portfolio in its respective primary market areas.  The Banks offer a wide variety of deposit products to its consumer and commercial customers.  Lending activities include the origination of real estate, commercial/agriculture business and consumer loans.  Banner Bank is also an active participant in the secondary market, originating residential loans for sale on both a servicing released and servicing retained basis.  In addition to interest income on loans and investment securities, the Banks receive other income from deposit service charges, loan servicing fees and from the sale of loans and investments.  The performance of the Banks is reviewed by the Company’s executive management and Board of Directors on a monthly basis.  All of the executive officers of the Company are members of Banner Bank’s management team.

Generally accepted accounting principles establish standards to report information about operating segments in annual financial statements and require reporting of selected information about operating segments in interim reports to stockholders.  The Company has determined that its current business and operations consist of a single business segment.

Note 5:  ACQUISITIONS OF F&M BANK, SAN JUAN FINANCIAL HOLDING COMPANY AND NCW COMMUNITY BANK

On May 1, 2007, we completed the acquisition of F&M Bank, Spokane, Washington (F&M), in a stock and cash transaction valued at approximately $98.2 million, with $19.4 million of cash and 1,773,402 shares of Banner common stock, for 100% of the outstanding common shares of F&M.  F&M was merged into Banner Bank and the results of its operations are included in those of Banner Bank starting in the quarter ended June 30, 2007.  The purchase of F&M allowed us to immediately expand Banner Bank’s franchise in the Spokane, Washington area, the fourth largest metropolitan market in the Pacific Northwest, by the addition of 13 branches and one loan office.

On May 1, 2007, we completed the acquisition of San Juan Financial Holding Company (SJFHC), the parent company of Islanders Bank, Friday Harbor, Washington, in a stock and cash transaction valued at approximately $41.7 million, with $6.2 million of cash and 819,209 shares of Banner common stock, for 100% of the outstanding common shares of SJFHC.  SJFHC was merged into Banner Corporation and Islanders Bank has continued to operate as a separate subsidiary of Banner.  The results of its operations are included in the Company’s consolidated operations beginning in the quarter ended June 30, 2007.  The acquisition of Islanders Bank, with its three branches located in the San Juan Islands, added to Banner Corporation’s presence in the North Puget Sound region.

On October 10, 2007, we completed the acquisition of NCW Community Bank, Wenatchee, Washington (NCW), in a stock and cash transaction valued at approximately $18.5 million, with $6.5 million of cash and 339,860 shares of Banner common stock, for 100% of the outstanding common shares of NCW.  NCW was merged into Banner Bank and the results of its operations are included in Banner Bank’s consolidated operations beginning in the fourth quarter of 2007.  The acquisition of NCW added two branches to our network and significantly enhanced our presence and market share within a desirable central Washington community.
 
 
 
 
 
 
 
 
 
 

 

 
14 

 

The acquisitions were accounted for as purchases in accordance with SFAS No. 141.  Accordingly, the purchase price was allocated to the assets acquired and the liabilities assumed based on their estimated fair values at the acquisition date as summarized in the following table:

 
F&M
May 1, 2007
(in thousands)
 
SJFHC
May 1, 2007
(in thousands)
 
NCW
October 10, 2007
(in thousands)
 
Total
(in thousands)
 
Date of acquisition
   
 
New shares issued in acquisition
1,773,402
 
819,209
 
339,860
 
2,932,471
 
                 
Cash paid to shareholders
$
19,404
 
$
6,159
 
$
6,505
 
$
32,068
 
Total value of Banner’s common stock exchanged with acquiree’s shareholders
 
78,030
   
35,177
   
11,813
   
125,020
 
Transaction closing costs
 
756
   
318
   
168
   
1,242
 
Total purchase price
$
98,190
   
41,654
   
18,486
   
158,330
 
                         
Allocation of purchase price
                       
Acquisitions’ equity
$
32,987
 
$
16,782
 
$
9,601
 
$
59,370
 
Adjustments to record assets and liabilities at estimated fair value
                       
Loans
 
(195
)
 
(604
)
 
(90
)
 
(889
)
Premises and equipment
 
3,315
   
1,800
 
--
--
   
5,115
 
Core deposit intangible (CDI)
 
10,867
   
6,147
   
1,245
   
18,259
 
Deposits
 
(336
)
 
37
   
(197
)
 
(496
)
Deferred taxes, net
 
(4,916
)
 
(2,659
)
 
(345
)
 
(7,920
)
Estimated fair value of net assets acquired
 
41,722
   
21,503
   
10,214
   
73,439
 
                         
Goodwill resulting from acquisition
$
56,468
 
$
20,151
 
$
8,272
 
$
84,891
 
                         
The fair value of assets and liabilities of acquired institutions at the date of acquisition follows:
 
 
F&M
May 1, 2007
(in thousands)
 
SJFHC
May 1, 2007
(in thousands)
 
NCW
October 10, 2007
(in thousands)
 
Total
(in thousands)
 
Date of acquisition
   
 
                 
Cash
$
12,056
 
$
7,449
 
$
2,916
 
$
22,421
 
Securities –available for sale
 
6,768
 
26
26,263
   
1,200
   
34,231
 
Federal funds sold and interest bearing deposits at banks
 
137
   
--
   
--
   
137
 
Loans-net of allowance for loan losses of $4,528, $1,429 and $1,319, respectively
 
389,290
   
116,999
   
90,522
   
596,811
 
Premises and equipment, net
 
11,872
   
5,756
   
3,012
   
20,640
 
BOLI
 
8,662
   
2,315
   
--
   
10,977
 
Other assets
 
7,528
   
2,082
   
1,597
   
11,207
 
Goodwill
 
56,468
   
20,151
   
8,272
   
84,891
 
Core deposit intangible (CDI)
 
10,867
   
6,298
   
1,245
   
18,410
 
Total assets
 
503,648
   
187,313
   
108,764
   
799,725
 
                         
Deposits
 
(348,822
)
 
(124,264
)
 
(86,756
)
 
(559,842
)
Advances from Federal Home Loan Bank
 
(20,000
)
 
(15,726
)
 
--
   
(35,726
)
Federal funds purchased and other borrowings
 
(19,625
)
 
--
   
(1,590
)
 
(21,215
)
Other liabilities
 
(17,011
)
 
(5,669
)
 
(1,932
)
 
(24,612
)
Total liabilities
 
(405,458
)
 
(145,659
)
 
(90,278
)
 
(641,395
)
                         
Net assets acquired
$
98,190
 
$
41,654
 
$
18,486
 
$
158,330
 

Additional adjustments to the purchase price allocation may be required, specifically related to other assets and taxes.  During the nine months ended September 30, 2008, we have incurred a net $12,000 of post-closing adjustments to professional fees and severance pay related to the 2007 acquisitions.  The CDI asset shown in the table above represents the value ascribed to the long-term deposit relationships acquired.  This intangible asset is being amortized using an accelerated method over an estimated useful life of eight years.  The core deposit intangible asset is not estimated to have a significant residual value.  Goodwill represents the excess of the total purchase price paid for the Banks over the fair values of the assets acquired, net of the fair values of the liabilities assumed.  Goodwill is not amortized, but is evaluated for possible impairment at least annually and more frequently if events and circumstances indicate that the asset might be impaired.  During the quarter ended June 30, 2008, we recorded a goodwill impairment charge of $50 million.  (See Note 6 of the Selected Notes to Consolidated Financial Statements.)  No impairment losses have been recognized in connection with core deposit intangibles during the period from acquisition to the end of the current reporting period.


 
15 

 

Note 6:  GOODWILL AND OTHER INTANGIBLES

The majority of goodwill and intangibles generally arise from business combinations accounted for under the purchase method.  Goodwill and other intangibles deemed to have indefinite lives generated from purchase business combinations are not subject to amortization and are instead tested for impairment no less than annually.  The goodwill recorded has been assigned to our one reporting segment, banking.

As a result of the Company’s market capitalization being less than our total shareholders’ equity at March 31, 2008 and this trend continuing during the second quarter of 2008, we engaged an independent valuation consultant to assist us in determining whether and to what extent our goodwill asset was impaired.  The GAAP standards with respect to goodwill require that we compare the implied fair value of goodwill to the carrying amount of goodwill on the Company’s balance sheet.  If the carrying amount of the goodwill is greater than the implied fair value of that goodwill, an impairment loss must be recognized in an amount equal to that excess.  The implied fair value of goodwill is determined in the same manner as goodwill recognized in a business combination is determined.  The estimated fair value of the Company is allocated to all of the Company’s individual assets and liabilities, including any unrecognized identifiable intangible assets, as if the Company had been acquired in a business combination and the estimated fair value of the Company is the price paid to acquire it.  The allocation process is performed only for purposes of determining the amount of goodwill impairment, as no assets or liabilities are written up or down, nor are any additional unrecognized identifiable intangible assets recorded as a part of this process.  After we completed this analysis, we determined the implied fair value of goodwill was less than the carrying value on the Company’s balance sheet, and we reduced the carrying value of goodwill by $50.0 million through a charge to earnings.  This impairment charge had no effect on the Company’s or the Banks’ cash balances or liquidity.  In addition, because goodwill and core deposit intangibles, net of related deferred income taxes, are not included in the calculation of regulatory capital, the Company’s and the Banks’ well-capitalized regulatory ratios were not affected by this non-cash expense.  No additional charge was recorded in the current quarter; however, no assurance can be given that our goodwill will not be written down further in future periods.

The following table presents the changes in goodwill for the nine months ended September 30, 2008 (in thousands):

 
Nine Months Ended
September 30, 2008 
 
     
Balance, beginning of period
$
121,109
 
Adjustments related to 2007 acquisitions
 
12
 
Goodwill write-off
 
(50,000 
)
       
Balance, end of period
$
71,121 
 

Intangible assets, such as core deposit intangibles and domain names with definite lives are amortized over their respective estimated useful lives to their estimated residual values and reviewed for impairment annually.  The estimated aggregate amortization expense related to these intangible assets is expected to be $2.8 million in 2008.  The estimated aggregate amortization expense related to these intangible assets for each of the subsequent four years is $2.6 million, $2.5 million, $2.3 million, and $2.1 million, respectively.

The following table presents the changes in the gross amounts of core deposit and domain name intangibles and the related accumulated amortization for the nine months ended September 30, 2008 and 2007 (in thousands):

   
Nine Months Ended
September 30
 
     
   
2008 
   
2007 
 
             
Gross amount:
           
Balance, beginning of period
$
18,435 
 
$
25
 
Additions
 
-- 
   
17,165 
   
Balance, end of period
$
18,435 
 
$
17,190 
 
             
Accumulated amortization:
           
Balance, beginning of period
$
(1,889 
)
$
(7 
)
Amortization
 
(2,154 
)
 
(1,145 
)
Balance, end of period
 
(4,043 
)
 
(1,152 
)
             
Net balance, end of period
$
14,392 
 
$
16,038 
 



 
16 

 

 
Note 7:  ADDITIONAL INFORMATION REGARDING INTEREST-BEARING DEPOSITS AND SECURITIES

The following table sets forth additional detail on our interest-bearing deposits and securities at the dates indicated (at carrying value) (in thousands):

 
September 30
 
December 31
 
September 30
 
 
2008
 
2007
 
2007
 
             
Interest-bearing deposits included in Cash and due from banks
$
403
 
$
310
 
$
62,628
 
                   
Mortgage-backed securities
 
91,580
   
99,775
   
98,064
 
Other securities—taxable
 
145,850
   
98,067
   
62,481
 
Other securities—tax exempt
 
56,390
   
50,812
   
49,195
 
Equity securities with dividends
 
578
   
7,725
   
2,451
 
Total securities
 
294,398
   
256,379
   
212,191
 
                   
FHLB stock
 
37,371
   
37,371
   
37,291
 
                   
 
$
332,172
 
$
294,060
 
$
312,110
 


The following table provides additional detail on income from deposits and securities for the periods indicated (in thousands):

 
Quarters Ended
September 30
 
Nine Months Ended
September 30
 
     
   
2008
   
2007
   
2008
   
2007
 
Mortgage-backed securities interest
$
1,040
 
$
1,343
 
$
3,280
 
$
4,653
 
                         
Taxable interest income
 
1,899
   
1,568
   
5,765
   
4,114
 
Tax-exempt interest income
 
635
   
548
   
1,851
   
1,516
 
Other stock—dividend income
 
121
   
27
   
403
   
94
 
FHLB stock dividends
 
131
   
56
   
355
   
147
 
   
2,786
   
2,199
   
8,374
   
5,871
 
                         
 
$
3,826
 
$
3,542
 
$
11,654
 
$
10,524
 
 
 
 
 
 
 

 

 
17 

 

Note 8:  FAIR VALUE ACCOUNTING AND MEASURMENT

The Company elected early adoption of SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, and SFAS No. 157, Fair Value Measurements, effective January 1, 2007.  SFAS No. 159, which was issued in February 2007, generally permits the measurement of selected eligible financial instruments at fair value (FV) at specified election dates.  Upon adoption of SFAS No. 159, the Company selected fair value measurement for all of our “available for sale” investment securities, FHLB advances and junior subordinated debentures, which had fair values of approximately $226.2 million, $176.8 million and $124.4 million, respectively, on January 1, 2007.  The initial fair value measurement of these instruments resulted in a $3.5 million adjustment for the cumulative effect, net of tax, as a result of the change in accounting, which was recorded as a reduction in retained earnings as of January 1, 2007, and which under SFAS No. 159 has not been recognized in current earnings.  While the adjustment to retained earnings is permanent, approximately $2.6 million of the amount was previously reported as accumulated other comprehensive loss at December 31, 2006, so the reduction in the January 1, 2007 opening stockholders’ equity was $897,000 when SFAS No. 159 was adopted.

The following tables detail the financial instruments measured at fair value, on a recurring basis, on the dates indicated (in thousands):

   
Cumulative Adjustment on Adoption of SFAS 159
   
   
January 1, 2007
 
September 30, 2007
 
     
Amortized Cost
   
Fair Market Valuation Adjustment
   
Fair Value
   
Related Taxes
   
Cumulative Effect of Adoption
   
Amortized Cost
   
Fair Market Valuation Adjustment
   
Fair Value
 
Assets:
                                                 
Securities available for sale reclassified to fair value
 
$
230,189
 
$
(4,036
)