Banner Corp (BANR) 2010 Q3 法說會逐字稿

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Banner's third-quarter performance 2010 conference call. (Operator Instructions). This conference is being recorded today, Thursday, October 21, 2010. I would now like to turn the conference over to Mark Grescovich, CEO and President of Banner Corporation.

Please go ahead, sir.

Thank you, Brandy, and good morning, everyone. I would also like to welcome you to the third-quarter performance call for Banner Corporation. Joining me on the call today is Rick Barton, our Chief Lending and Credit Officer; Lloyd Baker, our Chief Financial Officer; and Albert Marshall, the Secretary of the Corporation.

Al, would you please read our forward-looking disclosure statement?

Good morning. Our presentation today discusses Banner's business outlook and will include forward-looking statements. Both 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, 2010. Forward-looking statements are effective only as of the date they are made, and Banner assumes no obligation to update information concerning these expectations.

Thank you.

Thank you, Al. While our third quarter resulted in a substantial loss as originally reported in the preannouncement of operating results dated October 6, 2010, it also reflected the hard work throughout the Company on the disciplined execution of our strategic plan to strengthen the foundation of Banner. The significant events causing the loss for the quarter include a $24 million non-cash provision for income taxes as a result of adjustments to our current and deferred tax assets and a $3 million other than temporary impairment charge on a previously nonperforming trust preferred securities issued by a single banking institution.

Lloyd Baker, our Chief Financial Officer, will review these items in more detail in a moment.

Also, in the quarter we recorded an $8.6 million charge for valuation adjustments on real estate owned and a $20 million provision for loan losses. 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 emphasis on aggressively managing our problem assets and reducing our one to four family residential construction, lot and land portfolio, which we reduced another $47 million or 11% from the second quarter of 2010 and currently is 10.4% of the total loan portfolio.

As a result of these current quarter items, Banner reported a net loss to common shareholders of $0.40 per share for the quarter ended September 30, 2010, compared to a net loss to common shareholders of $0.44 per share for the third quarter a year ago and a net loss to common shareholders of $0.28 per share for the second-quarter 2010.

The credit and tax related charges to earnings overlay more positive developments in the Company's core operations. In the third quarter of 2010, we had solid revenue growth of 9% compared to the third quarter of 2009. Our net interest margin was 3.63% in the third quarter compared to 3.3% in the third quarter a year ago, and our cost of deposits decreased to 1.29% versus 2.16% in the third quarter of 2009. These improvements are reflective of our super community bank strategy, reducing our funding costs by remixing our deposits away from high-priced CDs and improving our core funding position.

To that point, our core deposits in the third quarter of 2010 grew 12% from the third quarter of 2009 and 6% from the second quarter of 2010. Further, our loan to deposit ratio now stands at 93%.

Finally, Banner's capital position remains strong. In the third quarter, our total capital to risk weighted assets ratio is 16.95%, and our tangible common equity ratio is 8.65%.

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

Rick?

Thanks, Mark. Banner's third-quarter asset quality scorecard was disappointing. These results were impacted by a more negative economic environment during the quarter and a sharp falloff in the sale of new homes after the termination of home buyer tax incentives. These economic realities softened demand for residential land assets in our markets, and that weaker demand, along with liquidation sales, is now being reflected in valuations of residential land assets.

Credit costs were up in both our REO and loan portfolios. Let me first discuss the REO portfolio, which increased during the quarter from $101 million to $106 million. Inflows were $25 million and were primarily residential construction and land properties from all of our markets. Reductions occurred from REO sales of $12 million with associated losses on sale of only $133,000 and the valuation adjustments Mark mentioned of $8.6 million. These valuation adjustments were based on new appraisals ordered in the normal course of business that reflected the weaker values and residential land I discussed earlier. The two largest adjustments were on AMD projects -- one in Puget Sound for $2.8 million and one in Western Oregon for $1 million. Overall, the Boise residential market was the weakest and accounted for charges of $2.5 million spread across 19 properties. The balance of the write-downs were smaller residential land properties in Oregon and Washington, adjustments to the carrying value of completed homes, and significantly, a $1 million charge to a commercial land parcel in Puget Sound.

Loan charge-offs for the quarter on a net basis were $19 million. After our provision of $20 million for the quarter, Banner's allowance for loan losses was 2.76% of total loans and coverage of nonperforming loans was 57%. These same measures last quarter were 2.63% and 54%, respectively. Once again, charge-offs were centered in residential construction assets with two notable exceptions. We took another charge of $2.6 million against the apartment project in Tacoma that we have discussed in our last two quarterly calls and a charge of $3.5 million on a commercial loan that financed a failed operating business. We have significant litigation and progress related to this commercial loan in an attempt to recover a portion of the loss. Other charges to the commercial portfolio are what you would expect, given the tenor of the economic recession. The same can be said of charges against our consumer portfolio.

We only showed modest improvement in our level of nonperforming loans as evidenced by the following measures. Nonperforming loans were $170 million at quarter end versus $178 million at 6/30/2010. And the ratio of nonperforming loans to total loans was flat at 4.9%.

Inflows of new nonperforming loans caused the flatness in these two credit metrics and were linked to current economic conditions. Some specifics on these inflows are total inflows were $40.1 million, inflow composition was 24% from residential construction loans, 16% from residential land loans, 23% from non-owner occupied commercial real estate loans, 16% from C&I loans, 8% from owner-occupied commercial real estate loans, 2% from agricultural loans, and 11% from consumer loans, including one to four family final loans.

A point that needs to be made concerning these inflows is that they are the product of our continued aggressive management of the loan portfolio. Said differently, these changes were internally identified, not directed by third parties.

However, not all asset quality metrics were flat during the third quarter. Total past-due loans decreased to 5.39% of total loans from 5.62% at June 30, 2010, and 6.79% at September 30, 2009. 30 to 89-day past due loans on accrual were down from $27 million to $18 million during the quarter, and performance of the Home Rush portfolio remains stellar with only two loans being delinquent for a past-due percentage of 0.8%.

Further, as noted, our allowance for loan loss strengthened both in its coverage of total loans and coverage of NGLs during the quarter.

I will now turn the presentation over to Lloyd Baker to discuss other aspects of the third quarter.

Thanks, Rick, and good morning, everyone. As Mark indicated and as we had noted in our preannouncement press release earlier in the month, as well as yesterday's more detailed release, for the third quarter of 2010, we again demonstrated significant progress generating revenue growth from our core operations. Unfortunately, that revenue growth was overshadowed by an elevated level of credit costs, including the provision for loan loss and valuation adjustments Rick just discussed, as well as in other than temporary impairment charge related to a debt obligation issued by another financial institution. Interest payments on that security had been in deferral for three quarters, and we had previously reported the security as non-accruing, nonperforming asset. However, publicly available information about the issuer that was released during the most recent quarter caused us to believe that collection of this asset had become more uncertain, and as a result, we elected to record the OTTI charge.

The combination of these continuing credit costs is still too high level of nonperforming assets and are slightly more subdued expectations relative to the near-term prospects for the general economy led us to conclude that recording a valuation allowance relative to our deferred tax asset and adjusting tax accruals was appropriate in the third quarter.

As I noted on the second-quarter call, reducing these credit costs to more acceptable levels is the primary requirement necessary to return Banner to profitability. And it now appears that that will take a little more time than we had believed earlier this year. However, we remain confident that despite the still challenging economic environment, we will turn the corner on credit costs, will return to profitability, and ultimately we will recover all of the deferred tax asset valuation allowance. That confidence was boosted by the improvements we achieved during the most recent quarter and for that matter for the first nine months of the year as we have been consistently increasing revenues from core operations.

Our revenues from core operations -- and by that I mean net interest income before provision for loan loss plus other operating items -- but excluding the volatile fair value in other than temporary impairment adjustments, so again revenue from core operations, increased to a record level of $49.2 million for the third quarter of 2010 compared to $45.9 million in the immediately preceding quarter and $45.2 million in the third quarter a year ago.

As Mark indicated, that represents an increase in those core operating revenues of nearly 9% compared to the same quarter a year ago. For the first nine months of 2010, our revenues from core operations increased to just over $140 million, an increase of 6% or $8.5 million compared to the same period a year earlier.

Although we did experience a 2 basis point narrowing of our net interest margin for the quarter, the improvement in core operating revenue was driven by a significant increase in net interest income. For the third quarter, Banner Corporation's net interest income of $39.9 million increased by 2.5% compared to the immediately preceding quarter and was nearly 10% greater than the same quarter a year earlier.

For the first nine months of 2010, net interest income has increased by $10.8 million, which is also 10% greater than the first nine months of 2009. Our net interest margin was 3.63% for the quarter, a 36 basis point increase compared to the third quarter a year ago. This margin improvement has resulted from continuing reductions in our funding costs and more specifically our deposit costs. Deposit costs decreased by another 25 basis points during the quarter and were 87 basis points lower than a year ago, requesting further changes to the deposit mix and significant downward pricing on maturing certificates of deposits and on transaction and savings accounts. The deposit mix changes reflect the focused efforts of our retail staff and provide further evidence of the maturing of our branch network and implementation of a number of strategic initiatives designed to strengthen the foundation of the Company.

While the economy certainly has played a role, for Banner Corporation the growth of core deposits and reduced deposit costs has been a truly significant and accelerating success story over the past year. Both non-interest-bearing and interest-bearing transaction accounts have had year-over-year balance increases of 12%. As a result of those increases and a planned reduction in high cost certificates of deposit, these core deposits have grown to represent 55% of total deposits compared to just 48% a year earlier.

The improvement in net interest income occurred despite further pressure on asset yields as a result of the very low rate environment and growth in our on-balance sheet liquidity. Loan yields decreased slightly to 5.69% for the third quarter, three basis points lower than the preceding quarter, but still only 2 basis points lower than the same quarter a year earlier. Loan yields have been holding around this level for about six quarters. However, as I noted in last quarter's call, pressure on loan yields is building and likely will become more evident in future periods if market interest rates remain this low for an extended time.

By contrast, with loans we experienced a meaningful decrease in the yield on our securities portfolio as repayments and calls of higher-yielding securities accelerated during the quarter.

In addition, for the third quarter, we had a much higher average balance in interest-bearing cash, which, of course, in the current environment produces a very low yield. As a result, our yield on earning assets decreased by 28 basis points for the quarter. While this drop in asset yields slightly exceeded the decrease in the cost of funds, net interest income increased by nearly $1 million compared to the preceding quarter as a result of the increase in earning assets and was more than $3.5 million greater than the same quarter a year earlier.

The net interest margin for the first nine months of 2010 was also 3.63%, an increase of 36 basis points compared to the first nine months of 2009 and, as I noted earlier, was responsible for an increase of $10.8 million in net interest income compared to the first nine months of 2009.

While still adversely impacted by the slow pace of economic activity, deposit fees increased slightly compared to the preceding quarter and were nearly unchanged compared to the same quarter a year earlier. For the first nine months of 2010, deposit fees have increased by almost 3%, largely as a result of an increase in customer relationships. As we noted in the press release, revenues from mortgage banking were particularly strong in the third quarter as very low interest rates sparked an increase in origination activities.

We also began to see benefits from the realignment of our residential mortgage origination process, which has now been more fully integrated into our retail delivery system.

In addition, we chose to sell a portion of the loans we had accumulated through our Great Northwest Home Rush program. As you may recall, those loans were originated at relatively low fixed interest rates and generally provided for 30-year amortization period. Selling those loans in the current environment resulted in a small gain, but more importantly allowed us to reduce our exposure to those potentially very long maturity assets.

Similarly to recent periods, for the third quarter of 2010, controllable operating expenses were generally well-behaved and only modestly changed from both the proceeding quarter and the same quarter last year. However, expenses related to acquired real estate, including real estate taxes, maintenance and valuation adjustments, were substantially increased for the quarter.

In addition, legal, appraisal and other collection costs remained high. And as a result, our aggregate noninterest operating expenses increased compared to both the preceding quarter and the same quarter a year ago.

Returning to credit quality, for the quarter we recorded a provision of loan loss of $20 million, which was slightly more than the $19.1 million of net charge-offs, despite the provision for the first nine months to $50 million compared to $48.8 million of net charge-offs.

As a result, and as Rick indicated at the end of the third-quarter 2010, the allowance for loan losses at $96.4 million represented 2.76% of total loans outstanding compared to 2.44% a year earlier and 57% of nonperforming loans compared to 40% at September 30, 2009.

So despite significant charges against the allowance, these coverage ratios have strengthened, and the unallocated portion of the allowance has also increased to $14.3 million compared to $9 million a year ago, giving us further comfort with the adequacy of these reserves.

Loan balances declined during the quarter as we experienced relatively modest demand for new loans aside from the pickup in mortgage originations that I mentioned before. Line utilization remained low, and we continued planned reductions in construction and land loans. The sale of the portion of the Home Rush loans also contributed to the decrease in the low total loan balances for the quarter.

Finally, as Mark noted, the capital base of the Company and Banner Bank remains strong at the end of the quarter, and both entities have consistently exceeded the regulatory guidelines to be well-capitalized. At September 30, Banner Corporation's total risk-based capital ratio was 16.95%, its Tier 1 leverage ratio was 12.12%, and the ratio of tangible equity to tangible assets was 8.65%.

In addition, following our capital raise, we have downstreamed $110 million of capital into Banner Bank, which increases its total risk-based capital ratio to 15.18% and its Tier 1 leverage ratio importantly to 10.77% at September 30, which is well in excess of the target in our agreement with the FDIC. So while the results for the quarter were a long ways from where we want to be and where we expect to be in the future, there was a continuation of a very positive trend of improvement in our revenues from core operations and further strengthening of our retail deposit base as we moved forward on the execution of our strategic plan.

With that brief overview, I will turn the call back to Mark. As always, I look forward to your questions.

Thank you, Lloyd. That concludes our prepared remarks for this morning, and Brandy, we will now open the call and we welcome your questions.

(Operator Instructions). Jeffrey Rulis, DA Davidson.

I guess the first question would be for Lloyd. Can you break out the amount of maturing CDs expected in Q4? I think you've broken out and maybe couch that versus Q3. Do you have the number of those?

Yes, I don't have the precise number. But we had a bulge in the third quarter. It was about $750 million of CDs maturing. We have in the next two quarters, it's a little over $500 million that is maturing. I think it's pretty evenly split between those two quarters. And that $500 million will similar to what we saw this quarter carrying interest rates that are considerably higher than current market rates and current offering rates.

So your point is do we expect to see further decline in deposit costs, and the answer is clearly yes.

And is there a -- I imagine an end to the repricing, but if you look over the bulk of 2011, we could expect that to slow the amount of CDs for repricing?

Well, actually, the amount will be about the same because the customers have a high propensity to invest in one year CDs at the moment. But the expected lift, if you will, that we will get out of that would be much lower, and if interest rates remain flat, eventually we hit a bottom to that process, you're right.

Thanks. And then if you could provide a little more color on the Great Northwest Home Rush, just had a question on would you have the number of loans that you sold or maybe the total dollar amount?

You know, I think the number was about 100 loans. The dollar amount was just under $27 million. And the portion of the mortgage banking profits for the quarter on that was just under -- did I say 700 -- I meant, yes, $700,000. It was $27 million in sales and $700,000 in gain on sale.

That make sense, okay. And then if you could just remind me, of the, I guess, portfolio mortgage loans you currently hold, I guess the $681 million, what percentage are Great Northwest Home Rush loans?

After the sale, roughly, the Northwest component is at $170 million.

Okay, that's helpful. And then lastly, if I could, just a question on the mortgage banking revenue was considerably strong, and obviously the Northwest Home Rush a part of that. But I guess if you could touch on your experience, is that bleeding into Q4 in terms of activity for the full quarter? Would you expect maybe down, but still elevated from the previous two quarters?

The pipeline is still pretty full. Obviously won't have the Home Rush component to that, and obviously we are less than 30 days into the quarter. So do I know exactly where it's going to go? No, but the pipeline remains pretty full, and activity has been strong. We are experiencing another little mini refi boom, among other things.

Jeff, this is Mark. The fact that the rates are staying low and we have better integration with our retail delivery system, we will see some natural lift there, and the backlog is still carrying over from the end of the third quarter.

Okay. And, Lloyd, were you alluding to the Great Northwest -- those sales would slow this quarter or stop?

Well, we likely won't do that again.

Okay. All right. That's it for me. Thanks.

Chris Stulpin, Howe Barnes.

Jeff touched on one issue I wanted to address, but I didn't catch the balance. Did you say there was $170 million left in the Great Northwest balance? What was that figure, please?

Yes, $170 million.

And slightly separately here, what was the volume of loan originations and renewals this quarter? And how does that compare to the prior quarter?

Yes, in the mortgage business specifically, you had roughly $114 million in new production from mortgage operations. That is up about 30%, a little over 30% from the second quarter.

Okay. How about -- that is this one of four family, you're saying?

Yes, that's the one to four family. The commercial originations are off slightly quarter over quarter. But we are seeing some interesting backlog build, but it's going to be a marketshare gain. We are not seeing a lot of activity in terms of business expansion yet.

And regarding your commercial real estate borrowers, specifically your non-owner-occupied borrowers, their tenants, are you seeing a settling or a stabilization in the cash flows from their tenants or cap rates? Can you comment on that at all?

This is Rick Barton. There is continued pressure on lease rates in some of our markets, which is having an impact on the owners of the commercial real estate that we have financed. We are going through our stress test again this year as we did last year to quantify the areas that we have to pay the most attention to. I am not seeing a great deal of change in the level of stress in the portfolio, and I think that is reflected in the numbers. While we have a few more problem assets and a few more nonaccrual assets in that portfolio, we still have recorded no losses.

Okay. Thank you very much.

(Operator Instructions). Tim Coffey, FIG Partners.

Lloyd, I just had a question about DTA again if you could just walk me through it. Was the charge -- the allowance you took was bigger than what we talked about the size of the DTA last quarter. Can you remind me again where the difference came from?

The difference comes out of the re-characterization of the current year's asset receivable, and as a part of the process of determining that there was enough uncertainty around not only the deferred tax asset, you didn't reverse the current year's accrual of tax benefit and put that into the deferred tax asset as well.

Okay. And then, Rick, is there any kind of visibility on when inflows of new NPAs are going to start to flow?

Well, that is a great question. And I think that, as I sit right now, there is some continued stress in the residential portfolio. The longer the level of home sales remain at low levels, the more the likelihood that there could be additional inflows from that portfolio. I think that is a manageable number at this point, however. I think that what we are seeing out of the C&I portfolio and ag portfolio is normal for what you would expect to see in this kind of economic environment. And I have already touched on what I foresee in the commercial real estate arena, which is the other significant part of our portfolio.

Okay.

Tim, this is Mark. If you really look at it, the problem is going to be in the land. So the rest of the performing land portfolio, which is roughly $130 million, is a manageable number. But you will see some continued migration there unless we see a significant uptick in the housing market.

Okay. And then, Mark, there is a natural increase in your non-interest bearing deposits. Was that one-time event, or do you see that continuing or we should start changing up the strategy and the structure of the Company?

I'm sorry. Could you repeat the question?

Sure. The uptick that we saw in the non-interest-bearing deposits this quarter, do you expect that to continue, or is that more of a one-time item, I guess?

No, that is clearly our strategic direction, is to get these branches up to their economic fair share within the number of households within the two-mile radius. So I would anticipate you will continue to see some aggressive account acquisition growth, which has also helped stabilize our fee income. It's not just driving the cost of deposits down. It's also stabilizing the deposit fee income that we talked about. So I see that as a continuing trend.

Okay. Do you have any kind of target that you would like as a percent of deposits?

Yes, we are are trying to hit the 60% core deposits on the funding side. So right now we're at 55%. We would like to drive that number up. Pardon me?

Is that a 12-month target?

Yes. But more broadly, on the fund as it relates to the funding side, we still are under penetrated in a number of our branches, more than 25 of our branches that I want to get their economic fair share of. And that will yield certainly more than 60% on the core funding side.

Okay. Those are all my questions. Thank you.

(Operator Instructions). [Joe Stephen, Stephen Capital].

I joined a little bit late, but I heard you talk about the $500 million of CDs repricing. I think you said in the next two quarters, is that correct?

That's correct.

And on average, with where your current rate offerings are right now, and what is the average WAC of what is maturing compared to your current rate offering?

WAC, okay.

Or the average coupon.

There you go. They are about 100 basis points above current market.

Okay. That's what I'm hunting for, just sort of an approximate --

Yes.

Okay, so 100 bps. Okay. Actually everything else that I was going to ask was answered. So thank you, guys.

(Operator Instructions). And at this time, we have no further questions. I would like to turn the call back over to management for any closing comments.

Great. Thanks, Brandy. Again, while we have much work to do, we are making good progress on our disciplined strategic plan to strengthen Banner by aggressively managing our problem assets and at the same time executing on our super community bank model.

Thank you for your interest in our Company and joining our call today. We look forward to reporting our results to you again in the future.

Thank you, everyone, for your time and interest. Have a good day.

Thank you. Ladies and gentlemen, this concludes the Banner's third-quarter performance 2010 conference call. If you would like to listen to a replay of today's conference, please dial 303-590-3030 or 1-800-406-7325, followed by a passcode 436-7087.

AT&T would like to thank you for your participation. You may now disconnect.