Banner Corp (BANR) 2012 Q1 法說會逐字稿

Welcome to the Banner Corporation's first-quarter 2012 conference call and webcast.

During today's presentation all participants will be in a listen-only mode. Following the presentation the conference will be open for questions. (Operator Instructions) Today's conference is being recorded April 24, 2012.

I would now like to turn the conference over to Mark Grescovich, President and Chief Executive Officer of Banner Corporation. Please go ahead, sir.

Good morning, everyone. I would also like to welcome you to the first-quarter earnings call for Banner Corporation.

Joining me on the call today is Rick Barton, our Chief Credit Officer; Lloyd Baker, our Chief Financial Officer; and Albert Marshall, the Secretary of the Corporation. Albert, would you please read our forward-looking Safe Harbor statement?

Surely. Good morning, everyone.

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; forecasted 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-K for the year ended December 31, 2011.

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, Albert. As announced, Banner Corporation continued our improving performance again in the first quarter, reporting a net profit available to common shareholders of $7.2 million, or $0.40 per share, for the period ended March 31, 2012. This compared to a net profit to common shareholders of $3.1 million, or $0.18 per share, for the fourth quarter of 2011 and a net loss of $9.8 million, or a loss of $0.60 per share, in the first quarter of 2011.

Looking at earnings before preferred stock dividends and discount accretion, Banner's net income improved to $0.52 per share for the first quarter of 2012 compared to a net loss of $0.48 for the same period 2011. The first-quarter performance provided consistent evidence and confirmed that through the hard work of all of our employees throughout the Company we are successfully executing on our strategies and priorities to strengthen our franchise and deliver sustainable profitability to Banner. And our return to profitability for the last four quarters further demonstrates that our strategic turnaround plan is effective and we are building shareholder value.

Our operating performance again this quarter showed improvement on every key metric when compared to the quarter one year ago. Our first-quarter core revenue increased 7% when compared to 2011. Our net interest margin expanded to 4.11% in the first quarter of 2012 compared to 3.94% in the first quarter of 2011, and our cost of deposits decreased to 52 basis points in the most recent quarter compared to 89 basis points in the same quarter of 2011.

These improvements are reflective of our Super Community Bank strategy; that is 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, our core deposits again increased in the most recent quarter and increased 7% compared to March 31, 2011.

Also, our non-interest-bearing deposits increased 24% from one year ago. 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, a primary focus of the Company. Again this quarter we continued making very good progress toward that objective. Our non-performing assets have been reduced nearly 22% compared to the fourth quarter of 2011 and 59% compared to March 31, 2011.

Further, the most problematic part of the portfolio, our one-to-four family residential construction lot and land portfolio, has reduced $61 million from the first quarter of 2011 and nearly $840 million from the peak outstandings. That portfolio now stands at just 7.4% of total loans.

In a few moments Rick Barton, our Chief Credit Officer, will discuss the credit metrics of the Company and provide some context around the loan portfolio, along with our continued successful execution in aggressively managing our problem assets. Although we are making good progress reducing troubled assets, we recorded a still large $5 million provision for loan losses in the quarter. As a result, the coverage of our allowance to non-performing loans again increased and is now 126% at March 31, 2012, up substantially from the first quarter of 2011.

Also, for the quarter we recorded $1.7 million of valuation adjustments on real estate owned.

While credit costs remain elevated in the first quarter and above our long-term goal, Banner's reserve levels are substantial and have been improving. Our capital position and liquidity remain strong. At the end of the quarter our ratio of allowance for loan and lease losses to total loans was 2.52%, our total capital to risk-weighted assets ratio improved to nearly 19%, our tangible common equity ratio improved to 10.15%, and our loan to deposit ratio was 94%.

In the quarter and throughout the preceding 24 months we continued to invest in our franchise. We have added additional bankers and commercial and retail talent to our company in all of our markets, and we have invested in new sales and credit training programs to further develop our bankers and integrate Banner's new credit and sales culture.

These efforts are yielding very positive results. Recently, Banner was notified by the well-known survey agency J.D. Power and Associates that Banner Bank was rated number one of all banks for customer satisfaction in the Pacific Northwest and we ranked in the top 10 nationwide.

Finally, our persistent focus on improving the risk profile of Banner that I spoke to has significantly reduced our volume of classified assets, improved our earnings, and demonstrated management's ability to execute our turnaround plan in a very difficult economy. As a result, in the quarter our memorandum of understanding with the Department of Financial Institutions for the state of Washington and the FDIC was terminated.

Also, subsequent to the end of the quarter, our memorandum of understanding with the Federal Reserve Bank of San Francisco was also terminated. We appreciate this recognition by our regulators of the progress that our company has made.

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

Thanks, Mark. My comments this morning will be brief. Mark has already noted that our quarterly results again show solid progress in our credit quality metrics. I would like to highlight and comment on several of them.

Net charge-offs were $6.4 million, down 22% from the linked quarter and down in absolute dollars for the sixth consecutive quarter. Non-performing assets now stand at 2.24% of total assets and for the quarter decreased $26 million, down 22%. Non-performing loans decreased by 14% and now are 2.1% of total loans.

In the residential construction portfolio, work out activities have reduced nonperforming loans to $16.9 million divided between construction, $6.3 million, and land, $10.6 million. Non-performing one-to-four family permanent loans, however, increased during the quarter by almost $2 million, reflecting continued weakness in home prices. This fact of life will continue to impact the sector in future quarters, but we do not expect that impact will be outsized.

We also should note here that the credit metrics of our Northwest Home Rush Peace of Mind portfolio remained stable with a delinquency rate of less than 1%. REO decreased $15 million, or 36%, during the quarter. On $15.4 million in sales during the quarter we realized a nominal gain on sale of $100,000. Residential construction and land remaining in our REO are only $1.1 million and $13.3 million, respectively.

Classified loan totals decreased $19.9 million during the quarter to $193.7 million, a reduction of 9.4%. Total delinquent loans decreased to 2.45% of total loans from 2.59% in the linked quarter.

Loans 30 to 89 days past due and on accrual did increase during the quarter by $4.4 million. This increase was caused by a single relationship. All loans in that relationship are now current.

The reserve is a source of strength for the Company. Our riskiest portfolios, residential construction and land, continue to shrink as already discussed. Coverage of non-performing loans continued to increase during the quarter and stand at 126%, up from 110% last quarter.

The reserve to total loans stayed level quarter to quarter at 2.52%, which is very strong from a historical perspective. We feel this little of reserve is warranted as the economic environment remains challenging and fragile and as the levels of classified and non-performing loans in the portfolio remain unacceptably high.

During the quarter we have received the written report for our annual regulatory examination conducted during the fourth quarter of 2011. This report substantiated preliminary exam findings and was a cornerstone in lifting our MoUs with the FDIC and the state of Washington and the Federal Reserve.

Good progress has been made in healing our loan portfolios, but be assured the necessary special asset teams will remain in place until the job is finished. As this is occurring we also are seeing attention on supporting and managing new loan growth and making sure our credit infrastructure is efficient and ready to address future challenges and opportunities.

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

Thank you, Rick, and good morning, everyone. As noted in our press release, Banner Corporation's improved operating results for the quarter ended March 31, 2012, reflect further progress during the quarter and significant progress over the past year highlighted by much improved credit quality, strong revenue generation, and net income of $9.2 million. Importantly, this net income reflects progress that we believe should result in sustained profitability going forward.

Rick has already addressed the improved credit quality metrics thoroughly, so I will again just note the obvious. The significant reductions in non-performing loans and real estate owned are having a very positive impact on our reported earnings. For Banner, this trend of improving credit quality has resulted in lower levels of loan-loss provisioning and expenses related to real estate owned, and has also significantly contributed to our improved net interest margin as the drag from non-accruing assets has been substantially reduced.

While our provision for loan losses for the first quarter again matched the $5 million that we recorded in the third and fourth quarters of 2011, it was well below the amounts recorded in earlier periods, including the $17 million provision in the first quarter a year ago. In addition, our expenses related to real estate owned, although still high, were further reduced in the quarter.

While these credit costs remain above long-term acceptable levels, we expect that our extended trend of improving asset quality will result in further reductions in credit costs in future periods. The first quarter of 2012 was also highlighted by the continuing trend of strong revenue generation that we have commented on for more than a year now. This was particularly encouraging since revenues for the first quarter of each year are generally adversely impacted by the fact that there are fewer days in the quarter, as well as other seasonal patterns that affect our local economies.

As I have noted before, the trend of year-over-year increases in core revenues that we have been reporting has been driven by significant improvement in our net interest margin and resulting net interest income, as well as solid deposit fee revenues fueled by growth in core deposits. However, for the current quarter the increase also reflects a large increase in revenues from mortgage banking operations, which increased by $1.7 million, or 175%, to $2.6 million for the quarter ended March 31, 2012, compared to slightly under $1 million for the first quarter a year earlier.

As a result, for the quarter ended March 31, 2011, our revenues from core operations, which includes net interest income before provision for loan losses and other non-interest operating income, but excludes fair value and other-than-temporary impairment adjustments, so revenues from core operations were $50.4 million, a modest decrease from $50.5 million in the immediately preceding quarter but $3.4 million, or 7% greater, than the first quarter a year ago.

Our net interest margin was 4.11% for the first quarter of 2012, a small increase from the preceding quarter, which in part reflects the affects of the shorter quarter on the annualization process, but 17 basis points stronger than the first quarter a year ago. The year-over-year margin improvement again reflects meaningful reductions in our funding costs, and as I previously noted, a significant reduction in the adverse effect of non-performing assets.

As a result, for the first quarter of 2012 Banner Corporation's net interest income was $41.1 million, which, although slightly lower than the immediately preceding quarter because of the shorter day count, was 3% greater than the first quarter of 2011. Deposit costs decreased by another 7 basis points during the first quarter and were 37 basis points lower than a year ago, reflecting further changes to the deposit mix, as well as downward pricing on maturing certificates of deposit and on transaction and savings accounts.

These are trends that have been dramatically contributing to our improved margin and increased net interest income for a number of quarters and resulted in an average cost of funds of just 66 basis points for the first quarter of 2012 compared to 100 basis points for the first quarter of 2011.

As a result of the growth in transaction and savings accounts and planned reductions in high-cost certificates of deposit, core deposits now represent 65% of total deposits compared to 59% a year earlier and 51% just two years ago. Importantly, we are not just adding balances, but instead continue to see solid growth in the number of accounts and customer relationships, significantly contributing to increased deposit fee revenues.

Of course, the very low rate environment continued to put downward pressure on asset yields. However, our net interest margin further benefited from changes in the mix of average assets to include proportionately more loans and less interest-earning cash and securities than in the immediately preceding quarter, as well as significantly decreased levels of non-accruing loans in REO compared to a year earlier. Both of which combine to offset some of this pricing pressure.

As a result of the mix changes, the yield on average assets at 4.72% declined by just 2 basis points compared to the fourth quarter, although reflecting the rate environment it was 16 basis points lower than the first quarter of 2011. The yield on loans was 5.44% for the first quarter of 2012, which was 9 basis points lower than the fourth quarter 2011 and 22 basis points lower than the first quarter a year ago. The adverse margin impact of non-accruing loans decreased to 13 basis points in the current quarter compared to 14 basis points in the preceding quarter and 27 basis points the first quarter a year ago.

While the continuing reductions in non-accruing loans and other non-earning assets, particularly REO, that we have achieved will be helpful to our net interest margin in future periods, yields on performing assets should continue to decline in the current interest rate environment. And although we expect further reductions in the current quarter, we will also have less opportunity to reduce funding costs in future periods. As a result, further improvement in our net interest income will become much more dependent on growth in earning assets going forward.

As noted in our press release, for the first quarter loan balances decreased slightly compared to the fourth quarter, primarily as a result of expected seasonal paydown of agricultural loans, the impact of refinancing activity on residential mortgage loans prepayments, and further planned reductions in land development loans. However, despite a still challenging economic environment, we did experience modest growth in commercial business loans as well as reasonable demand for and production of commercial real estate loans, although prepayments of these loan types are also accelerated in the low rate environment which curtailed growth.

Looking forward, we remain optimistic that the well-focused efforts of our bankers will continue to attract business clients and expect that the normal seasonal pattern will result in increased balances in agricultural loans and, to a lesser extent, construction loans as the year progresses.

As we have discussed before, in addition to the positive effect on our net interest margin, the other important aspects of continuing growth in deposit and core deposit accounts has been the impact on deposit fees. This was again evident in the first quarter as total deposit fees and service charges, which were nearly unchanged compared to the fourth quarter despite normal seasonal slowdown in the shorter first quarter, were 11% greater than the same quarter a year ago.

Also, as I noted before, revenues for mortgage banking activities picked up further from the strong pace of the second half of last year, increasing to $2.6 million for the first quarter of 2012 compared to $1.9 million in the fourth quarter of 2011 and $962,000 in the first quarter of 2011. Of course, the very low mortgage rates currently available in the market have caused application activity to remain high, which likely will positively impact revenues for at least the second quarter of 2012 as well.

Expenses related to real estate owned, while still high, declined, reflecting the reduced number of properties owned and fewer valuation adjustments. Although we expect these real estate owned expenses and other credit related costs to remain elevated for a little longer, we do expect that they will continue to decrease over time as additional problem asset resolution occurs.

Similar to recent periods, for the first quarter other operating expenses in aggregate were reasonably well behaved, although increases in compensation expense, in part reflecting the increase in mortgage banking activity as well as increased health insurance costs, offset a meaningful portion of the decreased REO expense. While revenue growth will continue to be important, effectively managing these controllable expenses carry a critical focus for us going forward.

Fair value adjustments for the first quarter of 2012 resulted in a net gain of $1.7 million, generally reversing a net charge of $1.8 million recorded in the preceding quarter. In each case primarily reflecting changes in the level of 90-day LIBOR. By comparison, fair value adjustments resulted in a net charge of $256,000 for the first quarter a year ago.

Finally, as Mark noted, the capital base of the Company and the subsidiary banks increased during the quarter and is substantial. At March 31, 2012, Banner Corporation's ratio of tangible common equity to tangible assets increased to 10.15%. Its total risk-based capital ratio increased to 18.98% and its Tier 1 leverage capital ratio increased to 14%.

Further, Banner Bank and Islanders Bank both enjoy similarly strong capital positions and reserves for loan losses that are substantial. As I have noted before, this strong capital position is significantly above the current regulatory guidelines. It is also well above the levels that most observers expect will be reflected in future guidelines and should allow Banner considerable flexibility with regard to capital management as we move forward.

So with that final thought, I would like to congratulate our employees for a very good start to 2012 and 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 Alicia will now open the call and welcome your questions.

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

Thanks. Good morning, guys. Maybe a question for Lloyd just a follow-up on those operating expenses. If you exclude OREO expense, operating costs were up 3% linked quarter. Again, the comp side was a little elevated and you alluded to mortgage banking being a component of that.

Would you expect, I guess stripping out mortgage banking if that stays steady, any falloffs in operating expenses, or is this a good base to grow off of?

Well, I think it's a pretty good base to grow off of, Jeff. The increases, as I noted, in addition to mortgage banking health insurance costs jumped pretty substantially from a year ago.

We also had -- a year ago we were just coming off of a period of extended control of compensation expense. We instituted some changes there. We were a little less optimistic a year ago about incentive accruals than we were in the first quarter of this year, so that number is up a little bit year over year.

We have added talent, as Mark mentioned, throughout the organization and that is having a bit of an impact as well. I think the health insurance costs could come down a little bit compared to what we accrued in the first quarter, but beyond that I think it's a pretty good base at this point in time.

Okay. And then kind of a housekeeping I have got to ask. Any updates given the profitability of the franchise on DTA timing? And, perhaps, if you could update us on net DTA benefit now that you have had another quarter without tax liability. So I guess the question is timing and amount.

Really surprised to get that question, Jeff. We discussed that yesterday and my smart aleck remark was we are 90 days closer to that event than we were when we last talked to you. We still believe it's sometime this year.

The size of the net adjustment, recall, was about $35 million in the DTA allowance, but coincident with that we expect to make an adjustment to the fair value of the junior subordinated debentures. The net benefit, as we noted before, is probably in that $12 million to $15 million range.

So that wasn't lower with the profitability this quarter?

We tagged the deferred for a little over $3 million this year, or this quarter rather. That brought the allowance down from the $38 million that it was a year-end.

Okay, got you. And then lastly, if I could, I guess with the MoUs lifted and the TARP auction complete, just any general thoughts now that dust has settled on perhaps partial or whole TARP repayment or redemption, when that could occur?

Jeff, this is Mark. First of all, it is no longer TARP. It is a preferred debt instrument, preferred stock instrument.

Got you.

That is in the secondary market, so as you know, the secondary market can behave differently in terms of redemption based on trading price. Also, we still remain to have all of the options available to us that were in the original offering by the Treasury so we can redeem at any time that we decide.

So our philosophy has not changed from the last quarter, which is we want to make sure we have complete clarity as to where the economy is going, and we will be prudent with our capital management and redeeming that debt.

Would it be safe to say the priority would be to retire the preferreds before any dividend payment was -- or an increase in the dividend?

Certainly once that increase goes to 9% that is very expensive capital.

Got you. Okay, thanks, guys. I will step back.

Thanks, Jeff.

Tim Coffey, FIG Partners.

Just to follow-up on that last question. Would there be any interest in doing a partial redemption of the preferred debt instrument in conjunction with recapture of the DTA?

I think that is -- first of all, Tim, all options are on the table, so we are reviewing all of our capital management plans to make sure that we have the proper capital structure to maximize earnings and shareholder value. So all options are on the table.

Okay. Was there a second part or was that just it?

No, that is pretty much it. We have been pretty consistent in our message.

Okay, okay. Since you have been looking at the adjustments for the fair value of your subordinated debt, have your inputs to whatever model you might use to affect discount rate change at all? Have you lowered the discount rate at all?

Tim, this is Lloyd. The only thing that has changed is, of course, 90-day LIBOR moves around, and so 90 days ago it was a little bit higher than it was at March 31 and that had a small impact. That really created most of the swing in fair value adjustments between the two quarters that I mentioned.

The other thing that, of course, changes is 90 days of time past us so it's a little shorter. But the more important point is the spread that we are using to create the discount rate; we have not made an adjustment in that spread from what we have been utilizing for quite a few years now.

Okay, okay. So the spread you are using is actually a few years old?

Yes. And, again, remember the conversation that we have had a number of times. We believe that if you come to the conclusion that it's appropriate to remove the allowance on the deferred tax asset because sustainable profitability is now more likely than not, that improvement in our credit standing should also be reflected in an adjustment to the discount rate that we are going to use on the junior subordinated debentures.

Okay, okay. That might be a subject for debate. You also made some comments in the conference call this morning about elevated REO expenses going forward. I am wondering if there is particular -- here in the next three quarters where scheduled appraisals are greater than other quarters. And if so, what quarter would that be?

Tim, this is Rick Barton. I don't think that is a factor. We reappraise our REO on a six-month rolling cycle basis, so that cost is fairly well spread throughout the year.

Tim, this is Lloyd. That was my comment in while $27 million, $28 million of REO is a substantial improvement over where it was it's still high by historical standards. And that was the basis for my comment that we will still have carrying costs related to REO as we work through that process.

So high by a historical standard, but certainly room for continued improvement compared to recent periods.

Right, that was my understanding of it, yes. Well, thanks, gentlemen. Those are all my questions.

Kipling Peterson, Columbia Ventures Corporation.

Good morning. This is a question on the TARP. When the Treasury auctioned off the TARP preferred it looks like they did it at about $0.88 on the dollar.

Two other banks were allowed to repurchase some or all of their TARP preferred, and I am wondering did you ask your regulators if you could participate in the auction? And if so, did they say no or yes? I am just wondering, it seems at $0.88 on the dollar Banner probably had the funds to purchase some of the TARP preferred and I am just wondering what your view of that was.

That is a good question, Kipling. Thank you -- this is Mark -- thank you for asking it.

Our view -- first of all, we have consistent conversations on a regular basis with our regulators. Not only in regards to the financial performance of the Company but also capital management.

My view on the redemption of the TARP from the Treasury being asked to bid in a Dutch auction of such magnitude philosophically has caused a reputational issue for me. Every day we make loans to our client base and we expect those loans to be paid back in full. Banner took out an obligation with the Treasury and made an arrangement to repay that in full with the Treasury.

That it had done; consistently paid dividends; had not missed a beat in terms of payment. And our obligation, which would have been to pay back the Treasury funds, which were taxpayer money, at 100 cents on the dollar, and that was what we -- that is the obligation we created and that is what we are going to live up to. So to bid it at a discount reputationally would have caused -- I don't think there was not enough economic gain to offset the reputational risk, so that is why we chose not to bid.

Do you feel the same way in the secondary market?

Now it's a very different market.

Okay, great. Thank you.

(Operator Instructions) I am showing no further questions in the queue. At this time, I would like to turn the conference back to Mr. Grescovich.

Thank you, Alicia. For the first quarter of 2012 our performance continued to demonstrate that we are making substantial and sustainable progress on our disciplined strategic plan to strengthen Banner by achieving a moderate risk profile, and at the same time executing on our Super Community Bank model by growing market share and improving our core operating performance.

As Lloyd mentioned, I would like to thank all our employees for their dedicated hard work at returning and restoring this company to sustainable profitability.

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

Ladies and gentlemen, this does conclude our conference for today. If you would like to listen to a replay of today's call, please dial 1-800-406-7325 or 303-590-3030 and enter the access code of 4527868 followed by the pound sign.

Thank you for your participation. You may now disconnect.