Form 10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

[ x ] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the fiscal year ended: December 31, 2007

[    ] 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: 000-25597

UMPQUA HOLDINGS CORPORATION

(Exact name of Registrant as specified in its charter)

 

OREGON   93-1261319
(State or Other Jurisdiction
of Incorporation or Organization)
  (I.R.S. Employer Identification Number)

ONE SW COLUMBIA STREET, SUITE 1200, PORTLAND, OREGON 97258

(Address of principal executive offices) (zip code)

(503) 727-4100

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

NONE

 

Securities registered pursuant to Section 12(g) of the Act:                         Common Stock

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes  [ x ]    No  [    ]

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes [    ]    No  [ x ]

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [    ]

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

Large Accelerated filer  [ x ]    Accelerated filer [    ]    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 Act). Yes  [    ]    No  [ x ]

The aggregate market value of the voting common stock held by non-affiliates of the registrant as of June 30, 2007, based on the closing price on that date of $23.51 per share, and 61,315,960 shares outstanding was $1,200,540,924. Shares of common stock held by each executive officer and director and by each person who owns 5% or more of the outstanding common stock have been excluded because those persons may be deemed affiliates.

Indicate the number of shares outstanding for each of the issuer’s classes of common stock, as of the latest practical date:

The number of shares of the Registrant’s common stock (no par value) outstanding as of January 31, 2008 was 60,011,464.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for the 2008 Annual Meeting of Shareholders of Umpqua Holdings Corporation are incorporated by reference in this Form 10-K in response to Part III, Items 10, 11, 12, 13 and 14.


Umpqua Holdings Corporation

FORM 10-K CROSS REFERENCE INDEX

 

Part I

     2

Item 1.

   Business   2

Item 1A.

   Risk Factors   13

Item 1B.

   Unresolved Staff Comments   15

Item 2.

   Properties   15

Item 3.

   Legal Proceedings   16

Item 4.

   Submission of Matters to a Vote of Securities Holders   16

Part II

     17

Item 5.

   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities   17

Item 6.

   Selected Financial Data   21

Item 7.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations   22

Item 7A.

   Quantitative and Qualitative Disclosures About Market Risk   44

Item 8.

   Financial Statements and Supplementary Data   48

Item 9.

   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure   95

Item 9A.

   Controls and Procedures   96

Item 9B.

   Other Information   96

Part III

     97

Item 10.

   Directors, Executive Officers and Corporate Governance   97

Item 11.

   Executive Compensation   97

Item 12.

   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters   97

Item 13.

   Certain Relationships and Related Transactions and Director Independence   97

Item 14.

   Principal Accountant Fees and Services   97

Part IV

     98

Item 15.

   Exhibits and Financial Statement Schedules   98

Signatures

  99

Exhibit Index

  101

 

1


PART I

ITEM 1.    BUSINESS.

This Annual Report on Form 10-K contains forward-looking statements, which statements are intended to be covered by the safe harbor for “forward-looking statements” provided by the Private Securities Litigation Reform Act of 1995. These statements may include statements that expressly or implicitly predict future results, performance or events. All statements other than statements of historical fact are forward-looking statements. You can find many of these statements by looking for words such as “anticipates,” “expects,” believes,” “estimates” and “intends” and words or phrases of similar meaning. We make forward-looking statements regarding projected sources of funds, adequacy of our allowance for loan and lease losses and provision for loan and lease losses, and subsequent charge-offs. Forward-looking statements involve substantial risks and uncertainties, many of which are difficult to predict and are generally beyond the control of Umpqua. Risks and uncertainties include the following:

 

   

The ability to attract new deposits and loans and leases

 

   

Competitive market pricing factors

 

   

Deterioration in economic conditions that could result in increased loan and lease losses

 

   

Market interest rate volatility

 

   

Changes in legal or regulatory requirements

 

   

The ability to recruit and retain key management and staff

 

   

Risks associated with merger integration

 

   

Significant decline in the market value of the Company that could result in an impairment of goodwill

There are many factors that could cause actual results to differ materially from those contemplated by these forward-looking statements. For a more detailed discussion of some of the risk factors, see the section entitled “Risk Factors” below. We do not intend to update these forward-looking statements. You should consider any forward looking statements in light of this explanation, and we caution you about relying on forward-looking statements.

Introduction

Umpqua Holdings Corporation (referred to in this report as “we,” “our,” “Umpqua,” and “the Company”), an Oregon corporation, was formed as a bank holding company in March 1999. At that time, we acquired 100% of the outstanding shares of South Umpqua Bank, an Oregon state-chartered bank formed in 1953. We became a financial holding company in March 2000 under the provisions of the Gramm-Leach-Bliley Act. Umpqua has two principal operating subsidiaries, Umpqua Bank (the “Bank”) and Strand, Atkinson, Williams and York, Inc. (“Strand”).

We file annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and other information with the Securities and Exchange Commission (“SEC”). You may obtain these reports, and any amendments, from the SEC’s website at www.sec.gov. You may obtain copies of these reports, and any amendments, through our website at www.umpquaholdingscorp.com. These reports are available through our website as soon as reasonably practicable after they are filed electronically with the SEC. All of our SEC filings since November 14, 2002 are made available on our website within two days of filing with the SEC.

General Background

Prior to 2004, the Company’s footprint included the Portland metropolitan and Willamette Valley areas of Oregon along the I-5 corridor, southern Oregon, and the Oregon coast. During the third quarter of 2004, we completed the acquisition of Humboldt Bancorp, which at the time of acquisition had total assets of approximately $1.5 billion and 27 branches located throughout Northern California. On June 2, 2006, we completed the acquisition of Western Sierra Bancorp and its principal operating subsidiaries, Western Sierra Bank, Central California Bank, Lake Community Bank and Auburn Community Bank. At the time of the acquisition, Western Sierra Bancorp had total assets of approximately $1.5 billion and 31 branches located throughout Northern California. On April 26, 2007, we completed the acquisition of North Bay Bancorp and its principal operating subsidiary, The Vintage Bank, along with its Solano Bank division. At the time of the acquisition, North Bay Bancorp had total assets of approximately $727.6 million and 10 Northern California branches located in the Napa area and in the communities of St. Helena, American Canyon, Vacaville, Benecia, Vallejo and Fairfield.

 

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Umpqua Holdings Corporation

 

Our headquarters is located in Portland, Oregon, and we engage primarily in the business of commercial and retail banking and the delivery of retail brokerage services. The Bank provides a wide range of banking, mortgage banking and other financial services to corporate, institutional and individual customers. Along with our subsidiaries, we are subject to the regulations of state and federal agencies and undergo periodic examinations by these regulatory agencies. See “Supervision and Regulation” below for additional information.

We are considered one of the most innovative community banks in the United States, combining a retail product delivery approach with an emphasis on quality-assured personal service. The Bank has evolved from a traditional community bank into a community-oriented financial services retailer by implementing a variety of retail marketing strategies to increase revenue and differentiate ourselves from our competition.

Strand is a registered broker-dealer and investment advisor with offices in Portland, Eugene, and Medford, Oregon, and in many of Umpqua Bank stores. The firm is one of the oldest investment companies in the Northwest and is active in many community events. Strand offers a full range of investment products and services including: stocks, fixed income securities (municipal, corporate, and government bonds, CDs, and money market instruments), mutual funds, annuities, options, retirement planning, money management services, life insurance, disability insurance and medical supplement policies.

Business Strategy

Our principal objective is to become the leading community-oriented financial services retailer throughout the Pacific Northwest and Northern California. We plan to continue the expansion of our market from Seattle to Sacramento, primarily along the I-5 corridor. We intend to continue to grow our assets and increase profitability and shareholder value by differentiating ourselves from competitors through the following strategies:

Capitalize On Innovative Product Delivery System.    Our philosophy has been to develop an environment for the customer that makes the banking experience enjoyable. With this approach in mind, we have developed a unique store concept that offers “one-stop” shopping and that includes distinct physical areas or boutiques, such as a “serious about service center,” an “investment opportunity center” and a “computer café,” which make the Bank’s products and services more tangible and accessible. In 2006, we introduced our “Neighborhood Stores” and in 2007, we introduced the Umpqua “Innovation Lab”. We expect to continue remodeling existing and acquired stores in metropolitan locations to further our retail vision.

Deliver Superior Quality Service.    We insist on quality service as an integral part of our culture, from the Board of Directors to our new sales associates, and believe we are among the first banks to introduce a measurable quality service program. Under our “return on quality” program, each sales associate’s and store’s performance is evaluated monthly based on specific measurable factors such as the “sales effectiveness ratio” that totals the average number of banking products purchased by each new customer. The evaluations also encompass factors such as the number of new loan and deposit accounts generated in each store, reports by incognito “mystery shoppers” and customer surveys. Based on scores achieved, the “return on quality” program rewards both individual sales associates and store teams with financial incentives.

Through such programs, we believe we can measure the quality of service provided to our customers and maintain employee focus on quality customer service.

Establish Strong Brand Awareness.    As a financial services retailer, we devote considerable resources to developing the “Umpqua Bank” brand. We promote the brand in advertising and merchandise bearing the Bank’s logo, such as mugs, tee-shirts, hats, umbrellas and bags of custom roasted coffee beans. The unique “look and feel” of our stores and our innovative product displays help position us as an innovative, customer friendly retailer of financial products and services. We build consumer preference for our products and services through strong brand awareness. During 2005, we secured naming rights to the office tower in Portland, Oregon in which our administrative offices and main branch are now located. This downtown building now displays prominent illuminated signage with the Bank’s name and logo.

Use Technology to Expand Customer Base.    Although our strategy will continue to emphasize superior personal service, we continue to expand user-friendly, technology-based systems to attract customers that may prefer to interact with their financial institution electronically. We offer technology-based services including voice response banking, debit cards, automatic payroll

 

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deposit programs, “ibank@Umpqua” online banking, bill pay and cash management, advanced function ATMs and an internet web site. We believe the availability of both traditional bank services and electronic banking services enhances our ability to attract a broader range of customers.

Increase Market Share in Existing Markets and Expand Into New Markets.    As a result of our innovative retail product orientation, measurable quality service program and strong brand awareness, we believe that there is significant potential to increase business with current customers, to attract new customers in our existing markets and to enter new markets.

Marketing and Sales

Our goal of increasing our share of financial services in our market areas is driven by a marketing and sales plan with the following key components:

Media Advertising.    Over the past five years, we have introduced several comprehensive media advertising campaigns. These campaigns augment our goal of strengthening the “Umpqua Bank” brand image and heightening public awareness of our innovative product delivery system. Campaign slogans such as “Why Not?,” “The Banking Revolution,” “Expect the Unexpected,” “Different for a Reason”, “Be a Localist”, and “Lemonaire” were designed to showcase our innovative style of banking, our commitment to providing quality customer service, and our commitment to the communities we serve. Our marketing campaigns utilize various forms of media, including television, radio, print, billboards and direct mail flyers and letters.

Retail Store Concept.    As a financial services provider, we believe that the store environment is critical to successfully market and sell products and services. Retailers traditionally have displayed merchandise within their stores in a manner designed to encourage customers to purchase their products. Purchases are made on the spur of the moment due to the products’ availability and attractiveness. Umpqua Bank believes this same concept can be applied to financial institutions and accordingly displays financial services and products through tactile merchandising within our stores. Unlike many financial institutions whose strategy is to discourage customers from visiting their facilities in favor of ATMs or other forms of electronic banking, we encourage customers to visit our stores, where they are greeted by well-trained sales associates and encouraged to browse and to make “impulse purchases.” A recent store design, referred to as the “Pearl,” includes features like wireless laptop computers customers can use, opening rooms with fresh fruit and refrigerated beverages and innovative products like the Community Interest Account that pays interest to non-profit organizations. The stores host a variety of after-hours events, from poetry readings to seminars on how to build an art collection. In 2006, to bring financial services to our customers in a cost-effective way, we introduced “Neighborhood Stores.” We build these stores in established neighborhoods and design them to be neighborhood hubs. These stand-alone stores are smaller and emphasize advanced technology. To strengthen brand recognition, all Neighborhood Stores will be nearly identical in appearance. The latest store design, referred to as the “Innovation Lab”, showcases emerging and existing technologies that foster community and redefine what consumers can expect from a banking experience. As a testing ground for new initiatives, the Lab will change regularly to feature new technology, products, services and community events.

Sales Culture.    Although a successful marketing program will attract customers to visit our stores, a sales environment and a well-trained sales team are critical to selling our products and services. We believe that our sales culture has become well established throughout the organization due to the unique facility design and our ongoing training of sales associates on all aspects of sales and service. We train our sales associates in our in-house training facility known as “The World’s Greatest Bank University” and pay commissions for the sale of the Bank’s products and services. This sales culture has helped transform us from a traditional community bank to a nationally recognized marketing company focused on selling financial products and services.

Products and Services

We offer a full array of financial products to meet the banking needs of our market area and targeted customers. To ensure the ongoing viability of our product offerings, we regularly examine the desirability and profitability of existing and potential new products. To make it easy for new prospective customers to bank with us and access our products, we offer a “Switch Kit,” which allows a customer to open a primary checking account with Umpqua Bank in less than ten minutes. Other avenues

 

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Umpqua Holdings Corporation

 

through which customers can access our products include our web site, internet banking through the “ibank@Umpqua” program, and our 24-hour telephone voice response system.

Deposit Products.    We offer a traditional array of deposit products, including non-interest-bearing checking accounts, interest-bearing checking and savings accounts, money market accounts and certificates of deposit. These accounts earn interest at rates established by management based on competitive market factors and management’s desire to increase certain types or maturities of deposit liabilities. We also offer a line of “Life Cycle Packages” to increase the number of relationships with customers and increase service fee income. These packages comprise several products bundled together to provide added value to the customer and increase the customer’s ties to us. We also offer a seniors program to customers over fifty years old, which includes an array of banking services and other amenities, such as purchase discounts, vacation trips and seminars.

Retail Brokerage Services.    Strand provides a full range of brokerage services including equity and fixed income products, mutual funds, annuities, options, retirement planning and money management services. Additionally, Strand offers life insurance, disability insurance and medical supplement policies. At December 31, 2007, Strand had 44 Series 7-licensed representatives serving clients at three stand-alone retail brokerage offices and “Investment Opportunity Centers” located in many Bank stores.

Private Client Services.    Our Private Client Services division provides integrated banking and investment products and services by coordinating the offerings of the Bank and Strand, focusing principally on serving high value customers. The “Prosperity” suite of products includes 24-hour access to a private client executive, courier service, preferred rates on deposit and loan products, brokerage accounts and portfolio management.

Commercial and Commercial Real Estate Loans.    We offer specialized loans for business and commercial customers, including accounts receivable and inventory financing, equipment loans, real estate construction loans and permanent financing and SBA program financing. Additionally, we offer specially designed loan products for small businesses through our Small Business Lending Center. Commercial real estate lending is the primary focus of our lending activities and a significant portion of our loan and lease portfolio consists of commercial real estate loans. We provide funding for income-producing real estate, though a substantial share of our commercial real estate loans are for owner-occupied projects of commercial loan customers and for borrowers we have financed for many years.

Residential Real Estate Loans.    Real estate loans are available for construction, purchase and refinancing of residential owner-occupied and rental properties. Borrowers can choose from a variety of fixed and adjustable rate options and terms. We sell most residential real estate loans that we originate into the secondary market.

Consumer Loans.    We also provide loans to individual borrowers for a variety of purposes, including secured and unsecured personal loans, home equity and personal lines of credit and motor vehicle loans.

Market Area and Competition

The geographic markets we serve are highly competitive for deposits, loans and leases and retail brokerage services. We compete with traditional banking and thrift institutions, as well as non-bank financial service providers, such as credit unions, brokerage firms and mortgage companies. In our primary market areas of Oregon and Northern California, major banks and large regional banks generally hold dominant market share positions. By virtue of their larger capital bases, major banks and super-regional banks have significantly larger lending limits than we do and generally have more expansive branch networks. Competition also includes other commercial banks that are community-focused, some of which were recently formed as “de novo” institutions seeking to capitalize on any perceived marketplace void resulting from merger and acquisition consolidation. In some cases, the directors and key officers of de novo banks were previously associated with the Bank or banks previously acquired by Umpqua.

Our primary competitors also include non-bank financial services providers, such as credit unions, brokerage firms, insurance companies and mortgage companies. As the industry becomes increasingly dependent on and oriented toward technology-driven delivery systems, permitting transactions to be conducted by telephone, computer and the internet, such non-bank institutions are able to attract funds and provide lending and other financial services even without offices located in our primary

 

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service area. Some insurance companies and brokerage firms compete for deposits by offering rates that are higher than may be appropriate for the Bank in relation to its asset/liability objectives. However, we offer a wide array of deposit products and believe we can compete effectively through rate-driven product promotions. We also compete with full service investment firms for non-bank financial products and services offered by Strand.

Credit unions present a significant competitive challenge for our banking services and products. As credit unions currently enjoy an exemption from income tax, they are able to offer higher deposit rates and lower loan rates than we can on a comparable basis. Credit unions are also not currently subject to certain regulatory constraints, such as the Community Reinvestment Act, which, among other things, requires us to implement procedures to make and monitor loans throughout the communities we serve. Adhering to such regulatory requirements raises the costs associated with our lending activities, and reduces potential operating profits. Accordingly, we seek to compete by focusing on building customer relations, providing superior service and offering a wide variety of commercial banking products that do not compete directly with products and services typically offered by the credit unions, such as commercial real estate loans, inventory and accounts receivable financing, and SBA program loans for qualified businesses.

Many of our stores are located in markets that have experienced growth below statewide averages and the economy of Oregon is particularly sensitive to changes in the demand for forest and high technology products. With the completion of the Humboldt, Western Sierra and North Bay acquisitions, the Bank’s market area expanded to include most of Northern California exclusive of the Bay Area. Like Oregon, some California stores are located in communities with growth rates that lag behind the state average. During the past several years, the States of Oregon and California have experienced some financial difficulties. To the extent the fiscal condition of state and local governments does not improve, there could be an adverse effect on business conditions in the affected state that would negatively impact the prospects for the Bank’s operations located there.

The current adverse economic conditions, driven by a slowdown in the housing industry, has primarily been focused in our Northern California region. A continued downturn in the residential real estate construction and development sector could negatively impact our operations in these markets.

The following table presents the Bank’s market share percentage for total deposits in each county where we have operations. The table also indicates the ranking by deposit size in each market. All information in the table was obtained from SNL Financial of Charlottesville, Virginia, which compiles deposit data published by the FDIC as of June 30, 2007 and updates the information for any bank mergers completed subsequent to the reporting date.

 

Oregon
County    Market
Share
     Market
Rank
   Number
of Stores

Benton

   7.7 %    6    1

Clackamas

   3.7 %    7    5

Coos

   34.6 %    1    5

Curry

   15.9 %    3    1

Deschutes

   4.5 %    9    5

Douglas

   54.1 %    1    9

Jackson

   12.4 %    3    9

Josephine

   15.4 %    1    5

Lane

   18.5 %    1    9

Lincoln

   11.6 %    3    2

Linn

   12.5 %    4    3

Marion

   5.4 %    7    3

Multnomah

   2.3 %    7    10

Washington

   3.7 %    9    3

 

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Umpqua Holdings Corporation

 

California
County    Market
Share
     Market
Rank
   Number
of Stores

Amador

   3.4 %    7    1

Butte

   2.9 %    9    2

Calaveras

   21.2 %    2    4

Colusa

   30.4 %    1    2

Contra Costa

   0.2 %    24    1

El Dorado

   10.4 %    5    5

Glenn

   24.8 %    3    2

Humboldt

   24.3 %    1    7

Lake

   12.0 %    4    2

Mendocino

   2.7 %    8    1

Napa

   11.9 %    4    7

Placer

   8.4 %    4    9

Sacramento

   0.6 %    20    6

San Joaquin

   0.4 %    20    1

Shasta

   2.4 %    8    1

Solano

   4.2 %    8    4

Stanislaus

   0.6 %    17    2

Sutter

   14.2 %    4    2

Tehama

   16.3 %    4    2

Trinity

   26.6 %    2    1

Tuolumne

   11.4 %    3    5

Yolo

   1.7 %    12    1

Yuba

   23.5 %    3    2

 

Washington
County    Market
Share
     Market
Rank
   Number
of Stores

Clark

   3.2 %    9    2

King

   0.1 %    46    1

Lending and Credit Functions

The Bank makes both secured and unsecured loans to individuals and businesses. At December 31, 2007, real estate construction/development, real estate mortgage, commercial real estate, commercial/industrial, and consumer/other loans represented approximately 20%, 10%, 50%, 19% and 1%, respectively, of the total loan and lease portfolio.

Inter-agency guidelines adopted by federal bank regulators mandate that financial institutions establish real estate lending policies with maximum allowable real estate loan-to-value limits, subject to an allowable amount of non-conforming loans as a percentage of capital. We have adopted as loan policy loan-to-value limits that range from 5% to 10% less than the federal guidelines for each category; however, policy exceptions are permitted for real estate loan customers with strong financial credentials.

Allowance for Loan and Lease Losses (ALLL) Methodology

The Bank performs regular credit reviews of the loan and lease portfolio to determine the credit quality of the portfolio and the adherence to underwriting standards. When loans and leases are originated, they are assigned a risk rating from 1 to 10 that is

 

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assessed periodically during the term of the loan through the credit review process. The 10 risk rating categories are a primary factor in determining an appropriate amount for the allowance for loan and lease losses. The Bank has a management ALLL Committee, which is responsible for, among other things, regularly reviewing of the ALLL methodology, including loss factors, and ensuring that it is designed and applied in accordance with generally accepted accounting principles. The ALLL Committee reviews loans and leases that have been placed on non-accrual status and approves placing loans and leases on impaired status. The ALLL Committee also approves removing loans and leases that are no longer impaired from impairment and non-accrual status. The Bank’s Audit and Compliance Committee provides board oversight of the ALLL process and reviews and approves the ALLL methodology on a quarterly basis.

Each risk rating is assessed an inherent credit loss factor that determines the amount of the allowance for loan and lease losses provided for that group of loans and leases with similar risk rating. Credit loss factors may vary by region based on management’s belief that there may ultimately be different credit loss rates experienced in each region.

Regular credit reviews of the portfolio also identify loans that are considered potentially impaired. Potentially impaired loans are referred to the ALLL Committee which reviews and approves designated loans as impaired. A loan is considered impaired when based on current information and events, we determine that we will probably not be able to collect all amounts due according to the loan contract, including scheduled interest payments. When we identify a loan as impaired, we measure the impairment using discounted cash flows, except when the sole remaining source of the repayment for the loan is the liquidation of the collateral. In these cases, we use the current fair value of the collateral, less selling costs, instead of discounted cash flows. If we determine that the value of the impaired loan is less than the recorded investment in the loan, we recognize an impairment reserve as a specific component to be provided for in the allowance for loan and lease losses.

The combination of the risk rating based allowance component and the impairment reserve allowance component lead to an allocated allowance for loan and lease losses. The Bank may also maintain an unallocated allowance amount to provide for other credit losses inherent in a loan and lease portfolio that may not have been contemplated in the credit loss factors. This unallocated amount generally comprises less than 5% of the allowance. The unallocated amount is reviewed periodically based on trends in credit losses, the results of credit reviews and overall economic trends.

Management believes that the ALLL was adequate as of December 31, 2007. There is, however, no assurance that future loan losses will not exceed the levels provided for in the ALLL and could possibly result in additional charges to the provision for loan and lease losses. In addition, bank regulatory authorities, as part of their periodic examination of the Bank, may require additional charges to the provision for loan and lease losses in future periods if warranted as a result of their review.

Employees

As of December 31, 2007, we had a total of 1,744 full-time equivalent employees. None of the employees are subject to a collective bargaining agreement and management believes its relations with employees to be good. Umpqua Bank was named #13 on Fortune magazine’s 2008 list of “100 Best Companies to Work For” and #34 on the 2007 list. Information regarding employment agreements with our executive officers is contained in Item 11 below, which item is incorporated by reference to our proxy statement for the 2008 annual meeting of shareholders.

Government Policies

The operations of our subsidiaries are affected by state and federal legislative changes and by policies of various regulatory authorities. These policies include, for example, statutory maximum legal lending rates, domestic monetary policies of the Board of Governors of the Federal Reserve System, United States fiscal policy, and capital adequacy and liquidity constraints imposed by federal and state regulatory agencies.

Supervision and Regulation

General.    We are extensively regulated under federal and state law. These laws and regulations are generally intended to protect depositors and customers, not shareholders. To the extent that the following information describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statute or regulation. Any change in applicable laws or regulations may have a material effect on our business and prospects. Our operations may be affected by legislative changes and by the policies of various regulatory authorities. We cannot accurately predict the nature or the extent of the

 

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Umpqua Holdings Corporation

 

effects on our business and earnings that fiscal or monetary policies, or new federal or state legislation may have in the future. Umpqua is subject to the disclosure and regulatory requirements of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, both as administered by the Securities and Exchange Commission. As a listed company on NASDAQ, Umpqua is subject to NASDAQ rules for listed companies.

Holding Company Regulation.    We are a registered financial holding company under the Gramm-Leach-Bliley Act of 1999 (the “GLB Act”), and are subject to the supervision of, and regulation by, the Board of Governors of the Federal Reserve System (the “Federal Reserve”). As a financial holding company, we are examined by and file reports with the Federal Reserve. The Federal Reserve expects a bank holding company to serve as a source of financial and managerial strength to its subsidiary bank and, under appropriate circumstances, to commit resources to support the subsidiary bank.

Financial holding companies are bank holding companies that satisfy certain criteria and are permitted to engage in activities that traditional bank holding companies are not. The qualifications and permitted activities of financial holdings companies are described below under “Regulatory Structure of the Financial Services Industry.

Federal and State Bank Regulation.    Umpqua Bank, as a state chartered bank with deposits insured by the FDIC, is subject to the supervision and regulation of the Oregon Department of Consumer and Business Services Division of Finance and Corporate Securities, the Washington Department of Financial Institutions, the California Department of Financial Institutions and the FDIC. These agencies may prohibit the Bank from engaging in what they believe constitute unsafe or unsound banking practices. Our primary state regulator (the State of Oregon) makes regular examinations of the Bank or participates in joint examinations with the FDIC.

The Community Reinvestment Act (“CRA”) requires that, in connection with examinations of financial institutions within its jurisdiction, the FDIC evaluate the record of the financial institutions in meeting the credit needs of their local communities, including low- and moderate-income neighborhoods, consistent with the safe and sound operation of those institutions. These factors are also considered in evaluating mergers, acquisitions and applications to open a branch or new facility. A less than “Satisfactory” rating would result in the suspension of any growth of the Bank through acquisitions or opening de novo branches until the rating is improved. As of the most recent CRA examination in November 2004, the Bank’s CRA rating was “Satisfactory.”

Banks are also subject to certain restrictions imposed by the Federal Reserve Act on extensions of credit to executive officers, directors, principal shareholders or any related interest of such persons. Extensions of credit must be made on substantially the same terms, including interest rates and collateral as, and follow credit underwriting procedures that are not less stringent than, those prevailing at the time for comparable transactions with persons not affiliated with the bank, and must not involve more than the normal risk of repayment or present other unfavorable features. Banks are also subject to certain lending limits and restrictions on overdrafts to such persons. A violation of these restrictions may result in the assessment of substantial civil monetary penalties on the affected bank or any officer, director, employee, agent or other person participating in the conduct of the affairs of that bank, the imposition of a cease and desist order, and other regulatory sanctions.

The Federal Reserve Act and related Regulation W limit the amount of certain loan and investment transactions between the Bank and its affiliates, require certain levels of collateral for such loans, and limit the amount of advances to third parties that may be collateralized by the securities of Umpqua or its subsidiaries. Regulation W requires that certain transactions between the Bank and its affiliates be on terms substantially the same, or at least as favorable to the Bank, as those prevailing at the time for comparable transactions with or involving nonaffiliated companies or, in the absence of comparable transactions, on terms and under circumstances, including credit standards, that in good faith would be offered to or would apply to nonaffiliated companies. Umpqua and its subsidiaries have adopted an Affiliate Transactions Policy and have entered into an Affiliate Tax Sharing Agreement.

The Federal Reserve and the FDIC have adopted non-capital safety and soundness standards for institutions under their authority. These standards cover internal controls, information and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, and standards for asset quality, earnings and stock valuation. An institution that fails to meet these standards must develop a plan acceptable to the agency, specifying

 

9


 

the steps that it will take to meet the standards. Failure to submit or implement such a plan may subject the institution to regulatory sanctions. We believe that the Bank is in compliance with these standards.

Federal Deposit Insurance.    The Federal Deposit Insurance Reform Act of 2005 (“Reform Act”), enacted in February 2006, increased the deposit insurance limit for certain retirement plan deposit accounts from $100,000 to $250,000. The basic insurance limit for other deposits, including individuals, joint account holders, businesses, government entities, and trusts, remains at $100,000. The Reform Act also provided for the merger of the two deposit insurance funds administered by the FDIC, the Bank Insurance Fund (“BIF”) and the Savings Association Insurance Fund (“SAIF”), into the Deposit Insurance Fund (“DIF”). The FDIC effectuated the merger of the BIF and the SAIF into the DIF as of March 31, 2006. As a result of the merger of the funds, the BIF and the SAIF were abolished.

The amount of FDIC assessments paid by each member institution is based on its relative risk of default as measured by regulatory capital levels, regulatory examination ratings and other factors. The Reform Act created a new system and assessment rate schedule to calculate an institution’s assessment. The new base assessment rates per the Reform Act range from $0.02 to $0.40 per $100 of deposits annually. The FDIC may increase or decrease the assessment rate schedule five basis points higher or lower than the base rates in order to manage the DIF to prescribed statutory target levels. For 2007 the effective assessment amounts were $0.03 above the base rate amounts. Assessment rates for well managed, well capitalized institutions ranged from $0.05 to $0.07 per $100 of deposits annually. The Bank’s assessment rate for 2007 fell within this range and is expected to fall within this range for 2008. In 2007 the FDIC issued one-time assessment credits that can be used to offset this expense. The Bank’s credit was fully utilized in 2007 and covered the majority of the assessment. The Bank does not have any remaining credit to offset assessments in 2008. Further increases in the assessment rate could have a material adverse effect on our earnings, depending upon the amount of the increase.

The FDIC may terminate the deposit insurance of any insured depository institution if it determines that the institution has engaged in or is engaging in unsafe and unsound banking practices, is in an unsafe or unsound condition or has violated any applicable law, regulation or order or any condition imposed in writing by, or pursuant to, any written agreement with the FDIC. The termination of deposit insurance for the Bank could have a material adverse effect on our financial condition and results of operations due to the fact that the Bank’s liquidity position would likely be affected by deposit withdrawal activity.

Dividends.    Under the Oregon Bank Act and the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), the Bank is subject to restrictions on the payment of cash dividends to its parent company. Dividends paid by the Bank provide substantially all of Umpqua’s (as a stand-alone parent company) cash flow. A bank may not pay cash dividends if that payment would reduce the amount of its capital below that necessary to meet minimum applicable regulatory capital requirements. In addition, under the Oregon Bank Act, the amount of the dividend may not be greater than net unreserved retained earnings, after first deducting to the extent not already charged against earnings or reflected in a reserve, all bad debts, which are debts on which interest is unpaid and past due at least six months; all other assets charged off as required by the Oregon Director or state or federal examiner; and all accrued expenses, interest and taxes. In addition, state and federal regulatory authorities are authorized to prohibit banks and holding companies from paying dividends that would constitute an unsafe or unsound banking practice. We are not currently subject to any regulatory restrictions on dividends other than those noted above.

Capital Adequacy.    The federal and state bank regulatory agencies use capital adequacy guidelines in their examination and regulation of holding companies and banks. If capital falls below the minimum levels established by these guidelines, a holding company or a bank may be denied approval to acquire or establish additional banks or non-bank businesses or to open new facilities.

The FDIC and Federal Reserve have adopted risk-based capital guidelines for holding companies and banks. The risk-based capital guidelines are designed to make regulatory capital requirements more sensitive to differences in risk profile among holding companies and banks, to account for off-balance sheet exposure and to minimize disincentives for holding liquid assets. Assets and off-balance sheet items are assigned to broad risk categories, each with appropriate weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items. The capital adequacy guidelines limit the degree to which a holding company or bank may leverage its equity capital.

 

10


Umpqua Holdings Corporation

 

Federal regulations establish minimum requirements for the capital adequacy of depository institutions, such as the Bank. Banks with capital ratios below the required minimums are subject to certain administrative actions, including prompt corrective action, the termination of deposit insurance upon notice and hearing, or a temporary suspension of insurance without a hearing.

FDICIA requires federal banking regulators to take “prompt corrective action” with respect to a capital-deficient institution, including requiring a capital restoration plan and restricting certain growth activities of the institution. Umpqua could be required to guarantee any such capital restoration plan required of the Bank if the Bank became undercapitalized. Pursuant to FDICIA, regulations were adopted defining five capital levels: well capitalized, adequately capitalized, undercapitalized, severely undercapitalized and critically undercapitalized. Under the regulations, the Bank is considered “well capitalized” as of December 31, 2007.

Federal and State Regulation of Brokers.    Strand Atkinson Williams & York, Inc. is a fully disclosed introducing broker dealer clearing through First Clearing LLC. Strand is regulated by the Financial Industries Regulatory Authority (“FINRA”) and has deposits insured through the Securities Investors Protection Corp (“SIPC”) as well as third party insurers. FINRA performs regular examinations of the firm that include reviews of policies, procedures, recordkeeping, trade practices, and customer protection as well as other inquiries.

SIPC protects client securities and cash up to $500,000, including $100,000 for cash with additional coverage provided through First Clearing for the remaining net equity balance in a brokerage account, if any. This coverage does not include losses in investment accounts.

Effects of Government Monetary Policy.    Our earnings and growth are affected not only by general economic conditions, but also by the fiscal and monetary policies of the federal government, particularly the Federal Reserve. The Federal Reserve implements national monetary policy for such purposes as curbing inflation and combating recession, through its open market operations in U.S. Government securities, control of the discount rate applicable to borrowings from the Federal Reserve, and establishment of reserve requirements against certain deposits. These activities influence growth of bank loans, investments and deposits, and also affect interest rates charged on loans or paid on deposits. The nature and impact of future changes in monetary policies and their impact on us cannot be predicted with certainty.

Broker-Dealer and Related Regulatory Supervision.    Strand is a member of the National Association of Securities Dealers and is subject to the regulatory supervision of the Financial Industry Regulatory Authority. Areas subject to this regulatory review include compliance with trading rules, financial reporting, investment suitability for clients, and compliance with stock exchange rules and regulations.

Regulatory Structure of the Financial Services Industry.    Federal laws and regulations governing banking and financial services underwent significant changes in recent years and are subject to significant changes in the future. From time to time, legislation is introduced in the United States Congress that contains proposals for altering the structure, regulation, and competitive relationships of the nation’s financial institutions. If enacted into law, these proposals could increase or decrease the cost of doing business, limit or expand permissible activities, or affect the competitive balance among banks, savings associations, and other financial institutions. Whether or in what form any such legislation may be adopted or the extent to which our business might be affected thereby cannot be predicted.

The GLB Act, enacted in November 1999, repealed sections of the Banking Act of 1933, commonly referred to as the Glass-Steagall Act, that prohibited banks from engaging in securities activities, and prohibited securities firms from engaging in banking. The GLB Act created a new form of holding company, known as a financial holding company, that is permitted to acquire subsidiaries that are variously engaged in banking, securities underwriting and dealing, and insurance underwriting.

A bank holding company, if it meets specified requirements, may elect to become a financial holding company by filing a declaration with the Federal Reserve, and may thereafter provide its customers with a broader spectrum of products and services than a traditional bank holding company is permitted to do. A financial holding company may, through a subsidiary, engage in any activity that is deemed to be financial in nature and activities that are incidental or complementary to activities that are financial in nature. These activities include traditional banking services and activities previously permitted to bank

 

11


 

holding companies under Federal Reserve regulations, but also include underwriting and dealing in securities, providing investment advisory services, underwriting and selling insurance, merchant banking (holding a portfolio of commercial businesses, regardless of the nature of the business, for investment), and arranging or facilitating financial transactions for third parties.

To qualify as a financial holding company, the bank holding company must be deemed to be well-capitalized and well-managed, as those terms are used by the Federal Reserve. In addition, each subsidiary bank of a bank holding company must also be well-capitalized and well-managed and be rated at least “satisfactory” under the Community Reinvestment Act. A bank holding company that does not qualify, or has not chosen, to become a financial holding company must limit its activities to traditional banking activities and those non-banking activities the Federal Reserve has deemed to be permissible because they are closely related to the business of banking.

The GLB Act also includes provisions to protect consumer privacy by prohibiting financial services providers, whether or not affiliated with a bank, from disclosing non-public personal, financial information to unaffiliated parties without the consent of the customer, and by requiring annual disclosure of the provider’s privacy policy.

Legislation enacted by Congress in 1995 permits interstate banking and branching, which allows banks to expand nationwide through acquisition, consolidation or merger. Under this law, an adequately capitalized bank holding company may acquire banks in any state or merge banks across state lines if permitted by state law. Further, banks may establish and operate branches in any state subject to the restrictions of applicable state law. Under Oregon law, an out-of-state bank or bank holding company may merge with or acquire an Oregon state chartered bank or bank holding company if the Oregon bank, or in the case of a bank holding company, the subsidiary bank, has been in existence for a minimum of three years, and the law of the state in which the acquiring bank is located permits such merger. Branches may not be acquired or opened separately, but once an out-of-state bank has acquired branches in Oregon, either through a merger with or acquisition of substantially all the assets of an Oregon bank, the acquirer may open additional branches. The Bank now has the ability to open additional de novo branches in the states of Oregon, California and Washington.

Anti-Terrorism Legislation.    The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act (“USA Patriot Act”), enacted in 2001:

 

   

prohibits banks from providing correspondent accounts directly to foreign shell banks;

 

   

imposes due diligence requirements on banks opening or holding accounts for foreign financial institutions or wealthy foreign individuals;

 

   

requires financial institutions to establish an anti-money-laundering (“AML”) compliance program; and

 

   

generally eliminates civil liability for persons who file suspicious activity reports.

The USA Patriot Act also increases governmental powers to investigate terrorism, including expanded government access to account records. The Department of the Treasury is empowered to administer and make rules to implement the Act, which to some degree, affects our record-keeping and reporting expenses. Should the Bank’s AML compliance program be deemed insufficient by federal regulators, we would not be able to grow through acquiring other institutions or opening de novo branches.

Sarbanes-Oxley Act of 2002.    The Sarbanes-Oxley Act of 2002 addresses public company corporate governance, auditing, accounting, executive compensation and enhanced and timely disclosure of corporate information.

The Sarbanes-Oxley Act represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and regulation of the relationship between a Board of Directors and management and between a Board of Directors and its committees.

The Sarbanes-Oxley Act provides for, among other things:

 

   

prohibition on personal loans by Umpqua to its directors and executive officers except loans made by the Bank in accordance with federal banking regulations;

 

12


Umpqua Holdings Corporation

 

   

independence requirements for Board audit committee members and our auditors;

 

   

certification of Exchange Act reports by the chief executive officer, chief financial officer and principal accounting officer;

 

   

disclosure of off-balance sheet transactions;

 

   

expedited reporting of stock transactions by insiders; and

 

   

increased criminal penalties for violations of securities laws.

The Sarbanes-Oxley Act also requires:

 

   

management to establish, maintain and evaluate disclosure controls and procedures;

 

   

report on its annual assessment of the effectiveness of internal controls over financial reporting;

 

   

our external auditor to attest to management’s assessment of internal controls.

The SEC has adopted regulations to implement various provisions of the Sarbanes-Oxley Act, including disclosures in periodic filings pursuant to the Exchange Act. Also, in response to the Sarbanes-Oxley Act, NASDAQ adopted new standards for listed companies. In 2004, the Sarbanes-Oxley Act substantially increased our reporting and compliance expenses.

ITEM 1A.    RISK FACTORS.

The following summarizes certain risks that management believes are specific to our business. This should not be viewed as including all risks.

Merger with North Bay Bancorp may fail to realize all of the anticipated benefits.

On April 26, 2007, Umpqua concluded its acquisition of North Bay Bancorp and its principal operating subsidiary, The Vintage Bank. We expect to generate cost savings and expense reductions through the consolidation of facilities, increased purchasing efficiencies, and elimination of duplicative technology, operations, outside services and redundant staff. The combined company may fail to realize some or all of the anticipated cost savings and other benefits of the transaction, and it may take longer than anticipated to realize such benefits. Any failure to realize the potential benefits could have a material adverse effect on the value of Umpqua common stock.

We are pursuing an aggressive growth strategy that is expected to include mergers and acquisitions, which could create integration risks.

Umpqua is among the fastest-growing community financial services organizations in the United States. Since 2000, we have completed the acquisition and integration of seven other financial institutions. There is no assurance that future acquisitions will be successfully integrated. We have announced our intent to open new stores in Oregon, Washington and California, and to continue our growth strategy. If we pursue our growth strategy too aggressively, or if factors beyond management’s control divert attention away from our integration plans, we might not be able to realize some or all of the anticipated benefits. Moreover, we are dependent on the efforts of key personnel to achieve the synergies associated with our acquisitions. The loss of one or more of our key persons could have a material adverse effect upon our ability to achieve the anticipated benefits.

Store construction can disrupt banking activities and may not be completed on time or within budget, which could result in reduced earnings.

The Bank has, over the past several years, been transformed from a traditional community bank into a community-oriented financial services retailer. We have announced plans to build new stores in Oregon, Washington and California as part of our de novo branching strategy. This includes our strategy of building “Neighborhood Stores.” We also continue to remodel acquired bank branches to resemble retail stores that include distinct physical areas or boutiques such as a “serious about service center,” an “investment opportunity center” and a “computer cafe.” Store construction involves significant expense and risks associated with locating store sites and delays in obtaining permits and completing construction. Remodeling involves

 

13


 

significant expense, disrupts banking activities during the remodeling period, and presents a new look and feel to the banking services and products being offered. Financial constraints may delay remodeling projects. Customers may not react favorably to the construction-related activities or the remodeled look and feel. There are risks that construction or remodeling costs will exceed forecasted budgets and that there may be delays in completing the projects, which could cause disruption in those markets.

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

Strand’s retail brokerage operations present special risks not borne by community banks that focus exclusively on community banking. For example, the brokerage industry is subject to fluctuations in the stock market that may have a significant adverse impact on transaction fees, customer activity and investment portfolio gains and losses. Likewise, additional or modified regulations may adversely affect Strand’s operations. Strand is also dependent on a small number of established brokers, whose departure could result in the loss of a significant number of customer accounts. A significant decline in fees and commissions or trading losses suffered in the investment portfolio could adversely affect Strand’s income and potentially require the contribution of additional capital to support its operations. Strand is subject to claim arbitration risk arising from customers who claim 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. See Management’s Discussion and Analysis of Financial Condition and Results of Operations—“Non-interest Income” in Item 7 of this report.

The majority of our assets are loans, which if not repaid would result in losses to the Bank in excess of loss allowances.

The Bank, like other lenders, is subject to credit risk, which is the risk of losing principal or interest due to borrowers’ failure to repay loans in accordance with their terms. Underwriting and documentation controls do not always work properly. A downturn in the economy or the real estate market in our market areas 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 and lease losses or unfunded commitments may be required. See Management’s Discussion and Analysis of Financial Condition and Results of Operations—“Allowance for Loan and Lease Losses and Reserve for Unfunded Commitments”, “Provision for Loan and Lease Losses” and “Asset Quality and Non-Performing Assets” in Item 7 of this report.

A rapid change 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, including general economic conditions and the policies of various governmental and regulatory authorities. As interest rates change, net interest income is 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 maturity of the asset or liability. Asset/liability management policies may not be successfully implemented and from time to time our risk position is not balanced. 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 and longer-term investments. Further, substantially higher interest rates generally reduce loan demand and may result in slower loan growth than previously experienced. See Quantitative and Qualitative Disclosures about Market Risk in Item 7A of this report.

The volatility of our mortgage banking business can adversely affect earnings if our mitigating strategies are not successful.

Changes in interest rates greatly affect the mortgage banking business. One of the principal risks in this area is prepayment of mortgages and the consequent detrimental effect on the value of mortgage servicing rights (“MSR”). We employ hedging strategies to mitigate this risk but if the hedging decisions and strategies are not successful, our net income could be adversely

 

14


Umpqua Holdings Corporation

 

affected. See Management’s Discussion and Analysis of Financial Condition and Results of Operations—“Mortgage Servicing Rights” in Item 7 of this report.

Our banking and brokerage operations are subject to extensive government regulation that is expected to become more burdensome, increase our costs and/or 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 customers, depositors and the deposit insurance fund, rather than shareholders. The Bank is an Oregon state-chartered commercial bank whose primary regulator is the Oregon Division of Finance and Corporate Securities. The Bank is also subject to the supervision by and the regulations of the Washington Department of Financial Institutions, the California Department of Financial Institutions and the Federal Deposit Insurance Corporation (“FDIC”), which insures bank deposits. Strand is subject to extensive regulation by the Securities and Exchange Commission and the Financial Industry Regulatory Authority. Umpqua is subject to regulation and supervision by the Board of Governors of the Federal Reserve System, the SEC and NASDAQ. Federal and state regulations may place banks at a competitive disadvantage compared to less regulated competitors such as finance companies, credit unions, mortgage banking companies and leasing companies. Further, future changes in federal and state banking and brokerage regulations could adversely affect our operating results and ability to continue to compete effectively.

The financial services industry is highly competitive.

We face significant competition in attracting and retaining deposits and making loans as well as in providing other financial services throughout our market area. We face pricing competition for loans and deposits. We also face competition with respect to customer convenience, product lines, accessibility of service and service capabilities. 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.

Our business is highly reliant on technology and our ability to manage the operational risks associated with technology.

We depend on internal and outsourced technology to support all aspects of our business operations. Interruption or failure of these systems creates a risk of business loss such as civil fines or damage claims from privacy breaches, and adverse customer experience. Risk management programs are expensive to maintain and will not protect the company from all risks associated with maintaining the security of customer information, proprietary data, external and internal intrusions, disaster recovery and failures in the controls used by vendors.

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

Recently, the Company’s common stock has been trading at a price below its book value, including goodwill and other intangible assets. The valuation of goodwill is determined 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 was deemed to exist, a write down of the asset would occur with a charge to earnings. See section titled “Goodwill and Other Intangible Assets” in Item 7 of this report.

ITEM 1B.    UNRESOLVED STAFF COMMENTS.

None.

ITEM 2.    PROPERTIES.

The executive offices of Umpqua are located at One SW Columbia Street in Portland, Oregon in office space that is leased. The main office of Strand is located at 200 SW Market Street in Portland, Oregon in office space that is leased. The Bank owns its main office located in Roseburg, Oregon. At December 31, 2007, the Bank conducted business at 147 locations, including 4 limited service facilities, in Northern California, Oregon and Washington along the I-5 corridor; in Bend, Oregon; along the

 

15


 

Northern California and Oregon Coasts; and in Bellevue, Washington, of which 53 are owned and 94 are leased under various agreements. As of December 31, 2007, the Bank also operated 17 facilities for the purpose of administrative functions, such as data processing, of which three are owned and 14 are leased. All facilities are in a good state of repair and appropriately designed for use as banking or administrative office facilities. As of December 31, 2007, Strand leased three stand-alone offices from unrelated third parties and also leased space in 14 Bank stores under lease agreements that are based on market rates.

Additional information with respect to owned premises and lease commitments is included in Notes 6 and 17, respectively, of the Notes to Consolidated Financial Statements in Item 8 below.

ITEM 3.    LEGAL PROCEEDINGS.

Because of the nature of our business, we are involved in legal proceedings in the regular course of business. At this time, we do not believe that there is other active or pending litigation the unfavorable outcome of which would result in a material adverse change to our financial condition, results of operations or cash flows.

See Part II, Item 7, Non-Interest Expense for a discussion of the Company’s potential liability arising from litigation involving Visa, Inc.

ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS.

No matters were submitted to the shareholders of the Company, through the solicitation of proxies or otherwise, during the fourth quarter of the year ended December 31, 2007.

 

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Umpqua Holdings Corporation

 

PART II

ITEM 5.    MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

(a) Our Common Stock is traded on the NASDAQ Global Select Market under the symbol “UMPQ.” As of December 31, 2007, there were 100,000,000 common shares authorized for issuance. The following table presents the high and low sales prices of our common stock for each period, based on inter-dealer prices that do not include retail mark-ups, mark-downs or commissions, and cash dividends declared for each period:

 

Quarter Ended    High    Low    Cash Dividend
Per Share

December 31, 2007

   $ 20.95    $ 14.15    $ 0.19

September 30, 2007

   $ 24.80    $ 18.52    $ 0.19

June 30, 2007

   $ 27.00    $ 23.27    $ 0.18

March 31, 2007

   $ 30.00    $ 25.39    $ 0.18

December 31, 2006

   $ 30.66    $ 27.21    $ 0.18

September 30, 2006

   $ 29.27    $ 23.98    $ 0.18

June 30, 2006

   $ 28.67    $ 24.50    $ 0.12

March 31, 2006

   $ 29.67    $ 26.25    $ 0.12

As of January 31, 2008, our common stock was held of record by approximately 5,094 shareholders, a number that does not include beneficial owners who hold shares in “street name”, or shareholders from previously acquired companies that have not exchanged their stock. At December 31, 2007, a total of 1.6 million stock options and 247,000 restricted stock and restricted stock units were outstanding. Additional information about stock options, restricted stock and restricted stock units is included in Note 18 of the Notes to Consolidated Financial Statements in Item 8 below and in Item 12 below.

The payment of future cash dividends is at the discretion of our Board and subject to a number of factors, including results of operations, general business conditions, growth, financial condition and other factors deemed relevant by the Board of Directors. Further, our ability to pay future cash dividends is subject to certain regulatory requirements and restrictions discussed in the Supervision and Regulation section in Item 1 above. During the fourth quarter of 2007, Umpqua’s board of directors approved a quarterly cash dividend of $0.19, unchanged from the third quarter of 2007 and an increase from $0.18 per share in the first and second quarters of 2007. This increase was made pursuant to our existing dividend policy and in consideration of, among other things, earnings, regulatory capital levels and expected asset growth. We expect that the dividend rate will be reassessed on a quarterly basis by the board of directors in accordance with the dividend policy.

We have a dividend reinvestment plan that permits shareholder participants to purchase shares at the then-current market price in lieu of the receipt of cash dividends. Shares issued in connection with the dividend reinvestment plan are purchased in open market transactions.

 

17


 

Equity Compensation Plan Information

The following table sets forth information about equity compensation plans that provide for the award of securities or the grant of options to purchase securities to employees and directors of Umpqua, its subsidiaries and its predecessors by merger that were in effect at December 31, 2007.

 

(shares in thousands)      
    Equity Compensation Plan Information
   
Plan category  

(A)

 

Number of securities to be
issued upon exercise of
outstanding options,
warrants and rights

 

(B)

 

Weighted average exercise
price of outstanding
options, warrants and rights(4)

 

(C)

Number of securities
remaining available for
future issuance under equity
compensation plans
excluding securities
reflected in column (A)

Equity compensation plans approved by security holders

     

2003 Stock Incentive Plan(1)

  659   $ 23.04   1,024

2007 Long Term Incentive Plan(2)

        1,000

Other(3)

  961   $ 11.36  
         

Total

  1,620   $ 15.94   2,024

Equity compensation plans not approved by security holders

       
         

Total

  1,620   $ 15.94   2,024
         

 

  (1) At Umpqua’s 2007 Annual Meeting, shareholders approved an amendment to the 2003 Stock Incentive Plan. The plan authorized the issuance of two million shares of stock through awards of incentive stock options, nonqualified stock options or restricted stock grants; provided awards of stock options and restricted stock grants under the 2003 Stock Incentive Plan, when added to options outstanding under all other plans, are limited to a maximum 10% of the outstanding shares on a fully diluted basis.

 

  (2) At Umpqua’s 2007 Annual Meeting, shareholders approved a 2007 Long Term Incentive Plan. The plan authorized the issuance of one million shares of stock through awards of performance-based restricted stock unit grants to executive officers. Target grants of 111 thousand and maximum grants of 194 thousand were approved to be issued in 2007 under this plan. No performance-based targets were met during 2007. The number of securities available for future issuance would be 806 thousand if the maximum grants were issued.

 

  (3) Includes other Umpqua stock plans and stock plans assumed through previous mergers. Includes 62 thousand shares issued under North Bay Bancorp’s stock option plans, having a weighted average exercise price of $16.46. Includes 104 thousand shares issued under Western Sierra Bancorp’s stock option plans, having a weighted average exercise price of $15.72. Includes 446 thousand shares issued under all other previously acquired companies’ stock option plans, having a weighted average exercise price of $7.70 per share.

 

  (4) Weighted average exercise price is based solely on securities with an exercise price.

 

(b) Not applicable.

 

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Umpqua Holdings Corporation

 

(c) The following table provides information about repurchases of common stock by the Company during the quarter ended December 31, 2007:

 

Period   

Total number

of Shares

Purchased(1)

  

Average Price

Paid per Share

  

Total Number of

Shares

Purchased as

Part of Publicly

Announced Plan(2)

  

Maximum Number

of Remaining

Shares that May

be Purchased at

Period End under

the Plan

10/1/07 - 10/31/07

   12,968    $ 16.59       1,542,945

11/1/07 - 11/30/07

      $       1,542,945

12/1/07 - 12/31/07

   84    $ 16.14       1,542,945
               

Total for quarter

   13,052    $ 16.59      

 

(1) Shares repurchased by the Company during the quarter consist of cancellation of 435 restricted shares to pay withholding taxes and 12,617 shares tendered in connection with option exercises. There were no shares repurchased pursuant to the Company’s publicly announced corporate stock repurchase plan described in (2) below.

 

(2) The Company’s share repurchase plan, which was approved by the Board and announced in August 2003, originally authorized the repurchase of up to 1.0 million shares. Prior to 2007, the authorization was amended to increase the repurchase limit to 2.5 million shares. On April 19, 2007, the Company announced an expansion of the Board approved common stock repurchase plan, increasing the repurchase limit to 6.0 million shares and extending the plan’s expiration date from June 30, 2007 to June 30, 2009. The timing and amount of future repurchases will depend upon the market price for our common stock, securities laws restricting repurchases, asset growth, earnings and our capital plan.

The Company repurchased 4.0 million shares under the repurchase plan in 2007 as compared to none in 2006. The 2003 Stock Incentive Plan and other stock plans we administer provide for the payment of the option exercise price or withholding taxes by tendering previously owned or recently vested shares. During the years ended December 31, 2007 and 2006, 42,762 and 4,277 shares, respectively, were tendered in connection with option exercises. Restricted shares cancelled to pay withholding taxes totaled 3,830 and 1,865 shares, respectively, during the years ended December 31, 2007 and 2006.

 

19


 

STOCK PERFORMANCE GRAPH

The following chart, which is furnished not filed, compares the yearly percentage changes in the cumulative shareholder return on our common stock during the five fiscal years ended December 31, 2007, with (i) the Total Return Index for Nasdaq Bank Stocks (ii) the Total Return Index for The Nasdaq Stock Market (U.S. Companies) and (iii) the Standard and Poor’s 500. This comparison assumes $100.00 was invested on December 31, 2002, in our common stock and the comparison indices, and assumes the reinvestment of all cash dividends prior to any tax effect and retention of all stock dividends. Price information from December 31, 2002 to December 31, 2007, was obtained by using the Nasdaq closing prices as of the last trading day of each year.

LOGO

 

     Period Ending
  12/31/2002   12/31/2003   12/31/2004   12/31/2005   12/31/2006   12/31/2007

Umpqua Holdings Corporation

  $ 100.00   $ 114.87   $ 140.69   $ 161.23   $ 169.88   $ 91.76

Nasdaq Bank Stocks

  $ 100.00   $ 130.51   $ 144.96   $ 141.92   $ 159.42   $ 125.80

Nasdaq U.S.

  $ 100.00   $ 149.75   $ 164.64   $ 168.60   $ 187.83   $ 205.22

S&P 500

  $ 100.00   $ 128.68   $ 142.69   $ 149.70   $ 173.34   $ 182.87

 

20


Umpqua Holdings Corporation

 

ITEM 6.    SELECTED FINANCIAL DATA.

Umpqua Holdings Corporation

Annual Financial Trends

(in thousands, except per share data)

 

     2007   2006   2005   2004   2003  

Interest income

    $488,392   $ 405,941   $ 282,276   $ 198,058   $ 142,132  

Interest expense

    202,438     143,817     72,994     40,371     28,860  
       

Net interest income

    285,954     262,124     209,282     157,687     113,272  

Provision for loan and lease losses

    41,730     2,552     2,468     7,321     4,550  

Non-interest income

    64,825     53,597     47,782     41,373     38,001  

Non-interest expense

    210,800     177,176     146,794     119,582     93,187  

Merger-related expense

    3,318     4,773     262     5,597     2,082  
       

Income before income taxes

    94,931     131,220     107,540     66,560     51,454  

Provision for income taxes and discontinued operations

    31,663     46,773     37,805     23,270     17,970  
       

Income from continuing operations

    63,268     84,447     69,735     43,290     33,484  

Income from discontinued operations, net of tax

                3,876     635  
       

Net income

    $    63,268   $ 84,447   $ 69,735   $ 47,166   $ 34,119  
       

YEAR END

         

Assets

  $ 8,340,053   $ 7,344,236   $ 5,360,639   $ 4,873,035   $ 2,963,815  

Earning assets

    7,146,841     6,287,202     4,636,334     4,215,927     2,596,775  

Loans and leases

    6,055,635     5,361,862     3,921,631     3,467,904     2,003,587  

Deposits

    6,589,326     5,840,294     4,286,266     3,799,107     2,378,192  

Term debt

    73,927     9,513     3,184     88,451     55,000  

Junior subordinated debentures, at fair value

    131,686                  

Junior subordinated debentures, at amortized cost

    104,680     203,688     165,725     166,256     97,941  

Shareholders’ equity

    1,239,938     1,156,211     738,261     687,613     318,969  

Shares outstanding

    59,980     58,080     44,556     44,211     28,412  

AVERAGE

         

Assets

  $ 7,897,568   $ 6,451,660   $ 5,053,417   $ 3,919,985   $ 2,710,388  

Earning assets

    6,797,834     5,569,619     4,353,696     3,392,475     2,359,142  

Loans and leases

    5,822,907     4,803,509     3,613,257     2,679,576     1,868,165  

Deposits

    6,250,521     5,003,949     4,002,153     3,090,497     2,212,082  

Term debt

    57,479     58,684     31,161     101,321     41,699  

Junior subordinated debentures

    221,833     187,994     165,981     130,644     76,444  

Shareholders’ equity

    1,222,628     970,394     711,765     490,724     303,569  

Basic shares outstanding

    59,828     52,311     44,438     35,804     28,294  

Diluted shares outstanding

    60,428     53,050     45,011     36,345     28,666  

PER SHARE DATA

         

Basic earnings

  $         1.06   $ 1.61   $ 1.57   $ 1.32   $ 1.21  

Diluted earnings

    1.05     1.59     1.55     1.30     1.19  

Basic earnings—continuing operations

    1.06     1.61     1.57     1.21     1.18  

Diluted earnings—continuing operations

    1.05     1.59     1.55     1.19     1.17  

Book value

    20.67     19.91     16.57     15.55     11.23  

Tangible book value(1)

    7.92     8.21     7.40     6.31     5.61  

Cash dividends declared

    0.74     0.60     0.32     0.22     0.16  

 

21


 

(Dollars in thousands)

 

     2007     2006     2005     2004     2003  

PERFORMANCE RATIOS

         

Return on average assets

    0.80 %     1.31 %     1.38 %     1.20 %     1.26 %

Return on average shareholders’ equity

    5.17 %     8.70 %     9.80 %     9.61 %     11.24 %

Return on average tangible shareholders’ equity(2)

    13.08 %     20.84 %     22.91 %     22.27 %     23.87 %

Efficiency ratio(3)

    60.62 %     57.33 %     56.93 %     60.58 %     62.05 %

Efficiency ratio—Bank(3),(4)

    56.55 %     51.97 %     52.47 %     53.51 %     55.49 %

Average equity to average assets

    15.48 %     15.04 %     14.08 %     12.52 %     11.20 %

Leverage ratio(5)

    9.24 %     10.28 %     10.09 %     9.55 %     8.73 %

Net interest margin (fully tax equivalent)(6)

    4.24 %     4.74 %     4.84 %     4.68 %     4.85 %

Non-interest revenue to total net revenue

    18.48 %     16.98 %     18.59 %     20.78 %     25.12 %

Dividend payout ratio

    69.81 %     37.27 %     20.38 %     16.67 %     13.22 %

ASSET QUALITY

         

Non-performing assets

  $   98,042     $   9,058     $   7,563     $   23,552     $   13,954  

Allowance for loan and lease losses

    84,904       60,090       43,885       44,229       25,352  

Net charge-offs

    21,994       574       2,812       4,485       3,929  

Non-performing assets to total assets

    1.18 %     0.12 %     0.14 %     0.48 %     0.47 %

Allowance for loan and lease losses to total loans and leases

    1.40 %     1.12 %     1.12 %     1.28 %     1.27 %

Net charge-offs to average loans and leases

    0.38 %     0.01 %     0.08 %     0.17 %     0.21 %

 

(1) Average shareholders’ equity less average intangible assets divided by shares outstanding at the end of the year.
(2) Net income divided by average shareholders’ equity less average intangible assets.
(3) Non-interest expense divided by the sum of net interest income (fully tax equivalent) and non-interest income.
(4) Excludes merger-related expenses.
(5) Tier 1 Capital divided by leverage assets. Leverage assets are defined as quarterly average total assets, net of goodwill, intangibles and certain other items as required by the Federal Reserve.
(6) Net interest margin (fully tax equivalent) is calculated by dividing net interest income (fully tax equivalent) by average interest-earning assets.

ITEM 7.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD LOOKING STATEMENTS AND RISK FACTORS

See the discussion of forward-looking statements and risk factors in Part I Item 1 and Item 1A of this report.

EXECUTIVE OVERVIEW

In 2007, Umpqua’s results reflect the impact of the significant slowdown in the housing industry. Primarily affecting our Northern California residential development portfolio, the impact of the slowdown resulted in:

 

   

Non-performing assets increased to $98.0 million, or 1.18% of total assets as of December 31, 2007, as compared to $9.1 million or 0.12% of total assets, as of December 31, 2006.

 

   

Net charge-offs increased to $22.0 million in 2007, or 0.38% of average loans and leases, as compared to $574,000 or 0.01% of average loans and leases in 2006.

 

   

The increase in non-performing assets and net charge-offs in 2007 contributed to a $41.7 million provision for loan and lease losses in 2007, as compared to $2.6 million in 2006.

 

22


Umpqua Holdings Corporation

 

However, the past year was not without some accomplishments. During the year, we:

 

   

Completed the acquisition and integration of North Bay Bancorp and its principal operating subsidiary, The Vintage Bank, along with its Solano Bank division in an all stock exchange valued at $142.1 million with 5.2 million shares of common stock issued in connection with the acquisition.

 

   

Increased gross loans and leases to $6.1 billion as of December 31, 2007, compared to $5.4 billion as of December 31, 2006, respectively, a growth of $693.8 million or 13%. The North Bay acquisition accounted for $443.0 million of the growth. Excluding the acquisition, the organic loan growth rate was 5% for 2007.

 

   

Increased deposits to $6.6 billion as of December 31, 2007, compared to $5.8 billion as of December 31, 2006, a growth of $749.0 million or 13%. The North Bay acquisition accounted for $462.6 million of the growth. The organic deposit growth rate (excluding growth through acquisition) was 5% for 2007.

 

   

Increased total consolidated assets to $8.3 billion as of December 31, 2007, compared to $7.3 billion as of December 31, 2006, an increase of $995.8 million or 14%. The North Bay acquisition accounted for $727.6 million of the growth. The organic asset growth rate (excluding growth through acquisition) was 4% for 2007.

 

   

Issued $61.9 million of new trust preferred securities, with a weighted average adjustable interest rate of 3 month LIBOR plus 182 basis points, and redeemed existing trust preferred securities representing obligations of $25.8 million.

 

   

Repurchased 4.0 million shares of stock at a weighted average price of $23.73 per share.

 

   

Declared cash dividends of $0.19 per share in the third and fourth quarters of 2007 which was an increase of $0.01 per share compared to the first and second quarters of 2007.

 

   

Opened two new stores in Portland and one in Bend, Oregon.

Also during the year:

 

   

Net interest margin decreased to 4.24% in 2007 from 4.74% in 2006. The decrease in net interest margin resulted primarily from volatility in short-term market interest rates and the competitive climate, characterized by increasing deposit costs combined with declining earning asset yields. The decline in earning asset yields was partially due to the reversal of interest income during the year related to new non-accrual loans.

 

   

We recorded an accrual for our estimated pro-rata share of VISA litigation related to Visa’s settlement with American Express ($3.9 million pre-tax) and its ongoing litigation with Discover ($1.2 million pre-tax).

 

   

Net income per diluted share was $1.05 in 2007, as compared to $1.59 per diluted share earned in 2006. The interest income reversal due to new non-accrual loans, provision for loan and lease losses and the VISA litigation accrual contributed to the significant decline in net income per diluted share.

SUMMARY OF CRITICAL ACCOUNTING POLICIES

The SEC defines “critical accounting policies” as those that require application of management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in future periods. Our significant accounting policies are described in Note 1 in the Notes to Consolidated Financial Statements in Item 8 of this report. Not all of these critical accounting policies require management to make difficult, subjective or complex judgments or estimates. Management believes that the following policies would be considered critical under the SEC’s definition.

Allowance for Loan and Lease Losses and Reserve for Unfunded Commitments

The Bank performs regular credit reviews of the loan and lease portfolio to determine the credit quality of the portfolio and the adherence to underwriting standards. When loans and leases are originated, they are assigned a risk rating from 1 to 10 that is

 

23


 

assessed periodically during the term of the loan through the credit review process. The 10 risk rating categories are a primary factor in determining an appropriate amount for the allowance for loan and lease losses. The Bank has a management ALLL Committee, which is responsible for, among other things, regular review of the ALLL methodology, including loss factors, and ensuring that it is designed and applied in accordance with generally accepted accounting principles. The ALLL Committee reviews loans that have been placed on non-accrual status and approves placing loans on impaired status. The ALLL Committee also approves removing loans that are no longer impaired from impairment and non-accrual status. The Bank’s Audit and Compliance Committee provides board oversight of the ALLL process and reviews and approves the ALLL methodology on a quarterly basis.

Each risk rating is assessed an inherent credit loss factor that determines the amount of the allowance for loan and lease losses provided for that group of loans and leases with similar risk rating. Credit loss factors may vary by region based on management’s belief that there may ultimately be different credit loss rates experienced in each region.

Regular credit reviews of the portfolio also identify loans that are considered potentially impaired. Potentially impaired loans are referred to the ALLL Committee which reviews and approves designated loans as impaired. A loan is considered impaired when based on current information and events, we determine that we will probably not be able to collect all amounts due according to the loan contract, including scheduled interest payments. When we identify a loan as impaired, we measure the impairment using discounted cash flows, except when the sole remaining source of the repayment for the loan is the liquidation of the collateral. In these cases, we use the current fair value of the collateral, less selling costs, instead of discounted cash flows. If we determine that the value of the impaired loan is less than the recorded investment in the loan, we recognize an impairment reserve as a specific component to be provided for in the allowance for loan and lease losses.

The combination of the risk rating-based allowance component and the impairment reserve allowance component lead to an allocated allowance for loan and lease losses. The Bank may also maintain an unallocated allowance amount to provide for other credit losses inherent in a loan and lease portfolio that may not have been contemplated in the credit loss factors. This unallocated amount generally comprises less than 5% of the allowance. The unallocated amount is reviewed periodically based on trends in credit losses, the results of credit reviews and overall economic trends.

The reserve for unfunded commitments (“RUC”) is established to absorb inherent losses associated with our commitment to lend funds, such as with a letter or line of credit. The adequacy of the ALLL and RUC are monitored on a regular basis and are based on management’s evaluation of numerous factors. These factors include the quality of the current loan portfolio; the trend in the loan portfolio’s risk ratings; current economic conditions; loan concentrations; loan growth rates; past-due and non-performing trends; evaluation of specific loss estimates for all significant problem loans; historical charge-off and recovery experience; and other pertinent information.

Management believes that the ALLL was adequate as of December 31, 2007. There is, however, no assurance that future loan losses will not exceed the levels provided for in the ALLL and could possibly result in additional charges to the provision for loan and lease losses. In addition, bank regulatory authorities, as part of their periodic examination of the Bank, may require additional charges to the provision for loan and lease losses in future periods if warranted as a result of their review. Approximately 79% of our loan portfolio is secured by real estate, and a significant decline in real estate market values may require an increase in the allowance for loan and lease losses. There has been deterioration in the northern California residential development market which has led to an increase in non-performing loans and allowance for loan and lease losses in the third and fourth quarters. A continued deterioration in this market may lead to additional charges to the provision for loan and lease losses.

Mortgage Servicing Rights

Retained mortgage servicing rights are measured at quoted market prices. Subsequent measurements are determined using a discounted cash flow model. The expected life of the loan can vary from management’s estimates due to prepayments by borrowers, especially when interest rates fall. Prepayments in excess of management’s estimates would negatively impact the recorded value of the mortgage servicing rights. The value of the mortgage servicing rights is also dependent upon the discount rate used in the model. Management reviews this rate on an ongoing basis based on current market rates. A significant increase in the discount rate would reduce the value of mortgage servicing rights.

 

24


Umpqua Holdings Corporation

 

Upon adoption of Statement of Financial Accounting Standards (“SFAS”) No. 156, Accounting for Servicing of Financial Assets an amendment of FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (“SFAS No. 156”) on January 1, 2007, the Company has elected to measure its residential mortgage servicing assets at fair value. Upon the change from the lower of cost or fair value accounting method to fair value accounting under SFAS No. 156, the calculation of amortization and the assessment of impairment were discontinued. Additional information is included in Note 7 of the Notes to Consolidated Financial Statements.

Valuation of Goodwill and Intangible Assets

At December 31, 2007, we had $764.9 million in goodwill and other intangible assets as a result of business combinations. Goodwill and other intangible assets with indefinite lives are not amortized but instead are periodically tested for impairment. Management performs an impairment analysis for the intangible assets with indefinite lives on a quarterly basis and determined that there was no impairment as of December 31, 2007. The valuation is determined 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 was deemed to exist, a write down of the asset would occur with a charge to earnings. The impairment analysis requires management to make subjective judgments. Events and factors that may significantly affect the estimates include, among others, competitive forces, customer behaviors and attrition, changes in revenue growth trends, cost structures, technology, changes in discount rates and specific industry and market conditions.

Stock-based Compensation

Effective January 1, 2006, we adopted the provisions of SFAS No. 123R, Share Based Payment, a revision to the previously issued guidance on accounting for stock options and other forms of equity-based compensation. SFAS No. 123R requires companies to recognize in the income statement the grant-date fair value of stock options and other equity-based forms of compensation issued to employees over the employees’ requisite service period (generally the vesting period). The requisite service period may be subject to performance conditions. The fair value of each option grant is estimated as of the grant date using the Black-Scholes option-pricing model. Management assumptions utilized at the time of grant impact the fair value of the option calculated under the Black-Scholes methodology, and ultimately, the expense that will be recognized over the life of the option. Additional information is included in Note 1 of the Notes to Consolidated Financial Statements.

Fair Value

Effective January 1, 2007, we adopted SFAS No. 157, Fair Value Measurements, which among other things, requires enhanced disclosures about financial instruments carried at fair value. SFAS No. 157 establishes a hierarchical disclosure framework associated with the level of pricing observability utilized in measuring financial instruments at fair value. The degree of judgment utilized in measuring the fair value of financial instruments generally correlates to the level of pricing observability. Financial instruments with readily available active quoted prices or for which fair value can be measured from actively quoted prices generally will have a higher degree of pricing observability and a lesser degree of judgment utilized in measuring fair value. Conversely, financial instruments rarely traded or not quoted will generally have little or no pricing observability and a higher degree of judgment utilized in measuring fair value. Pricing observability is impacted by a number of factors, including the type of financial instrument, whether the financial instrument is new to the market and not yet established and the characteristics specific to the transaction.

See Note 20 of the Notes to Consolidated Financial Statements for additional information about the level of pricing transparency associated with financial instruments carried at fair value.

RECENT ACCOUNTING PRONOUNCEMENTS

In December 2007, FASB issued SFAS No. 141 (revised), Business Combinations. SFAS No. 141R establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree and the goodwill acquired. SFAS No. 141R also establishes disclosure requirements to enable the evaluation of the nature and financial effects of the business combination. This statement applies prospectively to business combinations for which the acquisition date is on or after January 1, 2009. We are currently evaluating the impact of the adoption of SFAS No.141R.

 

25


 

In November 2007, the SEC issued Staff Accounting Bulletin No. 109, Written Loan Commitments Recorded at Fair Value through Earnings (“SAB 109”). SAB 109 provides guidance on the accounting for written loan commitments recorded at fair value under generally accepted accounting principles (“GAAP”). Specifically, the SAB revises the Staff’s views on incorporating expected net future cash flows related to loan servicing activities in the fair value measurement of a written loan commitment. SAB 109, which supersedes SAB 105, Application of Accounting Principles to Loan Commitments, requires the expected net future cash flows related to the associated servicing of the loan be included in the measurement of all written loan commitments that are accounted for at fair value through earnings. SAB 109 is effective on January 1, 2008 for the Company. Adoption of SAB 109 is not expected to have a material impact on the Company’s financial statements.

RESULTS OF OPERATIONS—OVERVIEW

For the year ended December 31, 2007, net income was $63.3 million, or $1.05 per diluted share, a decrease of 34% on a per diluted share basis compared to 2006. The decrease in net income in 2007 is principally attributable to increased provision for loan and lease losses and operating expenses, partially offset by increased net interest and non-interest income. We completed the acquisition of North Bay Bancorp on April 26, 2007, and the results of the acquired operations are only included in our financial results starting on April 27, 2007.

For the year ended December 31, 2006, net income was $84.4 million, or $1.59 per diluted share, an increase of 3% on a per diluted share basis over 2005. The improvement in diluted earnings per share for 2006 was principally attributable to improved net interest income, partially offset by increased operating expenses. We completed the acquisition of Western Sierra Bancorp on June 2, 2006 and the results of the acquired operations are only included in our financial results starting on June 3, 2006.

We incur significant expenses related to the completion and integration of mergers. Accordingly, we believe that our operating results are best measured on a comparative basis excluding the impact of merger-related expenses, net of tax. We define operating income as income before merger related expenses, net of tax, and we calculate operating income per diluted share by dividing operating income by the same diluted share total used in determining diluted earnings per share (see Note 21 of the Notes to Consolidated Financial Statements in Item 8 below). Operating income and operating income per diluted share are considered “non-GAAP” financial measures. Although we believe the presentation of non-GAAP financial measures provides a better indication of our operating performance, readers of this report are urged to review the GAAP results as presented in the Financial Statements and Supplementary Data in Item 8 below.

The following table presents a reconciliation of operating income and operating income per diluted share to net income and net income per diluted share for years ended December 31, 2007, 2006 and 2005:

Reconciliation of Operating Income to Net Income

Years Ended December 31,

(in thousands, except per share data)

 

      2007    2006    2005

Net income

   $63,268    $ 84,447    $ 69,735

Merger-related expenses, net of tax

   1,991      2,864      157
    

Operating income

   $65,259    $ 87,311    $ 69,892
    

Per diluted share:

        

Net income

   $    1.05    $ 1.59    $ 1.55

Merger-related expenses, net of tax

   0.03      0.06     
    

Operating income

   $    1.08    $ 1.65    $ 1.55
    

The following table presents the returns on average assets, average shareholders’ equity and average tangible shareholders’ equity for the years ended December 31, 2007, 2006 and 2005. For each of the years presented, the table includes the calculated ratios based on reported net income and operating income as shown in the table above. Our return on average

 

26


Umpqua Holdings Corporation

 

shareholders’ equity is negatively impacted as a result of capital required to support goodwill. To the extent this performance metric is used to compare our performance with other financial institutions that do not have merger-related intangible assets, we believe it beneficial to also consider the return on average tangible shareholders’ equity. The return on average tangible shareholders’ equity is calculated by dividing net income by average shareholders’ equity less average intangible assets. The return on average tangible shareholders’ equity is considered a non-GAAP financial measure and should be viewed in conjunction with the return on average shareholders’ equity.

Returns on Average Assets, Shareholders’ Equity and Tangible Shareholders’ Equity

For the Years Ended December 31,

(in thousands)

 

      2007     2006     2005  

RETURNS ON AVERAGE ASSETS:

      

Net income

     0.80%       1.31%       1.38%  

Operating income

     0.83%       1.35%       1.38%  

RETURNS ON AVERAGE SHAREHOLDERS’ EQUITY:

      

Net income

     5.17%       8.70%       9.80%  

Operating income

     5.34%       9.00%       9.82%  

RETURNS ON AVERAGE TANGIBLE SHAREHOLDERS’ EQUITY:

      

Net income

     13.08%       20.84%       22.91%  

Operating income

     13.50%       21.55%       22.96%  

CALCULATION OF AVERAGE TANGIBLE SHAREHOLDERS’ EQUITY:

      

Average shareholders’ equity

   $ 1,222,628     $ 970,394     $ 711,765  

Less: average intangible assets

     (739,086 )     (565,167 )     (407,313 )
        

Average tangible shareholders’ equity

   $    483,542     $ 405,227     $ 304,452  
        

NET INTEREST INCOME

Net interest income is the largest source of our operating income. Net interest income for 2007 was $286.0 million, an increase of $23.8 million, or 9% over 2006. Net interest income for 2006 was $262.1 million, an increase of $52.8 million, or 25% over 2005. The increase in net interest income in 2007 as compared to 2006 and 2006 as compared to 2005 is attributable to growth in outstanding average interest-earning assets, primarily loans and leases, partially offset by both growth in interest-bearing liabilities, primarily money-market and time deposits, and a decrease in net interest margin. In addition to organic growth, the North Bay merger, which was completed on April 26, 2007, and the Western Sierra merger, which was completed on June 2, 2006, contributed to the increase in interest-earning assets and interest-bearing liabilities in 2007 over 2006 and 2006 over 2005. The fair value of interest-earning assets acquired as a result of the North Bay merger totaled $523.5 million, and interest-bearing liabilities totaled $572.2 million. The fair value of interest-earning assets acquired as a result of the Western Sierra merger totaled $1.1 billion, and interest-bearing liabilities totaled $1.1 billion.

The net interest margin (net interest income as a percentage of average interest-earning assets) on a fully tax-equivalent basis was 4.24% for 2007, a decrease of 50 basis points as compared to the same period in 2006. The decrease in net interest margin in 2007 resulted from volatility in short-term market rates and the competitive climate (characterized by increasing deposit costs combined with declining interest earning asset yields), as well as interest reversals on new nonaccrual loans.

The net interest margin on a fully tax-equivalent basis was 4.74% for 2006, a decrease of 10 basis points as compared to 2005. This decrease is primarily due to increases in short-term market rates which led to an increase in deposit and borrowing costs. The increased yield on interest-earning assets of 81 basis points in 2006, was more than offset by a corresponding increase in our cost of interest-earning assets which increased by 91 basis points in 2006.

 

27


 

Our net interest income is affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities, changes in volume, as well as changes in the yields earned on interest-earning assets and rates paid on deposits and borrowed funds, or rates. The following table presents condensed average balance sheet information, together with interest income and yields on average interest-earning assets, and interest expense and rates paid on average interest-bearing liabilities for the years ended December 31, 2007, 2006 and 2005:

Average Rates and Balances

(dollars in thousands)

 

    2007     2006     2005  
     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
 

INTEREST-EARNING ASSETS:

                 
Loans and leases(1)   $5,836,980   $ 443,939   7.61 %   $4,818,884   $ 372,201   7.72 %   $3,628,548   $ 251,715   6.94 %
Taxable securities   743,266     35,216   4.74 %   607,267     27,655   4.55 %   613,748     26,432   4.31 %

Non-taxable securities(2)

  149,291     8,234   5.52 %   97,723     5,559   5.69 %   62,931     3,872   6.15 %

Temporary investments(3)

  68,297     3,415   5.00 %   45,745     2,203   4.82 %   48,469     1,484   3.06 %
                 

Total interest earning assets

  6,797,834     490,804   7.22 %   5,569,619     407,618   7.32 %   4,353,696     283,503   6.51 %

Allowance for loan and lease losses

  (70,177)       (52,801)       (44,866)    

Other assets

  1,169,911       934,842       744,587    
                       

Total assets

  $7,897,568       $6,451,660       $5,053,417    
                       

INTEREST-BEARING LIABILITIES:

               

Interest-bearing checking and savings accounts

  $3,136,738   $ 93,070   2.97 %   $2,483,155   $ 62,254   2.51 %   $2,041,090   $ 30,343   1.49 %

Time deposits

  1,849,910     87,770   4.74 %   1,399,623     57,627   4.12 %   993,215     29,235   2.94 %

Securities sold under agreements to repurchase and federal funds purchased

  65,660     2,135   3.25 %   166,831     6,829   4.09 %   86,201     2,207   2.56 %

Term debt

  57,479     2,642   4.60 %   58,684     2,892   4.93 %   31,161     659   2.11 %

Junior subordinated debentures

  221,833     16,821   7.58 %   187,994     14,215   7.56 %   165,981     10,550   6.36 %
                 

Total interest-bearing liabilities

  5,331,620     202,438   3.80 %   4,296,287     143,817   3.35 %   3,317,648     72,994   2.20 %

Non-interest-bearing deposits

  1,263,873       1,121,171       967,848    

Other liabilities

  79,447       63,808       56,156    
                       

Total liabilities

  6,674,940       5,481,266       4,341,652    

Shareholders’ equity

  1,222,628       970,394       711,765    
                       

Total liabilities and shareholders’ equity

  $7,897,568       $6,451,660       $5,053,417    
                       

NET INTEREST INCOME(2)

    $ 288,366       $ 263,801       $ 210,509  
                             

NET INTEREST SPREAD

      3.42 %       3.97 %       4.31 %

AVERAGE YIELD ON EARNING ASSETS(1),(2)

      7.22 %       7.32 %       6.51 %

INTEREST EXPENSE TO EARNING ASSETS

      2.98 %       2.58 %       1.67 %
                             

NET INTEREST INCOME TO EARNING ASSETS OR NET INTEREST MARGIN(1),(2)

      4.24 %       4.74 %       4.84 %
                             

 

(1) Non-accrual loans and mortgage loans held for sale are included in average balance.

 

28


Umpqua Holdings Corporation

 

(2) Tax-exempt income has been adjusted to a tax equivalent basis at a 35% tax rate. The amount of such adjustment was an addition to recorded income of approximately $2.4 million, $1.7 million and $1.2 million in the years ended December 31, 2007, 2006 and 2005, respectively.
(3) Temporary investments include federal funds sold and interest-bearing deposits at other banks.

The following table sets forth a summary of the changes in tax equivalent net interest income due to changes in average asset and liability balances (volume) and changes in average rates (rate) for 2007 compared to 2006 and 2006 compared to 2005. Changes in tax equivalent interest income and expense, which are not attributable specifically to either volume or rate, are allocated proportionately between both variances.

Rate/Volume Analysis

(in thousands)

 

     2007 COMPARED TO 2006    2006 COMPARED TO 2005
     INCREASE (DECREASE) IN INTEREST
INCOME AND EXPENSE DUE TO
CHANGES IN
   INCREASE (DECREASE) IN INTEREST
INCOME AND EXPENSE DUE TO
CHANGES IN
      VOLUME    RATE    TOTAL    VOLUME    RATE    TOTAL

INTEREST-EARNING ASSETS:

                 

Loans and leases

   $77,514    $ (5,776)    $ 71,738    $ 89,533    $ 30,953    $ 120,486

Taxable securities

   6,406      1,155      7,561      (281)      1,504      1,223

Non-taxable securities(1)

   2,849      (174)      2,675      1,998      (311)      1,687

Temporary investments

   1,125      87      1,212      (87)      806      719
    

Total(1)

   87,894      (4,708)      83,186      91,163      32,952      124,115

INTEREST-BEARING LIABILITIES:

                 

Interest-bearing checking and savings accounts

   18,157      12,659      30,816      7,654      24,257      31,911

Time deposits

   20,457      9,686      30,143      14,378      14,014      28,392

Securities sold under agreements to repurchase and federal funds purchased

   (3,506)      (1,188)      (4,694)      2,817      1,805      4,622

Term debt

   (58)      (192)      (250)      891      1,342      2,233

Junior subordinated debentures

   2,566      40      2,606      1,508      2,157      3,665
    

Total

   37,616      21,005      58,621      27,248      43,575      70,823
    

Net increase in net interest income(1)

   $50,278    $ (25,713)    $ 24,565    $ 63,915    $ (10,623)    $ 53,292
    

 

(1) Tax exempt income has been adjusted to a tax equivalent basis at a 35% tax rate.

PROVISION FOR LOAN AND LEASE LOSSES

The provision for loan and lease losses was $41.7 million for 2007, compared to $2.6 million for 2006. As a percentage of average outstanding loans, the provision for loan losses recorded for 2007 was 0.72%, an increase of 67 basis points and 65 basis points from 2006 and 2005, respectively.

The increase in the provision for loan and lease losses in 2007 as compared to 2006 and 2005 is principally attributable to an increase in non-performing loans and leases related primarily to the housing market downturn and its impact on our residential development portfolio, growth in the loan and lease portfolio and the increase in loans charged off in 2007. Within the allowance for credit losses, the Company has identified $9.9 million of impairment reserve related to $81.3 million of non-accrual loans, which are specifically measured for impairment. The net increase in impairment reserve, combined with downgrades within the portfolio related primarily to residential development, led to the $41.7 million provision for loan and leases losses during 2007. The provision for loan losses is expected to cover subsequent charge-offs on these non-performing loans.

 

29


 

The provision for 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 loan and lease losses. Additional discussion on loan quality and the allowance for loan and lease losses is provided under the heading Asset Quality and Non-Performing Assets below.

NON-INTEREST INCOME

Non-interest income in 2007 was $64.8 million, an increase of $11.2 million, or 21%, over 2006. Non-interest income in 2006 was $53.6 million, an increase of $5.8 million, or 12%, over 2005. The following table presents the key components of non-interest income for years ended December 31, 2007, 2006 and 2005:

Non-Interest Income

Years Ended December 31,

(in thousands)

 

     2007 compared to 2006    2006 compared to 2005
      2007    2006    Change
Amount
   Change
Percent
   2006    2005    Change
Amount
   Change
Percent

Service charges on deposit accounts

   $32,126    $ 26,975    $ 5,151    19%    $26,975    $ 21,697    $ 5,278    24%

Brokerage commissions and fees

   10,038      9,649      389    4%    9,649      11,317      (1,668)    –15%

Mortgage banking revenue, net

   7,791      7,560      231    3%    7,560      6,426      1,134    18%

Net (loss) gain on sale of investment securities

   (13)      (21)      8    -38%    (21)      1,439      (1,460)    NM

Other income

   14,883      9,434      5,449    58%    9,434      6,903      2,531    37%
               

Total

   $64,825    $ 53,597    $ 11,228    21%    $53,597    $ 47,782    $ 5,815    12%
               

NM—Not meaningful

The increase in deposit service charges in 2007 over 2006 is principally attributable to the increased volume of deposit accounts. The increase in brokerage commissions and fees in 2007 over 2006 resulted from management’s efforts to recruit new brokers, increase the weighting of managed fee sources and increase efficiencies in back room operations. The increase in other income over 2006 was primarily related to a gain of $4.9 million in 2007 resulting from the change in fair value of the junior subordinated debentures recorded at fair value and a $909,000 gain on sale of excess property. Additional information regarding the fair value election for the junior subordinated debentures is included in Note 15 of the Notes to Consolidated Financial Statements.

The increase in deposit service charges in 2006 over 2005 is principally attributable to the increased volume of deposit accounts as a result of the Western Sierra acquisition. The decrease in brokerage commissions and fees in 2006 over 2005 resulted from the departure of certain Strand investment advisors. The remaining increase in other non-interest income resulted primarily from increased revenue related to the Western Sierra acquisition.

NON-INTEREST EXPENSE

Non-interest expense for 2007 was $214.1 million, an increase of $32.2 million or 18% compared to 2006. Non-interest expense for 2006 was $181.9 million, an increase of $34.9 million or 24% compared to 2005. The following table presents the key elements of non-interest expense for the years ended December 31, 2007, 2006 and 2005.

 

30


Umpqua Holdings Corporation

 

Non-Interest Expense

Years Ended December 31,

(in thousands)

 

     2007 compared to 2006    2006 compared to 2005
      2007    2006    Change
Amount
   Change
Percent
   2006    2005    Change
Amount
   Change
Percent

Salaries and employee benefits

   $112,864    $ 98,840    $ 14,024    14%    $  98,840    $ 82,467    $ 16,373    20%

Net occupancy and equipment

   35,785      31,752      4,033    13%    31,752      24,693      7,059    29%

Communications

   7,202      6,352      850    13%    6,352      5,841      511    9%

Marketing

   5,554      5,760      (206)    –4%    5,760      4,564      1,196    26%

Services

   18,564      15,951      2,613    16%    15,951      13,245      2,706    20%

Supplies

   3,627      2,994      633    21%    2,994      2,706      288    11%

Intangible amortization

   6,094      3,728      2,366    63%    3,728      2,430      1,298    53%

Merger-related expenses

   3,318      4,773      (1,455)    –30%    4,773      262      4,511    NM

Other

   21,110      11,799      9,311    79%    11,799      10,848      951    9%
               

Total

   $214,118    $ 181,949    $ 32,169    18%    $181,949    $ 147,056    $ 34,893    24%
               

NM—Not meaningful

The increase in non-interest expense in 2007 over 2006 and 2006 over 2005 is primarily attributable to the inclusion of expenses from California operations as a result of the North Bay and Western Sierra acquisitions. Salaries and employee benefits have continued to increase due to increased incentives, benefit costs, additional staff at new stores, and primarily the addition of approximately 110 associates in April 2007 due to the North Bay acquisition and approximately 250 associates in June 2006 due to the Western Sierra acquisition. Net occupancy and equipment also continues to increase reflecting 10 new banking locations as a result of the North Bay acquisition in April 2007, 31 new banking locations as a result of Western Sierra acquisition in June 2006 and the addition of three de novo branches in 2007 and seven in 2006. The increase in services expense was primarily due to increased escrow accounting fees and higher consulting fees. The increase in intangible amortization is due to the increase in core deposit and other intangibles as a result of the Western Sierra and North Bay acquisitions.

Other expenses in 2007 included a $5.1 million charge for Visa litigation. In November 2007, Visa Inc. announced that it had reached a settlement with American Express related to an antitrust lawsuit. Umpqua Bank and other Visa member banks are obligated to fund the settlement and share in losses resulting from this litigation.

In the fourth quarter of 2007, we recorded a liability and corresponding expense of approximately $3.9 million pre-tax, for our proportionate share of that settlement.

In addition, Visa notified us that it had established a contingency reserve related to unsettled litigation with Discover Card. In connection with this contingency, we recorded, in the fourth quarter of 2007, a liability and corresponding expense of $1.2 million pre-tax, for our proportionate share of that contingent liability. We are not a party to the Visa litigation and our liability arises solely from the Bank’s membership interest in Visa, Inc.

Previously, Visa Inc. announced that it completed restructuring transactions in preparation for an initial public offering of its Class A stock planned for early 2008, and, as part of those transactions, Umpqua Bank’s membership interest in Visa was exchanged for Class B stock of Visa, Inc. In connection with Visa’s planned offering, it is expected that a portion of the Class B shares will be redeemed for cash, with the remaining shares to be converted to Class A shares three years after the offering or upon settlement of certain covered litigation, whichever is later. Visa is expected to set aside a portion of the proceeds from the offering to fund the American Express settlement and other litigation judgments or settlements that may occur.

In connection with the announced American Express settlement, and in consideration of accounting guidance that we have been informed was provided by the Securities and Exchange Commission, we currently anticipate that our proportionate share

 

31


 

of the proceeds of the planned initial public offering by Visa will more than offset any liabilities related to the Visa litigation, and no cash payments from Umpqua will be made in settlement of this liability.

We also incur significant expenses in connection with the completion and integration of bank acquisitions that are not capitalizable. Classification of expenses as merger-related is done in accordance with the provisions of a Board-approved policy. The decrease in merger-related expenses in 2007 over 2006 and the increase in 2006 over 2005 is due to the difference in timing and size of the Western Sierra and North Bay mergers.

The following table presents the merger-related expenses by major category for the years ended December 31, 2007, 2006 and 2005. Substantially all of the merger-related expense for 2007 and 2006 were related to the North Bay and Western Sierra acquisitions, respectively. We do not expect to incur any additional merger-related expenses in connection with the North Bay, Western Sierra or any other previous merger.

Merger-Related Expense

Years Ended December 31,

(in thousands)

 

      2007    2006    2005

Professional fees

   $   982    $ 1,082    $ 211

Compensation and relocation

   1,077      778     

Communications

   478      854     

Premises and equipment

   188      375      (65)

Other

   593      1,684      116
    

Total

   $3,318    $ 4,773    $ 262
    

INCOME TAXES

Our consolidated effective tax rate as a percentage of pre-tax income for 2007 was 33.4%, compared to 35.6% for 2006 and 35.2% for 2005. The effective tax rates were below the federal statutory rate of 35% and the apportioned state rate of 5% (net of the federal tax benefit) principally because of non-taxable income arising from bank-owned life insurance, income on tax-exempt investment securities, tax credits arising from low income housing investments, Business Energy tax credits and exemptions related to loans and hiring in designated enterprise zones.

Additional information on income taxes is provided in Note 10 of the Notes to Consolidated Financial Statements in Item 8 below.

FINANCIAL CONDITION

INVESTMENT SECURITIES

The composition of our investment securities portfolio reflects management’s investment strategy of maintaining an appropriate level of liquidity while providing a relatively stable source of interest income. The investment securities portfolio also mitigates interest rate and credit risk inherent in the loan portfolio, while providing a vehicle for the investment of available funds, a source of liquidity (by pledging as collateral or through repurchase agreements) and collateral for certain public funds deposits.

Trading securities consist of securities held in inventory by Strand for sale to its clients and securities invested in trust for former employees of acquired institutions as required by agreements. Trading securities were $2.8 million at December 31, 2007, as compared to $4.2 million at December 31, 2006. This decrease is principally attributable to a decrease in Strand’s inventory of trading securities.

Investment securities available for sale were $1.1 billion as of December 31, 2007, as compared to $715.2 million at December 31, 2006. This increase is principally attributable to the North Bay acquisition ($85.6 million of investment securities as of the acquisition date) and purchases of $372.2 million of investment securities, partially offset by sales and maturities of $137.5 million of investment securities available for sale and an increase in fair value of investment securities available for sale of $15.1 million.

 

32


Umpqua Holdings Corporation

 

Investment securities held to maturity were $6.0 million as of December 31, 2007, as compared to $8.8 million at December 31, 2006. This decrease is principally attributable to sales and maturities of investment securities held to maturity.

Investment securities for each of the last three years are as follows:

Summary of Investment Securities

As of December 31,

(in thousands)

 

     December 31,  
      2007    2006    2005  

AVAILABLE-FOR-SALE:

        

U.S. Treasury and agencies

   $    158,432    $ 193,134    $ 196,538  

Mortgage-backed securities and collateralized mortgage obligations

     672,344      362,882      359,583  

Obligations of states and political subdivisions

     169,994      110,219      67,836  

Other debt securities

     967      973       

Investments in mutual funds and other equity securities

     49,019      47,979      47,911  
        
     $1,050,756    $ 715,187    $ 671,868  
        

HELD-TO-MATURITY:

        

Obligations of states and political subdivisions

   $ 5,403    $ 8,015    $ 8,302  

Mortgage-backed securities and collateralized mortgage obligations

     227      372       

Other investment securities

     375      375      375  
        
     $       6,005    $ 8,762    $ 8,677  
        

 

33


 

The following table presents information regarding the amortized cost, fair value, average yield and maturity structure of the investment portfolio at December 31, 2007.

Investment Securities Composition*

December 31, 2007

(in thousands)

 

      Amortized
Cost
   Fair
Value
    Average
Yield
 

U.S. TREASURY AND AGENCIES

       

One year or less

   $   73,187    $ 72,875     3.60 %

One to five years

     85,632      85,557     4.23 %
          
     158,819      158,432     3.94 %

OBLIGATIONS OF STATES AND POLITICAL SUBDIVISIONS:

       

One year or less

     9,962      10,057     3.92 %

One to five years

     53,363      53,651     3.77 %

Five to ten years

     107,498      107,616     3.89 %

Over ten years

     4,024      4,093     4.39 %
          
     174,847      175,417     3.87 %

OTHER DEBT SECURITIES

       

One to five years

     526      487     7.33 %

Over ten years

     500      480     9.00 %
          
     1,026      967     8.16 %

Serial Maturities

     670,342      672,572     5.75 %

Other investment securities

     52,371      49,394     5.00 %
          

Total securities

     $1,057,405    $ 1,056,782     5.13 %
          

*Weighted average yields are stated on a federal tax-equivalent basis of 35%. Weighted average yields for available-for-sale investments have been calculated on an amortized cost basis.

The mortgage-related securities in “Serial Maturities” in the table above include both pooled mortgage-backed issues and high-quality collaterized mortgage obligation structures, with an average duration of 4.9 years. These mortgage-related securities provide yield spread to U.S. Treasury or agency securities; however, the cash flows arising from them can be volatile due to refinancing of the underlying mortgage loans.

Equity securities in “Other Investment Securities” in the table above at December 31, 2007 consisted principally of investments in two mutual funds comprised largely of mortgage-related securities, although the funds may also invest in U.S. government or agency securities, bank certificates of deposit insured by the FDIC or repurchase agreements.

Because the Bank has the ability and intent to hold these investments until a market price recovery or to maturity, none of the investment securities are considered other than temporarily impaired. Additional information about the investment securities portfolio is provided in Note 4 of the Notes to Consolidated Financial Statements in Item 8 below.

LOANS AND LEASES

Total loans and leases outstanding at December 31, 2007 were $6.1 billion, an increase of $693.8 million, or 13%, from year-end 2006. The growth in loans was due to the North Bay acquisition ($443.0 million of loans as of the acquisition date) and organic loan growth of $250.8 million, or 5%, primarily in the Oregon/Washington region.

The Bank provides a wide variety of credit services to its customers, including construction loans, commercial lines of credit, secured and unsecured commercial loans, commercial real estate loans, residential mortgage loans, home equity credit lines, consumer loans and commercial leases. Loans are principally made on a secured basis to customers who reside, own property or operate businesses within the Bank’s principal market area.

 

34


Umpqua Holdings Corporation

 

The following table presents the composition of the loan portfolio as of December 31 for each of the last five years:

Loan Portfolio Composition

As of December 31,

(in thousands)

 

    2007     2006     2005     2004     2003  
Type of Loan   Amount     Percentage     Amount     Percentage     Amount     Percentage     Amount     Percentage     Amount     Percentage  

Real estate secured loans:

                   

Construction

  $ 1,202,173     19.9 %   $ 1,189,090     22.2 %   $ 638,555     16.3 %   $ 481,836     13.9 %   $ 232,792     11.6 %

Mortgage

    582,771     9.6 %     523,715     9.8 %     427,877     10.9 %     445,976     12.9 %     259,316     12.9 %

Commercial and agricultural

    3,012,743     49.7 %     2,649,468     49.4 %     2,019,623     51.5 %     1,700,634     49.0 %     854,588     42.7 %
       

Total real estate loans

    4,797,687     79.2 %     4,362,273     81.4 %     3,086,055     78.7 %     2,628,446     75.8 %     1,346,696     67.2 %

Commercial and agricultural

    1,169,939     19.3 %     924,917     17.2 %     753,131     19.3 %     733,876     21.2 %     566,092     28.3 %

Leases

    40,207     0.7 %     22,870     0.4 %     17,385     0.4 %     18,351     0.5 %     10,918     0.5 %

Installment and other

    59,091     1.0 %     63,262     1.2 %     76,128     1.9 %     98,406     2.8 %     86,787     4.3 %

Deferred loan fees, net

    (11,289 )   –0.2 %     (11,460 )   –0.2 %     (11,068 )   –0.3 %     (11,175 )   –0.3 %     (6,906 )   –0.3 %
       

Total loans

  $ 6,055,635     100.0 %   $ 5,361,862     100.0 %   $ 3,921,631     100.0 %   $ 3,467,904     100.0 %   $ 2,003,587     100.0 %
       

The following table presents the concentration distribution of our loan portfolio by major type:

Loan Concentrations

As of December 31, 2007 and 2006

(in thousands)

 

     2007     2006  
      Amount     Percentage     Amount     Percentage  

Construction and land development

   $ 1,202,173     19.9 %   $ 1,189,090     22.2 %

Farmland

     94,687     1.6 %     77,283     1.4 %

Home equity credit lines

     196,895     3.3 %     152,962     2.9 %

Single family first lien mortgage

     200,570     3.3 %     178,159     3.3 %

Single family second lien mortgage

     29,451     0.5 %     30,554     0.6 %

Multifamily

     155,855     2.6 %     162,040     3.0 %

Commercial real estate

     2,918,056     48.0 %     2,572,185     48.0 %
        

Total real estate secured

     4,797,687     79.2 %     4,362,273     81.4 %

Commercial and industrial

     1,108,774     18.3 %     874,264     16.3 %

Agricultural production

     61,165     1.0 %     50,653     0.9 %

Consumer

     37,865     0.6 %     42,417     0.8 %

Leases

     40,207     0.7 %     22,870     0.4 %

Other

     21,226     0.4 %     20,845     0.4 %

Deferred loan fees, net

     (11,289 )   -0.2 %     (11,460 )   -0.2 %
        

Total loans

   $ 6,055,635     100.0 %   $ 5,361,862     100.0 %
        

 

35


 

Commercial, agriculture and construction loans are the most sensitive to interest rate changes. The following table presents the maturity distribution of our commercial and construction loan portfolios and the sensitivity of these loans to changes in interest rates as of December 31, 2007:

Maturities and Sensitivities of Loans to Changes in Interest Rates

(in thousands)

 

     By Maturity    Loans Over One Year
by Rate Sensitivity
      One Year
or Less
   One Through
Five Years
   Over Five
Years
   Total    Fixed
Rate
   Floating
Rate

Commercial and Agriculture

   $   504,314    $ 446,597    $ 219,028    $ 1,169,939      324,035    $ 341,590

Real Estate—construction

   980,332      134,031      87,810      1,202,173      87,728      134,113
    
   $1,484,646    $ 580,628    $ 306,838    $ 2,372,112    $ 411,763    $ 475,703
    

ASSET QUALITY AND NON-PERFORMING ASSETS

We manage asset quality and control credit risk through diversification of the loan portfolio and the application of policies designed to promote sound underwriting and loan monitoring practices. The Bank’s Credit Quality Group is charged with monitoring asset quality, establishing credit policies and procedures and enforcing the consistent application of these policies and procedures across the Bank. The provision for loan and lease losses charged to earnings is based upon management’s judgment of the amount necessary to maintain the allowance at a level adequate to absorb probable incurred losses. The amount of provision charge is dependent upon many factors, including loan growth, net charge-offs, changes in the composition of the loan portfolio, delinquencies, management’s assessment of loan portfolio quality, general economic conditions that can impact the value of collateral, and other trends. The evaluation of these factors is performed through an analysis of the adequacy of the allowance for loan and lease losses. Reviews of non-performing, past due loans and larger credits, designed to identify potential charges to the allowance for loan and lease losses, and to determine the adequacy of the allowance, are conducted on a quarterly basis. These reviews consider such factors as the financial strength of borrowers, the value of the applicable collateral, loan loss experience, estimated loan losses, growth in the loan portfolio, prevailing economic conditions and other factors. Additional information regarding the methodology used in determining the adequacy of the allowance for loan and lease losses is contained in Part I Item 1 of this report in the section titled Lending and Credit Functions.

Non-performing loans, which include non-accrual loans and accruing loans past due over 90 days totaled $91.1 million or 1.50% of total loans as of December 31, 2007, as compared to $9.1 million, or 0.17% of total loans, at December 31, 2006. Non-performing assets, which include non-performing loans and foreclosed real estate (“other real estate owned”), totaled $98.0 million, or 1.18% of total assets as of December 31, 2007, compared with $9.1 million, or 0.12% of total assets as of December 31, 2006. The increase in non-performing assets in 2007 related primarily to the housing market downturn and its impact on our residential development portfolio.

Loans are classified as non-accrual when collection of principal or interest is doubtful—generally if they are past due as to maturity or payment of principal or interest by 90 days or more—unless such loans are well-secured and in the process of collection. Additionally, all loans that are “impaired” in accordance with SFAS No. 114, Accounting by Creditors for the Impairment of a Loan, are considered for non-accrual status. These loans will typically remain on non-accrual status until all principal and interest payments are brought current and the prospects for future payments in accordance with the loan agreement appear relatively certain. Foreclosed properties held as other real estate owned are recorded at the lower of the recorded investment in the loan or market value of the property less expected selling costs. Other real estate owned at December 31, 2007 totaled $6.9 million and consisted of nine properties.

 

36


Umpqua Holdings Corporation

 

The following table summarizes our non-performing assets as of December 31 for each of the last five years.

Non-Performing Assets

As of December 31,

(in thousands)

 

      2007     2006     2005     2004     2003  

Loans on nonaccrual status

     $81,317     $ 8,629     $ 5,953     $ 21,836     $ 10,498  

Loans past due 90 days or more and accruing

     9,782       429       487       737       927  
        

Total non-performing loans

     91,099       9,058       6,440       22,573       11,425  

Other real estate owned

     6,943             1,123       979       2,529  
        

Total non-performing assets

   $ 98,042     $ 9,058     $ 7,563     $ 23,552     $ 13,954  
        

Allowance for loan and lease losses

     $84,904     $ 60,090     $ 43,885     $ 44,229     $ 25,352  

Reserve for unfunded commitments

     1,182       1,313       1,601       1,338        
        

Allowance for credit losses

     $86,086     $ 61,403     $ 45,486     $ 45,567     $ 25,352  
        

ASSET QUALITY RATIOS:

          

Non-performing assets to total assets

     1.18 %     0.12 %     0.14 %     0.48 %     0.47 %

Non-performing loans to total loans

     1.50 %     0.17 %     0.16 %     0.65 %     0.57 %

Allowance for loan and lease losses to total loans

     1.40 %     1.12 %     1.12 %     1.28 %     1.27 %

Allowance for credit losses to total loans

     1.42 %     1.15 %     1.16 %     1.31 %     1.27 %

Allowance for credit losses to total non-performing loans

     94 %     678 %     706 %     202 %     222 %

At December 31, 2007, there were no loans classified as restructured as compared to $8.0 million at December 31, 2006. The restructurings were granted in response to borrower financial difficulty, and generally provide for a temporary modification of loan repayment terms. Substantially all of the restructured loans as of December 31, 2006 were classified as impaired. No restructured loans were included as non-accrual loans in the table above at December 31, 2007 and 2006.

A decline in the economic conditions in our general market areas or other factors could adversely impact individual borrowers or the loan portfolio in general. Accordingly, there can be no assurance that loans will not become 90 days or more past due, become impaired or placed on non-accrual status, restructured or transferred to other real estate owned in the future.

Additional information about the loan portfolio is provided in Note 5 of the Notes to Consolidated Financial Statements in Item 8 below.

ALLOWANCE FOR LOAN AND LEASE LOSSES AND RESERVE FOR UNFUNDED COMMITMENTS

The allowance for loan and lease losses (“ALLL”) totaled $84.9 million and $60.1 million at December 31, 2007 and 2006, respectively. The increase in the allowance for loan and lease losses as of December 31, 2007 is principally attributable to an increase in provision for loan and lease losses in excess of charge-offs.

 

37


 

The following table sets forth the allocation of the allowance for loan and lease losses:

Allowance for loan and lease losses Composition

As of December 31,

(in thousands)

 

      2007    2006    2005    2004    2003

Commercial

   $19,513    $ 14,161    $ 11,230    $ 12,334    $ 11,091

Real estate

   60,840      44,179      30,137      29,464      12,689

Loans to individuals and overdrafts

   504      603      669      1,126      1,225

Unallocated

   4,047      1,147      1,849      1,305      347
    

Allowance for loan and lease losses

   $84,904    $ 60,090    $ 43,885    $ 44,229    $ 25,352
    

The unallocated portion of ALLL provides for coverage of credit losses inherent in the loan portfolio but not provided for in other components of ALLL analysis, and acknowledges the inherent imprecision of all loss prediction models. The increase in unallocated ALLL resulted from management’s evaluation of existing general business and economic conditions, and declining credit quality and collateral value trends in the residential housing segment. Additionally the ALLL composition should not be interpreted as an indication of specific amounts or loan categories in which future charge-offs may occur.

The following table provides a summary of activity in the ALLL by major loan type for each of the five years ended December 31:

Activity in the Allowance for loan and lease losses

Years Ended December 31,

(in thousands)

 

      2007    2006    2005    2004    2003

Balance at beginning of year

   $ 60,090    $ 43,885    $ 44,229    $ 25,352    $ 24,731

Loans charged off:

              

Real estate

   (21,340)      (734)      (132)      (42)      (15)

Commercial

   (2,030)      (2,135)      (6,538)      (5,244)      (5,429)

Consumer and other

   (1,360)      (1,336)      (1,082)      (1,143)      (633)
    

Total loans charged off

   (24,730)      (4,205)      (7,752)      (6,429)      (6,077)

Recoveries:

              

Real Estate

   1,250      897      32      292      123

Commercial

   785      1,916      4,344      1,292      1,761

Consumer and other

   701      818      564      360      264
    

Total recoveries

   2,736      3,631      4,940      1,944      2,148
    

Net charge-offs

   (21,994)      (574)      (2,812)      (4,485)      (3,929)

Addition incident to mergers

   5,078      14,227           17,257     

Reclassification(1)

                  (1,216)     

Provision charged to operations

   41,730      2,552      2,468      7,321      4,550
    

Balance at end of year

   $ 84,904    $ 60,090    $ 43,885    $ 44,229    $ 25,352
    

Ratio of net charge-offs to average loans

   0.38%      0.01%      0.08%      0.17%      0.21%

Ratio of provision to average loans

   0.72%      0.05%      0.07%      0.27%      0.24%

Recoveries as a percentage of charge-offs

   11%      86%      64%      30%      35%

 

(1) Reflects amount of allowance related to unfunded commitments, which was reclassified during the third quarter of 2004.

 

38


Umpqua Holdings Corporation

 

The significant increase in real estate loans charged off over previous years was due to significant slowdown in the housing industry which primarily affected our Northern California residential development portfolio.

The following table presents a summary of activity in the reserve for unfunded commitments (“RUC”):

Summary of Reserve for Unfunded Commitments Activity

Years Ended December 31,

(in thousands)

 

      2007      2006      2005

Balance, beginning of year

   $1,313      $ 1,601      $ 1,338

Acquisition

   134        382       

Net (decrease) increase charged to other expenses

   (265 )      (670 )      263
    

Balance, end of year

   $1,182      $ 1,313      $ 1,601
    

We believe that the ALLL and RUC at December 31, 2007 are sufficient to absorb losses inherent in the loan portfolio and credit commitments outstanding as of that date, respectively, based on the best information available. This assessment, based in part on historical levels of net charge-offs, loan growth, and a detailed review of the quality of the loan portfolio, involves uncertainty and judgment; therefore, the adequacy of the ALLL and RUC cannot be determined with precision and may be subject to change in future periods. In addition, bank regulatory authorities, as part of their periodic examination of the Bank, may require additional charges to the provision for loan and lease losses in future periods if warranted as a result of their review.

MORTGAGE SERVICING RIGHTS

The following table presents the key elements of our mortgage servicing rights asset as of December 31, 2007, 2006 and 2005:

Summary of Mortgage Servicing Rights

Years Ended December 31,

(in thousands)

 

      2007    2006    2005

Balance, beginning of year(1)

   $    9,952    $ 10,890    $ 11,154

Additions for new mortgage servicing rights capitalized

   892      1,487      3,318

Changes in fair value:

        

Due to changes in model inputs or assumptions(2)

   595          

Other(3)

   (1,351)          

Amortization of servicing rights

        (1,198)      (2,000)

Impairment charge

        (1,227)      (1,582)
    

Balance, end of year

   $  10,088    $ 9,952    $ 10,890
    

Balance of loans serviced for others

   $870,680    $ 955,444    $ 1,016,092

MSR as a percentage of serviced loans

   1.16%      1.04%      1.07%

 

(1) Represents fair value as of December 31, 2006 and amortized cost as of December 31, 2005 and 2004.
   The fair value as of December 31, 2005 and 2004 was $10.9 million and $11.5 million, respectively.

 

(2) Principally reflects changes in discount rates and prepayment speed assumptions, which are primarily affected by changes in interest rates.

 

(3) Represents changes due to collection/realization of expected cash flows over time.

As of December 31, 2007, we serviced residential mortgage loans for others with an aggregate outstanding principal balance of $870.7 million for which servicing assets have been recorded. Prior to the adoption of SFAS No.156 on January 1, 2007, the servicing asset recorded at the time of sale was amortized over the term of, and in proportion to, net servicing revenues. Subsequent to adoption, the mortgage servicing rights are adjusted to fair value quarterly with the change recorded in mortgage banking revenue.

 

39


 

The value of mortgage servicing rights is impacted by market rates for mortgage loans. Historically low market rates can cause prepayments to increase as a result of refinancing activity. To the extent loans are prepaid sooner than estimated at the time servicing assets are originally recorded, it is possible that certain mortgage servicing rights assets may decrease in value. Generally, the fair value of our mortgage servicing rights will increase as market rates for mortgage loans rise and decrease if market rates fall. We have started hedging the fair value change of the MSR portfolio starting in the fourth quarter of 2007 with a goal of minimizing the volatility to earnings.

GOODWILL AND OTHER INTANGIBLE ASSETS

At December 31, 2007, we had goodwill and other intangible assets of $723.3 million and $41.6 million, respectively, as compared to $645.9 million and $33.6 million, respectively, at year-end 2006. This increase in goodwill and other intangible assets is principally attributed to the North Bay acquisition. The goodwill recorded in connection with the North Bay acquisition represented the excess of the purchase price over the estimated fair value of the net assets acquired. A portion of the purchase price was allocated to the value of North Bay’s core deposits, which included all deposits except certificates of deposit, and merchant servicing portfolio. The value of the other intangible assets recorded in connection with the North Bay acquisition was determined by a third party based on the net present value of future cash flows for the merchant servicing portfolio and an analysis of the cost differential between the core deposits and alternative funding sources for the core deposit intangible.

We amortize other intangible assets on an accelerated or straight-line basis over an estimated ten to fifteen year life. Substantially all of the goodwill is associated with our community banking operations. We evaluate goodwill for possible impairment on a quarterly basis and there were no impairments recorded for the years ended December 31, 2007, 2006 or 2005. Additional information regarding our accounting for goodwill and other intangible assets is included in Notes 1, 2 and 8 of the Notes to Consolidated Financial Statements in Item 8 below.

DEPOSITS

Total deposits were $6.6 billion at December 31, 2007, an increase of $749.0 million, or 13%, from the prior year-end. The growth in deposits was principally due to the North Bay acquisition ($462.6 million of deposits as of the acquisition date). Organic deposit growth during 2007 was $286.4 million (5% organic growth), primarily in the Oregon/Washington region. Management attributes this growth to ongoing business development and marketing efforts in our service markets. Information on average deposit balances and average rates paid is included under the Net Interest Income section of this report. Additional information regarding deposits is included in Note 11 of the Notes to Consolidated Financial Statements in Item 8 below.

The following table presents the deposit balances by major category as of December 31:

Deposits

As of December 31,

(in thousands)

 

     2007    2006
      Amount    Percentage    Amount    Percentage

Non-interest bearing

   $1,272,872    19%    $ 1,222,107    21%

Interest bearing demand

   820,122    12%      725,127    12%

Savings and money market

   2,538,252    40%      2,133,497    37%

Time, $100,000 or greater

   1,138,538    17%      898,617    15%

Time, less than $100,000

   819,542    12%      860,946    15%
    

Total

   $6,589,326    100%    $ 5,840,294    100%
    

 

40


Umpqua Holdings Corporation

 

The following table presents the deposit balances by region as of December 31:

Deposits by Region

(in thousands)

 

     2007    2006
      Amount    Mix    Amount    Mix

DEPOSITS BY REGION:

           

Oregon/Washington

   $3,700,419    56%    $ 3,500,965    60%

California

   2,888,907    44%      2,339,329    40%
    

Total Deposits

   $6,589,326    100%    $ 5,840,294    100%
    

CORE DEPOSITS:(1)

           

Oregon/Washington

   $3,137,684    58%    $ 3,030,449    61%

California

   2,313,104    42%      1,911,228    39%
    

Total Core deposits

   $5,450,788    100%    $ 4,941,677    100%
    

% of total deposits

   83%         85%   

 

(1) Core deposits are defined as total deposits less time deposits greater than $100,000.

The following table presents the scheduled maturities of time deposits of $100,000 and greater as of December 31, 2007:

Maturities of Time Deposits of $100,000 and Greater

(in thousands)

 

 

Three months or less

   $ 461,643

Three months to six months

     359,165

Six months to one year

     247,442

Over one year

     70,288
      

Total

   $ 1,138,538
      

BORROWINGS

At December 31, 2007, the Bank had outstanding $36.3 million of securities sold under agreements to repurchase and $69.5 million of federal funds purchased. Additional information regarding securities sold under agreements to repurchase and federal funds purchased is provided in Notes 12 and 13 of Notes to Consolidated Financial Statements in Item 8 below.

At December 31, 2007, the Bank had outstanding term debt of $73.9 million. Advances from the Federal Home Loan Bank (“FHLB”) amounted to $73.1 million of the total and are secured by investment securities and residential mortgage loans. The FHLB advances outstanding at December 31, 2007 had fixed interest rates ranging from 3.25% to 7.44% and $42.0 million, or 57%, mature prior to December 31, 2008, while another $30.0 million, or 41%, mature prior to December 31, 2009. Management expects continued use of FHLB advances as a source of short and long-term funding. Additional information regarding term debt is provided in Note 14 of Notes to Consolidated Financial Statements in Item 8 below.

JUNIOR SUBORDINATED DEBENTURES

We had junior subordinated debentures with carrying values of $236.4 million and $203.7 million, respectively, at December 31, 2007 and 2006. Umpqua early adopted SFAS No. 159 and selected the fair value measurement option for certain junior subordinated debentures not acquired through acquisitions and new junior subordinated debentures issued in 2007.

At December 31, 2007, approximately $191.8 million, or 83% of the total issued amount, had interest rates that are adjustable on a quarterly basis based on a spread over LIBOR. Although any increases in short-term market interest rates will increase the

 

41


 

interest expense for junior subordinated debentures, we believe that other attributes of our balance sheet will serve to mitigate the impact to net interest income on a consolidated basis.

All of the debentures issued to the Trusts, less the common stock of the Trusts, qualified as Tier 1 capital as of December 31, 2007, under guidance issued by the Board of Governors of the Federal Reserve System. Additional information regarding the terms of the junior subordinated debentures, including maturity/redemption dates, interest rates and the adoption of SFAS No. 159, is included in Note 15 of the Notes to Consolidated Financial Statements in Item 8 below.

LIQUIDITY AND CASH FLOW

The principal objective of our liquidity management program is to maintain the Bank’s ability to meet the day-to-day cash flow requirements of our customers who either wish to withdraw funds or to draw upon credit facilities to meet their cash needs.

We monitor the sources and uses of funds on a daily basis to maintain an acceptable liquidity position. In addition to liquidity from core deposits and the repayments and maturities of loans and investment securities, the Bank can utilize established uncommitted federal funds lines of credit, sell securities under agreements to repurchase, borrow on a secured basis from the FHLB or issue brokered certificates of deposit.

The Bank had available lines of credit with the FHLB totaling $1.6 billion at December 31, 2007. The Bank had uncommitted federal funds line of credit agreements with additional financial institutions totaling $240.0 million at December 31, 2007. Availability of the lines is subject to federal funds balances available for loan and continued borrower eligibility. These lines are intended to support short-term liquidity needs, and the agreements may restrict the consecutive day usage.

The Company is a separate entity from the Bank and must provide for its own liquidity. Substantially all of the Company’s revenues are obtained from dividends declared and paid by the Bank. In 2007, the Bank paid the Company $44.0 million in dividends to fund regular operations. The Bank also paid the Company $60.0 million in special dividends in 2007 to fund share repurchases. There are statutory and regulatory provisions that could limit the ability of the Bank to pay dividends to the Company. We believe that such restrictions will not have an adverse impact on the ability of the Company to fund its quarterly cash dividend distributions to shareholders and meet its ongoing cash obligations, which consist principally of debt service on the $230.1 million (issued amount) of outstanding junior subordinated debentures. As of December 31, 2007, the Company did not have any borrowing arrangements of its own.

As disclosed in the Consolidated Statements of Cash Flows in Item 8 of this report, net cash provided by operating activities was $79.7 million during 2007. The principal source of cash provided by operating activities was net income. Net cash of $426.1 million used in investing activities consisted principally of $292.6 million of net loan growth and purchases of $372.2 million of investment securities available for sale, partially offset by sales and maturities of investment securities of $140.2 million, cash acquired in the North Bay merger, net of cash consideration paid, of $78.7 million and proceeds on sales of other real estate owned of $17.9 million. The $202.8 million of cash provided by financing activities primarily consisted of $286.3 million of net deposit increases, $60.0 million in proceeds on issuance of junior subordinated debentures and $69.5 million increase in Fed funds purchased, partially offset by financing outflows related to stock repurchases of $96.3 million, dividends payment of $43.5 million, and repayment of $36.1 million of junior subordinated debentures and $34.7 million of term loans.

OFF-BALANCE-SHEET ARRANGEMENTS

Information regarding Off-Balance-Sheet Arrangements is included in Note 17 of the Notes to Consolidated Financial Statements.

 

42


Umpqua Holdings Corporation

 

The following table presents a summary of significant contractual obligations extending beyond one year as of December 31, 2007 and maturing as indicated:

Future Contractual Obligations

As of December 31, 2007

(in thousands)

 

      Less than
1 Year
   1 to 3
Years
   3 to 5
Years
   More than
5 Years
   Total

Term debt

   $42,000    $ 30,000    $    $ 1,694    $ 73,694

Junior subordinated debentures

                  230,061      230,061

Operating leases, net of subleases

   10,583      18,004      15,105      30,899      74,591

Other long-term liabilities(1)

   4,852      5,149      4,384      41,898      56,283
    

Total contractual obligations

   $57,435    $ 53,153    $ 19,489    $ 304,552    $ 434,629
    

 

(1) Include maximum payments related to employee benefit plans, assuming all future vesting conditions are met. Additional information about employee benefit plans is provided in Note 16 of the Notes to Consolidated Financial Statements in Item 8 below.

The table above does not include deposit liabilities, interest payments or purchase accounting adjustments related to term debt or junior subordinated debentures.

Although we expect the Bank’s and the Company’s liquidity positions to remain satisfactory during 2008, there is significant competition for bank deposits. It is possible that our deposit growth for 2008 may not be maintained at previous levels due to increased pricing pressure or, in order to generate deposit growth, our pricing may need to be adjusted in a manner that results in increased interest expense on deposits.

CONCENTRATIONS OF CREDIT RISK

Information regarding Concentrations of Credit Risk is included in Notes 3, 5, and 17 of the Notes to Consolidated Financial Statements.

CAPITAL RESOURCES

Shareholders’ equity at December 31, 2007 was $1.2 billion, an increase of $83.7 million, or 7%, from December 31, 2006. The increase in shareholders’ equity during 2007 was principally due to the issuance of shares in connection with the North Bay acquisition valued at $142.1 million, shares issued in connection with stock plans and related tax benefit of $9.4 million, and retention of $18.8 million, or approximately 30%, of net income for the year, partially offset by stock repurchases of $96.3 million.

The Federal Reserve Board has in place guidelines for risk-based capital requirements applicable to U.S. banks and bank/financial holding companies. These risk-based capital guidelines take into consideration risk factors, as defined by regulation, associated with various categories of assets, both on and off-balance sheet. Under the guidelines, capital strength is measured in two tiers, which are used in conjunction with risk-adjusted assets to determine the risk-based capital ratios. The guidelines require an 8% total risk-based capital ratio, of which 4% must be Tier I capital. Our consolidated Tier I capital, which consists of shareholders’ equity and qualifying trust-preferred securities, less other comprehensive income, goodwill and deposit-based intangibles, totaled $695.7 million at December 31, 2007. Tier II capital components include all, or a portion of, the allowance for loan and lease losses and the portion of trust preferred securities in excess of Tier I statutory limits. The total of Tier I capital plus Tier II capital components is referred to as Total Risk-Based Capital, and was $771.9 million at December 31, 2007. The percentage ratios, as calculated under the guidelines, were 9.82% and 10.89% for Tier I and Total Risk-Based Capital, respectively, at December 31, 2007.

A minimum leverage ratio is required in addition to the risk-based capital standards and is defined as period-end shareholders’ equity and qualifying trust preferred securities, less other comprehensive income, goodwill and deposit-based intangibles,

 

43


 

divided by average assets as adjusted for goodwill and other intangible assets. Although a minimum leverage ratio of 4% is required for the highest-rated financial holding companies that are not undertaking significant expansion programs, the Federal Reserve Board may require a financial holding company to maintain a leverage ratio greater than 4% if it is experiencing or anticipating significant growth or is operating with less than well-diversified risks in the opinion of the Federal Reserve Board. The Federal Reserve Board uses the leverage and risk-based capital ratios to assess capital adequacy of banks and financial holding companies. Our consolidated leverage ratios at December 31, 2007 and 2006 were 9.24%, and 10.28%, respectively. As of December 31, 2007, the most recent notification from the FDIC categorized the Bank as “well-capitalized” under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Bank’s regulatory capital category.

At December 31, 2007, all three of the capital ratios of the Bank exceeded the minimum ratios required by federal regulation. Management monitors these ratios on a regular basis to ensure that the Bank remains within regulatory guidelines. Further information regarding the actual and required capital ratios is provided in Note 19 of the Notes to Consolidated Financial Statements in Item 8 below.

During the third and fourth quarter of 2007, Umpqua’s Board of Directors increased the quarterly cash dividend rate to $0.19 from $0.18 per share, which was the rate paid, in the first and second quarters of 2007. This increase was made pursuant to our existing dividend policy and in consideration of, among other things, earnings, regulatory capital levels and expected asset growth. The payment of cash dividends is subject to regulatory limitations as described under the Supervision and Regulation section of Part I of this report. There is no assurance that future cash dividends will be declared or increased. The following table presents cash dividends declared and dividend payout ratios (dividends declared per share divided by basic earnings per share) for the years ended December 31, 2007, 2006 and 2005:

Cash Dividends and Payout Ratios

 

      2007    2006    2005

Dividend declared per share

   $ 0.74    $ 0.60    $ 0.32

Dividend payout ratio

     70%      37%      20%

On April 19, 2007, the Company announced that the Board of Directors approved an expansion of the common stock repurchase plan, increasing the repurchase limit to 6.0 million shares and extending the plan’s expiration date from June 30, 2007 to June 30, 2009. As of December 31, 2007, a total of 1.5 million shares remained available for repurchase. There were no shares repurchased in open market transactions during the fourth quarter of 2007. The timing and amount of future repurchases will depend upon the market price for our common stock, securities laws restricting repurchases, asset growth, earnings and our capital plan. In addition, our stock plans provide that option and award holders may pay for the exercise price and tax withholdings in part or whole by tendering previously held shares.

ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The absolute level and volatility of interest rates can have a significant impact on our profitability. The objective of interest rate risk management is to identify and manage the sensitivity of net interest income to changing interest rates to achieve our overall financial objectives. Based on economic conditions, asset quality and various other considerations, management establishes tolerance ranges for interest rate sensitivity and manages within these ranges. Net interest income and the fair value of financial instruments are greatly influenced by changes in the level of interest rates. We manage exposure to fluctuations in interest rates through policies that are established by the Asset/Liability Management Committee (“ALCO”). The ALCO meets monthly and has responsibility for developing asset/liability management policy, formulating and implementing strategies to improve balance sheet positioning and earnings and reviewing interest rate sensitivity. The Board of Directors’ Loan and Investment Committee provides oversight of the asset/liability management process, reviews the results of the interest rate risk analyses prepared for the ALCO and approves the asset/liability policy on an annual basis.

Management utilizes an interest rate simulation model to estimate the sensitivity of net interest income to changes in market interest rates. Such estimates are based upon a number of assumptions for each scenario, including the level of balance sheet

 

44


Umpqua Holdings Corporation

 

growth, deposit repricing characteristics and the rate of prepayments. Interest rate sensitivity is a function of the repricing characteristics of our interest-earning assets and interest-bearing liabilities. These repricing characteristics are the time frames within which the interest-bearing assets and liabilities are subject to change in interest rates either at replacement, repricing or maturity during the life of the instruments. Interest rate sensitivity management focuses on the maturity structure of assets and liabilities and their repricing characteristics during periods of changes in market interest rates. Effective interest rate sensitivity management seeks to ensure that both assets and liabilities respond to changes in interest rates within an acceptable timeframe, thereby minimizing the impact of interest rate changes on net interest income. Interest rate sensitivity is measured as the difference between the volumes of assets and liabilities at a point in time that are subject to repricing at various time horizons: immediate to three months, four to twelve months, one to five years, over five years, and on a cumulative basis. The differences are known as interest sensitivity gaps. The table below sets forth interest sensitivity gaps for these different intervals as of December 31, 2007.

Interest Sensitivity Gap

(in thousands)

 

      By Repricing Interval    

Non-Rate-

Sensitive

    Total  
     0-3 Months    4-12 Months    1-5 Years    Over 5 Years      
        

ASSETS

               

Temporary Investments

   $         3,288    $    $    $     $     $ 3,288  

Trading account assets

     2,837                            2,837  

Securities available-for-sale

     157,023      177,309      436,016      292,884       (12,476)       1,050,756  

Securities held-to-maturity

     2,522      1,425      1,973      72       13       6,005  

Loans and loans held for sale

     2,353,187      936,448      2,428,587      357,252       (6,792)       6,068,682  

Non-interest-earning assets

                          1,208,485       1,208,485  
        

Total assets

     2,518,857      1,115,182      2,866,576      650,208       1,189,230     $ 8,340,053  
                     

LIABILITIES AND SHAREHOLDERS’ EQUITY

               

Interest-bearing demand deposits

     820,122                          $ 820,122  

Savings and money-market deposits

     2,538,252                            2,538,252  

Time deposits

     715,195      1,087,381      152,645      3,497       (638)       1,958,080  

Securities sold under agreements to repurchase

     36,294                            36,294  

Federal funds purchased

     69,500                            69,500  

Term debt

     50      42,154      30,960      704       59       73,927  

Junior subordinated debentures

     189,422      27,836           10,465       8,643       236,366  

Non-interest bearing liabilities and shareholders’ equity

                          2,607,512       2,607,512  
        

Total liabilities and shareholders’ equity

     4,368,835      1,157,371      183,605      14,666       2,615,576     $ 8,340,053  
                
               

Interest rate sensitivity gap

     (1,849,978)      (42,189)      2,682,971      635,542       (1,426,346)        

Cumulative interest rate sensitivity gap

     $(1,849,978)    $ (1,892,167)    $ 790,804    $ 1,426,346     $    
          

Cumulative gap as a % of earning assets

     –25.9%      –26.5%      11.1%      20.0%      
            

Changes in the mix of earning assets or supporting liabilities can either increase or decrease the net interest margin without affecting interest rate sensitivity. In addition, the interest rate spread between an asset and its supporting liability can vary significantly, while the timing of repricing for both the asset and the liability remains the same, thus impacting net interest

 

45


 

income. This characteristic is referred to as basis risk and generally relates to the possibility that the repricing characteristics of short-term assets tied to the prime rate are different from those of short-term funding sources such as certificates of deposit. Varying interest rate environments can create unexpected changes in prepayment levels of assets and liabilities that are not reflected in the interest rate sensitivity analysis. These prepayments may have a significant impact on our net interest margin. Because of these factors, an interest sensitivity gap analysis may not provide an accurate assessment of our exposure to changes in interest rates.

We utilize an interest rate simulation model to monitor and evaluate the impact of changing interest rates on net interest income. The estimated impact on our net interest income over a time horizon of one year as of December 31, 2007 is indicated in the table below. For the scenarios shown, the interest rate simulation assumes a parallel and sustained shift in market interest rates ratably over a twelve-month period and no change in the composition or size of the balance sheet. For example, the “up 200 basis points” scenario is based on a theoretical increase in market rates of 16.7 basis points per month for twelve months applied to the balance sheet of December 31 for each respective year.

Interest Rate Simulation Impact on Net Interest Income

As of December 31,

(dollars in thousands)

 

      2007    2006    2005
      Increase (Decrease)
in Net Interest
Income from
Base Scenario
  Percentage
Change
   Increase (Decrease)
in Net Interest
Income from
Base Scenario
  Percentage
Change
   Increase (Decrease)
in Net Interest
Income from
Base Scenario
    Percentage
Change

Up 200 basis points

   $ (7,646)   –2.7%    $ (2,596)   –0.9%    $ 2,664     1.1%

Up 100 basis points

   $ (3,868)   –1.4%    $ (1,082)   –0.4%    $ 1,482     0.6%

Down 100 basis points

   $ 4,622   1.6%    $ 989   0.4%    $ (2,147 )   –0.9%

Down 200 basis points

   $ 5,211   1.8%    $ (2,557)   –0.9%    $ (5,709 )   –2.4%

As of December 31, 2005, we believe our balance sheet was in an “asset-sensitive” position, as the repricing characteristics were such that an increase in market interest rates would have a positive effect on net interest income and a decrease in market interest rates would have negative effect on net interest income. The flattening yield curve and changed mix and pricing characteristics of our balance sheet in 2006 resulted in decreased asset sensitivity from the previous years. At December 31, 2006, we were “liability-sensitive” in three of four scenarios. However, our overall sensitivity in all four scenarios has decreased as compared to prior years indicating a more neutral interest risk position. As of December 31, 2007, we believe our balance sheet was in a “liability-sensitive” position, as the repricing characteristics were such that an increase in market interest rates would have a negative effect on net interest income and a decrease in market interest rates would have positive effect on net interest income. Some of the assumptions made in the simulation model may not materialize and unanticipated events and circumstances will occur. In addition, the simulation model does not take into account any future actions which we could undertake to mitigate an adverse impact due to changes in interest rates from those expected, in the actual level of market interest rates or competitive influences on our deposit base.

A second interest rate sensitivity measure we utilize is the quantification of market value changes for all financial assets and liabilities, given an increase or decrease in market interest rates. This approach provides a longer-term view of interest rate risk, capturing all future expected cash flows. Assets and liabilities with option characteristics are measured based on different interest rate path valuations using statistical rate simulation techniques.

 

46


Umpqua Holdings Corporation

 

The table below illustrates the effects of various market interest rate changes on the fair values of financial assets and liabilities (excluding mortgage servicing rights) as compared to the corresponding carrying values and fair values:

Interest Rate Simulation Impact on Fair Value of Financial Assets and Liabilities

As of December 31,

(dollars in thousands)

 

      2007    2006
      Increase (Decrease) in
Estimated Fair
Value of Equity
   Percentage
Change
   Increase (Decrease) in
Estimated Fair
Value of Equity
   Percentage
Change

Up 200 basis points

   $ (119,042)    –5.9%    $ (72,797)    –4.3%

Up 100 basis points

   $ (54,159)    –2.7%    $ (34,117)    –2.0%

Down 100 basis points

   $ 22,483    1.1%    $ 9,962    0.6%

Down 200 basis points

   $ 18,387    0.9%    $ (4,155)    –0.2%

Consistent with the results in the interest rate simulation impact on net interest income, our overall sensitivity to market interest rate changes has increased as compared to 2006.

IMPACT OF INFLATION AND CHANGING PRICES

A financial institution’s asset and liability structure is substantially different from that of an industrial firm in that primarily all assets and liabilities of a bank are monetary in nature, with relatively little investment in fixed assets or inventories. Inflation has an important impact on the growth of total assets and the resulting need to increase equity capital at higher than normal rates in order to maintain appropriate capital ratios. We believe that the impact of inflation on financial results depends on management’s ability to react to changes in interest rates and, by such reaction, reduce the inflationary impact on performance. We have an asset/liability management program which attempts to manage interest rate sensitivity. In addition, periodic reviews of banking services and products are conducted to adjust pricing in view of current and expected costs.

Our financial statements included in Item 8 below have been prepared in accordance with accounting principles generally accepted in the United States, which requires us to measure financial position and operating results principally in terms of historic dollars. Changes in the relative value of money due to inflation or recession are generally not considered. The primary effect of inflation on our results of operations is through increased operating costs, such as compensation, occupancy and business development expenses. In management’s opinion, changes in interest rates affect the financial condition of a financial institution to a far greater degree than changes in the rate of inflation. Although interest rates are greatly influenced by changes in the inflation rate, they do not necessarily change at the same rate or in the same magnitude as the inflation rate. Interest rates are highly sensitive to many factors that are beyond our control, including U.S. fiscal and monetary policy and general national and global economic conditions.

 

47


 

ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders

Umpqua Holdings Corporation and Subsidiaries

We have audited the accompanying consolidated balance sheets of Umpqua Holdings Corporation and Subsidiaries (the Company) as of December 31, 2007 and 2006, and the related consolidated statements of income, changes in shareholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2007. We also have audited the Company’s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Report of Management on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these financial statements and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audits.

We conducted our audits in accordance with auditing standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audit of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risks. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and Directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Umpqua Holdings Corporation and Subsidiaries as of December 31, 2007 and 2006, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2007, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, Umpqua Holdings Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007 based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

LOGO

Portland, Oregon

February 26, 2008

 

48


Umpqua Holdings Corporation

 

UMPQUA HOLDINGS CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

December 31, 2007 and 2006

(in thousands, except shares)

 

      2007    2006

ASSETS

     

Cash and due from banks

   $   188,782    $ 169,769

Temporary investments

   3,288      165,879
    

Total cash and cash equivalents

   192,070      335,648

Investment securities

     

Trading

   2,837      4,204

Available for sale, at fair value

   1,050,756      715,187

Held to maturity, at amortized cost

   6,005      8,762

Loans held for sale

   13,047      16,053

Loans and leases

   6,055,635      5,361,862

Allowance for loan and lease losses

   (84,904)      (60,090)
    

Net loans and leases

   5,970,731      5,301,772

Restricted equity securities

   15,273      15,255

Premises and equipment, net

   106,267      101,830

Goodwill and other intangible assets, net

   764,906      679,493

Mortgage servicing rights, net

   10,088      9,952

Other assets

   208,073      156,080
    

Total assets

   $8,340,053    $ 7,344,236
    

LIABILITIES AND SHAREHOLDERS’ EQUITY

     

Deposits

     

Noninterest bearing

   $1,272,872    $ 1,222,107

Interest bearing

   5,316,454      4,618,187
    

Total deposits

   6,589,326      5,840,294

Securities sold under agreements to repurchase

   36,294      47,985

Federal funds purchased

   69,500     

Term debt

   73,927      9,513

Junior subordinated debentures, at fair value

   131,686     

Junior subordinated debentures, at amortized cost

   104,680      203,688

Other liabilities

   94,702      86,545
    

Total liabilities

   7,100,115      6,188,025
    

COMMITMENTS AND CONTINGENCIES (NOTE 17)

     

SHAREHOLDERS’ EQUITY

     

Preferred stock, no par value, 2,000,000 shares authorized; none issued and outstanding

       

Common stock, no par value, 100,000,000 shares authorized; issued and outstanding:

59,980,161 in 2007 and 58,080,171 in 2006

   988,780      930,867

Retained earnings

   251,545      234,783

Accumulated other comprehensive loss

   (387)      (9,439)
    

Total shareholders’ equity

   1,239,938      1,156,211
    

Total liabilities and shareholders’ equity

   $8,340,053    $ 7,344,236
    

See notes to consolidated financial statements

 

49


 

UMPQUA HOLDINGS CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

For the Years Ended December 31, 2007, 2006 and 2005

(in thousands, except per share amounts)

 

      2007     2006     2005

INTEREST INCOME

      

Interest and fees on loans

   $443,939     $ 372,201     $ 251,715

Interest and dividends on investment securities

      

Taxable

   34,891       27,370       26,268

Exempt from federal income tax

   5,822       3,882       2,645

Dividends

   325       285       164

Interest on temporary investments

   3,415       2,203       1,484
    

Total interest income

   488,392       405,941       282,276

INTEREST EXPENSE

      

Interest on deposits

   180,840       119,881       59,578

Interest on securities sold under agreements to repurchase and federal funds purchased

   2,135       6,829       2,207

Interest on term debt

   2,642       2,892       659

Interest on junior subordinated debentures

   16,821       14,215       10,550
    

Total interest expense

   202,438       143,817       72,994
    

Net interest income

   285,954       262,124       209,282

Provision for Loan and Lease Losses

   41,730       2,552       2,468
    

Net interest income after provision for loan and lease losses

   244,224       259,572       206,814

NON-INTEREST INCOME

      

Service charges on deposit accounts

   32,126       26,975       21,697

Brokerage commissions and fees

   10,038       9,649       11,317

Mortgage banking revenue, net

   7,791       7,560       6,426

Net (loss) gain on sale of investment securities

   (13 )     (21 )     1,439

Other income

   14,883       9,434       6,903
    

Total non-interest income

   64,825       53,597       47,782

NON-INTEREST EXPENSE

      

Salaries and employee benefits

   112,864       98,840       82,467

Net occupancy and equipment

   35,785       31,752       24,693

Communications

   7,202       6,352       5,841

Marketing

   5,554       5,760       4,564

Services

   18,564       15,951       13,245

Supplies

   3,627       2,994       2,706

Intangible amortization

   6,094       3,728       2,430

Merger related expenses

   3,318       4,773       262

Other expenses

   21,110       11,799       10,848
    

Total non-interest expense

   214,118       181,949       147,056

Income before provision for income taxes

   94,931       131,220       107,540

Provision for income taxes

   31,663       46,773       37,805
    

Net income

   $  63,268     $ 84,447     $ 69,735
    

BASIC EARNINGS PER SHARE

   $      1.06     $ 1.61     $ 1.57

DILUTED EARNINGS PER SHARE

   $      1.05     $ 1.59     $ 1.55

See notes to consolidated financial statements

 

50


Umpqua Holdings Corporation

 

UMPQUA HOLDINGS CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

For the Years Ended December 31, 2007, 2006 and 2005

(in thousands, except shares)

 

      Common Stock    Retained
Earnings
   Accumulated
Other
Comprehensive
Loss
   Total
      Shares    Amount         

BALANCE AT JANUARY 1, 2005

   44,211,075    $ 560,611    $ 128,112    $ (1,110)    $ 687,613

Net income

           69,735         69,735

Other comprehensive loss, net of tax:

              

Unrealized losses on securities arising during the year

              (8,799)      (8,799)
                  

Comprehensive income

               $ 60,936
                  

Stock-based compensation

        693            693

Stock repurchased and retired

   (84,185)      (1,904)            (1,904)

Issuances of common stock under stock plans and related tax benefit

   429,379      5,179            5,179

Cash dividends ($0.32 per share)

           (14,256)         (14,256)
    

Balance at December 31, 2005

   44,556,269    $ 564,579    $ 183,591    $ (9,909)    $ 738,261
    

BALANCE AT JANUARY 1, 2006

   44,556,269    $ 564,579    $ 183,591    $ (9,909)    $ 738,261

Net income

           84,447         84,447

Other comprehensive income, net of tax:

              

Unrealized gains on securities arising during the year

              470      470
                  

Comprehensive income

               $ 84,917
                  

Stock-based compensation

        1,932            1,932

Stock repurchased and retired

   (6,142)      (179)            (179)

Issuances of common stock under stock plans and related tax benefit

   784,715      10,814            10,814

Stock issued in connection with acquisition

   12,745,329      353,721            353,721

Cash dividends ($0.60 per share)

           (33,255)         (33,255)
    

Balance at December 31, 2006

   58,080,171    $ 930,867    $ 234,783    $ (9,439)    $ 1,156,211
    

BALANCE AT JANUARY 1, 2007

   58,080,171    $ 930,867    $ 234,783    $ (9,439)    $ 1,156,211

Adoption of fair value option—junior subordinated debentures

           (2,064)         (2,064)

Net income

           63,268         63,268

Other comprehensive income, net of tax:

              

Unrealized gains on securities arising during the year

              9,052      9,052
                  

Comprehensive income

               $ 72,320
                  

Stock-based compensation

        2,684            2,684

Stock repurchased and retired

   (4,061,439)      (96,291)            (96,291)

Issuances of common stock under stock plans and related tax benefit

   797,856      9,408            9,408

Stock issued in connection with acquisition

   5,163,573      142,112            142,112

Cash dividends ($0.74 per share)

           (44,442)         (44,442)
    

Balance at December 31, 2007

   59,980,161    $ 988,780    $ 251,545    $ (387)    $ 1,239,938
    

See notes to consolidated financial statements

 

51


 

UMPQUA HOLDINGS CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

For the Years Ended December 31, 2007, 2006 and 2005

(in thousands)

 

      2007    2006    2005

Net income

   $63,268    $ 84,447    $ 69,735

Unrealized gains (losses) arising during the year on investment securities available for sale

   15,074      762      (13,226)

Reclassification adjustment for losses (gains) realized in net income, net of tax (benefit of $5 and $8 in 2007 and 2006 and expense of $576 in 2005, respectively)

   8      13      (863)

Income tax (expense) benefit related to unrealized gains/losses on investment securities, available for sale

   (6,030)      (305)      5,290
    

Net unrealized gains (losses) on investment securities available for sale

   9,052      470      (8,799)
    

Comprehensive income

   $72,320    $ 84,917    $ 60,936
    

See notes to consolidated financial statements

 

52


Umpqua Holdings Corporation

 

UMPQUA HOLDINGS CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Years Ended December 31, 2007, 2006 and 2005

(in thousands)

 

      2007    2006    2005

CASH FLOWS FROM OPERATING ACTIVITIES:

        

Net income

   $63,268    $84,447    $69,735

Adjustments to reconcile net income to net cash provided by operating activities:

        

Restricted equity securities stock dividends

   (234)    (285)    (164)

Deferred income tax (benefit) expense

   (5,080)    (6,143)    7,575

(Accretion) amortization of investment discounts and premiums, net

   (373)    1,101    1,150

Loss (gain) on sale of investment securities available-for-sale

   13    21    (1,439)

Provision for loan and lease losses

   41,730    2,552    2,468

Depreciation, amortization and accretion

   12,765    11,331    12,297

Change in fair value of mortgage servicing rights

   756      

Change in fair value of junior subordinated debentures

   (4,829)      

Stock-based compensation

   2,684    1,932    693

Net decrease (increase) in trading account assets

   1,367    (1,132)    976

Origination of loans held for sale

   (253,647)    (259,767)    (289,277)

Proceeds from sales of loans held for sale

   256,830    254,873    299,868

Increase in mortgage servicing rights

   (892)    (1,487)    (3,318)

Tax benefits from the exercise of stock options

         2,425

Excess tax benefits from the exercise of stock options

   (289)    (1,173)   

Net (increase) decrease in other assets

   (31,347)    27,476    (10,096)

Net (decrease) increase in other liabilities

   (3,084)    4,249    7,298
    

Net cash provided by operating activities

   79,638    117,995    100,191
    

CASH FLOWS FROM INVESTING ACTIVITIES:

        

Purchases of investment securities available-for-sale

   (372,223)    (60,651)    (175,546)

Sales and maturities of investment securities available-for-sale

   137,497    90,841    166,012

Maturities of investment securities held-to-maturity

   2,737    2,764    3,169

Redemption of restricted equity securities

   5,603    9,322    119

Net loan and lease originations

   (315,860)    (437,549)    (478,694)

Proceeds from sales of loans

   23,295    23,444    22,945

Proceeds from disposals of furniture and equipment

   5,813    247    89

Purchases of premises and equipment

   (9,560)    (13,597)    (12,051)

Sales of real estate owned

   17,906    1,192   

Cash acquired in merger, net of cash consideration paid

   78,729    36,950   
    

Net cash used by investing activities

   (426,063)    (347,037)    (473,957)
    

CASH FLOWS FROM FINANCING ACTIVITIES:

        

Net increase in deposit liabilities

   286,315    539,172    487,610

Net increase (decrease) in Federal funds purchased

   69,500    (55,000)    27,000

Net decrease in securities sold under agreements to repurchase

   (11,691)    (10,880)    (1,402)

Term debt borrowings

      600,000   

Proceeds from the issuance of junior subordinated debentures

   60,000      

Repayment of junior subordinated debentures

   (36,084)      

Repayment of term debt

   (34,685)    (652,634)    (85,188)

Dividends paid on common stock

   (43,461)    (28,131)    (11,557)

Excess tax benefits from the exercise of stock options

   289    1,173   

Proceeds from stock options exercised

   8,955    9,415    2,754

Retirement of common stock

   (96,291)    (179)    (1,904)
    

Net cash provided by financing activities

   202,847    402,936    417,313
    

Net (decrease) increase in cash and cash equivalents

   (143,578)    173,894    43,547

Cash and cash equivalents, beginning of year

   335,648    161,754    118,207
    

Cash and cash equivalents, end of year

   $192,070    $335,648    $161,754
    

 

53


 

UMPQUA HOLDINGS CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Years Ended December 31, 2007, 2006 and 2005

(in thousands)

 

      2007    2006    2005

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:

        

Cash paid during the year for:

        

Interest

   $ 202,979    $ 137,034    $ 68,821

Income taxes

   $ 50,495    $ 46,084    $ 19,418

SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES:

        

Change in unrealized gain or loss on available-for-sale securities, net of taxes

   $ 9,052    $ 470    $ (8,799)

Cash dividend declared and payable after year-end

   $ 11,436    $ 10,476    $ 5,352

Transfer of loans to other real estate owned

   $ 24,853    $    $ 1,190

Acquisitions:

        

Assets acquired

   $ 648,877    $ 1,455,140    $

Liabilities assumed

   $ 585,494    $ 1,138,369    $

Net

   $ 63,383    $ 316,771    $

See notes to condensed consolidated financial statements

 

54


Umpqua Holdings Corporation and Subsidiaries

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years Ended December 31, 2007, 2006 and 2005

NOTE 1.    SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations—Umpqua Holdings Corporation (the “Company”) is a financial holding company headquartered in Portland, Oregon, that is engaged primarily in the business of commercial and retail banking and the delivery of retail brokerage services. The Company provides a wide range of banking, asset management, mortgage banking and other financial services to corporate, institutional and individual customers through its wholly-owned banking subsidiary Umpqua Bank (the “Bank”). The Company engages in the retail brokerage business through its wholly-owned subsidiary Strand, Atkinson, Williams & York, Inc. (“Strand”). The Company and its subsidiaries are subject to regulation by certain federal and state agencies and undergo periodic examination by these regulatory agencies.

Basis of Financial Statement Presentation—The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States and with prevailing practices within the banking and securities industries. In preparing such financial statements, management is required to make certain estimates and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the balance sheet and the reported amounts of revenues and expenses for the reporting period. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan and lease losses, the valuation of mortgage servicing rights and the valuation of goodwill and other intangible assets.

Consolidation—The accompanying consolidated financial statements include the accounts of the Company, the Bank and Strand. All significant intercompany balances and transactions have been eliminated in consolidation. As of December 31, 2007, the Company had 14 wholly-owned trusts (“Trusts”) that were formed to issue trust preferred securities and related common securities of the Trusts. The Company has not consolidated the accounts of the Trusts in its consolidated financial statements in accordance with FASB Interpretation 46R, Consolidation of Variable Interest Entities. As a result the junior subordinated debentures issued by the Company to the Trusts, are reflected on the Company’s consolidated balance sheet as junior subordinated debentures.

Cash and Cash Equivalents—Cash and cash equivalents include cash and due from banks, and temporary investments which are federal funds sold and interest-bearing balances due from other banks. Cash and cash equivalents generally have a maturity of 90 days or less at the time of purchase.

Trading Account Securities—Debt and equity securities held for resale are classified as trading account securities and reported at fair value. Realized and unrealized gains or losses are recorded in non-interest income.

Investment Securities—Debt securities are classified as held-to-maturity if the Company has both the intent and ability to hold those securities to maturity regardless of changes in market conditions, liquidity needs or changes in general economic conditions. These securities are carried at cost adjusted for amortization of premium and accretion of discount, computed by the effective interest method over their contractual lives.

Securities are classified as available-for-sale if the Company intends and has the ability to hold those securities for an indefinite period of time, but not necessarily to maturity. Any decision to sell a security classified as available-for-sale would be based on various factors, including significant movements in interest rates, changes in the maturity mix of assets and liabilities, liquidity needs, regulatory capital considerations and other similar factors. Securities available-for-sale are carried at fair value. Unrealized holding gains or losses are included in other comprehensive income as a separate component of shareholders’ equity, net of tax. Realized gains or losses, determined on the basis of the cost of specific securities sold, are included in earnings. Premiums and discounts are amortized or accreted over the life of the related investment security as an adjustment to yield using the effective interest method. Dividend and interest income are recognized when earned.

Unrealized losses due to fluctuations in the fair value of securities held to maturity or available for sale are recognized through earnings when it is determined that an other-than-temporary decline in value has occurred. The Company assesses other-than-temporary impairment based on the nature of the decline and whether the Company has the ability and intent to hold the

 

55


 

investments until a market price recovery. No other-than-temporary impairment losses were recognized in the years ended December 31, 2007, 2006 or 2005. Additional information on investment securities is included in Note 4.

Loans Held for Sale—Loans held for sale includes mortgage loans and are reported at the lower of cost or market value. Cost generally approximates market value, given the short duration of these assets. Gains or losses on the sale of loans that are held for sale are recognized at the time of the sale and determined by the difference between net sale proceeds and the net book value of the loans less the estimated fair value of any retained mortgage servicing rights.

Loans—Loans are stated at the amount of unpaid principal, net of unearned income and any deferred fees or costs. All discounts and premiums are recognized over the estimated life of the loan as yield adjustments. This estimated life is adjusted for prepayments.

Loans are classified as impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal and interest when due, in accordance with the terms of the original loan agreement. The carrying value of impaired loans is based on the present value of expected future cash flows (discounted at each loan’s effective interest rate) or, for collateral dependent loans, at fair value of the collateral. If the measurement of each impaired loans’ value is less than the recorded investment in the loan, an impairment allowance is created by either charging the provision for loan and lease losses or allocating an existing component of the allowance for loan and lease losses. Additional information on loans is included in Note 5.

Income Recognition on Non-Accrual and Impaired Loans—Loans, including impaired loans, are classified as non-accrual if the collection of principal and interest is doubtful. Generally, this occurs when a loan is past due as to maturity or payment of principal or interest by 90 days or more, unless such loans are well-secured and in the process of collection. If a loan or portion thereof is partially charged-off, the loan is considered impaired and classified as non-accrual. Loans that are less than 90 days past due may also be classified as non-accrual if repayment in full of principal and/or interest is in doubt.

When a loan is classified as non-accrual, all uncollected accrued interest is reversed to interest income and the accrual of interest income is terminated. Generally, any cash payments are applied as a reduction of principal outstanding. In cases where the future collectibility of the principal balance in full is expected, interest income may be recognized on a cash basis. A loan may be restored to accrual status when the borrower’s financial condition improves so that full collection of principal is considered likely. For those loans placed on non-accrual status due to payment delinquency, this will generally not occur until the borrower demonstrates repayment ability over a period of not less than six months.

The decision to classify a loan as impaired is made by the Bank’s Allowance for Loan and Lease Losses (ALLL) Committee. The ALLL Committee meets regularly to review the status of all problem and potential problem loans. If the ALLL Committee concludes a loan is impaired but recovery of the full principal and interest is expected, an impaired loan may remain on accrual status.

Allowance for loan and lease losses—The Bank performs regular credit reviews of the loan and lease portfolio to determine the credit quality of the portfolio and the adherence to underwriting standards. When loans and leases are originated, they are assigned a risk rating from 1 to 10 that is assessed periodically during the term of the loan through the credit review process. The 10 risk rating categories are a primary factor in determining an appropriate amount for the allowance for loan and lease losses. The Bank has a management ALLL Committee, which is responsible for, among other things, regular review of the ALLL methodology, including loss factors, and ensuring that it is designed and applied in accordance with generally accepted accounting principles. The ALLL Committee reviews loans that have been placed on non-accrual status and approves placing loans on impaired status. The ALLL Committee also approves removing loans that are no longer impaired from impairment and non-accrual status. The Bank’s Audit and Compliance Committee provides board oversight of the ALLL process and reviews and approves the ALLL methodology on a quarterly basis.

Each risk rating is assessed an inherent credit loss factor that determines the amount of the allowance for loan and lease losses provided for that group of loans with similar risk rating. Credit loss factors may vary by region based on management’s belief that there may ultimately be different credit loss rates experienced in each region.

 

56


Umpqua Holdings Corporation and Subsidiaries

 

Regular credit reviews of the portfolio also identify loans that are considered potentially impaired. Potentially impaired loans are referred to the ALLL Committee which reviews and approves designated loans as impaired. A loan is considered impaired when based on current information and events, we determine that we will probably not be able to collect all amounts due according to the loan contract, including scheduled interest payments. When we identify a loan as impaired, we measure the impairment using discounted cash flows, except when the sole remaining source of the repayment for the loan is the liquidation of the collateral. In these cases, we use the current fair value of the collateral, less selling costs, instead of discounted cash flows. If we determine that the value of the impaired loan is less than the recorded investment in the loan, we recognize this impairment reserve as a specific component to be provided for in the allowance for loan and lease losses.

The combination of the risk rating-based allowance component and the impairment reserve allowance component lead to an allocated allowance for loan and lease losses. The Bank also maintains an unallocated allowance amount to provide for other credit losses inherent in a loan and lease portfolio that may not have been contemplated in the credit loss factors. This unallocated amount generally comprises less than 5% of the allowance. The unallocated amount is reviewed periodically based on trends in credit losses, the results of credit reviews and overall economic trends.

As adjustments become necessary, they are reported in earnings in the periods in which they become known as a change in the provision for loan and lease losses and a corresponding charge to the allowance. Loans, or portions thereof, deemed uncollectible are charged to the allowance. Provisions for losses, and recoveries on loans previously charged off, are added to the allowance.

The reserve for unfunded commitments (“RUC”) is established to absorb inherent losses associated with our commitment to lend funds, such as with a letter or line of credit. The adequacy of the ALLL and RUC are monitored on a regular basis and are based on management’s evaluation of numerous factors. These factors include the quality of the current loan portfolio; the trend in the loan portfolio’s risk ratings; current economic conditions; loan concentrations; loan growth rates; past-due and non-performing trends; evaluation of specific loss estimates for all significant problem loans; historical charge-off and recovery experience; and other pertinent information.

Management believes that the ALLL was adequate as of December 31, 2007. There is, however, no assurance that future loan losses will not exceed the levels provided for in the ALLL and could possibly result in additional charges to the provision for loan and lease losses. In addition, bank regulatory authorities, as part of their periodic examination of the Bank, may require additional charges to the provision for loan and lease losses in future periods if warranted as a result of their review. At December 31, 2007, approximately 79% of our loan portfolio is secured by real estate, and a significant decline in real estate market values may require an increase in the allowance for loan and lease losses.

Additional information on the allowance for loan and lease losses is included in Note 5.

Reserve for Unfunded Commitments—A reserve for unfunded commitments is maintained at a level that, in the opinion of management, is adequate to absorb probable losses associated with the Bank’s commitment to lend funds under existing agreements such as letters or lines of credit. Management determines the adequacy of the reserve for unfunded commitments based upon reviews of individual credit facilities, current economic conditions, the risk characteristics of the various categories of commitments and other relevant factors. The reserve is based on estimates, and ultimate losses may vary from the current estimates. These estimates are evaluated on a regular basis and, as adjustments become necessary, they are reported in earnings in the periods in which they become known. Draws on unfunded commitments that are considered uncollectible at the time funds are advanced are charged to the allowance. Provisions for unfunded commitment losses, and recoveries on loans previously charged off, are added to the reserve for unfunded commitments, which is included in the Other Liabilities section of the consolidated balance sheets.

Loan Fees and Direct Loan Origination Costs—Loan origination and commitment fees and direct loan origination costs are deferred and recognized as an adjustment to the yield over the life of the related loans.

Restricted Equity Securities—Restricted equity securities were $15.3 million at December 31, 2007 and 2006. Federal Home Loan Bank stock amounted to $14.3 million and $14.2 million of the total restricted securities as of December 31, 2007 and 2006, respectively. Federal Home Loan Bank stock represents the Bank’s investment in the Federal Home Loan Banks of Seattle and San Francisco (“FHLB”) stock and is carried at par value, which reasonably approximates its fair value. As a member of the

 

57


 

FHLB system, the Bank is required to maintain a minimum level of investment in FHLB stock based on specific percentages of its outstanding mortgages, total assets, or FHLB advances. At December 31, 2007, the Bank’s minimum required investment in FHLB stock was $7.0 million. The Bank may request redemption at par value of any stock in excess of the minimum required investment. Stock redemptions are at the discretion of the FHLB.

Premises and Equipment—Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is provided over the estimated useful life of equipment, generally three to ten years, on a straight-line or accelerated basis. Depreciation is provided over the estimated useful life of premises, up to 39 years, on a straight-line or accelerated basis. Leasehold improvements are amortized over the life of the related lease, or the life of the related asset, whichever is shorter. Expenditures for major renovations and betterments of the Company’s premises and equipment are capitalized.

In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, management reviews long-lived and intangible assets any time that a change in circumstance indicates that the carrying amount of these assets may not be recoverable. Recoverability of these assets is determined by comparing the carrying value of the asset to the forecasted undiscounted cash flows of the operation associated with the asset. If the evaluation of the forecasted cash flows indicates that the carrying value of the asset is not recoverable, the asset is written down to fair value.

Additional information regarding premises and equipment is provided in Note 6.

Goodwill and Other Intangibles—Intangible assets are comprised of goodwill and other intangibles acquired in business combinations. Goodwill and intangible assets with indefinite useful lives are not amortized. Intangible assets with definite useful lives are amortized to their estimated residual values over their respective estimated useful lives, and also reviewed for impairment.

Amortization of intangible assets is included in other non-interest expense in the consolidated statements of income. Goodwill is tested for impairment on a quarterly basis and more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount of the asset exceeds its fair value. Additional information on goodwill and intangible assets is included in Note 8.

Mortgage Servicing Rights—Retained mortgage servicing rights (“MSR”) are measured at quoted market prices. Subsequent measurements are determined using a discounted cash flow model. The expected life of the loan can vary from management’s estimates due to prepayments by borrowers, especially when interest rates fall. Prepayments in excess of management’s estimates would negatively impact the recorded value of MSR. The value of the MSR is also dependent upon the discount rate used in the model. Management reviews this rate on an ongoing basis based on current market rates. A significant increase in the discount rate would reduce the value of MSR.

Upon adoption of Statement of Financial Accounting Standards (“SFAS”) No. 156, Accounting for Servicing of Financial Assets an amendment of FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (“SFAS No. 156”) on January 1, 2007, the Company has elected to measure its residential mortgage servicing assets at fair value. Upon the change from the lower of cost or fair value accounting method to fair value accounting under SFAS No. 156, the calculation of amortization and the assessment of impairment were discontinued. Additional information is included in Note 7.

Prior to the adoption of SFAS No. 156, MSR were capitalized at their allocated carrying value and amortized in proportion to, and over the period of, estimated future net servicing income in accordance with SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. The carrying value of MSR was evaluated for possible impairment on a quarterly basis in accordance with SFAS No. 140. If an impairment condition existed for a particular valuation tranche, a valuation allowance was established for the excess of amortized cost over the estimated fair value through a charge to mortgage servicing fee revenue. If, in subsequent periods, the estimated fair value was determined to be in excess of the amortized cost net of the related valuation allowance, the valuation allowance was reduced through a credit to mortgage servicing revenue.

SBA/USDA Loans Sales and Servicing—The Bank, on a regular basis, sells or transfers loans, including the guaranteed portion of Small Business Administration (“SBA”) and Department of Agriculture (“USDA”) loans (with servicing retained) for cash proceeds equal to the principal amount of loans, as adjusted to yield interest to the investor based upon the current market

 

58


Umpqua Holdings Corporation and Subsidiaries

 

rates. The Bank records an asset representing the right to service loans for others when it sells a loan and retains the servicing rights. The carrying value of loans is allocated between the loan and the servicing rights, based on their relative fair values. The fair value of servicing rights is estimated by discounting estimated future cash flows from servicing using discount rates that approximate current market rates and using estimated prepayment rates. The servicing rights are carried at the lower of cost or market and are amortized in proportion to, and over the period of, the estimated net servicing income, assuming prepayments.

For purposes of evaluating and measuring impairment, servicing rights are based on a discounted cash flow methodology, current prepayment speeds and market discount rates. Any impairment is measured as the amount by which the carrying value of servicing rights for a stratum exceeds its fair value. The carrying value of SBA/USDA servicing rights at December 31, 2007 and 2006 were $1.0 million and $1.2 million, respectively. No impairment charges were recorded for the years ended December 31, 2007, 2006 or 2005 related to SBA/USDA servicing assets.

A premium over the adjusted carrying value is received upon the sale of the guaranteed portion of an SBA or USDA loan. The Bank’s investment in an SBA or USDA loan is allocated among the sold and retained portions of the loan based on the relative fair value of each portion at the time of loan origination, adjusted for payments and other activities. Because the portion retained does not carry an SBA or USDA guarantee, part of the gain recognized on the sold portion of the loan may be deferred and amortized as a yield enhancement on the retained portion in order to obtain a market equivalent yield.

Other Real Estate Owned—Other real estate owned represents real estate which the Bank has taken control of in partial or full satisfaction of loans. At the time of foreclosure, other real estate owned is recorded at the lower of the carrying amount of the loan or fair value less costs to sell, which becomes the property’s new basis. Any write-downs based on the asset’s fair value at the date of acquisition are charged to the allowance for loan and lease losses. After foreclosure, management periodically performs valuations such that the real estate is carried at the lower of its new cost basis or fair value, net of estimated costs to sell. Revenue and expenses from operations and subsequent adjustments to the carrying amount of the property are included in other non-interest expense in the consolidated statements of income.

In some instances, the Bank may make loans to facilitate the sales of other real estate owned. Management reviews all sales for which it is the lending institution for compliance with sales treatment under provisions established by SFAS No. 66, Accounting for Sales of Real Estate.

Income Taxes—Income taxes are accounted for using the asset and liability method. Under this method a deferred tax asset or liability is determined based on the enacted tax rates which will be in effect when the differences between the financial statement carrying amounts and tax basis of existing assets and liabilities are expected to be reported in the Company’s income tax returns. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established to reduce the net carrying amount of deferred tax assets if it is determined to be more likely than not, that all or some portion of the potential deferred tax asset will not be realized.

Derivative Loan Commitments—The Bank enters into forward delivery contracts to sell residential mortgage loans or mortgage-backed securities to broker/dealers at specific prices and dates in order to hedge the interest rate risk in its portfolio of mortgage loans held for sale and its residential mortgage loan commitments. The commitments to originate mortgage loans held for sale and the related forward delivery contracts are considered derivatives. In the fourth quarter of 2007, the Bank began using derivative instruments to hedge the risk of changes in the fair value of MSR due to changes in interest rates. The Company accounts for its derivatives under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended. The Statement requires recognition of all derivatives as either assets or liabilities in the balance sheet and requires measurement of those instruments at fair value through adjustments to accumulated other comprehensive income and/or current earnings, as appropriate. None of the Company’s derivatives qualify for hedge accounting and the Company reports changes in fair values of its derivatives in current period net income.

The fair value of the derivative loan commitments is estimated using the present value of expected future cash flows. Assumptions used include pull-through rate assumption based on historical information, current mortgage interest rates, the stage of completion of the underlying application and underwriting process, and the time remaining until the expiration of the derivative loan commitment.

 

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Operating Segments—SFAS No. 131, Disclosure about Segments of an Enterprise and Related Information, requires public enterprises to report certain information about their operating segments in a complete set of financial statements to shareholders. It also requires reporting of certain enterprise-wide information about the Company’s products and services, its activities in different geographic areas, and its reliance on major customers. The basis for determining the Company’s operating segments is the manner in which management operates the business. Management has identified three primary business segments, Community Banking, Retail Brokerage and Mortgage Banking. Additional information on Operating Segments is provided in Note 22.

Share-Based Payment—The Company has two active stock-based compensation plans that provide for the granting of stock options and restricted stock awards to eligible employees and directors. Effective January 1, 2006, we adopted the provisions of SFAS No. 123R, Share Based Payment, a revision to the previously issued guidance on accounting for stock options and other forms of equity-based compensation. SFAS No. 123R requires companies to recognize in the income statement the grant-date fair value of stock options and other equity-based forms of compensation issued to employees over the employees’ requisite service period (generally the vesting period). Prior to January 1, 2006, we accounted for share-based compensation to employees under the intrinsic value method prescribed in Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees. Under the intrinsic value method, compensation expense is recognized only to the extent an option’s exercise price is less than the market value of the underlying stock on the date of grant. We also followed the disclosure requirements of SFAS No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure. We adopted SFAS No. 123R under the modified prospective method which means that the unvested portion of previously granted awards and any awards that are granted or modified after the date of adoption will be measured and accounted for under the provisions of SFAS No. 123R. Accordingly, financial statement amounts for prior periods presented have not been restated to reflect the fair value method of recognizing compensation cost relating to stock options. The Company will continue to use straight-line recognition of expenses for awards with graded vesting.

The compensation cost related to stock options, including costs related to unvested options assumed in connection with acquisitions, that has been charged against income (included in salaries and employee benefits) was $1.3 million, $1.4 million and $59,000 for the years ended December 31, 2007, 2006 and 2005, respectively. The total income tax benefit recognized in the income statement related to stock options was $540,000, $551,000 and $24,000 for the years ended December 31, 2007, 2006 and 2005, respectively.

Under APB No. 25, for all options originally granted by the Company, no compensation cost was recognized related to stock options in the years ended December 31, 2005. Compensation cost, net of tax, of $35,000, was recognized as salaries and benefits expense for the year ended December 31, 2005 for certain unvested options that were assumed in connection with prior acquisitions that continued to vest after acquisition. The following table presents the effect on net income and earnings per share if the fair value based method prescribed by SFAS No. 123, using straight-line expense recognition, had been applied to all outstanding and unvested awards in the year ended December 31, 2005:

(in thousands, except per share data)

 

      2005

NET INCOME, AS REPORTED

   $ 69,735

Deduct: Additional stock-based employee compensation determined under the fair value based method for all awards, net of tax effects

     (813)
      

Pro forma net income

   $ 68,922
      

NET INCOME PER SHARE:

  

Basic—as reported

   $ 1.57

Basic—pro forma

   $ 1.55

Diluted—as reported

   $ 1.55

Diluted—pro forma

   $ 1.53

 

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Umpqua Holdings Corporation and Subsidiaries

 

The fair value of each option grant is estimated as of the grant date using the Black-Scholes option-pricing model using assumptions noted in the following table. Expected volatility is based on the historical volatility of the price of the Company’s stock. The Company uses historical data to estimate option exercise and stock option forfeiture rates within the valuation model. The expected term of options granted is derived from the vesting period and contractual term using an allowed “short-cut method” and represents the period of time that options granted are expected to be outstanding. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. The following weighted-average assumptions were used to determine the fair value of option grants as of the grant date to determine compensation cost under SFAS No. 123R and SFAS No. 123 for the years ended December 31, 2007, 2006 and 2005:

 

      2007    2006    2005

Dividend yield

     3.29%      2.68%      1.67%

Expected life (years)

     6.2      6.4      7.5

Expected volatility

     34%      35%      38%

Risk-free rate

     4.46%      4.30%      4.21%

Weighted average grant date fair value of options granted

   $ 7.49    $ 9.18    $ 9.50

The Company’s stock compensation plan provides for granting of restricted stock awards. The restricted stock awards generally vest ratably over 5 years and are recognized as expense over that same period of time.

Additional information on share-based payments is provided in Note 18.

Earnings per ShareBasic earnings per share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed in a similar manner, except that the denominator is increased to include the number of additional common shares that would have been outstanding if potentially dilutive common shares were issued using the treasury stock method. For all periods presented, stock options, unvested restricted shares and restricted stock units are the only potentially dilutive instruments issued by the Company.

Advertising expenses—Advertising costs are generally expensed as incurred.

Recently Issued Accounting Pronouncements—In December 2007, FASB issued SFAS No. 141 (revised), Business Combinations. SFAS No. 141R establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree and the goodwill acquired. SFAS No. 141R also establishes disclosure requirements to enable the evaluation of the nature and financial effects of the business combination. This statement applies prospectively to business combinations for which the acquisition date is on or after January 1, 2009. We are currently evaluating the impact of the adoption of SFAS No.141R.

In November 2007, the SEC issued Staff Accounting Bulletin No. 109, Written Loan Commitments Recorded at Fair Value through Earnings (“SAB 109”). SAB 109 provides guidance on the accounting for written loan commitments recorded at fair value under GAAP. Specifically, the SAB revises the Staff’s views on incorporating expected net future cash flows related to loan servicing activities in the fair value measurement of a written loan commitment. SAB 109, which supersedes SAB 105, Application of Accounting Principles to Loan Commitments, requires the expected net future cash flows related to the associated servicing of the loan be included in the measurement of all written loan commitments that are accounted for at fair value through earnings. SAB 109 is effective on January 1, 2008 for the Company. Adoption of SAB 109 is not expected to have a material impact on the Company’s financial statements.

Reclassifications—Certain amounts reported in prior years’ and quarters’ financial statements have been reclassified to conform to the current presentation. The results of the reclassifications are not considered material and have no effect on previously reported net income and earnings per share.

NOTE 2.    BUSINESS COMBINATIONS

On April 26, 2007, the Company acquired all of the outstanding common stock of North Bay Bancorp (“North Bay”) and its principal operating subsidiary, The Vintage Bank, along with its Solano Bank division. The results of North Bay’s operations have

 

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been included in the consolidated financial statements since that date. This acquisition added North Bay’s network of 10 Northern California branches, including locations in the Napa area and in the communities of St. Helena, American Canyon, Vacaville, Benicia, Vallejo and Fairfield, to the Company’s network of Northern California, Oregon and Washington locations. This merger was consistent with the Company’s community banking expansion strategy and provided further opportunity to enter growth markets in Northern California.

The aggregate purchase price was $143.2 million and included 5.2 million common shares valued at $135.2 million, options to purchase 542,000 shares of common stock valued at $6.9 million and $1.1 million of direct merger costs. North Bay shareholders received 1.228 shares of the Company’s common stock for each share of North Bay common stock (“exchange ratio of 1.228:1”). The value of the common shares issued was $26.18 per share based on the average closing market price of the Company’s common stock for the fifteen trading days before the last five trading days before the merger. Outstanding North Bay stock options were converted (using the exchange ratio of 1.228:1) at a weighted average fair value of $12.78 per option.

The following table summarizes the purchase price allocation, including the estimated fair value of the assets acquired and liabilities assumed at the date of acquisition. Additional adjustments to the purchase price allocation may be required, specifically related to other assets, taxes and compensation adjustments.

(in thousands)

 

      April 26, 2007

ASSETS ACQUIRED:

  

Cash and equivalents

   $ 78,729

Investment securities

     85,589

Loans, net

     437,863

Premises and equipment, net

     12,940

Intangible assets

     14,210

Goodwill

     78,794

Other assets

     19,481
      

Total assets acquired

   $ 727,606
      

LIABILITIES ASSUMED:

  

Deposits

   $ 462,624

Term debt

     99,227

Junior subordinated debentures

     10,342

Other liabilities

     13,301
      

Total liabilities assumed

     585,494
      

Net Assets Acquired

   $ 142,112
      

The intangible assets represent the value ascribed to the long-term deposit relationships and merchant services portfolio income stream acquired. These intangible assets are being amortized on an accelerated basis over a weighted average estimated useful life of ten to fifteen years. The intangible assets are estimated not to have a significant residual value. Goodwill represents the excess of the total purchase price paid for North Bay over the fair values of the assets acquired, net of the fair values of liabilities assumed. Goodwill has been assigned to the Company’s Community Banking segment. Goodwill is not amortized, but is evaluated for possible impairment on a quarterly basis and more frequently if events and circumstances indicate that the asset might be impaired. No impairment losses were recognized in connection with intangible or goodwill assets during the period from acquisition to December 31, 2007. At December 31, 2007, goodwill recorded in connection with the North Bay acquisition was $77.0 million. The $1.8 million decrease from April 26, 2007 is primarily due to the recognition of a tax benefit upon exercise of fully vested acquired options.

 

62


Umpqua Holdings Corporation and Subsidiaries

 

On June 2, 2006, the Company acquired all of the outstanding common stock of Western Sierra Bancorp (“Western Sierra”) of Cameron Park, California, and its principal operating subsidiaries, Western Sierra Bank, Central California Bank, Lake Community Bank and Auburn Community Bank. The results of Western Sierra’s operations have been included in the consolidated financial statements since that date. This acquisition added Western Sierra’s complete network of 31 Northern California branches, including locations in the Sacramento, Auburn, Lakeport and Sonora areas, to the Company’s network of California, Oregon and Washington locations. This merger was consistent with the Company’s community banking expansion strategy and provided further opportunity to enter growth markets in Northern California.

The aggregate purchase price was $353.7 million and included 12.7 million common shares valued at $343.0 million, and 723,000 stock options valued at $10.7 million. Western Sierra shareholders received 1.61 shares of the Company’s common stock for each share of Western Sierra common stock (“exchange ratio of 1.61:1”). The value of the common shares issued was determined as $26.91 per share based on the average closing market price of the Company’s common stock for the two trading days before and after the last trading day before public announcement of the merger. Outstanding Western Sierra stock options were converted (using the exchange ratio of 1.61:1) at a weighted average fair value of $14.80 per option.

The following table summarizes the purchase price allocation, including the estimated fair value of the assets acquired and liabilities assumed at the date of acquisition. Additional adjustments to the purchase price allocation may be required, specifically related to taxes.

(in thousands)

 

      June 2, 2006

ASSETS ACQUIRED:

  

Cash and equivalents

   $ 36,978

Investment securities

     76,229

Loans, net

     1,009,860

Premises and equipment, net

     10,109

Core deposit intangible asset

     27,624

Goodwill

     247,799

Other assets

     83,519
      

Total assets acquired

   $ 1,492,118
      

LIABILITIES ASSUMED:

  

Deposits

   $ 1,016,053

Term debt

     59,030

Junior subordinated debentures

     38,746

Other liabilities

     24,540
      

Total liabilities assumed

     1,138,369
      

Net Assets Acquired

   $ 353,749
      

The core deposit intangible asset represents the value ascribed to the long-term deposit relationships acquired. This intangible asset is being amortized on a straight-line basis over a weighted average estimated useful life of ten years. The core deposit intangible asset is estimated not to have a significant residual value. Goodwill represents the excess of the total purchase price paid for Western Sierra over the fair values of the assets acquired, net of the fair values of liabilities assumed. Goodwill has been assigned to our Community Banking segment. 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. No impairment losses were recognized in connection with core deposit intangible or goodwill assets during the period from acquisition to December 31, 2007. At December 31, 2007, goodwill recorded in connection with the Western Sierra acquisition was $247.1 million.

The following tables present unaudited pro forma results of operations for the year ended December 31, 2007, 2006 and 2005 as if the acquisitions of North Bay and Western Sierra had occurred on January 1, 2005. Any cost savings realized as a result of

 

63


 

the mergers are not reflected in the pro forma consolidated condensed statements of income. The pro forma results have been prepared for comparative purposes only and are not necessarily indicative of the results that would have been obtained had the acquisitions actually occurred on January 1, 2005:

Pro Forma Financial Information—Unaudited

(in thousands, except per share data)

 

      Year Ended December 31, 2007
      Umpqua    North
Bay(a)
   Western
Sierra
   Pro Forma
Adjustments
    Pro Forma
Combined

Net interest income

   $285,954    $ 8,732    $    $ 454 (b)   $ 295,140

Provision for loan and lease losses

   41,730                      41,730

Non-interest income

   64,825      1,434                 66,259

Non-interest expense

   214,118      6,985           (3,537) (c)     217,566
    

Income before income taxes

   94,931      3,181           3,991       102,103

Provision for income taxes

   31,663      1,054           1,596 (d)     34,313
    

Net income

   $  63,268    $ 2,127    $    $ 2,395     $ 67,790
    

Earnings per share:

             

Basic

   $      1.06            $ 1.10

Diluted

   $      1.05            $ 1.09

Average shares outstanding:

             

Basic

   59,828      1,325           302 (e)     61,455

Diluted

   60,428      1,376           314 (e)     62,118

 

(a) North Bay amounts represent results from January 1, 2007 to acquisition date of April 26, 2007.
(b) Consists of additional net accretion of fair value adjustments related to the North Bay and Western Sierra acquisitions.
(c) Consists of merger related expenses of $3.3 million at Umpqua, adjusted for amortization of intangible assets and premises purchase accounting adjustment related to the North Bay and Western Sierra acquisitions.
(d) Income tax effect of pro forma adjustments at 40%.
(e) Additional shares issued at an exchange ratio of 1.228:1 for North Bay and 1.610:1 for Western Sierra shares.

 

64


Umpqua Holdings Corporation and Subsidiaries

 

(in thousands, except per share data)

 

      Year Ended December 31, 2006  
      Umpqua    North
Bay
   Western
Sierra(a)
   Pro Forma
Adjustments
    Pro Forma
Combined
 

Net interest income

     $262,124    $ 29,094    $ 25,834    $ (474) (b)   $ 316,578  

Provision for loan and lease losses

     2,552      200      350            3,102  

Non-interest income

     53,597      4,547      5,040            63,184  

Non-interest expense

     181,949      22,461      18,168      (1,959) (c)     220,619  
        

Income before income taxes

     131,220      10,980      12,356      1,485       156,041  

Provision for income taxes

     46,773      3,854      4,898      594 (d)     56,119  
        

Net income

     $  84,447    $ 7,126    $ 7,458    $ 891     $ 99,922  
        

Earnings per share:

             

Basic

   $ 1.61            $ 1.59  

Diluted

   $ 1.59            $ 1.57  

Average shares outstanding:

             

Basic

     52,311      4,131      3,292      2,950 (e)     62,684  

Diluted

     53,050      4,290      3,378      3,039 (e)     63,757  

 

(a) Western Sierra amounts represent results from January 1, 2006 to acquisition date of June 2, 2006.
(b) Consists of additional net accretion of fair value adjustments related to the North Bay and Western Sierra acquisitions.
(c) Consists of merger related expenses of $4.8 million at Umpqua, adjusted for amortization of intangible assets and premises purchase accounting adjustment related to the North Bay and Western Sierra acquisitions.
(d) Income tax effect of pro forma adjustments at 40%.
(e) Additional shares issued at an exchange ratio of 1.228:1 for North Bay and 1.610:1 for Western Sierra shares.

(in thousands, except per share data)

      Year Ended December 31, 2005
      Umpqua    North
Bay
   Western
Sierra
   Pro Forma
Adjustments
    Pro Forma
Combined

Net interest income

   $209,282    $ 28,660    $ 59,428    $ 5,398 (a)   $ 302,768

Provision for loan and lease losses

   2,468      815      2,050            5,333

Non-interest income

   47,782      4,064      13,198            65,044

Non-interest expense

   147,056      21,171      42,758      5,232 (b)     216,217
    

Income before income taxes

   107,540      10,738      27,818      166       146,262

Provision for income taxes

   37,805      4,105      10,072      66 (c)     52,048
    

Net income

   $  69,735    $ 6,633    $ 17,746    $ 100     $ 94,214
    

Earnings per share:

             

Basic

   $      1.57            $ 1.52

Diluted

   $      1.55            $ 1.49

Average shares outstanding:

             

Basic

   44,438      4,074      7,707      5,630 (d)     61,849

Diluted

   45,011      4,254      7,951      5,820 (d)