Banner Corp (BANR) 2014 Q3 法說會逐字稿

Good day and welcome to the Banner Corporation's third-quarter 2014 earnings conference call and webcast.

All participants will be in listen-only mode. (Operator Instructions). After today's presentation, there will be an opportunity to ask questions. (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.

Thank you, Andrew, and good morning everyone. I would also like to welcome you to the third-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?

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 our recently filed Form 10-Q for the quarter ended June 30, 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 yet another strong quarter of performance, reporting a net profit available to common shareholders of $14.8 million, or $0.76 per diluted share, for the period ended September 30, 2014. This compared to a net profit to common shareholders of $0.60 per share for the third quarter of 2013, and $0.88 per share in the second quarter of 2014.

I'd like to remind you that 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 earnings of $0.65 per share in the second quarter of 2014.

The third-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 14 quarters shows convincingly that execution on 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 third quarter of 2014 core revenue was a strong $59 million supported by an improved earning asset mix and a net interest margin that remained above 4%, and actually was 4.07% in the quarter.

Also our cost of deposits again decreased in the most recent quarter to 19 basis points compared to 26 basis points in the third quarter of 2013. Overall, this resulted in a solid return on average assets of 1.23% in the quarter.

Our performance this quarter again reflects the value of 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, improving our core funding position, and promoting client loyalty and advocacy through our responsive service model. To that point, our core deposits increased 19% compared to September 30, 2013. Also, our non-interest-bearing deposits increased 24% from one year ago. The predominant portion of this balanced 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 74% since December 31, 2009. It's important to note that the major portion of this growth is organic from our existing branch network. In addition, our loan portfolio expanded 16% 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 quality metrics related to credit reflect a moderate risk profile and our nonperforming assets represent 0.5% of total assets at September 30, 2014.

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 and our success in aggressively managing our problem assets while also increasing the loan portfolio.

Given our successful credit risk 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 additional loan growth. Nonetheless, Banner's coverage of allowance for loan losses to nonperforming loans is a strong 376% at September 30, 2014, up significantly from 305% in the third 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 1.95%. Our total capital to risk weighted assets ratio was 16.6% and our tangible common equity ratio was 12%.

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 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, 16% year-over-year growth in the loan portfolio, improving cross-sell ratios, and strong deposit fee income.

Further, we have received marketplace recognition of our progress in 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 14 consecutive quarters of profitability, and our tangible book value increased nearly 8% to $29.16 per share when compared to September 30, 2013.

Before I turn the call over to Rick Barton to discuss the trends in our loan portfolio, I want to recognize our new colleagues from Siuslaw Bank, an outstanding organization in Eugene, Oregon, and their clients that will soon be joining Banner. We are extremely pleased with this opportunity to expand our Super Community Bank model in the Willamette Valley I-5 corridor, and complement our recent Oregon branch acquisition. I will now turn the call over to Rick.

Thank you Mark. The same two significant themes again drive my comments this morning about the Company's loan portfolio, credit metrics and loan growth. Banner's current credit metrics definitely support our objective of maintaining a moderate credit risk profile and they serve as a continuing source of strength for the Company.

Recoveries on charged-off loans more than offset the quarter's loan losses, resulting in a net recovery of $21,000. And for the first nine months of 2014, Banner's net recovery position is $71,000.

Total nonperforming assets declined another 2% from the linked quarter and are now just 0.5% of total assets. Nonperforming loan totals were unchanged during the quarter. Orderly liquidation of REO continues. During the quarter, REO sales reduced REO outstanding by 10% and resulted in a net gain of $265,000. And once again, no valuation adjustments were recorded.

Classified loans in Banner's portfolio were $75 million versus $78 million at June 30, 2014. This is a decrease of 3.8%. Classified loans now represent only 1.97% of total loans.

Delinquent loans, including nonperforming loans, were down slightly to 0.7% compared to 0.73% in the linked quarter. The allowance for loan and lease losses continues as a source of strength for the Company even with no provision for the seventh consecutive quarter. Coverage of nonperforming loans is a strong 376%, and the reserve to total loans is robust at 1.95%, even after loan growth during the quarter of $44 million, or 1.2%.

Having just cited third-quarter loan growth provides a perfect transition to further discussing the Company's loan growth. Excluding loans acquired in the southern Oregon branch transaction, year-over-year loan totals increased $444 million, or 13.6%. Setting aside the acquired loans, the year-over-year and third-quarter portfolio growth was organic and occurred across the franchise, reflecting an improving economy in the region and an optimistic view of the future by borrowers, albeit tempered by world political and economic events.

The press release details third-quarter loan growth by portfolio segments. Additional comments about this growth include multifamily construction loans increased $9 million, or 23%, quarter-to-quarter as drawdowns continue on existing commitments. We continue to be very selective in adding new commitments in this portfolio segment, given the multitude and size of new apartment projects in our major markets.

Residential construction loans outstanding remained flat during the quarter despite significant new loan production, again demonstrating the vitality of homebuilding in the Northwest. Markets are in balance with low levels of unsold inventory and payoffs are keeping pace with residential construction advances.

Residential land loans did increase $16.6 million, or 23%, from the linked quarter. These new loans are located in major markets with strong demand for new housing and shortages of available building lots. The underwriting of these new commitments is strong, as is the financial capacity of the borrowers. While this category has increased, it represents only 2.4% of total loans.

Total C&I loans decreased marginally during the quarter as the result of paydowns on seasonal lines of credit.

I will conclude my remarks with the recurring theme that the moderate risk profile of Banner's loan portfolio, along with the Company's strong reserve and 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 in our press release, our third-quarter operating results again reflect increased revenue generation driven by significant balance sheet growth, additional client acquisition, and compared to both the preceding quarter and the third quarter a year ago, improved mortgage banking activity. This strong performance for the quarter, as well as our nine-month year-to-date results, continues to demonstrate that our well received value proposition, the keenly focused efforts of our employees, and the strength of our balance sheet are combining to produce consistent earnings momentum and add to the value of the Banner franchise.

Our net income available to common shareholders was $14.8 million, or $0.76 per diluted share, in the quarter ended September 30, 2014 compared to $11.7 million, or $0.60 per diluted share, in the third quarter a year ago, and $17 million or $0.88 per diluted share in the second quarter of 2014.

As previously noted, the prior quarter's results were augmented by a $9.1 million bargain purchase gain related to the acquisition of six branches in Oregon, which, net of related expenses and taxes, added $0.23 to earnings per share in the second quarter. In the current quarter, there were reductions to some of the expense accruals related to that acquisition, which added $0.02 to earnings per share. The current quarter's results were also increased by a $1.5 million net gain for fair value adjustments related to the changes in the valuation of financial instruments carried at fair value, which added another $0.05 to earnings per share in the quarter.

For the nine months ended September 30, 2014, our earnings available to common shareholders increased to $42.4 million compared to $35 million for the first nine months of 2013. Excluding the bargain purchase gain and related costs and taxes, earnings for the first nine months were $37.6 million.

Compared to the nine-month period a year earlier, the increased net interest income and increased deposit fees and other service charges, as well as a favorable variance in fair value adjustments, more than offset decreased mortgage banking revenues, a reduction in the net gain on sale of securities, and increased operating expenses. However, as I previously noted, our mortgage banking revenue improved in the third quarter compared to the first two quarters of this year as well as the same quarter a year ago as our origination of home purchases increased, largely as a result of additions to our mortgage loan production staff.

Primarily as a result of significant loan -- significant growth in the average loan balances outstanding, our net interest income increased by $3.3 million, or 7%, compared to the preceding quarter, and by $5.2 million, or 12%, compared to the third quarter a year ago. In addition, for the seventh consecutive quarter, we did not identify a need to reduce net interest income as a provision for loan losses as nearly all of our credit quality indicators continued to improve. This strong net interest income, coupled with significantly increased deposit fees and the additional rebound in mortgage banking revenues, allowed our revenues from core operations to increase to $59 million for the quarter ended September 30, 2014.

Revenues from core operations were 13% greater than the same quarter a year earlier and represented a new quarterly record for Banner. Also reflecting the strong year-over-year loan growth for the nine-month period ended September 30, our net interest income increased by $8.1 million or 6.5% compared to the first nine months of 2013. In addition, deposit fees increased by $2.3 million or nearly 12% for the nine-month period. As a result, our revenues from core operations increased to $164.8 million for the first nine months of 2014, a 5.4% increase compared to the first nine months of 2013 despite a $1.7 million decrease in mortgage banking revenues.

As Mark noted, our net interest margin remains strong at 4.07% for the third quarter compared with 4.06% in the second quarter and 4.09% in the third quarter of 2013. The strength of the margin compared to a year ago is notable in light of the continuing decrease in loan yields, which declined by 25 basis points compared to last year's third quarter and largely reflects changes to the mix of earning assets as well as further reductions in our funding costs.

For the first nine months of 2014, our net interest margin decreased to 4.07% compared to 4.15% for the first nine months of 2013. Importantly, in none of these periods has Banner's margin or net interest income been augmented by any acquisition accounting yield adjustments. Although our success with client acquisition strategies have resulted in significant core deposit and loan growth, which has offset much of the declining asset yield pressure, it still 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 $8.3 million in the third quarter, a 13% increase compared to $7.3 million in the second quarter of 2014, and 19% greater than 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 as well as our decision to move our debit card relationship to MasterCard.

However, the current quarter also included a $560,000 adjustment related to the under accrual of interchange revenues in prior periods. This adjustment added approximately $0.02 are earnings per share for the quarter.

As noted in the press release, we had another good quarter for loan production. However, portfolio growth slowed from the elevated pace of the preceding quarter as certain seasonal factors resulted in expected reductions in commercial and agricultural loan balances. In addition, we had a significant amount of loan prepayments for our one-to-four family residential loans. Nonetheless, the loan portfolio increased to just over $3.8 billion, an increase of $531 million or 16% compared to the end of the third quarter a year ago.

We also had an expected seasonal increase in deposit balances which ended the quarter at $3.99 billion, an increase of 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 8% during the quarter and by 24% compared to a year earlier. Total core deposits, which includes non-interest-bearing and interest-bearing transaction and savings accounts but excludes all certificates of deposit, increased by 5% during the quarter and by 19% compared to a year earlier. As a result, at September 30, 2014, core deposits represented 79% of total deposits. Reflecting the increasing core deposits, the cost of all deposits decreased to 19 basis points for the quarter ended September 30, 2014 compared to 26 basis points for the same quarter a year earlier.

Of course, as I previously noted, growth does not come without a cost, and this was again true for Banner as our operating expenses also increased compared to the preceding quarter and the corresponding three and nine-month periods a year earlier. The increase in expenses compared to prior periods is largely attributable to acquisition related costs and the incremental costs associated with operating the acquired branches, as well as generally increased compensation expenses. However, as I noted on last quarter's call, we are pleased that the six branches and more than 10,000 new client relationships associated with those branches have been fully integrated into the Banner systems, and we remain very optimistic about the prospects for this new market.

We also had a substantial increase in the advertising and marketing expense during the quarter in part as a result of the expansion into Southern Oregon, but more generally reflecting certain frontloaded costs for some new media campaigns as well as full resumption of our direct mail programs that had been scaled back in the first half of the year. While the current quarter's advertising and marketing expenses were higher than our expected run rate, the two preceding quarters were considerably below our typical pattern. On a year-to-date basis, advertising and marketing expenses were nearly unchanged compared to the prior year.

This concludes my prepared remarks relative to the financial statements. In summary, I think it's fair to say Banner Corporation had a very good third quarter as well as first nine months of 2014, and is clearly position for continued success in future periods. As always, I look forward to your questions. Mark?

Thank you Lloyd and thank you Rick. That concludes our prepared remarks. Andrew will now open the call and welcome your questions.

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

Thanks. Good morning guys. Maybe a couple of questions for Rick. Do you have the loan origination numbers in Q3 versus Q2, and then maybe a similar question in line utilization for C&I in Q3 versus the prior quarter.

Okay. I'll speak specifically to the commercial real estate and residential real estate production numbers. For the first nine months of the year, those numbers are just short of $550 million, and this compares to about $450 million for the same period last year.

As far as line utilizations on C&I, you know, they are up marginally from what they were previously. And if I look over a longer period of time, it's a pretty consistent level of utilized commitments in the portfolio.

When you say marginally, you're saying sequentially versus the prior quarter?

You know, there is some seasonal impact in there, but taking that out, I would say it's sequential.

Okay. And then you quoted those originations kind of year-to-date year-over-year. Any sense of origination volume solely in Q3 versus Q2?

It basically was flat from Q2 to Q3.

Okay. So I guess getting to the question is more -- it really was payoff activity on the net growth figure Q3 versus Q2. And I guess if you could comment, any of the three, on just expectations for growth to kind of close the year.

I think that the pipelines look like we will continue to have a strong production quarter in the fourth quarter. But by the same token, on the residential construction side, we see payoff velocity continuing at a similar rate, so I don't see any meaningful expansion in loan outstandings for that segment of the portfolio.

In commercial construction loans, I think that it's fair to say that while there's going to be drawdowns on existing commitments and some new commitments had it, but we also have a number of transactions that are scheduled for payoff. So, I think, on a net basis, we will see some expansion in that portfolio segment.

In terms of the commercial real estate portfolio, we are continuing to add assets in the permanent portfolio, and I see that trend continuing. As Lloyd mentioned, we are getting into the seasonal paydown period, both on some of our commercial lines of credit and our ag credit, so we have to factor that into what's going to be happening with loan outstandings there as well.

Okay.

This is Mark. Another way to look at it is the portfolio grew by $44 million, overall loan portfolio $44 million from quarter to quarter with roughly $31 million in payoffs in the one-to-four family. So had that one-to-four family payoffs not occurred or that it would plateau would suggest that the growth pattern is a little bit higher than what actually was reported.

Okay. All right, that helps. And maybe on the Siuslaw acquisition, maybe an update on the timing of close and maybe what you've secured in terms of approvals. So, that's I guess question one. And then two related is any idea of how that I guess 9-30 balances at Siuslaw compare to at announcement?

This is Lloyd. So, I'm going to take the last one first. The balances were just a little stronger at 9-30 than they were at announcement date. They had a good third quarter and we continue to feel very optimistic about that transaction as well. Having said that, the regulatory approval process is going fine. We do have to wrestle the schedule around a shareholder meeting for them. And whether that gets done late this quarter or early next quarter is still a little bit up in the air.

What we do have -- this is Mark -- is we do have the state and the FDIC approval for the transaction, so things are moving according to plan.

Okay, I appreciate it guys. Thanks.

Russell Gunther, Macquarie.

Just a question around expenses. You guys gave some good color on what you've been investing in and still done a pretty good job keeping a lid on that. But as you look out through 2015 in terms of other franchise investment, and maybe just adjusting for any noise with the transaction, but do you have expectations to be able to work down the efficiency ratio from around this 67% range it's hovering around, absent the benefit of any rate movement?

Sure, Russell. This is Lloyd. We have been pretty clear for an extended period of time that our business model and our geography don't lend themselves to an efficiency ratio that will be low by anybody's standards. Having said that, as we continue to grow revenue and the size of the balance sheet and integrate the Siuslaw acquisition and further integrate the Southcoast branches, we would expect to push that number down. We will continue to focus on managing expenses as effectively as we can and still invest in the franchise and grow revenue at the same time.

All right. Thank you for that. I Appreciate it. And just moving to the margin real quick, the margin has been remarkably resilient over the course of the year. I'm just wondering. As you look out, in addition to the asset remix you're benefiting, the cost of funds has come down. So, as you look forward, what kind of levers remain on the liability side to kind of help support this margin in the tight range that it's been, or are we kind of at the point where just core asset yield pressure may start to whittle things down from here? Just your thoughts looking forward please?

This is Lloyd. Those who have been on this call for a number of quarters know that I have been pretty consistent in saying I think the margin is going to go down. Mr. Grescovich and the rest of the team have proven me wrong. Having said that, we had a situation this quarter where yields on loans declined, yields on securities and cash decline, the margin actually went up 1 basis point in large part because the mix changed to have more loans and fewer securities on a relative basis and also because we continue to grow those non-interest-bearing account categories, deposit account categories, and reduce the cost of funds.

We are at 79% core deposits today. We've set internal targets to get that number above 85%. As we continue to move in that direction, there is still some room for improvement on the funding side. But as I've said for a long time, in a low interest rate environment, we assume to be stuck in that low interest rate environment, there will be ongoing pressure on asset yields.

And our loan to deposit ratio is currently at 95%, so changing the mix that way gets more and more difficult. But if we continue to grow and continue to have the success we have had, I would be remiss if I didn't complement our bankers on the success they have had at maintaining asset yields in this very challenging market rate environment. But I still believe that, without an adjustment in interest rates, at some point in time that margin is going to drift a little lower. Your point is really valid. It's been exceptionally well performed over a number of quarters now, and we couldn't be more pleased about that.

All right. Thanks Lloyd. Thanks, guys, for taking my questions.

This is Mark. Let me just add one additional comment to that is you asked what the levers are. We outlined our strategic priorities last year to the investment community and suggested that protecting our net interest margin was one of our top priorities. At 79% core deposit funding, we need to be north of 85%, so we need to continue the client acquisition on the deposit front to help protect that interest margin. But to Lloyd's point, it will drift lower in a prolonged low interest rate environment.

Thanks Mark.

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

Good morning. Lloyd, can you clarify? So was it kind of a jump off 50-50 proposition that the deal closes this quarter versus next quarter?

Yes, I think that's fair.

And there are no other regulatory approvals needed, right? You don't need Fed, it's just FDIC and the states are done, so it's just matter of getting shareholder approval now on the other side?

That's right, which of course involves getting documents prepared and approved by the SEC for that and then the approval process. And then as we get close to the end of the year, it becomes more challenging.

Got it. Would you guys like to see the deal close before the end of the year?

Of course we would. Of course, we'd like to.

Just testing.

But we like the deal regardless of when it closes.

Anything pushing it off into early next quarter is not material financially. What we want to make sure of is that we do it correctly, and that's the most important thing.

That makes great sense. And then another question, on the mortgage banking -- a couple of questions on the P&L side. Mortgage banking income, $2.8 million. Can you characterize that? Are you guys going to get any benefit from -- mortgage ops are way up for refi it sounds like from last week and this week and a lot of people locked. Do you guys get any benefit from that?

We certainly should get some benefit from that, although the nature of the production has changed significantly to purchase activity away from refinance. But the most recent decline in mortgage rates, if it holds, will add some additional refinance volume.

I think the main thing there is we have added production capacity. Those people are gaining traction, including some of the people that came on board down in southern Oregon. And looking forward, we would expect to gain some traction when we close the Siuslaw transaction there as well. So we had, in the second half of 2012 and the first six months of 2013, we had an exceptional refinance market and exceptional volume, and that tailed off and we are now, as I characterized it, rebounding nicely in terms of production activity there.

Fourth quarter, though, chances are seasonal trends in purchase activity are going to be lower and that's going to impact the revenue generated there too.

I think that's a good characterization. That's been the pattern as long as I've been in the business.

And then that spike in service charges to $8.3 million, is that -- a big chunk of that, obviously there's some new business capture there. But also the debit card business benefit is reflected in that number as well. Is there anything one-time in nature about that debit card business revenue that manifested in the third quarter that's going to not be there in the fourth quarter?

Yes. As we noted, there was about $560,000 of adjustment to some under accrual in prior periods.

Anything else?

Beyond that, no. Beyond that, it's a matter of volume and a slightly more favorable fee arrangement on the MasterCard situation.

And then you also said there was some frontloading on the advertising and marketing expense. How much -- how big was that piece that kind of you paid forward? A couple hundred grand, or --?

It was probably more than that. We were $2.4 million -- what was it, $2.4 million or $2.5 million of advertising expense in the current quarter. And that's half of what we spent for the entire year was spent in the current quarter. Now, we were low in the first two quarters. We were very high in the current quarter. I think our expectation if you look at our last few years is about $7 million a year in advertising expense. And we are a little bit behind that this year because of some dialed-back, scaled-back effort earlier in the year that now we're going forward with. But there were some production costs for some media advertising that hit in the most recent quarter. So, I don't expect the fourth quarter to be anywhere near as high as the current quarter, but you can kind of look at what our normal run rate has been and that would be more likely the case.

Thanks Lloyd. And then a last question on the loan book. The $31 million decline in single-family mortgages this quarter, what was behind that? And was that a one-time anomaly?

This is Rick. There is an anomaly in that. We had structured a workout program of a plot that we had foreclosed some time ago with the anticipation that the endgame would be that it would be taken out in bulk and refinanced elsewhere, and that's exactly what happened.

That portfolio tends to be a little more stable, I guess. And that -- your expectation or thought is it's going to return to that kind of a situation?

Correct.

Thanks for answering my questions.

Jacque Chimera, KBW.

Hi, good morning guys. Lloyd, I'm sure you're going to be shocked, but I'm going to ask you for a little bit of clarification on the fair value market flow-through -- or the flow-through fee income.

No, I was actually hoping somebody would. So we have a group of securities as well as our issued junior subordinated debentures that we've carried on fair value for an extent -- well, for eight years or something like that now. And included in that group of securities were some trust preferred CDOs, collateralized debt obligations, structured transactions. And for the second quarter in a row, we were carrying relatively about $0.78 on the dollar. For the second quarter in a row, there were options of the underlying collateral which are resulting in us receiving $1.00 on the dollar. So that happened at the end of the second quarter and again at the end of the third quarter. Unfortunately, we don't have a lot of expectation that that's going to continue going forward. And that contributed about a $2.2 million gain in fair value for that one block of securities in the current quarter.

So as you can see then, other things move the other direction. Principally, as we've said for a long time, the junior subordinated debentures, which are marked down well below par, will continue with passage of time to go up towards par. Now, that's over still remaining 20 years roughly, and that would -- all else being equal, you would expect about a $300,000, $350,000 charge in that line. And then it depends on what happens with interest rates on the rest of it.

I know last quarter there was the change in the discount rate to 5%, so none of that happened this quarter? It was all just purely the TRUP CDOs that happened?

Yes, that's correct.

Okay. And are the remaining securities that you have in the portfolio, do those continue to be held at $0.78?

The remaining TRUP CDO does. We also have a few single issuer trust preferreds. They're carried at a value that's close to that, maybe a little bit less. They are valued exactly the way we value our junior subordinated debentures. And then there's still a residual of mortgage-backed securities and some other debt securities in there which would be much closer to par. In fact, many of them were carried at a premium because they have been on the books for a long time and interest rates are so low right now.

Okay. So, essentially that line item should be fairly steady, absent other transactions like this, which are unpredictable, and then absent the potential for the discount rate to change once again?

That's correct.

Okay. And then on the interchange income, you had mentioned that the accrual was based on prior periods. How many prior periods is that from?

From whenever we started issuing debit cards, so it had built up over an extended period of time that, in the process of implementing the MasterCard, there were some changes in procedures and we recognized that we essentially had a missing month of accrual.

Okay. So the go-forward impact of the change in the process would be de minimis.

That's correct. It should be nothing. The go-forward impact is that we will continue to issue more debit cards as we increase clients, and we will benefit marginally from the change to MasterCard in terms of the fee structure there.

Okay. Thank you. That's helpful. And then one last one. Rick, this one is for you. If I look out over the last call it may be almost two years or so, your recoveries have almost matched your net charge-offs. What kind of a pool do you have left? And I know you can't give forward guidance or anything, but I guess do you think this is sustainable over the next couple of quarters? Is it a possibility that it's sustainable?

As everyone well knows, there was a substantial pool of charge-offs that we had during the great recession, and our special assets people continue to mine those for recoveries. We've gotten obviously a lot of the lower-hanging fruit behind us, but there are still potential areas that we can get some recoveries out of.

Okay. And if I look at the gross charge-offs, how much of that is related to legacy substandard loans, and how much of it is related to just new generation within the last four years or so?

There's an element that can be traced back to legacy loans, but I think what we're seeing now is a normal charge-off pattern.

Okay, great. That's good color. Thank you very much.

Don Worthington, Raymond James.

Good morning everyone. In terms of the acquisition related costs, Lloyd, you mentioned there was I guess some sort of adjustment to the accrual that resulted in a reduction in expense in the quarter. Are there more acquisition costs that you would expect, say, over the next couple of quarters related to the pending acquisition?

Yes, absolutely related to the pending acquisition. The adjustment related to the accrued expenses relative to the branch acquisition in southern Oregon where we had overestimated some expenses and as we worked through the transaction, we were a little more efficient than we had hoped for when we close the books 90 days earlier. There will be normal, meaningful expenses related to the Siuslaw acquisition which should impact the fourth quarter as well as the first quarter of 2015.

Okay. Thank you. And then just any general commentary on the M&A outlook in the region? You know, bid ask spread changes from last quarter, and kind of what your thoughts are there on additional merger activity?

This is Mark. I Don't think it's changed substantially from the last quarter. I think there's still quite a bit of excitement around some combinations that are occurring, obviously with the one we announced, and I think you will see continued progress on some smaller acquisitions occurring over time.

Okay, thank you.

Tim Coffey, FIG Partners.

Good morning gentlemen. You guys talked a little earlier in the Q&A about the improvement in earnings asset mix, more loans, more securities, or more loans less securities rather. Now, that trend has been rather consistent for the last seven quarters or so. Do you see more ability to improve the mix going forward?

We do, to the extent that we continue to grow deposits and fund loans with those deposits. We've had a fairly stable sized securities and cash equivalent portfolio for a long period of time, but we've been growing the loan book and so on a relative basis it goes down.

At some point in time, I guess if we grew deposits excessively, we would end up with the need to invest in securities again. But right now, as Rick pointed out earlier, loan demand continues to be reasonably robust, and we are optimistic that that mix could continue to change slightly. On the other hand, we are at, as I mentioned, 95% loan to deposit ratio, which is the top end of our comfort level.

Right, right. So it seems, in a flat interest rate environment, growth in spread income then is likely to come from overall balance sheet growth. Right?

Absolutely. Absolutely. I'm not optimistic about the margin widening.

As I've noticed the last several quarters, Lloyd.

Yes, despite being wrong in the past, I'm not going to think about it.

I'm not going to hold that against you. So then if the balance sheet needs to grow, wouldn't marketing expenses obviously not next quarter but perhaps going forward start to rise?

Potentially, but I think our program has been pretty stable at the level it's been at for a number of years. And until the footprint expands dramatically, I don't know why it would go up a lot.

Okay. But you feel pretty good about kind of the pipeline for customer acquisition then.

Yes. We continue to do well in terms of client acquisition. There's no doubt about that.

All right. Those are my questions. Thank you.

This concludes our question-and-answer session. I would like to turn the conference back over to Mark Grescovich for any closing remarks.

Thank you Andrew. As I stated, we are very pleased with our strong third-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 our expanding balance sheet, strengthening our deposit franchise, improving our core operating performance, and maintaining a moderate risk profile.

I would like to thank all my colleagues who are driving this solid performance for our Company. Thank you all for your interest in Banner and for joining our call today. We look forward to reporting our results to you again in the future. Thank you everyone.

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