Banner Corp (BANR) 2015 Q3 法說會逐字稿

Good day and welcome to the Banner Corporation's third quarter 2015 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, CEO. Please go ahead.

Thank you, Carrie, and good morning everyone. I would also like to welcome you to the third quarter 2015 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 and services, forecasts of financial or other performance measures, and statements about Banner's general outlook for economic and other conditions.

We also may make other forward-looking statements in the question-and-answer period following management's discussion. These forward-looking statements are subject to a number of risks and uncertainties, and actual results may differ materially from those discussed today.

Information on the risk factors that could cause actual results to differ are available from the earnings press release that was released yesterday and our recently filed form 10-Q for the quarter ended June 30, 2015.

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, reporting a net profit available to common shareholders of $12.9 million or $0.62 per diluted share for the quarter ended September 30th, 2015.

This compared to a net profit to common shareholders of $0.64 per share for the second quarter of 2015 and $0.76 per share in the third quarter of 2014.

Results for the quarter just ended were impacted by acquisition-related expenses and a fair value adjustment, which, net of taxes, reduced net income by $0.10 per diluted share.

By comparison, the third quarter 2014 earnings included positive fair value and acquisition expense adjustment, which together, net of taxes, contributed $0.07 to net income per diluted share in that quarter.

Excluding these acquisition-related expenses and fair value adjustments, Banner's earnings from quarter operations were $0.72 per diluted share in the third quarter of 2015, compared to $0.69 per diluted share in the third quarter of 2014.

Our core operating performance for the third quarter of 2015 maintained our positive core momentum and further demonstrated that through the hard work of our employees throughout the Company, we continue to successfully execute on our strategies and priorities to deliver sustainable profitability and revenue growth to Banner, and expand our balance sheet with strong organic loan and deposit growth coupled with opportunistic acquisitions.

Our consistent and increasing year-over-year core profits show that execution on our strategic plan is effective, and we continue building shareholder value.

Our third quarter 2015 core revenue was strong at $67.4 million and increased 14% compared to the year-ago quarter.

We benefited from a larger and improved earning asset mix, a net interest margin that remained above 4%, very good deposit fee income, and strong mortgage banking revenue.

Also, our cost of deposits was 16 basis points compared to 19 basis points in the third quarter of 2014.

Overall, this resulted in a solid return on average assets of 0.97% for the quarter.

Once again, our strong performance this quarter reflects continued execution on our super community bank strategy. That is, growing new client relationships, improving our core funding position by growing core deposits, and promoting client loyalty and advocacy through our responsive service model.

To that point, our core deposits increased 17% compared to September 30th, 2014. Also, our non-interest-bearing deposits increased 20% from one year ago.

Although a large portion of this balance growth is from the addition of 10 new branches in Oregon as a result of the Siuslaw Bank acquisition, we also saw continued strong organic generation of new client relationships.

Our net client growth in these product categories is now 100% since December 31st, 2009. Further, our loan portfolio expanded 15% 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 new client relationships, deliver sustainable profitability, and prudently invest our capital, we have also focused on maintaining our improved risk profile for our Company.

Again this quarter, our credit quality metrics reflect our moderate risk profile, and our non-performing assets remained at just 0.56% of total assets at September 30th, 2015.

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 at maintaining a moderate credit risk profile while also increasing our loan portfolio.

Given our successful credit risk management, our low level of non-performing loans, and our moderate risk profile, we did not record a provision for loan losses in the quarter, despite additional loan growth.

Nonetheless, Banner's coverage of the allowance for loan losses to non-performing loans is a strong 329% at September 30th, 2015. 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 1.77%, our total capital to risk weighted assets ratio was 15.68%, and our tangible common equity ratio was 12.2%.

In the quarter and throughout the preceding five years, we continued to invest in our franchise. We have added talented commercial and retail banking personnel to our Company, and we have invested in further developing and integrating all our bankers in the Banner's-proven credit and sales culture.

While these investments have increased our core operating expenses, they have resulted in positive core revenue growth of 14%, strong customer acquisition, 15% year-over-year growth in the loan portfolio, improving cross sell ratios, and strong deposit fee income growth of 18%.

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 two consecutive years. And this year, we remained Regional Lender of the Year.

Also, Forbes magazine ranked Banner Corporation as one of the top 50 most trustworthy financial institutions in the United States.

The successful execution of our organic growth plan and our persistent focus on improving the risk profile of Banner has now resulted in 18 consecutive quarters of profitability and our tangible book value increased nearly 6% to $30.75 per share when compared to September 30th, 2014.

Finally, I'm very excited about the recently closed acquisitions of Siuslaw Bank and AmericanWest Bank. With these strategic combinations, we will have the opportunity to deploy our super community bank model throughout a strengthened presence in Washington, Oregon, and Idaho, and enter into attractive growth markets of California and Utah.

These combinations will provide significant benefits to our expanded group of clients, communities, shareholders, and employees. And I'd like to reinforce are welcome to our Siuslaw and AmericanWest Bank clients, employees, and shareholders, who joined the Banner Bank team on March 6th and October 1st, 2015, respectively.

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

Thanks, Mark. As you read in our press release and heard in Mark's comments, Banner's loan portfolio maintained its moderate risk profile during the third quarter. Consequently, my remarks this morning can again be limited to commenting on select credit metrics and touching on a few general loan portfolio highlights.

Net loan losses for the quarter were a modest $9,000. Charge-offs for the quarter totaled $1.1 million and were driven by write-downs on two commercial enterprises with different lines of business and geographies.

Recoveries primarily came from payment plans negotiated over the past several years and totaled just $1 million.

Non-performing assets increased by $500,000 during the quarter. This increase occurred because a single relationship of approximately $3 million was added to non-performing loans. This relationship was responsible for one of the loan charge-offs mentioned earlier in my remarks.

The other components of non-performing assets either improved slightly or remained stable during the quarter.

Classified loans in Banner's portfolio at quarter end were $47 million versus $54 million at June 30th, 2015. Classified loans now represent only 1.1% of total loans, down from 2% one year ago. This improvement reflects ongoing collection efforts and improved economic condition.

The allowance for loan and lease losses remains appropriate for Banner's growing loan portfolio with no provision for loan losses being made for the 11th consecutive quarter.

And it should be noted that the calculation of the reserve to total loans, 1.77%, and the coverage of non-performing loans, 329%, includes the Siuslaw loans, but not the [purchase accounting market] against those loans.

Delinquencies remain low at 0.63%, down from 0.65% for the linked quarter as a result of strong portfolio management and the vibrant Northwest economy that is strengthening the balance sheets of our clients.

Mark noted that total loans, including the Siuslaw loans, grew 15% year over year. Key year-over-year portfolio changes are summarized as follows. Commercial business loans outstanding were up 12%. Commercial commitment utilization, however, remains low, as clients continue to be reluctant to leverage their balance sheets.

Commercial real estate loans, including both investor and owner-occupied, grew by 21.2% with Siuslaw, and 11.3% without Siuslaw. This growth occurred throughout our footprint.

Excluding a modest Siuslaw portfolio, multifamily permanent loans were flat year over year and down $6 million from the linked quarter, as some owners are electing to sell projects for significant premiums.

Multifamily construction outstandings did increase $13 million or 22% during the quarter, as draw downs on existing commitments accelerated.

We continue to be selective in the multifamily projects we choose to add to the portfolio, given the volume of new construction in our markets.

Residential construction and land and land development loans grew by 17.7% or $54 million, but September 30th, 2015 balances are compared to those at September 30th, 2014. $33 million of the growth has been in the one to four family construction segment and $21 million in the land and land development categories.

This growth is focused in the Seattle and Portland markets where robust new home sales have kept standing finished inventories low and created shortages of finished building lots.

Loan turnover at all price points in our portfolio remains brisk and is indicative of balanced markets. While the rate of growth in this portfolio is significant, it still is only 8.1% of the bank's total loan portfolio.

Market dynamics are continually monitored to identify changes in demand that might occur because of interest rate increases or other market factors.

I want to close my remarks this morning by again saying we are managing our loan portfolio to maintain its moderate risk profile.

Additionally, we are now engaged in the integration of the former AmericanWest Bank loan portfolio and are pleased to date with the progress being made and the portfolio's credit metrics.

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

Thank you, Rick, and good morning everyone. As Mark has noted and as reported in our third-quarter earnings release, Banner Corporation had another good quarter as well as nine-month period ended September 30, 2015.

While completion of the purchase and integration of Siuslaw Bank was certainly a highlight of the first half of the year, our solid financial performance in the current quarter as well as the nine-months year to date continues to be highlighted [were] strong revenue growth driven by a solid net interest margin, significant earning asset growth, both organic and acquisition-related and increased non-interest income, including substantially increased deposit fees and service charges and strong mortgage banking revenues.

As I've noted before, this revenue growth follows trends that have been evident for extended periods and continues to demonstrate the successful execution of our super community bank business model and the increasing value of the Banner franchise.

Similar to previous periods, fully appreciating Banner's core operating results for the current quarter and nine months ended September 30, 2015, requires a clear understanding of the impact of the merger and acquisition-related expenses and last year's bargain purchase gain, as well as the valuation adjustments for certain financial instruments that we carry at fair value, which also flow through our income statement.

For the third quarter of 2015, Banner reported earnings available to common shareholders of $12.9 million or $0.62 per diluted share. This amount was adversely impacted by $2.2 million of acquisition-related expense, as well as net fair value charges of $1.1 million, which together, net of related tax benefits, reduced earnings for the quarter by $0.10 per diluted share.

By contrast, for the quarter ended September 30, 2014, our net income included a positive fair value adjustment of nearly $1.5 million and a recovery of previously recognized acquisition-related expenses of $494,000, which, net of taxes, added $0.07 per diluted share to reported earnings.

So as Mark noted, excluding these acquisition-related expenses and fair value adjustment, the earnings from our core operations increased to $15.1 million or $0.73 per diluted share for the current quarter, compared to $13.6 million or $0.69 per diluted share in the same quarter a year ago.

In addition to the acquisition-related expenses and fair value adjustments for the year-over-year comparison, operating earnings for the nine-month period ended September 30, it's also necessary to exclude the gains and losses on security sales in both periods and the $9.1 million bargain purchase gain in last year's reported earnings.

Excluding those items, Banner's earnings from core operations for the nine months ended September 30, 2015, increased by 19% to $43.1 million or $2.11 per share, compared to $36.3 million or $1.87 per share for the first nine months of 2014.

This increase in earnings from core operations reflects significant organic growth to the balance sheet and client base as well as last year's purchase of six branches on the southern Oregon coast and this year's acquisition of Siuslaw Bank, which included 10 additional branches in western Oregon.

Importantly, as Mark has already noted, our revenues from core operations, which is revenues excluding gains and losses on the sale of securities, net fair value adjustments and last year's bargain purchase gain, were $67.4 million in the third quarter of 2015. A modest increase compared to the immediately preceding quarter, but an increase of $8.3 million or 14% compared to the same quarter a year ago.

As a result, for the first nine months of 2015, our revenues from core operations increased by $28.6 million to $193.9 million, an increase of 17% compared to a year earlier.

The strong revenue generation for the quarter and year to date is the result of significant balance sheet growth, a remarkably solid and stable net interest margin, additional client acquisition, and increased mortgage banking activity.

Taken together, these trends clearly demonstrate that our value proposition is being well received and that the focused efforts of our employees are continuing to produce consistent earnings momentum.

Primarily as a result of growth in average balances in core deposits -- loan balances and core deposits, our net interest income increased by $5.1 million or 11% compared to the third quarter a year ago.

While we experienced a modest and expected decline in our net interest margin compared to the elevated level of the immediately preceding quarter, for both the quarter and nine months ended September 30, 2015, our net interest margin was 4.14% compared to 4.07% for both at the same periods a year earlier.

Further, as Rick has noted, again this quarter we did not identify a need to reduce net interest income with a provision for loan losses as all of our credit indicators remain strong.

Deposit fees and service charges were $9.7 million in the third quarter, a 2% increase compared to the second quarter of 2015, and an increase of 18% compared to the third quarter a year ago.

For the first nine months of 2015, deposit fees and service charges increased by 23%. Similar to recent quarters, the significant increase in these fees and service charges compared to a year earlier, is a direct result of growth in core deposit accounts and related transaction activity reflecting the success of our client acquisition strategies as well as the branch purchase in June of last year and more recent merger with Siuslaw Bank in March of this year.

As reported in the earnings release, our mortgage banking revenues were again strong, contributing $4.4 million in 2015 third quarter revenues, compared to $4.7 million in the preceding quarter and $2.8 million in the third quarter a year ago.

For the first nine months of 2015, our mortgage banking revenues were $13.2 million, an 82% increase compared to the first nine months of 2014.

While this increased mortgage banking revenue certainly reflects continually low mortgage rates which have supported strong home purchase activity in our markets, as well as ongoing refinance activity, it also reflects incremental production as a result of our continued investment in this line of business. Importantly, home purchase activity accounted for 71% of our third-quarter mortgage loan originations.

Total other operating expenses were $46.7 million in the third quarter compared to $47.7 million in the preceding quarter and $38.5 million in the third quarter of 2014.

Acquisition-related expenses were $2.2 million in the current quarter compared to $3.9 million in the preceding quarter. And by contrast, a $494,000 expense recovery in the third quarter a year ago.

For the first nine months of 2015, total other operating expenses were $136.3 million compared to $112.5 million in the same nine-month period of 2014.

Year-to-date acquisition-related expenses were $7.7 million in 2015, compared to $1.5 million a year ago. Aside from these acquisition-related expenses, the year-over-year increase in operating expenses is largely attributable to incremental costs associated with operating the 16 branches acquired in June of 2014 and March of 2015.

In addition, the current year's expenses reflect our compensation costs, including generally higher salaries and benefits, as well as increased costs associated with our expanded mortgage banking operations and increased payment and card processing expenses driven by greater activity volumes.

Finally, with respect to the income statement, our effective tax rate increased slightly to 33.9% in the third quarter, as our expenses included a greater portion of non-deductible acquisition-related expenses than previous periods. For the first nine months of 2015, our effective tax rate was 33.6%.

Of course, compared to a year ago, the current quarter-in statement of conditions has been significantly impacted by the Siuslaw acquisition. In particular, Siuslaw Bank contributed $236 million to our consolidated loan totals and $336 million to total deposits as of September 30, 2015.

We also recorded approximately $21 million of goodwill as a result of the purchase and increased paid-in capital by just over $58 million, to reflect the value of the Banner shares issued to the former Siuslaw shareholders.

As I noted last quarter, aside from these balance sheet changes, we're pleased to report that we have very successfully converted all of the data processing and operating systems in the former Siuslaw Bank branches, and employees are now all proudly and effectively serving their clients under the Banner flag.

Aided by expected seasonal factors, our loan growth was strong in the third quarter. Total loans increased by $126 million or 3% during the quarter and, as a result of strong organic growth as well as the Siuslaw acquisition, ended the quarter up by nearly $566 million or 15% compared to a year ago.

Loan growth during the quarter was broad-based and included meaningful increases in commercial real estate, agricultural business, construction and development, and consumer loans.

Also reflecting expected seasonal factors, deposit totals increased 2% during the quarter and, as a result, total deposits have increased 10% compared to a year earlier.

More importantly, the year-over-year growth in total deposits continues to reflect significant growth in core deposits which increased by 16% and non-interest-bearing deposits which increased by 20% compared to a year earlier.

As a result, core deposits increased to 83% of total deposits at September 30th, 2015. As we have frequently noted, these core deposits provide a stable funding base and represent the foundational account for relationship banking, which is the basis of Banner's super community bank model.

This concludes my prepared remarks to the third quarter financial statements and operating results.

In summary, I will reiterate that we had another good quarter, that the first nine months of 2015 reflect strong revenue growth and solid earnings momentum that position Banner Corporation well for further success in future periods.

Finally, as previously announced, on October 1st, we did complete the acquisition of AmericanWest Bank, which, of course, means next quarter we will be discussing much different Banner Corporation financial statements, with approximately $7 billion in loans, $8 billion in deposits, $9.9 billion dollars in total assets, and substantially increased revenues.

I look forward to that future discussion and, as always, I look forward to your questions today. Mark?

Thank you, Rick and thank you, Lloyd, for your comments. That concludes our prepared remarks. And Carrie will now open the call and welcome your questions.

We will now begin the question-and-answer session. (operator Instructions) At this time, we will pause momentarily to assemble our roster. Paul Miller of FBR Capital.

This is Jessica Ribner in for Paul. I just have a quick one on rates. We've heard a lot of banks who are kind of repositioning their balance sheets and rethinking about their loan portfolios, given what looks like will be lower rates for longer. How are you thinking about that?

Jessica, hi. This is Lloyd. As we've noted a number of times, our balance sheet is sort of naturally positioned to do slightly better in a rising rate environment, but not materially. It's a very balanced book. And that allows us to do things like add fixed rate loans to our portfolio on a regular basis, particularly as we continue to grow the non-interest-bearing and core deposit portion of the funding source.

So we're not quite smart enough to know exactly when and how much rates are going to go up. We're fairly convinced at some point they will. And so we're not going to dramatically change the composition of the balance sheet based on the forecast.

What we will continue to do is add to the loan portfolio in general proportion to what it looks like today, and that positions us to perform fairly well regardless of which direction interest rates go.

And, Jessica, this is Mark. Just to add onto that, we'll also continue to be aggressive in our client acquisitions to grow core deposits and non-interest-bearing deposits.

And it looks like you've been obviously very successful in that.

In terms of your net interest margin, kind of a follow-on to that, do you see much downside? Or should we see relative stability since you've already become or you're already fairly comfortable with balance sheet and fixed rate loans and the like?

So, Jessica, this is Lloyd again. You're fairly new to following Banner, I realize. If you'd been with us for a while, you'd know that I'm always nervous in the current rate environment the margin will be under pressure.

Obviously, it contracted some in the current quarter, principally because it had been elevated in the previous quarter by some unexpected collection of interest.

If we stay in an extended period of time of low interest rates, there will continue to be pressure on asset yields. You saw in the quarter we had a pretty meaningful drop in yields on our loans.

Right.

We've been very successful in maintaining that margin in a very stable, well above 4% level for a period of time, principally by some very well-disciplined pricing action on the part of some of our lenders, but, more importantly, by changing the mix of assets and liabilities, as Mark pointed out, aggressively growing core deposits, and also keeping the loan-to-deposit ratio very high.

So that's allowed us, through managing the mix, to stabilize that margin at a level that we feel good about. But low interest rates are always going to be a challenge.

All right, great. Thank you so much.

Jeff Rulis of D.A. Davidson.

Has any determination been made for potential restructuring of the balance sheet and/or branch consolidation with regards to the AmericanWest franchise?

Good morning, Jeff. It's Lloyd. As you'll recall, we noted when we announced the acquisition that we would carefully manage the balance sheet to stay below $10 billion at the end of this year. And it would be some opportunity to do that principally by managing down a few wholesale liabilities and securities positions in the AmericanWest portfolio.

We did, as we did announce, and as I mentioned, we're at $9.9 billion at closing. So we need to get comfortably below that $10 billion. So there will be some of that balance sheet activity going on.

With respect to the branches, we have about 11 locations that we have identified where there's overlap and there will be some consolidation. But of course, we won't be affecting that consolidation until we complete integration in data processing conversion, which is currently scheduled for February of next year.

Great. And, Lloyd, could you remind us on the determination of the, actually the $10 billion mark, that's, I guess you're judged, for lack of a better word, is it mid-calendar year that that's -- and then it wouldn't -- you're not deemed a $10 billion franchise until -- or subjected to the Durbin Amendment until the following year?

Actually, the Durbin Amendment is measured based on December 31 end-of-period balances. And so 12/31 of this year is a critical date for us to stay under the $10 billion mark, which would postpone -- the Durbin impact on fees will take effect six months after whatever December 31 year you cross that.

And Durbin, by the way, is based on the holding company totals not the bank.

There are other implications to crossing $10 billion. Principally, additional regulatory scrutiny and expense that have various measurement points generally based on a rolling four-quarter average of assets.

So, and in the timing on those, the implications of that take effect in subsequent periods depending on which issue we're talking about, most importantly the DFAS testing.

Our expectation is, however, that we will incur incremental costs in preparation of crossing that level as we, I mean, our belief is the regulators will expect in our plan is to adopt more of that DFAS-type testing capital planning as well as some of the consumer protection implications of that $10 billion asset [site].

But most importantly, we do intend to stay under $10 billion at the end of this year and postpone that Durbin hit at least into 2017.

Thanks, Lloyd. And maybe one quick last one on the -- I'm just trying to get the mortgage banking run rate.

When you roll in the AmericanWest, I guess either conceptually, what are you anticipating as you add that revenue stream to your current projections on mortgage banking?

Well, I don't have a real hard number for you. Obviously, there are some additional markets that open up. They have some mortgage production people that are joining the team.

And so what I will tell you is we expect it to be more than it has been. But I can't scale it very well for you yet, yes.

But in terms of the management of their mortgage banking group and the momentum there, it, I guess broadly speaking, is that a growing or flat business for them?

Well, I think for them, it was flat for them. We're fairly hopeful that with our management and product depth and the abilities that there'll be some increase in their run rate of production, which means, obviously, it will be additive to ours.

Now, mortgage business, we all know mortgage business has some sensitivity to interest rates. And so the good news, as I pointed out, is that we're focused on purchase activity and at 71% of current production we're far less dependent on refinancing than might have been the case couple years ago.

Thanks, Lloyd.

Russell Gunther of Macquarie.

The first question, I noticed in the release you mentioned this significant potential for growth based on where pipelines were at the end of the quarter.

I was just wondering if you could update us sort of sequentially where the pipeline stands this quarter versus last. And then maybe how the mix is shaping up for legacy business.

Russell, this is Rick Barton. I think in the last couple of calls, we've indicated that the pipeline year over year is up about 15% for legacy Banner. And that number is holding steady through the end of the third quarter. I think it's a balanced mix.

There's a good strong pipeline on the real estate side of the house and the commercial pipelines are holding up quite well. And as I mentioned just a couple of seconds ago, are up about 15% year over year.

Okay, great. That's helpful. And then I heard you guys loud and clear in terms of measured growth. Just wondering if you could give us a sense, legacy Banner loan growth has been really solid last couple of quarters, understandably managing below that $10 billion line [next] quarter.

But as we layer on AmericanWest, could you give us a sense for what that pro forma loan growth opportunity looks like, particularly in consideration of some new markets? But again understanding your balanced risk-adjusted approach.

Russell, this is Mark. Our posture has not changed. I think we gave -- you asked a similar question last quarter. And we're holding our position about the same, which is on a combined basis we would estimate high single-digit growth in the loan portfolio.

Okay, great. I appreciate the --

And we've obviously outperformed that. I mean that's what we projected.

Yes, understood. Thank you. And then I guess just trying to tie all that together, right, the high single-digit growth, obviously credit quality remains pristine, recoveries continue, and then, as you mentioned, we'll get a pro forma balance sheet next quarter.

How should we think about reserve levels going forward? Maybe if you could give us a sense for where you're providing for new loans and then thoughts on continued recoveries. Just some forward guide there would be helpful.

Well, I'll try to take a stab at that. I'll take on the recovery aspect of it first, Russell.

That's really very hard to predict because it's dependent on some factors that are outside of our control. With the volume of charge-offs that we've had during the recession, it's realistic to expect there to be some continuing recoveries. But I don't see any kind of outsized recoveries coming down the road, if that will be helpful to you.

In terms of the reserve, it's obviously going to change in terms of what the numbers look like once the AmericanWest portfolio is added in during the fourth quarter. I don't have an exact number, but it will be a lot closer to 1% than we are right now.

Once we take into account the purchase accounting mark, which is still under consideration, I would expect that the combination of the reserve plus the purchase accounting mark to be somewhere between, pick a range of 160 to 180, in that range.

And over the long run, I think we obviously don't give guidance on reserving or anything like that, but that we are comfortable in that range or slightly less than that.

That's very helpful. I appreciate the color there. And then just my last question as a follow-up, and I just may have missed it. But as it relates to the timing of Durbin, is the revenue impact a 2016 or 2017 event?

Russell, this is Lloyd. Assuming that we cross that $10 billion line at December 31 of 2016, the revenue impact will begin in the third quarter of 2017.

Okay, great.

There's a six-month lag.

Got it. And then with regard to the expenses, you mentioned reg expense and DFAS and building sort of ahead of that. Do we see some of that incremental spend in the back half of 2016?

Yes, even into first half of 2016, I think you'll see that we'll start moving in that direction.

We plan to be well ahead of the curve here in terms of preparation for dealing with the regulatory issues around being a larger institution.

All right, guys. Thank you so much for taking my questions.

Don Worthington of Raymond James.

Just a little more color on the construction Lending, particularly kind of the one to four residential construction that you're doing. It sounds like the location is Seattle, Portland. But just curious about the types of projects you're financing.

Don, this is Rick Barton again. It's primarily one to four family detached, again centered in the Seattle market and the Portland market.

There is some attached housing in that that is fee simple attached housing. There's really no condominium component to it.

Okay, great. Thank you. And then, in terms of additional merger costs, ballpark number for the fourth quarter?

I was hoping somebody was going to ask that question, Don.

So if you'll recall, when we announced the transaction, we thought there'd be about $50 million of merger-related expenses. We also indicated that some of that would be on the books of AmericanWest and some of it would be on the books of Banner.

I will tell you that it turns out the accounting literature and guidance is going to put more of it on the books of Banner than I originally anticipated.

So what does that mean? It looks to us right now that there'll be somewhere in the neighborhood of $20 million to $25 million of merger-related expenses in the fourth quarter and then another $10 million to $15 million in the first quarter of the following year, which would be principally related to the data processing conversion and the closure of some offices and the like.

So there's quite a bit to come, and they're big numbers. I guess I don't have anything else to say other than they're big numbers.

Okay, great. Thanks, Lloyd.

Tim O'Brien of Sandler O'Neill.

Just a little cleanup kind of. Is there any chance that you guys -- are there any potentials for non-mortgage loan sales here, post-deal close?

Non-mortgage loan sales? As part of our balance sheet management, is that what you're getting at?

Yes, maybe part of that or maybe there are some loan types that didn't get reconciled at AmericanWest while it was independent that you guys might look to clear out.

This is Mark, Tim. I don't think you're going to see anything material that would be non-mortgage-related.

Okay.

There is certainly some real estate out there that has mortgages on it that we could consider offloading. But nothing outside of that category, there's nothing material.

And then one other question for you guys. Can you compare and contrast the construction lending business at AmericanWest versus your own? I know that it's smaller obviously. But what kind of construction deals do they have on the books? And how do you like those businesses? And what's the opportunity there for either scaling those or bringing talent or expertise over that you guys can ramp up in your traditional historic footprint?

Tim, this is Rick Barton. In looking at the AmericanWest portfolio, their construction lending overall is less than 1% of their portfolio. They have a little bit of residential construction of land and a little bit of commercial construction, and much of that is centered in owner-occupied.

So really, it's going to be a very easy thing to pull that into our operation. They have a little bit of talent in that area, but it's just simply not been a focus of theirs. So it's not really a big factor in the integration of the portfolios.

What it does speak to, Tim, is the opportunity to take our construction expertise and translate it into some higher growth markets.

Great. Thanks for answering my questions.

Jacque Chimera from KBW.

Lloyd, I'm sure you're expecting this question from me. The fair value mark in the quarter, was there any change to model assumptions or any sales of anything in the quarter associated with that?

There were no changes to the model assumptions. There was a unique transaction that we had the opportunity to repurchase a trust preferred security out of one of the CEOs that was liquidating collateral, where we were the issuer.

And it's fairly complex. But the essence of it is we bought the security at a deep discount, but we marked it down a little bit further to market consistently with the way that we're marking some of our other assets that are similar in nature, as well as the liabilities that we have.

The economics of the transaction were very positive in terms of essentially a riskless transaction that we're purchasing your own debt. But because of the structure, we couldn't just collapse the debt and it did have an impact on the fair value adjustment.

So, and then, if you'll recall, the two preceding quarters we had positive fair value adjustments principally as a result of some securities that we had marked down substantially that ended up paying off in full at par.

So it did create a fairly significant slide from quarter to quarter, that one unique transaction.

So then the mark was basically related to this, and, excluding anything else of this nature, it would go back to its normalized level in future quarters. Is that a good assumption?

Yes, that's a good assumption. You'll recall that normally what I've said all along is that because we have the fair value mark against our junior subordinated debentures that, all else being equal, there'll be about a $300,000 to $400,000 charge each quarter as those march towards maturity.

Obviously, there are other parts of the portfolio that it can be affected by interest rates and the like, although the number of securities that we have that are carried at fair value is fairly modest.

Okay. And this event in the quarter, does it create the potential for a positive event in the future?

No, I don't think it creates --

No. Okay.

-- the potential for a positive. I mean, let me be perfectly honest with you, potential event that's out there would be if spreads were deemed to be materially tighter, we might take a fairly good size charge against marching our subordinated debt back up. I think the important thing to remember though, is that these are just accounting.

Yes.

They're not real economics. They're just accounting entries based on some valuation decisions that were made a long time ago.

Okay. Thank you. That's really good color.

Was there anything unusual in the payment and card processing line item this quarter? I know this --

Not really -- not unusual, just a reflection of continued growth in that activity. So we'll call it that's one expense that if that expense goes up, the reason is is revenue has gone up as well.

Okay. So that's a fairly good -- assuming that revenue continues to be where it's at, that's a good run rate then going forward?

Yes, I think so. There's a little bit of lumpiness in there, but not much.

Okay. And can I get just a reminder. I have in my notes that the impact of interchange would be round $8 million.

Was that legacy Banner or is that combined Banner/AmericanWest? Or do I have that number completely off altogether?

Now, that is what we discussed. Although as we continue to grow, that is a combined number for AmericanWest and Banner. As we continue to grow, looking forward, the impact might be a little bit more. By the time we get around to 2017, you actually see that. So we're currently thinking it could be $9 million to $10 million instead of $8 million.

Okay. And the $9.9 million that you discussed in terms of the combined franchise [effect] before any work on borrowings or anything of that nature, right?

That's right. That's as of October 1st closing.

Okay.

And so as I mentioned, we are going to want to be comfortably below the $10 billion at 12/31. It's not unusual for us to see $50 million to $100 million swings in deposit totals anymore. And so we need to make sure that -- clients have a propensity to do some window dressing at the end of the year. So we're going to want to be comfortably below that, that $10 billion level.

Okay, understood. And then just one last one. So the timing on the cost savings, given the October 1st close date, if you could just update us on when you think you can have those, the cost saves enacted, and if that $37.5 million is still kind of the level that you're thinking?

It's still in line with our thought process. But that'll be a run rate that we won't achieve until late in 2016, in terms of being awarded there.

So we will begin to effect cost savings and already have, effective with this current quarter. But having said that, as I mentioned earlier, there's going to be much of the merger and acquisition-related expense, it'll be in this quarter to next quarter as well, because, again, it was an October 1st closing.

So things that are triggered by the closing of the transaction will start flowing through.

But the biggest cost savings advantage, of course, comes after we're able to convert systems and consolidate locations. And as I noted, that main conversion is scheduled for February of next year.

So we'll probably see the majority of cost savings in 2Q then? Is that a good assumption?

I'd probably say 2Q or 3Q.

2Q or 3Q, okay. All right. Thank you very much.

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

Thanks, Carrie. As I stated, we are pleased with our solid third-quarter performance and see it as evidence that we're making substantial and sustainable progress.

Our disciplined strategic plan develops shareholder value by executing on our super community bank model, by growing market share, strengthening our deposit franchise, improving our core operating performance, maintaining a moderate risk profile, and prudently deploying excess capital.

I'd like to thank all my colleagues who are driving this solid performance for our Company.

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.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect your lines. Have a great day.