Columbia Banking System Inc (COLB) 2006 Q4 法說會逐字稿

Welcome to the Columbia Banking System fourth quarter and year 2006 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given at the that time. [OPERATOR INSTRUCTIONS] As a reminder, this conference is being recorded.

I would now like to turn the call over to your host, Melanie Dressel, President and Chief Executive Officer of Columbia Banking System.

Thank you, Arneka. And good afternoon, everyone, thanks for being with us today. I'm going to assume that you have all seen our earnings, which were released this morning and which are available on our website. Today we going to briefly review our 2006 performance. We will talk a bit about economic factors driving growth in our markets and we're going to discuss our strategies going forward to expand our franchise and build shareholder value.

Joining me on the call today are Gary Schminkey, our Chief Financial Officer; Mark Nelson, our Chief Banking Officer; Andy McDonald, our Chief Credit Officer. After our discussion, we will give you a chance to ask us questions.

Before we begin today, I need to remind you that we will be making some forward-looking statements, which are subject to economic and other factors. For a full discussion of the risks and uncertainties associated with the forward-looking statements, please refer to our our securities filings, and in particular, our Form10-K filed with the SEC for the year 2005.

2006 was a year in which we saw solid loan growth, increased interest income and effective management of expenses. We had good growth in our loans, particularly in the the commercial business loans which, were up over 9% year-over-year and up $53 million from the third quarter of 2006. We have continued our focus on managing our balance sheet composition to minimize both interest rate risks and economic risk.

Our deposit growth was relatively flat in 2006, but we're very pleased with our ability to maintain a strong and stable core deposit base of over 73% total deposits. Of course, this has helped us manage the expected pressure on our net interest margin, as costs for deposits caught up with rising interest rates. Our net interest margin averaged 4.49% for the year, just up from an average of 4.44% for the year 2005.

As always, we focus on our core value of deepening and strengthening customer relationships by providing the best possible service. And this focus will help us meet the intense competition coming from other financial institutions, the equity markets and of course, the trend of businesses using their own cash first before borrowing.

Our revenue grew 6% in 2006, to $122 million, from $116 million in 2005, with an 8% increase in net interest income. Non-interest income was relatively flat for the year, $24.7 million in 2006, as compared to $24.8 million in 2005. This is primarily due to decreased mortgage banking income, as well as merchant services fees. The growth volume for merchant card services actually increased last year, however, the increased income due to volume was offset by net fees paid to the card associations. We also saw some reduction in correspondent banking merchant card revenue because of consolidation.

I would like to mention our stock performance over the last year. At the end of 2006, Columbia's stock price closed at $35.12, an increase of 21% from the year end 2005, when our stock closed at $29.14 per share.

During the first half of 2006, we successfully completed the conversion of Columbia Bank's operating system. The implementation of our new system, while requiring time and resources, as we diligently work to have a smooth transition for our customers, has positioned us for the future. It's given us significantly more flexibility in developing and implementing new products and services for our customers. Now, we have already seen a significant drop in our data processing expenses.

During the fourth quarter, we allocated $950,000 to our provision for loan losses, compared to $15,000 for the same period in 2005. In addition to loan growth, we had charge-offs of $1.7 million during the quarter, primarily centered in one loan we referred to as a legacy credit that originated in December of 1999 for $7.4 million, and was classified as non-performing in November of 2003. We felt it was prudent to recognize a write-down on the remaining balance of this loan as additional collateral became impaired and reduced the book value of the loan to $1.1 million from $2.6 million during the quarter. We'll talk about this credit a little bit more later in this conference call.

The balance of our loan portfolio has continued to perform very well, with our non-performing loans at their lowest level in seven years. We believe we stand in good stead compared with other banks because of our diversified loan portfolio. Over 36% of our portfolio is composed of commercial business loans and leases, with just over 43% in real estate, 23% in real estate construction, and almost 9% in consumer loans.

Our earnings for the year were $32.1 million, an increase of 8% from 2005. And diluted earnings per share for 2006 were $1.99, an increase of 6% from $1.87 in 2005. Return on average assets was 1.3% for 2006 as compared to 1.29% for 2005. And our return on average equity for the year was 13.5%, compared to 13.81% for the year 2005.

At this point, I would like to spend a little time talking about the regional economy in the Pacific Northwest. Now though we saw moderation in economic expansion in 2006, the Pacific Northwest economic continued to show good growth across the board. I will begin with Pierce County. It's our largest market and accounts for two-thirds of our deposit base and contributes significantly to our growth.

The Tacoma/Pierce County Chamber of Commerce recently released their annual forecast and review of 2006, based on the Pierce County economic index, which is a broad measure of real economic activity. They are forecasting that after two years of very strong growth, the local economy will register more moderate but still very solid economic gains in the Pierce County economy, along with improving conditions in neighboring counties. Dr. Bruce Mann, a Professor of Economics at the University of Puget Sound, believes it's a healthy moderation since the county experienced a two-year run well above what could be sustained, with 10% expansion during both 2004 and 2005.

Strong labor market conditions late in 2005, continued into last year and a steady balance in the labor market is predicted with the rate of job creation in the 2% range for this year. A good solid performance is anticipated for retail sales in 2007, along with a rise in per capita income, averaging a very healthy 4.4% annual rate of growth. The full report is available at www.tacomachamber.org, if you are interested in more information.

While the housing and the real estate sectors slowed down a bit at the end of 2006, Dr. Mann believes activity will expand later in 2007. Pierce County housing prices are still very attractive in relation to the Seattle/King County area, where housing is 30 -- excuse me, 30% more costly. The Port of Tacoma continues to see growing volumes and was recently named the most efficient port on the West Coast. Over the past five years, the Port's continued traffic has grown 59%, and there are expectations for 50% growth in container volumes by the year 2010. There are a number of major public construction projects underway in the South Sound region, as well as -- such as the Tacoma Narrows Bridge project and the continued rejuvenation of the downtown core.

The economic forecast is even more favorable for King County, which is a very large, affluent market, and it is expected to outperform the nation for several years. We have eight branches throughout King County, accounting for about 18% of our deposits. However, with only 1% of the market share currently, we just see a lot of opportunity for expansion.

According to the Puget Sound Economic Forecaster, the near term outlook for the Puget Sound economy is very healthy. They are predicting 2.9% and 2.7% employment growth in 2007 and 2008. That's roughly twice the expected U.S. growth rate. Software employment is expected to grow through 2009, and the aerospace industry continues to add jobs. The ramp-up of Boeing's airplane production and the growing backlog of deliveries is one of the factors driving growth in the region.

It's been over two years, now, since we acquired the Bank of Astoria in the fourth quarter of 2004. And this acquisition has been accretive to both 2005 and 2006 earnings. The Bank of Astoria is on the north coast of Oregon, less than a two hour drive from Portland and a very popular market for second homes. The Bank of Astoria has maintained its number one ranking in its share of the deposit market in Clatsop County. The outlook for northwest Oregon also looks good, as non-farm employment continued to grow and unemployment rates decreased in 2006.

At this point, I'm going to ask Gary Schminkey, our Executive Vice President and Chief Financial Officer, to review some additional financial highlights.

Thank you, Melanie. As Melanie mentioned, 2006 was a decent year for us. We had good growth in loans, particularly during the second half of the year, and saw our net interest margin exhibit some stability during the fourth quarter. We remained our -- we maintained our strong percentage of core deposits to total deposits by deepening relationships with our customers. Our efficiencies improved and credit quality remained strong.

At this point, I will talk a little bit about the fourth quarter of 2006. Earnings for the quarter were $8.3 million, compared to $8.6 million for fourth quarter 2005. On a diluted per share basis, net income for the quarter was $0.52, a decline from $0.54 in 2005.

The net interest margin was 4.43% in the fourth quarter of 2006. While this was a decrease from 4.61% for the same quarter last year, it was a two basis point rise from 4.41% from the third quarter of 2006. The pressure on our net interest margin is due to increased competition for loans, slower core deposit growth, and an increasing reliance on higher cost deposits and borrowings to fund loan growth. For 2007, we will continue to emphasize core deposit growth, while allowing the cash flows from our investment portfolio to pay down borrowings.

From an interest rate risk perspective, we believe the Company to be well-positioned if interest rates rise or if interest rates fall over a one to two year period. Our efficiency ratio for the fourth quarter improved to 57.4%, from 58.46% for the same period last year. Return on average equity for the fourth quarter was 13.28%, compared to 15.23% for the same period in 2005. Return on average assets for the quarter was 1.31%, compared to 1.47% for the fourth quarter last year.

Revenue, which we define as net interest income plus non-interest income, was $31.1 million for the quarter, up 2% from $30.4 million one year ago. As Melanie mentioned earlier, the decrease in earnings for the fourth quarter was primarily due to the increased provision for loan losses of $950,000, compared to $15,000 for the same period last year.

In addition to loan growth, we saw an increase in charge-offs during the quarter, primarily centered in one credit, which was originated in December of 1999 for $7.4 million, and was classified as non-performing in November of 2003. The current book value for this loan has been reduced to $1.1 million. We believe the balance to be collectible, based on the remaining collateral that secures the loan. Although some recovery is possible, we felt a prudent action was to take the write-down.

As Melanie mentioned earlier, the balance of our loan portfolio continues to perform extremely well. Overall credit quality improved this year, with non-performing assets dropping by 29% to $3.5 million, or 0.2% of total loans, at the end of December of 2006, compared to $4.9 million, or 0.31% of total loans, at the end of 2005.

Non-interest expense for 2006 increased 5% to $76 million, from $73 million in 2005. Some of this increase is due to compensation and employee benefits, as we added two new lending teams based in King County, including a four-person commercial team in Bellevue and an experienced builder banking team. We also increased our investment in advertising and promotion. Our television advertising has helped us build name recognition and generate visibility in our market area. We were pleased that our investment in our core processing system resulted in significantly lower data processing expenses, allowing us to control overall expenses.

Total loans were $1.71 billion at year end, a 9% increase from December 31st, 2005. The loan portfolio remains about 40% commercial real estate loans, excluding construction, and 36% commercial business loans. This diversity in our loan portfolio positions us well to evaluate all new loans on their individual merits without constraints that excessive concentrations in any given section of the portfolio would create.

Overall, Columbia continues to have a strong and diversified balance sheet, excellent sources of liquidity for future growth and a strong capital position. In fact, our average loan to deposit ratio is just 83%. So we have yet to tap into many existing sources of liquidity.

And now I turn the conference call back over to Melanie.

Well, having completed our 13th year of operation, we are pleased with our progress in strengthening our balance sheet and expanding our profitability. Over the past five years assets have grown at a compounded annual growth rate of 11.25%, equity at 16.23%, and net income at 20.7%.

We believe we are well-positioned for success in 2007. The upcoming year will undoubtedly provide its share of challenges, with increased competition for both loans and deposits, but we anticipate -- and then, of course, we anticipate a continuing flat yield curve with a potential for pressure on our net interest margin. We'll need to deepen and strengthen our relationships with our customers.

We recently hired a four-person commercial team in Bellevue, as Gary mentioned, an experienced builder banking system based in King County. And we call these teams Columbia bankers rather than lenders, as deposit gathering is as important as generating loans and we will continue to be a strong -- it will continue to be a strong focus for this year. However, I believe our team of professionals at both Columbia Bank and Bank of Astoria are up to the task. And we'll continue to make a difference for our customers and our communities.

I'm very proud of the fact that last November, Columbia Bank received the 2006 Outstanding Philanthropic Corporation Award from the Association of Fundraising Professionals. This award not only reflects a strong commitment to their community by our Columbia bankers, but also demonstrates our staff's dedication to their customers, translating into value for the shareholders.

Our plans for 2007 and beyond are to expand our geographic footprint as we position ourselves as a Pacific Northwest regional community bank. We have several branches in the pipeline, and I'm optimistic that we will open two new branches this year. We are actively negotiating on locations now, and have eager and experienced bankers looking forward to developing these new markets for us.

We will also remain focused on growth and earnings, and increasing market share in every area we serve. We have several initiatives in place to meet the challenge of growing deposits and deepening our relationships towards our customers. For example, we have several marketing promotions being launched and we will begin offering our remote deposit product in April of this year. Just as important, we will stay true to our core values, remaining grounded in long-term decision making that will benefit our employees, our customers and our shareholders.

We look forward to our annual meeting, which will be held at 1:00 on Wednesday, April 25th, at the Greater Tacoma Convention and Trade Center. And we invite any of you who are available to attend.

Now, we'll open it up for questions. And I will just remind you that Mark Nelson, our Chief Banking Officer, Andy McDonald, our Chief Credit Officer, are with Gary and I here to answer your questions. Thank you.

[OPERATOR INSTRUCTIONS] The first question comes from Matthew Clark with KBW.

Good afternoon.

Hi, Matt.

Just a few questions on the margin. Unusual that we see a margin that's up, at least this quarter. Was there anything in there that was unusual that helped prop that up, whether it be prepayment fees or -- that you could quantify for us?

No, actually there was nothing unusual in the margin calculation at all. We did have some -- we did have good growth in loans in the fourth quarter, and we were able to hold core deposit costs fairly level for the quarter.

Okay. Great. And then, I guess with the lower lender deposit ratio and the competition out there, do you find that you have some -- the ability to kind of restrain from pricing up?

And the follow-on, I guess, it sounds as though the pricing competition has picked up in January. I wondered if you could confirm that?

Mark, would you like to answer that?

We have a very disciplined approach towards our pricing. We meet regularly to talk about that. As we have a balanced approach on the loan side of our pricing, and that's been a big factor in helping us. But the competition is heavy out there. There are new banks in our market place. Some of the exiting banks are more squeezed on the loan to deposit ratios. We see them being more aggressive. We're going to continue to focus on the kind of things that we have been successful on in the past and grow our core deposits to keep our margins strong. And we are coming out of '07 with the same kinds of emphasis that we've had in the past that has made us successful.

Okay. Great. And then on the merchant service fees, is there any -- is there an expectation that that fee line can actually grow in '07?

Mark?

Yes. Our strategy there is to really continue to offer this to the correspondent banks that we deal with. We have a lot of contacts. Our people continually are out making calls on new community banks joining the market place. And I think if we have an opportunity to do it, it will certainly be focused on building our correspondent bank relationships.

Okay.

This is Andy. I think it's also important to point out that the merchant card business also brings some really nice deposits for us, as those monies are moved through the bank.

Okay. Great. And then lastly, your tangible equity is getting up to, 8.7 now, or so. I guess what are you hearing out there? Has deal chatter picked up at all? And maybe you could just update us on your -- your basis for doing deals.

Well, I think that the regulatory environment, clearly, is causing more banks to begin thinking about whether or not they are having a good time. And that could create some real opportunities. I'm talking about some of the smaller bank boards where it's very expensive to continue to comply with the increased regulations and perhaps also looking for a liquidity event. And we continually talk with other banks that we feel would fill our needs, in terms of acquisition requirements. And they are -- to expand our geographic footprint, we want them to be accretive in the first full year of operation. And just as importantly, we want them to be culturally compatible to our style of banking. And there is probably more deal chatter out there, but it's a little unclear how much of it is directly related to the banks themselves versus all of us just wondering what the other people are thinking.

Understood. Thanks.

Thank you, Matt.

Your next question comes from Jeff Rulis with DA Davidson.

Hi, Jeff.

Hi. Melanie, I don't know if I caught this in sort of the -- you talked about the new branches. Is there a timeframe or a region you'd look to add those?

Well, the core Pierce County area is fairly well built-out; although there are a few areas still in Pierce County that we would consider and look at and areas that we want to fill in. But our concentration is really in the King County marketplace, filling in from our Kent branch, for instance, to our downtown Seattle and Bellevue and Redmond offices. So that's really where we're looking the hardest. And Mark has done a great job of identifying spots for negotiating on a few locations. We are kind of picky about the spots that we want to go into. We have certain criteria that we want, but we also feel that a couple of branches a year is really where we want to be. We were disappointed this year that we weren't able to get Lacey open, and that's just strictly working through the permitting process. And it looks like things are moving along now on Lacey.

Okay. And somewhat of a related question, as I sort of look at expenses for '07, if you are going to add a couple of branches, and then say, you've got some savings from your core processor -- how -- I guess, how would you shape '07 expenses versus this past year?

As far as the run rate is -- what you are talking about?

Sure.

I think -- well, we grew roughly 5% on our expenses in '06. And we did add some teams of bankers, which -- I guess those teams that we've added could approximate two branches, I would imagine, in terms of the number of people that were added. So really the only addition to that would be the branch physical location itself. Which relatively speaking, is fairly small. So I guess my response would be that '06 and '07 would be very similar.

And separately, the tax rates sort of hopped around the last couple of quarters, Gary. Do you have something we should assume, going forward?

It does hop around a little bit. We did do small investment portfolio restructure in the fourth quarter, where we did add some [unis] to the portfolio to position ourselves a little bit better going forward. So I think -- but as far as a run rate, I think if you looked in the neighborhood of 27.5%, to 29%, that would be a good rate going forward. There are some timing things, related to our CRA investments in there as well. And unfortunately, those are -- I guess unpredictable at best, when they come through. So if we could stick with that, I think that would be reasonable.

And then lastly, net charge-offs, not only the big one this quarter, but sort of Q1, Q3; we are a little bit up from the previous year. Is there sort of a renewal to kind of clean up older credits? Or how does that affect the loan loss provision? Could we expect more charge-offs, going forward?

Andy, I will let you answer that.

Well, I don't like any charge-off at all, no matter when the loan was originated. But our charge-offs this year were pretty well split evenly between what we call our legacy credit, and then the balance where just sort of -- you would consider to be the normal level of charge-offs that we would have on a recurring basis in this kind of a credit environment. And so I think absent the legacy credit, that's about eight basis points. And that's really not too bad. We are not too disappointed at that level. If we could maintain that level on a good-forward basis, I think that would be more than satisfactory.

We don't have a lot left to clean up. So in answer to your question, I don't think that it would be a matter of cleaning up any other credits that might have been on the books for a long time. Would that be fair, Andy?

Yes. I don't think that we're -- there is no questions -- we are not cleaning house here. When the events happen and we have to take action, we do.

And would you be comfortable saying a range for the loan loss provision on a quarterly basis?

We don't give forward guidance. Sorry.

All right, thanks, guys.

Thank you.

Your next question comes from Aaron Deer with RBC Capital Markets.

Hi, Aaron.

Hi, good afternoon, everyone. Once again, you guys had some pretty strong loan growth in the quarter. I guess there was some -- it looked like maybe some paydowns in the commercial real estate and multi-family but some real strong commercial real estate construction. I wonder if you could give your sense of what's going on in terms of the trends? And what your outlook is for '07 in those portfolios?

Mark?

Yes. Commercial real estate stays very strong in the northwest. We continue to have opportunities through our existing commercial lenders, and of course, the new teams we brought on are creating opportunities for us already. So I would expect that we would see the market to remain reasonably strong through '07. Our focus will be very similar.

I might just mention, too, something that I really feel good about, and that's that these two teams of bankers that we were successful in bringing over -- they sought us out. And I'm really pleased that we -- we're operating at a fairly low loan to deposit ratio, which allows us to bring on teams like this as these opportunities arise.

Okay. And then maybe following up on Matthew Clark's question about capital levels. Absent any deal opportunities, any thoughts on -- increasing the buyback?

Well, we haven't used the buyback. It's in place if we choose to. It's something that we talk about every quarter, what our plans are for our capital. And certainly, we are in very well capitalized right now.

Okay. Thank you.

Thank you.

[OPERATOR INSTRUCTIONS] Your next question comes from Louis Feldman with Punk, Zeigel & Co.

Hi, Lou.

Good afternoon. The distinguished gentleman from Lake Oswego got most of my questions.

Are we getting the leftovers? Is that what you are saying, Lou?

Oh, no, I'm always good at coming up with original questions. Certainly, you made a comment about you wanted to move bankers. So for the two branches that you are looking for this year, these are people that you already have in place?

Yes. We've got -- well, coming on at the very end of last year. So the expense would not necessarily show up in the fourth quarter numbers.

Okay. You continue to seek out other lenders?

We're always looking for new really solid, good bankers. I think that that is one of the challenges in our industry to make sure that we have got a good bench. And I think that Mark is always open-minded. We always ask people that approach us to talk about a business plan and it needs to make financial sense for us as well. Anything you want to add, Mark?

Yes, I would say -- we have a whole network of bankers out there; retail, private banking, commercial bankers, who have contacts throughout the industry. We have not had to go outside and search for people. We have been very fortunate in that we get many opportunities to talk to qualified folks. And if it really matches up with our strategy, we are quick to move on that, Lou.

Okay. You mentioned Lacey. Can I assume Lacey will be one of the two branches?

Yes.

I'm sorry?

I said yes. I'm anxious to get it opened.

Lacey is under construction.

Okay. Any thoughts of expanding [Sheri]'s footprint?

Yes. That's something that Sheri and the Bank of Astoria board are actively discussing.

I mean, would you move further down the coast? Or would they move -- or would they move a little closer to your footprint, as we've joked in the past?

Either way, actually. There are opportunities going in both directions.

Clatskanie is definitely a hopping metropolis. Okay. That's it for me. Thank you.

Thanks, Lou.

At this time, there are no further questions.

Okay. Well thanks, everyone, for joining us. Hopefully we will see you at the annual meeting.

This concludes today's conference call. You may now disconnect.