Banner Corp (BANR) 2009 Q3 法說會逐字稿

Good morning, ladies and gentlemen and thank you for standing by. Welcome to the Banner's third-quarter 2009 results conference call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded today, Wednesday, October 21, 2009. I would now like to turn the conference over to Mike Jones, President. Please go ahead, sir.

Thanks, Mitch and thanks all of you for taking the time to listen into our third-quarter conference call. I have here sitting with me in Walla Walla Cindy Purcell, who is the Chief Operating Officer of the bank; Lloyd Baker, who is the Chief Financial Officer of the bank; Rick Barton, who is the Chief Lending and Credit Officer of the bank and Al Marshall, who is the Secretary of the Corporation. It is getting to be a real crowd around the table here. But we want to be able to answer all of your questions. So before we get started, I would like to have Al read a paragraph if you would at this time.

Good morning. Our presentation today discusses Banner's business outlook and will include forward-looking statements. Those statements include descriptions of management's plans, objectives or goals for future operations, products or services, forecasts of financial or other performance measures and statements about Banner's general outlook for economic and other conditions.

We also may make other forward-looking statements in the question-and-answer period following management's discussion. These forward-looking statements are subject to a number of risks and uncertainties and actual results may differ materially from those discussed today. Information on the risk factors that could cause actual results to differ are available from the earnings press release that was released yesterday and a recently filed Form 10-Q for the quarter ended June 30, 2009. Forward-looking statements are effective only as of the date they are made and Banner assumes no obligation to update information concerning these expectations.

Thanks, Al. Now I would like to turn it over to Lloyd Baker to kind of give an overview of the third-quarter results. So Lloyd, go ahead.

Okay, thanks, Mike, and good morning, everyone. I have just a few comments on our operating results and financial condition and then as always, I look forward to your questions.

The most obvious comment for the third quarter for Banner Corporation is that we continue to find ourselves dealing with a very difficult economic environment. That, of course, was highlighted by the recording a $25 million loan loss provision, which while it was considerably less than the previous quarter and perhaps was less than the expectations of some, it is considerably more than our normal expectations and continue to be the primary reason that we are reporting a net loss for the quarter and year-to-date.

This loan loss provision, which more than covered our net charge-offs, was again driven primarily by declining property values adversely impacting our residential construction and land development portions of our portfolio. As we have noted in the press release, other portions of the loan portfolio continued to experience only normal credit problems, producing a much less significant impact on the provision.

I am going to leave most of the comments with respect to asset quality to Mike and Rick. However, I do want to note, as we have noted in the release, that our provisioning continues to reflect very current and I might add very expensive real estate appraisals and evaluation estimates.

So aside from loan loss provisioning, I think the most important observation with respect to the income statement is the linked-quarter increase in net interest income, which at $36.4 million for the quarter was up a little more than 4% compared to the second quarter. Importantly, this reflects a modest improvement in our net interest margin. We noted on last quarter's call that we anticipated margin improvement in the second half of this year and we are encouraged that that projection is becoming a fact.

The margin improvement reflects a continuing decrease in our funding costs, which primarily results from much improved deposit pricing. Deposit costs dropped by another 20 basis points during the quarter and continued a year-to-date trend of decreasing each month during the quarter. As a result, we are again confident that we will see a further decline in the cost of funds in the fourth quarter and hopeful that that will result in increased margin as well.

By contrast to the declining cost of funds, and this is also rather encouraging, loan yields increased by 4 basis points during the quarter despite the continuing drag from non-accrual loans. That was really a good sign I think that we could see stabilization in loan yields despite the adverse effect of exceptionally low interest rates that continues to be very evident when comparing our net interest margin to the third quarter a year ago. However, again, as I mentioned, it seems pretty clear to us that, barring something really overseen, the margin should increase again in the fourth quarter and likely into next year.

Another important revenue observation is that deposit fees and service charges also showed linked-quarter improvement. While this in part reflects an increase in our account base, it primarily reflects increased customer and merchant transactions, which is hopefully an encouraging economic indicator not only for Banner, but also for our customers.

While not as strong as the previous quarter, mortgage banking was again robust and well above the year-ago levels. Although we expect mortgage banking activity will show some seasonal declines over the next couple of quarters, we also expect that the low level of interest rates will continue to have a very positive effect on loan originations and on home sales I might add going forward.

Again this quarter, our results reflect significant effort by our staff to keep manageable operating expenses well under control. Unfortunately, the significant progress in general operating expenses has been masked by higher FDIC insurance charges and collection in REO expenses. These trends are particular -- both the trend in decreased manageable costs and the increases in FDIC charges in particular are very evident when you look at the year-over-year comparisons.

And just to scale that, for the nine months ended September 30, compensation expense was down $5.1 million compared to a year ago while FDIC insurance charges were up $6.2 million. So we are dealing with increased expenses for insurance and obviously, increased collection costs. But our staff is making a really tremendous effort to manage those expenses that we can and holding the net changes at very modest levels.

Looking at the balance sheet, the most important observation continues to be the really impressive job our branches are doing growing retail deposits. Despite further planned runoff of $39 million in public funds and $62 million in brokered CDs, we were able to grow deposits by $111 million in the third quarter. That means that our retail deposits increased by $212 million while, as I noted before, we were significantly reducing the cost of deposits at the same time. We believe this deposit growth is really building a strong foundation for performance in future periods and as I noted, continues to be probably the most significant activity going on at the bank all year long.

The deposit growth coupled with modest loan demand and continued paydown in construction loaons also allowed us to significantly improve our on-balance sheet liquidity. While low short-term interest rates make holding this liquidity a bit expensive on our net interest margin, it makes our regulators happy and it provides us with much better flexibility in still rather uncertain economic times.

I think I will let Rick discuss most of the activity in the loan portfolio and then, of course, the other significant concern with respect to the balance sheet is our capital position. While recording a net loss obviously has a negative impact on our retained earnings, we were fortunate to continue to have significant interest in our dividend reinvestment and stock purchase plan during the quarter, which generated approximately $4.8 million of additional common equity during the quarter.

As a result, our total capital position was only modestly changed from the levels at June 30. And further, as we have noted in the release, both of our subsidiary banks continue to be well-capitalized at levels significantly in excess of the regulatory definitions of well-capitalized.

And then finally, and equally important, we remain confident that this level of capital is sufficient to allow us to work through the challenging economic environment.

So certainly, a difficult quarter, but as I have noted in previous quarters, there is always some good things going on and right now, those good things seem to be focused largely on great progress in repositioning our balance sheet, establishing a foundation for stronger earnings out of that balance sheet in future periods.

So those are my prepared comments. I am going to let Mike and Rick I guess talk about asset quality here for a moment and then again look forward to questions.

Thanks, Lloyd. I would now like to turn it over to Rick Barton to talk a little bit about the loan portfolio and so forth. So Rick, go ahead.

Okay, thank you, Mike. There are several areas that I will just touch on very briefly and then save the balance of the comments for questions. First, the press release noted that we had seen a slowdown in the growth of problem assets. And I see this when I look at all the various credit quality measures, whether it be 30 day past dues, the level of criticized assets and nonperforming loans and nonperforming assets. And hopefully this is further evidence of what Mike has talked about the last couple of quarters that we appear to be at the crest of the problems that we're going to have in the portfolio. Time will tell on that, but I see some positive indicators in the numbers and the measures that I just mentioned.

As far as nonperforming assets go, looking at the nonperforming loans first. They continue to be dominated by the construction and land portfolio and the bulk of the increases that we saw in the third quarter came out of that portfolio. I think it is good to note or important to note that, of the $243 million in nonperforming loans, we have done FAS 114 analyses on $218 million of that amount. Those analyses being based on the appraisals that Lloyd already mentioned, as well as some additional market data and valuations that we have done.

So we think that the reserve that we have is very reflective of the continuing values of those assets. And it also probably should be noted that the $218 million that we have done the 114 and analyses on is after $45 million in charge-offs. So those assets have been substantially written down.

The one troubling aspect of the reserve is coverage of nonperforming loans. I think this is in part mitigated by the number of 114 analyses that we have done. And if you artificially split the reserve into a FAS 114 and FAS 5 component, the coverage of the FAS 5 component is about 3.7 times. So when you take the 114 non-accruals out and take the amount of the reserve allocated to that out, coverage of the remaining non-accruals is at more historic levels.

REO actually was a good story for us during the third quarter. You see from the press release that we showed a net reduction in REO assets of about $3.4 million. What this does not reflect is that we had transfers into REO during the quarter of about $10 million. We had to spend some money completing some projects, but we had total sales of REO during the quarter of approximately $16 million. And this is a real tip of the hat to the people managing those assets for us that they are finding ways to move them off the balance sheet.

The only other area that I would touch on very briefly is our CRE portfolio. It is significant when you combine the owner occupied and non-owner occupied portions of approximately $1 billion. The credit metrics for that portfolio remain very stable. 30 day past dues ae running about 1%. Nonperforming loans are about 6/10 of 1% and the level of classified assets has been very stable over the last year or so. And charge-offs in that portfolio have been very nominal and there were none for the last two quarters.

Despite the fact that we have these strong metrics in the portfolio, this continues to be an area of a great emphasis for us. We are in the final stages of completing loan-by-loans stress tests on the portfolio so that we can identify where weakness might occur in the portfolio before it actually migrates into the credit metrics so that we can get a leg up on trying to do restructuring, etc. with that portfolio to prevent problems down the road. The results of the stress tests indicate to me that what we see in the portfolio is very manageable at this juncture. With that, those conclude my comments, Mike.

Thanks, Rick. I will just make a couple of comments and then we'll turn it over to the question session. First, and I'm a little uncomfortable talking about this because this is new territory for me, just brief elaboration on our comment relative to the recent regulatory exam of our lead bank, Banner Bank by the FDIC and th DFI in the state of Washington.

The things that I think are important to note that came out of that exit conference with them was, in essence, an agreement by them with our risk ratings, there were very few exceptions and very few changes in the downgrades that took place in that process.

Secondly, they did a fairly in-depth, as you would suspect, review of our ALLL calculation methodology, at the end of which they had no suggestions for changes and actually had not asked for any increase over the reserve provisioning that we did in the third quarter. So we felt very good about that. And although we still do not have the written report from them and we are expecting that sometime in the next month or so I guess.

As it relates to going forward, I think Rick said it well. We are clearly seeing a leveling off that is taking place in the amount of assets moving into the nonperforming and classified categories. There still are some occurring, but we believe on the other side that we now have control of enough of these assets that we are going to be able to move them out as fast as they move in. So we are hopeful as we go forward that there won't be dramatic increases in our NPAs.

Fourth-quarter estimates for us are very difficult and I am not here to predict that we are going to make a profit in the fourth quarter. It's possible, but probably not probable. But the one thing I can say is, based on where we sit today, we expect to be a whole lot closer to making a profit than we were in the third quarter. So with that, I think I would stop and Mitch, if you wouldn't mind, I think it is appropriate at this point to field some of the questions that are out there.

(OPERATOR INSTRUCTIONS). Matthew Clark, KBW.

Hey, good morning, guys. I guess, first, is there any -- I guess in terms of the -- you gave us -- that was very helpful in giving us the FAS 114 impairment analysis. It looks like you guys have marked those down by about 17%. Now is that -- I guess -- I assume the regulators had a look at that. I guess what is your sense for your ability to unload some of these nonperformers relative to where you have them marked at now? Do you have -- I guess is there some desire to even maybe get a little bit more aggessive and take -- write them down a little bit further to try and unload these things and start to reduce your nonperformers?

Rick, why don't you go ahead?

Well, that is a question that is difficult to answer because each, as I have said before, each one of these deals is unique and we take an individual approach to each one of them. Given some of the dynamics that we have seen in the marketplace, we have actually been able to sell select assets at or above the levels that we have them marked down to now. And that leads me to say that I am not, at this point, interested in taking additional discounts just to move the assets off the balance sheet when I am seeing some success in moving them off at the levels we are currently carrying them out. That doesn't mean that all assets are created equal and that there would not be select cases where that strategy would be considered.

And I think it is fair to say, Matthew, in certain segments of Puget Sound as an example where we have a construction concentration geographically, these won't mean much to you, but they are small suburbs of Seattle such as [Bellevue], Redmond, Kirkland, Issaquah and that area that there are dramatically less available housing on the market. In some of those markets, it is a two- month supply that is on and so there is going to be a start of construction that is going to take place there.

And as that has happened and frankly some of the national homebuilders have begun to move back into the market there in acquiring lots and we actually completed a transaction in October with one of the national homebuilders on some of those lots, that my suspicion is that some of those are going to have some appreciation value on a go-forward basis. Now that isn't uniformly true throughout Puget Sound, but it happens to be true where a lot of our concentration of construction is.

Okay, great. And then the home financing program that you guys have, used to try to build absorption and help a lot of your borrowers out. I guess can you give us a sense for how much in the way of financing you have done for those types of projects and how it may have -- how might -- may have helped mitigate new non-accruals for example?

Back to you, Rick.

Well, the press release indicated that I think we have sold 361 of the 617 houses. That amounts to a reduction of approximately $125 million, $130 million in outstandings. And I think last I focused on that number, there was order of magnitude about $100 million of that that we had put on our balance sheet. The balance people paid cash for or financed elsewhere. We have gone through a process with those assets of valuing and discounting them to account for the below-market financing.

Which was a charge against the provision.

Which was a charge against the provision.

Okay. Can you give us maybe a better sense then in terms of how that $100 million is performing? Delinquency perspective?

To date, it is performing. I don't believe we have a single delinquency in the special financing program at this time, Matthew.

Okay, thank you.

Jeff Rulis, D.A. Davidson.

Good morning. Lloyd, just to follow up on the DRIP program. I think you said $4.8 million in common was raised in Q3. I guess your expectations going forward, do you feel like you could match that value and I guess if you could just put it in the context of the shares that were added in the quarter?

A painfully large number of shares, Jeff. Are we confident that we can do that going forward? Yes, I think we are. We actually had the results for October and we had another good month in October. So we think that that is a sustainable level as long as we are willing to sell the shares.

That is the $64 question, Jeff. I think it is a discussion point at every Board of Directors meeting is whether or not we should continue this DRIP program with selling the stock at where it is relative to tangible book because the Board has a clear expectation that the stock price will come closer to tangible book as we go forward.

Okay, so the capacity on that is -- I forget the share count -- what is the constraints on the program?

There is a capacity issue. We have registered I believe it is 3 million, 3.8 million shares currently available under the plan and if you followed that, I think we are on our third registration now under that plan. So we don't do a lot of shares when we do the registration, but we have had to do more as the prices have been at the current level.

That helps. And then, Mike, you talked a little bit about Seattle in terms of the area there. I guess if you could compare and contrast Portland versus Seattle in terms of how good do you feel about construction and land development in those two markets?

Actually, if you don't mind, Jeff, I am going to let Rick Barton answer that.

Sure.

Okay, well, of the two markets generally, I think Seattle is in better condition than the greater Portland market and in the Seattle market, the closer you are to Seattle's core, the better off you are when you get off into Pierce County and [Snohomish] County. Things are still fairly weak and the overhang in inventories in those outer areas is still quite dramatic. Fortunately, our exposure in both [Snohomish] and Pierce Counties is very small compared to the overall size of our portfolio and the overall amount of product in those markets.

Portland, as I said, is a situation which is weaker than metropolitan Seattle. That is pretty generally the case in all markets; although we are seeing some areas in which the inventory overhang is decreasing. And there is some indication of some stabilization of land prices in some of the markets.

Probably the weakest area in general right now is across the Columbia River in Vancouver, Washington. But again, our exposure in that market, while we have some, is a small fraction of our total exposure to metropolitan Portland.

Okay, thanks. Then lastly, just trying to get an idea of how much further -- rundown on the construction and land segment. It is clearly sort of cannibalizing overall loan growth. If you could talk about your expectations going into next year on how much further do you want to run that down and overall 2010, do you think that is a loan growth year or again we will be sort of flatfish for the next year?

Actually, Jeff, I think it is going to depend a little bit on how the economies go and frankly, I don't want to get back to this as the only thing that counts, but we would really like to see the [dreamliner] from Boeing fly because I think that would help the overall economy and Puget Sound even more, not only just from an economic real dollars, but from a perception standpoint amongst the consuming public out there.

If things get better going forward, which we think they will, we will start to let our builders build on some of the lots they have on a selective basis and not just go crazy building it, but we will start that process. And that process will Cause the one to four construction portfolio to level out at the levels that it is at and not have significant additional declines going forward.

If on the other hand, in a market I would point to hear in this particular case, Boise, which we think is still going to be very weak into 2010, we are not going to build out in that marketplace or start additional construction at the same rate we would in certain parts of the Seattle area. And as a result of that, that part of our portfolio will run down during the course of 2010. Overall, I think at the end of 2010, our portfolio will be about the size that it is today if the economy performs as we think it will.

Okay, thanks for the comments.

Kipling Peterson, Columbia Ventures Corporation.

Good morning. Just a question. One of your competitors on his call made the comment that many, if not most, Pacific Northwest banks are no longer in the lending business. And I am wondering if you could, A, comment on that and then B, this fellow also said that the loans they are writing are the best loans he has ever seen in his lifetime due to the fact that they can cherry pick from the borrowers who are no longer able to borrow at their traditional banks.

Well, good for him. In our particular case, we are lending money and I am guessing he is right. There are some banks in the Pacific Northwest that are electing not to really be aggressive in their lending stance. We are not being real aggressive on our lending stance either because frankly, the economy of our region is reasonably troubled and it continues to be troubled. And I am glad that he can have the best loans he has ever seen in his life, but there are a lot of companies out there doing business in an economic region that has got some problems with it.

So we are looking at loans, we are being very supportive of our existing customer base. We have actually done some loans that were previously at other banks and we continue to look for that sort of thing. We are not real excited about doing CRE until we determine what is going to happen with valuations and vacancies and cap rates in that particular market. So you can do those. We could double our balance sheet doing CRE loans in the Pacific Northwest. We are choosing not to do that. We are much more interested in doing small business and C&I lending and being supportive of our existing customer base.

So I hope that answers your question. I am just not quite as bullish as he is about how well some companies are doing in the Northwest.

I think maybe what he was getting to was they are now able to require 50% collateral and lend at 6% margins or something.

And maybe we all -- and we all -- every bank in the area, and for that matter I'm sure nationally, has tightened up their standards for approving loans and so forth and what they require in the area of collateral and so forth. Because there are fewer lenders out there in the marketplace, at least in the Pacific Northwest, rates are a bit higher, but that was a nice statement. Good for him.

Thank you.

Tim Coffey, FIG Partners.

Good morning, gentlemen. How are you doing?

Good, Tim.

I hate to keep beating on this, but can you tell me how much of the C&D portfolio is classified at this point?

The C&D?

I'm sorry, construction and land development?

I don't know if I have that number. Do you have it, Rick? I am going to bet half of it.

Okay.

I mean that is just a shot in the dark, Tim and I don't mean to be flippant, but clearly most of it is -- most of those builders are in distressed positions.

Order of magnitude, $190 million.

Okay, so a little less than half.

Okay. And given the comments that we have learned in the press release and what I have heard this morning, would it be safe to assume that that trend is actually trending lower at this point?

I think it has flattened out.

Okay. And then given the supportive comments you are making about the CRE portfolio, what kind of -- where is that support coming from? Is it something in the underwriting and the projects that you chose to finance? What do you think it is?

Rick?

I think it is a real combination of things. First of all, it is a very granular portfolio. There are nearly 2000 loans in it. So the average size of the loan is about $500,000 or so.

Another thing is that while there are concentrations in metropolitan Seattle, Portland and Boise, a significant chunk of that portfolio was underwritten in our more traditional markets in Eastern Washington and Eastern Oregon where there was much less run-up in value and cap rates were more normal over the last several years. So there is less impact that the current economic environment is having on values there.

And I would like to think that part of it rests in good risk selection on the front end. We have had a very disciplined underwriting process for real estate for the last number of years. And I think that is going to pay real dividends as we go through this economic cycle.

Okay, great. Those were my only two questions. I appreciate your time. Thanks.

Louis Feldman, Wells Capital Management.

Thank you. Actually my question has been answered. Thank you.

(OPERATOR INSTRUCTIONS). Matthew Clark, KBW.

Just a follow-up question. Having never had the fortunate experience of sitting through a rate exam, which actually pleased to be able to say that, can you give us maybe a sense for what the risk is, if there is a risk in terms of how an exit interview might differ from a formal report, whether or not you feel -- how comfortable do you feel with that exit interview in terms of the amount of information that you gain from that relative to what might be in a formal report?

Matthew, the exit interview was held about a week after they concluded their fieldwork. So they have been back in their offices for a week. In sitting in on that meeting, although not the presenter, they always allow the lead examiner from the field to be the lead presenter in the exit interview, were senior people from both the FDIC and the state of Washington. So I am not saying it can't change because I am sure it can change, but we would be surprised if it changed very much from where it was because of the length of time that they had from the time they completed their fieldwork to the exit review when they were back in their offices and secondly because of the fact of the senior people listening in and frankly, contributing from time to time in the process.

Great, okay, thank you.

Sarah Hasan, McAdams Wright Ragen.

Good morning, guys. I was wondering if you could talk about the deferred tax asset. Is there some kind of deadline for when you need to be able to have some inkling of when you will be able to use it?

Hi, Sarah. It is Lloyd. There is not a deadline per se. I think you understand we get to look at our carryback capabilities on the deferred tax asset, as well as our projections for future earnings. And of course, that is where -- that is where the issue really lies is can you comfortably project future earnings and under the GAAP standards, we and our accountants right now are comfortable that we can.

Now, I will give you a quick additional comment, which is the regulatory standard with respect to the deferred tax asset are a little different and they give you only a 12-month period for the carryforward portion of it. And if you can't project earnings over that 12-month period of time, in their regulatory capital calculation, it is not reflected in your balance sheet. But in the capital calculation, there is a disallowed portion of the tax asset and for Banner Bank, our capital ratios reflect that there was a portion, a significant portion of that deferred tax asset that was disallowed. So the effect on regulatory capital ratios has already been captured.

And I think as an addition to that, although I don't think this is a sure thing, but it appears to have some real support in the Senate, 43 senators have signed onto a bill that would extend the carryback provisions from two years to five years. And a significant number of representatives have also signed onto a similar bill in the House, something just short of 100 representatives have signed on. So I think it is at least possible, if not closer to probable, that we are going to get a five-year carryback for the industry. Not just us, but for the whole industry, which in essence will take this problem away.

Thank you.

Which we would encourage anybody who wants to support that position with their congressmen and senators.

I think that would help a lot of banks.

Thank you. Ladies and gentlemen, that does conclude our Q&A session for today. I would now like to turn the conference back over to management for any closing statements.

Well, thank you all for taking the time to listen. I have sitting here beside me Cindy Purcell, our Chief Operating Officer, who knows more about all of this than I certainly know and I am sorry that I didn't get to have her be a part of the presentation so you get to know her a little bit better. But nevertheless, she is here and part of the operation.

A question I often get when institutional investors and/or analysts call me is on the issue of capital and so forth. It is not that we don't look at capital and the opportunity to raise capital often. We are still one of those banks that are shown by the FDIC, banks on their resolution problem list and we look at that not daily, but certainly a couple, three times a week for opportunities there. And we have not made an aggressive bid on anything at this point in time, but we continue to see them. We are also being approached by a number of smaller banks, regional banks, smaller than us that would like the opportunity to consider merging with us. And it is not that we would say never to that either, but it is probably unlikely that we would do that. We do have a lot of that.

And if some opportunity like that did come along that we think makes sense to the Company and would enhance its value, we would consider the capital issues at that point in time. So right now, we have no bids out and frankly, no serious discussions going with anybody; although some people would certainly like to get started.

So we appreciate you taking the time to listen in on our conversation and we look forward to talking to you at the end of the fourth quarter hopefully with we think will be better results.

Ladies and gentlemen, this concludes the Banner's third-quarter 2009 results conference call. If you would like to listen to a replay of today's conference, please dial 800-406-7325 or 303-590-3030 with the passcode 4171247. ACT would like to thank you for your participation and you may now disconnect.