Columbia Banking System Inc (COLB) 2008 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to Columbia Banking Systems Second Quarter 2008 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 that time. If you should require assistance during the conference, please press *0. As a reminder, this conference is being recorded.

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

Thank you, Michelle. Good afternoon everyone and welcome to Columbia's Second Quarter Conference Call. Joining me on the call today are Gary Schminkey, our Chief Financial Officer, Andy McDonald, Chief Credit Officer, and Mark Nelson, Chief Operating Officer.

Before we begin, I'd like to remind you that we will be making some forward looking statements today, 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 securities filings, and in particular our Form 10-K filed with the SEC for the year 2007.

I'm going to assume that you've all had a chance to read our second quarter press release as well as our July 9 pre-release about the changes in our markets and our intention to increase our loan loss provision. In today's call, we will provide additional clarity and details to the information that we already have provided in these two releases and on our earlier conference call.

Gary Schminkey will discuss with you our second quarter 2008 results, including our equity position, liquidity ratio, and net interest margin. He will be followed by Andy McDonald who will provide you with some additional color related to the allowance for loan losses, our loan MECs and credit quality. We'll then open up the discussion to your questions.

I want to reiterate that while credit challenges are effecting all financial institutions, our underlying banking fundamentals continue to be strong and we remain positive that we have the right strategy in place to manage through this business cycle. As we've monitored the weakness in the national economy during the past year or two, we've often said that we're not immune to the instability in the real estate markets and mortgage related industries.

We've taken proactive steps to identify the scope of the impact on our region and implement the appropriate actions. Our solid core deposits, which consist of checking, savings, and money market accounts, as well as CDs under $100,000 represent 80% of our total deposits and result from strong relationships that our bankers have built with our customers. We will stay the course with our focus on fundamental banking.

As we mentioned in our earnings release, the increase in our loan loss provision was due to a slowing economic environment resulting in an increase in our nonaccrual loans. At this point, I want to take just a minute to discuss with you what we're currently observing in the economy in our market. As you know, until recently our market areas here in the Pacific Northwest, particularly in the Puget Sound region have been outperforming the rest of the country.

In the past few months, however, we have seen housing foreclosures increase as well as double digit declines in both year-over-year housing sales and in sale prices for land and lots. Construction employment has been declining for the past six months or so. The statewide unemployment rate rose to 5.5% in June compared with 5.3% in May. The Seattle area unemployment rate is increasing as well, although it's rising at a considerably slower rate than the rest of the country.

In June, the Seattle Belleview Everett rate remained at 4% from a month earlier, which was up from 3.8% a year ago, but substantially below the state and national rates. There continues to be concern about consumer attitudes as well. According to the Conference Board Consumer Research Center, the Consumer Confidence Index, which had declined in May, declined even further in June. The index now stands at 50.4, down from 58.1 in May. This is the fifth lowest reading ever.

In June, the State of Oregon's Office of Economic Analysis projected a slowing economy for the state in 2008, which will probably continue into the first half of next year with mild growth at the second half of 2008. The outlook for Oregon has been historically similar to that of the United States' business cycle, and the state has also been affected by the weakness in the housing market, a sharp decline in building activity, and the high cost of energy.

However, Oregon's housing market has shown a relatively milder downturn than the rest of the country and shows continued strength in foreign exports. It's also important, though, to note that within the Puget Sound area there are tangible positives. Let me share with you just a few. First, Boeing, Microsoft, and other tech companies are continuing to hire. In fact, Boeing is predicting that it will deliver almost 30,000 jetliners in the next 20 years as global air travel increases, along with the demand for more fuel efficient planes.

Second, Washington State has in migration with people moving here for well paying jobs. And third, Washington is the most export focused state in the union, and not only due to Boeing. Marple's indicated that no state exports a higher share of its output than Washington, more than 2.5 times the national average.

These are important factors that need to be remembered even if we assess today's conditions. The fact is, while there is no doubt that the economy and the nation and the Northwest continues to soften, we still see growth opportunities in all of our Washington and Oregon markets. At Columbia, we're committed to building our company the right way. We are relatively less dependent than our pair banks and more volatile funding sources such as wholesale certificates of deposit.

We have a diversified loan portfolio as well. In addition to commercial real estate lending and consumer lending, we have a healthy 34% of our loans in commercial business loans. We carefully monitor our loan portfolio staying in frequent touch with our customers and taking a proactive approach to any credit problems that may service.

Of course, our business is lending money and we will continue to make prudent loans, taking into account the economic climate and collateral values. Our strong retail system now includes 53 branches in ten counties in Washington and Oregon. We focus our business on our core deposits and maintaining strong relationships with our customers.

As I mentioned earlier, we will stay the course with our focus on fundamental banking, and now I'd like to turn the call over to Gary.

Thanks Melanie. As a reminder, the results for the second quarter and year to date reflect the financial consolidation of Mountain Bank Holding Company and Town Center Bank Corp, which were both acquired on July 23, 2007. The second quarter and year to date 2007 financial information does not include the results of these two organizations.

So comparisons of results requires a more in depth analysis. Yesterday, we announced earnings for the second quarter 2008 of $1.9 million, or $0.11 per diluted share, compared to net income of $8.5 million, or $0.53 per diluted share for the second quarter of 2007.

Columbia has faced the same economic pressures as challenges as the rest of the banking industry. Our challenges remain centered on working through our credit quality issues, persevering our net interest margin, and maintaining our well capitalized designation and our strong liquidity position.

We talked about the bank's fundamentals in our release. Let's review a few of these important points. Columbia's estimated total risk based capital stands at 11.43% up from 10.9% at year end 2007 and 11.07% at March 31, 2008. Our capital ratios are in excess of the regulatory definition of well capitalized of 10%. Should the need for additional capital arise, we would certainly do everything we can to maintain the interests of existing shareholders.

As Melanie mentioned, the board declared a $0.17 dividend for the second quarter. We are very pleased to be able to maintain our dividend for the second quarter and to modestly improve our well capitalized position. Given our current market valuation, the board will review future dividends in light of our higher dividend yield and our payout ratio.

Our liquidity ratio is a measure to track the funds available to meet the loan and deposit needs of our customers, and for the general operations of the company. Our excess liquidity is about 28% or $890 million. This liquidity comes from the bank's investment portfolio, our borrowing line at the FHLB of Seattle, the Federal Reserve Bank, repurchase agreements, and wholesale funding sources.

You may have noticed that we included a section in the press release for core earnings. We removed the gains on sales of Visa and MasterCard common stock, and proceeds from life insurance received in the second quarter. Removing these items produced an operating or core earnings number for the quarter of $854,000 or $0.05 per diluted share, as compared to $8.5 million, or $0.53 per diluted share last year at this time.

The tax equivalent net interest margin for the second quarter was 4.39% as compared to 4.36% one year ago. Despite the 300 basis points decline in short term rates since December 2007, including 200 basis points in the first quarter of 2008, the core net interest margin was up 10 basis points from 4.29% in the fourth quarter of 2007 and up 1 basis point from the first quarter of 2008.

As you may recall, over 40% of our loans are tied to the crime rate or other short term indices. The reduction in interest income was more than offset by repricing our less rate sensitive core deposits, as well as taking advantage of funding opportunities as we saw a disruption in the market.

Average asset yields have decreased to 6.31% or 92 basis points quarter over quarter. Average interest bearing liability costs have decreased to 2.43% or 119 basis points quarter over quarter. We expect the pressure on our earnings to continue as we manage our loan growth and competition for low cost deposits continues.

Interest income reversals for the second quarter were $335,000 net of recovery. This negatively impacted the net interest margin by four basis points, producing a core net interest margin of 4.43% for the second quarter 2008. Nonperforming assets entered the quarter at 2.28% of total assets as compared to 0.46% in year end 2007. The provision for loan losses was $15.4 million for the second quarter 2008 versus $329,000 for the same period in 2007.

Looking ahead, we anticipate the provision for loan losses to be at elevated levels in relation to prior periods. Our loans ended the quarter at $2.3 billion, down slightly from year end 2007. Our commercial business loans totals are unchanged from December. Commercial real estate loan totals are down $23 million due to loan payoffs, while consumer lending is up $19 million.

Our commercial construction loans have declined by $8.5 million and residential construction has increased $12.7 million as we fund our commitments, all compared to year end 2007. We continue to report a well diversified loan portfolio. Return on average equity for the second quarter of this year was 2.2% compared to 13% for the second quarter 2007.

Removing the effect of our acquisitions, tangible return on equity was 3.6% for the second quarter 2008 as compared to 15% for the same period in 2007. Our efficiency ratio was 59.3% for the second quarter 2008 compared to 60% during the same period last year. We are encouraged to report an efficiency ratio below 60%, especially since interest rates have declined so dramatically since December of 2007.

We will continue to work toward achieving a ratio in the mid-50s, but we expect additional expenses going forward as we maintain expected real estate owned, and work our way through problem credits. Non-interest expense grew by $3.1 million for the second quarter 2008 over the same period last year. Compensation costs accounted for roughly $1.5 million of that total.

While it is difficult to compare period to period due to the 2007 acquisitions, as a percentage of gross revenue, core non-interest expense was 43.3% of gross revenue as compared to 41.8% for the first six months of 2008 and 2007 respectively.

This increase is mainly a function of the decline in interest rates over the last nine months, the additions of two branches in the fourth quarter of 2007, and the addition of a professional banking team during the second half of 2007. We continue to closely monitor and control expenses and will undertake many initiatives in 2008 to reduce overall expense growth while maintaining our commitment to customer service, and our overall strategic plan.

Some of these initiatives involve working to improve our internal partnerships, market penetration, and cross selling capability of our retail banking and commercial banking groups. Another example is to improve our technological capabilities to deliver our services utilizing new and more efficient practices.

Our federal income was a $1.1 million benefit in the second quarter as compared to a rate of 27.8% for the second quarter of last year. The tax rate is influenced by tax credit, municipal security earnings, and various CRA programs. As we move to a more normal earnings pattern, we expect the tax rate to be between 27% to 28% of pre-tax income.

At this point, I'd like to turn the call over to Andy McDonald, our Chief Credit Officer. Andy?

Thanks, Gary. To reiterate some of the things that Melanie mentioned. While it is certainly true that all financial institutions in the Pacific Northwest are facing some of the same challenges that we are, it's equally true that Columbia's lower level of construction lending versus some of our peers, puts us in a relatively better position than most.

As Melanie mentioned, our increased provision for the quarter is a prudent step by management. This action will increase our total allowance for loan losses to about 1.83% of net loans at the end of the quarter. Net charge offs for the quarter were approximately $1.6 million compared with $761,000 for the first quarter of 2008.

We also reported that nonaccruals totaled about $72 million as of the end of June compared with nonaccruals of $14.4 million at the end of March 2008. Today our challenges have been centered in our for sale housing portfolio, which has been impacted by the 30% decline in housing sales across most of our footprint.

We have also seen modest declines in the sale prices which are down 6% year-over-year. Some of the data, though, is encouraging, and in June we saw inventory levels drop to around seven months in King County, Washington, eight months in Pierce County, Washington, and 9.5 months in the Metro Portland area.

The weakest segment, though, continues to be lots and land where we have seen values decline between 10% to 30% due to a lack of available financing. As a result of this weakness, we have placed over $29 million of performing, for sale housing loans on nonaccrual. Furthermore, after evaluating the collateral which secures these loans, we allocated $7 million in specific reserves, which we feel is prudent to set aside at this time.

We have been diligent in our efforts to reduce our exposure in the for sale housing segment, and in this regard we have made progress. As you can see in the numbers, our exposure to the for sale housing segment is essentially unchanged from the prior quarter at around $282 million in loans. However, our unfunded exposure has declined a little over $42 million since December 31, 2008 and now stands around $32 million as of June 30, 2008.

I would also like to mention that since quarter end we have had another $4 million in vertical construction loans pay off, and we were able to reduce our A&D commitments by another $5 million, most of which was centered in one credit, which I will talk a bit about later. I can also tell you that we had another $21 million of our commercial construction book convert to performing term loans this month with acceptable loan to values and debt service coverage ratios, furthering reducing our overall exposure to construction related loans.

As I discussed in our conference call a few weeks ago, the distribution of our for sale housing portfolio is as follows. Approximately 34% is located in Pierce County, Washington and 30% is located in King County, Washington. In total, we have about 80% of our for sale housing portfolio in Washington State. The Pierce County market can be further segregated into acquisition and development loans, which makes up about 40% of our exposure in that county, while vertical construction loans account for about 28%, lot loans at 20% and land at 7%.

Most of the loans we have placed on nonaccrual related to the for sale housing portfolio in Pierce County. In total, we have placed 30% of this market on nonaccrual. King County can be divided into vertical construction at 60%, lots at 17%, acquisition and development is also around 17% and land at 6%. King County continues to perform better than Pierce County, however we have placed about 8% of our King County for sale housing loans on nonaccrual.

The remaining 20% of our for sale housing portfolio is in Oregon, primarily in a three county area, Clackamas, Washington, and Multnomah, which collectively make up 15% of this portfolio. This three county area can be broken down as follows, acquisition and development loans at 38%, vertical construction loans at 43%, lot loans at 12% and land at 6%. We have placed approximately 28% of this portfolio on nonaccrual as of June 30.

Concerning past dues for the quarter, as you will see in our call report detail, we had approximately $21 million in past due loans as of June 30, 2008, up from $15 million as of March 31, 2008. Approximately $8 million was centered in one credit, an acquisition and development deal. I'm pleased to tell you that as of today, the loan is again current and the borrower paid down the loan to a conforming advance rate after a reappraisal indicated a decline in value since origination.

The borrower also recharged the interest reserve for the life of the loan. In total, the commitment was reduced by $3.5 million and the loan was paid down by $2.7 million during the first week of July. Obviously, this is one of our strongest borrowers and the delay was a result of issues surrounding redocumenting the loan.

Some of the steps we have taken to address the weakness we have seen in our for sale housing portfolio include increased staffing levels in our special credits department, the engagement of outside advisors to assist us in determining the best course of action for each individual project and borrower, as well as constantly reassessing our collateral position.

Again, we believe we have assembled a strong team of in-house professionals and outside advisors to help us work through these issues. We continue to review our for sale housing portfolio on a monthly basis and we are constantly monitoring the market for updated information, not only as it pertains to the projects we have financed, but also the projects which our borrowers are involved in and how it may impact their overall performance.

We know we must remain diligent in our efforts in managing the for sale housing portfolio and we are not shy about devoting the necessary resources needed to deal with the challenges ahead. We believe that these risk management strategies and actions are prudent steps for Columbia. We will continue to focus intently on any and all potential credit issues within our portfolio. I would like to remind everyone that total construction lending comprises less than 20% of our entire portfolio.

More specifically, the for sale housing component comprises about 13%. The balance of our loan portfolio which makes up 80% of what we do is exhibiting acceptable levels of nonaccruals and past due loans as of June 30, 2008. Nevertheless, we are continually monitoring closely the entire loan portfolio for any signs of weakness caused by a slowing economy and declining consumer confidence.

Thanks, Andy. To sum up our comments this afternoon, we believe an underlying strength in Columbia and have confidence in the actions we've taken to ride out the current economic cycle. We have the right people, and the right risk management practices, and monitoring systems in place, and continue to take proactive steps to address our challenges.

We have a diversified loan portfolio and a strong core deposit base as a result of the customer relationships Columbia Bankers have built over the past 15 years. As Gary mentioned, we're well capitalized and have multiple sources of liquidity. Our strategy as always is to make decisions that will benefit our shareholders, our customers, and our employees for the long term.

I'd like to take this opportunity to congratulate our superb team of bankers who are the foundation of our success and give me great confidence in our future. We're very proud of what we've achieved in our 15 year history. This concludes our prepared comments. Before we open the call for our questions, I'll remind you that Gary Schminkey, Chief Financial Officer, Andy McDonald, Chief Credit Officer, and Mark Nelson, Chief Operating Officer are with me to answer your questions.

And now, Michelle, if you'll open up the call for questions.

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Aaron Deer.

Hi, Aaron.

Hi, Melanie. Hi Gary, Hi Andy. I guess if you could, I missed some of your prepared comments, so maybe you commented on this. But can you talk a little bit about what's behind the balance sheet shrinkage on the loan side, the deposit side, and if you're kind of intentionally reducing originations given the environment.

I'll ask Mark Nelson, our Chief Operating Officer, to answer that one, Aaron.

Hi, Aaron. Well, yes it is intentional when we're starting to talk on the asset side. We're focusing clearly on making sure our pricing is right on anything new that we do. We're focusing heavily on relationship based commercial real estate, not speculative construction type projects. We're seeing a lot of irrational pricing in the marketplace today, and we have just decided to take that kind of business out of our pipeline and be much more conservative.

On the deposit side, as we've mentioned in previous conferences our deposits tend to be very seasonal, and in first quarter we see a run out of business deposits primarily early in the quarter. With year end payments, we tend to see the same thing again in April and early May. Tax payments drive that largely. We had a pretty good number at the end of March. We were only $7 million off of that all in core deposits at the end of June, and actually after the big run out in April we saw a really good build up back by the end of June.

And so we feel that's very consistent with our seasonal patterns that we've seen in previous years.

Okay, that's helpful. And then I was surprised to see the resilience in the margin I guess for a couple of reasons. One is just given at least some of the modest asset sensitivity they have, and given where rates have gone. But also because I expected to see greater interest reversals than the $335,000 that you mentioned.

At what point do you trigger an interest reversal? Because I would have thought that with the nonaccruals that you had, that that number would have been higher?

Aaron, the interest reversal was actually a little bit higher than that, but we had one credit that actually came back in as an accruing loan. So we talked about the interest reversals being netted. So the total interest reversal was $578,000 for the quarter, but we brought back in a non-accruing loan, which added back $243,000 to earnings.

But typically what we do is we'll reverse interest going back to the last payment that was made.

And Aaron, about half of what we put into nonaccruals were performing loans. So we would not have had interest reversals on those.

No, I understand. Okay, that's great. Thank you.

Your next question comes from the line of Matthew Clark.

Hi, Matt.

Hey, guys. Hey, Andy, would you mind just maybe giving us on a dollar basis the breakdown of the construction book, including the commercial construction buckets. I have a lot of the percentages, but I just want to make sure I capture everything. So if we kind of think about the four categories in for sale, and then the other four in commercial.

Well, the for sale category is broken out and that's about $282 million. And then income property loans are roughly $74 million. Then you've got condos that are roughly $32 million and then we have owner occupied construction, which is around, say, $51 million. So those are kind of the rough numbers that break out that four categories.

Sounds good. I might follow up with you on that, though, still. And in terms of -- can you give us some visibility as to what might be behind, we heard your delinquency number, but can you give us -- do you want to try to size up maybe what your watch list is, or even your stuff that's substandard?

Well, we generally don't give that guidance because there's as much art as there is, I guess, science to that number. And I always kind of say that my substandard asset is somebody else's pass. And that certainly is the case when they pay me off. So I'm not really sure it's a good number for comparison across banks.

Okay, and can you give us -- I'm assuming when you update appraisals here and you're probably discounting them in many cases, can you give us a sense of your appetite to hold these problem assets, and whether or not you're considering maybe a liquidation value in some cases or not, or you think that you can get rid of this stuff more orderly?

Well, I think that we look at each project specifically, and certainly as we work through these issues with our borrowers, there will be certain cases where disposing of the asset in a more timely fashion will make better sense for us. But certainly given where the market is, there may be other assets that will take us a longer period of time to work out.

And that's one of the reasons that we've engaged some advisors to really help us make some of those decisions by providing us with deeper analysis from a real strong real estate developer's perspective, as opposed to just a banker's perspective. So that we are making sure that if we do decide to take a longer term approach, that we really selected the right asset to do that with.

But we're still in the midst of going through all of that analysis, and so I don't really have anything more than that for you right now.

And Gary, the impact from the gain on the sale of loan floors this quarter on a basis point impact, what was that? And then I guess just remind us what your expectations are for the third and fourth?

I'm remembering off the top of my head, Matt. I can get that number for the floors, but I believe we're at 1.7 in the first quarter, and I think it went up to 2.6 in the second. But I'll have to confirm that.

I think I have those numbers anyway. Thank you.

Your next question comes from the line of Joe Morford.

Hi, Joe.

Thanks. Good afternoon, everyone. I guess the first question is just a follow up on the credit. You gave the total delinquency number I think was $21 million or so of past dues. Can you break that out between the 30 to 89 day bucket and the 90 day bucket?

All of our past due loans are 30 to 90. Anything over 90, we put on nonaccrual.

And I guess the other question is just on expenses. The comp line was down maybe $1 million sequentially from the first quarter. Was that just seasonal stuff, or was there any bonus reversals, or anything like that? And just in general, what should we be expecting in terms of cost control going forward?

Joe, on the comp line we did have some true ups in the second quarter. At the end of each quarter we true up our medical cost, and we did that in the second quarter as well. So that was about almost $500,000 and then I think we also -- we trued up incentive accruals for the year based on the current environment.

And we also had two branch consolidations during the quarter as well that improved the comp line.

Any thoughts just on general expense management going forward given the environment?

Well, we mentioned that we anticipate having increased expenses just to manage to our problem credit, as we talked about. But we do have many expense initiatives in place that we continue to work on. We've been working on several over the last several months and we continually add others as we move along.

But yes, that's always been a factor for us.

It's been a little bit masked, our efforts, because of the two acquisitions that we did last year, but we have several initiatives that we're well down the road on. They're long term in perspective so we're still a growth organization, have a lot of things that we want to accomplish and that does require making investments from time to time.

Thanks so much, Melanie and Gary.

Your next question comes from the line of Jeff Rulis.

Hi, Jeff.

Hi, good afternoon. Andy, could you repeat the NPA reductions that came after quarter end that you stated?

I didn't give NPA reductions, I gave instruction loan reductions.

Okay, I must have missed that.

And just to make sure I say the same thing twice, I got to find my point in the script where I covered that.

It was in total about $30 million or so?

Well, we had a little over $20 million in income property loans convert to term loans, as they were scheduled to do, and we had about $4 million of vertical construction loans pay off. And then we had the $3.5 million reduction in A&D or commitments, and that was about a $2.5 million, I believe, pay down in dollar totals. But I can't find that place in the script, but that's pretty close. And that adds up to about your number.

All right, great, and then the capital level you stated, Gary, was that the holding company or bank?

That's the consolidated capital.

Okay, do you have a bank level number?

Not yet. Well, I do have that, but I don't have it in front of me, unfortunately. But it's typically, roughly the same. We have some funds available up in parent that we can downstream to the bank should that be needed.

And I was also a little surprised about the margins that held up. Is there any sort of lag effect of interest reversals, or is that immediate and it would all be in Q2? In other words, would you expect any sort of margin impact in Q3 on stuff that went in, in Q2?

Well, the nonaccruals that are not performing, of course, would be for the full quarter. Of course that doesn't account for the loans that are performing, and I guess to answer an earlier question from Matt, if you don't mind, I just have the number that was included in Q2 for the floors, and that was about $468,000. We have $1.75 million that will be amortized to income from the floors for '08, $2.6 million that will be amortized in '09 into the margin.

But other than that, the margin is essentially a function of how well, as I said, our pricing committee has done a terrific job in repricing our core deposits and taking advantage of our strong deposit base. And also we've done some things from the treasury side to lock in some rates in the first quarter.

And then lastly, have you had a safety and soundness exam recently or have scheduled one?

We don't have one scheduled. We anticipate that there will be one in the fall.

Thank you.

Your next question comes from the line of Matthew Clark.

Hi guys, again. Just a point of clarification, Andy. The $7 million of specific reserves that you've set aside, is that for the total for sale portfolio? Or is it for all the nonaccruals?

The specific reserves are detailed -- there's more detail in the prior conference call, but the majority of it is for the for sale housing portfolio. And then we have about $1.5 million that we've set aside for our condos.

And not set aside for the $29 million that's still performing?

No, some of those reserves have been set aside for loans that are still performing.

Okay, so it could include that. And then can you give us a sense for why that $29 million is still performing? Is it just because they're on interest reserves? Is that all, really?

Yes, about a third are on interest reserves and then the rest are still being paid current, but we don't believe that that will continue to be the case.

Thank you.

(OPERATOR INSTRUCTIONS) Okay, there are no further questions.

Okay, well thank you all very much for joining us. We'll talk to you next quarter.

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

Thank you, Michelle.