Banner Corp (BANR) 2014 Q2 法說會逐字稿

Good day, and welcome to the Banner Corporation's second-quarter 2014 conference call and webcast. All participants will be in a listen-only mode. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Mr. Mark Grescovich, President and CEO. Please go ahead, sir.

Thank you, Denise, and good morning, everyone. I would also like to welcome you to the second-quarter 2014 earnings call for Banner Corporation. As is customary, 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?

Certainly. 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, 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 the recently filed Form 10-Q for the quarter ended March 31, 2014.

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.

Thank you, Al.

As announced, Banner Corporation had another strong quarter of performance, reporting a net profit available to common shareholders of $17 million or $0.88 per share for the period ended June 30, 2014. This compared to a net profit to common shareholders of $0.60 per share for the second quarter of 2013 and $0.54 per share in the first quarter of 2014.

Earnings in the second quarter included a $9.1 million gain related to the acquisition of our Oregon branches which, net of related expenses, added $0.23 per share to earnings. Exclusive of that gain, Banner had a very strong quarter of $0.65 per share.

The second-quarter performance continued our positive momentum and further demonstrated that, through the hard work of our employees throughout the Company, we continue the successful execution of our strategies and priorities to deliver sustainable profitability to Banner and expand our balance sheet with strong organic loan and deposit growth coupled with opportunistic acquisitions.

Our return to profitability for the last 13 quarters further demonstrates that our strategic plan is effective and we continue building shareholder value. Our operating performance again this quarter was very solid when analyzing our core key metrics. Our second quarter of 2014 core revenue was a strong $54.4 million despite lower year-over-year mortgage banking revenue due to a reduction in refinance activity.

Supported by an improved earning asset mix, our net interest margin remained above 4% and was 4.06% in the second quarter of 2014 and our cost of deposits again decreased in the most recent quarter to 21 basis points compared to 29 basis points in the second quarter of 2013. This overall performance resulted in a solid return on average assets of 1.51% in the quarter.

This quarter's strength is reflective of the continued execution on 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 increased 19% compared to June 30 of 2013.

Also, our non-interest-bearing deposits increased 26% from one year ago. The predominant portion of this balance growth is from the generation of new client relationships and the acquisition of the six new branches previously mentioned.

Our net client growth in these product categories is 72% since December 31 of 2009. It's important to note that the major portion of this growth is organic from our existing branch network. Further, our loan portfolio expanded 14% from one year ago. In a few moments, Lloyd Baker will discuss our operating performance in more detail.

While we have been effectively executing on our strategies to protect our net interest margin, grow client relationships, and deliver sustainable profitability, improving the risk profile of Banner and aggressively managing our troubled assets also has been a primary focus of the Company. Again this quarter, our credit quality metrics reflect our moderate risk profile and our nonperforming assets have been reduced another 8% compared to the first quarter of 2014 and 27% compared to June 30 of 2013.

In a moment, Rick Barton, our Chief Credit Officer, will discuss the credit metrics of the Company and provide some context around the loan portfolio, our success in aggressively managing our problem assets while at the same time increasing our loan portfolio. Given our successful credit management, our reduction in nonperforming loans, and our moderate risk profile, we did not record a provision for loan losses in the quarter despite our strong loan growth. Nonetheless, Banner's coverage of allowance for loan losses to nonperforming loans is a strong 376% at June 30, 2014, up significantly from 292% in the second quarter of 2013.

Banner's reserve levels are substantial and our capital position and liquidity remain extremely strong. At the end of the quarter, our ratio of allowance for loan and lease losses to total loans was 1.97%. Our total capital to risk-weighted assets ratio was 16.5%, and our tangible common equity ratio was 11.8%.

In the quarter and throughout the preceding four years, we continued to invest in our franchise. We continued to add talented commercial and retail banking personnel to our company in all of our markets and we continue to invest in further developing and integrating all our bankers into Banner's proven credit and sales culture.

While these investments have increased our core operating expenses, they are resulting in positive revenue growth, strong customer acquisition, 15% year-over-year growth in the C&I portfolio, and improving cross-sell ratios, resulting in deposit fee income growth of 11%.

Further, we've received marketplace recognition of our progress and our value proposition as the Small Business Administration named Banner Bank community lender of the year for the Seattle and Spokane district for the second consecutive year, and Forbes Magazine ranked Banner Corporation as one of the top 50 most trustworthy financial institutions in the United States.

Finally, the successful execution of our organic growth plan and our persistent focus on improving the risk profile of Banner has now resulted in 13 consecutive quarters of profitability and our tangible book value increased nearly 8% to $28.57 per share when compared to June 30, 2013.

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 about the Company's loan portfolio can be broken down into two themes: credit metrics and loan growth. Banner's credit metrics continue as a strength for the Corporation and definitely support our objective of maintaining a moderate risk profile. The metrics I will discuss include the loans acquired as part of the Oregon branch purchase.

Net loan charge-offs for the quarter were $61,000, less than 0.1% of average loans. Total nonperforming assets declined another 8% from the linked quarter and are now just 0.51% of total assets. The nonperforming loan category decreased $5.3 million or 25% during the quarter. Reductions primarily came from payments.

Assets moving to REO both reduced nonperforming loans and resulted in a modest $1.1 million REO increase during the quarter. Orderly liquidation of REO continues. During the quarter, sales yielded a net gain of $150,000 and no valuation adjustments were recorded.

Classified loans in Banner's portfolio were $78 million versus $80 million at March 31, 2014. This is a decrease of 2.5%. Classified loans now represent only 2.1% of total loans.

Delinquent loans, including non-performing loans, were 0.73%, essentially unchanged from the linked quarter. The allowance continues as a source of strength for the Company, even with no provision, for the sixth consecutive quarter. Coverage of nonperforming loans is a strong 376% and the reserve to total loans also is strong at 1.97% even after loan growth during the quarter of $240 million, or 6.8%.

Having just cited second quarter's strong loan growth provides a perfect segue to further discuss the Company's loan growth. Year over year, total loans have increased $472 million or 14%. $88 million or 19% of the growth resulted from the recent branch transaction. These acquired loans have a commercial real estate concentration but also include excellent C&I credit relationships.

The balance of the year-over-year portfolio growth, $384 million, was organic. This growth occurred across the franchise reflecting an improving economy in the region as well as a more optimistic view of the future by borrowers.

The press release details second-quarter loan growth by portfolio segments. Additional comments about this growth include commercial real estate growth in the second quarter was skewed by the Oregon branch transaction. The commercial real estate totals also include owner-occupied properties. Compared to the linked quarter, this category grew $37 million.

Multifamily construction loans decreased by 38% quarter to quarter as several projects [were] completed and we are being very selective in adding new commitments given the sheer volume of new apartment units in our major markets.

Residential construction loan outstandings were flat during the quarter despite significant new loan production which reflects the vitality of homebuilding in the Northwest. Markets are in balance with low levels of unsold inventory and payouts are keeping pace with residential construction advances.

Solid growth was recorded in both C&I and agricultural loans reflecting our strategic emphasis on those portfolio segments.

I will conclude my remarks with the recurring theme that the moderate risk profile of the Banner loan portfolio, along with the Company's strong capital ratios, will allow us to continue executing our strategic plans, which include further growth of the Company.

With that, I'll turn the stage over to Lloyd for his comments.

Thank you, Rick, and good morning, everyone. As Mark has already indicated and as reported our press release, our second-quarter operating results reflect solid revenue generation driven by significant balance sheet growth, additional client acquisition, and compared to the preceding quarter, improved mortgage banking activity.

This strong performance follows a solid first quarter for 2014 as well as two very successful years in 2012 and 2013 and continues to demonstrate that our value proposition and the strength of our balance sheet are producing consistent earnings momentum and adding value to the Banner franchise.

Our net income available to common shareholders was $17 million or $0.88 per diluted share in the quarter ended June 30, 2014 compared to $10.6 million or $0.54 per diluted share in the first quarter of 2014 and $11.8 million or $0.60 per diluted share in the same quarter a year ago.

As noted, the current quarter's results were augmented by a $9.1 million bargain purchase gain related to the acquisition of six branches in Oregon, which added $0.23 to earnings per share. Adjusting for that gain and the related cost and taxes, our earnings per diluted share increased to $0.65 for the second quarter of 2014 compared to $0.54 in the preceding quarter and $0.60 in the second quarter a year earlier.

For the six months ended June 30, 2014, our earnings available to common shareholders increased to $27.6 million compared to $23.3 million for the first six months of 2013. Excluding the bargain purchase gain and related costs and taxes, earnings for the first six months of 2014 were $23.1 million, nearly unchanged from a year earlier as increased net interest income and increased deposit fees and other service charges were essentially offset by decreased mortgage banking revenues and increased operating expenses.

However, as I previously noted, our mortgage banking revenues improved meaningfully in the second quarter compared to the first quarter as originations for home purchases increased in large part as a result of additions to our mortgage loan production staff.

Our first half results, as encouraging as they are, continue to reflect the difficult challenge presented by the prolonged period of very low interest rates, which again pressured asset yields and our net interest margin.

Our net interest margin was nearly unchanged from the preceding quarter primarily as a result of strong loan growth and a resulting change in earning asset mix. Loan yields continued to decline and despite further small reduction in our funding costs, our net interest margin was 14 basis points below the same quarter a year ago.

Nonetheless, as a result of significant loan growth, our net interest income increased by $1.6 million compared to the second quarter a year ago and, coupled with a $700,000 increase in deposit fees, allowed revenues from core operations to increase by $1.3 million to $54.4 million for the quarter ended June 30 compared to $53.1 million for the same quarter in 2013 despite a $1 million decrease in mortgage banking revenues.

In addition, for the sixth consecutive quarter, we did not identify a need to reduce net interest income with a provision for loan losses as nearly all of our credit quality indicators continued to improve.

Also reflecting the strong loan growth for the six-month period ended June 30, 2014, our net interest income increased by $2.9 million or 3.5% compared to the first six months of 2013. And deposit fees increased by $1 million or 8%, more than offsetting a $2 million decrease in mortgage banking revenues. As a result, our revenues from core operations increased to $105.8 million for the first six months of 2014 compared to $104 million for the first six months a year ago.

As Mark noted, our net interest margin remained strong at 4.06% in the second quarter compared to 4.07% for the first quarter, but not surprisingly declined from 4.20% in the second quarter of 2013. Importantly, however, none of these periods has Banner's margin or net interest income been augmented by any acquisition accounting yield adjustments.

Although our successful client acquisition strategies have resulted in significant core deposit and loan growth, which has offset much of the declining yield pressure, it remains clear that the low interest rate environment will continue to adversely impact the margin going forward.

Deposit fees and service charges were particularly strong at $7.3 million in the second quarter, an 11% increase compared to the $6.6 million in both the first quarter of 2014 and the second quarter a year ago. As I have noted before, continuing increases in these fees and service charges are a direct result of the success of our client acquisition strategies and resulting growth in core deposits.

However, in the current quarter, we also experienced an increase in these fees as a result of our decision to move our debit card relationship to MasterCard. While this change resulted in some one-time income recognition, which impacted this revenue in the current quarter and will also boost third-quarter revenues modestly, there also will be an ongoing positive impact on our revenues as well as continuing benefits for our clients from this changed relationship.

As noted in the press release, we had another outstanding quarter for loan growth, particularly with respect to targeted loan categories. Including the loans acquired in the branch purchase, total loans increased 7% compared to the prior quarter and 14% compared to a year ago. These increases reflect solid growth in commercial and agricultural business loans and commercial real estate loans.

Agricultural loan balances experienced a normal seasonal increase in utilizations while the aggregate total of construction and development loans decreased during the quarter as a result of significant payoffs and the completion of certain multifamily projects.

Primarily as a result of the branch acquisition, total deposits increased 6% during the quarter and, reflecting significant organic growth as well as the acquisition, increased by 13% compared to a year earlier. Importantly, deposit growth continued to be largely centered in transaction and savings accounts including non-interest-bearing accounts which increased by 26% compared to a year earlier.

As a result, at June 30, 2014, our core deposits increased by 19% and represented 76% of total deposits compared to 73% a year earlier. Of course, as I have noted before, growth does not come without a cost and that was again true for Banner as our operating expenses also increased compared to the preceding quarter and corresponding three- and six-month periods a year earlier. The increase in expenses compared to prior periods principally reflects additional compensation as we continue to invest in our human capital.

In addition, expenses related to the branch acquisition were approximately $2 million. However, we are pleased to note that the six branches and more than 10,500 new client relationships have been fully integrated into the Banner systems and we are very optimistic about the prospects for this new market.

This concludes my prepared remarks. In summary, I think it is fair to say Banner Corporation has clearly had a strong first half of 2014 and is well-positioned for continued success in future periods. As always, I look forward to your questions.

Mark?

Thank you, Lloyd and Rick. That concludes our prepared remarks, and Denise, we will now open the call and welcome your questions.

We will now begin the question and answer session. (Operator Instructions) Jeff Rulis, D.A. Davidson.

A question on the loan growth, just a broader question. You get the sense that this was more a function of improved demand in the footprint or taking market share?

Jeff, this is Mark. It's a combination of both. I think the value proposition that we've demonstrated -- I think we are taking market share -- significant market share gains for our company as evidenced, as I said, by the significant client growth we've had. But without a doubt the regional economy, I believe, is performing significantly better than other parts of the country. So it's a combination of both.

Okay. I guess if -- to further make it more granular, I guess sequentially, you getting a sense that, maybe just separately, demand is increasing? I mean, you've got some seasonal factors in there, but certainly it feels more positive quarter to quarter?

Yes, I think adjusting for the seasonal impact, yes, it is getting better quarter to quarter.

Got you. Okay. Just to clarify on the -- maybe this is for Lloyd, but the -- just was interested in the amount of the costs and taxes that you netted against that gain. So, the $9.1 million gain, what did you account against that?

Good morning, Jeff. We accounted against it all of the related expenses, which as we've identified in the release were roughly $2 million.

Okay.

Most of that in the current quarter. There was a small amount in the first quarter. And then the marginal tax rate on that would be 36%.

Okay.

Which is a combination of state and federal tax impact on the marginal dollars.

Okay. Great.

That marginal rate and that large contribution from the bargain purchase gain is also the reason, if you'll note in the press release, that our effective tax rate for the quarter was up about 1% over the prior -- in recent quarters.

Right.

And that's driven by more fully taxable stuff at the higher marginal rate.

Got it. Okay. And then maybe just one last one. Just interested in the yields on the loans you acquired in the branch deal relative to the legacy book and maybe the impact on the funding costs as well, what you're bringing over. So, I guess, loan yields and funding costs, expected impact.

Jeff, this is Lloyd. The yield on that portfolio was pretty comparable to our existing portfolio. As Rick noted, there's a little bit of a bias towards commercial real estate in there, which generally is going to be a little bit higher than C&I loans, but it's pretty comparable as were the consumer segments of it. The deposit costs were also reasonably comparable to ours and it was a very attractively priced deposit portfolio. So as a result of that, when we went to the fair value mark to market on both the loans and the deposits in the purchase accounting activity, there were very small marks.

Got it. Okay, and are you seeing any runoff subsequent to quarter end or any expected?

Not at this point in time anything meaningful, and I don't think we expect it either. We've got to be optimistic.

Jeff, this is Mark. We obviously modeled in that as part of the purchase, but we're actually very optimistic that we're going to grow and continue to take market share down there.

Okay. Thank you. That's it for me.

Thanks, Jeff.

Jacque Chimera, KBW.

Lloyd, I'm sorry if I missed this in your prepared remarks, but was there anything that happened with the fair value mark with it suddenly going positive when it's been negative the last couple of quarters? The one in fee income.

There was. There were actually a handful of things that happened in the fair value mark. If you'll note, we took the valuation of our debt, our junior subordinated debt, up changing the spread from 525 that we had previously used to 500 basis points over LIBOR on that, as well as some related assets that we have where we own some trust preferred debt issued by other financial institutions.

And we were just finding evidence in the market that spreads have tightened some more on those products. In addition, and as part of that evidence, we own some pooled trust preferred securities, trust preferred CDOs, if you will. And on one particular security that was rather sizable, we were carrying it around $0.78 on the dollar and we became aware that there was a successful auction on the collateral and that we would be paid in full on that security. So, it was moved to a mark of par in anticipation of that.

So those tended to offset each other. The mark in the rest of the portfolio was pretty modest as interest rates really haven't moved around much.

Okay. So going forward in future quarters we'll go back to the small amount of amortization then?

That's correct. As I've mentioned a number of times, there's a fairly sizeable mark against that liability that just the passage of time will be about $300,000 to $350,000 a quarter of fair value charge, if you will.

Okay. That's very helpful. Thank you. And then one for you, Mark. Just as you look to -- and I realize that this particular quarter was different because you had an acquisition that had higher deposits than loans. But how do you think about balancing this excellent loan growth that you've been having versus trying to get deposit accounts up to keep the loan-to-deposit ratio around the 95% level?

That's a great question. We have set a long-term target of having our loan-to-deposit ratio between 90% and 95%. Seasonal factors will cause you to move at the higher end of that ratio given the seasonality in our loan portfolio. We have had strong loan growth. We are certainly not going to cease our momentum on the loan production side. I do believe that there is some seasonal impact on the deposits as well, and I feel pretty confident that our continued acquisition, client acquisition strategy, along with the seasonal pickup in deposits will allow us to continue to be core funded as an institution going forward.

Okay. And do you -- is it part of your incentive plan for some of your branches or anything like that regarding deposits?

Yes, it is, significantly. And let's keep in mind that at the end of 2009 our core deposit mix was 50% core deposits and that's now, as Lloyd said, 76%. So I think the incentive plans, along with the value proposition that we're putting in front of the client base, along with our sales structure, is yielding very positive results, and we expect that to continue.

Okay. Great. Thank you for all the color. I appreciate it. I'll step back now.

Thank you, Jacque.

(Operator Instructions) Russell Gunther, Macquarie.

Just one quick follow-up for me at this point. On the loan growth, even adjusting for the branch impact, so you guys showed incremental improvement from 1Q and have really demonstrated some strength going forward. I think last quarter you remarked some cautious optimism. This quarter in your prepared comments you talked about the pipeline boding well for growth going forward. So I'm just wondering if your level of confidence in the ability to maintain growth momentum from here has increased, and if so, if you could just talk about what you'd expect the drivers to be going forward.

Russell, this is Lloyd. I think that we have significant confidence in our loan production units and personnel. Having said that, the pace of growth in the second quarter -- really the first half of the year, but the second quarter in particular, that pace of growth is something that probably is not sustainable on a long-term basis. So, there's seasonality in there. There's uneven deal flow always. But as we've noted for an extended period of time, we've been investing in talent. And that talent is gaining traction in a number of locations and producing positive results and we would continue to be optimistic about that.

So, Russell, this is Mark. In summary, I would characterize our pipelines are strong. We are optimistic, but we are not more optimistic than we were last quarter.

That's great. That's really helpful, guys. I appreciate it.

You bet.

Don Worthington, Raymond James.

In terms of -- broker deposits went up a bit in the quarter, and I'm assuming you're using that to kind of fill the gap until you generate more core deposits. Just curious as to kind of the term and the rates paid for the brokered accounts.

Don, this is Lloyd. The terms were actually quite short because we do view that as a stop-gap measure. We maybe haven't mentioned this enough yet this morning, but we typically see a seasonal flatness in deposit flows in the first half of the year and most of our deposit growth in recent years has occurred in the second half. So, when we utilize wholesale funding, we keep that in mind. So the terms are really quite short.

We're also in a position where our interest rate risk profile, which we've noted for an extended period of time, is modest risk. But clearly we would prefer to see rates go up than go down, so it makes it -- utilizing short-term funding makes sense in that case.

Okay. Great. Thank you. And then noninterest bearing deposits were up pretty strong in the quarter. How much of that was acquired in the branch deal?

The Oregon branch acquisition had with it approximately $150 million of core deposits associated with it. It was approximately $225 million, I believe, of total deposits and roughly $150 million of what you would characterize as core.

Okay. Great. All right. Thank you.

Thanks, Don.

Tim O'Brien, Sandler O'Neill & Partners.

First question -- commitments, C&I commitments, did they change in the quarter?

Well, with the -- this is Rick, Tim. With the loan activity that we have had there, there's always some expansion in C&I commitments related to that activity. There still remains a good portion of those commitments that are undrawn at this point.

And did utilization rates increase?

I would say that utilization rates increased slightly, and part of that is related to the seasonal patterns that Lloyd has talked about earlier.

And that's specific to C&I, not construction. Right?

Correct.

And then kind of going forward in the second half, would it be fair to say that seasonal factors in ag -- are you going to see increased line usage in ag in the third quarter? Or is that going to top out here now that we're through the second quarter? And then also by extension, are we going to see probably balances wind down from here even on the construction book? Was that the right take-away from the comments made on that?

Well, I think that you need to break the construction book into different segments. When you take a look at the multifamily portion of that, I think that's a fair statement. As I mentioned, we're being very selective about making new commitments in that segment currently. Given the vitality and health of the residential markets here in the Northwest, I think that those will remain fairly stable as we go forward through the balance of the year.

And then on the ag side, do we see further draws from here and expansion in the book in the third quarter or are we going to start topping out and you're going to see more payoffs here?

There will be some continued drawdowns during the third quarter. And the pay downs typically occur as we move into the fourth quarter and the first quarter of next year.

Got it. So, in other words, that's kind of incrementally a differentiator between second and third quarter as related to those two segments. That might take a little bit of the edge off that strong growth you guys experienced in the second quarter but relative to the third quarter. But all other things being equal growth prospects look promising still. Does that sound right?

Yes.

Okay. Great, and then another question, just kind of a true-up. Are there any other incidental costs related to the branch deal that you guys are going to book in the third quarter?

That's a great question, Tim. In the press release, we noted that the fair value adjustments of assets and liabilities and the costs were all estimated. I don't think they'll be material, but from an accounting conservativeness standpoint, we left that option open. But, it's not going to be material.

Not material. Great. That's all I needed. And then one last question for you. Where was that? Conversions completed. Fair value marks, got that. I'll step back from here. Thanks a lot, guys.

(Operator Instructions) Showing no further questions at this time, this will conclude our question and answer session. I would like to turn the conference back over to Mr. Mark Grescovich for any closing remarks.

Thanks, Denise. As I stated, we are pleased with our strong second-quarter performance and the reinforcing evidence that we are making substantial and sustainable progress on our disciplined, strategic plan to build shareholder value by executing on our super community bank model, by growing market share as evidenced by the expanding balance sheet, strengthening our deposit franchise, improving our core operating performance, and maintaining our moderate risk profile.

I would like to thank all my colleagues who are driving this solid performance for our company, and we all welcome our new colleagues and clients as a result of our Oregon bank acquisition. 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.

Denise, I'll turn the call back to you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.