Albina Community Bancorp (the "Company") is an Oregon business corporation organized in 1993 by a group of concerned community and corporate citizens to promote community development services in North and Northeast Portland, Oregon, to benefit the low- and moderate-income residents and to support and finance private-sector redevelopment projects in the area. The Company's activities are focused on promoting investment and development in the Albina district through its wholly-owned subsidiary community development bank, Albina Community Bank (the "Bank"). The Company currently has no operations separate from the Bank.
Albina Community Bank
The Bank is a commercial bank organized under Oregon law, the deposits of which are insured by the FDIC. The Bank's lending programs are focused on residential loans for acquisition, rehabilitation, and home improvement, including federally guaranteed loans. In addition, the Bank offers commercial loans to ses, including inventory and working capital financing, and loans guaranteed by the federal S Administration. The Bank's primary deposit base includes large time deposits by governmental entities, corporations, socially responsible local citizens, and program-related investors. The Bank conducts its business from its office located at 2002 N.E. Martin Luther King, Jr. Blvd, Portland, Oregon.
Plan of Operation
Overview
The Company's business plan was created in consultation with Shorebank Advisory Services, a subsidiary of South Shore Bancorp in Chicago, Illinois, the parent holding company of South Shore Bank, one of the first community development banks in the United States. Community development banks, as well as other community development financial institutions, tailor specific loan products to meet the needs of low-income and minority communities, and have been innovators in the creation of non-standard transactions which have sometimes been adopted by mainstream lending institutions. These institutions have also been successful in promoting community revitalization by providing a presence that is known and trusted within communities which have become disconnected from the mainstream social and economic system. Moreover, these institutions provide a wide array of services intended to build the capacity of borrowers and community institutions and to promote revitalization efforts. The success of these institutions is due in part to the focus of lending decisions on the collective benefit to entire communities, rather than on the benefit to the institution of discreet transactions.
The business plan is intended to implement the Company's stated mission of promoting redevelopment and reinvestment in North/Northeast Portland, Oregon (the "Target Area"), through credit assistance for renovation and rehabilitation of existing residences, stimulation of the rehabilitation industry and small business enterprises, and by attracting capital from outside investors.
The business plan calls for making credit available to residents of the Target Area for acquisition and rehabilitation of residential properties, small business financing, and consumer loans. The Bank participates with other financial institutions in loans which exceed the Bank's lending limit, or which are originated by other institutions and present opportunities for the Bank to deploy its capital within the market area at an appropriate level of risk. Over time it is expected that there be more emphasis on business development and housing development within the Target Area. The Company believes that by focusing its resources on a concentrated area, the perception of outside investors and entrepreneurs will improve, attracting additional capital, business development, and employment prospects.
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Although the Company has no current plans to do so, it may consider opportunities in the future to acquire one or more existing banks which may be positioned to further the objectives of the Company, and may consider prudent business opportunities outside the Target Area.
Capital Resources
The Company currently has no operations separate from the Bank. The Bank commenced operations on December 19, 1995, following a private offering of the Company's Class A Common Stock which raised approximately $4.75 million. In addition, the Company filed a registration statement with the Securities and Exchange Commission, which became effective on June 26, 1996, in connection with the offering of 100,000 shares of the Company's Class A common stock at a price per share of $10.00. The offering has not yet been completed, but is expected to be completed in the second quarter of the current fiscal year.
The Company believes that proceeds of the public offering, together with existing capital will satisfy the cash requirements of the Company for at least the next six months of operation. It is anticipated that the Company's cash requirements will not exceed $1.0 million during that period.
Credit Risk
The most significant risk to the Bank is that of losses resulting from defaults on loans. The market area of the Company is concentrated in an economically highly distressed part of the city of Portland, which area has historically experienced high unemployment and low income levels. The financial success of the Bank and the Company is dependent on the ability of borrowers to make timely payments, and on the positive impact of community development efforts on property values in the market area. Although the Bank has established an allowance for possible loan losses, if its loss experience is high, the charge to income to cover such losses could eliminate any profits of the Company, and could jeopardize the Bank's capital and ongoing operations. As the Bank may make loans which other commercial lenders have not made, or are unwilling to make, the underwriting criteria utilized by the Bank, and the credit risk assessment made by its management team, become particularly critical to limiting potential loan losses.
Management believes it can limit such losses to an acceptable level by the use of government guarantees when available, retaining adequate security for loans, and by becoming more familiar with the borrowers and the Community than other lenders have been able to do. As of December 31, 1996, the Bank had experienced no losses as a result of defaults on loans.
Interest Rate Risk
It is the Bank's business to borrow funds from depositors and other sources, and to lend those funds to borrowers or invest in interest-bearing securities. Net interest income, the Bank's primary source of income, is determined by the difference between the cost of deposits or other funds and the interest earned on loans or investment securities. Consequently, the Bank could suffer significant losses if its cost of funds were to rise and the additional costs could not be passed on to borrowers. Similar interest rate risks apply if the Bank invests in long-term fixed rate securities.
The Bank strives to ameliorate such risk in two ways: First, the Bank offers loans with variable interest rates, which permit the Bank to increase the interest rate, periodically, to reflect changes in the prevailing cost of funds.
The second way the Bank attempts to reduce the effects of interest rate changes is to match, to the extent possible, the maturities of the interest-bearing liabilities (such as time certificates of deposit) and fixed-rate loans or investment securities (such as U.S. Treasury bonds) it has purchased. In this way, as loans or investments are paid off or mature, a like or similar amount of deposits also matures, and loans can be matched with deposits to establish an acceptable interest rate spread over the maturity of the loan. Although management strives to minimize risk through asset/liability management policies, from time to time maturities may not be balanced. During such periods, a 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 results of operations of the Bank.
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The following table sets forth an analysis of the sensitivity of the loan portfolio to changes in interest rates.
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Results of Recent Operations
The Company has no operations separate from the Bank. The Bank commenced operations in December, 1995, and its activities have primarily consisted of gathering deposits and writing loans, as well as installing internal operating systems. At December 31, 1996, the Bank had total assets of approximately $19.8 million, total loans of approximately $11.3 million, and total deposits of $15.8 million. The Bank experienced a loss of $1.16 million for the year ended December 31, 1996, primarily as a result of operating costs exceeding revenues during the initial stages of operation. It is anticipated that as the deposits and loans continue to grow, the rate of losses will decline, although various factors, including adverse experience with credit risk and interest-rate risk, discussed below, may nonetheless result in losses. Moreover, as lending officers gain experience with lending in the Bank's target market, the level of loan production will increase, and the operating expenses as a percent of revenue will decline. It is not known, and cannot be accurately predicted at this time if or when the Bank will achieve profitability. Typically, a new bank's operating expenses will exceed operating revenue for the first two or three years of operations.
Deposits
The following table sets forth the average deposit liabilities of and the rates paid by the Bank for the year ended December 31, 1996: Average Balance Average Rate Paid
Non interest-bearing demand $311,897 n/a Interest-bearing demand 267,057 2.9% Savings 1,220,393 4.4% Time 5,898,973 5.3% --------- Total deposits $7,698,320
Of the time deposits listed above, the deposits of $100,000 or more had the following times remaining to maturity:
Balance at December 31, 1996 Remaining maturity: less than 3 months 2,470,292 3-6 months 914,588 6-12 months 1,113,665 over 12 months 495,000 ---------- Total deposits $100,000 or more $4,993,545 ==========
Loans
Interest earned on the loan and investment portfolios are the primary source of income for the Bank. Net loans represent 57.2% of total assets as of December 31, 1996. The Bank makes the majority of its loans to customers located within the Bank's service area. The Bank has no loans defined as highly leveraged transactions by the Federal Reserve Board, and has no loan charge-offs as of December 31, 1996. The following table sets forth the composition of the loan portfolio at December 31, 1996:
Commercial - lines of credit $2,482,743 Commercial - construction 401,016 Commercial - real estate 4,790,122 Residential Real Estate 3,578,624 Installment 335,518 Other 3,745 ----------- Total loans 11,591,768 Deferred loan fees, net (85,530) Allowance for loan losses (172,590) ------------ Net loans $11,333,648
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Investment Portfolio
The investment portfolio at December 31, 1996, had an aggregate book value of $6,090,352, as follows:
US Government and Federal Agencies $3,046,499 Mortgage Backed Securities 3,043,853 Total Securities $6,090,352
Employees
As of December 31, 1996 the Bank had a total of 19 employees, of which 16 were permanent full-time, 2 were temporary full-time and 1 was temporary part-time. The Company has no employes other than those of the Bank.
Supervision and Regulation
General
The Company and the Bank are extensively regulated under federal and state law. These laws and regulations are intended to protect depositors, 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 statutory or regulatory provisions. Any change in applicable laws or regulations may have a material effect on the business and prospects of the Company and the Bank. The operations of the Company and the Bank may be affected by legislative changes and by the policies of various regulatory authorities. The Company is unable to predict the nature or the extent of the effects on its business and earnings that fiscal or monetary policies, economic control or new federal or state legislation may have in the future.
The Company, as a corporation organized under Oregon law, is subject to certain limitations and restrictions of state law. Such limitations and restrictions relate to such corporate matters as indemnification of directors, distributions to shareholders, transactions with officers or directors, proper maintenance of books and records, and procedural requirements with respect to directors' and shareholders' meetings.
Federal Bank Holding Company Regulation
The Company is a bank holding company within the meaning of the Bank Holding Company Act (the "BHCA"), and as such, it is subject to regulation, supervision and examination by the Board of Governors of the Federal Reserve System (the "Federal Reserve"). The Company is required to file annual reports with the Federal Reserve and to provide the Federal Reserve such additional information as the Federal Reserve may require.
The BHCA requires every bank holding company to obtain the prior approval of the Federal Reserve before (i) acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company, after such acquisition, if it would own or control more than 5% of such shares (unless it already owns or controls the majority of such shares); (ii) acquiring all or substantially all of the assets of another bank or bank holding company; or (iii) merging or consolidating with another bank holding company. The Federal Reserve will not approve any acquisition, merger or consolidation that would have a substantial anti-competitive result, unless the anti-competitive effects of the proposed transaction are clearly outweighed by a greater public interest in meeting the convenience and needs of the community to be served. The Federal Reserve also considers capital adequacy and other financial and managerial factors in reviewing acquisitions or mergers.
With certain exceptions, BHCA also prohibits a bank holding company from acquiring or retaining direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank or bank holding company, or from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries. The principal exceptions to these prohibitions involve
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certain non-bank activities which, by statute or by Federal Reserve regulation or order, have been identified as activities closely related to the business of banking or of managing or controlling banks. In making this determination, the Federal Reserve considers whether the performance of such activities by a bank holding company can be expected to produce benefits to the public such as greater convenience, increased competition or gains in efficiency in resources, which can be expected to outweigh the risks of possible adverse effects such as decreased or unfair competition, conflicts of interest or unsound banking practices. Community redevelopment entities are among the activities deemed permissible by the Federal Reserve.
Subsidiary banks of a bank holding company are subject to certain restrictions imposed by the Federal Reserve Act on extensions of credit to the bank holding company or its subsidiaries, on investments in their securities and on the use of their securities as collateral for loans to any borrower. These regulations and restrictions may limit the Company's ability to obtain funds from the Bank for its cash needs, including funds for payment of dividends, interest and operating expenses. Further, under the Federal Reserve Act and certain regulations of the Federal Reserve, a bank holding company and its subsidiaries are prohibited from engaging in certain tying arrangements in connection with any extension of credit, lease or sale of property or furnishing of services. For example, the Bank may not generally require a customer to obtain other services from the Bank or the Company, and may not require that the customer promise not to obtain other services from a competitor, as a condition to an extension of credit to the customer.
Federal and State Bank Regulation
The Bank, as a state chartered bank with deposits insured by the Federal Deposit Insurance Corporation ("FDIC") that is not a member of the Federal Reserve System, is subject to the supervision and regulation of the Director of the Oregon Department of Consumer and Business Services, administered through the Division of Finance and Corporate Securities (the "Oregon Director"), and to the supervision and regulation of the FDIC. These agencies may prohibit the Bank from engaging in what they believe constitute unsafe or unsound banking practices.
As of July 1, 1989, Oregon has permitted out-of-state banking institutions to acquire banks or holding companies that have been in existence for a period of no fewer than three years. Generally, such acquisitions are subject to the approval of the Federal Reserve Board and the Oregon Director. As a result of 1993 Oregon legislation and 1995 federal law changes, Oregon banks may merge with out-of-state national or state banks, and out-of-state national and state banks may acquire Oregon branches or may merge with or acquire branches of Oregon or federal savings associations. Initial acquisitions must involve institutions which have been engaged in banking in Oregon for at least three years, but once such an acquisition is made, the resulting bank may add additional branches.
The Community Reinvestment Act (the "CRA") requires that, in connection with examinations of financial institutions within their jurisdiction, the Federal Reserve or the FDIC evaluates 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 banks. These factors are also considered in evaluating mergers, acquisitions and applications to open a branch or facility. The provisions of the CRA may be enforced by private citizens and interest groups as well as federal banking regulators, who conduct regular CRA examinations. A satisfactory rating means the Bank has adequately met the needs of the community, consistent with safe and sound banking practices. Although the Bank has not yet been subjected to a CRA examination, it is anticipated that the Bank will consistently receive more than satisfactory ratings on its CRA performance, as a result of its particular focus on meeting such credit needs.
The Bank is 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 (i) must be made on substantially the same terms, including interest rates and collateral as, and following credit underwriting procedures that are not less stringent than, those prevailing at the time for comparable transactions with persons not covered above and who are not employees, and (ii) must not involve more than the normal risk of repayment or present other unfavorable features. The Bank is 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 Bank or any officer, director, employee, agent or other person participating in the conduct of the affairs of the Bank, the imposition of a cease and desist order, and other regulatory sanctions.
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Under the Federal Deposit Insurance Corporation Improvement Act ("FDICIA"), each Federal banking agency is required to prescribe, by regulation, non-capital safety and soundness standards for institutions under its authority. These standards are to cover internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, such other operational and managerial standards as the agency determines to be appropriate, and standards for asset quality, earnings and stock valuation. An institution which fails to meet these standards must develop a plan acceptable to the agency, specifying the steps that the institution will take to meet the standards. Failure to submit or implement such a plan may subject the institution to regulatory sanctions. The Company believes that the Bank already meets substantially all the standards which have been or are likely to be adopted, and therefore does not believe that the implementation of these regulatory standards will materially affect the Company's business operations.
Deposit Insurance
As an FDIC member institution, the deposits of the Bank are currently insured to a maximum of $100,000 per depositor through the Bank Insurance Fund ("BIF"), administered by the FDIC. The Bank is required to pay semi-annual deposit insurance premium assessments to the FDIC.
The FDICIA includes provisions to reform the Federal deposit insurance system, including the implementation of risk-based deposit insurance premiums. The FDICIA also permits the FDIC to make special assessments on insured depository institutions in amounts determined by the FDIC to be necessary to give it adequate assessment income to repay amounts borrowed from the U.S. Treasury and other sources or for any other purpose the FDIC deems necessary. Pursuant to the FDICIA, the FDIC implemented a transitional risk based insurance premium system on January 1, 1993. Generally, under this system, banks are assessed insurance premiums according to how much risk they are deemed to present to BIF. Banks with higher levels of capital and a low degree of supervisory concern are assessed lower premiums than banks with lower levels of capital or involving a higher degree of supervisory concern. The premium range is from $.00, for the highest-rated institutions (subject to a statutory minimum assessment of $2,000) to $.27 per $100 of domestic deposits. The Bank's current FDIC premium rate is $.01 per $100 of domestic deposits.
Dividends
The principal source of the Company's cash revenues is dividends received from the Bank. Under the Oregon Bank Act, the Bank is subject to restrictions on its payment of cash dividends to the Company. The 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, the amount of the dividend may not be greater than its net undivided profits then on hand, after first deducting (i) all losses; (ii) all bad debts, unless the debts are well-secured, (a) on which interest for a period of one year is past due and unpaid, and (b) upon which final judgment has been obtained, but for more than one year the judgment has been unsatisfied and interest has not been paid; (iii) all assets or depreciation charged off as required by the Oregon Director; and (iv) all accrued expenses, interest and taxes of the Bank.
In addition, the appropriate regulatory authorities are authorized to prohibit banks and bank holding companies from paying dividends which would constitute an unsafe or unsound banking practice. The Bank and the Company are not currently subject to any regulatory restrictions on their dividends other than those noted above. However, the Bank is currently unable to pay dividends to the Company as a result of the lack of retained earnings. It is not known when, if ever, the Bank will be able to pay such "upstream" dividends.
Capital Adequacy
The federal bank regulatory agencies use capital adequacy guidelines in their examination and regulation of bank holding companies and banks. If the capital falls below the minimum levels established by these guidelines, the bank holding company or bank may be denied approval to acquire or establish additional banks or non-bank businesses or to open facilities.
The FDIC and Federal Reserve have adopted risk-based capital guidelines for banks and bank holding companies. The risk-based capital guidelines are designed to make regulatory capital requirements more sensitive to differences in risk profile among banks and bank holding companies, to account for off-balance-sheet exposure
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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 guidelines are minimums, and the Federal Reserve has noted that bank holding companies contemplating significant expansion programs should not allow expansion to diminish their capital ratios and should maintain ratios well in excess of the minimum. The current guidelines require all bank holding companies and federally-regulated banks to maintain a minimum risk-based total capital ratio equal to 8%, of which at least 4% must be Tier 1 capital.
Tier 1 capital for bank holding companies includes common shareholders' equity, qualifying perpetual preferred stock (up to 25% of total Tier 1 capital, if cumulative; under a Federal Reserve rule, redeemable perpetual preferred stock may not be counted as Tier 1 capital unless the redemption is subject to the prior approval of the Federal Reserve) and minority interests in equity accounts of consolidated subsidiaries, less intangibles except as described above. Tier 2 capital includes: (i) the allowance for loan losses of up to 1.25% of risk-weighted assets; (ii) any qualifying perpetual preferred stock which exceeds the amount which may be included in Tier 1 capital; (iii) hybrid capital instrument; (iv) perpetual debt; (v) mandatory convertible securities and (vi) subordinated debt and intermediate term preferred stock of up to 50% of Tier 1 capital. Total capital is the sum of Tier 1 and Tier 2 capital less reciprocal holdings of other banking organizations, capital instruments and investments in unconsolidated subsidiaries.
Banks' and bank holding companies' assets are given risk-weights of 0%, 20%, 50%, and 100%. In addition, certain off-balance sheet items are given credit conversion factors to convert them to asset equivalent amounts to which an appropriate risk-weight will apply. These computations result in the total risk-weighted assets.
Most loans are assigned to the 100% risk category, except for first mortgage loans fully secured by residential property, which carry a 50% rating. Most investment securities are assigned to the 20% category, except for municipal or state revenue bonds, which have a 50% risk-weight, and direct obligations of or obligations guaranteed by the United States Treasury or United States Government agencies, which have 0% risk-weight. In converting off-balance sheet items, direct credit substitutes, including general guarantees and standby letters of credit backing financial obligations, are given 100% conversion factor. The transaction related contingencies such as bid bonds, other standby letters of credit and undrawn commitments, including commercial credit lines with an initial maturity of more than one year, have a 50% conversion factor. Short-term, self-liquidating trade contingencies are converted at 20%, and short-term commitments have a 0% factor.
The Federal Reserve also has implemented a leverage ratio, which is Tier 1 capital as a percentage of total assets less intangibles, to be used as a supplement to risk-based guidelines. The principal objective of the leverage ratio is to place a constraint on the maximum degree to which a bank holding company may leverage its equity capital base. The Federal Reserve requires a minimum leverage ratio of 3%. However, for all but the most highly rated bank holding companies and for bank holding companies seeking to expand, the Federal Reserve expects an additional cushion of at least 1% to 2%.
For bank holding companies with less than $150 million in consolidated assets, the guidelines are applied on a bank-only basis unless the holding company is engaged in a non-bank activity involving significant leverage or has a significant amount of outstanding debt that is held by the general public. As of December 31, 1996, the Company was in compliance with applicable capital requirements.
The FDICIA also created a statutory framework of supervisory actions indexed to the capital level of the individual institution. Under regulations adopted by the FDIC, an institution is assigned to one of five capital categories depending on its total risk-based capital ratio, Tier 1 risk-based capital ratio, and leverage ratio, together with certain subjective factors. Institutions which are deemed to be "undercapitalized" depending on the category to which they are assigned are subject to certain mandatory supervisory corrective actions. The Company does not anticipate that these regulations will have any material effect on the Bank.
Under Oregon law, shares of the Bank may be assessable under certain circumstances. If the capital of the Bank becomes impaired, shareholders of the Bank (i.e. the Company) may be required to contribute additional capital. Shareholders of the Company would not be called upon for such a contribution.
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Effects of Government Monetary Policy
The earnings and growth of the Bank, and its existing and future activities, 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 can and does implement national monetary policy for such purposes as curbing inflation and combating recession, but 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, 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 the Company cannot be predicted with certainty.
Changing Regulatory Structure of the Banking Industry
The laws and regulations affecting banks and bank holding companies are currently undergoing significant changes. Bills are now pending or expected to be introduced in the United States Congress that contain proposals for altering the structure, regulation, and competitive relationships of the nation's financial institutions. If enacted into law, these bills could have the effect of increasing or decreasing the cost of doing business, limiting or expanding permissible activities (including activities in the insurance and securities fields), or affecting the competitive balance among banks, savings associations, and other financial institutions. Some of these bills would reduce the extent of federal deposit insurance, broaden the powers or the geographical range of operations of bank holding companies, modify interstate branching restrictions applicable to banks, regulate bank involvement in derivative securities activities, and realign the structure and jurisdiction of various financial institution regulatory agencies. Whether or in what form any such legislation may be adopted or the extent to which the business of the Company might be affected thereby cannot be predicted with certainty.
Of particular note is legislation which has been recently been enacted by Congress, as referred to above, permitting interstate banking and branching, which would allow banks to expand nationwide through acquisition, consolidation or merger. Under this law, an adequately capitalized bank holding company may acquire banks in any state if permitted by state law. In addition, banks may acquire branches of out-of-state banks through merger followed by conversion of the acquired bank branches into branches of the resulting bank. 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 in located permits such merger.
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