Banner Corp (BANR) 2010 Q2 法說會逐字稿

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Banner Corporation second quarter 2010 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) This conference is being recorded today, Thursday, July 22 of 2010.

At this time, I'd like to turn the conference over to Chief Executive Officer, Mr. Mike Jones. Please go ahead, sir.

Thank you very much, and thank all of you for taking the time to listen to our second quarter earnings conference call. We appreciate you taking the time to do that. I'm very pleased today to have online with me the senior management of Banner Corporation, starting with Mark Grescovich who's currently President of the Bank, but very soon will be my successor of the Company. And with him is Rick Barton, our Chief Credit Officer and Lloyd Baker, our Chief Financial Officer. We also have in attendance Al Marshall, who is the Secretary of the corporation. And before we begin the formal presentation, Albert, would you read your commentary, please?

Thank you, and 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, forecast 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 March 31, 2010. Forward-looking statements are effective only as of the date they are made and Banner assumes no obligation to update information concerning its expectations. Thank you.

Thanks, Albert. And with that, what I'd like to do is turn it over at this point in time to Mark Grescovich, as I indicated, the President of the corporation for his comments. Mark?

Thank you, Mike, and good morning everyone. Thanks for joining our call. While the second quarter resulted in a loss due to high credit-related costs, it also reflected the impact from our hard work throughout the Company and marked a significant event that is beneficial to Banner's future stability, path to profitability, and long-term growth potential.

Before I go into some detail there, let me briefly recap the quarter. For the second quarter of 2010, Banner reported a loss of $0.28 per average diluted share, compared to a net loss of $1.04 per average diluted share for the second quarter a year ago, and a loss of $0.16 for the first quarter of 2010. Our provision for loan losses in the second quarter of 2010 was $16 million versus $30 million for the second quarter 2009, and $14 million from the first quarter 2010.

While we have shown significant improvement compared to 2009, our credit costs remained too high. In a few moments, Rick Barton, our Chief Credit and Lending Officer, will discuss the credit metrics of the Company and provide some context around the loan portfolio, along with our continued emphasis to reduce our residential and construction portfolio, which now stands at 11% of total loans outstanding versus a high of 19.5%. Needless to say, the credit costs associated with this particular portfolio are high and have been a continual drag on profitability. We will continue to focus diligently at mitigating the risk to Banner in this portfolio.

We experienced further improvement of our net interest margin during the second quarter of 2010, increasing to 3.65%, compared to 3.24% for the second quarter 2009, and 3.61% for the preceding quarter. This improvement is reflective of our strategy to reduce our funding cost, re-mix our deposits away from high-priced CDs, and improve our core funding position. To that point, at June 30, 2010, our loan-to-deposit ratio was 95% versus 104% for the second quarter of 2009, and 96% in the first quarter of 2010.

Revenues from core operations were $45.9 million in the second quarter of 2010, an increase of 4.6% from the second quarter a year ago, and versus $45.2 million in the first quarter 2010. In the second quarter, we had a significant event that improved the capital position of the Company to weather a protracted economic downturn should one occur and also position Banner for organic growth.

On June 30, 2010, we completed an add-on public offering of 75 million shares of common stock and the sale of 3.5 million additional shares pursuant to the partial exercise of the underwriters' over-allotment option. Further on July 2, we announced the completion of the capital raise, as the underwriters had exercised their over-allotment option for an additional 7,139,000 shares. Together, Banner issued 85,639,000 shares in the offering resulting in net proceeds of approximately $162 million. This additional capital has significantly improved our balance sheet and our capital ratios. As of June 30, 2010, our Tier 1 leverage capital ratio increased to 13.01% versus 9.9% in the second quarter of 2009, and 9.76% in the first quarter of 2010. Also, our tangible common equity level improved to 9.08% at June 30, 2010, compared to 6.09% at March 31, 2010. Clearly this capital raise is a milestone for the Company and positions Banner well to service our existing clients through this economic cycle and allows for organic growth and reinvestment in our business.

I will turn the call over to Rick Barton to discuss the trends in our loan portfolio and credit metrics. Rick?

Thanks, Mark. Asset quality at Banner during the second quarter continued to stabilize. While our net charge-offs for the quarter did increase from the first quarter of 2010 by $2.7 million, they were significantly less than charges for the same quarter in 2009 and the 2009 quarterly averages.

Losses remained centered in the residential construction and land portfolio with those charges totaling $12.3 million or 76% of total second quarter charge-offs. A significant portion, $646,000 to be exact, of the one-to-four family real estate losses were not credit losses, as they represent mark-to-market charges for our Home Rush Peace of Mind program that continues to help our homebuilder clients sell completed homes. The performance metrics for the Home Rush portfolio remain strong with only two of the 492 loans currently more than 30 days past due.

Tangible evidence of stabilizing credit quality is demonstrated by looking at several portfolio metrics. Total non-performing assets decreased during the quarter both in absolute dollars and as a percentage of total assets, with the latter measure decreasing from 6.4% to 6%. The improvement in non-performing assets was driven by a $19 million reduction in non-performing loans. And importantly, new non-performing loans showed another quarter-to-quarter reduction. 30 to 89-day past due loans on accrual were down from $51 million to $27 million. And total past due loans decreased from 6.7% to 5.6% of loans outstanding.

Total adversely classified loans also decreased, going from $420 million to $388 million or approximately an 8% reduction. The ALLL provision, as a percentage of total loans, again increased to 2.63% and its coverage of non-performing loans improved to 54%. This occurred despite higher loan losses for the quarter. And finally, as Mark mentioned, the concentration of residential constructional loans in the portfolio has now been reduced to 11%.

REO showed another quarter-to-quarter increase, but at a sharply reduced pace from recent quarters. The sale of REO for the quarter was $10.4 million, with sale proceeds being 95% of carrying value. This liquidation performance is consistent with recent quarters both in terms of sales velocity and proceeds to book.

While we are encouraged by these stabilizing trends in asset quality, significant work remains to move portfolio metrics to acceptable levels. We are constantly assessing our collection processes to make sure adequate and appropriate resources remain dedicated to this important task. This is challenging, as the national economic recovery is still fragile. And some of our markets, Portland and Boise by name, have yet to fully stabilize.

With that, I will turn the presentation over to Lloyd for comments on the quarter's financial results.

Thanks, Rick, and good morning everyone. As Mark indicated and as we had projected in the prospectus supplement for our recent common stock offering, for the second quarter 2010 we again recorded a net loss. And that net loss was again the result of an elevated level of credit cost, including a substantial provision for loan losses, as well as significant loan collection expenses [leading to that] attorney's bills, appraisal costs and the like, and carrying costs related to the acquired real estate. While reducing these credit costs to a more acceptable level is the primary requirement necessary to return Banner to profitability and it will take some time, the financial results for the second quarter do reflect additional progress for the Company, including further improvement in our net interest margin and more importantly net interest income, as well as a few hopeful signs of modestly improving economy evident in increased deposit fee revenues, and commercial and agricultural loan growth.

Specifically, net interest income at $38.9 million increased by 2% compared to the immediately preceding quarter, and was more than a 11% greater than the same quarter a year earlier. For the first six months of 2010, net interest income has increased by $7.2 million or 10% compared to the first six months of 2009. These increases reflect significant improvement in our net interest margin, which as Mark indicated increased to 3.65% for the quarter, that's 41 basis point increase compared to 3.24% a year ago. This margin improvement has been driven by continuing reductions in our funding costs and more specifically in our deposit cost. Deposit cost decreased by another 15 basis points during the quarter or 82 basis points lower than a year ago, reflecting the deposit mix changes that Mark mentioned, as well as better pricing discipline by Banner and for that matter by many of our competitors, and importantly demonstrating further maturing of our branch network.

This margin improvement occurred despite further pressure on asset yields, as a result of a very low interest rate environment and growth in our on-balance sheet liquidity, in part because of fairly remarkable stability in loan yields. Loans yielded 5.72% for the quarter, two basis points lower than the first quarter, but five basis points higher than the same quarter a year earlier. Loan yields have been holding around this level for about five or six quarters now. However, looking forward, this is an area where we may see some pressure in future periods if market rates remain this well for an extended amount of time. Although, further reductions in non-performing loans may help offset some of this pressure.

As I mentioned earlier, another area of encouragement was the increase in deposit fees and service charge revenues for the second quarter. While this in part reflects the additional business days compared to the first quarter, the improvement particularly compared to a year ago also reflects an increase in customer accounts and a modest pickup in customer activity, which I would like to think is a hopeful sign relative to the economy.

On the other hand, mortgage banking revenue and activity remained very modest during the quarter despite the availability of exceptionally low mortgage interest rates, as home buyers remain cautious. The other possible sign of encouragement is in the loan portfolio balances. While total loans decreased modestly, that decrease largely reflected further reductions in our construction and land development loans, which was an intentional result of our strategies to reduce that lending concentration.

(inaudible) for the quarter we did have reasonable growth in commercial, business and agricultural loans, which in addition to the efforts of our bankers may reflect a little more optimism on the part of borrowing customers. Going forward, stronger loan demand will be another necessary requirement for improved performance.

Similar to recent periods for the second quarter, controllable operating expenses were generally well behaved and for the most part below levels recorded in the same quarter a year earlier. In addition, FDIC insurance, which is not an expense that we would characterize as controllable, while up modestly from the preceding quarter was substantially less than the second quarter of 2009 when the FDIC levied a large special assessment on all insured institutions.

As an aside, this is an area where we should see some meaningful relief going forward, as a result of the revised assessment provisions in the recently passed financial regulation legislation. Unfortunately, as I indicated before, expenses related to acquired real estate, including taxes, maintenance, valuation adjustments and loss on sale were substantially increased for the quarter. In addition, legal, appraisal and other collection costs remained high or increased for the quarter. As a result, our aggregate non-interest operating expense increased compared to both the immediately preceding quarter and the same quarter a year ago.

Turning to credit quality; for the quarter we recorded a provision of $16 million, which essentially matched our net charge-offs. This brought the provision for the first six months to $30 million, which while still painfully high is less than half the amount that we recorded in the first six months of 2009. At the end of the quarter, the allowance for loan losses at $95.5 million represented 2.63% of total loans outstanding compared to 2.32% a year earlier, and 54% of non-performing loans compared to 40% at June 30, 2009. So despite significant charges against the allowance, these coverage ratios have strengthened, and in addition the unallocated portion of the allowance stood at $9.6 million compared to $4 million a year ago, giving us further comfort with the adequacy of these reserves.

Finally, as Mark noted, we did significantly strengthen the capital base of the Company and of Banner Bank at the end of the quarter. While both entities have consistently exceeded the regulatory guidelines to be considered well capitalized, the portion of the net proceeds of the stock offering received on June 30 was sufficient to increase Banner Corporation's Tier 1 leverage ratio to 13.01% and increase the total risk-based capital ratio to 17.12%. In addition, we downstreamed $50 million as capital into the equity of Banner Bank, which increased its Tier 1 leverage ratio to 10.77% and its total risk-based capital ratio to 14.4% at June 30.

The final exercise of the underwriters' over-allotment option, which funded on July 2, will provide an additional $13.5 million of capital to the Company in the third quarter. So while the results for the quarter were a long way from where we want to be, there was a continuation of very positive trend of improvement in our net interest margin and net interest income, despite continuing drag from non-performing assets, continued improvement in the deposit area, including both interest cost and activity fees, and some modestly encouraging signs in the loan portfolio, and importantly significant improvement in the capital base, which will allow us to move forward confidently, despite a still very challenging economic environment.

So with that brief overview, I'll turn the call back to Mark. As always, I look forward to your questions.

Thank you, Lloyd. As indicated, while our results are not where we want them to be, it is important to point out that since our last call, we have laid the foundation for Banner's future by reorganizing the Company around revenue lines delivered through a super community bank model, substantially improved our capital strength, and added significant liquidity to the Company and the Bank.

That concludes our prepared remarks. And, Bow, we'll now open the call for questions.

Thank you, sir. We will now begin the question-and-answer session. (Operator Instructions) And our first question comes from the line of Jeff Rulis with D.A. Davidson. Please go ahead.

Good morning.

Hi, Jeff.

In terms of the -- with the capital raise done, do you see much use for the DRIP going forward or just view that as a as-needed basis?

Hi, Jeff, it's Lloyd. We will continue to DRIP it this quarter, we've already made that decision. Looking forward, I think couple of points; number one, it's a bit of a challenge to shut it down and then turn it back on. But obviously the need for capital has been addressed and I think we're going to take a hard look at that on every quarterly basis, but for the first 90 days anyhow we'll continue it.

Okay. And then, Lloyd, I guess on your margin discussion, I would ask if you estimate any margin pressure due to the proceeds from the deal for the full quarter, as you wait to deploy that?

Yes, I think not only the proceeds there, but as we've indicated for a while, we've been building on-balance sheet liquidity through stronger flow through the deposit area than demand for loan and so that pressure is there. Having said that, we'll probably be very prudent in the way we price CDs, in particular, going forward here over the next six to nine months, as we watch the economy. And so there -- I would expect the deposit flows to be a little in that area, in the CD area to be less and that may relieve some of the pressure there. We're certainly going to continue to see for some period of time a decline in the cost of deposits, but you're right on point, the issue is our asset yield is going to hold in there.

Okay. And then lastly, I mean, I think you guys had a regulatory exam in the fall of last year, is that anticipated in the next little while that should be due for one this year, in the next couple of months?

Yes. Jeff, this is Mark. Certainly we anticipate a regulatory exam sometime at the end of the third quarter or fourth quarter, but it has not been scheduled as of yet.

Got it. Okay, thanks.

Thank you. (Operator Instructions) And our next question comes from the line of Tim Coffey with FIG Partners. Please go ahead.

Good morning, gentlemen. How are you doing?

Good. How are you, Tim?

Good, thank you. Mike, is there a timetable set on the transition for a CEO?

Yes, it'll be soon. It'll be before the end of the third quarter.

Okay.

Sooner than that probably.

Okay. [Now that] you have the capital and maybe you've been burning on on-balance sheet liquidity, are there any thoughts about selling the assets, reducing perhaps the credit risk within the portfolio that way?

Tim, this is Rick Barton. We continually evaluate that as an option, but at this time we feel that the economics of our collection program argue against that and I point to the success we're continuing to have in REO sales, recognizing 95% of book and we compare that to what people are offering for REO assets in the open market and we feel we would just be giving away too much potential upside for our shareholders by considering that, and we see similar dynamics in the purchase market for non-performing loans as well.

Okay. Okay, understood. And I also -- I heard your comments, Rick, regarding what you're seeing in terms of delinquencies and the such. Do you have any kind of feeling that perhaps going forward we could see provision expenses matching charge-offs?

Well, our provision expense has matched charge-offs.

So [you feel comfortable] in the forward looking of the credit quality assets and portfolio to continue there, see that can continue?

We did, Tim. We don't see a significant need to build reserves if that's where you're going with that. We think the allowance is appropriate and consistently reviewed and subject to current appraisals and the like. And so, right now conversely we're not ready yet to take the provision below net charge-offs, we think there's a point in time when that will be appropriate, but we're not quite there yet.

Okay. Okay, [thank you]. And then if we look at the kind of the balance sheets of your typical C&I customers, say, for example, are those balance sheets improving at all?

Well, over the last couple of years, the average small business, which is our sweet spot, has had some tough operating environments. So in general, if you had to pick an average, the balance sheets of those guys are somewhat weaker today than they were two years ago. Depending upon the industry and the geographic location, we're seeing signs of stabilization in some of those balance sheets.

Okay. [But I'm guessing] the weaker balance sheets [will be in kind of that] Portland, Boise area.

Primarily yes.

Okay. Okay. And then, Lloyd, just kind of a (inaudible) question here. (inaudible) securities portfolio, it looks like there was a decrease in the trading securities and an increase in the available for sale. Was there any kind of offsetting changes there?

All that's going on there is, it -- as we've had securities mature or call the way that were in the trading portfolio we have elected to put them into the available for sale the replacement purchases, if you will. We just -- well, we initially thought that the flexibility provided by putting things in the fair value portfolio made some sense. We've sort of reevaluated that and think that the use of available for sale for most of that stuff is in -- provides similar flexibility and helps us not have unusual things running through the income statement, if you will.

Sure. Okay. Okay, those are all my questions. Appreciate it.

Thanks, Tim.

Thank you. And our next question comes from the line of Kipling Peterson with Columbia Ventures Corporation. Please go ahead.

Good morning, gentlemen.

Hello, Kipling.

Couple of questions. The first one, what is the Bank's view on the fin reg passage, does it view it as a net negative, net positive or neutral or too early to determine?

Yes, Kipling, this is Mark. Certainly we're supportive of regulation that has been passed and we will accommodate it accordingly. I think it's still a little too preliminary to tell. There's positives in it certainly for banks under $10 billion. I think the community banks will have some benefit of the regulation that passed, specifically in some FDIC expense, but there'd be challenges on other fronts, particularly as it relates to interchange income. So I think it's too preliminary to tell, but we'll certainly have a clearer picture over the course of the next nine months. So I guess that's a long way of saying there's positives to us and that may be offset with some of the other issues.

Okay. And the other question is, after the completion of this massively dilutive capital raise, is the Bank doing anything differently today than it was before, and I'm thinking does the Bank now feel comfortable going to its depositors and saying, hey, we're no longer at risk of failing or being taken over by government regulators, or is it going to potential borrowers? And saying, we're going to be more aggressive because we're more comfortable with our balance sheet. We know that everybody is saying that loans aren't available. Or is it going to more aggressively pursue the disposition of the REO assets and just take the haircut because it no longer is worried about having that negatively impact the balance sheet, or is it looking to bid on assets of failed or failing banks? Is something different happening today because of this massive dilution than have happened before?

Yes, Kipling, this is Mark. I'll let Mike weigh in on a piece of it, but in terms of the business going forward, first of all we did not have considerations that we were going to be at risk of failure in the past and this capital raise simply allowed us to weather an economic downturn for a protracted period of time should one occur. But it also allows us to continue to support our clients and grow organic market share. So it'll give us the opportunity to reinvest in the business itself in terms of additional products and delivery channels, so that we can invest in the core franchise in the super community bank model in the Northwest. So that's the overarching theme of why we did this.

Is there an example of that -- of this investment into the super community bank?

Sure. What you'll end up seeing is potential additional product lines on the commercial banking front, as well as the retail front. You'll see some additional treasury management products. We've been able to reinvest in changing some of our retail product base, as well as things such as our asset-based lending capabilities and some additional product lines.

Okay.

And my only addition to that, Kipling, is it would be that there is real opportunity for organic growth, as banks in the Northwest, some of them are really floundering. We've had opportunities in the past to take over relationships from other banks. But at the end of the day, larger middle market customers, middle market small business to most people, want to make sure that you are a player that's going to be here for a long period of time before they switch banks. This really solidifies our opportunity to take that business on a go-forward basis.

And you're going to market with that, you're aggressively out there looking for these?

Yes, we are.

Great. Thank you.

Thank you. (Operator Instructions) And our next question is a follow-up question from the line of Jeff Rulis with D.A. Davidson. Please go ahead.

Hey guys. I was hoping to just get a deferred tax asset update, I'm aware that in past you've made comments that limited impact to regulatory capital, but any change in the feeling on establishing an allowance towards that?

No. We really don't, Kipling -- I'm sorry it's Jeff. We continue to look at that every quarter. We don't believe an allowance is appropriate, but your comment is correct. It's not a large asset, it's $14.5 million at the end of the quarter again of deferred tax asset on a consolidated basis and the impact of an allowance would not be particularly significant on the capital ratios.

Okay. And then I guess one last one, if I could. On the remaining $581 million in construction and land balance, I guess what -- that represents what percent of, I guess, write-downs from original value or average LTVs, or I guess any metric that you can tell us that would represent the amount of adjustment you've taken on that book with respect to the current downturn?

Well, where the action really is on that, Jeff, is in the residential construction and land portfolio. And that component of the $580 million is about $411 million and that's down from $470 million at the end of the first quarter. And in rough terms, that's at about 60% of original loan, so that's not a 40% reduction from the original loan.

Got you. That's helpful. Thanks.

Thank you. And I'm sure there's no further questions in the queue. I'll turn it back over to Mr. Jones for closing comments.

Mark, do you have a few comments you'd like to make first?

No, I don't think so, Mike. I think we wrapped it up. I just want to thank everybody for your interest in the Company and thank you for joining us on the call. It's always good to talk with you and I look forward to talking with many of you at our next investor conference and certainly on our next earnings call. So Mike?

Well, again thank you all for taking the time to listen to our second quarter earnings report. And hopefully as we go forward, this will start to get better and better under the leadership of Mark Grescovich who will be my successor, as we indicated, very soon. Very capable senior management here and I look forward to watching the progress of the Company. So with that, we're adjourned. Thank you.

Thank you, sir. And ladies and gentlemen, if you'd like to listen to a replay of today's call, please dial 303-590-3030 or 1-800-406-7325, enter the pass code 4326727. That does conclude today's Banner Corporation's second quarter 2010 conference call. Thank you for your participation. You may now disconnect.