Banner Corp (BANR) 2011 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Banner Corporation's second-quarter 2011 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) This conference is being recorded today, Thursday, July 21, 2011.

I would now like to turn the conference over to Mr. Grescovich, President and CEO of Banner Corporation. Please go ahead.

Thank you, Mauritza, and good morning, everyone. I would also like to welcome you to the second-quarter earnings call for Banner Corporation. Joining me on the call today is Rick Barton, our Chief Lending and Credit Officer, and LLoyd Baker, our Chief Financial Officer.

I would like to remind everyone of our safe harbor disclosure and that 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 release that was released yesterday and a recently filed Form 10-Q for the quarter ended March 31, 2011.

Forward-looking statements are effective only as of the date they are made and Banner assumes no obligation to update information concerning its expectations.

Now let me turn to the quarter. As announced, Banner Corporation returned to profitability in the second quarter by reporting a net profit of $224,000 or $0.01 per share for the period ended 6/30/2011. This compared to a net loss of $9.8 million or a loss of $0.61 per share for the first quarter 2011 and a net loss of $6.9 million or a loss of $1.97 per share in the second quarter of June 30, 2010.

For the first six months ended June 30, 2011, Banner reported a loss of $0.58 per share compared to a loss of $3.11 per share for the first six months of 2010. The second-quarter performance provided further evidence and confirmed that through the hard work of our employees throughout the entire company we are successfully executing on our strategies and priorities to strengthen our franchise and position Banner for sustainable, improved performance, and further that our strategic turnaround plan is effective.

Our operating performance showed improvement on every metric when compared to a year ago. Our core revenue increased nearly 6% when compared to the second quarter of 2010 and 3.2% when compared to the first quarter of 2011. Our net interest margin expanded to 4.09% in the second quarter of 2011 compared to 3.65% in the second quarter of 2010, and our cost of deposits decreased to 80 basis points in the most recent quarter compared to 154 basis points in the same quarter of 2010.

These improvements are reflective of our super community bank strategy, reducing our funding costs by remixing our deposits away from high priced CDs, growing new client relationships, and improving our core funding position. To that point, while our core deposits decreased slightly compared to the linked-quarter, due to the seasonality of our agricultural clients they increased 6% from the second quarter of 2010. It's important to note that this is organic growth from our existing branch network.

In a moment LLoyd Baker will discuss our operating performance in more detail. Clearly, improving the risk profile of Banner and aggressively managing our troubled assets has been and will remain the primary focus of the Company. We continue to show progress here as well.

Our non-performing assets have been reduced 18% compared to the first quarter of 2011 and 34% compared to June 30, 2010. Further, the most problematic part of the portfolio, our one-to-four family residential construction lot and land portfolio, has reduced $141 million from the second quarter of 2010 and $805 million from the peak outstanding. That portfolio now stands at just 8% of the total loans.

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 successful emphasis in aggressively managing our problem assets. Although we are making good progress reducing these troubled assets, we recorded a still large $8 million provision for loan losses in the quarter.

As a result, the coverage of our allowance to non-performing loans increased to 80% at June 30, 2011, from 74% in the first quarter of 2011 and 54% in the second quarter of 2010. Also for the quarter, we recorded $4.8 million of valuation adjustments on real estate owned.

While credit costs remained elevated in the second quarter, Banner's reserve levels are substantial and our capital position and liquidity remained strong. At the end of the quarter our ratio of allowance for loan and lease losses to total loans was 2.78%, our total capital to risk-weighted asset ratio improved to 17.29%, our tangible common equity ratio improved to 9.14%, and our loan to deposit ratio was 95%. Also, our primary liquidity ratio for on-balance-sheet liquidity was a solid 11.74%.

Finally, in the quarter we continued to invest in our franchise. We have added additional commercial banking talent to our company in our Northern Puget Sound market, our specialty banking group, and our SBA group. Also, Banner now has preferred lender status with the Small Business Administration.

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. As already noted by Mark, the second quarter of 2011 continued the trend of improving credit metrics at Banner Corporation. Before discussing our metrics in more detail, two comments need to be made. First, the results validate our portfolio management and collection strategies and, second, the results are testimony to the skill and dedication of the credit professionals working on our problem asset portfolios.

Now let me turn to Banner's credit metrics at the end of the second quarter. Net charge-offs for the quarter were $13.6 million, down 19% from the preceding quarter. Non-performing loans declined 12.5% to $115 million during the quarter. The ratio of non-performing loans to total loans is now 3.5%, down from 4% at March 31, 2011, and as a point of reference at June 30, 2010, non-performing loans were $178 million or 4.9% of total loans.

For the first time in recent years our provision for loan losses did not match or exceed net charge-offs. This decision reflects continued improvement in our loan portfolios as measured by non-performing loans, past due loans, and adversely classified loans. And after this decision the reserve continues to be appropriate for our portfolio and is a source of strength for the corporation.

This statement is supported by the following. Our riskiest portfolio, residential construction and land, shrank another 10% to $270 million and the non-performing portion of this portfolio shrank from $63 million to $49 million. While our reserve to total loans did contract 16 basis points in the quarter, our coverage of non-performing loans continued to increase and now stands at 80%, up from 70% at the end of the first quarter.

At 2.78% our reserve to total loans is high by historical standards and the unallocated portion of the reserve remained substantial at $15.5 million.

During the quarter REO assets decreased by 25% from $95 million to $71.2 million. This net decrease was after new foreclosures of $11.9 million during the quarter. Total REO dispositions were $32.4 million, well above our normal run rate, as we were able to move two large REO assets with a combined balance of nearly $13.5 million. The rest of the dispositions followed the pattern of previous quarters and were made up of numerous transactions spread throughout our geographical footprint.

A small gain of $58,000 was realized from these REO sales, which again validates how we value assets. REO valuation adjustments of $4.8 million were taken during the quarter, driven by continued weakness in land and lot values.

As a result of the just discussed reductions in non-performing loans and REO, total non-performing assets decreased $40.2 million or nearly 18% during the quarter and now stand at $188.4 million. In total, performing TDRs decreased from $61 million to $55.7 million.

Past due loan measures also behaved well during the quarter. Total past due loans, including non-performing loans, decreased $21.5 million or nearly 14.5% and are now 3.83% of total loans. And importantly, loans 30 to 89 days past due and on accrual were only $11.6 million or 0.36% of total outstanding loans.

While we are pleased with the progress made on asset quality during the second quarter, we also acknowledge that much work remains to be done to return our credit metrics to normal levels. This task continues to be made challenging by a weak economic environment and more evidence that residential land assets are being dumped by other banks and the FDIC throughout our operating footprint, placing further pressure on land values.

With that I will turn the mike over to Lloyd for his comments.

Thank you, Rick, and good morning, everyone. As Mark has already noted and as reported in our press release, after a long difficult period Banner did return to profitability in the second quarter. This return to profitability reflects the continued trend of strong revenue generation, particularly continued improvement in net interest income, and a reduction in credit costs, more specifically in the provision for loan losses. The second-quarter results were also positively impacted by $1.9 million of fair value adjustments.

As noted in our press release, for the second quarter credit costs remained stubbornly high and above our long-term expectations, reflecting persistent weakness in economic conditions and additional declines in property values. However, credit costs were significantly reduced from recent quarters and compared to a year ago, as a result of meaningful improvement in all of our credit metrics.

Rick has already provided a great deal of detail on this subject, so I will not add any comments other than to note that as a result of the reduction in delinquencies, non-performing loans, and non-performing assets the prospects for Banner to return to more normal credit costs are improving and the timeframe for that to occur is getting shorter. Further, as Mark noted, our capital and reserve levels are substantial and provide a significant ability to absorb expected and unexpected credit losses.

That said we realize that we have a lot of work to do and understand that the economic environment remains challenging. Aside from the reduction in credit costs, the second-quarter and year-to-date operating results were notable for the continuation of strong revenue generation.

For the quarter ended June 30, 2011, our revenues from core operations, which includes net interest income before provision for loan losses plus other non-interest income but excludes the fair value and OTTI adjustments, revenues from core operations increased by $1.5 million over the first quarter and, at $48.5 million, were nearly 6% greater than the second quarter a year ago.

For the first six months of 2011 our revenues from core operations were $95.6 million, which is a 5% increase compared to the first six months of 2010. As I mentioned on last quarter's call, this continues a solid trend of year-over-year increases in core revenues that we have been reporting for the past two years. This consistent trend of increases in core revenues has been driven by continued improvement in our net interest margin and resulting net interest income, as well as solid deposit fee revenues resulting from growth in core deposits.

For the second quarter of 2011 Banner Corporation's net interest income was $41.2 million, which as expected showed a seasonal increase compared to the immediately preceding quarter, but was also 5% greater than the second quarter of 2010. And, looking at the longer trend, was 18% greater than the same period two years earlier.

Our net interest margin was 4.09% for the second quarter of 2011, an increase of 15 basis points compared to the first quarter and 44 basis points stronger than the second quarter a year ago. For the first six months of 2011 our net interest margin was 4.01% compared to 3.62% for the first six months of 2010. This margin improvement reflects continuing reductions in our funding costs, and more specifically in our deposit costs, but also resulted from modest changes in our asset mix, including reductions in non-accruing loans and low yielding interest-earning cash balances.

Deposit costs decreased by another 9 basis points during the first quarter and were 74 basis points lower than a year ago, reflecting further changes in the deposit mix and additional downward pricing on maturing certificates of deposit and on transaction and savings accounts. As Mark has noted, the deposit mix changes reflect the hard work and focused efforts of our retail staff and commercial bankers implementing a number of strategic initiatives designed to strengthen the foundation of the Company.

As we have mentioned on the last two or three calls, Banner Corporation's growth in core deposits and reduced deposit costs has been fundamental to our improving operating trends. Non-interest-bearing accounts increased nicely during the second quarter and both non-interest-bearing and interest-bearing transaction and savings accounts had year-over-year balance increases resulting in core deposit growth of nearly 6% compared to a year ago.

As a result of the growth in these transaction and savings account and a planned reduction in high-cost certificate of deposits, core deposits now represent 60% of total deposits compared to 51% a year earlier and just 44% two years earlier. Importantly, we are not just adding balances but instead continuing to grow the number of accounts and relationships.

The improvement in our net interest margin again occurred despite further pressure on asset yields as a result of the very low interest rate environment. Loan yields decreased to 5.64% for the first quarter, just 2 basis points lower than the preceding quarter and still only 8 basis points lower than the same quarter a year earlier.

As I have noted for a number of quarters, I continue to be pleasantly surprised by how well loan yields have held up. But at the risk of being compared to the Little Boy Who Cried Wolf, I will say it again -- pressure on loan yields is intense and likely will become more evident in future periods.

What I will add that I have not given enough attention to in my prepared remarks for previous calls is the positive impact on loan yield and the margin from the declining level of non-accruing loans that has offset some of this pricing pressure. As we noted in the press release, the adverse impact of non-accruing loans decreased to 23 basis points in the current quarter compared to 27 basis points in the preceding quarter and 34 basis points for the second quarter a year ago.

Going forward, further reductions in the drag from non-accruing loans will be critical for us to maintain our improved net interest margin.

As expected, loan balances declined further in the second quarter as we continued planned reductions in construction and land loans as well as other non-performing loans. In addition, demand for new loans again was relatively modest and line utilizations remained low, although our agricultural loan fundings did exhibit a normal seasonal increase which should continue in the current quarter.

While total balances declined slightly, our production levels of targeted loans remained encouraging and the disciplined calling efforts and consistent execution of our bankers are resulting in a stronger pipeline of opportunities. While we expect further reductions in land loan balances, we believe that these efforts will allow us to stabilize and then grow the portfolio over the remainder of the year despite the still challenging economic conditions.

In addition to the effect on our net interest margin, the other important aspect of the continuing growth in core deposits has been the impact on deposit fees. For the first half of 2011 the positive impact of that growth has been somewhat masked by the decline in OD and NSF charges subsequent to changes in the regulatory environment last summer. Those changes, which had not been implemented in the first or second quarter of last year, had a dampening effect on deposit fees which is reflected in the year-over-year comparison.

However for Banner, the reduction has been offset by an increase in the number of accounts as well as increased interchange revenues from higher customer usage of debit and credit cards. As a result, for the first two quarters of 2011 total deposit fees and service charges were modestly increased from the same period a year ago despite a reduction of roughly $600,000 in overdraft revenues.

Whether it continues to be uncertainty about how the final rules implementing the restrictions on interchange fees and competitive responses to those changes will impact revenues, it is clear that the growth in accounts and customer relationships that Banner has achieved will support recurring revenue-generating opportunities going forward.

Revenues from mortgage banking activities for the quarter and the six months year to date were essentially unchanged from a year ago; however, they were decreased significantly compared to the second half of 2010. As I noted last quarter, this is a common seasonal pattern that we believe is also indicative of fewer refinancing opportunities as interest rates have remained near their current levels for an extended period, and further is reflective of continued weakness in home sales. This latter point is obviously concern for all of us.

Similar to recent periods, for the second quarter of 2011 controllable operating expenses in aggregate were only modestly changed from both the preceding quarter and the same quarter last year. Increases in compensation expense and payment processing costs were partially offset by lower deposit insurance expense and reduced professional fees. However, expenses related to real estate owned increased, primarily as a result of valuation adjustments reflecting further declines in property values.

Legal, appraisal, and other collection costs also remained high. Although we expect these credit-related and real estate owned expenses to remain elevated for a few more quarters, we do expect that they will decrease substantially over time as additional problem asset resolution occurs.

Finally, as Mark noted, the capital base of the Company and its subsidiary banks remains strong at the end of the quarter and all have consistently exceeded the regulatory guidelines to be considered well capitalized. At June 30, 2011, Banner Corporation's total risk-based capital ratio was 17.29%, its Tier 1 leverage ratio was 12.9%, and the ratio of tangible common equity to tangible assets was 9.14%.

Further, although we made no additional contributions to Banner Bank in the quarter, and for that matter for the last three quarters, its capital ratios also increased modestly from the prior quarter. As a result, at June 30, 2011, Banner Bank's total risk-based capital ratio was 15.32% and its Tier 1 leverage capital ratio was 11.37%, which of course continues to be well in excess of the levels targeted in our agreement with the FDIC.

So 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 and, Mauritza, we will now open the call and welcome your questions.

(Operator Instructions) Jeff Rulis, D.A. Davidson.

Good morning, guys. I had a question about the NPA reductions this quarter; obviously a big number. Would you characterize that as some particularly lumpy or sizable dispositions kind of timing wise in this quarter, or is that characterizing perhaps future reductions going forward?

Jeff, this is Rick Barton. It was a little bit lumpy in the REO side with the two large transactions that I referenced in my comments that totaled about $13.5 million. Beyond those two it was just a continuation of what has been going on in previous quarters of addressing all of the problem assets across the board and producing reductions.

Okay. To the degree -- and I know that a portion of the other real estate owned costs were write downs. Given the activity, is it -- could you I guess equal the activity that happened and the movement that you had related to higher REO costs in the quarter? And going forward would you expect that to lower?

The REO costs, the valuation adjustments, were not linked to the assets that were sold. The assets that were sold we had the small gain.

Okay. I guess switching gears a bit, wanted to get an update -- Lloyd, I don't know if you had an update on the size of the potential recovery of the DTA. I presume you saw a little benefit this quarter given some profitability.

Yes, in the current quarter, of course we have had no tax provision, which if you look at the pre-dividend earnings of $2.2 million the tax provision on that would have been roughly 36% of that. And so that reduces the NOL portion of the DTA a little.

The DTA in the aggregate is about $39 million, which as you know has an allowance against that full amount. Obviously, getting closer to sustainable profitability gets us closer to the point where we will be able to make some recovery, meaningful recovery against that.

I do want to caution, as I have before, that we also -- as we achieve sustainable profitability the way that we mark to market our subordinated debt takes into consideration some credit factors that, similar to the DTA, relate to sustainable profitability. And so there will be an offset, a partial offset against that DTA recovery in what I have described I think before as a noisy quarter of accounting entries.

I can't tell you when that quarter is, but it's -- we are closer to it than we were 90 days ago.

Got it. Okay, thanks for the color. And then I guess lastly, just did you guys apply for the Small Business Lending Fund?

Yes. Jeff, this is Mark. We did make application for that.

Okay, thanks.

(Operator Instructions) Tim Coffey, FIG Partners.

Good morning, gentlemen. Lloyd, since we are on the topic of the fair value adjustment of debt, do you anticipate any more in the near term quarters?

Well, we evaluated every quarter. I don't anticipate any sort of meaningful reduction in the debt. I do anticipate over time that we will move back closer to the par value of that debt.

Remind you that we do have assets that are similarly marked. Not equal in amount, but a number of securities that we own that are also subject to sort of the same credit trends, which is the primary driver behind that mark to market. So there is some offset that occurs there as well.

Okay. That is helpful. And then, Rick, can you give me an idea of what percent of your reserves right now are general reserves?

When you say general reserves do you mean the part that is allocated specifically to credits or --?

Yes, either one. Either of the specific reserves allocated to the impaired credits or the other general?

Well, the reserve is $92 million, about $15.5 million of that is unallocated, so the balance of the reserve is allocated either under our general methodology or under the 114 portion of the reserve methodology.

Great, that is what I was looking for. Then did I hear you right where you said the net gain on the sale of REO was $58,000?

That is correct.

Yes, I think those were all my questions. This was a good quarter, guys. Congratulations.

Dan Oxman, Jacobs Asset Management.

Congrats on a good quarter. My question has to do with the inflows to non-performers. What were the gross inflows to non-performing loans this quarter and how has that trended over the last couple quarters?

The gross inflows were just short of $19 million and that continues a trend over the last six quarters of decreasing inflows.

What were they last quarter, just for comparison purposes?

Last quarter they were nearly $24 million.

Great. And your foreclosures, the inflows into OREO, can you describe which buckets those fell into?

They fell primarily into a few completed homes from consumers out of the one-to-four portfolio and the balance was spread amongst residential land assets and a few homes under construction.

Nothing at the CRE?

I don't remember anything meaningful in the CRE. There might have been a small asset here and there, but nothing meaningful.

Okay. And finally, do you have what the classified asset balance or classified loan balance is for the quarter?

Yes, I do as a matter of fact. If we take a look at our classified loans, one is classified substandard and doubtful; they are just short of $285 million.

Great, that is all I have. Thank you very much.

Matthew Clark, KBW.

I am [Mike Gruzado] calling in for Matthew Clark. Can you guys talk a little bit about the breakdown of the $6.5 million of OREO expense? How much was related to valuation adjustments versus the general maintenance of the properties?

Mike, this is Lloyd. That is in the press release actually and about $4.8 million of the expense was valuation adjustments, the balance of it would be taxes, maintenance, insurance, some legal expenses related to it.

And just one more. We talked a little bit about liquidity; it looks like you guys deployed some cash this quarter which helped the yield on earning assets. Just wondering what you guys deployed it into.

That is exactly right. As I noted, we did draw down the low yielding, interest-earning cash balances. A portion of that, of course, went into further reductions in CDs that we intentionally moved off the balance sheet.

Then the portion that went into the investment securities was generally pretty short duration stuff, so it was invested in things that -- are yield levels that for me, as a former portfolio manager, are very hard to accept, but we are not very far out on the duration curve.

All right, thanks, guys.

At this time I am not showing any further questions. Management, please continue with any closing remarks.

Great, thanks, Mauritza. Let me say again, as I have on the other calls, while we still have plenty of work to do as a company as part of our strategic turnaround plan, we are demonstrating very good progress to strengthen Banner and achieving a moderate risk profile. And at the same time executing on our super community bank model and overall improving the core operating performance of the Company.

Thank you again for your interest in Banner and joining our call today. We look forward to reporting our results to you again in the future. Thank you, everyone, and have a great day.

Ladies and gentlemen, that does conclude our conference call for today. If you would like to listen to a replay of today's conference you may do so by dialing 303-590-3030 or 1-800-406-7325 using the access code 4453037.

Thank you for your participation. You may now disconnect.